Camille Van Vyve
12 Jul 2021
Home bias: the fear of the unknown
Buy Colruyt shares rather than Walmart. Solvay rather than Celanese. UCB rather than Pfizer. This is a usual investment reflex, often irrational, called "home bias". Are you subject to this little quirk? What consequences can this have on your portfolio?
Home bias : definition
Home bias refers to investors' natural inclination for domestic securities, ignoring the benefits of diversifying into foreign securities. This bias is not only found in finance, however: sports fans around the world often have a deep attachment to the teams of their country or their city, this preference having no rational basis. Bookmakers know a thing about this in Euro football times: most players tend to bet totally unreasonably on their national team!
Better a demon you know than an angel you don't know
We prefer what we know. In behavioral finance, this trend can be explained by the perception that investors have of transaction costs and the accessibility of foreign securities, and especially by their ignorance of companies established outside their local market.
French people are very patriotic, Belgians a little less
Our French neighbors are champions of national preference. While France's global index weight (its share of global market capitalization) amounts to only 3%, its inhabitants make 60% of their investments in equities on the domestic market. In comparison, Belgians make “only” 45% of their investments on the local market.
Not just private investors
A 2012 Indiana University study titled No Place Like Home: Familiarity in Mutual Fund Manager Portfolio Choice found that even US fund managers were inclined to overweight stocks from their home state or country. State of domiciliation of the fund in their investment decisions. This is a little less true in Europe where most of the funds are located in financial centers such as Luxembourg or London, without this really influencing their constitution. However, “national preference” therefore does not only concern individual investors.
Against the principle of diversification
It's a basic principle: diversification reduces risk by spreading your investments across different types of assets, geographies and industries. The goal of diversification is to maximize return by reducing the risk of a particular event having negative consequences for the entire portfolio. By remaining invested in their local market, the investor increases the volatility of their portfolio and likely misses investment opportunities in higher growth markets.
Even though globalization reduces the risk
Globalization means that the economies of different countries are increasingly interconnected and that companies are more international. A negative event that occurs in one part of the world therefore often reverberates in others; this was the case, for example, with the subprime crisis which started in the United States in 2008 and which had consequences on world markets. But this is not necessarily the case for events of a more fable scale, or of a more political than economic nature, for example. Globalization is therefore not a sufficient argument to neglect the geographic diversification of one's portfolio.
ETFs, a simple and inexpensive way to reduce the impact of national preference
Investing in foreign stocks has become much easier and cheaper with the advent of the Internet, the acceleration of the flow of information, the creation of online trading platforms and the launch of listed funds (ETFs) that are easily accessible for any investor. With easyvest's ETF investment formulas, you are de facto exposed to all listed companies in the world: a simple and effective way to avoid overweighting Belgian stocks in your portfolio.
Note: This article was written when Easyvest was authorized and regulated by the FSMA as an agent in banking and investment services.