All of us are patriots to some degree. However, it’s good to beware of home country bias to protect ourselves from unexpected risk. Home country bias refers to investors’ tendency to favor companies from their own country over those from other countries or regions.
After all, it’s usually better to invest in what we know rather than invest in what we don’t. The more insights we have into an industry or company, the more we feel comfortable investing. Sometimes, with our superior knowledge, we might even outperform.
Home country bias investing is a worldwide phenomenon. No matter where you are from, the chances are high that you will overweight investing in the country where you currently reside. Consequently, a lot of your investment performance might actually result largely from luck.
Home Country Bias Investing By Country
Take a look at the domestic equity allocation of total equity of residency by select countries.
At one extreme, we have Bangladesh, which has an almost 100% domestic equity allocation. The Bangladeshi people either must be extremely patriotic, know something we don’t about the growth of their economy, or don’t have as much access to other global equity markets. The Dhaka Stock Exchange has a total market capitalization of about $70 billion.
At the other extreme, we have Austria, which has only about a 23% domestic equity allocation. The Vienna Stock Exchange has a total market capitalization of about $150 billion, which is only about six percent the size of Apple Inc’s market capitalization. Perhaps Austrians are less bullish about their economy and more enthusiastic about international equities.
The United States, in yellow, has a 75% domestic equity allocation of total equity. Our home country bias is strong given U.S. companies only make up ~50% of the total world market capitalization. Our home country bias is not surprising given the strength of our economy, currency, and stability of our government.
Since I first started investing in 1995, it has been commonly suggested to diversify our domestic equity exposure with international equities by around 25%. Many have logically recommended investing in emerging markets for greater growth.
Too Much Home Country Bias Can Be A Big Problem
For whatever reason, the home country bias for Russians is extremely high. Roughly 96% of a Russian’s domestic equity allocation of total equity is in Russian equities. When Putin decided to invade Ukraine on February 24, Russian stocks collapsed and the ruble depreciated by over 50%.
The Russia stock market ETF, RSX, was down a whopping 70%+ a week after the war started. Further, many Russian banks and energy stocks are down even further. The Russian stock market is now closed and many of the Russian ADRs, GDRs, and ETFs are at risk of being delisted.
RSX is 50%+ below where it was during the 2008-2009 global financial crisis. But it could still go down another 90% once trading resumes given its Net Asset Value is down a similar amount.
Russian stocks will likely be dead money for a very long time. Sure, there will likely be some big bounces. But investing in Russian equities for long-term growth will be difficult.
The faith in Russian equities by homeland-based Russians has led to their economic devastation. There will be a great depression like no other as companies go bankrupt and lay off millions of people. The combination of losing all your money in the stock market plus losing your job might become unbearable for some.
Therefore, as an investor, we must be aware of our home country bias. It is more prudent to have a lower home country bias if your country is run by a dictator. Conversely, it is safer to have a higher home country bias if your country has a strong democracy.
Below is a chart of the Russia ETF, RSX. ~20 years of economic progress has been lost in just one week. At the moment, if you are based in Russia, there is no point working to invest. There is also no point doing business in Russia. If martial law is declared, the future for local Russians will look like North Korea.
Understanding Home Country Bias Is To Understand Human Nature
We will always be biased towards things we know versus things we don’t know. Inherent bias is why people will tend to take care of people who look more like themselves or come from similar backgrounds. If we want to give historically marginalized people a better chance at competing, manual changes in the system may be needed.
Left to their own devices, the majority of those who are privileged will continue to take care of their own.
Pretend you are a rich parent who went to an elite private university. Do you really think you will willingly give up your daughter’s admissions spot so that an underprivileged applicant who doesn’t have your resources be admitted? Probably not.
To make yourself feel better, you might donate money to provide scholarships for underprivileged families. You might even tell the world how you’re all for equality and inclusion. However, whether you are willing to actually sacrifice your opportunity or a loved one’s opportunity may be a different matter.
Why do wealthy politicians vociferously support public schools and send their children to private schools? Why are some adamantly for raising taxes but aren’t willing to pay more themselves? It’s more important to observe what people do rather than what they say.
Example Of Not Being Able To Give Up Your Spot
Back on July 13, 2020, Rachel Nichols, an ESPN host at the time who is white, discussed her career on a phone call with Adam Mendelsohn, the longtime adviser of the Los Angeles Lakers’ LeBron James and James’s agent, Rich Paul. Somehow, their conversation leaked. Here’s what she said.
“I wish Maria Taylor (a Black ESPN host) all the success in the world – she covers football, she covers basketball. If you need to give her more things to do because you are feeling pressure about your crappy longtime record on diversity – which, by the way, I know personally from the female side of it – like, go for it. Just find it somewhere else. You are not going to find it from me or by taking my thing away.”
