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The UK government wants UK investors to put more money into the UK economy. That ambition may prompt rhetoric and even concrete reforms in next week’s Budget.
This will leave me feeling shifty. Yes, friends, I confess it: I am suffering from unpatriotic portfolio shame. My investments are those of a cheese-eating declinist. A posse will come for me soon.
Chancellor Rachel Reeves has already launched a “landmark” review of UK pensions savings, which aims to encourage UK investment. The Labour party had even promised to create a “Brit Isa”, before post-election cold feet set in.
Meanwhile, we would-be citizens of nowhere have been seduced by the soft living of foreign climes. We spurn or sideline honest domestic assets.
The tenets of behavioural finance — the subject of these columns — encourage us to do exactly this. Cognition pundits warn us against “familiarity bias”. This is defined as irrational preferences for anything we believe we know and understand. In investment, the term used by academics is “home bias”.
A common test is whether your exposure to local investments is heavier than international benchmarks would dictate.
The government is essentially saying “more home bias, please”. This creates an opportunity to kick the tyres of the underlying concept. The first thing to establish is whether typical British savings patterns already spell “home bias” in big red, white and blue letters.
18%Percentage of UK pensions capital invested in UK ‘productive’ assets
Let us start with pensions. Researcher Jackie Wells conducted an analysis for the Pensions Policy Institute (disclosure: I am a trustee, opinions are mine, not theirs). She found that 18 per cent of £3tn in UK pensions capital is invested in UK “productive” assets, including buyout funds and bonds, with gilts excluded from the latter group.
UK-listed shares — the easiest assets to measure against benchmarks — made up some 15 per cent of total equity holdings.
That is still a lot compared with the UK sliver of an important global equity index, the MSCI ACWI Investable Market Index. UK-listed shares account for just under 3.5 per cent of that.
Professionals invest the lion’s share of UK pensions money on behalf of scheme beneficiaries. Savers mostly make their own choices when they invest in stocks and shares Isas. Here, home bias weighs even more heavily. Figures from New Financial, a think-tank, show that UK stocks comprise 29 per cent of equity exposure.
That chimes with researchers’ claims that professional investors counter cognitive biases better than amateurs.
I checked the UK numbers against the geographic exposure of my own small DIY-invested Isa, the Baskerville Global Equities Fund. This is named after my dog and has done better than some of my other nest eggs. An unpatriotically modest one-tenth is in UK index funds. Over 50 per cent is in US equivalents.
My low home bias is evidence of happenstance, not professionalism. A few years ago, I returned from a trip to the US enthused by its economic dynamism. Like someone who comes back from an Alpine skiing trip as a convert to schnapps, I invested in US trackers. These rose in value.
I have not rebalanced. I do not know how to. Sooner or later, something will shake fellow investors’ faith in the ability of artificial intelligence to keep tech stocks high. Markets will then spank me. But I do not know how to do market timing either. So I am sitting on my hands until I find myself sitting on an ice pack.
Besides, good paybacks have made me wary of tilting away from the US. Returns on the Baskerville GEF stand at almost 10 per cent over five years, annualised and before fees. That compares to a FTSE 100 return of 7 per cent, only 2.5 percentage points above UK inflation.
The UK’s flagship index is dominated by companies with high international revenues. So I envisaged a more patriotic version, the Warm Beer and Cricket Fund. This consisted of 33 FTSE 100 stocks with proportionately high UK revenues. Constituents included Lloyds Banking Group, Tesco and the utilities Severn Trent and SSE.
Average returns over five years would have been 6 per cent. The S&P 500 returned 14.5 per cent over the same period. Clearly, high UK home bias has recently come at a high cost.
Alexander Joshi, head of behavioural finance at Barclays Private Bank and Wealth Management, has run some longer-term numbers. He found that a UK investor with zero home bias would have made an annual risk-adjusted return of around 7 per cent between 1999 and 2023. A counterpart investing solely in the FTSE 100 would have garnered two percentage points less.
However, this has left me sceptical whether home bias is always a bad thing, as its name suggests. Home bias has been great for US private investors. Domination of world indices by their domestic market now limits their ability to indulge in it.
Two more quibbles. First, unhedged foreign investment exposes investors to currency risk as well as to shares. Second, stock indices appear to dominate attempts to measure home bias because they are available, not because they are ideal for the purpose.
They cannot, for example, account for an investor’s exposure to their home economy via housing equity.
Investment guru Warren Buffett, himself something of a behavioural finance buff, encourages us to invest in what we think we understand. In the UK, that is more likely to be Marks and Spencer than a Palo Alto cyber security start-up, which makes sense pragmatically, even if it does not do so in statistical hindsight.
Joshi says: “Home bias isn’t necessarily a bad thing. It is important for investors to feel comfortable with what they are holding.”
My conclusion is two-fold. First, home bias is mainly useful to private investors for testing our concept of the “right” level of exposure to domestic assets. Second, Brits are not shunning UK investments to the extent government rhetoric implies.
If the chancellor wants to increase investment in UK assets, she should redouble her efforts to woo international investors. They have more money but less exposure. They favour an unfettered, transparent UK economy that stimulates enterprise.
But creating this is harder than flourishing a Union Flag.
Jonathan Guthrie is a journalist, adviser and former head of the Lex column. [email protected]