Advert

The pros and cons of investor home bias

Like it or not, we are all prone to a common trait of bias, which stems from human nature of preferring one object to another, one person to another, based on personal prejudices and stereotypes.

Despite the fact that we often speak of bias in a negative manner, this does have its positive sides. Digging in human nature, bias was the way hunters identified risks, made alliances, and pretty much managed to survive.

Fast-forward some three thousand years, and these innate biases are still a strong part of what makes us who we are. Today bias can be seen as a much less useful tool compared to the usefulness it had for our ancestors, but nevertheless, like the proverbial sword it has a two-sided blade.

In the world of investments, looking at the preferences of investors around the globe, it is clear that investor bias remains strong. Investor bias is broadly taken as the overall preference of investors to invest in what they perceive as local or national – anything they can associate themselves with. Therefore the questions that will naturally come to mind are: what are the factors that spur this sentiment, making investors opt for local investments above other investments that may have better fundamental qualities? Secondly, how has this home bias impacted investors over the years?

If an investor were to allocate their portfolio efficiently, then they would allocate a portion of their portfolio in each market which is equal to the weighting of the total market. This, however, does not hold true, as investors from across the world tend to allocate significant portions of their portfolios in securities of their home countries, missing out on the benefits of international diversification.

The main source of home bias is the perception of knowledge local investors feel they possess regarding local corporations. This behavioural bias is cultivated through the investor’s exposure, be it to advertisements and possibly by other local news sources.

Fast-forward some three thousand years, and these innate biases are still a strong part of what makes us who we are

However, selection of any investment requires a much more thorough analysis and evaluation prior to selection. Another factor impacting investors’ preference towards local securities is the lack of knowledge regarding international securities. Rightly so, local investors feel less knowledgeable about foreign investments and feel that they are venturing into unknown territory.

Maltese investors are no different from their global counterpart, and allocating heavily towards local securities holds true. It can be argued that in the case of Malta this may be more of an issue than in other countries. This is because investors in countries with much bigger economies are compensated to some extent through the diversification and global nature of corporations listed in their home country.

Needless to say, Malta has become more interconnected with the global economy with the accession to the EU and as local businesses look abroad for expansion, it can be said that a number of locally listed companies have such exposure – be it limited in number.

Despite these developments, investing in local markets remains a niche. Looking at the data, investing in the Malta Stock Exchange over the last decade has generated a total return of 4.9 per cent annualised, comparatively the return on a broad global equity index such as the MSCI World Index generated an annualised return of 10.6 per cent.

This represents a strong opportunity cost for equity investors who base their portfolios solely on the local stock market. On the other hand, local bond investors draw comfort from the fact that local bonds tend to be more stable – however it should be noted that the European high yield bond index generated a 7.5 per cent annualised total return over the previous decade. Both these measures give an indication on a broad basis of the overall opportunity cost of investors with a strong home bias.

Investors who are aware of their home bias can make changes to their portfolios to take advantage of opportunities in different markets. By adding exposure to different markets, investors reduce home-market risk. Also, investors benefit from an increased variety in their exposure, as investing away from home will provide more options, compared to the local market which is small and limited in its options. In doing so, investors increase diversification.

Also, we need to appreciate that not all markets are at the same stage of their cycle. At any given point in time there would be markets experiencing rapid growth and some reaching a point of maturity, while others could be experiencing a correction.

Investors who venture in overseas direct equities should remember that any gains are tax at the individual personal rate of tax while gains from local shares are free of tax.

Despite literature suggesting that home bias is steadily decreasing, as more information becomes available to investors, this phenomenon is here to stay.

In the eyes of investors, it may look like an arduous task for them to be able to correctly apply these principles in order to assure a diversified return over their portfolio that mitigates home bias risk. Selecting the right securities, at the right time, from areas that provide favourable economic conditions is more than a full-time job. For this reason, it is critical to take great care when selecting the investment vehicles of choice. Fund managers provide the solution to this through their active management and selection strategies. Obviously we need to appreciate that these do come at a cost, but seeking financial advice in these important decisions is imperative.

This article was prepared by Daniel Gauci HnD Management, CeFa Investments, investment advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The company is licensed to conduct investment services by the MFSA and is a member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on tel: 2122 4410, e-mail daniel.gauci@jesmondmizzi.com or visit www.jesmondmizzi.com.

Comments not loading? We recommend using Google Chrome or Mozilla Firefox with javascript turned on.
Comments powered by Disqus  
Advert
Advert