Investors should get out more, Northern Trust Asset Management (NTAM) argues in a new study detailing the perils of home country bias.
The NTAM report says investors would benefit from some quantitative-based home bias corrective training designed to improve diversification and lower portfolio risks.
In fact, the paper – authored by NTAM portfolio strategy specialists Michael DeJuan, Laura Di Poce and Prahhllada Saragur – says local share market weights in global indices should serve as the baseline for determining allocation levels.
“It should be noted that investors should have a solid rationale for increasing the weight to their domestic market (over and above market weight), such as strong capital market assumptions, an investment edge in the domestic market, or risk reduction/diversification purposes,” the NTAM study says.
For NZ-based investors the global context translates to a local equities portfolio weighting of just 0.1 per cent but idiosyncratic factors – such as tax, regulatory barriers and “information asymmetries” – provide a wider range of reasonable outcomes.
Based on the “general guidelines” laid out in the NTAM paper, for instance, the arguable NZ home share market allocation spans from 0 to 40 per cent. UK investors face the widest home-v-away choice with a reasonable domestic equities weight ranging from 4 to 72 per cent.
South Korean investors, by contrast, should keep local share allocations to between 2 and 5 per cent of their overall portfolio, the report says.
While the US market – the most liquid and widely diversified in the world – can support a higher home bias, the paper says even there a global allocation is advisable.
“We note that following these guidelines, a U.S. investor’s domestic equity allocation would be anchored at approximately 60% of their equities, but could range as high as 89%, based on current data,” the NTAM study says. “We believe that due to sector concentrations, and other issues of concentration and diversification outlined above, that foreign equities should not be entirely eliminated from a U.S investor’s portfolio, as they can still serve as a useful diversification tool.”
The paper notes that despite the broader diversification in US markets, sector concentration “has become an increasing issue of late given the stock performance of companies such as Apple, Microsoft and other tech behemoths”.
But the NZ share market has the highest concentration of all those covered in the NTAM study.
“In New Zealand, the top 10 names make up an astounding 76% of the MSCI New Zealand IMI index,” the report says. “All of the country indexes that we reviewed had a higher top 10 concentration than the MSCI ACWI IMI Index (14%).”
After NZ, South Korea shows the highest top 10 stock market concentration of 50 per cent followed by Australia (46 per cent) and Canada (41 per cent).
“Adding foreign equity investments to a domestic portfolio helps produce more diversified portfolios and alleviates concentration risks related to investing domestically only,” the study says. “The trick is to identify the right balance. Many rational reasons validate a home bias, but we have presented analysis to challenge that bias and a framework for working out allocations to home country equities.”
NTAM has an increasing presence in NZ including through recent deals with ANZ Investments, Westpac/BT as well as a long-standing mandate with the NZ Superannuation Fund.