Why you should invest outside of your home country.
In this episode you’ll learn:
- Why investing in multinational companies is not the same as global investing.
- What is home country bias and why does it exist.
- How home country bias differs between different countries.
- How to get inexpensive overseas stock exposure.
- Why have both currency hedged and unhedged international equity exposure.
Jack Bogle: I Wouldn’t Risk Investing Outside the U.S by Carla Fried – Bloomberg – December 2014
Are You A Home Country Biased Investor?
When I was an investment advisor, my U.S. based clients would on occasion ask why they should invest in non-U.S. stocks when there are so many multinational companies trading on U.S. stock exchanges that get a large percentage of their revenue from overseas.
I’d respond that U.S. multinationals indeed get much of their revenue overseas, but since their stocks trade on U.S. exchanges they tend to perform in line with the U.S. stock market.
By investing in a broad array of stocks that trade on local stock exchanges in dozens of countries investors benefit from a variety of return drivers and conditions. That’s what diversification means.
I’d then show my clients pretty graphs and tables reinforcing my point that by allocating to international stocks to complement their U.S. equity allocation the expected overall annual portfolio volatility was lower than if they kept all their stock allocation in the U.S.
Pretty graphs and tables usually convinced them as they liked the idea of a less risky (i.e. less volatile) portfolio. My clients typically allocated 20% to 25% of their stock allocation to international markets.
There was no magic to that 20-25% number.
In some ways, it was the international equity allocation I knew my clients would be comfortable with so it was what I recommended.
Safe At Home
Most investors continue to keep most of their stock allocation in their home country.
According to a study prepared by Vanguard using data from the International Monetary Fund, U.S. investors in 2010 had 72% of their equity allocation in U.S. stocks even though the U.S. comprises 53% of the global stock market as measured by market capitalization (i.e. the number of shares outstanding multiplied by the price).
This home country bias is even larger for non-U.S. investors.
According to the same study, Canadians kept 65% of their stock holdings in Canadian companies even though Canada comprised only 3% of the global stock market.
The Australian stock market comprises 2% of the global stock market, yet Australian investors had 74% of their equity allocation in Australian stocks.
Finally, UK investors kept 50% of their stock allocation in UK listed shares even though the UK comprises 7% of the global stock market.
Most investors keep most of their investments in their home country because it is the place where they have the greatest familiarity and comfort.
The Rowboat Syndrome
Jack Bogle, founder of the Vanguard Group who has done more to popularize passive index investing than anyone I know, invests very little in international stocks.
His rational is the market is a great equalizer and over time he thinks international stocks will perform the same as U.S. stocks so why take the currency risk.
During an interview on Bloomberg, the interviewer asked Bogle about the U.S. stock market being more expensive than other international markets so shouldn’t investors be less enthusiastic about U.S. stocks?
Bogle replied, “It would be nice to only invest when valuations are low. Moments of great depression in stock values are a great time to buy. You can’t invest at 2009 valuations today. So what are you going to do? You have to invest at today’s valuations. You can’t not invest now. Choose to not invest and you are ensuring you will have nothing 40 or 50 years from now.”
“You’re investing for a lifetime. A 40-year-old probably has a 50-year life expectancy. That’s what you’re investing for. I am an indexer. That’s well known. I’d keep it simple and have my money in the S&P 500 or a broad market index, and the rest in the bond index.”
In an earlier interview with Morningstar when commenting on how well emerging markets stocks had performed and how investors were plowing a great deal of money into that area, Bogle called it the “Rowboat Syndrome.”
Bogle described the “Rowboat Syndrome” as “You are always looking back where you know where you’ve been, but you have no idea where you are going.”
Simple Is Better
Bogle makes two excellent points.
Simple is usually better when it comes to investing, and we generally have no idea where markets are going.
Having said that, I disagree with Jack Bogle regarding international investing. He suggests U.S. markets will perform similarly to non-U.S. markets.
There is no way to know that.
The Case of Japan
In the mid to late 1980s, Japanese stocks performed very well and comprised over 40% of global stock market capitalization.
Japanese investors are the most home-biased in the world according to a research study by Geert Bekaert and Xiaozheng Wang of Columbia University.
Japanese investors who kept things simple by keeping all of their stock investments in Japan would have had a very disappointing investing experience over the past couple of decades.
Japanese stocks as measured by the MSCI Japan Index in yen fell 68% on an absolute basis between the end of December 1989 and the end of April 2003.
Since May 1994, that same index has returned only 1.15% annualized through October 2015
A Japanese investor who discarded their home country bias and invested in a global stock market index such as the MSCI World Index that was hedged into Japanese yen in order to avoid currency risk would have generated an annualized return of 7.9% from May 1994 through October 2015.
Japanese investors didn’t need to know where markets were heading to make the decision to allocate a portion of their portfolios to non-Japanese stocks.
They could have simply looked at the valuation of the Japanese stock market to see it was significantly overvalued relative to its historical norms.
Low Cost Global ETFs and Funds
Being mindful of market valuations is one way to decide an allocation to international stocks, but the simplest way to determine the amount of international equity exposure versus your home country is to let the market decide for you.
Investors can purchase low-cost passive index funds and ETFs that are global in nature with exposure to over 40 countries and several thousand securities weighted by market capitalization. These funds and ETFs are available in both currency hedged and non-hedged versions.`
Now that is diversification.