Home bias and the hidden risks of not diversifying abroad

Tuesday, Aug 30 2016 by
20
Home bias and the hidden risks of not diversifying abroad

It’s well known that UK investors tend to overweight their portfolios with stocks from their home country. It’s a pattern of behaviour you find all over the world. To varying degrees, investors everywhere are prone to ‘home bias’ because of the unfamiliar nature of foreign markets. But while international investing comes with uncertainties, staying local risks having a much more concentrated portfolio than you might think.

Since the mid-1990s, there’s been a notable decline in home bias. In that time, globalisation and the internet have radically improved knowledge and access to foreign markets. But according to the IMF, British investors still only allocate around half of their equity portfolios to international stocks.

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On paper, that level of concentration in the home market makes little sense. After all, the UK stock market only accounts for around 8-9% of global market capitalisation. So in theory, if you wanted a fully diversified world folio, just over 90% of it would be made up of foreign stocks.

In reality though, most investors would find that kind of international weighting absurd. On one hand, it’s often argued that there’s ample opportunity to buy UK-quoted stocks with exposure to foreign markets. For instance around 77% of revenues in the FTSE 100 are derived from outside the UK.

In addition, there are several practical reasons for the resistance to foreign investing. Among them are the perceived difficulty and expense of trading (including forex fees), foreign languages, governance concerns and general unfamiliarity of companies and reporting standards. In fact, 51% of respondents to a 2015 survey of Stockopedia blamed the unfamiliarity of foreign stocks as the main reason for steering clear of them.

Potential risks of hidden exposure

Yet, while some of the deterrents to international investing are understandable, home bias may be much more risky than some investors think. New research shows that markets in some major countries have actually performed like a single sector of the world stock market. As a result, a portfolio of domestic stocks - even if appears to have broad sector exposure - could be far less diversified that you might expect.

This is the finding of Jeffrey Kleintop, the chief global investment strategist at brokerage, Charles Schwab. He looked at various country indices that are tracked by the benchmarking group MSCI and found that, far from resembling a ‘world index’, the markets of these…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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19 Comments on this Article show/hide all

bigbadbear69 30th Aug '16 1 of 19
2

Really true.
I have always taken an international perspective.
There are extra costs but so long as you take a buy and hold approach
well worth it in the long run.

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shipoffrogs 30th Aug '16 2 of 19

"As Kleintop notes, over the past ten years it has become increasingly the case that stocks correlate (move in line) more with others in the same sector in foreign markets than they do with stocks in other sectors in their home market."

If that's the case is it really worthwhile running the same sector risk in foreign markets where you have no local knowledge.

It's noteworthy that Buffett's two big UK investments - Diageo and Tesco both turned out badly.

There's also currency risk to consider which has been amplified some, post Brexit.

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PJ0077 30th Aug '16 3 of 19

In reply to shipoffrogs, post #2

"It's noteworthy that Buffett's two big UK investments - Diageo and Tesco both turned out badly"

But therefore Diageo & Tesco also turned out badly for UK investors too... reason enough for UK investors to consider investing overseas!

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shipoffrogs 31st Aug '16 4 of 19
5

In reply to PJ0077, post #3

PJ - my point was that the world's most successful investor has done badly when he has invested in the UK - a foreign market to him.

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hayashi22 31st Aug '16 5 of 19
1

In buying many quoted larger UK companies you are buying international exposure anyway. The other factor is currency exposure as your holdings are expressed in sterling.If forecasting stock price movements is hard -doing the same for currency is even harder.

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FREng 31st Aug '16 6 of 19

Do we need to stockpick to get international diversification? Would a percentage investment in overseas ETF's do the job? Maybe Ben could crunch the numbers - I can't think how to start doing it for myself.

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GN100 31st Aug '16 7 of 19

Another factor in some jurisdictions is with holding tax. It's possible to mitigate the direct effect of these by purchasing an appropriate ETF - in which case these taxes are handled within the fund, but they are still there.

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vik2001 31st Aug '16 8 of 19
1

ive bought funds to help me diversify. I only buy individual shares in uk companies as I find it easier to research.

funds as follows:
1x Uk fund - Woodford Equity
3x Global funds - Fundsmith/Lindsell Train Equity/First State Infrastructure
1x Emerging mkt fund - JP Morgan EM

all funds are up nicely. I use the global funds as my exposure to the US markets and Europe. They are more weighted towards the US however.
EM coverups the EM areas for me. and a UK fund and mix of individual shares for UK.

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roy1 31st Aug '16 9 of 19
2

You can prove anything with statistics. If you change the amplificación of the World Index it can match any of the other lines. All markets are influenced by others, the clever bit is to forecast the differences, the opportunities.

