THE HOME COUNTRY BIAS PROBLEM
The home country bias is dangerous for investor portfolios for two reasons:
1) Higher Risks: It unnecessarily increases portfolio risks because it does not provide investors’ portfolios with diversification benefits caused by less than perfect correlations among different countries’ equity markets. Put it simply, diversification benefits arise from the fact that when some markets go down, others go up. As a timeless proverb says, “Do not put all your eggs in one basket”. Investing a large portion of one’s liquid assets in domestic stocks and bonds is riskier for investors than diversifying one’s investments among assets of many countries.
Example: Investors’ country might be hit by a political or economic crisis, or even a series of crises, as it happened in 2008 and 2011. During these years, the Global Financial Crisis and the European Sovereign Debt Crisis decimated portfolios of investors in many but not all countries around the world.
2) Lower Returns: It lowers investors’ potential returns by limiting their investment opportunities to a single market.
Example: If a US investor put all his/her money in domestic US equities (S&P 500 equity index), he/she would have doubled the money over the 10-year period since January 1, 2004 to December 31, 2013. This is not bad if we look at it in isolation. However, if we compare these returns to returns of other 42 countries that we followed over this same 10-year period, these US equity market returns would not have been as impressive. The US equity market would be only 31st best out of the 43 countries (see the chart below).
1) Higher Risks: It unnecessarily increases portfolio risks because it does not provide investors’ portfolios with diversification benefits caused by less than perfect correlations among different countries’ equity markets. Put it simply, diversification benefits arise from the fact that when some markets go down, others go up. As a timeless proverb says, “Do not put all your eggs in one basket”. Investing a large portion of one’s liquid assets in domestic stocks and bonds is riskier for investors than diversifying one’s investments among assets of many countries.
Example: Investors’ country might be hit by a political or economic crisis, or even a series of crises, as it happened in 2008 and 2011. During these years, the Global Financial Crisis and the European Sovereign Debt Crisis decimated portfolios of investors in many but not all countries around the world.
2) Lower Returns: It lowers investors’ potential returns by limiting their investment opportunities to a single market.
Example: If a US investor put all his/her money in domestic US equities (S&P 500 equity index), he/she would have doubled the money over the 10-year period since January 1, 2004 to December 31, 2013. This is not bad if we look at it in isolation. However, if we compare these returns to returns of other 42 countries that we followed over this same 10-year period, these US equity market returns would not have been as impressive. The US equity market would be only 31st best out of the 43 countries (see the chart below).
