When The Virgin Investor starts out on their investing journey, more often than not there is a bias towards equities in their home market. Approaching investing for the first time can be daunting, especially with the potential to lose more than is gained. Many investors will feel domestic company shares offer a certain level of comfort in familiarity and almost appear less risky than dealing on overseas stock markets, where governance and costs may not be as well controlled. This logic rarely stands up to scrutiny.
The overriding logic that does stand up to scrutiny is that greater diversification of a portfolio has a better chance of maximising returns and minimising risks. Limiting to a domestic market potentially means an opportunity cost of missing out on other faster growing global markets. For example, by 2030, emerging market GDP is set to make up 40% of the global total, up from around 25% today. The investor who hasn’t diversified their portfolio into emerging markets will, without doubt (and frustratingly), miss out on a large part of global growth over the next decade.
Also it goes without saying that a portfolio that is more exposed to the fortunes of a single domestic market will inevitably be hugely volatile.
It isn’t only The Virgin Investor that is guilty of home market bias in their investment portfolios. In 2014, FTSE 350 pension schemes allocated around a third (29%) of their total equity exposure to domestic shares despite the UK market making up only 7% of global equity capitalisation. With the UK returning lower (0.7%) than the MSCI Global Equity Index (10%) over the year, these pension schemes suffered heavily from their home market bias.
At this point, pension schemes may step in and point out that the UK home market bias is justified as UK listed company revenues are sufficiently global (especially on the FTSE 100) to offer diversification. The significantly poor performance of the UK share indexes vs the global index would suggest this strategy isn’t working. Also UK listed companies aren’t perfectly spread across industries and tend to over-index on certain industries (for example technology is particularly poorly represented on the FTSE).
There are numerous strategies for diversifying a portfolio across a number of different global markets and it is important that this is considered within a wider investment strategy. In all of this, the main point to take away for The Virgin Investor is to evaluate whether excessive home market bias has crept into their investment portfolio. And if that is the case, take actions to diversify.