Investing

Q14: What is home country bias?

There’s no place like home but investing your money away from home may be worth looking at

Dorothy was right; there really is no place like home. It has all your favourite things: a comfortable couch, your own bed. It’s the place you like to be. It’s familiar to you and it’s your safe haven. Your home country is familiar to you and you know a lot about it. But when it comes to investing, places other than your home country may be worth investigating and there are some very good reasons to expand your investment horizon around the world.

world_map_2

There’s a whole world of opportunity out there

 

It’s called home country bias

Concentrating an investment portfolio in your home country’s sharemarket is a natural thing to do. We discussed some behavioural effects in a recent post such as Availability Bias and the attendant familiarity with local markets: we know most of the big names in our local market and we know what the companies do. You might know what Insurance Australia Group does, but did you know that German-listed Muenchener Rueckversicherungs Gesellschaft AG is in the same business?

Investors are likely to have a positive outlook for their local economy and to be indifferent or negative to offshore markets which they’re less familiar with. Dividend imputation rules in the Australian market may entice local investors to have a portfolio highly concentrated in ASX-listed shares. For many different reasons, investors have a natural bias to investing in their home market.

equity_home_bias

Chart 1: Equity Market Home Bias [Source: livewiremarkets.com]

As you can see in Chart 1, everybody’s doing it, but that doesn’t make it a good idea. Australians are among the worst with the average investor having about two-thirds of their equity portfolio in domestic equities when Australia’s share of the global market is around 2%.

The downside of home bias

We’ve learned that portfolio diversification brings with it the potential to mitigate risk and provide some protection against negative market movements in any one asset class. But as previously discussed our brain seems to want us to lose money so we have a tendency to ignore what we know about diversification and instead fall back on complacency. Home bias can cause a portfolio to have less-than-optimal diversification. In the Australian case, our share market is around 2% of the global developed market by value. So 98% of investment opportunity is offshore.

The Australian market is characterised by a small number of companies accounting for most of the market’s capitalisation. This is called market concentration. The top ten companies account for about 42% of the market with banks alone making up 23%. Australia’s banks have more than half their loan assets in residential housing so the Australian market is overexposed to the risks of a downturn in the housing market. Mining companies make up nearly 20%, so investors are betting that the materials sector, which is highly leveraged to the Chinese economy, remains healthy.

The global markets are far less concentrated, and much less exposed to the vagaries of any one sector. The pie charts below make this clear. In the S&P/ASX 200 Index, the Financials and Materials sectors make up about half the index (data sourced from ASX in July 2018).

asx200

The MSCI World Index — which is generally recognised as a reliable indicator of the developed world equity market — is much more diversified, and these two sectors account for only about 21% of the index (data sourced from MSCI in July 2018). Not only that, the sectors in the MSCI World Index are more evenly spread among the total market. This reduction in concentration makes global investing an efficient way to achieve a more diversified investment portfolio.

msci_world

What you can do about it

Simply put, if home bias is a concern for you, speak to an adviser about expanding your investment horizons to invest in global equities. There are many ways to achieve this with direct share ownership, managed funds or locally- or internationally-listed ETFs. When selecting an offshore investment the broadest diversification is achieved by investing in a fund which contains the widest range of global shares. The MSCI World index may be a good place to start, with over 1,600 different companies from 23 developed economies. You can invest in funds or ETFs which track this index, and others which aim to outperform it. Whichever way you choose, a broader diversification in an investment portfolio spreads your investment eggs into more baskets, reducing risk and potentially increasing returns.

Set sail for far-off places

Generally speaking, investment portfolios benefit from global diversification. It may be worthwhile to take a look at your investments and reduce your home country bias. Like the explorers of old, through your adviser, you may discover some exciting new worlds as you broaden your investment horizons. After all, there’s a whole world of investment opportunity out there. You’ve just got to venture beyond your own borders.

 

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