Domestic bias shows financial understanding is still a major issue
Today, in a context of relentless change and churn, it’s especially important to think long-term, think thematically, and – perhaps most importantly – think globally.
Short-termism is perhaps the best-known manifestation of a myopic approach to markets, but it is not necessarily the most widespread.
This dubious honor arguably comes down to the domestic bias – the tendency to invest the majority of a portfolio in domestic assets.
Numerous studies show both the pervasiveness and the persistence of this phenomenon, most often associated with stocks but which can also be found in areas such as fixed income and real estate.
Nearly half of UK advised investors hold more than 50% of their holdings in UK stocks, according to a survey earlier this year.
This finding is particularly puzzling – not to say very worrying – because, although there is now light at the end of the tunnel, the UK was among the worst performing major stock markets in 2020.
Flashing in Great Britain
There are many reasons for the comparative woes of the UK stock market.
The shortage of tech companies explains a lot.
While by no means should be seen as representative of the UK economy as a whole, the FTSE 100 derives less than 2.5% of its overall value from technology – while the S&P 500 derives around 30%.
That’s not to say the UK stock market should be avoided. It still offers many interesting opportunities.
Despite the added complication of Brexit, the gradual emergence of promising new companies and the growing influence of venture capital show that it is far from dying; and its price-to-earnings ratios, which are currently lower than those of their peer stock indexes, may be understated.
What the above observations illustrate, however, is that domestic bias may make little or no sense.
So why are some investors so reluctant to look elsewhere?
A lasting puzzle
The simplest reason is a desire for familiarity.
Investors might feel more comfortable with assets they know well – or at least they think Âthey know well – and perceive more risk in the supposed unknowns that lie further down.
Likewise, some investors display an âaversion to ambiguityâ.
Such a prospect forces them to prioritize what they believe to be known results over what they suspect to be unknown results.
In many cases, of course, the situation is much less ambiguous than one imagined.
Historically, the domestic bias has also resulted from a reluctance to encounter the difficulties traditionally associated with investing in foreign stocks.
The most common complaints were about inaccessibility and additional transaction costs – issues that are much less relevant today but which in some cases could still constitute legitimate grounds for caution.
Naturally, it’s a little harder to criticize the home bias if your home happens to be the strongest economy in the world.
In the late 1980s, when one of the first major studies in this area was done, Americans held about 94% of their wealth in U.S. stocks – and many portfolios, both in the U.S. and elsewhere, are still American. centered today.
Yet even then, it’s likely that it pays – literally and figuratively – to remember one of the oldest principles of investing: never put all your eggs in one basket. .
The overview revisited
Anyone who knows Douglas Adams The Hitchhiker’s Guide to the Galaxy will surely remember his humiliating description of space.
âSpace,â he said, âis big. Really big. You won’t believe how huge, huge, breathtaking it is.â
You could say something analogous to the global investment universe.
One of the main attractions of its vastness is that it encourages unconstrained thinking on a larger scale.
Why focus on one country when all borders can be ignored?
Regional diversification, like its asset class counterpart, is not some sort of abstruse theory.
It’s actually quite simple. Yet we know that domestic prejudices persist; What’s more, we know it persists even when its innate flaws are fairly obvious, as they were in the UK for much of 2020.
We need to pay close attention to such an unfortunate quirk, as it highlights that many people’s level of financial understanding could be dramatically improved.
This is of utmost importance at a time when investment is both digitized and, therefore, democratized.
The point is, family bias is rarely conducive to superior results.
Ultimately, it’s another stark reminder that empowerment must come with education.
As an industry, we must play our part to bridge the gap between an explosion in accessibility and a potentially damaging lack of awareness.
Looking to the future, this is a challenge that we must not lose sight of in the face of what should be positive and lasting change.
Colin Fitzgerald is EMEA Distribution Manager at Invesco