“What the farmer doesn’t know, he won’t eat,” goes a widespread saying. It describes the tendency to disregard things that are unfamiliar or that we have no influence over. At first glance, that’s not a bad trait. It protects us and keeps us from making possible mistakes. Because as long as we engage only with what we already know, we stay in control. Or at least that’s what we like to believe.
Just how deeply this belief is rooted in many of us is shown by an example from investing. Here we see the phenomenon that investors tend to overweight investments in their home market. This is all the more astonishing given that the effect – known as home bias – contradicts the findings of financial market research. Portfolio theory calls, for instance, for diversification across asset classes, because this strategy reduces risk. For this reason, spreading your investments across a wide range of markets makes sense.
This love of home is a worldwide phenomenon, and it affects professional investors too. The Investment Company Institute found that the managers of US equity funds had invested almost three times as much money in domestic stocks as in securities from the rest of the world. It becomes downright bizarre when you look at a study by Tobias Moskowitz and Joshua Coval. The economists discovered that US fund managers hold every tenth company in their portfolio for no other reason than that it comes from the manager’s home town. You don’t need to be a professional to picture how a regional crisis would affect a portfolio weighted that way.
When it comes to investing, the same rule applies as with your diet: it needs to be balanced.
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Looking beyond your own plate
Of course, there are always good reasons for behaving this way. According to a study by Credit Suisse, many investors cite a lack of information, arguing that you simply can’t know foreign companies as well as domestic ones. On top of that come possible differences in regulation and accounting, as well as language barriers, transaction costs and tax hurdles. In Australia, for example, the study found that domestic investors receive tax reductions on dividend payments from Australian companies, but not from foreign ones.
Ultimately, investing is like your diet: it should be balanced. “An exaggerated home bias leads to a severe lack of diversification in a portfolio – and thus to needless emotional stress and possibly higher losses,” says analyst Joachim Klement, author of the Credit Suisse study. That said, it is almost impossible for private investors to build a portfolio with diversification aligned to the global equity markets. How broadly do I need to spread my investments? Which markets are a sensible addition?
Answers to these questions come from investment teams specialized in scientifically grounded investing. The digital investment advisor quirion, for example, follows the principles of portfolio theory and invests globally in index funds, ETFs and asset-class funds. As a result, its clients hold indirect stakes in more than 10,000 companies worldwide and systematically look beyond their own plate.
