A bias for home country stocks

Most investors should be familiar with the concept of ‘Home Country Bias’, the natural tendency to be more familiar and comfortable with public companies in your home country. Investors everywhere consistently display this trait, which is in direct conflict with the basic principles of international diversification. A 2014 report by Vanguard found that “equities not domiciled in the US accounted for 51 per cent of the global equity market as of December 31, 2013.” US equities accounted for the rest. Despite the size of non-US markets, US mutual funds engaged in classic home country bias, holding “only 27 per cent of their total equity allocation in non-US domiciled assets.”

In other words, investors were about 50 per cent underweight when it came to equities outside their country. This bias increases the risk and volatility of portfolios, and is a drag on performance. In the US, the impact is partially muted, given the dominant size of US equity capitalisation (49 per cent) relative to the rest of the world. Nonetheless, the Vanguard study shows that US investors’ holdings of US stocks significantly exceeded the country’s share of the global market.

Now consider the typical domestic portfolio in Canada, which accounts for 4 per cent of global equity capitalisation. According to a recent survey from the International Monetary Fund, Canadian investors allocate a mere 40 per cent of their total equity investments outside Canada. Their local allocation to Canada is about 10 times what it should be.

Radically reduced diversification