The global fashion industry is fickle by nature, pushing and then pulling trends to keep hapless consumers forever turning over their wardrobes. Some people in the financial services industry work the same way.
Busy investing is not smart investing
A big part of the financial services industry has a vested interest in convincing you that the key to a successful investment experience is staying busy. Where you stand in the debate about staying "busy" by thinking like a trader often depends on whether you see investment as the means to an end or as an end in itself!
Going green with your investments
According to a global sustainable investment group that covers Australia, New Zealand and other developed nations, assets managed under "responsible investment" strategies increased by 25 per cent between 2014-16 to US$22.89 trillion.
Unhealthy attachments to bad investments
Have you ever made yourself suffer through a bad movie because, having paid for the cinema ticket, you felt you had to get your money's worth? Some people treat investment the same way.
Which hat are you wearing?
Most of us have multiple roles — as business owners, professionals, workers, consumers, citizens, students, parents, and investors. So, our views of the world can differ according to whatever hat we're wearing at any one time.
Rainy-day Investing
Like farmers planning a harvest, investors pinning their expectations on statements about arithmetical "average" investment returns can be disappointed. As with rainfall, market returns are rarely evenly distributed either across time or place.
In and out of currency fashion
Bitcoin and other cryptocurrencies are receiving intense media coverage, prompting many investors to wonder whether these new types of electronic money deserve a place in their portfolios.What are investors to make of all this media attention? What place, if any, should bitcoin play in a diversified portfolio?
Should I consider dollar cost averaging?
We are sometimes asked about dollar cost averaging when investing client funds and whether this is a good idea. It is certainly something which should be considered, particularly for first time investors, and those whom are introducing a substantial lump sum deposit into their investment portfolio.
Will I run out of money in retirement?
Bill Gates wisely pointed out that "most people overestimate what they can do in one year and underestimate what they can do in 10 years".
Seven simple lessons on volatility
Renewed volatility in markets has awoken the investors from summertime slumber.
News directors drag out dated file footage of frantic traders and summon talking-head experts to explain what it all means. Well, what does it mean? More importantly, does it matter?
AI and real-time risk decisions in wealth management
This promises to be the year we see the culmination of some key technologies — from blockchain and artificial intelligence (AI), to design thinking and the cloud.
FAANG and the catchphrase investing
The financial media is drawn to catchphrases, acronyms, and buzzwords that can be sold as the new thing. FAANG (Facebook, Apple, Amazon, Netflix, and Google) is the latest of these. But does this constitute an investment strategy?
It's not all smashed avocado for millennials – Part II
In New Zealand, trend pieces often depict millennials in the context of young urban professionals spending too much money on avocado-based brunches and too little time saving for a deposit on a house.
Millennials, take charge of your financial future – Part I
We have all read about the financial plight of millennials, who are not only drowning in student loan debt but other loans and expenses as well. They include car payments, rents or mortgages, and credit card bills.
The seven virtues of process
Success as an investor starts with the key questions of why, what, where, when and how. But it’s the “how” that’s often overlooked.
‘Tis season to set yourself good financial goals
This New Year it is also a great time to start making solid financial resolutions that can help get you closer to your money goals, whether it’s increasing your retirement savings or setting enough money aside for a down payment on a house.
Seven ways to tighten your Christmas spending
Last year, New Zealanders managed to spend a record $6 billion shopping in December, which was the highest monthly figure recorded by Statistics New Zealand.
Hawke's Bay enjoyed the highest holiday splurge, with a near 11 per cent increase on the previous year.
The bitcoin bubble – Part I
What if there is a technological advancement so powerful that it transforms the fundamental pillars of our society?
A technology that fundamentally influences the way our economy, governance systems and business functions, and could change our conceptual understandings of trade, ownership, and trust.
Ponzi schemes and fools' gold
You've probably heard the saying "If it sounds too good to be true, it probably is." This rings particularly true in the case on Ponzi schemes.
A Ponzi scheme is not a new wonder drug or an Italian beach resort, it's terrible for your financial health.
Leaving Home?
Everybody loves the comforts of home, but investors who become too anchored to familiar territory can end up with a very narrow view of the world.
Home bias, the tendency of investors to allocate a disproportionate amount of their funds to their domestic market, is a well-documented phenomenon.
As at 31 December 2016, superannuation funds regulated by the Australian Prudential Regulation Authority had nearly 50% of their total equity exposure in local shares. For self-managed super funds, the average home allocation was 72%.
There can be rational reasons for home bias. Australian investors, for instance, have the advantage of dividend imputation. This is where firms that have already paid income tax on profits attach tax credits in distributions to shareholders.
A second understandable reason they might tilt to their home market is familiarity with the companies they are investing in. Companies like Westpac, ANZ, Qantas and Air New Zealand are household names and are frequently in the news.
