As investors, we often concentrate our portfolios in favour of the home market at the expense of global diversification.
According to a recent article in the Sunday Times, “the average customer of Interactive Investor, an investment platform, has 80% of their investment portfolio in UK stocks.”
That is despite the UK stockmarket representing just 4% of the value of global equity markets (as at end-2022). For reference, US stocks make up 59%; Developed Europe ex-UK about 13%; Japan 6%; and China 4% (albeit potentially lower now given the continued stockmarket underperformance).
This phenomenon is known as ‘home country bias’.
Some of that bias exists because of historical norms – it used to be difficult to get low-cost exposure to international equities. But some of it is simply due to familiarity – investing in the companies you know through day-to-day experiences (I often come across DIY portfolios with the likes of BP, Shell, Nat Grid, Lloyds, Barclays, BAE, Rolls Royce, GSK, to name but a few).
Higher risk, lower return
Such a disproportionately high weighting to domestic stocks may occasionally deliver superior returns – in 2022 for example, UK companies held up extremely well during a rout in US tech stocks.
However, over the long-term, neglecting the benefits of global diversification (i.e. putting all your eggs in the UK basket) increases risk and reduces potential returns.
If you were to invest solely in the FTSE All-Share index for example, you’d hold a portfolio of around 600 companies, with c. 40% in thetop-10. In the context of around 20,000 listed companies globally, that represents a concentrated portfolio.
In a previous blog, I referenced the ‘Power Law’ in investing, whereby the vast majority of stockmarket returns come from a surprisingly small handful of companies – in the US for example, “all of the wealth creation in the US stockmarket since 1926 came from just 4% of stocks – the other 96%were statistically irrelevant.”
By confining yourself to domestic stocks only, the opportunity for outperformance reduces considerably.
In terms of those potential returns, I make no prediction of what the future holds for domestic stocks – on the one hand, they’re cheap; onthe other, the FTSE is skewed towards ‘old industries’ (mining, energy, etc.),with only a handful of tech stocks.
But historically, a high domestic weighting would have weighed heavily on returns.
The chart below shows what £10,000 invested in the FTSE All-Share index (proxy for the UK stockmarket) back in February 2014 would beworth today, and how this compares with an equivalent amount invested in the MSCI World (global stockmarket):
That is, over the last ten years, the global stockmarket hasdelivered returns of c. 102%, vs just 18% for UK plc.
Disclaimer: When investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you mayget back less than you invested, particularly where investing for a short timeframe (we normally recommend a horizon of at least 5 years). Neither simulated nor actual past performance are a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. Changes in the rates of foreign exchange between currencies may cause the value of your investment to fluctuate.
Global diversification
Attempting to pick winning stocks in a single country is a challenging proposition.
Instead, by holding a globally diversified portfolio, you’re well positioned to capture returns wherever they occur.
Disclaimer: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require in order to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
