Diversification unbound:

Gaining international exposure with closed-end funds

2018
Key points

• Diversifying internationally gives investors

the freedom and flexibility to access a
broader range of opportunities and be
selective in investing among regions.
• Closed-end funds offer a professionally
managed solution that promotes long-
term investing and a variety of approaches
to diversification, from global to specific
regions or countries.
• Ways to diversify include adding an
allocation to a specific country or using
both region- and country-specific funds to
develop an appropriate allocation that is
tailored to investors’ individual needs.

Great Wall of China

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Expanding opportunities for diversification1
A world of choices
We live in an era of unprecedented choice. For example, between 1975
and 2015, the average number of items in a supermarket ballooned
from an average of 8,948 to 40,000 to 50,000, according to the Food
Marketing Institute, a trade group. Investment options have followed suit;
where investors may have seen just a few readily available opportunities
to diversify internationally 40 years ago, there are now thousands of ways
to achieve this objective in a portfolio.
However, the majority of investors don’t seem to recognize the
benefits of investing outside their home country. A recent survey by the
International Monetary Fund (IMF) showed that U.S. investors allocated
more than 70% of their equity assets to the U.S., despite the fact that
the U.S. represents less than 50% of overall global market capitalization.2
Yet home bias can mean missing out on a wider range of investment
opportunities that may have the potential for strong returns.
If one asset class has negative performance, another asset class with
low correlation to the first asset class wouldn’t have the same degree
of negative performance or, in the case of negative correlation, would
experience positive returns. MPT suggests that enhancing portfolio
diversification with a mix of asset classes with low, negative or no
correlation to one another should help increase returns on a risk-adjusted
basis.3 Since global market correlations have been moving lower recently
(as shown in Chart 1), and many asset classes have low or negative
correlations to one another, international diversification makes sense.
Chart 1: Global equity market correlations
Rolling 1-year correlations, 30 countries
0.8
0.7

Diversifying internationally gives investors the freedom and flexibility

to access a broader range of opportunities and be selective in investing 0.6
should some regions not seem as attractive as others. Additionally, lower
correlations among certain asset classes can help reduce portfolio volatility. 0.5
We believe that, when diversification is unbound, possibilities abound.
In this paper, we will look at the reasons investors should consider 0.4
diversifying beyond their backyard and the many ways that closed-end May 2017:
funds can help meet this objective. 0.41
0.3

What do we mean by diversification?

0.2
The term “diversification” seems to be thrown around a lot when it comes
to investing. But what exactly are we referring to? According to modern
0.1
portfolio theory (MPT), the risk of investment loss can be diversified away to
‘97 ‘99 ‘01 ‘03 ‘05 ‘07 ‘09 ‘11 ‘13 ‘15 ‘17
a certain extent by constructing a portfolio with asset classes that have low
correlations to one another, or that move differently in relation to another. Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. For
illustrative purposes only. All return values are MSCI Gross Index (official) data.
Table 1 on the following page lists correlations between various asset Chart is for illustrative purposes only. PAST PERFORMANCE IS NOT INDICATIVE
classes, regions and countries. OF FUTURE RESULTS. Please see disclosure page for index definitions. Countries
included in global correlations include Argentina, South Africa, Japan, UK, Canada,
Correlations are measured in a range from -1.0 to 1.0. A correlation of 1.0 France, Germany, Italy, Australia, Austria, Brazil, China, Colombia, Denmark, Finland,
means that assets move in lock-step with one another; when one asset Hong Kong, India, Malaysia, Mexico, the Netherlands, New Zealand, Peru, Philippines,
Portugal, Korea, Spain, Taiwan, Thailand, Turkey, United States. Guide to the Markets
moves up or down, the other asset would move proportionately in the –U.S.Data are as of May 31, 2017.
same direction. Similarly, for a correlation of -1.0, the two asset classes
would move in opposite directions in some constant of proportionality
to one another. A correlation of zero would mean that the relationship
between the movements of two asset classes cannot be predicted. We believe that, when diversification is unbound,
possibilities abound.

1
Diversification does not ensure a profit or protect against a loss in a declining market.
2
International Monetary Fund, “Coordinated Portfolio Investment Survey,” June 2016.
3
Ross, Sean. “How is correlation used in modern portfolio theory?” Investopedia, March 5, 2015.

