How a home bias can harm investors’ portfolios: Dimensional

New commentary from Dimensional Fund Advisors (DFA) has made the case for Australian and New Zealand investors to rectify the ‘home bias’ that may be tanking their portfolios. 

The research conducted by DFA warned investors against having “too large a home bias” which, while beneficial for tax reasons or awareness of local stocks, can have “undesirable consequences”.

“[A home bias may] leave investors with concentrated exposures to individual companies and sectors and in turn missing out on the opportunities from exposure to sectors not well represented in the local market.

“The concentration trade-off in Australia is magnified by the large market share of a handful of companies. Highlighting the degree of potentially lost opportunity, stocks of the roughly 18,000 companies trading outside Australia represent about 98% of the world’s more than $120 trillion equity market.

“Yet, it is not uncommon for some local investors to have a 50% allocation to Australia. In other words, half of their equity portfolios are in a market that represents just 2% of the global market. In the case of New Zealand investors with a similar home bias, the concentration is even more pronounced.

“To put this in context, a portfolio with a 50% allocation to Australia has just five stocks (BHP Billiton, CSL and three of the big four banks) holding a weight roughly equivalent to all the stocks outside of Australia and the US. Just to be clear, this means that just five stocks in such a portfolio will have more weight than 46 markets with more than 15,500 companies!

“When Australians and New Zealanders invest outside their home markets, they can capture equity returns from thousands of companies around the globe and potentially offset weak performance in one market with stronger returns elsewhere. In other words, holding a globally diversified portfolio positions investors to capture returns wherever they occur.”

The DFA research also showed the diversification benefits of investing globally, offsetting the repercussions of market downturns on portfolios.

“Returns in 2021 offer a useful example of this phenomenon: The Australian stock market grew 16%, but non-Australian developed
markets like the UK (26%) and US (35%) performed much better.

“Similarly, in fixed interest markets, both yields and total returns  typically vary across the globe and often do not move in lockstep, which is no surprise. Bonds issued in different countries and currencies can offer a range of yields and expected returns.

“By looking outside their home market, investors can expand their choices and opportunities for higher expected returns. A global approach can also enhance diversification, which may help reduce portfolio risk and volatility.

“This isn’t guaranteed to produce strong returns every year, but it can deliver more reliable outcomes over time, helping investors stay on track toward achieving their long-term goals.”