Banking

Home bias shows financial understanding is still a major problem

Today, amid incessant change and churn, it is especially important to think about the long term, to think thematically and – maybe above all – to think globally.

Short-termism may be the most well-known manifestation of a myopic approach to the markets, but it is not necessarily the most widespread.

That dubious honour arguably goes to home bias – the tendency to invest the majority of a portfolio in domestic assets.

Numerous studies demonstrate both the pervasiveness and the persistence of this phenomenon, which is most often associated with equities but can also be found in arenas such as fixed income and real estate.

According to a survey carried out earlier this year, almost half of advised investors in the UK have more than 50% of their holdings in British stocks.

This finding is notably baffling – not to mention highly concerning – since, although there is now light at the end of the tunnel, the UK was among the worst-performing major equity markets in 2020.

Blinkered in Britain

There are many reasons for the comparative woes of the UK stockmarket.

The dearth of technology businesses explains a lot.

While it should in no way be seen as representative of the British economy as a whole, the FTSE 100 derives less than 2.5% of its overall value from tech ­- whereas the S&P 500 derives around 30%.

This is not to imply that the UK stockmarket should be avoided. It still offers many attractive opportunities.

In spite of the added complication of Brexit, the gradual emergence of promising new firms and the growing influence of venture capital show that it is far from moribund; and its price/earnings ratios, which are at present lower than those of their peer equity indices, may be undervalued.

What the above observations do illustrate, though, is that home bias can make precious little sense – if any at all.

So why are some investors so reluctant to look elsewhere?

An enduring puzzle

The most straightforward reason is a desire for familiarity.

Investors might feel more comfortable with assets that they know well – or at least that they think ­they know well – and perceive more risk in the supposed unknowns that lie further afield.

Similarly, some investors display ‘ambiguity aversion’.

Such an outlook compels them to favour what they believe to be known outcomes over what they suspect are unknown outcomes.

In many instances, of course, the situation is much less ambiguous than imagined.

Historically, home bias also stemmed from an unwillingness to encounter the difficulties traditionally attached to investing in foreign equities.

The most common complaints revolved around inaccessibility and additional transaction costs – issues that are far less germane today but which in some cases might still constitute legitimate grounds for caution.

Naturally, it is somewhat harder to criticise home bias if your home happens to be the strongest economy on earth.

In the late 1980s, when one of the first significant studies in this sphere was carried out, Americans were found to be holding roughly 94% of their wealth in US equities – and many portfolios, both in the US and elsewhere, are still US-centric today.

Yet even then it is likely to pay – both figuratively and literally – to remember one of the oldest tenets of investing: never put all your eggs in one basket.

The bigger picture revisited

Anyone familiar with Douglas Adams’ The Hitchhiker’s Guide to the Galaxy will surely remember its humbling description of space. “

Space,” it says, “is big. Really big. You just won’t believe how vastly, hugely, mind-bogglingly big it is.”

Something analogous might be said of the global investment universe.

One of the principal attractions of its immensity is that it encourages unconstrained thinking on the grandest scale.

Why focus on a single country when all boundaries can be disregarded?

Regional diversification, like its asset-class counterpart, is not some sort of abstruse theory.

It is actually rather simple. Yet we know that home bias endures; moreover, we know that it endures even when its innate shortcomings are quite obvious, as they were in the UK during much of 2020.

We should pay close attention to such an unhappy quirk, because it underscores that many individuals’ level of financial understanding could be substantially improved.

This is of tremendous significance at a time when investing is being both digitised and, as a consequence, democratised.

The fact is that home bias is seldom conducive to superior outcomes.

Ultimately, it is another stark reminder that empowerment must be accompanied by education.

As an industry, we have to play our part in closing the gap between an explosion in accessibility and a potentially damaging paucity of awareness.

Going forward, this is a challenge we must not lose sight of in the face of what should be positive, lasting change.

Colin Fitzgerald is head of EMEA distribution at Invesco

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