How overcoming home bias could benefit your portfolio

“Stick to what you know” is a maxim that generally encourages familiarity and security in place of risk and adventure.

However, when it comes to your investments, sticking to what you know could entail greater risk and less security than broadening your horizons and diversifying your portfolio across different regions.

“Home bias” refers to the tendency for investors to favour domestic equities. This means you may miss the benefits of exposure to foreign markets and diversification, namely risk mitigation and potentially even improved performance.

Read on to find out how overcoming home bias could benefit your portfolio.

Home bias has existed since the dawn of financial markets

There are several reasons behind the existence of home bias, some of which are due to the cognitive biases of investors.

For example, you may believe that you have better information regarding your domestic market and can improve returns by working in a terrain you are familiar with. Or you may view foreign assets as riskier and prefer to stay in your comfort zone as a means of risk management.

Other reasons for the existence of home bias are based on the technicalities of the market.

For example, different market regulations, taxes, and transaction fees could make foreign investments seem less attractive.

Or if you have static investments that remain fixed in a particular business or asset class in your portfolio, you may be left with a home bias as the global market evolves.

This is particularly true in the UK, as the size of the UK market relative to the total global equity market has declined significantly in recent decades.

Research suggests UK investors have a home bias despite the UK accounting for a small percentage of global equity and bond markets

FTAdviser reports that a survey of UK investors found that the average balanced model portfolio (comprised of both stocks and bonds) has around 25% of the total exposure in UK equities and around 18% in UK bonds.

However, the UK only accounts for around 4% of global equity and bond markets, and just 3% of global Gross Domestic Product (GDP).

The graph below shows that the global weight of UK equities has declined since the 1990s:

Source: FTAdviser

Since the emergence of markets such as the Shanghai Stock Exchange, Euronext, and the Japan Exchange Group, the percentage share of UK equities in the global market has fallen.

Consequently, a UK home bias could restrict your exposure to broader global growth opportunities.

Diversifying your investments could lead to improved performance

Although most UK investors appear to be over-exposed to their own market, research indicates that a globally diversified portfolio offers greater potential for long-term growth.

A study reported by FTAdviser found that the returns on £10,000 invested in the UK market between 2003 and 2022 would have been considerably different depending on the level of global diversification in the portfolio.

The study looked at UK portfolios with a moderate balance of 60% equities and 40% bonds. It analysed how different splits between domestic and global investments would have affected returns and volatility.

A portfolio with 100% domestic investments – a full home bias – would have returned £31,472 over the decade. Meanwhile, a portfolio with 100% global investments would have returned £43,276 over the same period.

Source: FTAdviser

As you can see, avoiding a home bias improved overall returns and reduced risk.

Furthermore, portfolios that were more exposed to the global market had lower maximum drawdown, which is a measure of an asset’s largest price drop from peak to trough. This means globally exposed portfolios were less vulnerable to market volatility than portfolios with a home bias.

A globally diversified portfolio can also reduce risk

As you saw in the table above, home bias could leave you more exposed to market fluctuations and the risks associated with regional concentration.

In the UK, the 10 largest companies account for roughly 42% of the total market capitalisation. Similarly, in the US, the seven largest companies comprise almost a third of the S&P 500 index.

In both instances, investors are exposed to significant risks depending on the performance of a handful of the largest securities.

A concentrated portfolio increases your vulnerability to market fluctuations and volatility, and diversifying across sectors, asset classes, and regions can help mitigate this risk.

The chart below shows the annual returns from different indexes around the world over a decade:

Source: JPMorgan

As you can see, predicting which index will perform well or badly in a given year based on the previous year’s performance is all but impossible.

For example, the UK FTSE All-Share was the best-performing index in 2016 and the worst in 2017. The MSCI Asia ex-Japan experienced a similar fall between 2020 and 2021.

Markets are volatile and with so many variables at play, performance is hard to forecast.

So, diversifying your portfolio and avoiding a home bias might not only help you capture returns on global growth but could also mitigate losses.

Get in touch

A financial planner can work with you to diversify your portfolio across a range of asset classes, sectors, and regions.

Our international focus means we are well-positioned to help you overcome your home bias and capture the potential benefits of global exposure.

To speak to a financial planner, get in touch.

Email info@abg.net or call us at +44 (0)151 346 5460.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.