I’ve been in Japan recently looking into their small caps over there.
A lot of people don’t like the idea of investing far from home…
It’s to be expected. I’ve been in the newsletter business long enough to know that most investors really don’t like putting their money abroad.
Academics call it the home bias: the tendency of investors to put more of their money in their home country than they really should.
Today I want to dig into that idea. I hope to convince you that putting some of your cash outside the UK is a smart move.
I could explain home bias using technical economic concepts and data. But really, it boils down to common sense. Why keep all your eggs in one basket?
You don’t get anything extra out of it. It’s not as though UK stocks outperform foreign stocks in the long run. By keeping everything in the UK, you expose yourself to more risk for no good reason.
The Brexit referendum result is an example of how this can hurt you. After Brexit, most UK stocks fell (apart from the biggest companies with lots of overseas earnings). Sterling fell too.
But an investor who’d allocated a good chunk of his portfolio to foreign stocks wouldn’t have lost out, because the gains from foreign stocks (due to the fall in sterling) would’ve cancelled out losses at home.
You need stocks in your portfolio because they’re the best long-term investment ever discovered. But there’s nothing to say they have to be UK stocks. The UK stock market makes up somewhere between 2 and 2.5% of all stocks. Why would you limit yourself?
Risk, three ways
The “all your eggs in one basket” problem manifests itself in a couple of different ways…
Lets say you’re a generic UK investor who buys the FTSE 100 index. Well, the FTSE is dominated by a couple of big companies in just three industries: banks, oil & gas, and consumer goods. Companies from those three industries make up 53% of the index. Do you really want to bet heavily on the volatile oil & gas sector, or on super-leveraged banks?
If you’re taking a view on those sectors then invest away — and more power to you. But if don’t know anything about banking or oil & gas, you have to ask whether it’s smart to allocate a lot of your money in them.
Then there’s Brexit. The UK is at a crossroads right now. Depending on who wins the big argument going on at cabinet, the country could look very different in two years’ time. Is this something you want to make a high-stakes bet on? Are you taking a view? If not, hedge your bets! A couple of quid in foreign stocks will protect you in case of a WTO or Canada style Brexit, which would surely drag the pound down (along with UK stocks).
And another thing! Dividends are weird in the UK. In other countries, dividend payments are spread around companies fairly evenly. In other words, if you’re looking for a company that pays good dividends, there are loads to choose from.
Not so in the UK. According to Mark Whitehead of the Securities Trust of Scotland, dividends from the top 20 dividend-paying stocks in the UK account for 64 per cent of all dividend payouts in the FTSE All Share. In the MSCI All Country World Index, dividends the top 20 dividend payers make up just 18% of total payouts.
So if you’re solely investing in UK stocks and relying on dividend income, you’re in a potentially risky situation. A bad year for the oil & gas industry, for example, could blow a hole in your income. And at the risk of repeating myself, you get nothing extra that you couldn’t get by investing in overseas dividend stocks.
Not all upside
What about the downsides of investing overseas?
People aren’t stupid. Historically, there have been good reasons not to do so.
Cost is the first one. It used to be tricky and expensive for retail investors to deal in overseas shares. It took a determined investor to go through all the steps involved.
But happily that’s not the case anymore. The biggest stockbrokers deal in loads of foreign markets, at no extra cost.
Language and distance another one. It’s still hard to come by good information on, for example, Japanese stocks. English language investment writers don’t dig around there too often. And the companies don’t make it easy either. So if you’re going to be investing in specific overseas companies, you definitely need help and advice.
The best argument is that UK investors live in the UK, so spend their money there and pay their mortgages there. It’s where UK investors’ liabilities are. It makes a certain amount of sense to match UK assets with UK liabilities. But as far as I’m concerned this an argument to be overweight UK stocks in a portfolio. Not an argument to invest exclusively in UK stocks.
The cliché is “diversification is the only free lunch in finance”. But it’s a cliché for a reason. If you don’t have a few foreign stocks or indexes in your portfolio, you’re missing a trick.