Global diversification is an integral strategy of a well-built portfolio.It is even more important to make sure that diversification is done right.

Australia is classified as a developed economy and its main stock market index the Australian All Ordinaries Index is part of the MSCI World Index. In contrast South Africa is considered as an emerging market and its main index the All Share Index is included in the MSCI Emerging Market Index.

However the developed market of Australia is highly correlated with emerging market of South Africa. This is because the economy of both these countries are natural-resources based. So investing in these two markets at the same time would not offer the diversification desired by an investor.The following charts proves this point.

Returns of Australia’s  All Ordinaries Index Vs. South Africa’s All Share Index:

The graph shows that both the markets track each other almost consistently. Australia has been more volatile but offered better returns especially during the commodity boom from 2003 and 2007.

Correlation between South Africa and Australia:

Source: http://www.equinox.co.za

The table above shows that the Australian All Ordinaries and the South African All Share Index are quite highly correlated to one another.The Australian index has a higher correlation to the MSCI World index than the All Share Index. However both the indices have the same correlation to the MSCI Emerging Market index, which is interesting.

ETFs Performance:

The chart below shows the 5-year performance of the iShares MSCI Australia Index fund (EWA) and the iShares MSCI South Africa Index fund (EZA).

Based on the above analysis it is clear that when choosing different markets for diversification purposes one must choose the right countries.