Home country bias can lead to heartbreak

July 17, 2014 Categories: Portfolio Corner
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For much of the world, the FIFA World Cup has been the focus. In the World Cup, 32 countries competed to be crowned the king of soccer. Now, the U.S. has not always been the most ardent soccer nation, but the courageous struggle of the U.S. Men’s National Team warmed the hearts of millions of Americans.

Watching the tournament come to an end last week, I was struck by how many lessons could be drawn from the spectacular events in Brazil.

Let’s examine a couple of them.

1. Home field advantage or home country bias?

Anyone who follows sports knows that, in general, playing on home turf is an advantage. The World Cup is no different. Brazil, being the host as well as a nation devoted to the love of soccer, was favored to win the tournament by virtually everyone from ESPN to Goldman Sachs.1 However, in the end they were brutally beaten by Germany, crushing the hopes of Brazilian fans.

Investors can take a lesson from this: don’t bet everything on the home team. Financial literature has a name for the practice of “rooting for the home team.”It’s called home country bias and it is a well-documented fact that investors tend to hold a disproportionate amount of their portfolio in equities domiciled in their home country. According to research by Vanguard,2 in 2010 the average investor in the U.S. had a 29% overweight to U.S. equities relative to the asset class’s weight in the MSCI All Country World Index at the time.

Companies domiciled in the same country have historically had higher correlations to one another than between companies spread out across the globe3, so for investors, missing a global focus could lead to a less diversified portfolio.

Not only that, but investors could be passing up returns. U.S. equities (represented by the Russell 3000® Index) returned about 7% in the year-to-date as of June 23, 2014 – which didn’t even earn it a spot among the top 10 country performers based on return for that period. To continue our World Cup analogy, consider the chart below that ranks World Cup nations based on national market returns.4

Country Return
(Cumulative, Jan 1, 2014 – June 20, 2014)

Returns by country

 

2. Just because it worked last time…

In the last World Cup four years ago, Spain owned the entire tournament. They trounced their opponents all the way through, and then proceeded to win the next European championship in 2012. Coming into this World Cup, many pundits projected Spain would go far in the tournament again. Then, in their first game, the Netherlands annihilated Spain 5-1. Following that game, Chile danced over the defending champions to a 2-0 victory, eliminating Spain for the tournament completely.

The story often goes much the same in investments. Take the commodities asset class as an example. In 2013, the Bloomberg Commodity Index5 was down -9.5% at the end of the year. Especially in a year of strong market returns (the Russell 3000® Index ended the year up 34%), investors may have been tempted to dump such a drag on performance. However, in the year-to-date as of 6/30/14, commodities (represented by the Bloomberg Commodity Index6) are up 7.1%, beating the Russell 3000 Index, which returned 6.9% over the same time period. Virtually every asset class has seen similar reversals of fortune over various time periods.

The bottom line

A portfolio, properly diversified across a variety of asset classes, geographies and strategies, can help investors weather market fluctuations. Chasing performance leads to whipsaw for an investor, and always betting for the home team can lead to sub-par diversification and performance.

Nick Tunell is an Intern for PCS Consulting Services Group. 

1 http://blogs.wsj.com/moneybeat/2014/05/28/goldman-sachs-predicts-the-world-cup-winner/

2 https://pressroom.vanguard.com/nonindexed/6.26.2012_The_Role_of_Home_Bias.pdf

3 Bekaert, Geert, Robert J. Hodrick, and Xiaoyan Zhang. “International stock return comovements.” The Journal of Finance 64.6 (2009): 2591-2626.

4 Country returns expressed in local currency. Argentina represented by Russell Argentina Index, Italy by Russia Italy Index, Spain by Russell Spain Index, Portugal by Russell Portugal Index, Greece by Russell Greece Index, Colombia by Russell Colombia Index, the Netherlands by Russell Netherlands Index, Belgium by Russell Belgium Index, France by the Russell France Index, Switzerland by the Russell Switzerland Index, USA by the Russell 3000, Chile by Russell Chile Index, Brazil by Russell Brazil Index, Australia by Russell Australia Index, Germany by Russell Germany index, Mexico by Russell Mexico Index, Nigeria by Russell Nigeria Index, Croatia by the Russell Croatia Index, the UK by the Russell UK Index, Ecuador by the BVG index, Costa Rica by the CRSMBCT index, Algeria by the SGBV index, Bosnia and Herzegovina by the BIFX index, the Ivory Coast by BRVM-10 index, Cameroon by the Douala Stock Exchange, and Iran by the TEDPIX index. All return data is from Jan 1st, 2014 to June 23rd, 2014.

5 Then called the DJ-UBS Commodities Index

6 Then called the DJ-UBS Commodities Index

The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 Index® represents approximately 92% of the U.S. market. The Russell 1000® Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are reflected.

The Russell 3000® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Bloomberg Commodity Index: Composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position.

MSCI All Country Indexes include both Developed Markets and Emerging Markets countries across particular regions. For example, the MSCI AC Far East Index includes Developed Markets countries such as Hong Kong and Singapore along with Emerging Markets countries such as Indonesia and Thailand. The MSCI ACWI Index covers 46 countries.

“World Cup” is a trademark of the Federation Internationale de Football Association (FIFA).

RFS 13178

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