I was speaking to some American financial advisors once and we started talking about geographic diversification. I mentioned that it wasn’t uncommon for Canadians to have extreme home biases, and many Canadians only invest in Canadian stocks. They said the same thing for American investors.
Considering that the US has traditionally been 50% of the world’s stock market (by size) it’s less of a stretch for Americans than it is for Canadians (Canada has traditionally been about 2 to 4% of the world’s stock markets by size). Some of the American financial advisors fell of their chairs during our discussion since it would be akin to an American investor putting their entire portfolio into handful of US mid-cap, industrial stocks (for example).
On the world stage, Canada is more akin to a small-cap and mid-cap market (there are only a few large cap companies on the global stage’s standards), and we all know our market is dominated by energy, financials and materials (they account for the vast majority of all companies by size in Canada – leaving out 7 other major sectors).
So why do we have such a home bias?
Partly because there is a slight tax advantage to holding Canadian stocks, but mostly its psychological. You tend to feel more comfortable investing in companies whose names you know and whose signs you see all the time. As reader Connie also points out, currency fluctuations between your home currency and foreign investments denominated in other currencies adds another variable to the mix (which can help or hurt).
Advisors and investors bring biases to their portfolios all the time. For example, I can tell you that investors and advisors who have immigrated from the Far East have 2x to 3x the allocations to emerging markets than born and raised Canadians. This is just from experience, I don’t have any stats to back that up empirically, but it’s true. :)
So what are the right allocations? Well, that would take a long time and is best saved for some future posts. There is no perfect allocation, but you do have to understand what risks you are exposed to with the allocations you take – and my point is that people, generally, don’t.