05 Dec 2017
Home bias hurting portfolios?
It is human nature to favour the familiar over what might seem unfamiliar, but could ‘home bias’ hurt your investment portfolio?
Could what some City experts call ‘home bias’ hurt your investment portfolio? The question is worth asking when the FTSE 100 index of Britain’s biggest shares has delivered total returns of 9% during the year to date but the Dow Jones index of American blue chips has done twice as well, with total returns of 18%.
Technology stocks listed on the Nasdaq exchange in New York soared even higher, rising by 22% since the start of 2017, while emerging markets in Latin America have bounced back from multi-year lows to rise by an average of 27% this year, according to independent statisticians Morningstar.
Meanwhile, the Far East excluding Japan did even better with a total return of 33% since the start of 2017. While the past is not a guide to the future, these figures do show how a global approach to investment can pay off.
Professional advice can help you maximise returns and diminish the risk inherent in stock markets by international diversification. There is a world of opportunity out there but also some potential pitfalls to beware.
‘It is possible to diminish or avoid currency exposure by ‘hedging’ – or effectively obtaining protection against disadvantageous changes’
For example, most readers of this article will have their earnings and liabilities predominantly denominated in sterling and so it can be argued that it makes sense to favour the same currency when allocating assets. Exchange rate movements are another consideration when considering overseas investments because any capital gains or income received from them might be diminished if the pound rises against the foreign currency in which these assets are denominated.
While future fluctuations in exchange rates are unknowable, it is possible to diminish or avoid currency exposure by ‘hedging’ – or effectively obtaining protection against disadvantageous changes – and professional advice can help you identify the best way to achieve this. Some pooled funds, such as unit and investment trusts, offer inbuilt currency hedging because of the way they are managed – and to meet the needs of most of their retail investors, who are British and will ultimately measure returns in sterling.
Even so, from time to time most of us buy goods and services from overseas and also enjoy foreign travel. So, whether we like it or not, our real wealth – in terms of what our money can buy – may be adversely affected if sterling weakens against foreign currencies. Nor is this a theoretical concern; many people aged over 50 can well remember when the pound went a lot further in France, Germany or America than it does today.
Don’t mention Switzerland.
More recent history also demonstrates why it makes sense to seek professional advice on how to construct a balanced and diversified portfolio of international assets; it can reduce your exposure to events closer to home. For example, Brexit is a big deal in Britain and so is the economic uncertainty it entails but neither worry matters much on the other side of the Atlantic or Pacific oceans.
‘Brexit is a big deal in Britain and so is the economic uncertainty it entails but neither worry matters much on the other side of the Atlantic or Pacific oceans’
So it is interesting to note that, according to the MSCI World .Index, America accounts for 52% of the total global stock market allocation, followed by Europe ex-UK with 15%, Emerging Markets with 12% and Japan with 8%. The UK has a weighting of just 6% with the remainder of this global index spread across Canada, Asia ex-Japan and other countries.
Pooled funds, such as unit and investment trusts or exchange traded funds (ETFs), offer convenient and cost-effective ways to gain exposure to markets that may trade while you are asleep, without needing to worry about local taxes or dealing costs. All these forms of pooled fund also offer automatic diversification by spreading individual investors’ money over dozens of different companies shares or bonds or other assets.
The fundamental idea is to maximise rewards but to minimise risks by reducing investors’ exposure to setbacks or failure at any one company. International funds extend that principle of diminishing risk through diversification by allocating assets over more than one country.
Against all that, it can be argued that those of us lucky enough to live in Britain already have access to a wide range of overseas earnings and profits, via companies listed on the London Stock Exchange. For example, about two-thirds of the revenues generated by companies that constitute the FTSE 100 are generated overseas.
‘The British market is heavily exposed to energy and commodities but relatively underweight in healthcare and technology companies.’
But there is still a risk that home bias or favouring the familiar may inadvertently mean the unwary investor can put too many eggs in too few baskets. For example, just 10 of the hundred firms that constitute the FTSE 100 are expected to deliver 58% of the dividends that this blue-chip index pays out this year.
Remember that income payments to shareholders are not guaranteed and can be cancelled or reduced without notice. Even blue chips can disappoint, as demonstrated by dividend cuts announced in recent years by FTSE 100 giants including the miner Anglo American; the insurer Admiral; the oil major BP; the publisher Pearson; RBS, formerly Royal Bank of Scotland; and the retailer Tesco – although some of these have since been reinstated.
Another consideration is that because of the composition of the companies listed in London, focussing solely on these shares or funds invested in them can create an unintended bias towards certain commercial sectors while overlooking others. The British market is heavily exposed to energy and commodities but relatively underweight in healthcare and technology companies.
For example, energy shares account for about 14% of the total value of those listed on FTSE All Share index – a broad measure of the London stock market – but only 6% of the total market capitalisation of the Standard & Poor’s (S&P 500) index in America and only about 4% of equivalent indices in Europe ex-UK.
‘Investors seeking income or growth or a mixture of both should consider a global approach to asset allocation’
So it is important to consider how home bias can affect asset allocation and whether this might help or hinder returns. It’s human nature to favour the familiar over what might seem unfamiliar but investors seeking income or growth or a mixture of both should consider a global approach to asset allocation. Professional advice and pooled funds can bring a world of investment opportunities within reach.
Ian Cowie is a financial columnist for The Sunday Times; previously personal finance editor.
This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of the information provided.