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You can’t go home again Additionally, investing outside of your home country can provide
At first glance, investors may have reservations about investing outside of exposure to economies experiencing faster growth, such as those in China
their home country, especially if they live in the U.S. After all, the U.S. is and India. During the global financial crisis in 2008, the U.S. economy
one of the most diverse markets in the world, has experienced moderate contracted and then recovered, and continues to maintain a modest
economic growth, and represents a large share of what’s available in the level of growth. On the other hand, the Chinese and Indian economies
global market. But investing in only one country can still be limiting. continued to grow during this time and are currently experiencing a much
faster pace of growth as noted in Chart 3 below.
As you can see in Chart 2 below, each region has a different concentration
of certain sectors of the global equity market. Choosing not to invest Chart 3: Economic growth in China, India and the U.S.
outside of one’s own home country can mean missing out on some of the
18
current and future leaders in various industries.
16
Chart 2: Sector exposure varies across regions 14
30

GDP Growth (% change)

12

10
Percentage of sector exposure

25
8
20
6
15 4

2
10
0
5
-2
0 -4
Basic Materials

Communication
Services

Healthcare

Industrials

Real Estate

Technology

Energy

Financial
Services

Utilities
Consumer
Cyclical
Consumer
Defensive

1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020E
2022E
China India United States
Source: Morningstar Direct, December 31, 2017. Projections are offered as opinion and
are not reflective of potential performance. Projections are not guaranteed and actual
MSCI USA MSCI Europe MSCI AC Asia Pacific events or results may differ materially. For illustrative purposes only.
MSCI EM MSCI World ex USA MSCI World
Source: Morningstar Direct, December 31, 2017. For illustrative purposes only. Indexes
are unmanaged and have been provided for comparison purposes only. No fees or
expenses are reflected. You cannot invest directly in an index.

Table 1: Correlations among regions

MSCI EM
MSCI AC MSCI Latin
MSCI MSCI Asia World ex MSCI MSCI MSCI MSCI MSCI America MSCI MSCI MSCI MSCI
USA Europe Pacific MSCI EM USA World India China Japan Israel 10-40 Singapore Indonesia Chile Australia
MSCI USA 1.00
MSCI Europe 0.85 1.00
MSCI AC Asia Pacific 0.75 0.77 1.00
MSCI EM 0.76 0.81 0.88 1.00
MSCI World ex USA 0.86 0.96 0.91 0.91 1.00
MSCI World 0.96 0.95 0.85 0.84 0.96 1.00
MSCI India 0.51 0.59 0.69 0.73 0.67 0.60 1.00
MSCI China 0.56 0.55 0.70 0.75 0.65 0.60 0.46 1.00
MSCI Japan 0.59 0.60 0.89 0.63 0.73 0.69 0.51 0.47 1.00
MSCI Israel 0.55 0.55 0.48 0.55 0.57 0.58 0.45 0.31 0.37 1.00
MSCI EM Latin America 10-40 0.69 0.74 0.75 0.90 0.83 0.77 0.60 0.62 0.52 0.49 1.00
MSCI Singapore 0.69 0.70 0.77 0.82 0.78 0.75 0.60 0.67 0.54 0.44 0.72 1.00
MSCI Indonesia GR US 0.45 0.46 0.55 0.60 0.53 0.49 0.47 0.44 0.38 0.30 0.50 0.63 1.00
MSCI Chile 0.55 0.60 0.61 0.73 0.66 0.61 0.54 0.50 0.40 0.40 0.75 0.59 0.42 1.00
MSCI Australia 0.74 0.80 0.83 0.84 0.87 0.82 0.60 0.63 0.59 0.52 0.77 0.74 0.52 0.61 1.00
Source: Morningstar Direct, December 31, 2017.

