Improving the Odds: The Impact of Diversification on the Distribution of Excess Returns
Diversification and rebalancing form the cornerstone of Parametric’s Emerging Markets Strategy. The strategy provides greater country-level diversification by underweighting larger countries, overweighting smaller ones, and systematically rebalancing to maintain this greater level of diversification. We expect that a diversified portfolio should outperform a concentrated benchmark in the emerging markets for a number of reasons, including the harvesting of a rebalancing premium, the historical tendency of smaller countries to outperform larger countries, and improved downside protection characteristics.
That said, as the MSCI Emerging Markets Index has become increasingly concentrated at the country level, we’ve fielded a growing number of questions about our desire to maintain country-level diversification—even if it means underweighting the largest countries. To answer these questions, it’s important to revisit one of the core reasons we diversify.