| Florbela Yates is the head of Equilibrium in the Momentum Metropolitan group. Equilibrium is an independent discretionary fund manager that partners with financial advisors to help them enable their advice outcomes. Equilibrium brings balance to an advice practice by delivering services and investment solutions to help clients achieve their defined investment goals. |
A behaviour we see from investors is having a home-country bias, where they over-invest in local stocks relative to the optimal portfolio. We see this for a couple of reasons, including barriers to foreign investments, risk-aversion and behavioural factors.
These behavioural factors include familiarity bias and availability bias.
People who express familiarity bias tend to invest in the companies that they know. For example, they believe that because they use a specific brand, it must be popular, so they are more likely to invest in the companies whose brands they use.
The second is availability bias: Buying more South African equities because they believe that due to living here, they have more influence over how local companies perform.
Then there are cultural biases and factors that often affect how they invest their money.
Of course, the vehicle through which you invest may also limit your ability to invest in other countries.
Regardless of what the biases are or why they exist, our challenge is to help people avoid behavioural biases by putting together optimal portfolios with allocations to other countries besides their home country. When we construct portfolios, we look not only at the return expectations but also spend time understanding the risks associated with certain countries as well as how asset classes behave in various market conditions. We then build robust and diversified portfolios that make it easier for investors to stay invested. This requires a deep understanding of financial drivers, different asset classes, various investment styles, what risk means for different investors and, yes, an understanding of what triggers certain behaviours.
We recently analysed model portfolios managed on behalf of South African investors. Of the 67 balanced model portfolios we examined, just over 43% had no exposure outside South Africa and only 10% had 45% or more invested outside South Africa. The difference in performance between these portfolios ranged enormously, and without detailed information about all the underlying holdings, we can assume volatility will be vastly different without the full benefits of geographical diversification.
We have a team based in the UK that manages hard currency portfolios for South African and UK investors, and so I investigated whether there is any difference between the two ranges in terms of home-country bias. Those managed on behalf of largely South African investors have a more neutral allocation to the MSCI World Index, while those managed on behalf of UK investors tend to have a bias towards the UK. The models with a UK bias significantly underperformed those with a more neutral weighting over one year, three years and five years.
When we look deeper, it’s not actually only the allocation to US equities that drove this, although this was a contributor over the more recent period (our managers were underweight on the mega US tech stocks in both ranges). The biggest impact on portfolios was the diversification across countries and the sectors available in different economies that contributed significantly to the differences.
Lack of diversification and irrational biases affect returns and investors’ long-term investment amounts. We can’t prevent investors from having biases. But we can spend more time analysing their impact and making investors aware of the dangers of biases. This allows our clients to make more informed decisions. They will be better able to manage the risk/return trade-off, are more likely to stay invested and ultimately more likely to reach their investment goals.
