Most investors instinctively allocate most of their money to their home market but, argues investor, author and financial podcast pioneer Meb Faber, history shows this risk is simply not compensated for over time
Home bias is a wholly admirable quality when it comes to picking sporting allegiances – indeed, for most fans, it is non-negotiable. As investor, author and financial podcast pioneer Meb Faber points out in his recent appearance as a guest on The Value Perspective podcast, however, home bias in the context of portfolio construction can be a real liability.
“Home-country bias is a very simple concept – that most people invest most of their money in their own stockmarket,” he explains. “Taking my own home market, the US is only about 60% of the world’s total stocks but the average US investor puts 80% of their stock allocation there. Now, that is a huge active overweight – and maybe you are OK with it. The reality, though, is you at least need to be aware of it.”
As Faber points out, of course, this is even more problematic for investors based outside the US. “Countries may only be 3%, say, of the world’s market cap yet investors will still allocate the lion’s share of their portfolio to their domestic stockmarket,” he says. “At the start of March, for example, we tweeted out a statistic that showed the average Russian had 95% of their stock investments in the Russian stockmarket.
History of research
“If you look at the history of research – and we have a summary article called The Case for Global Investing – you will find an equal-weighted or GDP-weighted or index-weighted global portfolio almost universally beats any single country. In other words, home bias is a risk that is just not compensated for across time – although, of course, there are periods where one country will shine.
“If you talk to the average American today, they will be really happy they were overweight the US for the past decade because it has stomped everything else. But if you look at the decade prior – from the internet bubble crashing through the financial crisis – the US is one of the worst-performing markets. Before that, the US outperforms in the 1990s – but, for the example before that, you have to go all the way back to the 1910s.”
Investors love to extrapolate recent history into the indefinite future, argues Faber – before using my home country to make his point. “I was down in Bogota around 2014, when the Colombian stockmarket was ripping and roaring,” he says. “I gave a speech and told the audience, look, I love this country – the people are super nice, the food is amazing, the scenery is gorgeous ... however, your stockmarket is really expensive.
“And the responses I got were, Meb, you just don’t understand – and then all the sort of things people say when a market has done well and is now at all-time highs. But I also gave talks around Eastern Europe when those countries were super-cheap – and I heard all the sort of things people say when a market has done badly and no-one is interested. You find these things rinse-repeat over and over again.
“Take the US as an example, again. The PE ratio – we like to use the 10-year price/earnings ratio or Cape Shiller ratio but it really doesn’t matter – has traded as low as 5x and as high as 45x. Meanwhile, there are other countries in the world, such as Japan, that have got darn near 100x. So you have these investments people love to chase – and a great quote on this is ‘People love to buy what they wish they had bought’.”
Nobody likes to be told the party is ending, Faber observes – and the same holds true with an investment that is doing well. “If I come and see you guys in London and we go get a few pints, you are probably going to have to drag me out of the pub,” he promises. “And when the good times are happening for an investment, people don’t want some wet blanket saying, hey, the odds are not favourable to you now.
No real returns
“I think this is very much the case in the US – market cap-weighted. The craziness seems to have peaked in February last year but the market cap weight has continued to go up and we will see if that has peaked. But it got to a PE ratio of 40x, which historically has portended the next decade of no returns on a real basis. That would be my expectation now – that you would have no returns in the US stockmarket for the next decade.
“Yes, there are opportunities within value and other ideas but the broad market cap weight? If you look at all the coincident indicators – people trading risky options; meme stocks; the Robin Hood crowd; unrealistic expectations; high valuations – it is like the high sentiment in recent Schroders Global Investor Studies. The final indicator is when the trend rolls over – and here we are now because the trend is finally negative.”
A big challenge for investors then, concludes Faber, is to be ‘asset class agnostic’. “But it is really hard – particularly with your home country,” he concedes. “I am a Denver Broncos fan so it would be really hard for me to cheer for the Raiders but, when it comes to investing, you have to diversify. You have to realise that every asset class and every country will have its moment in the sun and its moment in the shade.”