Home Bias

This is going to be my first of probably 2 or 3 posts on more macro issues, because it seems like a lot of buzz these days is about stuff that's happening macro-economically (i.e. Greek debt crisis, Irish debt crisis, potential US debt crisis, etc.).

I'd like to start off with a fairly simple and relatively short post about "home bias" and why I think it's not really that relevant for a country like the US. If you don't know what "home bias" is, it's basically this theory based on the premise that everyone in the world should be globally diversified in terms of the stocks they own and that the percentage of a person's portfolio that someone has in each country's stock market should be proportionate to that country's market cap as a percentage of world market cap (so, for a few examples, as of June 2008- obviously outdated, but it doesn't really matter for the sake of this example- France is about 4.5% of the world market cap, so according to the theory, everyone should invest 4.5% of their portfolio in French stocks; the US has about 30% of world market cap, so everyone should have 30% of their porfolio in US stocks; Brazil is about 3% of world market cap, so everyone should have about 3% of their portfolio in Brazilian stocks; and so on; Source: http://seekingalpha.com/article/80998-percent-of-world-market-cap-by-country). But the reality is that most people invest the vast majority of their portfolios in their home country (like, for example, even though Germany is only 3.6% of world market cap, probably most of the stock that Germans own is of companies traded on German exchanges). So that's what academics refer to as "home bias"- that most people prefer to invest all or most of their money in stocks in their own country, rather than being globally diversified.

Anyway, basically my thoughts on why it's not really necessary to be globally diversified as an American (and thus why home bias is more or less irrelevant), is because there's so many large US-based corporations that get a significant amount of their revenues from around the world. So, basically, you could argue that you still are globally diversified , indirectly, by owning US companies that have significant international operations. Some really clear examples of this would be GE, Coca-Cola, Pepsico, McDonald's, Procter & Gamble and Johnson & Johnson.

The second, and more important reason to me though, is that if you actually look at most world stock markets, the consumer sector is generally pretty small in most country's stock markets. Like, most world stock markets have the vast majority of their market caps in industries like oil & gas, financials, basic materials (i.e. mining and such), telecommunications and other basically "commodified" industries. And, you may disagree with me, but personally I'm not really interested in investing in those types of industries. Generally speaking, the only significant exceptions to this that I can think of are the US market, major European markets- like the UK, France and Germany- and Japan. But, obviously, all of these other countries do have sizable consumer sectors- it just so happens that a lot of the demand in that sector is supplied by established American, Western European and Japanese companies (at least currently, but obviously that could change in the future). So that's why I think if you live in a country like the US, especially, or possibly a country like the UK, France, Germany or Japan, it actually makes a lot of sense to have a "home bias." Like, I don't really want to invest in an oil company in the US, so why would I want to invest in a Chinese or Brazilian or Russian oil company (aside from probably higher growth prospects, obviously, but that's beside the point in this case, because the reason I wouldn't invest in an oil company is because I don't feel I understand them near well enough and I don't really like the industry as much as I like others)? I don't really want to invest in a US telecom company, so why would I want to invest in a Spanish or Indian or Australian one? I don't want to invest in a US bank, so why would I want to invest in a Chilean or South African or Canadian bank? Not to mention exchange rate risk (although, I guess theorists could argue that if you have a perfectly globally diversified portfolio, any exchange rate changes will offset each other) and political risk.

My main point is that what I want to own, primarily, are branded consumer staple- or at least relatively non-major consumer discretionary, depending on how exactly you want to classify them- companies (i.e. P&G, Coca-Cola, Kraft, General Mills, McDonald's, Nike, etc.), service companies with significant competitive advantages (i.e. ADP payroll processing, Rollins pest control, Moody's bond ratings, etc.) and maybe major diversified industrial conglomerates (i.e. 3M, United Technologies, GE, assuming they get rid of GE Capital, etc.). And it just so happens that most of the companies in those industries are US-based. Although, obviously there are some examples of non-US companies in these industries as well (i.e. Adidas of Germany, Unilever of UK/Netherlands, Siemens of Germany, Nestle of Switzerland, Sapporo Brewery of Japan, etc.), but there's enough offered in the US in this area that I really don't need to go outside of the US. And, at the same time, I guess I would say for citizens of other countries, they should probably have a far higher proportion of their portfolios in American, Western European and Japanese companies than the home bias theory suggests, because those are currently where most of the companies in the best industries are based (although, I won't completely discount the fact that if you live in China, you probably have a far better chance of spotting the rise of a successful Chinese soft drink or chain restaurant, etc. on it's way up than someone living on the other side of the world in America).

Anyway, that's just my view. And just in case you can't tell, I obviously don't believe in Modern Portfolio Theory or anything like that either...haha. I basically just believe in investing in the best companies in what I think are the best industries.

As always, feel free to comment or ask a question.

VF