Domestic market bias

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ukbogler
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Domestic market bias

Post by ukbogler » Thu Oct 03, 2019 7:05 am

I found an interesting article the other day, offing the conclusion that any 'rational' investor would only invest in an international whole world tracker, and explaining why 'home country bias' was generally a bad thing.

Seeing as a lot of boglers seem to split their investments into [home country / international excluding home country / global bonds] I was just wondering what justification they used for overweighting the home country. My own justification for bumping my FTSE stuff up way past the proportion represented (eg) in VWRL is that the FTSE 100 seems way undervalued to me right now, being in the same ballpark as 20 years ago, which has led to a dividend yield of almost 5%. Seeing as I live in the UK and require pounds to live on, holding more of it seems like a good idea to me.

I'd be interested if there was any actual scientific justification for overweighting domestic equities in a boglehead portfolio though.

Here's that article I mentioned.

https://monevator.com/why-a-total-world ... -you-need/

UpperNwGuy
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Re: Domestic market bias

Post by UpperNwGuy » Thu Oct 03, 2019 7:09 am

Did you read the many prior threads on this topic before posting your question? This topic has been discussed ad nauseam on this forum for years. There's nothing new left to say on either side of the debate.

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JoMoney
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Re: Domestic market bias

Post by JoMoney » Thu Oct 03, 2019 7:49 am

Risks, expenses, tax considerations...
https://personal.vanguard.com/pdf/icrrhb.pdf
Image
... Although there may be many rational reasons for home bias, we present certain metrics that investors can use to help determine an appropriate allocation to foreign securities. Generally speaking, our framework suggests that U.S. investors may have some quantitative justification for a home bias, and investors in other countries might consider increasing their global diversification. We provide an example of how our framework can be used; however, it or any systematic evaluation process must also be individualized. ...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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BeBH65
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Re: Domestic market bias

Post by BeBH65 » Thu Oct 03, 2019 8:32 am

Our wiki lists different studies in the subject of home county bias Vs global diversification.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles

Topic Author
ukbogler
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Re: Domestic market bias

Post by ukbogler » Thu Oct 03, 2019 8:47 am

Yes, I did read them (although I confess I only skimmed the Vanguard 'research'). None of them provided anything I could regard as a valid reason for overweighting locally in the context of the article I posted. Did you even read it?

TN_Boy
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Re: Domestic market bias

Post by TN_Boy » Thu Oct 03, 2019 9:34 am

ukbogler wrote:
Thu Oct 03, 2019 8:47 am
Yes, I did read them (although I confess I only skimmed the Vanguard 'research'). None of them provided anything I could regard as a valid reason for overweighting locally in the context of the article I posted. Did you even read it?
I don't believe the article you posted talked specifically about US investors. Many people on this board believe the US investor can safely ignore international diversification due to the large size of the US economy, its good business environment, and the fact that many US companies have large international revenue. And probably some other reasons I'm leaving out. I don't totally agree with this point of view, but there is no doubt that the US is at least somewhat "different" than other countries due to its (current) economic and military strength.

I think you are a UK investor, yes? I think it is critical that YOU should be internationally diversified. The UK economy is far far smaller than the US economy, and currently subject to Europe-specific Brexit risk.

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ukbogler
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Re: Domestic market bias

Post by ukbogler » Thu Oct 03, 2019 2:02 pm

The article has a simple theme - nobody can tell which stocks will outperform in future, so buy them all using an index. As the same thing applies to which markets might outperform, buy them all. Therefore, buy a whole world index.

I go with the boglehead theme, and although I have international indexes (FTSE whole world ex UK), I also have the entire UK market too, and I have overweighted it because I want the juicy dividends the FTSE kicks off right now. That's a factual reason, not a conviction the UK will outperform over the coming decade (dividends are not especially volatile compared to most other things, citation available). If you're NOT in the UK, what's your justification for overweighting your local market in the boglehead style?

I'm just asking... if you have no justification for it, that's fine.