Rachel voiced her opinion and wanted to protect her job after working so hard and for so long to get it. It’s only natural to want to protect what you have worked so hard to obtain. Most people would think and act the same way, which is why change is slow.
For those who are entrenched in power or who got a head start, it is only natural for these people to take care of their friends and family. Therefore, if you are outside the circle of power, you must work harder and strategize better to get ahead.
Optimism Reigns Supreme
Investors who exhibit home country bias with their investments tend to be more optimistic about their domestic markets and indifferent or more pessimistic toward foreign markets. In other words, we tend to believe we are smarter, better looking, harder working, and more productive than we actually are!
Unless you’ve lived in multiple countries, it’s hard to get a true sense of how your country’s culture stacks up against another country’s culture. The reason why some first-generation immigrants excel is because they appreciate how good they have it in their new country. Perspective matters.
I used to work in international equities, specifically covering the Asian ex-Japan markets. I also lived in Taiwan and Malaysia for elementary and middle school. As a result, at one point, I had roughly 20% of my portfolio in Asian country ETFs and individual stocks such as Taiwan Semiconductor, Baidu, Tencent, Alibaba, and Samsung Electronics.
My bias for these Asian companies was due to my upbringing and my work experience. I was optimistic about the growth of the Asian markets and especially Taiwanese and Chinese tech companies. It is a common strategy to try and invest in the “Google of X country,” or the “Uber of Y country” to try and capitalize.
As my time away from working in finance grew, so did the decline in my exposure to Asian equities.
With Russia’s invasion of Ukraine, my proclivity to invest in emerging markets has waned even further. In the unlikely event that China invades Taiwan, both Chinese and Taiwanese equities will plummet. Therefore, domestic investors in China, Taiwan, and Asia overall should probably consider reducing their home country bias.
More Capital Should Flow To The United States
Some believe home country bias can cause an investor to build an unbalanced portfolio that lacks diversification and is subject to unnecessary risk. However, I argue it’s more important to invest in countries with the strongest economies, the best infrastructure, and the most stable governments, regardless of home country bias.
The main country to invest in is The United States Of America, which has outperformed most other countries since the pandemic began. During times of war, the United States looks even more attractive because it has the most powerful military to protect its citizens.
Therefore, I expect more foreigners to buy more U.S. assets in the coming years. I fully expect foreign investors to gobble up a lot more U.S. property as the pandemic eases. The pandemic throttled foreign demand for U.S. property for two years. But now the pent-up demand is too great.
If you are not a U.S.-based investor, then I think would be wise to reduce your home country bias and invest more in U.S. equities. If you are a domestic U.S. investor, then I think it’s smart to increase your home country bias above 75% for the foreseeable future.
The outperformance of U.S. equities and the U.S. economy is undisputed. But of course, I’m biased for the U.S. since I’ve lived here since 1991!
If You Still Want To Buy International Equities
If you must diversify your portfolio with international securities as a U.S. investor, maybe diversify into the most democratic nations. According to World Population Review, the top 10 most democratic nations in the world as of 2020 are.
- Norway (9.87)
- Iceland (9.58)
- Sweden (9.39)
- New Zealand (9.26)
- Finland (9.25)
- Ireland (9.24)
- Canada (9.22)
- Denmark (9.22)
- Australia (9.09)
- Switzerland (9.03)
The United States scored 7.92 in 2020 and again landed in the “flawed democracy” category, where it has resided since falling from “full democracy” in 2016. But of course, I think this characterization of the U.S. democracy to be flawed!
But as we learned from a previous article, there’s a lot of bias for these happiest countries based on who is deciding. It turns out, most of the people who decide which countries are the happiest and most democratic come from the top 10 countries!
Besides, there will likely be a growing valuation discount for European equities given the proximity of the Russian war. The fear is that Putin continues to march west and wreak havoc.
Keeping My Home Country Bias In U.S. Assets
I’m keeping my home country bias high at over 95% of my investments in U.S. assets. The risk:reward ratio for investing in emerging markets is simply not worth it. Further, if U.S. investments are in trouble, emerging market investments will likely experience even more downside.
In times like these, we should really appreciate the value of our U.S. real estate holdings. The less exposure an asset has to uncontrollable exogenous variables the better. I love owning a stable income-generating asset that provides an important purpose.
Readers, what is your home country bias? Why do you think some countries such as Bangladesh, India, Turkey, the Philippines, Russia, Indonesia, and Brazil have such a strong home country bias? Should the CEOs of United States companies and real estate developers do more to court international investors?