Will Australian investors pay a heavy price for home bias?
International experts have warned home bias could prove detrimental to Aussie investors, reports Janine Mace.
Staying warm and cosy in familiar surrounds sounds attractive when the world around you is looking shaky and uncertain, but it can also be a recipe for disappointment when it comes to building wealth.
Although the problems inherent in Australian investors’ love affair with local shares (or their strong ‘home country bias’), has been discussed many times in the past, the current environment means the issue has once again come to the fore.
A recent study by international firm Towers Watson into global pension assets found Australia was second only to the US in its home country equity bias.
Although Australia’s strong economic position since the GFC has generated positive returns for investors, investment experts are warning the results in 2013 may not be as positive for portfolios heavily weighted towards local shares.
It’s a point made by BlackRock’s San Francisco-based global chief investment strategist, Russ Koesterich, during a recent visit to Australia.
“With Australia now trading at a premium to most developed markets, I am currently recommending maintaining a benchmark weight to the Australian market and encouraging investors to add international investments to their portfolios to avoid home bias,” he says.
Koesterich believes home country bias is not a good thing, but knows it is not specific to the Australian market.
“It is a very understandable bias, but it is still not a good idea, as you are not getting diversification in the portfolio - especially in Australia – where the index is very concentrated in banks and resource companies,” he explains.
“Investors in very concentrated markets will do better by broadening their investment horizon. It is a long-term issue that needs to be addressed, as a better diversified portfolio will do better in the long-term.”
Many investors also believe keeping their investments at home will provide some level of protection against the vagaries of international markets, but this no longer rings true.
“It is hard to shut the rest of the world out – even if you want to – as events happening overseas will have an impact on local shares. Even if investors want to keep investments at home they will be impacted by overseas events,” Koesterich says.
Hexavest’s Montreal-based vice president Asian markets, Frederic Imbeault, is another international expert who questions the future success of emphasising Australian shares.
“It is hard in a small country like Australia or Canada to be over-exposed to local markets. For individual investors, they need to be diversified locally and worldwide. Often there are very few names to buy in the market and as the institutions have to buy them, they can be pricier than they would be otherwise,” he explains.
Andrew Doherty, head of equity research at Morningstar, agrees market concentration is an important issue for local investors.
“Banks and resources represent half of the Australian market, so it is very narrowly focussed. It makes a lot of sense for investors to look offshore for diversification purposes, as it allows access to quality businesses like GE, Google and Apple, which aren’t in Australia.”
Total return counts
Although MLC acting CIO and head of equities, Jonathan Armitage, agrees a lack of international diversification is important when it comes to constructing a good portfolio, he acknowledges the strength of the bias towards an investor’s home market.
“It is part of human nature that investors want to invest in companies they are familiar with. However, the significance of the home country bias depends on the individual and their risk tolerance and their timespan for investing,” he explains.
Donald Williams, Platypus Asset Management chief investment officer, is largely unconcerned by the phenomenon.
“Home-country bias is not a problem as the return profile of the Australian equity market is similar to that of the US, so you get the same total return,” he argues.
“It makes sense to diversify, but Australian investors can get a similar total return without going offshore. They also get the benefit of franking credits and don’t have to worry about currency movements. The Australian currency moves a lot and is very hard to predict and it is expensive to hedge, given the interest rate differential.”
Issues around familiarity and access to information often tip the balance towards the local market for retail investors, Williams says.
“It is easier to analyse and understand local companies than when you go offshore. A lot of the best equity managers offshore are full or can’t continue to perform due to size constraints, so it can be difficult to go offshore.”
However, Doherty believes the investment and information constraints are breaking down.
“Australians typically focus on domestic investing, but it is getting easier to go offshore through increased information availability and access.
"For example, Morningstar has research for 2,000 companies worldwide. Online brokers are also gearing up to allow investing offshore, and that will make it easier,” he says.
Favouring franking credits
Despite the importance of portfolio diversification, the key argument used to support the home-country bias exhibited by most local portfolios is tax-based, according to Roy Maslen, AllianceBernstein’s CIO Australian value equities.
“The prime reason most often cited for home-country bias in Australia is the availability of franking credits,” he says.
AMP Capital head of retail, Craig Keary, agrees the availability of franking credits is hard to ignore, especially for those in high tax brackets.
“It is not just the investment returns, but the after-tax return that matters. If you invest in blue chip companies with franking credits, that is always a big attraction,” he explains.
It is an advantage yield-hungry investors will not give up easily, Armitage says.
“Franking credits are a very important feature of the local market, especially for those looking for income. Domestic companies have a big advantage through their dividends and franking credits, and this is very important to many investors.”
However, Maslen believes investors for whom yield and tax are important should also consider manager services that aim to enhance after-tax returns.
“We believe the best way to enhance after-tax returns in Australian equities is to consider tax at every stage of the investment process, rather than as a bolt-on at the end of the process,” he notes.
In Doherty’s view, franking credits are only part of the story.
“What matters most is the total return and franking credits are very important, but they are only one part of the equation. If Australian companies are overvalued, isn’t it better to invest in cheaper high-quality companies overseas? You need to be investing in high quality companies that can be bought at a good price,” he says.
The experts also believe now is a good time to look offshore.
“International equities shouldn’t be dismissed due to the opportunities available, especially if the Australian dollar weakens, as returns will rise,” notes Armitage.
“Advisers need to have the conversation now while the Australian dollar is buying more to get an increased return later.”
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