When is home bias not home bias?

Posted by on November 3, 2010 in Investment Information

Home bias describes the tendency of investors to overweight  in their domestic stock markets over international markets. In theory, home bias is poor asset allocation. By putting too many eggs in a geographic basket, a shock to a local market will cause greater damage to a portfolio than one that is more evenly weighted in many different markets.

The underlying premise of home bias, however, is that the companies listed on domestic stock exchanges earn revenue primarily in local markets. Traditionally, this has been the case. But I would not be the first to note that large multinational corporations now work, in some cases, completely independently of the economies where their headquarters are domiciled. How can it be that Apple earns billions in profits and has tens of billions of dollars on hand (over $40 billion) when the American economy suffers so greatly?

It is because, in part, the free flow of capital has allowed many businesses to work outside the traditional confines of a local economy. A company listed on a domestic exchange is now not necessarily tied to a local economy. Where a company lists as publicly traded may be a function of regulatory or jurisdictional ease rather than source of earnings.

For example, Bespoke Investment Group wrote recently that approximately 30% of the revenue of companies compromising of the S & P 500 derived revenues outside the U.S. The tech sector averaged over 53% of revenues outside of the U.S. while materials average a little over 40% (…and you thought only Canada was selling its resources to the world). Thus, playing the tech sector listed locally may not mean a home bias per se if over half the revenue is earned elsewhere in the world.

The traditional assumption that companies listed on local exchanges are tied to local economies leads to several curious results:

  • Investors, especially American investors, are moving money out of local exchanges and investing in emerging markets; USA today reports that Americans have poured over $43 billion this year into emerging market funds. If we presume, in part, this movement is due to declining confidence in the U.S. economy, have investors missed the fact that some publicly traded companies saw the same thing and already have moved operations abroad but continue to trade in a jurisdiction with relatively high investor protection and protection of seizure of property by the state (two uncertainties when investing in emerging markets)? In some cases, is home bias actually welcomed?
  • Large cap companies trading on mature exchanges tend to provide some semblance of stability over companies trading in emerging markets. By moving money to international markets, is an investor actually increasing their risk in a time of uncertainty when a home bias in stocks with more than modest international operations may provide some international upside without the same amount of risk?

The tradition home bias argument continues to hold true for smaller exchanges (see TSX) or in sectors tied to local economies (see telecos). But, in a world where capital flows freely, one can’t look at the home bias using traditional analysis.

5 Comments on When is home bias not home bias?

By » Weekly Roundup of Blogs Canadian Business Blogs | Advice on Investment in Canada, Stock Market, Small Businesses Opportunities on November 3, 2010 at 12:12 pm

[...] Thicken My Wallet sees home bias as more of a problem for investors in small countries. [...]

By Dr Dale Rathgeber on November 3, 2010 at 1:13 pm

Let us not lose sight of the biggest reason (and sound justification) for home bias. Most people invest for retirement in their home jurisdiction, and don’t want the risk of currency debasement. Moreover, most folks like to invest in companies and products with whom/which they are familiar. Those tend to be close to home.

By LinkStuff – Media Week Edition on November 4, 2010 at 7:51 pm

[...] My Wallet observes that investing in domestic companies is a safer way to invest in foreign [...]

By RESP Book Winner and Weekend Reading | Million Dollar Journey on November 5, 2010 at 7:31 am

[...] When is home bias not home bias? @ Thicken My Wallet [...]

By Tweets that mention Thicken My Wallet » Blog Archive » When is home bias not home bias? -- Topsy.com on November 5, 2010 at 2:41 pm

[...] This post was mentioned on Twitter by Buy-Sell Adviser, Sara. Sara said: RT @BuySellAdviser – This Canadian blogger asks — when is it all right to load up on stocks in the local market? http://bit.ly/c8km6O [...]

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