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Home Bias and Global Diversification

January 31, 2018

 

By pursuing a globally diversified approach to investing, one doesn’t have to attempt to pick winners to achieve a rewarding investment experience.

 

Every day we enjoy the benefits of an interconnected world. We might start our day with a cup of coffee that originated in South America, check our email on a smartphone designed in California and manufactured in Taiwan, then dress in clothes woven from Egyptian fabrics before driving a German-made car or riding in a French-built train to work.

 

As consumers, we rarely think twice about the benefits of access to the variety of goods the global market has to offer. Yet, as investors, we will often concentrate our portfolios in favour of our home market at the expense of global diversification. For example, while UK stock markets represent just six percent of the value of global equity markets, many UK investors tend to allocate around a third of their equity assets to domestic stocks [1]. This phenomenon, which can be observed across countries around the world, is known in the investment community as “home-country bias.”

 

Given that certain frictions may be associated with investing abroad, a home-country bias may make sense for an investor in certain cases. In general, however, neglecting the benefits that global diversification has to offer may increase risks and decrease the investment opportunity set.

 

As Exhibit 1 illustrates, 13 different developed countries (out of 21) had the best-performing equity market in a given calendar year for the 20 years ended in December 2016, and no country had the best‑performing market for more than two consecutive years.

 

 

Exhibit 1. Equity Returns of Developed Markets

                 Annual Return (%)

 

In GBP. Source: MSCI developed markets country indices (net dividends). MSCI data © MSCI 2017, all rights reserved. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio.Past performance is not a guarantee of future results.

 

This trend was also observable in emerging markets. As Exhibit 2 illustrates, 13 different emerging market countries (out of 20) had the best-performing market in a given year, and no country had the best-performing market in consecutive years.

 

This data shows that it is difficult to know which markets will outperform from year to year. By holding a globally diversified portfolio, investors are instead well positioned to capture returns wherever they occur.

 

 

Exhibit 2. Equity Returns of Emerging Markets

                 Annual Return (%)

 

In GBP. Source: MSCI developed markets country indices (net dividends). MSCI data © MSCI 2017, all rights reserved. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.

 

Clearly, attempting to pick only winning markets in any given period is a challenging proposition. By pursuing a globally diversified approach to investing, one doesn’t have to attempt to pick winners to achieve a rewarding investment experience. By expanding the investment opportunity set beyond their domestic stock market, investors can help increase the reliability of outcomes. Thus, investors can be confident that a globally diversified portfolio will hold the best (and worst) performing countries each year.

 

  1. Willis Towers Watson, Global Pension Assets Study 2017.

 

 

RISKS

Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Diversification neither assures a profit nor guarantees against loss in a declining market.

 

 

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