Are You A Victim Of Home Bias?
Having a bias for your home country is, ironically, truly global, especially among investors. Mutual fund and equity investors alike all around the world tend to shy away from “foreign” markets, preferring to stick to the funds that are close to home – a phenomenon that”s known as “home bias” or “domestic bias.”
It”s no mystery that there”s comfort in the familiar. The question for mutual funds investors is this: what does home bias do to your mutual fund portfolio? Are these investors actually going to get closer to their goals with this approach, or are they missing out?
For Canadians, there”s an even bigger explanation for home bias – performance. From 2003 to 2012, the S&P/TSX Composite Index outperformed the S&P 500 in seven of 10 years. But as disclaimers warn, past performance is no guarantee of future performance. In 2011 and 2012, the S&P 500 outpaced the S&P/TSX Composite. It is interesting to note that as of December 31, 2012, the Canadian Pension Plan (CPP) Investment Board did not show domestic bias, instead holding 82% of the CPP Fund”s equities in markets outside the Great White North.
To illustrate the risks of domestic bias and the opportunities presented by exposure to global equity funds, let”s compare the strategies of two mutual fund investors, Ian and Marie.
Ian has always trusted Canadian equity mutual funds for almost all of his equity holdings. Marie takes a different tack. Her equity mutual funds are diversified across Canadian, U.S., and international markets – and her plan is based on her tolerance for volatility, her investment goals, and her time horizon.
Expand those horizons
Ian believes he”s playing it safe by focusing on Canadian equities, but he is limiting his investment opportunities – the Canadian market capitalization represents only about 5% of that of the world. He”s not only sacrificing diversification by geographic region, but also by sector. Nearly 80% of the benchmark S&P/TSX Composite is composed of only three sectors – energy, financial services, and materials. And what if Ian wants the security of large caps? Canada is home to only 11 of the world”s largest 500 companies.
Marie, on the other hand, gains all of the benefits of diversification by geographic region, sector, and market capitalization. She has the opportunity for higher potential returns through exposure to the best-performing markets. Marie decreases risk because she spreads out her investment dollars over a variety of markets. Also, over time, diversifying tends to smooth out the highs and lows of her overall portfolio performance.
Is your portfolio constructed to take advantage of equity opportunities around the world? Together, we can make sure your investments are well-diversified globally, without domestic bias or overemphasizing any one geographic region or sector.