Chris Forgan, Portfolio Manager, Fidelity Multi Asset Allocator range
Home biases can exist within portfolios but is this due to investment rationale or historical norms? In a more economically and geographically diverse world, Chris Forgan portfolio manager of Fidelity’s Multi Asset Allocator range, explains why home bias can act as a hindrance rather than a help in static allocation portfolios.
Why home bias exists
Home bias – the inclination to invest more in domestic assets – has been prevalent since the dawn of financial markets for several reasons. First, some investors assume they have better information on their home markets and can therefore improve returns by tilting towards domestic securities. Second, some investors regard foreign assets as riskier and prefer to invest in their ‘comfort zone’ as a form of risk management. Third, regulations and transactions costs can make foreign securities less attractive. Finally, investors with static allocations can be left with a home bias by long-term changes in global markets. This is especially true in the UK, where the decline in size of the UK market over the past few decades could mean investors are unwittingly left with a home bias.
Chart 1: UK investors with static regional weights could now have a home bias
MSCI UK and MSCI World used. Source: Refinitiv, Fidelity International, January 2024
Home bias is still common today. However, the evolution of financial markets over the years has weakened or eliminated many of these arguments, especially in developed economies such as the UK. Information on even distant markets is now more readily available and foreign investment is routine. Regulations in the UK have shifted to facilitate and encourage the international flow of capital, while the increasing sophistication of the financial system has reduced transaction costs across virtually all asset classes.
Therefore, one of the primary reasons that home bias still exists in the UK is because it has become a structurally embedded industry norm, rather than a superior investment approach.
Our research highlights the benefits of increasing diversification
In the Fidelity Multi Asset Allocator range, we have worked hard over the last few years to make sure we offer a simple proposition based on sound investment principles and global diversification at an attractive price. To reflect this, we have eliminated the UK home bias in our portfolios. We believe this will improve performance, reduce risk, and provide more transparency for investors.
- Improve performance
Industry surveys suggest that the average balanced model portfolio has around 25% of the overall equity exposure in UK equities1, and around 18% in UK bonds2. However, the UK accounts for just 3% of global GDP and only 4% of global equity and bond markets.3 Therefore, reducing or eliminating UK home bias gives investors access to a greater share of the growth that helps drive asset performance.
Reducing home bias also increases the number of return drivers in a portfolio. Greater exposure to a particular region can be desirable when taking shorter term decisions. But running a long-term overweight to a single region increases the dependency on a narrower set of return drivers and can lead to missed opportunities in other regions. On the contrary, increasing global diversification gives exposure to a broader set of opportunities and tends to smooth returns over time.
- Reduce risk
Having a few large companies dominate a regional equity index can be a feature of even well-developed markets. This is known as concentration risk, and it is especially prevalent in the UK, where the largest 10 companies account for 42% of the total market capitalisation.4 This exposes investors in the UK market-cap weighted index to potentially significant idiosyncratic risks from the largest securities, something that is greatly reduced when moving to a more globally diversified portfolio.
Table 1: The UK and European equity markets have relatively high concentration risk
Reducing home bias can also reduce unintended sector and style bias. Every region has its own characteristics, and having a home bias will introduce these into a portfolio compared to a global allocation. While this might be desirable when making active investment decisions in the short term, having a structural home bias is likely to introduce unintended or unknown biases that can lead to investors not getting what they bargained for.
Table 2: UK equities currently tilt towards value sectors such as financials and energy, but not all investors want that
This is especially true for UK investors over the past decade or so. The UK equity market is weighed towards banks, consumer staples, energy, and healthcare, which also tilts the index towards the value style. But the UK market features almost no information technology or communication services, reducing the exposure that UK portfolios with a home bias have had to one of the main drivers of asset performance in recent years.
Chart 2: All markets have inherent biases that investors need to be aware of
A simple investment approach based on diversification
Our analysis shows that over the past 20 years, UK investors with a 60/40 portfolio could have improved returns, reduced volatility, and reduced maximum drawdowns by reducing or eliminating home bias. Investing £10,000 in a diversified global portfolio returned £43,276 compared to only £37,980 when using a portfolio with a 40% UK home bias, with identical volatility and a lower maximum drawdown.
Table 3: UK and European investors could benefit from an increase in global diversification
Analysing a balanced 60/40 portfolio with different domestic/global asset combinations.
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1 Citywire’s MPS Monitor data, as of March 2023.
2 JPMorgan, as of December 2022.
3 Source: World Bank (World Development Indicators, July 2023
4 Source: Fidelity International, Bloomberg, Factset, 2023. *As on 31st October 2023. Geographical revenue as on 31st December 2022.
Important information
This information is for investment professionals only and should not be relied upon by private investors. The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity’s Multi Asset funds can use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. When interest rates rise, bonds may fall in value, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. The investment policy of these funds means they invest mainly in units in collective investment schemes, deposits or derivatives, or replicates a stock or debt securities index. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and current and semi-annual reports, free of charge on request, by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0124/386040/SSO/NA