TN_Boy
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Re: Domestic market bias

Post by TN_Boy » Thu Oct 03, 2019 2:52 pm

ukbogler wrote:
Thu Oct 03, 2019 2:02 pm
The article has a simple theme - nobody can tell which stocks will outperform in future, so buy them all using an index. As the same thing applies to which markets might outperform, buy them all. Therefore, buy a whole world index.

I go with the boglehead theme, and although I have international indexes (FTSE whole world ex UK), I also have the entire UK market too, and I have overweighted it because I want the juicy dividends the FTSE kicks off right now. That's a factual reason, not a conviction the UK will outperform over the coming decade (dividends are not especially volatile compared to most other things, citation available). If you're NOT in the UK, what's your justification for overweighting your local market in the boglehead style?

I'm just asking... if you have no justification for it, that's fine.
I gave three justifications for the US investor above. For the non-US investor, I'd be interested in the justifications also.

Japan is always held up as an example of how home country bias can turn out badly. And Japan has a pretty large economy. The smaller the country, the riskier that home country bias is.

andrew99999
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Re: Domestic market bias

Post by andrew99999 » Thu Oct 03, 2019 7:24 pm

Increasing home country equities has these upsides

1. Some countries get a tax credit so there is a boost to return, although in the case of Australia a lot of that is priced-in, but even then there is some benefit (although much smaller than people realise).

2. Lowers currency risk - this can also be done with a global fund hedged into your currency. The cost of hedging is very low (around 3-4bps), but unfortunately in some markets the fund that is hedged is expensive (I think EURO or GBP hedged by ishares is like 0.55)

3. Even with hedging, over the long term, the stock market tends to track the economy which hedging may fail to do. For example, what if you live in a developing country that out does the global index which is mostly made up of developed countries. Your returns would lag causing a new type of risk - that of not meeting your needs.

Of course all these come at the cost of concentration risk which is a massive risk that outweighs all of them.

That doesn't mean home country equities are rubbish. It then becomes a trade-off of how much concentration risk you deem to be tolerable for the benefits. The same way that the low returns of bonds does not make them rubbish and the high risk of stocks does not make them rubbish - you need to weight it up and decide on a ratio that moderates each risk.

Also if you retire at normal retirement age (and therefore with around half your assets in bonds) with sufficient assets and some padding, then you are already hedged into your currency and so less or no need for home currency based equities at all and you can avoid concentration risk altogether.
PassiveInvestingAustralia.com

glorat
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Re: Domestic market bias

Post by glorat » Thu Oct 03, 2019 10:23 pm

My personal 2c having looked closely at the UK home bias issue... the topic simply doesn't matter much! Here are my reasonings

1) The US forum discussing modern portfolio theory that there is little diversification benefit between US large caps and international developed world large caps. I.e. if you deviate from global market cap weighted on this principle, take US large caps and ignore developed large caps. Large caps tend to be international companies anyway.

Would the same theory hold for UK home bias? Well...

2) The FTSE-100 is clearly dominated by companies that earn abroad. They are arguably just as international as many of the US and global large caps. As such, they are already somewhat decoupled from the local UK economy. To take some case in points - the FTSE-100 is a strong hedge against a falling GBP because it mainly earns abroad - it tracks much closer to USD than GBP (FXDelta about 0.7). And see the dominating companies of the FTSE-100 that clearly have strong business abroad.

3) If you want "true" home bias in terms of the local economy, then you probably need to overweight the UK mid-caps and small-caps. E.g. buy the FTSE-250 for mid-cap exposure. These companies are more weighted towards serving the local UK economy than the global economy and therefore fits the spirit of home-bias


For further reading, the modern portfolio theory discussions in the US forum would suggest diversification would involve a mixture of large caps (any) + local small caps + emerging markets + other bits and pieces. For UK you could do that too if you like complexity and attempts at optimality. I can't be bothered much.

In short, my assessment to implement UK home bias involves saying that large cap doesn't matter so much, global FTSE/MSCI is fine. If you want to have local home bias, go long FTSE-250 (e.g. VMID ticker). But now we are into "complicated" territory for not so much gain. I'd rather stick to simple. I think if you toss a coin between where to tilt your large caps it will make no difference compared to other choices.

