Is home bias affecting your investment returns?

The practice of keeping your money close to home isn't a new phenomenon, and investors in Britain are not alone in wanting to invest their capital into something they're comfortable with. But home bias can come at a cost.

“People start investing in things they are familiar with," says Frédérique Carrier, head of investment strategy at RBC Wealth Management in London. “It's a good starting point, but you forgo other opportunities. You would say that investors are not diversified if they only have a portfolio of UK equities,” she adds.

According to research by The Economist Intelligence Unit (EIU), commissioned by RBC Wealth Management, 63 percent of high-net-worth investors in the UK say they have savings or cash holdings in Europe. Younger generations* are more likely to invest this way (68 percent), versus 56 percent of older generations.

The New wealth rising survey, which targets high-net-worth individuals (HNWIs), adult children of HNWIs and high-earning professionals across the UK, Canada, U.S., China, Hong Kong, Singapore and Taiwan, explores the future of wealth, what it will be invested in and how it will be invested.

With the largest transfer of wealth in history underway, major attitudinal shifts are emerging. Interests are swinging from local to global, smart philanthropy is taking hold, and impact- and alternative investing are going mainstream. As wealth shifts—globally and from one generation to the next—the influence of affluence will change.

Facing headwinds from global markets, 73 percent of younger HNW investors say they are far more attentive to their portfolio now than in the past, due to the current market cycle, according to EIU data.

The power of diversification

Casting a net across a broader geographical area can allow for a smoother ride through the investment process. "Stocks don't go up in a straight line," adds Carrier. "It could be that UK stocks are being sold off, but if you are diversified, then that will cushion the negative performance." Diversification doesn't harm long-term investment returns, but it can help reduce portfolio volatility.

A recent case in point is the performance of the UK market relative to foreign markets. "If you had all your eggs in the UK basket you would have had assets in a weaker currency and an underperforming market," says Carrier. "Being 100 percent invested in the UK would not seem optimal at the moment."

Since the Brexit referendum on June 23, 2016, the value of investments in the UK stock market has fallen behind those of other key markets. In the period from June 2016 to July 2019, the FTSE 100 index gained around 10 percent. This is compared to the S&P 500, which increased 38 percent, according to Yahoo data. Both figures exclude dividends.

While that difference in returns is considerable, it doesn't tell the whole story. Over the same period, the value of sterling dropped relative to the U.S. dollar. Prior to the Brexit referendum, one pound would fetch around US$1.44. Yet more recently, the currency was trading 16 percent lower at $1.21, according to data from Bloomberg.

The combination of lower returns and a falling currency would have hurt investors who held a disproportionately large portfolio of UK stocks.

When asked about managing their wealth, 79 percent of HNWI the UK say they are confident in reaching their financial goals, compared to those in Canada (86 percent) and the U.S. (87 percent).

Lack of industry breadth

Not only is the choice of UK MSCI stocks limited in number, relative to global opportunities, but they also don't represent a broad selection of industries. "There's a relatively high percentage of sectors that are defensive such as healthcare, consumer staples, utilities," says Carrier. Those three sectors represent 30 percent of the MSCI UK market, versus just 24 percent of the world index.

According to the New wealth rising survey, 55 percent of older generations in the UK say they currently invest in health care/pharma. Other sectors popular with this cohort are technology (58 percent) and financial services (56 percent). These generations also believe those industries will see the biggest investment potential in the next five years.

In a recession, such investments tend to be resilient, which gets viewed as a positive phenomenon for investors. For those reasons, the UK market tends to do better than others during an economic slowdown.

However, recessions are relatively rare, and the UK market falls short in other ways because of its limited exposure to fast-growing industries. Notably, the UK MSCI index has a one percent exposure to the technology sector, which compares to 17 percent in the MSCI World index. That should matter to investors because tech firms, especially those from the U.S., have performed particularly well in the last couple of decades.

Of those surveyed in the UK who say their personal wealth is over $5MM (£3.842MM), 23 percent say one of the greatest obstacles to reaching their financial goals is poor investment performance. Additionally, 42 percent of all UK respondents say economic uncertainty in their country concerns them when it comes to their ability to create, preserve or manage their wealth. Other areas of concern include an increased cost of living (40 percent) and global economic uncertainty (37 percent).

Diversify for the long term

When diversifying assets, it's essential to be smart, says Carrier. "We wouldn't recommend diversification for its own sake," she says. Investors should work with professionals who have access to the latest investment research, covering multiple sectors and countries.

Tapping into such a wealth of knowledge can help protect long-term returns and address volatility across global markets.