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Finding a good value Chart 4: Dividend yields across various regions
4.0
A common piece of advice for investors is to buy low and sell high with an
aim to maximize returns. Valuations can help determine whether an asset
3.5
class or region is relatively expensive or cheap within the current market
environment. Because of its strong stock market performance over the past 3.0
several years, the U.S. equity market is looking expensive relative to other
areas of the world, as shown in Table 2 below. Diversifying into less expensive 2.5

Dividend yield (%)

regions can help investors toward achieving their return objectives.
Table 2: Valuations for the U.S. equity market have become more expensive 2.0
Trailing P/Book World Europe USA EM
1.5
Current 2.4x 1.9x 3.2x 1.7x
5 year average 2.1x 1.8x 2.8x 1.5x
1.0
10 year average 2.0x 1.7x 2.5x 1.7x
Max since Jan 98 4.2x 4.3x 5.8x 3.0x 0.5
Min since Jan 98 1.2x 1.1x 1.5x 0.9x
Date of high since Jan 98 Dec-99 Mar-00 Dec-99 7-Oct 0.0
Date of low since Jan 98 9-Feb 9-Feb 9-Feb Aug-98 MSCI USA MSCI MSCI AC MSCI EM MSCI World MSCI World
Europe Asia Pacific ex USA
Current Premium/Discount to
5Y average 10.90% 7.60% 15.60% 13.90% Source: Morningstar Direct, December 31, 2017. For illustrative purposes only.
10Y average 20.70% 13.40% 29.30% 1.50%
Source: RIMES, MSCI, Morgan Stanley Research, data as of December 31, 2017. A shortage of psychics
Regions are represented by their respective MSCI indexes. For illustrative purposes only. We would all appreciate having the ability to see clearly into the future,
but unfortunately none of us has a crystal ball. The U.S. equity market has
Dividends make a difference performed well for the past several years, but it’s uncertain how long this
While some investors might not give a second thought to whether or not trend can continue. We can’t predict the next geopolitical hotspot or the
a stock they invest in pays a dividend, studies have shown that dividend- next international success story, so it gives us even more of a reason to
paying stocks have historically outperformed those that don’t. Currently, make sure our investments are diversified.
the U.S. market has a dividend yield of around 2%, while other countries Chart 5 on the following page shows the medium- and long-term
such as Spain, Australia and the UK all have dividend yields exceeding performance of various regions of the globe. Top performers and
3%.3 This can make a significant difference in the compounding of underperformers change all the time. By breaking free of the limitations
returns and how quickly investments grow over time. Chart 4 compares of investing solely in domestic equities, and instead investing across a
various regions and their dividend yields. Choosing to diversify among broad range of industries and locales, there is a better chance that you
international stocks allows investors an opportunity to generate income can capitalize on the most attractive opportunities worldwide.
and potentially achieve greater returns.

We would all appreciate having the ability to see

clearly into the future, but unfortunately none of
us has a crystal ball.

3
Moore, Simon. “Five Ways to Protect Your Stock Portfolio.” Forbes, June 7, 2017.

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Chart 5: Trailing performance of domestic and international equities Chart 6: Average monthly premiums and discounts* for closed-end
40 fund peer group, January 2015-December 2017
-2
35

30 -4
Trailing performance (%)

25

-6
20

15
-8
10

5 -10

0
1 Year 3 Years 5 Years 10 Years 15 Years
-12
MSCI USA MSCI Europe MSCI AC Asia Pacific
Jan-15

May-15
Jun-15
Jul-15
Aug-15
Sep-15

Jan-16

May-16
Jun-16
Jul-16
Aug-16
Sep-16

Jan-17

May-17
Jun-17
Jul-17
Aug-17
Sep-17
Nov-15

Nov-16

Nov-17
Oct-15

Oct-16

Oct-17
Feb-15

Feb-16

Feb-17
Mar-15
Apr-15

Mar-16
Apr-16

Mar-17
Apr-17
Dec-15

Dec-16

Dec-17
MSCI EM MSCI World ex USA MSCI World
Source: Morningstar Direct, December 31, 2017. For illustrative purposes only.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS. Performance of Source: Morningstar Direct, December 31, 2017. For illustrative purposes only. Peer
the indexes above is not necessarily indicative of the performance of any Aberdeen product. group is Morningstar US Closed-End Funds.*Data definition: The monthly premium/
discount from its NAV at the closing price.

