What is home bias and how do we manage its effects?
It is natural for us to favour the familiar, and when investing we may also be drawn to the brands and companies we use and recognise the most, often in the country where we live. While the effects of this ‘home bias’ may be minimised by the impact of globalisation, we should recognise we may have a bias towards certain investments, and manage this effect.
The tendency to favour investing in companies from your home country is not unique to the UK; it is widespread across the world. This 2020 academic paper, “The home bias and the local bias: A survey” highlights a wealth of research on the phenomenon before drawing its own conclusions on its “decreasing” effects.
Nuance is important, and the relationship between where a company is based and where its profits are sourced can be blurred. Larger corporations from any country often make most of their profits abroad, and with regions like Europe, a single currency makes it easier for investors to choose from a broader palette.
Our role, therefore, when we invest on behalf of our clients is to be aware of the attributes of home bias and to understand that its implications are not always negative.
Providing a stable core
Our aim in managing portfolios is to provide efficient, diversified access to easily-traded assets in a risk-controlled way that can provide the ‘core’ of clients’ investments. Although we also offer portfolios designed for euro and US dollar denominated clients, the majority of our clients have investment goals that are focused on life in the UK.
Therefore, it is important to recognise the role that an allocation to the domestic stock market can perform in constructing the best fit.
Currency management is key to prospective returns, and UK equity allocations are an effective lever to control that exposure, especially when the cost of broad access to the market can be gained via ETFs for less than 0.1%pa. Investing on an international basis brings either an additional layer of currency risk, or additional costs of hedging, implicitly (through interest rate differentials) and explicitly (higher ETF costs).
Looking under the bonnet of a UK fund is key though, to understand where many of the global companies that make up the FTSE 100 earn their revenues, as that will influence the dynamic between currency movements and companies’ share prices.
Complementary attributes of the UK market
We also appreciate the unique characteristics of the UK market which complements global equity market allocations nicely. After a sustained period of underperformance, the UK market is cheap, so we could see sustained outperformance in the coming years.
At the moment, our portfolios are exposed to the small and medium-sized companies in the FTSE 250 Index. Political uncertainty and sluggish economic growth has led international investors to ignore these companies which are more geared to the domestic outlook, which we think is improving.
Also, the larger UK stocks represented by the FTSE 100 now offer twice the level of dividend yield of the US stock market, where companies tend to reinvest their profits more readily for future growth, rather than distribute them to investors. At times, this dependability of cashflows is sought after, although we would be wary of any concentrated strategy that relies on the dividends of any one company, as accidents can happen.
The types of companies on the UK market is just as important as their location. Banks, Energy and Natural Resources companies which carry a big weight in the UK have all struggled over the past 10 years. If they can show even the potential to deliver better future profitability, the market may reward early investors.
At Netwealth, we provide globally diversified portfolios to meet the varying needs of UK investors – to find out how we can help you to manage your investment goals, please get in touch.
Please note, the value of your investments can go down as well as up.