Home Country Bias

November 1st, 2010
by David Tarantino

Home country bias is a term used to describe investment behavior whereby investors display a tendency to hold a large percentage of their assets in investments within their borders.  This bias may have a positive net effect during periods when their home country is growing faster than foreign competitors and/or their currency is appreciating relative to other currencies.  However, this bias may lead to missed opportunities if foreign competitors are gaining world market share due to faster economic growth and/or their currencies are appreciating versus the home currency.

Home country bias served U.S. investors quite well for the better part of the 80’s and 90’s.  Rapid growth, fueled by technological innovation, helped equity investors earn about 17% per annum during this period.  The U.S. comprised well over 50% of the world’s market cap in 2000. Fast-forward 10 years to the current environment, and we see a different picture.

The typical U.S. investor has the following global equity allocation*: 80% U.S., 15% Developed International, and 5% Emerging Market.  Contrast this allocation with the total world equity market capitalization**: 43% U.S., 45% Developed International, and 12% Emerging Market, and it is fair to conclude that many U.S. investors are underexposed to markets abroad.  Many of these foreign markets have performed well over the past decade, a period that sustained two recessions and negative returns for U.S. equity markets.  Developed countries with vast natural resources (Canada and Australia), and Emerging countries with inexpensive labor and consumers demanding a higher living standard (Brazil and China), fared much better than the U.S.  Will this continue?  A Goldman Sachs study claims that Emerging countries will make up over 30% of the world’s equity market capitalization by 2030.

While allocating assets overseas may add elements of risk to equity investing, it is difficult to ignore the successes over the past decade, as well as the apparent opportunities for economic growth, and in turn positive investment returns into the future.  Additionally, many Developed and Emerging market economies have fewer of the fiscal and budgetary problems that are likely to persist in this country.  We strongly recommend that U.S. equity investors avoid home country bias.

*Cap Gemini World Wealth Report 2009
** MSCI AC World Index 5/2010