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ukbogler
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Re: Domestic market bias

Post by ukbogler » Fri Oct 04, 2019 3:02 am

Great stuff guys, thanks for your answers! As always, well thought out and informative!

Valuethinker
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Re: Domestic market bias

Post by Valuethinker » Fri Oct 04, 2019 4:09 am

glorat wrote:
Thu Oct 03, 2019 10:23 pm
My personal 2c having looked closely at the UK home bias issue... the topic simply doesn't matter much! Here are my reasonings

1) The US forum discussing modern portfolio theory that there is little diversification benefit between US large caps and international developed world large caps. I.e. if you deviate from global market cap weighted on this principle, take US large caps and ignore developed large caps. Large caps tend to be international companies anyway.

Would the same theory hold for UK home bias? Well...

2) The FTSE-100 is clearly dominated by companies that earn abroad. They are arguably just as international as many of the US and global large caps. As such, they are already somewhat decoupled from the local UK economy. To take some case in points - the FTSE-100 is a strong hedge against a falling GBP because it mainly earns abroad - it tracks much closer to USD than GBP (FXDelta about 0.7). And see the dominating companies of the FTSE-100 that clearly have strong business abroad.
The sectoral weighting issue is huge, though. FTSE 100 now has only one tech stock AFAIK (Sage, an accounting software vendor).

If you look at the top companies F100 is heavily weighted towards energy (BP & Royal Dutch Shell are together over 15% last time I checked), tobacco (BAT & Imperial), pharmaceuticals (GSK & Astra Zeneca), Banks (HSBC), Mining (BHP Billiton, Rio Tinto, Glencore)

It has very few industrial companies (I think Rolls Royce is the largest).

So "diversification" in currency terms, yes. In terms of sectors though? No.
3) If you want "true" home bias in terms of the local economy, then you probably need to overweight the UK mid-caps and small-caps. E.g. buy the FTSE-250 for mid-cap exposure. These companies are more weighted towards serving the local UK economy than the global economy and therefore fits the spirit of home-bias


For further reading, the modern portfolio theory discussions in the US forum would suggest diversification would involve a mixture of large caps (any) + local small caps + emerging markets + other bits and pieces. For UK you could do that too if you like complexity and attempts at optimality. I can't be bothered much.

In short, my assessment to implement UK home bias involves saying that large cap doesn't matter so much, global FTSE/MSCI is fine. If you want to have local home bias, go long FTSE-250 (e.g. VMID ticker). But now we are into "complicated" territory for not so much gain. I'd rather stick to simple. I think if you toss a coin between where to tilt your large caps it will make no difference compared to other choices.
There are 2 questions here:

1. do I diversify my stock portfolio to global weightings. The answer from an efficient capital markets point of view is almost certainly "yes" - resoundingly so. There is no reason not to seek maximum diversification other than taxes &/or transactions costs.

2. do I hedge my sterling exposure? The answer is not simple. Most international bond funds hedge, most equity funds do not.

Hedging costs something (but should not be too much). As GBP has been so weak it has counted against you but that could reverse.

Your income and your property equity are in GBP, so is your state pension rights, so arguably one has enough exposure to GBP

The answer is, I think, to be pragmatic. Early in one's savings career, one accepts full volatility in the belief that eventually sterling will settle to "about right" level.

As your bond percentage grows over time, so will your sterling "lock in". You will have reduced your foreign exchange exposure.

I would suggest that a portfolio level no UK investor should be less than 20-30% foreign exchange exposed - a hard limit on UK assets. The example of the 1970s when UK inflation beat all other countries' inflation, looms too large. Ideally you would fight this by holding index linked gilts (ie UK equivalent of TIPS) but the real interest rates right now are -2.0% which is a truly painful level of real returns to accept (the certainty that your money would halve in value every 36 years *unless* inflation is above market expectations).

