The home-bias trap for share investors
28 May 2019 | Portfolio construction
The latest bout of higher sharemarket volatility should remind investors that the global diversification of their share portfolios can reduce portfolio volatility as well as spread their risks and opportunities for returns.
A new Vanguard research paper* points out that the Australian sharemarket has been markedly more volatile than the global sharemarket over the past almost 50 years.
Australian shares account for just 2 per cent of the global sharemarket against 55 per cent by US shares. In short, stay-at-home Australian investors are blocking out much of the world.
Researchers found that the volatility of domestic sharemarkets in all 17 developed countries examined was higher than the global market over the almost 50 years to September 2018.
Yet as this research emphasises, investors on average have allocations to their home-market shares that are “significantly larger” than their country’s market-capitalisation in a globally-diversified share portfolio.
“Although no one answer fits all investors,” the researchers write, “global market-capitalisation weight serves as a helpful starting point in determining the appropriate allocation between domestic and international shares.”
In practice, many investors who recognise the home-bias trap still decide to hold an allocation to their home-market shares that is well above their home country’s weight in the global sharemarket. This decision may be based on a series of factors including their personal circumstances and preferences.
Investors holding a widely-diversified international share portfolio:
- Gain exposure to a wider array of economic and market forces outside their narrower home market.
- Own a stake in leading global companies.
- Gain exposure to whichever regional market is outperforming. While the United States, for example, may outperform at some times other countries or regions may outperform at other times.
Many Australian investors gain their international share exposure through managed global funds such as a low-cost exchange traded fund (ETF) tracking the MSCI World Index (ex Australia) index. This index covers more than 1500 companies listed in 22 developed countries.
The index’s top 10 companies are currently Microsoft, Apple, Amazon, Facebook A, JP Morgan Chase, Johnson & Johnson, Alphabet C and A (Google’s parent companies), Exxon Mobil, and Nestle.
Despite the number of information technology stocks in its top 10, the MSCI World Index (ex Australia) is widely diversified in different sectors. By contrast, the Australian sharemarket is highly concentrated in financial and resources – almost half the market in just two sectors.
Unfortunately, the extra risks and lost opportunities of being a stay-at-home share investor are often overlooked.
*Global equity investing: The benefits of diversification and sizing your allocation, Vanguard 2019.
Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.
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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.