Home country bias

Home country bias is the tendency for investors to focus their investments in their domestic markets. Financial theory suggests that investors should construct their asset class exposure in line with global-market capitalization. Yet investors from most countries over-concentrate their portfolios in domestic assets. The home bias phenomenon occurs all over the world, and is often intentional. This article documents the phenomenon for Canadian investors, and then discusses pros and cons of overweighting domestic securities in fixed income and equities.

Quantifying our home bias
Canadian equities represent about 3% of world stock markets in September 2021. Similarly, Canada represents 3% of the world's fixed income markets. Canada is the 8th largest stock market by capitalization and the bond market ranks in the world's top ten.

Nevertheless, as of Feb. 2014, Canadian investors (including institutions) had a 59% domestic allocation for equities. By late 2016 the figure was about 50%. By 2020 the figure was still above 40%. The home bias in equities is probably higher for individual investors, since Canadian defined benefit pension plans, for instance, held only about a quarter of their equity allocation in Canada in 2020.

In 2010 Canadian investors (presumably including institutions) had a 89% domestic allocation for fixed income. By 2020 the figure was about 84% for all Canadian investors including institutions, and presumably even higher for retail investors.

Home bias in fixed income
For Canadians, keeping all fixed income domestic has the following advantages:
 * matching the currency of expenses to the currency of assets
 * simplicity
 * the domestic fixed income market is reasonably diversified by issuer type (federal government and agencies, provinces, municipalities, corporate), term (short, medium, long), credit rating, etc. (e.g., see Canadian versus global bonds); although see
 * the domestic market has historically provided returns and volatilities comparable to developed markets as a whole ; although see
 * better investor knowledge of domestic markets
 * no exposure to foreign currencies, which would add greatly to the volatility of fixed income investments
 * no additional costs in the form of higher management expense ratios (MERs) or currency hedging costs

Therefore it appears that the home bias of Canadian investors in largely justified for fixed income. However certain investors may still want to consider adding some foreign bonds to their portfolios.

Home bias in equities
Vanguard research lists the following possible causes of home bias for equities:
 * a preference for the familiar
 * corporate governance issues for overseas companies and (historically) high costs to access foreign securities
 * liability hedging (domestic investor spending is influenced by domestic inflation and interest rates)
 * multinational companies provide international diversification (this seems to work better for US or German investors than for Canadian investors )
 * limiting exposure to foreign currencies

Other arguments for investing mostly in Canadian equities are
 * the dividend tax credit (applies to unregistered accounts only)
 * no additional costs in the form of higher MERs or currency hedging costs

Arguments against too strong a home bias for Canadian investors are:
 * the Canadian stock market is highly concentrated in three sectors (energy, materials, financials) which are quite cyclical, and has significant under-representations in several other sectors, relative to the rest of the world
 * issuer concentration. The Canadian market has 39% of its capitalisation in the top-ten stocks, compared to 23% for the US market
 * global diversification can reduce the volatility of returns because the correlations coefficients between Canada and global stocks are less than one (rolling 36-month correlation coefficients have varied between 0.37 and 0.87 over the period 1972-2014 )

Each investor has to evaluate the pros and cons of a strong home bias versus global diversification for equities, taking into account his/her personal situation. Financial Wisdom Forum members have indicated allocations to Canada ranging from 0% to 100% within the equity part of their portfolios. Canadian investors looking for a reference point based on substantial research can look at the proportions in VEQT, which contains about 30% domestic (Canadian) equities and 70% foreign ones.