Patriotic: When it comes to our investments, a home bias is not always the best strategy
When it comes to our groceries and soft furnishings, many of us prefer to be patriotic and buy British. But when it comes to our investments, a home bias is not always the best strategy.
Investing in UK-listed companies is common among investors. Recent research conducted by asset manager Quilter found that nearly two thirds of those it surveyed had more than a quarter of their portfolio invested in the UK stock market.
Some were even more wedded to home bias, with 46 per cent holding more than half of their investments in UK companies and around 8 per cent having all their investments in UK investment funds or shares.
It's easy to understand why UK companies end up as the bedrock of so many investors' portfolios. 'People like to invest in companies they know and, for UK investors that happens to be UK companies,' says David Henry, investment manager at Quilter. 'You see exactly the same home bias among investors in other countries too.'
A desire for income also fuels UK investors' home bias. Chunky dividends are a characteristic of many large UK companies, which makes them a popular choice for anyone looking to top up their income.
Home bias also helps to limit currency risk. 'Most UK investors have their liabilities in sterling so it makes sense to have their investments in the same currency,' says Daniel Casali, chief investment strategist at Tilney Smith & Williamson. 'Currency movements can make a huge difference to returns: holding assets in sterling removes this additional layer of risk.'
Although there are plenty of good reasons why home bias exists, investing close to home can increase risk, potentially transforming safe, well-known investments into performance draining holdings.
In particular, you can miss out on the benefits of diversification. Spreading your investments as broadly as possibly, ideally globally, means you're not tied to the fortunes of one country. Instead, if a country or region performs badly, it's likely that another will be seeing stronger growth, helping to stabilise your overall returns.
Sticking rigidly to your home market also means you miss out on sector diversification. The UK stock market is weighted towards sectors such as energy and financials. So, if you only invest in the UK, you'll miss out on growth in some other sectors.
A prime example of this is technology, as Quilter's Henry explains. He says: 'Many technology companies have experienced huge growth over the past few years. Indeed, you only need to look at the latest upbeat results published last week from the likes of Apple and Alphabet to see that the technology investment theme remains a dominant one.'
He adds: 'But the UK stock market has only a 1.93 per cent weighting in the tech sector. So, if you had only invested in UK companies, you would have missed out on this profitable investment theme. Part of the reason geographical diversification works is because it gives you exposure to every sector.'
The risks of a home investment bias come into sharp focus when you consider just how small a part of the global stock market the UK represents. The UK accounts for just 3.7 per cent of the constituents that make up the MSCI All Country World Index. In comparison, the US makes up 59 per cent, with Japan at 5.9 per cent and China at 4.9 per cent.
Our standing in the world indices might make you want to rush off and sell most of your UK holdings to replicate that 3.7 per cent weighting. But Ed Monk, associate director of personal investing at Fidelity International, argues that having a home bias doesn't necessarily mean you're overexposed to the UK stock market.
'It can work in your favour,' he explains. 'If you're familiar with the names of the companies you invest in, perhaps as a customer, it can help you make a more informed decision.'
Particular features of the UK stock market can also help reduce the risk associated with home bias. Some of the companies listed on the UK stock market are global giants, earning their money from all around the world. In fact, across the FTSE100 Index, as much as 70 per cent of company earnings are made overseas.
As an example, take consumer goods company Unilever. Although it's part of the FTSE 100 – and can trace its roots back to William Lever's Sunlight soap in Victorian Merseyside – it has customers in 190 countries around the world.
For an investor, this means that when you buy shares in Unilever, you're actually getting exposure to the growth of economies in many other countries too. Having a home bias might not be as bad as it initially sounds, but the risk of missing out on growth around the world means it's prudent to diversify and shift into more international holdings.
Fidelity's Monk says investors should always aim for a balance of exposure to different geographic regions, even if an element of home bias is natural. He advocates having an allocation of between 5 per cent and 10 per cent of investment to the UK.
If your portfolio is considerably more biased to the UK than this, and you'd like to take advantage of more diversification, Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, has the following advice: 'Don't panic. You don't need to move everything in one go. It's about trimming your portfolio rather than pulling it out at the roots.'
A global investment fund can provide an instant hit of diversification, giving you exposure to everything from US technology shares to European pharmaceutical companies. But it's also worth checking exactly where such funds are invested as, in spite of the global name, many also have a home bias of their own.
As an example, Monk points to Invesco Perpetual Global Equity Income fund, which has a UK weighting approaching 13 per cent. He says: 'This is probably due to the fund's focus on income, which is easier to come by in the UK than in many other markets. Other global funds tend to have lower UK exposure. For example, the successful Fundsmith Equity fund, managed by Terry Smith, has just over seven per cent exposure to the UK.
'But do check the allocation to British companies in any global fund, especially if you're thinking of adding some specialist UK funds to sit alongside them.'
Building a portfolio around a solid global fund can keep some of the fun out of investing. One of the key reasons for home bias is our familiarity with leading UK companies: watching the performance of a global fund can be less exciting than seeing your favourite sausage roll company do well on the back of its latest product announcement.
Quilter's Henry is a big fan of this approach. 'I'd never discourage anyone from buying companies whose products they like, provided they don't make these types of investment more than between 5 per cent and 10 per cent of their portfolio,' he says.
'It can act as a behavioural release, giving you the excitement of investing while the bulk of your portfolio is tucked away in a global fund and ticking along nicely.'
Another reason not to rush into losing the home bias you might have in your portfolio is that the UK's fortunes may be about to change. After a few years of lagging behind global peers as a result of the pandemic and the fallout from the EU referendum, the fundamentals for the UK stock market now look more positive.
Global equities overall are quite expensive compared to their long-term average. This can be seen in the recent interest from private equity firms for UK companies such as supermarket chain Morrisons and construction company John Laing.
ONE BEGINNER'S TRAP IT'S EASY TO FALL INTO
Whether you're British, American or French, home bias is likely to come into play when you're investing. But, whatever your nationality, you can fall foul of stock market skews towards particular sectors.
In the UK, the stock market is dominated by energy, commodity and financial companies such as banks and insurance firms.
Across the Channel, European stock markets are peppered with pharmaceutical companies, including the likes of Roche and Bayer while the Japanese stock market is the gateway to emerging Asia and futuristic sectors such as robotics.
The US also has more than its fair share of technology companies listed on its stock market – the likes of Alphabet, Apple and Microsoft – as well as many high-quality global consumer brands.
It may feel you need to pick a country to gain decent exposure to a specific sector. However, the UK is proposing reforms that could change the make-up of its stock market. Hargreaves Lansdown's Susannah Streeter says: 'The Government is keen to change the stock market rules to make it more attractive to list companies.
'For example, fintech company Wise recently listed on the London Stock Exchange, with the potential for significant growth.
'By making it easier for companies to list here, we could see a wider mix of companies make up the UK stock market.'