Russia’s attack on Ukraine has again underscored the importance of diversification in equity investments. Investors with significant exposure to their home market found out how it feels to hold European companies exposed to Russia when large investors became unnerved. It led to outflows of money from those companies and a rapid decline in share prices. This should be the final wake-up call for investors to shed their home market bias.
Over the past decade, many European stock indices have delivered quite robust returns, even when the spring of COVID-19 is included. Risks have seemed fairly small – after all, European companies are usually well managed and they are easy to keep an eye on through local business media.
The upturn in stock prices after the spring of COVID-19 has further increased investors’ misconceptions about their strengths as an investor and the low level of risk in home country equities. The alarm bells should be ringing at the latest now that Russia’s belligerence has shrouded the future in uncertainty.
What is home country bias?
Home country bias is the tendency of investors to favor domestic stocks at the expense of other countries or regions.
This bias can easily lead to a poorly diversified equity portfolio that increases risk for the investor.
Far from being one country’s invention, home country bias is a globally recognized distortion. Among Sifter Fund investors, for example, the same phenomenon has been seen in Scandinavian countries as well as in Switzerland, France, and the UK.
Why should investors also invest abroad?
Let’s put things into perspective. There are a few hundred companies listed on most of the local stock exchanges, compared to over 65,000 companies listed globally. For example, the Helsinki Stock Exchange represents less than half a percent of globally listed companies.
As an investor, you need to consider whether you should invest your wealth specifically in companies listed on your home country stock exchange.
Investors with a home country bias have a high country-specific risk if their entire portfolio – or most of it – consists of stocks listed in one country. From the perspective of risk management, it makes sense to invest some of your assets internationally. Your money will still work for you if you invest it in Taiwanese chip manufacturers or the railways of Canada, if the European economy were to stagnate in the future or if the business conditions in European countries were to suffer from crises.
Diversification reduces risk and may even lead to higher returns if the choices of companies are successful.
Why does it feel more difficult to invest in global listed companies?
The thought of investing in companies you don’t know can feel challenging. This is often the heart of the problem. Investing abroad is not difficult in a technical sense. It can feel difficult due to the issues related to knowing the companies and keeping an eye on their performance. That is the root of home country bias.
It is more difficult to keep an eye on the situation of a Taiwanese chip manufacturer or Starbucks’ quest for world domination compared to familiar domestic companies.
Monitoring foreign companies is also more difficult because financial media tend to mainly cover well-known local companies.
Emotions play no role in the Sifter Fund’s choice of companies – this is how we avoid home country bias
For 20 years now, the Sifter Fund has been analyzing high-quality companies around the world. Since its inception, the fund has invested in over 100 quality companies. Sifter Fund has not invested in risky countries like Russia or China.
However, diversification does not have intrinsic value in an equity portfolio. What’s more important is the quality of the companies chosen for the portfolio.
From a pool of 65,000 listed companies, we have chosen 30 high-quality companies that have exceptionally strong revenue models. In this process of elimination, we apply quantitative and qualitative screening criteria in order to identify high-quality companies.
There is no room for emotions in Sifter’s investing process.
Interested in long-term quality investing? Download our 20-page guide: Long-term quality investing. Our guide explains how time and high-quality companies work in an investor’s favor.
CEO, Sifter Capital