Home country bias & Investor myopia

Would UK investors be the first to spot problems in the British economy?  Conventional wisdom values local knowledge, but we also know it is possible to be too close to make an objective judgement.  Myopia from domestic investors in many countries has been the story of 2011, as economic and political surprises emerged.  Might British investors have just too rosy a view of their home country, too?

 Research from domestic broking analysts highlights the problem.  In late January, as the Arab Spring unfolded, domestic Egyptian investors bought up what foreigners sold.  Even after the regime in Tunisia fell, Egyptian brokers dismissed the risk to their much larger nation. For a fortnight, local institutions thought a 10% market fall was a bargain – but the market subsequently halved, in belated recognition of reality. A similar story has unfolded across the North Africa and Middle East stockmarkets.

 And, as the year has progressed, Portugal, Ireland and Greece have typically seen their broking research and institutional investors well behind the curve.  Indeed, critical views have often been presented as a conspiracy by foreign investors.  The fall in the Chinese market of the past two years has largely seen foreigners sell to domestic buyers.  This pattern may tell us more about emotion than valuations and prospects. 

 The scale of Britain’s economic and banking problems attract scant press coverage.  Neither politicians nor analysts want to worry people.  If only the economy could be talked up so easily.  Instead – as weak house prices and growth show – optimism alone is not enough.  And, it may be diverting us from the right action.  Misplaced faith in a “normal” recovery could be propping up the wrong policies. 

 London-based City investors might be seeing only part of the picture.  Quantitative easing has boosted London house prices and prime commercial property, but elsewhere it is a different story.  Most of the property assets banks need to sell are actually secondary.  And, the parts of the mortgage book that pose the greatest risk of impairment to banks are not in the South East.  The UK economy could spend many years bumping along the bottom with short, shallow cycles.  With banks failing to lend on a net basis, growth is severely constrained.  What we should fear is not a double dip in the sense of a sharp downturn now, but many small dips to come with low underlying trend growth.

 Behavioural finance offers clues to what is going on.  Availability bias encourages us to give undue weight to more accessible readily recalled information.  Generally optimistic press comment makes it hard for those in the UK to remain objective.  Some of the data by which we measure debts in other nations – such as the ratio of UK debt to GDP, or the leverage of British banks if derivatives are included – are rarely mentioned.  Collecting unbiased data is difficult; our judgement is affected by the wave of optimism.

 The problem of favouring domestic equities has been recognised as home bias.  There is a comfort in investing closer to home, even if it exposes currency risks and lack of diversification.  In the past, it meant many investors and pension funds had too little overseas, but globalisation was meant to have ended that.  However, there are still large parts of the UK stockmarket, such as retailers, utilities and consumer services, that are largely domestic.  Many funds and private investors favour UK exposure.  And, in most nations, those who sell their own market or stocks short, or take a negative stance on their country’s credit, are viewed as unpatriotic.

There are certainly many UK companies that are globally exposed and even world class.  But, more domestic sectors and gilts are closely tied to the UK’s growth, credit rating and currency.  Few analysts are currently factoring in the need for a further round of economic stimulation, the potential for a run on Sterling or significant additional capital raising by some of our banks.  Investors need to recognise the risks in home bias, and look beyond the more optimistic spin they are immersed in. 

This article is for informational purposes only. The opinions in this article are the author’s own. The information presented in this article has been obtained from sources believed by the author to be reliable, however, he makes no representation as to their accuracy or completeness and accept no liability for loss arising from the use of the material. Colin McLean may have an investment in any of the companies mentioned in this article.

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