Why is it important to be globally diversified? [video]

Exploring diversification and home country bias with Vanguard's Peter Westaway

    Which is riskier - a global portfolio or a home bias?

    Discover why a home bias is a bad thing in international investing terms, and how diversifying globally makes the most sense for the strongest investment returns.

    Understanding the importance of global diversification: with a little help from Vanguard

    Robin Powell: One of the most common behavioural biases that investors are prone to is home bias.

    In other words, we invest too much of our portfolio in stocks and bonds in our own countries, and not enough in assets elsewhere. Here’s Peter Westaway from Vanguard.

    Peter Westaway: The idea of home bias is that investors will systematically tend to overweight the assets, whether its equities or fixed income, but the assets from their home market. So, for example in the UK, whereas the UK stock market is around 8% of the global stock market, the average holding of a UK investor is around 50%. So there’s a big overweight to UK assets.

    RP: Of course, it’s not just the UK. Investors all over the world have this preference for investing close to home. Often advisers and investors will use currency risk to justify it.

    PW: And so, overweighting to home market is a way of avoiding currency risk. That’s not always the best way to get away from currency risk, though. We think that, in fixed income markets, for example, it’s much easier to “hedge out”. Just buy a type of asset that is hedged out, so that you no longer expose your overseas bonds to currency fluctuations.

    With equities, you can hedge that out as well. Although, actually we think having unhedged equity exposure is sometimes a benefit because it doesn’t necessarily add volatility to your portfolio, when you have currency exposure, because sometimes a local stock market and a local currency may be going into the opposite direction and cancel each other out.

    RP: So, what if you have a hunch that a particular country’s fortunes are about to rise or fall, perhaps as a result of an election or a referendum? Well, unfortunately, its very difficult to profit from those sorts of events.

    PW: By the time there is some information that becomes compelling and it becomes the consensus view and it’s clearly going to happen then, by that point - even if it turns out to be true - that’s probably already priced into the market. So you’ve almost lost the opportunity by then to profit from it. So that’s kind of the irony.

    So really it’s about being able to predict those events, that nobody else is being able to do. And, that’s something really difficult. Some people get paid a lot of money to try and do that, but the reality is, on average, most of those don’t deliver.

    So, what’s the alternative strategy to that? Well, really having a portfolio of investments that aren’t loaded up on particular political events or particular states of the world coming around.

    RP: So, being aware of home bias and diversifying globally really do make sense.

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