Studies have shown that there can be a considerable disconnect between investment allocations to one’s own country and the proportional representation of that country in a global portfolio.1 But while favoring one’s home country may be a patriotic gesture, when it comes to investing, home-country bias can be detrimental to a portfolio.
Investors remain too close to home
Home-country bias is a common phenomenon in which investors tend to allocate a large majority of their portfolio to investments in their home country. The result? Portfolios have a concentrated country exposure, limiting potential returns as well as diversification.
Studies demonstrate that home-country bias is prevalent among US investors. According to the International Monetary Fund’s (IMF’s) Coordinated Portfolio Investment Survey, US investors allocate over 70% of their equity exposure to US securities.2 However, measuring on the basis of market capitalization of equity, the US represents just 53% of the market cap weighted MSCI ACWI Index—a broad representation of 47 investable countries.3
Another way to look at the size of a country’s global representation is through the lens of gross domestic product (GDP). As shown below, per the World Bank, the United States’ share of global GDP currently stands at 24% and is trending lower. In fact, the IMF is projecting that US GDP growth, while still expected to be positive, will decline from +2.5% in 2019 to +1.38% in 2023. This represents a 45% cut in growth, suggesting that a US home-country bias could expose a portfolio to faster decelerating US growth, as the projected average change in growth by 2023 for the rest of the Group of Seven (G7) countries is just -2.3%.4 So not only are you missing out on 95% of the global population, as the US only makes up around 5%,5 but are also unable to participate in stronger economic growth trends resulting from shifting demographics and consumer behavior across the pond.
Source: Bloomberg Finance L.P., as of 12/31/2017.
Some have argued that investing in US equities can still provide international exposure through globally derived US company revenues. However, when we look at a geographic breakdown of revenue sources over the past 12 months, over 60% of S&P 500® Index constituent’s revenue can be traced to the US.6 This reveals that large US company revenue isn’t as geographically diverse as some might think, and as shown below, the revenue profile of US firms drastically differs from the makeup of economic growth around the world. Just because some firms have revenues from outside the borders of the US doesn’t mean you have exposure to all non-US countries and their local macroeconomic sensitivities and cycles.
Why does home-country bias matter?
Home-country bias wouldn’t be a concern if it didn’t have a material impact on portfolio outcomes. There are several reasons why correcting home-country bias can improve a portfolio’s risk/return profile, as well as higher income generation potential:
1. Non-US equities can have periods of outperformance
As shown below, there are streaks when the S&P 500 outperforms or underperforms both international developed and emerging market (“EM”) stocks. The average length of time that international developed outperforms the US is 12 months, while the average length of emerging market outperformance is 15 months. The more interesting aspect is when analyzing the longest duration of outperformance. For international developed it is 58 months, and for EM it is 64 months. As such, a constant overweight exposure to the US may negatively impact portfolio returns during different market cycles, leading to poor performance relative to strategies that are more globally diversified. This is shown below; international developed is represented by the MSCI EAFE Index, and EM is represented by the MSCI Emerging Markets Index.
2. The S&P 500 doesn’t move in lock step with other major global indices
International equities can at times exhibit low correlations relative to US stocks. As shown below, rolling 52-week correlations between the S&P 500 and international and emerging market equity exposures have experienced numerous dips since 2002. Low correlations have been particularly pronounced when looking at US stocks relative to emerging markets.
Source: FactSet, as of 02/28/2019.
Correlations are one way to show differences in return patterns and the potential diversification benefits a low-correlated asset can provide to a broader portfolio. The other is to look at month-to-month divergence. If we go back to 1970, we can see that in 22.2% of observations, the S&P 500 and MSCI EAFE had diverging returns (one was up while the other was down), with one month witnessing the S&P 500 underperforming the MSCI EAFE by a sizeable 16%. Data for emerging markets doesn’t go back as far as developed international, but even with the 30 years of history the divergence in monthly returns for EM to the S&P 500 is noticeable, as shown below. These numbers further demonstrate the diversification benefits of including non-US equities.
