Aviva Investors: The folly of home bias

An investor who focuses only on the UK will be handicapped in their ability to maximise returns.

The UK has become a far less insular country over the past 40 years or so. British eating habits, for example, have undergone a revolution. While dried and fresh pasta was not even recorded on the government’s National Food Survey until 1998, today’s supermarkets are packed with food from across the globe to cater for the increasingly adventurous appetite of modern Britons. Many are as familiar with Mexican, Thai and Italian cuisine as the traditional roast dinner, appreciating the different international flavours and sometimes the health benefits that flow from spurning familiar local dishes.

Yet when it comes to investing, the British (and other nationalities) appear to have little appetite for exploring foreign opportunities. In other words, investors across the globe have an apparently innate home bias, preferring to invest in companies based in domestic markets rather than looking abroad.

Why home bias should be avoided

There is a large body of research that shows that home bias handicaps the ability of investors to maximise investment returns. Investors who focus on the domestic market will be far less diversified than those who hold a portfolio of international stocks. This is true even in the UK, where an estimated 75% of the revenues of FTSE 100 member-companies are earned from abroad, according to CityWire.¹

Why do investors have a home bias?

Common concerns for investing globally include:

• Currency risk

Investors may worry about the currency risk associated with exposure to foreign markets.

• Concerns over protections of investments

They may also wonder if their money invested abroad will be as safe as it is invested in the UK with its established legal framework and solid corporate governance.

• Geopoltical risks and tax implications

Investors may be concerned about geopoltical risks and tax implications. Or investors may simply wish to avoid putting their savings into companies located in markets on the other side of the world, about which they have little knowledge.

Whatever the reason, academic studies from around the world highlight the propensity of investors towards a home bias. For example, UK equities accounted for 4.6% of the overall global equity market in 2016, according to Bloomberg, yet they accounted for around 27% of UK multi-asset portfolios.²

Why does home bias affect UK investors specifically?

In the UK, the index is heavily concentrated in terms of companies and sectors. Just four companies (HSBC Holdings, British American Tobacco, Royal Dutch Shell and BP) account for 25% of the FTSE 100’s market capitalisation. Banking, insurance and financial services, pharmaceuticals, basic resources, and oil and gas account for over half of the FTSE 100’s market capitalisation. So, an investor who focuses on the UK is only exposed to a relatively small number of sectors and companies, which makes them highly vulnerable to adverse shocks in either.

The benefits of investing globally

• Greater Diversification – Investors have exposure to potentially fast-growing stocks and sectors, such as technology, that are simply lacking in domestic markets.
• More Growth Potential – Investing internationally means you can access economies and companies with greater growth potential than the UK. The International Money Fund (IMF) expects China to expand by around 6.5%³ while the UK will only grow by 2% in 2017.⁴
• Access to Emerging Economies – One of the reasons for China’s predicted growth is because of the potential for corporate earnings growth. The UK is already a mature economy, so investing globally is the only way to access emerging and rapidly growing economies.

The dangers of home bias

With global investments, a common concern is geopolitical risk. However, this is certainly no longer confined to emerging markets as the UK’s vote to leave the European Union and the election of Donald Trump as president of the US have demonstrated. There are strong arguments to suggest that investors’ fear of emerging markets is therefore unfounded. Indeed, the seeds of the global financial crisis were largely sown by regulatory failures in the US and not among emerging economies, which generally weathered the storm well.

We certainly believe in the importance of taking a global approach at Aviva Investors. In our multi-asset funds, we invest globally to seek out the best risk-adjusted returns.

Sources

¹ Citywire, 30 June 2016: citywireukinsights.co.uk/2016/06/the-uk-stocks-most-and-least-hitby-weak-pound.

² Bloomberg: www.businessinsider.com/world-stock-market-capitalizations-2016-11?IR=T; Aviva Investors. 

³ IMF World Economic Outlook Update, January 2017: https://www.imf.org/external/pubs/ft/weo/2017/update/01/.  

⁴ HM Treasury, Forecasts for the UK economy, January 2017: https://www.gov.uk/government/statistics/forecasts-for-the-uk-economy-january-2017

KEY RISKS

The value of an investment and any income from it can go down as well as up and can fluctuate in response to changes in currency exchange rates. Investors may not get back the original amount invested.

These funds use derivatives; these can be complex and highly volatile. This means in unusual market conditions the funds may suffer significant losses.

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Important Information

For financial advisers only.  This commentary is not an investment recommendation and should not be viewed as such. Except where stated as otherwise, the source of all information is Aviva Investors as at 31 December 2017.  Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.

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