When is home bias not home bias?
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.