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Home bias is the concept of having a strong affinity for investing in assets from one’s own country. For Australian investors, this means there is a strong bias towards investing in local assets such as equities, fixed income, and property. And while home bias is an understandable phenomenon as investors are often told to “stick to what they know,” Australian investors are missing out on potential opportunities from around the world – particularly considering directly held domestic shares are still the mainstay of many portfolios. Though some would consider this approach tried and true, it has a few distinct downfalls that may prevent portfolios from performing to their utmost potential. Hence, to help beat home bias, investors can use ETFs to access a range of international markets.
Let’s X-Plain:
- Why is home bias a potential portfolio killer?
- How can capital growth be increased by investing internationally?
- Why use ETFs to access global markets?
Why is Home Bias a Potential Portfolio Killer?
According to the latest ASX Investor Study, 58% of local investors have directly held Australian shares in their portfolio, making them the most popular option in the country. Meanwhile, only 16% directly hold international shares.1
Besides being more aware of the companies listed in Australia, local investors have generally been attracted to domestically listed shares because of franking credits. Franking credits generally increase tax efficiencies as they avoid tax being paid twice: once by the company on profits generated and once by the investor through any dividends collected. Currency risk may also be a consideration for local investors as the US dollar is comparatively stronger than the Australian dollar.
How to Increase Capital Growth by Investing Internationally?
By only investing in Australia, investors may miss out on the scale, sector and stock performance of other countries and regions.
Australia’s market size is a key factor compounding the effects of home bias. It represents only 2% of the global market, while in comparison, the US constitutes around 60%. This can be detrimental to portfolio performance as Australian investors are not capturing the potential growth and returns of larger markets.2
In addition to overall size, sector weightings in each market play a notable role in performance. Seven out of the top ten companies listed on the ASX fall into the financial or materials sectors, and make up a significant portion of the S&P/ASX 200.3 These blue-chip stocks, seen as the cornerstones of the Australian economy, are generally characterised by their consistent performance, dividend distributions and value. However, the growth potential of these industries is often reduced, given their limited ability to innovate in line with broader megatrends.
Meanwhile, information technology (IT) is one of the smallest sectors in the Australian market, making up approximately 2.5%.4 This indicates that Australian portfolios are likely underweight in this sector and may miss out on its potential growth and returns. In the US however, IT represents not only a larger portion of key indices such as the Nasdaq 100 and S&P 500 but represent a strong cohort of technology-focused stocks which have driven outperformance in recent years.
The below chart highlights how the S&P/ASX 200 has performed in comparison to the US’s S&P 500, EURO STOXX 50 and India’s Nifty 50 over the last 10 years. This underscores the potential capital gains which could have been realised by incorporating international investments into a well-diversified portfolio.
Why use ETFs to Access Global Markets?
Australian domiciled ETFs can be an effective vehicle for local investors looking to access international markets. Australian domiciled simply refers to stocks and funds which are listed on an Australian stock exchange, such as the ASX or Cboe, meaning local investors can easily access them through a financial adviser or online broker. It also means that Australian tax laws and benefits apply to these stocks and funds.
Conversely, stocks or funds which are internationally domiciled (those listed on stock exchanges outside of Australia including developed and emerging markets) can be challenging to access, incur a range of fees or involve a range of cumbersome administration forms.
Hence, Australian domiciled ETFs which invest in global markets can help Australians access international stocks without many of the costs and complications usually associated with doing so themselves.
Three ETF Strategies to Help Beat Home Bias
Invest in the World’s Largest Economy
The US share market is the largest in the world, and while you can purchase a broad index which aims to track the performance of the overall market, it may be beneficial to explore more strategic approaches to best suit your portfolio needs. These could include:
- An index which tracks 100 of the most innovative stocks in the US,
- A concentrated, equally weighted index which tracks 10 of the largest, highly traded stocks in the US,
- Or an index which tracks a large basket of US small cap stocks.
Invest in an Established Region
Europe is home to some of the most established companies in the world, including prestige brands many may recognise like Ferrari and L’Oreal. Investing in the 50 largest companies listed in the eurozone can offer exposure to a range of stocks across economic sectors. This is a well-trodden path; in fact, the EURO STOXX 50 Index is one of the most traded indices in the world.
Invest in a Promising Emerging Market
Emerging markets present another unique avenue to help generate portfolio growth. As the name suggests, these are emerging opportunities on the global stage which should evolve alongside the country’s economic and social development. India is a leading emerging market which is backed by increasing domestic consumption and foreign investment as well as notable government policies. Hence, an ETF which tracks the 50 largest companies in India is designed to capture this potential growth.
Goodbye Home Bias
Although investing in local equities has its merits for Australian portfolios, having home bias can ultimately limit overall performance and returns. Looking to international markets, like the US, eurozone, or emerging markets offers geographic and sector diversification. Hence, accessing these leading internationally-listed companies via an ETF may be an effective option for Australian investors looking to beat their home bias.