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VegPatch 31st Aug '16 10 of 19
1

One of the first rules of investing for me is only invest in what you know and understand. As a result that rules out much of the international universe for me. Then there are accounting differences, which hinder my understanding of some companies. Third we have a really diverse set of UK listed companies, so if I want exposure to US residential and commercial construction I can buy Somero and Wolseley.

So for me I feel I can achieve diversification adequately by investing the majority of my funds in UK listed companies.

As a comeback, have you looked at the performance of most global funds vs the Global index? Better to buy a global tracker in my view...

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JoeRussell 31st Aug '16 11 of 19

I imagine most PIs will have a fair amount invested in ISAs which would preclude the owning of foreign shares. Surely this would tend to skew the statistics?

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marben100 31st Aug '16 12 of 19
2

In reply to JoeRussell, post #11

Joe,

That is not correct. See https://www.gov.uk/guidance/individual-savings-acc...

Shares, other than shares in an investment trust are qualifying investments if they’re:

  • issued by a company that is incorporated anywhere in the world
    • officially listed on a recognised stock exchange
    • admitted to trading on a recognised stock exchange in the European Economic Area (EEA)

Cheers,

Mark



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JoeRussell 31st Aug '16 13 of 19

In reply to marben100, post #12

Thanks Mark
I obviously had the wrong end of the stick there!
Best
Joe

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marben100 31st Aug '16 14 of 19

In reply to JoeRussell, post #13

The rules about what's permitted in an ISA have been relaxed in recent years, and there's now much more freedom to invest in what you want. However, you still need to find an ISA provider that offers what you want. I use TD Direct because they make it very easy to deal in a broad range of overseas exchanges, but their FX rates are rather poor.

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BlueFrew 31st Aug '16 15 of 19

In reply to JoeRussell, post #13

The problem comes with dividend payments. You can only have cash in pounds within the ISA wrapper, so your ISA provider will automatically do a foreign exchange transaction on your dividend transaction. That can take a chunk out of your dividend payment as some ISA providers aren't exactly competitive when it comes to foreign exchange.

It's particularly unhelpful if you were planning to spend the dividend payment on another foreign share as then you will be paying for 2 foreign exchange transactions on the same money. You don't have that issue with a trading account which allows you to keep cash in various currencies.

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jonesj 31st Aug '16 16 of 19

In reply to marben100, post #14

I stopped using TD Direct for foreign stocks when they increased their forex spread to 2%. That's what they deserve for being so greedy.

So be honest, since there are too many stocks to research, most of my overseas funds are now in investment trusts.

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PhilH 31st Aug '16 17 of 19
1

For me the question is...

Does diversifying across markets allow me to maintain a coherent investment approach that provides excellent returns?

And do the benefits of going international outweigh costs associated with that strategy, e.g. fx charges and with holding tax?

For me the answer is a resounding YES

Even if you're a value investor you could mirror The Nifty Thrifty and get an annualised return in the UK of 21% and 23% in the US. US stocks are easy and cheap to trade and tax issues are reasonably simple.

I started a thread a couple of years ago along the lines of ... compromise your investment strategy or broaden your investment pond.

Best of luck
Phil

Professional Services: Sunflower Counselling
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Ardipithecus 4th Sep '16 18 of 19

I am in agreement with GN100, VegPatch & BlueFrew. As an income oriented investor with most of my portfolios in ISAs I got fed up with unrecoverable witholding taxes on my divis and then loosing some more on the fx. So my German and other EU shares have all been sold. I still have a lot of global exposure through UK registered companies whose business is largely or entirely ex UK. The other factors for home bias are corporate governance and access. Try contacting the investor relations dept. of a Japanese, Chinese or Russian company! Spend a quiet weekend reading all 500 pages of a German annual report. Looking forward to meeting with the directors of an Italian or French company at an investors presentation or agm? Forget it.

The US is different, I have a dollar account for US registered shares. So no fx losses and the witholding tax at 15% is not too onerous.

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PhilH 4th Sep '16 19 of 19
2

In reply to Ardipithecus, post #18

I have and will never attend an agm, attempt to clarify something with a ceo/cfo or investor relations department.

It would be interesting to be able to my strategy blind with the only info being ...

The Stockopedia stock report (and the ability to screen it)
Identifying company details removed
Country details removed including product details
I'd even go as far as company description removed too but I'd want to know the sector and be able to compare my key screening metrics against peers in the same sector.

That'd be an interesting experiment.
Phil

Professional Services: Sunflower Counselling
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About Ben Hobson

Ben Hobson

Strategies Editor at Stockopedia. My goal is to help private investors learn and invest with confidence through the articles, ebooks and other resources we publish on site. I also occasionally bunk off to interview famous investors at expensive restaurants. I studied History at Aberystwyth University, trained as a journalist and covered business news and corporate finance before settling in as one of the first staff members at Stockopedia.  Away from Stockopedia I'm a mountain bike junkie. more »

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