A third justification might be that a home bias satisfies an individual investor’s particular goals or risk appetite. These are all issues for an advisor to consider.
But a large home bias also can have undesirable consequences. Those consequences relate to the risks of a portfolio ending up with very concentrated exposure to individual countries, companies, and sectors.
DIVIDING UP THE WORLD
This is particularly the case where your home market is relatively small in a global sense or where it is dominated by one or two sectors.
Chart 1 shows the natural weights of some of the countries in the MSCI All Country World index, a popular benchmark for the global share market. You can see the US is by far the biggest market, with a weight of more than 53% as at 31 January 2017.
Japan is a distant second with a weight just above 8%, then the UK, Canada, France and Germany, China and Switzerland. Australia is ninth with a weight of 2.4%, while New Zealand is in 36th place with a weight of just 0.1%, too small to see on the chart.
Now, what happens when we bias our portfolio to the home market? Chart 2 shows the country representation in an equity portfolio with a home bias of 60% to Australia.
As a result of this tilt, we have to scale down representation of other major markets. For instance, the US exposure is lowered from 53% to 22% and emerging markets from 11% to just 4%. Put another way, the weight of all countries, apart from Australia and the US, in this portfolio is just 18%.
So you can see that this degree of home bias represents a pronounced deviation from the global market portfolio and leaves you taking unnecessarily big bets. For instance, Canada was the best performing developed market in 2016 with a gain of more than 25%. But with our home bias, the weight to Canada is reduced by two thirds.
Since we have no reliable way of predicting which country will be the best performer year of year, it makes sense not to deviate too far from the market portfolio.
DIVIDING UP THE SECTORS
Having a sizeable home bias means not only taking a big bet on a single country, but ending up with a disproportionate exposure to certain sectors.
In Australia’s case, the big four banks represented nearly 28% of the market, as of early 2017. Financials overall made up 38%, while materials stocks represented 17%. In other words, two sectors made up more than half of the market.
To put that into perspective, financials represented just 19% of the global market while materials had a share of just 6%.
Another way of looking at this bias is to consider which sectors are poorly represented in Australia. For instance, information technology stocks made up just 1.3% of the local market, compared to 16% globally.
Chart 3 shows the natural market weight of sectors in a global portfolio. Chart 4 shows what happens when you have a 60% home bias. In other words, you end up taking a significant bet on financials and materials stocks, at the expense of other sectors like technology and healthcare. It’s a much less diversified portfolio.
DIVIDING UP THE STOCKS
We’ve seen that a home bias means concentrated bets on a single country and a couple of sectors. So it shouldn’t be a surprise that it also means you end up taking outsized bets on a handful of stocks.
With a 60% Australian home bias, a single stock—the Commonwealth Bank—will represent nearly 6% of your portfolio. That is more than the weight of the UK and Japan combined or more than your entire holdings in emerging markets.
Put another way, the top five stocks (the four big Aussie banks and BHP Billiton) will make up more than 20% of your portfolio. You will also more than halve your exposure to big overseas names like Apple, Microsoft, Amazon, Vodafone, Nestle and Volvo.
In fact, of the top 50 stocks in this Australian-biased “global” portfolio, all but four are local stocks, the exceptions being Apple, Microsoft, Exxon Mobil and Amazon.
Chart 5 illustrates how concentrated this portfolio becomes once the home bias is accounted for.
PUTTING IT ALL TOGETHER
Given investors tend to source most of their income from their home nation and hold most of their other assets there, you can see that this degree of home bias represents a very big bet on one country, a couple of sectors and a handful of stocks.
So the question then becomes what degree of home bias is acceptable. It shouldn’t be surprising that there is no one right answer to that. It depends on each individual investor’s tastes, preferences, circumstances and goals.
A good approach is to use a global market portfolio as your starting point. If you want to increase the expected return of your portfolio, you can use information in current market prices and company fundamentals to tilt your portfolio towards stocks with higher expected returns. Research has shown that small caps, low relative price and high profitability stocks deliver a premium over the market return.
While you may tilt your portfolio towards Australia for the franking credits or your familiarity with the stocks, it’s important to understand this has nothing to do with the expected return of your portfolio. It is just a preference. But it also comes at a cost.
In contrast, broad global diversification creates a portfolio that spreads its risk to more economies, to a greater number of stocks, to a wider range of companies and to a wider spread of sectors.
Again, there is no single right answer in terms of asset allocation. It will depend on the individual investor’s circumstances, goals and risk appetite.
But it is worth reflecting on the fact that an investor whose allocation is made up 60 percent of Australian equities is overweighting Australia relative to the global market by a factor of 25.
At some time or another, we all have to leave home.
- Source: Jim Parker, Vice President, DFA Australia Limited
