Of all the investment errors which experts are likely to offer homilies on, home bias is one of the most common. Currently, however, there may be a case for indulging this most natural of foibles to a degree.
Home bias is the tendency for investors to allocate a large proportion of their portfolio to domestic equities which is, of course, the enemy of the diversification across markets we should seek. The reasons behind this pattern (which is seen all over the world when investors act without professional guidance) are many.
Historically, home bias owed a lot to the fact that people simply didn’t know enough about foreign equities, in addition to the fact that many markets were inaccessible and entailed high transaction costs. The democratisation of information brought about by the internet and the rise of investing via mutual and Exchange-Traded Funds – as opposed to directly into the underlying equities – changed all that. For decades it has been possible to buy a basket of equities in almost any market you’d care to name in one easy, and usually very cost-effective, transaction.
But despite this opportunity, research shows that home bias has remained very persistent. Investors tend to maintain allocations to their home country far in excess of the its market capitalisation in a globally diversified equity index[i]. And this issue isn’t just confined to the amateurs, nor is it confined to the country level either. In one seminal study[ii], professional US fund managers were found to be favouring companies from their home states a lot of the time.
However, home bias, like all behavioural biases, is stronger among less experienced investors, again for reasons which are understandable if largely wrong. In the absence of a more suitable benchmark, many people take the performance of the FTSE 100 as a proxy for how their investments should be doing and, since this is a market tracked by the media prominently every day, they may feel most comfortable investing in the biggest UK names. They may also be adhering to Warren Buffet’s advice to “invest only in what you know” and feel it makes sense to invest in brands they interact with (and spend money on) week in, week out. Patriotism likely also plays a part for many of us as well as comfort, and there is certainly nothing wrong with that.
The problem is that falling prey to home bias due to these feel good factors generally makes for worse returns – and often very much so. In 2019, the MSCI World Index generated almost double the performance of the FTSE 100 and if you had stuck to the main UK market alone since the 1980s, you would have made five times less than investing in an index representing the world’s biggest stocks.
The heightened volatility you suffer from home bias is another concern, due to effect of domestic events like interest rate rises or changes in the leading political party (known as “country risk”). Whichever country you reside in, it has been shown that the way to get volatility down as far as possible is to have an allocation to international equities of between 40% and 50% of your portfolio[iii].
The savvy investor’s aim should therefore be to build exposure to a globally diversified index of equities across regions, countries and sectors, not forgetting the need to diversify into other asset classes too.
No place like home
That said, now may be a time when being overweight UK equities might be a very good bet indeed.
After a long time in the wilderness, love for UK is finally flooding back. Although we can expect further challenges, Brexit woes are weighing far less on Britain and our economy is poised for an explosive growth spurt as we come out of the COVID-19 pandemic and lockdowns. Indeed, analysts are scrambling to revise their growth predictions up and up, with many now saying an explosive 8% GDP rise or even higher is a reasonable scenario.
It is thought that half of fund managers are now overweight UK equities and it has been said by several experts that they offer the best returns of any asset class over the rest of this year. Having suffered so much from being cyclical and heavy on financials during the pandemic, the FTSE 100 could now turn that to very good effect. Stock-picking will still call for discernment, and investors will need to keep a close eye on risks like runaway inflation, but there does seem to be a case for buying British to the (slight) expense of other countries.
Truly, for the time being, there really might be no place like home.
This piece is for informational purposes only, and is not intended in any way as financial planning or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
[i] Vanguard, 2019
[ii] "No Place Like Home: Familiarity in Mutual Fund Manager Portfolio Choice", Indiana University (2012)
[iii] Vanguard, 2019