Why home biases may be bad

There is always a healthy debate among investors: what is the right thing to do versus what is comfortable. Sometimes the two outcomes align and the course an investor should follow is the one taken and there is a minimal level of discomfort. Other times, however, the choices we make as investors are governed by emotions, even if we won’t acknowledge this.

One area in which feelings often sway actions is where investors consciously, or subconsciously, weight significant percentages of their portfolio to their home market. Falling within the umbrella of familiarity bias, many investors around the world are culpable of favouritism for certain stocks over others that may require a bit more work to select. The bias is prevalent in so many of the decisions we make on a daily basis with regard to our favourite brands and, as we use the same decision-making process for less frequent choices, why wouldn’t we drift towards the stock selections behind the choices we enjoy all the time? Some may even believe their spending alone is propping up the share price!

These preferences are also relatively easily validated given we are more likely to hear or read what’s happening with the firm(s) on a regular basis in the local or national news outlets. Since Warren Buffet is often quoted as advocating that we should invest in businesses we understand, where better to invest in those companies we know?

There is also another argument advocated for UK investors in particular with regard to home bias, given significant sums invested locally are in companies that are part of the FTSE 100 index. Although the names are technically domestic investments, the reality is that typically 70-80% of these companies’ earnings are from overseas activities. These stocks are not, therefore, reliant on our local fortunes and, instead, should act as a useful counterpoint to changes in the value of Sterling. The argument is that if the value of Sterling has risen and our imports cost more, FTSE 100 companies should see the value of their overseas earnings increase too. This money is passed to investors via the regular dividends UK companies usually pay out, which drives higher share prices, and, in the end, should balance out the higher bills.

The reality is that home bias worked well for the industry a couple of decades ago when overseas investing was difficult given we could lean in to investors’ pre-existing biases.

Since then, however, investing overseas has become easier. At the same time, the benefits of globalisation have advanced and we may realise we are missing out on a similar opportunity that yields more. The brands we buy on the high street and online aren’t just ones from the UK either. It leads people to question why we would invest in a home-grown company, when we can invest in the best company in that sector regardless of its jurisdiction.

As a result of these and other changes, the average proportion of assets that UK-managed equity funds invest at home fell from around 50% on average a decade ago to just below 30% in 2020. Many believe investors should go further and only invest in the UK what it’s global market capitalisation warrants – between 4-5% of an equity portfolio – not least as UK stocks have underperformed their peers in recent years as shown by the below table:

Source: Bloomberg as at each market close on 10 September 2021.

But why is it then that investment managers still introduce home bias as if it were a good thing?

It is our experience, however, that many of the arguments for a home bias are not actually linked to the bias per se, but instead because it is easy to confuse between approaches and outcomes, and especially in the case of the UK. Being rewarded for investing with a home bias often has nothing to do with the assets’ locality and everything to do with their underlying fundamentals.

Those who advocate for a home bias, for example, may try to argue that aligning your portfolio based on market capitalisation may mean you are investing less of your equity portfolio in the UK than in, say, a single tech name in the US. However, we believe this is very unlikely to be the case if your portfolio is properly diversified across asset classes, geographies, industries and investment styles.

Instead, whether you are based in the UK or not, even holding 4-5% of your equity allocation in UK stocks may have been too much since the global financial crisis given that there is a far larger proportion of cyclical and value stocks versus growth stocks (such as communication services and technology) in UK indices versus our financial market peers, and particularly when we compare the UK’s FTSE 100 to the US’s S&P 500. As cyclical and value stocks have underperformed other styles, we should not conclude that the UK is good or bad based on its status as home market for some investors, but due to its stock market composition.

This make up should be borne in mind now the global recovery is underway. Any increases in UK investments should also not be assigned to an increasing preference for what’s comfortable. Instead, investors should reconsider their UK holdings because, at this point in the economic cycle, cyclical and value stocks traditionally outperform growth stocks, and its stocks are rebounding off far more reasonable valuations than their peers around the world.

You should also reconsider UK holdings now, again not because they are UK stocks per se, but because they have tended to provide better protection against any unexpected bursts of inflation. This is because lots of UK stocks regularly pay out dividends and, although many cut or stopped their dividends in 2020 due to the pandemic – wisely choosing to retain cash against unforeseen events and uncertainties – many pay-outs have now restarted and these should grow in line with domestic pricing power. Incidentally, value and cyclical stocks have also tended to do well when inflation is on the increase. Since inflationary fear is stalking investors in other parts of the world too, not just in the UK, and dividends can mitigate the effects of rising prices regardless of their source, it gives us another reason to investment more in the FTSE All Share Index.

Last but not least, although it may not feel like it, much of the uncertainty linked to Brexit is behind us, as is some of the uncertainty linked to the pandemic. With one of the highest levels of vaccinated populations in the world (and access to more vaccines and the science behind them), yet again there are more reasons for more investors to put more money in UK stocks.

It was against this backdrop, therefore, that Nedbank Private Wealth chose to increase its allocation to the UK. It was not a reversal of our view on home bias – which we still believe to be flawed – but based on careful research that highlighted all the reasons for the UK stock market to enjoy a better period than in previous years.

We still, therefore, advise against a home bias for clients because many of their other assets are denominated in their home currency. If, for UK clients, your house, car and culturally-led chattels already mean you have a significant percentage of your assets in Sterling, why would you again choose to overweight the UK in your investment portfolios given we intrinsically understand the importance of diversification?

And for those still wanting to promote home bias as an investment approach? I would only ask you enquire as to whether the investment house in question can manage currency risks. Lots of investment firms can’t and, therefore, continue to push investment fundamental stories as reasons to back a bias. With currency management in place, investors are able to invest based on the most compelling investment case alone – regardless of location – and without confusing the reasons why. And, unlike the difficulties in accessing global brands physically due to the many supply chain issues, we continue to invest on behalf of clients globally based on the very best opportunities we, and our underlying managers, uncover.