By Sandrine Soubeyran and Christine Haggerty, directors, research and analytics
We recently blogged about the negative impact of home bias on equity returns for institutions based in North America, Japan and Australia since the global financial crisis.
Despite decades of collapsing barriers in financial markets, we found institutional investors in almost every market were overweight domestic equities—what’s called home-country bias—resulting in a large underperformance versus a basket of global stocks. The sole beneficiary of home bias in this period were US institutions, which benefited from the outperformance of US equities and the strength of the US dollar over the 12-year period examined.
Our follow-up paper looks at the Eurozone home bias in equity allocations and demonstrates a similar picture.
Our research examined the characteristics, performance and return-to-risk profiles of the equity markets in France, Germany, Italy, Netherlands and Spain from 2008 through September 2019, comparing their portfolios with the FTSE All-World Index, which includes large- and mid-cap developed and emerging companies in its representation of the global universe of listed companies.
First, let’s examine the degree of home bias. All five European equity markets examined exhibited favorability to local stocks relative to their weight in the global index. But the degree is remarkable.
Chart 1: Pension funds estimated allocation to local equities relative to total equity exposure and country weight in the FTSE All-World Index (%)
Source: FTSE Russell as of December 31, 2018, and Mercer European Asset Allocation Survey 2018.4
As chart 1 shows, in the least home-biased market—Germany—the domestic equity allocation was 53%, 18 times the nation’s weight in the FTSE All-World Index index. The most domestically biased of these markets is Spain, with an average estimated asset allocation of 67%. This is 67 times Spain’s 1% weight in the FTSE All-World. France, The Dutch and Italian pension funds were similarly overweight domestically.
For most of the period, all five markets underperformed their broad international counterparts, with euro weakness and higher stock-market volatility weighed heavily on absolute and risk-adjusted terms. The domestic skew has been extremely costly for investors in these countries.
Chart 2: Relative total returns ‒ FTSE country indices versus the FTSE All-World ex local indices (EUR, rebased)
Source: FTSE Russell from December 31, 2007 to September 30, 2019 (Q3 2019). Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Europe’s difficult decade made local investment bias painful. The multi-year European sovereign-debt crisis took a severe toll on Europe’s peripheral economies and financial markets, notably Italy and Spain. The weak euro also hurt returns for euro-based investors. And US stock outperformance was a factor: the FTSE USA produced higher risk-adjusted returns than the FTSE All-World ex US in 10 (or more than 80%) of the past 12 years1. Investors underweight US stocks, the engine of global equity performance during the decade, had a tall hurdle to clear.
There are several rationales for investor preference for home markets, including the desire to avoid exposure to exchange rate or political risks, the extra costs to hedge against these risks, regulatory barriers and asset-liability matching needs. And the outcome could have been worse for more bullish investors: pension fund providers in each market tended to allocated less than one third of their overall assets to equities.
These caveats are understandable, but an uncomfortable truth remains: in a decade where Europe’s pension crisis and weak economy were never far from investors’ minds, domestically focused equity strategies tended to deliver significant underperformance compared with more global equity allocation strategies.
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1Source: Appraising home bias exposure using the FTSE Global Equity Index Series (FTSE GEIS), FTSE Russell, October 2019: https://www.ftserussell.com/research/appraising-home-bias-exposure-using-ftse-global-equity-index-series
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