All of us have a certain bias towards different things. Some people love reading books, others prefer to watch sport on television.  Some people like to live near the beach, others prefer to live in the country. Whatever your bias the same principle applies for your investment portfolio.

Home bias refers to the amount of extra allocation you have to your home country.  A bias is brought about by the difficulties of investing in international equities, such as legal restrictions and additional transaction costs.  

For Australians, having a home bias towards Australian shares does have it’s benefits.  In Australia we have franking credits which apply to the income received from Australian listed companies.  This provides extra incentive to hold blue chip Australian Shares who have strong dividend yields and a strong track record in paying dividends to owners.

Investing internationally provides access to economies and industries that have low correlations to the Australian market, adding significant diversification benefits and increasing the potential for improved risk-adjusted returns over the long term.

It is important to note that despite the obvious benefits of investing in Australian Shares the Australian share market capitalisation makes up approximately 3% of the world stock market capitalisation.  Therefore having a home bias to Australian equities provides portfolios with an extremely high concentration to the home country of Australia.

If we look back at the recent returns in Australian and world markets, having no exposure to international equities would have proved costly in the past 12 months. However over the long term of 20 years we see a different story.

Australian Shares vs International Shares – 31 December 2013

Investment

One-year return (%)

Five-year return      (% a year)

Ten-year return     (% a year)

20-year return  (% a year)

MSCI Australia Gross Total Return Index ($A)

21.1

12.5

10.0

8.7

MSCI World ex-Australia Gross Total Return Index Hedged (Local currency)

29.9

15.0

6.9

7.0

MSCI World ex-Australia Gross Total Return Index Unhedged ($AUD)

48.9

10.0

5.6

6.0

It’s important to have a well diversified portfolio so that you can benefit from different asset classes when they have periods of good returns.  It’s important to remember that past performance is not a true indicator of future performance.

Please contact Tim Ward on tim@fwo.net.au for more information or to organise a meeting to discuss your investment strategy.