“To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify. If you search worldwide, you will find more and better bargains than by studying only one nation.” Sir John Templeton
Harry Markowitz, a pioneer of modern portfolio theory, once described diversification as the only free lunch in finance. By investing across geographies and asset classes, it is possible to reduce risk and improve returns. Even so, investors often shun foreign shares - a behaviour that has baffled academics for decades and become known as the 'equity home-bias puzzle'.
Explanations for this puzzle range from investor fear of higher costs and the hassle of investing abroad to the fact that people simply like sticking to what they know. In the UK more than 60% of investment allocations are tied up in the UK stock market despite the fact that London only accounts for less than 10% of the world’s total stock market value. Americans suffer from home-bias too, but have less to worry about given that, according to a 2013 Vanguard study, US stocks account for a much more substantial 49% of the global equity market value.
So, on paper it look like UK investors are particularly exposed to the vagaries of the domestic market. But many don’t see it like that. They point to the fact that London is a popular destination for large international stocks to list, and that many UK-quoted companies earn large slugs of revenue from foreign markets. The precise figures vary, but recent research has found that as much as 77% of the revenues generated by companies in the FTSE 100 - which itself represents 80% of the capitalisation of the entire UK market - come from outside the UK.
The UK lacks diversification
But even though there appears to be an in-built diversification in UK-quoted blue chips, research by MSCI Barra shows that a UK-focused large-cap investing strategy still produces a very concentrated portfolio with significant asset-specific risk. In other words, those companies with high levels of foreign exposure tend to be bunched together in the same sectors.
Evidence of this concentration can be seen in some of the reporting and dividend payouts made by FTSE 100 stocks. According to Capita Asset Services, companies in the mining and energy sectors - which deal in commodities priced in dollars - are responsible for over a…
