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Home Bias: Why it’s Important to be Globally Diversified

One of the most common behavioural biases that investors are prone to is home bias.

In other words, home bias is when we invest too much of our portfolios in stocks and bonds from our own countries and not enough in assets from elsewhere in the world.

Peter Westaway from Vanguard explains that the idea of home bias is that investors will systematically tend to overweight the assets.

For example, in the UK the stock market is around 8% of the global stock market.

The average holding of the UK investor is around 50% so there’s a big overweight to UK assets.

Of course, it’s not just the UK.

Investors all over the world have this preference for investing close to home. Often advisers and investors will use currency risk to justify it and so waiting to home markets is a way of avoiding currency risk.

This is a classic example of home bias, and is not always the best way.

For example, in fixed income markets it’s much easier just to buy a type of asset that’s hedged out so that you no longer expose your overseas bonds to currency fluctuations.

With equities, you could hedge that out as well, although we think having unhedged equity exposure is sometimes a benefit because it doesn’t necessarily add volatility to your portfolio.

Because sometimes a local stock market and the local currency go in the opposite direction and cancel each other out, what if you have a hunch that a country’s fortunes are about to rise or fall?

Unfortunately, it’s very difficult to profit from those sorts of events.

By the time there’s some information that becomes compelling, it becomes the consensus view and is clearly going to happen. By that point even if it turns out to be true that’s probably already priced into the market.

You’ve even lost the opportunity by then to profit from it.

It’s about being able to predict those events that nobody else can do and home bias makes this difficult.

Some people get paid a lot of money to try and do that, but the reality is on average most of those don’t deliver.

the alternative strategy to that is having a portfolio of investments that aren’t loaded up on political events or states of the world coming around.

So being aware of home bias and diversifying globally really does make sense

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