The average advisor seems to be taking a Wizard of Oz approach to allocating their clients’ assets: There’s no place like home.
According to a recent study of 3,000 advisor portfolios by Janus Henderson Investors, advisors are heavily biased towards U.S.-based investments. Unfortunately for their clients, international diversification doesn’t come as easily as clicking ruby-red heels together.
“Home bias is a long-running trend, and to be honest, it’s been one of the best biases to have over the past five or six years,” says Adam Hetts, vice president and head of portfolio construction services at Janus Henderson. “People already like to own what they’re familiar with, and the outperformance of U.S. equities has exacerbated that long-term trend.”
While approximately 40 percent of the global equity market resides outside of the U.S., the average advisor allocates just 22 percent of their client portfolios to ex-U.S. equities, according to “Myths, Misconceptions and Blind Spots,” a report from the Janus Henderson portfolio construction team.
While their clients may ignore the risk behind the curtain, advisors who continue to follow the home bias trend might be buying yesterday’s best stocks and missing an opportunity to capture stronger growth and income in the future, says Hetts.
“Going forward, overseas markets may have better potential for double-digit returns,” he says. “Reality may point advisors to being reasonably overweight overseas stocks and underweight in the U.S., however, the MSCI World index is now at around 40 percent ex-U.S. Advisors would just get to neutral after doubling their current allocations to overseas stocks, though I would say that would probably feel overweight to many of them and their clients.”
Many advisors suffer under the misconception that an actively managed global fund will deliver international diversification that approximates the MSCI All World Index, says Hetts. “Using an active manager for global diversification on a forward-looking basis may be two steps forward, one step back for investors. They’re an important tool, there’s a huge burden for research on individual investors and most will find that they need a manager to achieve international diversification.”
Janus-Henderson found that active global funds vary greatly, with some funds offering approximately 30 percent non-U.S. exposure, others offering 55 percent non-U.S. exposure. Thus, an advisor allocating 10 percent of a client portfolio to a global manager may only be allocating 3 to 6 percent to ex-U.S. stocks.
Echoing statements made by investment moguls like Vanguard founder Jack Bogle, some advisors may believe that international diversification can be achieved through owning U.S.-based multinational companies like those found in the S&P 500, but Hetts argues that they’re still exposed to most of the concentration risk of an all-U.S. portfolio of companies only operating domestically.
“I wouldn’t say that they’re wrong, but from a risk-based perspective going global has to mean more than owning U.S. companies,” he says, noting that it is also suboptimal to diversify merely by purchasing developed-market multinational equities to access emerging and frontier markets. “These companies have diversified their revenue with sources outside their home country’s borders, but they still deliver most of the same risks as companies operating within their home country’s borders.”