3. Non-US equities have historical had a higher dividend yield
There are corporate cultural differences as well as tax legislation that have led non-US firms to have historically higher dividend payout ratios, and therefore higher dividend yields. For instance, in Australia and New Zealand there is a policy of dividend imputation which eliminates double taxation on dividends, leading to investors favoring dividends over capital gains. Some European nations have had similar tax rules in the past as well, leading to investors historically having a preference to receive higher proportions of profits in the way of dividends. There are also the corporate cultural differences where some of the firms outside the US have higher family or state-owned control, and studies7 have shown that those types of firms have higher dividend payout ratios than the average firm. In Russia, for example, the government has steadfastly pushed state-owned firms to pay out more than 50% of their profits as dividends. Some do, while others have received exemptions but still pay close to 30%.8
The end result is that non-US equities have carried a higher dividend yield and been a source of additive income generation over US equities, as shown below.
Source: Bloomberg Finance L.P., as of 04/26/2019.
Each of these reasons suggests home-country bias can have a material impact on a portfolio’s diversification potential as well as risk/return profile. To correct for this, investors should diversify US equity positions toward a global portfolio mindset.
International equity ETFs offer a breadth of implementation choices
Given the proliferation of ETFs, non-US equity implementation can be as easy as carving out some of your equity allocation for a distinct position in international stocks, or allocating to a broad global equity allocation that provides coverage to numerous countries and firms around the world.
With either implementation type, there’s a multitude of SPDR® ETFs that can help investors meet a range of international equity objectives across both developed and emerging markets:
- For a broad, global one-stop-shop allocation, the SPDR Portfolio MSCI Global Stock Market ETF (SPGM) seeks to track the MSCI ACWI IMI Index covering over 40 different countries and 8,000 different stocks.9
- For more non-US regional specificity, the SPDR Portfolio Developed World ex-US ETF (SPDW) offers broad exposure to developed international stocks at just 4 basis points, while the SPDR Portfolio Emerging Markets ETF (SPEM) offers broad emerging market exposure for just 11 basis points.
- For a multifactor approach that harnesses value, quality, and low-volatility factors, the SPDR MSCI EAFE StrategicFactorsSM ETF (QEFA) or SPDR MSCI Emerging Markets StrategicFactorsSM ETF (QEMM) could also help diversify an investor’s US equity exposure.
You can read additional posts in our Spotlight On series, where we examine different sub-asset classes that can be incorporated into a diversified portfolio, and what role they can play in helping each investor achieve their individual risk/return profile.
1International Monetary Fund, “Coordinated Portfolio Investment Survey,” June 2016.
2International Monetary Fund, “Coordinated Portfolio Investment Survey,” June 2016.
3MSCI, as of 04/25/2019.
4FactSet, IMF World Economic Outlook Forecast, as of 02/28/2019.
5US Census Bureau, 12/31/2018.
6FactSet, as of 03/05/2019. Percent of total revenue measured for the last 12 months.
7“The effect of family control on the corporate dividend policy: An empirical analysis of the Euro zone”, Pindadoa, Requejoa, Chabela de la Torre January 2011; “Dividend Policy of State-Owned Companies: Evidence from the Russian Federation”, Belomyttseva, Grinkevich December 2016; “Ownership Structure, Control and Dividend Pay-outs: Evidence from PRC listed companies”, Wang, Wang, May 2017.
8“Russia’s dividend regime is relaxed for those with clout”, Financial Times May 2017.
9MSCI, Inc as of 04/26/2019.
Basis Point (bps)
A unit of measure for interest rates, investment performance, pricing of investment services and other percentages in finance. One basis point is equal to one-hundredth of 1 percent, or 0.01%.
Gross Domestic Product (GDP)
The monetary value of all the finished goods and services produced within a country’s borders in a specific time period.
Group of Seven (G7)
A group consisting of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
MSCI All Country World Index (ACWI)
A free-float weighted global equity index that includes companies in 24 emerging market countries and 23 developed market countries and is designed to be a proxy for most of the investable equities universe around the world. With 2,771 constituents, the index covers approximately 85% of the global investable equity opportunity set.
MSCI ACWI Investable Market Index (IMI)
Captures large, mid and small cap representation across 23 developed markets (DM) and 24 emerging markets (EM) countries. With 8,675 constituents, the index is comprehensive, covering approximately 99% of the global equity investment opportunity set.
MSCI EAFE Index
An equities benchmark that captures large- and mid-cap representation across 22 developed market countries around the world, excluding the US and Canada.
MSCI Emerging Markets Index
Captures large and mid-cap representation across 24 emerging markets (EM) countries. With 1,136 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
S&P 500 Index
A popular benchmark for US large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.