By Trevor Muchedzi, CFA
Many investors and their financial advisors are prone to home bias; the behavioural bias in which they systematically overweight their investments/wealth in local assets (stocks, bonds and properties) and underweight in assets from everywhere else in the world.
The JSE constitutes ~0.8% of the global equity market by market capitalization yet an average South African investor has more than 70% of their capital invested locally (that is a ~69.2% overweight). South Africa is also a very concentrated market with the top five companies (Richemont SA, British American Tobacco, BHP Billiton, Naspers and Anglo American) constituting ~38% of the All Share Index by weight. Compare that, for example, with the US where the top five companies (Apple, Microsoft, Amazon, Alphabet and Facebook) only constitute less than 12.5% of the US Total Stock Market Index. This implies that home bias also exposes investors to very high concentration risks.
Home bias is a psychological trait that has been ingrained within us and below are some of the reasons investors are prone to it:
- People are generally comfortable investing in companies or assets they are familiar with and can easily relate to. For example, South Africans can easily identify with Shoprite, MTN or Standard Bank, but very few can relate to companies on the other side of the globe like Square Inc, The Trade Desk Inc or Okta Inc from an investment perspective. It’s therefore natural that investors tend to systematically limit their investment opportunity set to opportunities that are in their backyard;
- In addition, most investors don’t seem to know that it’s even possible to invest offshore, or those who do don’t know where to start. This is unfortunate given that investing in offshore companies is equally as easy as investing in locally listed companies.
So why should investor diversify globally
No. 1 – Diversification
Diversification is sometimes referred to as the “only free lunch” when it comes to investing. However, for investors to achieve true diversification, the assets they are adding to their portfolio must have a low or negative correlation with the existing assets they have. For example, because South African stocks have a very low correlation with developed market equities, investing in global assets provides substantial benefits to local investors from a diversification perspective. It also protect investors from much home events, political or otherwise that tend to affect South Africa stocks in a similar fashion
No. 2 – Access to sectors that are not available locally
Offshore markets provide investors with exposure to companies that are not available locally. Investor can invest in companies that are on the forefront of the 4th Industrial Revolution (Artificial Intelligence, 3D Printing, Nano Technology, Cybersecurity etc.) which normally have superior growth prospects driven by fast growing economies. For example, ETFs tracking the tech heavy Nasdaq 100 index and the U.S. medical devices index have delivered more than 20.5% p.a. in US$ terms over the last 10 years. Add to this the effects of Rand depreciation over the same period, then returns to investors are even better.
No. 3 – Bigger and better investment universe
Global markets offer better investment opportunities both in terms of quality of assets and a broader selection of companies available. There are over 45 000 companies listed globally compared to 370+ on JSE. A wider pool of assets to choose from can potentially increase investor returns under different conditions
No. 4 – Managing currency risk
Advisors and market commentators often argue that increasing investment allocation to global assets introduces currency risk and hence volatility into an investor’s portfolio. Although this is partly true, it doesn’t capture the entire story and negates the fact that there are better ways to effectively manage currency risk rather than to underweight global investment opportunities.
A good example are hedged equity ETFs which allow investors to gain exposure to the performance of the underlying assets without the associated currency risk. In addition, there is also empirical evidence that currency exposure in equity investments can actually be beneficial to the investor given the often negative correlation between equity and currency movement, especially for developed countries. This actually reduce risk in an investor’s overall portfolio.
Investing offshore should be a core part of every investor’s long-term financial plan. However, the decision to go offshore shouldn’t be a knee-jerk reaction to a weakening Rand or scaring economic/political news headlines. Rather it should be a well thought out process that is directly informed by your individual goals. Decide how much of your portfolio you want invested offshore and rump up your exposure consistently over time to get there. Don’t let anyone prescribe to you what that number should be: go for makes you sleep better at night!
In conclusion, don’t be afraid to look outside your home country for opportunities. Diversify globally and every now and then rebalance your portfolio to restore your target asset allocation. Until next time, happy investing
I will be interested to hear your views and comments about investing offshore. You can reach out to me on firstname.lastname@example.org