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Everybody loves the comforts of home, but investors who become too anchored to familiar territory can end up with a very narrow view of the world. Jim Parker is the Vice President of DFA Australia Limited and he helps explain that when it comes to investing, it can pay to look beyond your local market!

 

As at 31 December 2016, superannuation funds regulated by the Australian Prudential Regulation Authority had nearly 50% of their total equity exposure in local shares. For self-managed super funds, the average home allocation was 72%1.

 

There are a number of rational reasons for home bias. Australian investors, for instance, have the advantage of dividend imputation. This is where firms that have already paid income tax on profits attach tax credits in distributions to shareholders.

 

A second understandable reason they might tilt to their home market is familiarity with the companies they are investing in. Companies like Westpac, ANZ, Qantas and Telstra are household names and are frequently in the news.

 

Undesirable consequences

Having a sizeable home bias means not only taking a big bet on a single country, but ending up with a disproportionate exposure to certain sectors. Your portfolio ends up with very concentrated exposure to individual countries, companies and sectors.

 

This is particularly the case where your home market [Australia] is relatively small in a global sense [ie: around 2%] or where it is dominated by one or two sectors.

 

In Australia’s case, the big four banks represented nearly 28% of the market, as of early 2017. Financials overall made up 38%, while material stocks represented 17%. In other words, two sectors made up more than half of the market.

 

What happens at home…

Another way of looking at this bias is to consider which sectors are poorly represented in Australia. For instance, information technology stocks made up just 1.3% of the local market, compared to 16% globally.

 

These details help us to understand that home bias represents a pronounced deviation from the global market portfolio. It can leave you taking unnecessarily risks.

 

Given investors tend to source most of their income from their home nation and hold most of their other assets there, this degree of home bias represents a very big bet on one country, a couple of sectors and a handful of stocks.

 

So the question then becomes what degree of home bias is acceptable? It shouldn’t be surprising that there is no one right answer. It really depends on each individual investor’s tastes, preferences, circumstances and goals.

 

How to use a Global Market Portfolio to your advantage when investing

Broad global diversification creates a portfolio that spreads its risk to more economies, to a greater number of stocks, to a wider range of companies and to a wider spread of sectors.

If you want to increase the expected return of your portfolio, you can use information in current market prices and company fundamentals to tilt your portfolio towards stocks with higher expected returns.

 

There is no single right answer in terms of asset allocation. It will depend on the individual investor’s circumstances, goals and risk appetite. That’s where a discussion with us may help you create a Global Market Portfolio to help you reach your lifestyle goals.

 

 

  1. SMSF Investment Patterns Survey, SuperConcepts, December 2016

 

Additional information: “Leaving Home” Jim Parker, Vice President, DFA Australia Limited, April 2017.

Jim Parker

Vice President of DFA Australia Limited

Jim Parker has a long history of applying academic research to practical investing.

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