Cognitive Biases Part 6: Geographical Biases

A great deal of investment decisions are skewed towards the familiar, such as our neighbourhood, our city, and our country.  It’s a comfort and safety thing. From an equity perspective, in Canada most portfolios contain a higher proportion of domestic stocks. According to a report from Vanguard funds, “the average Canadian investor has a 60 percent domestic equity weighting…”.  The reality is that the Canadian market for stocks represents between 3-6 percent of the global market capitalization of stocks. It seems Canadians are predisposed to investing more of their savings in Canada than abroad. This behaviour is known as Geographical Bias.

It’s quite interesting we are still focused on investing at home and one reason may be the government. If you remember years and years ago, Canadians were capped in terms of how much foreign assets they could hold in their RRSP’s. The amount was capped at 20 percent of their total assets. About 20 years ago, the Government began increase the foreign content limit and eventually eliminated the cap. I suspect many investors who invested during those Foreign Cap days may have carried over the behaviour when it was abolished as a certain bias had been built up institutionally.

On the other side of the spectrum, despite world trade becoming the norm thanks to liberalized free trade policies, financial analysts, especially those in North America and Europe, cover companies with an overemphasis on the domestic operations of a business rather than their overall global footprint. McDonalds, the quintessential American company, does more than half of their business outside the US, yet when you read their research reports, they often skew and based their evaluation of the company on the US sales numbers which makes no sense.  Foreign sales represented almost 1/3 of total revenues of S&P 500 companies in 2013. The median S&P500 company reported 29 percent of its sales were from outside the US.  You wouldn’t know it by reading an analyst report. Why does the analysis remain too US-centric? The big reason is a lack of boots on the ground experience in foreign countries by analysts. Investment research has been getting a little too detached and ivory tower like.

This geographical bias can put foreign companies in the US at a disadvantage and subsequently placed at a lower valuation. One example was Research in Motion. If you read the analyst reports you would think the company was done even though it had a solid balance sheet. The analysts kept harping on the US falling market share of their hardware versus the iPhone and Androids ecosystems, which was true. However, if the analysts had dug a little deeper they would have discovered that outside North American and more specifically Southeast Asia, Blackberry was doing incredibly brisk business. It still retained an iconic status in countries like Indonesia. North American analysts didn’t seem to care as they tend to adopt a centre of the universe mentality.

That’s not to say investing in foreign assets is without risk and an automatic. It can be very risky especially in countries that are not as advanced in corporate governance and financial reporting standards. You still have to do some extra due diligence and for most people the best way to get exposure to foreign assets is through a passive exposure through Exchange Traded Funds. Understanding your risk tolerances is critical to determining how much of your portfolio should be exposed. Conversely some of best, well run businesses in the world are not in your back yard. They’re everywhere, so why limit your scope and future returns? For investors, the world is truly our oyster and more than ever.