Topic Author
ukbogler
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Re: Domestic market bias

Post by ukbogler » Fri Oct 04, 2019 6:22 am

It is a bit worrying the FTSE 100 is so 'old skool'. That's probably why it yields so well. Lots of money in pimping drugs, smokes, loans to the desperate, and shiny bling :D :D :D

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happyisland
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Re: Domestic market bias

Post by happyisland » Fri Oct 04, 2019 7:01 am

Question for the OP: why do you care what the dividend yield is? I've read a lot of threads here over the years that have argued the only important thing to keep in mind is total portfolio performance. Does the UK have favorable tax treatment of dividends or is there something else I'm missing?

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ukbogler
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Re: Domestic market bias

Post by ukbogler » Fri Oct 04, 2019 7:33 am

First off, if you have no other source of income, you get (AFAIR) 11,000 allowance, no tax, no need to even declare it. If you're married that's 22k of dividends to spend, no tax. You also get something similar in cap gains allowance, so you can potentially extract 40k from the pot without tax using dividends and selling gains, and that's before you start looking at the tax saving wrappers like ISAs or SIPPs.

Secondly, If I'm winning at the casino, every now and then I like to 'take a little money off the table'.

Thirdly, research shows that dividends historically make up something like 50% of all returns - you may have noticed how the market news has been full of stories recently about a rotation away from momentum to value - hardly surprising when the SP is at such a crazyhigh CAPE value. Hard example - the SP is back where it was at the start of 2018. As it yields only about 2%, what was the point of the last couple of years? Inflation gobbled that up.

Fourthly, if you're only doing the 'greater fool' thing, and investing solely for cap gains, you have a hard time of it when the bear arrives. The Dow, FWIW, has been in such a state for a surprisingly large amount of time over the last 100 years. During those times, dividends are your friend.

Fifthly, if you automatically reinvest your dividends, you're essentially saying 'the price of this security is of no interest to me'.

I'm no expert though, so no doubt counter arguments exist.

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Peculiar_Investor
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Re: Domestic market bias

Post by Peculiar_Investor » Fri Oct 04, 2019 8:09 am

JoMoney wrote:
Thu Oct 03, 2019 7:49 am
Risks, expenses, tax considerations...
https://personal.vanguard.com/pdf/icrrhb.pdf
Image
... Although there may be many rational reasons for home bias, we present certain metrics that investors can use to help determine an appropriate allocation to foreign securities. Generally speaking, our framework suggests that U.S. investors may have some quantitative justification for a home bias, and investors in other countries might consider increasing their global diversification. We provide an example of how our framework can be used; however, it or any systematic evaluation process must also be individualized. ...
As a Canadian investor, I found the linked Vanguard paper is an excellent framework to examine the question and understand the impact of home country bias. Once you understand there are some valid reasons to have some extra home country bias, it becomes easier to design an asset allocation that works for your circumstances and biases.

I'm well aware that Canada represents about 3-4% of global equity market capitalization and is another example of sector concentration in a small number of sectors, financial and energy are the top 2. My asset allocation to Canadian equities isn't quite that low mostly because of local taxation and spending (now and future) patterns that will mostly be in Canadian dollars.

I don't agree with Bogle and many others who preach the notion of buying the whole haystack, i.e. a broad-based index, but somehow limit their haystack selection to just the US haystack. I see no reason this shouldn't be extended to the global haystack.
Normal people… believe that if it ain’t broke, don’t fix it. Engineers believe that if it ain’t broke, it doesn’t have enough features yet. – Scott Adams

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ukbogler
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Re: Domestic market bias

Post by ukbogler » Fri Oct 04, 2019 8:28 am

Peculiar_Investor wrote:
Fri Oct 04, 2019 8:09 am

I don't agree with Bogle and many others who preach the notion of buying the whole haystack, i.e. a broad-based index, but somehow limit their haystack selection to just the US haystack. I see no reason this shouldn't be extended to the global haystack.
Cheers, agree with you. Most rational people probably do - it's the allocation they normally seem to get het up about.

Being objective for a mo, the US has gone nowhere in 2 years, despite trillions of dollars to pump it up. The CAPE is at levels usually only seen before a crash, and it's literally deformed because some of the biggest companies in it are essentially nothing more than advertising firms and we all know what happens to them in a recession - if I had any sense I'd keep right away from it. But I don't :D

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