Look beyond own backyard

New research by wealth management firm AXA Australia has found the home-country bias held by most investors needs to change and urged financial advisers to start seriously looking at global equities.

The research analysed three arguments investors held for investing locally, including the belief that a home-country bias reduced portfolio risk, that it would better match future liabilities and that it offered better alpha potential.

According to AXA chief investment officer Mark Dutton, the research has proven all three assertions to be erroneous. “Every country in the world shows bias towards investing in assets in its own country, and it’s not because of better returns. What we found was that home bias has more to do with perception of better returns based on emotion rather than concrete analysis,” Dutton said.

“Investors stick close to home because it’s familiar and comfortable. But unfamiliarity with overseas markets is not a good investment reason not to invest in them.”

The research did a comparative volatility analysis over 30 years of the five major markets and found local markets were consistently more volatile than the global market.

Dutton pointed out that there were 1,796 stocks on the world index, compared to roughly 300 in Australia, and because there are far fewer stocks in the local market, there are fewer ways to diversify risk.

“Consider also that there is far greater concentration of the really large stocks in the local market. So the biggest stock locally comprises 10 per cent of the index, whereas the largest global stock comprises only 2 per cent of the total index. So the risk of being exposed to the volatility of any single stock is greatly reduced,” he said.

Dutton said many opportunities for increasing alpha would be missed by limiting investments to local stocks.

Taken from January 1994 through to December 2004, the data found that the median alpha for a global manager was 2.7 per cent, while for Australia it was 1.3 per cent, and 1.7 per cent in the US.

“Although the Australian market is attractive, it is simply not true that there are more opportunities. The conclusion is that you are better off diversifying internationally than you are investing in the home market, and financial advisers need to start looking at global equities seriously,” Dutton said.

The research also refuted the belief that home-country bias offered a better match for long-term liabilities. To do this, AXA compared the tracking errors of each country’s 10-year local government bond with those of its local index, versus the hedged world index, and found the latter offered a better match for local liabilities.