7IM’s Verona Kenny is proudly Australian but, unlike many of her home citizens, believes a portfolio should be geographically well-diversified.
‘Diversify’ is one of the golden rules of investment, but it’s a strategy that’s sometimes pushed aside, as many investors choose to skew their portfolios towards their home country. Asia may hold the promise of huge potential, and the US has provided some sturdy returns for investors recently – but, regardless of this, does the lure of home still win our hearts?
If you’ve noticed this preference among your clients, you’re not imagining it. It’s a well-recognised phenomenon affecting investors all over the world. We Australians are enthusiastically home-biased, for example, with a typical investor holding about 66% of their portfolio solely in Australian equities. And given that there aren’t as many available, mostly mining and banking, that’s a lot of eggs in one basket.
Not-unreasonable reasons for home bias
While my fellow Australians may have taken it to worrying levels, home bias can be based on some sound philosophies and practicalities.
‘Invest in what you know’ stands up as one of the golden rules of investing, with local knowledge being of potential benefit for investors of all types. A natural preference for what’s familiar isn’t unreasonable – if you live in Singapore, you’ll see the Straits Times Index in the Straits Times every day, and you’ll know much more about what’s going on with local companies and shares.
Be it patriotism or self-interest, your clients may want to support their home economies – boosting local businesses, employment and growth. Who wouldn’t want to live in a wealthier country?
Home bias could also be about practicalities – investors can avoid currency risk by investing in their own country, along with legal restrictions and additional transaction costs.
What about diversification?
Despite all these not-unreasonable reasons, concentrating investments heavily in one market does make investors more vulnerable to volatility in that market. Plus, they’ll miss opportunities in other markets too.
As we’ve already mentioned, ‘diversify’ is one of the most powerful investment golden rules. Even if you ‘invest in what you know’ it could still turn out to be a disaster, but at least if you’re diversified you won’t lose everything.
Where does the business really come from?
A strong home bias is obviously going to affect the level of diversification in a portfolio. But just how much depends on where you’re from. And crucially, we would argue that it’s not just about where a company’s head office is based, it’s also about where the sales come from.
For example, a UK home bias gives you a more diversified portfolio than a Chinese home bias. UK companies do lots of their business abroad. Only 20% of business from UK companies is actually done in the UK. BP sells around 75% of its wares overseas and Diageo is similar.
Investing in UK companies can also give you exposure to some areas of the world that you can’t access anywhere else – like parts of Africa. Unilever announced in its 2018 annual report that 58% of turnover was from emerging markets.
By contrast, in China, over 88% of sales are made at home, and for Japan, it’s more than 70%. Hollywood movies may flicker on screens around the world, but most US market sales are US-based. 75% of US company sales are to US people. Europe is roughly a 50/50 split, with half of sales to Europe and half elsewhere.
7IM’s Ben Kumar talks about sales location in his article Deliberately different diversification.
Look carefully and challenge convention
Taking sales (rather than head office) location into account can have a major impact on where you invest to achieve the diversification you’re looking for. Keep an eye on this when planning your clients’ portfolios, especially if they’re keen to invest in their home market.
Sources: Vanguard / Datastream / Unilever
This article also appeared on International Adviser: https://international-adviser.com/is-investing-in-your-own-country-the-best-strategy/