Home Bias and Implications for Investing
December 10, 2021
It’s an age-old question – how much should I allocate away from home? As a business with clients in the US and the Asia Pacific, we find ourselves having this conversation at least once a month. The seemingly never-ending outperformance of US stocks vs. the rest of the world has investors wondering if they should throw in the towel on global and simply go with “made in America” for good.
Our short answer is “No” – there’s value in having global exposure. The slightly longer answer is “It Depends” – on your investment objectives, time horizon, the rest of your portfolio, and where we are in the cycle. A slight tilt to your desired goals often makes more sense than an outright call to go all in or outright avoid a market. The right answer is somewhere in-between and different for each investor. No long-term portfolio should be 0% or 100% US or home-biased.
What goes up, must come down
One of the strongest arguments for home bias, particularly bias toward the US, is that investors shouldn’t bet against the US economy and that the US will continue to outperform. And while it certainly feels that way right now, this is not the first time we’ve experienced a period of outperformance, only to be disappointed in the next few years. Think Japan in the 1980s (+253%) vs. the 1990s (-26%). Or perhaps more relevant, the US in the 1990s and other periods. Contrary to popular belief, the US has not always outperformed.
Below is a chart of historical single country performance by decade. There are a few clear takeaways:
- In seven decades, no country has repeated at the top for two decades in a row
- The US is a consistent performer but has only been at the top twice – ‘60s and ‘10s
- Extraordinary returns are followed by big drops in ranking – Swiss ‘90s vs. ‘00s, HK ‘70s vs. ‘80s, Japan ‘80s vs. ‘90s and ‘00s
- Triple-digit returns (over 100%) 2 decades in a row are rare
In short, regional diversification is an investor’s best friend when seeking long-term returns.
Yield is where the heart is
One frequently cited reason for investing at home is safety. And often the perception of safety and income go hand in hand as investment objectives. We’ve observed that the greater the need for income, the more investors talk about safety and bias their portfolios to home. But is this indeed true? A little-mentioned fact of the investing world is that the US is one of the lower dividend payers in the world.
- The average dividend yield on US exchanges is currently 1.3% vs. a global developed market average of 1.7%, and an emerging market average of 2.2%
- Only 12% of US stocks yield more than 3%; lower than any major market
- 55% of US stocks don’t pay a dividend at all; second only to Australia, which has many pre-revenue commodity and mining stocks
- The UK and Australia currently offer the highest average dividend yields globally, given their large concentration of financial stocks
So, if income is the goal, it can actually pay to look globally rather than at home or in the hottest markets of recent years. When we constructed our equity income strategies earlier this year, the US Equity Income strategy had a 4% yield, while its global equivalent yielded 4.9%.
Valuations and exposures – it all matters
While we are unabashed proponents of having global exposure, it’s important to understand the implications. Looking at valuations and the resulting exposures is vital. Following a 199% US equity return during the ‘10s, the US is the most expensive market by valuations globally. It has a PE of 27x and a forward PE of 22x, materially higher than global developed markets (24x and 20x) and emerging markets (15x and 13x). In short, a global exposure today is also a better valuation exposure. But the high valuation premium commanded by the US is not without its causes.
Technology (29%) and Communications (11%) stocks dominate the US market. The FAANG stocks are significant contributors to that, but it goes beyond the top few names. Looking at global developed equities it is clear that an allocation to the US is an overweight to the global technology sector, whereas an allocation to non-US markets is an overweight to Financials, Industrials, Consumer Staples, and Materials names. These sectors have grown slower than the technology sector in recent years. But they also have lower valuations and should fare well if rates rise. On the flip side, there are few signs of any waning of technology sector dominance over our lives. Profits continue to benefit from network effects, and returns on equity are well beyond other sectors. But again, what goes up must come down eventually. Rarely have this decade’s leaders remained on top in the next decade. Global technology companies are likely to face regulatory pressure, not just in China where we saw it this year, but in the US and Europe in coming years. Many argue that social media and internet companies are so integral to our lives that it is time for them to be regulated like utilities – with consumers, not profits or investors, in mind.
To sum up, balancing international exposure with US exposure today means improving valuations and diversifying the sector concentration of portfolios away from tech.
What does an unbiased allocation look like (where’s the growth at)?
Now that we’ve established that a global portfolio may make sense, how should we think about the what and where? In other words, the weights and countries. Valuation drives one potential approach – allocate more to the cheapest markets. But valuations take a long time to play out and often are what they are for a reason. How can growth-oriented investors think about their allocations? One potential approach is to look at GDP growth and R&D spending. Both are potentially predictive of future market returns. North America and Europe have grown the slowest over approximately the last 20 years and are expected to see the largest jumps over the next five years. But they’ll only be catching up to Pacific countries and remain more than 2% behind emerging markets, which are holding steady at 5% annualized growth.
From an R&D point of view, the US is in the top 10 countries by R&D spend as a percentage of GDP, and well ahead of the global average. Meanwhile, traditional investment destination countries like the UK and Australia are not even on the top 20 list. Instead, Israel, Korea, and Taiwan (all emerging markets) dominate the top three spots. Sweden, Austria, Japan, Germany, Switzerland, and Belgium (traditional developed market economies) round out the top nine ahead of the US.
Another school of thought is to let markets do what they do best – drive information into prices. As such, the best course of action is to allocate based on global equity weights passively and let the market dictate allocations. The US makes up 40% of global equity market capitalization, China is at 12%, and Japan is at 7%. Bundling China and Hong Kong takes us to an 18% weight for Greater China overall. Yet one reason for this is that the less developed countries have many more companies listed, not all of which are of material size and relevant to global investors. By number of stocks, the US is only 9% of the global universe of listed stocks.
How should we make sense of this disparity? The US is 40% of global equity value, 9% of global stock listings, but of course, is home to some of the most profitable and most widely known companies in the world. How do we sift through all the irrelevant and micro-cap stocks, remove the uninvestable names and adjust for currency and regulatory risks in emerging markets? This is what index providers strive to do, and below is the result of one such undertaking from MSCI, a NY-based index provider. Their neutral country weights, as represented by the MSCI All Country World Index are:
So where does this leave us?
It is without question that a bias toward the US has been rewarded over the last decade. But rarely does such outperformance last. Global allocation allows investors to take advantage of dynamic markets that offer plenty of opportunities for future growth. Economic growth globally is similar and often higher than in the US. Dividend yields are higher in nearly every country. Should rates rise or sector leadership change away from technology, global markets are likely to benefit given their overweights to other sectors and lower valuations overall.
There is no right allocation percent to global equities vs. the US. Many investors look at approximately 60% as neutral while some investors based in the US split the difference and target about 80%. At Leo Wealth, we believe in diversification and global investment opportunities over the long-term, tilting our portfolios right now on the principle of a little bit less in the US is more.
Aleksey Mironenko is Global Head of Investment Solutions at Leo Wealth, an independent global wealth advisor. Based in Hong Kong, Aleksey is responsible for constructing client portfolios and overseeing the firm’s investment function. He is a strong believer in cost-efficient portfolio construction and asset allocation as the primary drivers of investor returns and thrives on achieving meaningful results and providing considered counsel to clients.
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