US equity returns have historically dominated those of most other countries for over a decade. So it’s not surprising to observe that US investors continue to chase these returns with what is most common to them: more US equities. In the vernacular of behavioral economics, this is called familiarity bias – the tendency to feel most comfortable investing in what is most well-known. In some cases, this could mean investing in stocks that an individual is most familiar with, like the company they work for or a business they frequent. However, in broader terms it also means that investors tend to invest more locally, in US equities, demonstrating a more specific kind of familiarity bias called home country bias. At Goldman Sachs Asset Management, we have observed home country bias among professional investors, and we believe that overlooking non-US equity opportunities may be detrimental to returns in the long run.
Avoiding non-US equities may result in investors potentially missing attractive returns. Of the top 50 performing global stocks each year, on average, more than 75% have been domiciled outside of the US over the last decade1.
Consider the recent allocations we observe from thousands of portfolios collected through our GS PRISM™ portfolio construction analysis. As shown in Exhibit 1, our team has observed that the average allocation to non-US equity as a percent of total equities is less than 28%, which is less than the global market cap as well as our GS Asset Management 70:30% model.
Source: Goldman Sachs Asset Management/SAS Portfolio Strategy Group. “Average GS PRISM™ Portfolio” refers to the average asset allocations of over 1,600 financial intermediary portfolios analyzed through GS PRISM™ that have a 30-40% allocation to core fixed income. “Global Equity Market Capitalization” is represented by the MSCI ACWI Investable Market Index (IMI), which captures large, mid and small cap representation across 23 developed and 27 emerging market countries, based on the market capitalization as of July 30, 2021. “Illustrative GS Asset Management 70:30%” refers to a proprietary model portfolio created by SAS Portfolio Strategy, composed of 70% core equity, diversifiers, and alternatives and 30% core fixed income. For illustrative purposes only. This does not constitute a recommendation to adopt any particular asset allocation.
In our view, the case could be made that US investors are simply smart, rather than biased, and they chose to weight US stocks in excess of their market cap. Certainly that exposure has worked to their advantage in recent years. However, anecdotal evidence suggests that international investors favor their home countries too, and by under-owning US stocks these biases have worked against them. We think the more likely explanation is that all investors are biased, rather than that US investors are “smarter than the rest.”
The disparity grows for small cap equities, where non-US developed small cap equity exposures are, on average, only around 32% of the total small cap exposure – approximately two-thirds of the global market cap exposure. Moreover, 66% of advisor portfolios that we’ve worked with have no exposure to non-US developed small cap at all.
Source: Goldman Sachs Asset Management SAS Portfolio Strategy Group. “Average GS PRISM™ Portfolio” refers to the average asset allocations of over 1,600 financial intermediary portfolios analyzed through GS PRISM™ that have a 30-40% allocation to core fixed income. “Global Developed Small Cap Market Capitalization” is represented by the MSCI World Small Cap Index, which captures small cap representation across 23 developed markets countries, based on the market capitalization as of July 30, 2021. “Illustrative GS Asset Management 70:30%” refers to a proprietary model portfolio created by SAS Portfolio Strategy, composed of 70% core equity, diversifiers, and alternatives and 30% core fixed income. For illustrative purposes only. This does not constitute a recommendation to adopt any particular asset allocation.
We believe that non-US equities are a key strategic investment, and current market conditions may be creating opportunities. For investors concerned with full US equity valuations, non-US equities may be compelling on both an absolute and sector-adjusted basis. In particular, we believe earnings growth in 2021 will be particularly strong as these assets are more levered to the acceleration in global growth. In Europe, first quarter earnings delivered the largest positive surprise since the Global Financial Crisis, while the price reaction has been relatively modest. We expect a continued strong recovery in earnings outside the US in 2021 as more countries rebound from the lingering effects of COVID-19.
While familiarity and home country bias are very common, the good news is that they are easily overcome by exploring the ample investment opportunities outside of the US. As of June 2021, there are nearly 1,000 mutual funds and exchange traded funds (ETFs) across the Morningstar Foreign Large, Foreign Small/Mid, and Diversified Emerging Markets categories2. If selecting multiple new funds to cover the developed non-US large and small cap, and emerging market markets is too onerous, one can consider mutual fund options that help hit two birds with one stone. For example, according to Morningstar, mutual funds in the Foreign Large Cap categories have, on average, approximately 10% exposure to emerging market countries. Perhaps now is a good time for investors to consider becoming more familiar with international assets.
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