Home or Away? Are you biased?

We were contacted by the press this week about how investors allocate assets in their portfolios. Are investments evenly split or do investors have a preference for their home market (home bias)? Here we dig in to what a home bias is, does it exist and does it really matter.

 

Home bias is a well-known phenomenon – it means massively over-weighting your home market, because it is what you are familiar with, and it feels safer.  In contrast, some would theorise that your portfolio more closely reflects the size of each market, as reflected in a global index e.g. FTSE All-World.

 

Home bias does exist and UK investors do this, but it applies all over the world.

 

On stock market exposures of UK investors there is a marked difference between the totals invested into UK stock market funds versus funds focussed on stock markets outside the UK, and you can see this in Table 1.

 

Of course, the right-hand side of table, where the global index is broken down, takes no account of two very important matters:

 

Current valuations. On some measures the US stock market is more over-valued than in 1929 and 1999. Many institutions generally will stay tight to the benchmark so will have over 50% invested in the US.  However, you have a choice, which goes back to what we said last week on differences between amateurs and experts (more here). If you strictly split your portfolio by capitalisation of markets (as a global index tracker will do) you are almost certainly falling into the clutches of a nasty bear trap with 56.9% of your portfolio.

 

Future, longer term, prospects. These will be dictated by demographics, potential for productivity improvements, and political stability combined with a commitment to reform. By 2050, 3 of the top 4 economies will be in Asia.  Asia is diverse.  It is home to vast, growing middle class populations, countries with lower debt levels and innovative companies with the potential to hugely increase productivity.

 

But Asia represents just 4.1% of the index.

 

It is particularly interesting that investors are voting with their feet for Asia relative to the global index, with over twice as much invested in Asia-Pacific ex-Japan.

 

 

If you’re a UK investor with a home bias, this has paid off in spades. 

 

Our Dynamic UK Portfolio, which invests in the top 3 funds from the three main UK sectors (UK All Companies, UK Equity Income and UK Smaller Companies) is up 396% over the last 10 years.

 

That’s compared to just 140% for the FTSE 100 index.

 

But if you are a Japanese investor with a home bias it’s been a disaster.  The Japanese market peaked in December 1989 and is still down about 40%.  This is why you must protect yourself from what we call “The Japan Problem”.

 

This is when a home bias can be devastating. If you are investing a significant chunk of your life savings this is a very serious point.  Prolonged falls of 50%+ over an extended number of years can destroy not just a significant part of your capital, but your life plans.

 

Does a “home bias” exist? Yes. Have a look at your own investments and see how evenly spread they are.

 

Does it matter? Yes. You can’t know whether or not a home bias will work out in your favour.

 

What can you do about it? Have an investment process that records why you bought your funds and then regularly review this. If the reason you had for buying the fund no longer applies you should sell.

 

For example, our Global Dynamic portfolio automatically moves you into sectors that are performing well, so has an inbuilt protection against a home bias.  Find out more about the different portfolios that we track in the Dynamic Portfolio Library.