Over one year ago, Morningstar published a report on investor preferences worldwide. This report included a look at how Canadians construct their portfolio. One lens in particular examined home bias – the overabundance of stocks and bonds from one’s own country compared to global indexes – a situation not rooted in sound investment rationale.
Home Bias in Canada looks beyond retail investors to retail funds managed by investment managers; non-professionals are already shown to have a home bias in Canada. However, professional investors can look at the entire world for opportunities. They possess far more resources than the individual investor and so they should be immune to falling to behavioural tendencies like home bias, right?
In a review of over 3,000 funds spanning equity, fixed income, and balanced funds, the answer is not so clear. As of September 2023, a significant portion of funds hold a disproportionate amount in Canada when compared to a truly global alternative - referred to as comparison indexes in the report. This meant investment managers, like retail investors, exhibit home bias in the funds they manage.
The study also found that this exists to a far greater extent in funds-of-funds and balanced funds, two structures where asset allocators and manager selectors can hold significant influence on a fund’s design. Global equity funds-of-funds, on average, held nearly three times the exposure to Canadian stocks than conventional global equity funds, for example.
Canadian Global Equity Funds Hold Far More Local Stocks
Source: Morningstar Direct, as of September 2023.
When looking at the average global balanced fund, this disparity widens. The weight of Canadian stocks is almost four times higher in global balanced funds than it is in the average global equity fund when adjusting for allocation differences. Less than a tenth of global balanced funds hold the same or less weight in Canadian stocks as a percentage of their equity exposure than the Morningstar Global Markets Index.
For fixed income, the story is the same, though it's even rarer to find a global balanced fund without home bias. Around 1 in 20 funds hold less in Canadian bonds as a percentage of their fixed-income exposure than the Morningstar Global Core Bond Index.
Which Balanced Funds Aren’t Biased Toward Canadian Bonds?
Source: Morningstar Direct, as of September 2023.
Those who leaned more on Canadian stocks, and away from global stocks, faced an uphill battle over the last decade. A $10,000 investment in September 2013 in the Morningstar Global Markets Index would have earned $7,500 more than the same investment in the Morningstar Canada Index by September 2023; Canada underperformed the market heavily over the last ten years.
Investing Abroad Paid Off
Source: Morningstar Direct, as of September 2023.
But while home bias mattered significantly for stocks, it seems to not matter nearly as much for fixed income as long as non-domestic bonds had their currency hedged. That condition is crucial; many funds hedge their foreign currency exposure back to the Canadian Dollar to remove the influence of how the Canadian Dollar performs against other currencies, but especially the U.S. Dollar. The report compares three indexes – Morningstar Canada Core Bond, Morningstar Global Core Bond, and Morningstar Global Core Bond (Hedged to CAD) – and demonstrates the importance of currency hedging in fixed income. With it, returns look very similar. Without it, investors would have gone through an unnecessarily bumpy ride.
Fixed Income Outcomes Less Influenced by Bias
Source: Morningstar Direct, as of September 2023.
Geographic exposure matters significantly in an investor’s portfolio. It seems both retail investors and investment managers aren’t totally immune to the phenomenon known as home bias. This matters most when it comes to equity strategies and equity sleeves – Canada struggled against the world, and especially the US, over the last decade. Investors would be wise to evaluate their biases and make sure the decisions they make are rooted not in comfort, but in sound rationale.
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