How to Overcome Home Country Bias in Investing

Home country bias is when an investor has more of their portfolio allocated to financial securities domiciled in the country in which they reside than what global market value proportions would dictate. While home country bias is pervasive across the globe, Canadian investors are typically more prone to this phenomenon. Studies suggest anywhere between 50-60% of an average Canadian investor’s equity portfolio is invested in Canadian equities, versus Canada’s global equity market capitalization weight of approximately 3%. These extremely active bets that Canadian’s are taking on their home market can lead to big performance differentials. While the total return of the Canadian stock market (S&P TSX) is outpacing that of the U.S. (S&P 500) by about +1.5% this year (to the end of August), 2018 was a much different story, with Canada underperforming its neighbour to the south by just under -13% (all figures in Canadian dollars). Now there is a rationale for why Canadians would want to have a larger portion of their investment portfolio domiciled in Canada than what global market weights would dictate. One of the main reasons would be because it is likely the majority of their liabilities are domiciled in Canada as well. However, there are a number of options for Canadian investors that would like to invest globally but not take on the foreign exchange exposure associated with ~97% of their portfolio being domiciled outside of Canada: currency-hedged ETFs.

Speaking of ETFs, we hear a lot about how the rise in passive investment vehicles are creating distortions in the financial market (in our opinion most of these are off-base), but this blog post from Elm Partners details how a greater use of indexed investment strategies may theoretically lead to less market distortion! Haghani and White detail how home country bias can actually lead to large market cap equity markets eliciting a structurally higher upward shift in demand (higher valuations and lower expected return) and the reverse for small market cap equity markets (e.g. Canada). The authors opine that if more investors constructed their portfolios closer to global market capitalization weights through indexing strategies (ETFs or otherwise) this could actually lead to less of a distortion in market prices. It’s not often that indexed solutions are thought of as helping to decrease price distortions in markets!