When investing it’s important to look global
Everybody loves the comforts of home, but investors who become too anchored to familiar territory can end up with a very narrow view of the world.
Home bias, the tendency of investors to allocate a disproportionate amount of their funds to their domestic market, is a well-documented phenomenon.
There can be rational reasons for home bias. New Zealand investors, for instance, have the advantage of dividend imputation. This is where firms that have already paid income tax on profits attach tax credits with distributions to shareholders.
Often investors have an attraction to companies they are familiar with like Westpac, ANZ, Fletchers and Air New Zealand which are household names and are frequently in the news.
But a large home bias can have undesirable consequences. Those consequences relate to the risks of a portfolio ending up with very concentrated exposure to individual countries, companies and sectors.
This is particularly so for New Zealand investors where our home market is very small in a global sense and is dominated by a few big companies.
The chart below shows the relative size of global sharemarkets:
Source: Dimensional Fund Advisers. In US dollars. Market cap data is free-float adjusted and meets minimum liquidity and listing requirements. China market capitalisation excludes A-shares, which are generally only available to mainland China investors. Many nations not displayed. Totals may not equal 100% due to rounding. For educational purposes; should not be used as investment advice. Data provided by Bloomberg
You can see the US is by far the biggest market, with a weight of 52%. Japan is a distant second with a weight just above 8%, then the UK, Canada, France and Germany, China and Switzerland. Australia is ninth with a weight of 2.4%, while New Zealand is in 36th place with a weight of just 0.1%.
Too much home bias can represent a pronounced deviation from the global market portfolio and leave you taking unnecessarily big bets.
For investors that like to preserve capital, diversification makes sense.
Given investors tend to source most of their income from their home nation and hold most of their other assets there (homes, baches, etc), this degree of home bias represents a very big bet on one country, a couple of sectors and a handful of stocks.
So the question then becomes what degree of home bias is acceptable. It shouldn't be surprising that there is no one right answer to that. It depends on each individual investor's tastes, preferences, circumstances and goals.
A good approach is to use a global market portfolio as your starting point.
While you may tilt your portfolio towards New Zealand for the imputation credits or your familiarity with the stocks, it's important to understand this has nothing to do with the long run expected return of your portfolio. It is just a preference and it potentially comes at a cost.
In contrast, broad global diversification creates a portfolio that spreads its risk to more economies, to a greater number of stocks, to a wider range of companies and to a wider spread of sectors.
Again, there is no single right answer in terms of asset allocation. It will depend on the individual investor's circumstances, goals and risk appetite.
But at some time or another, we all have to leave home.