From the vantage point of the Square Mile, the UK today may not feel like a safe haven for investors. Whilst growth is ticking along and inflation remains under control, the UK is suffering from low productivity, stagnant wage growth, a fragile political situation and the possibility of a “no-deal” Brexit. All these factors coalesce to mean that UK investors face a significant challenge in how to position their portfolio in the face of such uncertainty. 
The importance of diversification in a portfolio is one of the oldest investing adages. UK fund managers are regularly assessed on how diversified their portfolios are, across both geographies, sectors and asset classes, and it is a primary consideration for fund buyers advising their clients.
However, it seems that direct investors – those who invest directly without the assistance of a financial adviser – are not taking the same precautions. Instead, UK retail investors have a strong tendency to invest in things that they know, in businesses they recognise and in places they inhabit; they feel a strong pull to invest in what they understand best – their home market.
Recognising the domestic pull
This is the hypothesis that we set out to assess. The Home Bias Report, which we published recently, comprises quantitative research based on a poll of 200 UK direct investors with a minimum of £25,000 of investible assets. The study found that 74 per cent of UK investors are looking to invest the majority of their assets in their home market over the next twelve months. Only 14 per cent are considering investing in other major markets including the US, China or Japan. The fact that nearly one in ten investors did not know, or were unsure of, their favoured markets demonstrates how little investors are considering foreign equities compared to their own.
The question is why this concentration risk and, possibly subconscious, home bias exists? When asked why they were attracted to investing in their home market, 48 per cent said that they felt most informed about domestic companies; 40 per cent wanted to actively support local companies by investing; and 39 per cent felt they best understood the dynamics of their own economy. UK direct investors are therefore clearly more comfortable allocating money to economies and stocks with which they are immediately familiar, even if the data suggests there may be better returns elsewhere.
Storm clouds ahead for the UK market
As with any market position, if returns justified the bias then this preference for UK equities would not present a problem. But UK equities have underperformed the US market by about 5 per cent over the past five years.
Darker storm clouds may lie ahead: leaving the European Union may put further pressure on the UK economy, as companies across all sectors may have to shift how they operate and trade globally. Capital investment by corporates has already fallen and the Bank of England recently warned that a ‘no deal’ Brexit – an outcome which remains a possibility – could send shock waves through the economy. The share price performance of mid and small cap companies is highly correlated with the domestic market. Only around 40 per cent of FTSE 250 companies generate revenue from outside the UK market. These companies headquartered in the UK are aware that any post-Brexit trade deal could impact their cost of doing business.
Such uncertainty could lead to heightened volatility and investors overweight in UK assets could find themselves at the sharp end of any market pull back. Whilst a significant number (59 per cent) of UK investors say that Brexit has made them consider diversifying their portfolio away from UK stocks, even if only for the short term, the fact that only 26 per cent are actively considering other equity markets remains a concern.
Beware of structural bias
This is not to say that UK investors should avoid domestic equities altogether. There are many reasons why the UK remains an attractive equity market. It boasts world class companies and a large and liquid capital market. However, an over-reliance on UK equities means investors may miss out on wider market opportunities and inadvertently expose themselves to a high degree of risk.
Investors may instinctively feel that being overweight domestic stocks provides a hedge against global uncertainty. But UK companies do not exist in a vacuum; nearly three quarters of FSTE 100 company revenue is generated from overseas and, whilst a weak pound may have bolstered their share price in the short term, events in key international markets – and the confidence they do or do not inspire – can have a ripple effect on returns in these companies.
Similarly, backing only one market makes investors more likely to be both over or under exposed to certain sectors. Recognising this structural bias is key for anyone who pick stocks or invest in funds themselves. If one sector underperforms, a portfolio which holds a wider set of securities across sectors will be better protected during a downturn.
Seeking returns from further shores
Domestic bias prevents investors from taking advantage of developments in markets not immediately on the doorstep. For example, the US stock market has seen a remarkable few years. The labour market remains tight enough to keep wage growth on an upward trajectory and the most recent earnings season has been received positively. This good news appears to be filtering through to rising inflation, consumers are gaining conviction in this economic expansion and personal spending is on the rise. Businesses are equally confident, with regional manufacturing surveys continuing to surprise on the upside.
However, despite the potential high returns from US stocks, political tension in the US has resulted in UK investors shying away from investing in American equities. 60 per cent of respondents say that the political situation in Washington puts them off investing in the US market, and a further 58 per cent agree that geopolitical tension has dissuaded them from investing altogether. Whilst geopolitical events may have given stock markets some jitters over the past six months, headlines can often be a distraction and, in general, economics and markets usually have a larger impact on politics than the other way around.
Challenging the home bias
Over-allocating to domestic markets because of an instinctive trust towards what they know can cut investors off from higher returns. Home bias is just that – a preference for a certain market regardless of how well it will perform. Regional variety is crucial for robust portfolio selection, as every stock’s peer group is global rather than local. Challenging innate partiality towards the UK can result in a more compelling, and rewarding, investment prospect. The message is clear – diversify to protect and diversify to grow.
Kully Samra is vice president at Charles Schwab. The views expressed above are his own and should not be taken as investment advice.