Open possibilities with closed-end funds
One way to efficiently gain international diversification within a portfolio
is through using closed-end funds. Closed-end funds issue a fixed number
of shares, meaning that the managers of these funds have a stable pool of
capital to use when investing for the long term, even when redemptions
occur. With a stable level of assets to work with, closed-end funds can
remain fully invested in less liquid markets over market cycles. And because
of their unique structure, these funds are suitable for a high-conviction
investment strategy that aims to diversify internationally and ride out
short-term market dislocations while maintaining a focus on the long term.
Another benefit to using this unique vehicle is that closed-end funds can
also trade either at a premium or a discount to net asset value (NAV) or
their underlying portfolio. When a fund trades at a discount, investors
can buy shares at a lower price while gaining exposure to international
investments and actively managed strategies. Conversely, when CEFs
trade at a premium, investors will have to buy at a higher price. In a
recent Closed-end Fund Association survey, 88% of respondents said
the discount associated with a closed-end fund was a deciding factor in
whether or not to invest in a fund.4
Premiums and discounts tend to vary throughout the year (see Chart 6
above) because prices are established by the competitive markets. This
reflects supply and demand for closed-end funds in the current market
environment. Price differences are influenced by investor perceptions,
fears and needs for specific types of investments, among other factors,
according to the Closed-end Fund Association.
While closed-end funds can help investors manage risk, changes in
exchange rates and other risks will also affect the investments. Therefore,
closed-end funds should be used as part of a larger portfolio that is
broadly diversified.
This is also relevant when it comes to evaluating the other unique
capabilities of closed-end funds. Because closed-end funds trade on
stock exchanges, there must be both a buyer and a seller for a trade to
occur, which can make it more challenging to buy or sell a fund in certain
market environments. Investors might also need to pay a premium on a
closed-end fund, which would result in purchasing shares at a price that
exceeds a fund’s NAV.
Additionally, higher volatility can occur when a closed-end fund uses
leverage. Such factors should be examined before investing, keeping
in mind that closed-end funds are best-suited for long-term investors
looking for exposure to specific areas of the world, whether they are
specific countries or broader regions.
Closed-end funds can help investors
efficiently gain international diversification
over the long term.

4
Source: Closed End Fund Center

06 of 08
Conclusion

International diversification can benefit

investors and their portfolios over the long
term, provided that investors are willing to
look beyond their home turf to discover the
new opportunities offered through
international investing. Not only can an
allocation to investments outside one’s home
country provide a wider range of investment
opportunities, but it can also offer the
potential for greater returns with lower
volatility for the portfolio overall.
Closed-end funds can help long-term
investors achieve greater diversification while
gaining the benefits of an actively managed
approach. Ways to diversify include adding an
allocation to a specific country or using both
region- and country-specific funds to develop
an appropriate allocation that is tailored to
their individual needs. Ultimately, there is a
world of possibilities when diversification is
unbound, and few limits to the possibilities
that are available when investors are free to
invest in all parts of the globe.

Taj Mahal

07 of 08
Aberdeen closed-end funds Open your world.
Aberdeen Asset Management Inc. is a wholly-owned U.S. subsidiary To learn more about Aberdeen Closed-End Funds
of Aberdeen Asset Management PLC, one of the world’s largest asset
managers. We know the global markets from a local level upwards, Visit:

drawing on more than 2,700 staff members, across 39 offices in 26 Aberdeen Closed-End Fund Center
countries as of March 31, 2017. We invest globally, and follow a cef.aberdeen-asset.us/
predominately long only, active management strategy - we do not
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We package our skills to offer a suite of U.S. closed-end funds that Aberdeen Closed-End Fund TV
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IMPORTANT INFORMATION
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.
Diversification does not ensure a profit or protect against a loss in a declining market.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment),
credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations
earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as
anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic
risks. These risks are enhanced in emerging markets countries.
Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund’s investment return and principal value will fluctuate so that an investor’s
shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund’s
portfolio. The Net Asset Value (NAV) is the value of an entity’s assets less the value of its liabilities. The Market Price is the current price at which an asset can be bought or sold.
There is no assurance that the Fund will achieve its investment objective.
The above is for informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. Aberdeen Asset
Management (AAM) does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for
errors or omissions in such information and materials.
Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries,
markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make his/her own assessment of the relevance,
accuracy and adequacy of the information contained in this document, and make such independent investigations, as he/ she may consider necessary or appropriate for the
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