Home Bias and Global Diversification

Every day we enjoy the benefits of an interconnected world. We might start our day with a cup of coffee that originated in South America, check our email on a smartphone designed in California and manufactured in Taiwan, then dress in clothes woven from Egyptian fabrics before driving a German-made car or riding in a French-built train to work.

As consumers, we rarely think twice about the benefits of access to the variety of goods the global market has to offer. Yet, as investors, we will often concentrate our portfolios in favour of our home market at the expense of global diversification.

For example, while UK stock markets represent just six percent of the value of global equity markets, many UK investors tend to allocate around a third of their equity assets to domestic stocks. This phenomenon, which can be observed across countries around the world, is known in the investment community as “home-country bias.”

Given that certain frictions may be associated with investing abroad, a home-country bias may make sense for an investor in certain cases. In general, however, neglecting the benefits that global diversification has to offer may increase risks and decrease the investment opportunity set. By pursuing a globally diversified approach to investing, one doesn’t have to attempt to pick winners to achieve a rewarding investment experience.