Analyst Insight
Introduction
In the current environment, marked by uncertainty and increasing recession expectations, some investors may be seeing red or very little returns in their equity portfolio. Can home bias help to improve the returns on one’s portfolio or is it limiting it? Home bias refers to the tendency by investors to invest most of their portfolio in domestic equities, rather than diversifying with foreign equities”. I would expand this definition to include not just equities, but any asset class, whether it be real estate, fixed income, etc. However, for this article, we will be focusing on equities.
Home Bias – The Good
Those who say home bias is good will likely say this because of the advantage of being closer to the action, therefore generating greater insight into what is currently happening with the investment in real-time and forming a more informed opinion of its prospects. For example, let’s take Honey Bun, which sells its products to supermarkets and other customers. If for example, one goes to the supermarket often and consistently sees empty shelves where Honey Bun products are supposed to be or consistently sees multiple customer’s trolleys full of Honey Bun products, one may then form an opinion that there is momentum, or at the very least a strong persistence in the demand for the company’s products. Additionally, if the prices of Honey Bun’s products have increased and yet shelves are still empty and customers are still buying, it further bolsters the idea that the demand for the company’s products is not only strong but also not very sensitive to changes in price. Foreign investors are often late to these insights or miss them completely, especially if their information is limited to what they see in the quarterly or annual reports released by the company, as it is not likely to fully reveal the nuances of the market on the ground. It is essential to note that this should not be the only deciding factor in investing, however, this could be a good starting point. Empty shelves could mean supply challenges and increasing prices could reflect broad-based inflation within the economy. It is best to supplement this by further research and analysis of the economy, the industry, and the company itself.
Home Bias – The Bad
On the other hand, others say home bias is not a good thing. They will likely say this because, it limits the investment opportunities available to an investor, opportunities that could provide higher risk-adjusted returns. There is a vast universe of available investments internationally, especially as technology has advanced and the world becomes a much more connected place. Let’s look at the data. Over the past three years, the JSE Combined Index declined 27.4%, from 524,421.61 on August 12, 2019, to 380,712.84 on August 12, 2022. While that Index was declining, other Indexes in major regions were increasing at the same time. For example, according to Investing.com, in the United States, the S&P 500 Index has a 3-year return of 50.31%, in the United Kingdom, the FTSE 100 Index has a 3-year return of 6.14%, in the European Union, the Euro Stoxx 50 Index has a 3-year return of 15.05%, in Japan, the Nikkei 225 Index has a 3-year return of 39.90%, in China, the Shanghai Index has a 3-year return of 16.38% and in India, the Nifty 50 Index had a 3-year return of 60.46%. This implies that some exposure to these countries/regions would have helped one’s portfolio gain a higher return when compared to a portfolio totally or heavily weighted towards the JSE Combined Index over those three years. This is not to say that segments of the market could not have outperformed the JSE Combined Index. For example, the Junior Market Index has a 3- year return of 15.42% and there are individual stocks which have even outperformed the index. However, an important note to make here and something investors need to keep in mind is that if one wants to invest in another country, they will now be exposed to additional country risk while at the same time, would be reducing their exposure to concentration risk. Either way, the investor will now have to research that country and, if the information is available, the industry or target market in that country as well, before deploying capital.
Conclusion
There may be merits to both perspectives and at the end of the day, the actions of an investor should be in line with their goals and risk tolerance. Investing is a personal journey and everyone should find what works for them. So, whether you have a home bias or not, whether you think home bias is good or not, ultimately, if an investor is consistently hitting their goals and is pleased with their returns, not much else should matter. New investors may have a smoother learning experience focusing primarily on the local market and getting experience there before moving on to more advanced markets. Experienced investors, on the other hand, in addition to investing locally, may consider opportunities in foreign markets where, as shown earlier, potentially higher returns can be found. Of course, experienced investors should take this course of action if it will aid in hitting their goals. Financial institutions such as Barita are here to help with this by covering and providing research on securities across different markets to help the investor make more informed investment decisions.
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