This paper analyzes the role of industrial structure, currency risk and country factors on country returns and their impact on international diversification strategies in the G7 countries over the past 30 years. We introduce a new test to compare the relative efficiency of different portfolios, which may be used to make a direct comparison between country, global industry, amd ICAPM based portfolios. Both unconditional and conditional efficiency tests yield indistinguishable country and industry Sharpe ratios. Still, further gains can be achieved by considering dynamic ICAPM motivated portfolios that explicitly include currency deposits. Whereas the annual no-short sales country and industry portfolios Sharpe ratios are 0.70 and 0.80 respectively, dynamic ICAPM portfolios have a considerably higher Sharpe ratio of 1.46. Style analysis shows that a larger part of industry return variation is explained by country factors than vice versa and that the domestic component of global industries is crucial for their ability to mimic country returns. However ICAPM portfolios excel in replicating country and industry returns. We find that while country-based strategies perform at least as well as industry-based strategies, the full benefits of international portfolio strategies can be achieved only by explicitly including currency assets.

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