Home Bias

People generally prefer the familiar to the foreign. In investing, this preference expresses itself through home country bias. Biased investors allocate more to their home country’s stocks than the percentage their home country’s stocks are of the world's stock market.

We often show clients the following cartogram illustrating countries' shares of the global market capitalization.

Percent of world market capitalization as of Dec 31, 2015. Courtesy of Dimensional Fund Advisors.

Many are surprised that the U.S. is only half of the world stock market. Apple, Google, Chevron, Microsoft, GE... aren’t most great companies American? Judging by the U.S.-heavy portfolios new clients show us, many investment advisors may think so.

There are myriad cited reasons for U.S. investors to have a home bias. The U.S. has strong corporate governance and rule of law. The U.S. has a track record of producing world-renowned products and businesses. U.S. multi-national corporations provide ample global revenue exposure. U.S. investing removes currency risk and has generally low transaction costs.  

All of those statements are true. However, they are common knowledge. The markets have already priced them in. Still, a recent paper by Vanguard shows that an over-allocation to domestic stocks is part of a wider phenomenon.

Data as of Dec 31, 2014. Courtesy of the International Monetary Fund.

Americans actually look quite worldly in comparison. Canadian, British, and Australian home biases are staggering. The most incredible figure is that Japanese companies are a majority of Japanese stock portfolios. These are the very same Japanese stocks that remain far below their 1989 peak!

Yahoo! Finance as of September 30, 2016.

The next chart displays the Japanese stock market (Nikkei 225) starting in 1988. A systematic investor may have made money by buying the dips. But someone who held Japanese stocks over the past quarter century earned nothing.

For those who remember the 1980s, the hype was that Japan would overtake the U.S. as the world’s largest economy. Instead, during the last 25 years, the Japanese economy barely grew. A Japanese citizen suffered the double-whammy of bleak returns and an economic catastrophe at home.

Today, a few clicks can buy stocks anywhere. With every stock on everyone’s menu, the collective wisdom of the world’s investors – investment managers, endowments, retirement plans, etc. – values global stocks according to the cartogram. Yet with heavy home biases, individual investors in effect reject that collective knowledge.

Reasonable investors can disagree on whether some home bias is justified. However, it’s hard to justify the dramatic biases we see above. An investor with a strong home bias (a) reduces his access to the global opportunity set, (b) attempts to outsmart the collective wisdom of millions of investors, (c) is under-diversified, and (d) risks overexposure to a lackluster market.