Equity investment: Do countries matter?

The majority of investors, from individuals to the biggest foundations, exhibit a significant home country bias—regardless of where they are located in the world.

The propensity to invest at home is partially caused by the abundance of options in the world equity markets. People are paralyzed by their options, and so invest close to home.

Countries matter, said David Garff, president of Accuvest Global Advisors, speaking at the annual Investment Management Consultants Association (IMCA) 2012, in National Harbor, Maryland.

“A country-focused approach to a global equity mandate that includes exposure to both developed and emerging markets can enhance performance,” he said, “so investors should mind this tendency to avoid going global.”

Graff outlined two fundamental drivers of home bias.

Familiarity: Investors are more interested in what they know. “That’s a function of what people can get comfortable with and this goes to the heart of why investors invest at home and not abroad,” he said.

But the truth is, “a U.S. investor can no more predict the S&P 500 than he can predict the DAX.”

Familiarity with domestic markets creates a false sense of security among investors, he added.

Risk: Investors are instinctively risk averse. Many tend to avoid exposure to currency fluctuations, political and economic risks, lack of publically available information and low accounting standards in certain markets.

“We would never want to invest in a country where you have a presidential election and the results aren’t known for months, countries where the largest companies in the stock exchange are committing massive fraud right under the nose of the regulators,” said Graff. “When we invest at home, it’s just a way for us to sleep better at night.”

Back in the ’70s, he said, countries were the main drivers of stock returns. But in the ’90s, when correlations started to rise across countries, regions and sectors, country effect no longer dominated sector effect in explaining variability in returns.

“Country effects have been more important on average over time,” said Graff. “Sector effects, however, in recent years have increased their importance.”

It doesn’t really matter where companies are headquartered. What matters is what markets they’re in and what percent of stake is out of country, said Graff.

In the final analysis, though, both historical and recent research indicates countries do matter, he added.

“In the past decade, sector and industry effects have become more important, but they haven’t eclipsed country effects in emerging markets and developed markets,” said Graff. “Therefore, exposure to these markets can benefit from the country-focused investment model.”

And, decoupling of fiscal and monetary policies will lead to increased cross-sectional volatility in various markets. “Along with the increased dispersion in return, expect an increased opportunity set for investors seeking alpha through countries election,” said Graff.

Back to the Expert outlook: Analysis from 2012 IMCA and CFA conferences Report