Column-Relentless outperformance and inertia feed US home bias: Mike Dolan

By Mike Dolan

LONDON (Reuters) – For all the valuation and diversification arguments routinely touted, bitter and sweet experience tells U.S. investors to stay at home.

A decade of underperformance of global equity portfolios against plain vanilla domestic U.S. megacap and blue chips stock indexes leaves a heavy burden of proof to convince already-wary U.S. long-term investors to venture again overseas.

Over the past 10 years, MSCI’s USA stock index has outstripped its Europe, AustralAsia and Far East (EAFE) index by some 55%, its emerging markets equivalent by 60% and by 66%.

And even if the eye-popping relative performance over the past 10 years counted for nothing, savers are not exactly being tempted rosy scenarios abroad for foreseeable future.

Fractured geopolitics since Russia invaded Ukraine and related regulatory risk; China redefining its political and economic centre of gravity closer to isolated Moscow than Washington; higher U.S. economic and earnings growth projections and interest rates than in Europe or Japan; and a resilient dollar exchange rate – none of this is luring already flush U.S. funds.

In a world of zero interest rates, there may have been some compelling relative value options in moving overseas.

But even if U.S. investors get tired of Wall Street stocks, they now have 5% dollar cash and near 4% 10-year Treasury coupons to fall back on. And why take the risk in foreign equity that has disappointed for so long despite being ostensibly “cheaper” for a decade?

High frequency fund flow data from the U.S.-based Investment Company Institute shows there was a rolling net withdrawal of long-term U.S. funds from overseas stocks over the course of 2023 despite some easing of the negativity earlier in year.

Perhaps unsurprisingly, that flow has not been positive since March 2022 – the month of the Ukraine invasion. And another potentially-escalating Middle East conflict bodes ill for a return of that appetite any time soon, as a polarized world hardens in blocs with a clear reduction of countries still favourable to liberal democracy, open markets or foreign money.

A year of elections – not least the White House race in November – won’t encourage much movement abroad either.

The big reversal is clearly taking place in China – where an investor exodus accelerated through late last year amid concerns about a deepening property bust, Beijing’s designs on Taiwan, support for Russia in Ukraine, strategic tit-for-tat investment curbs with the West and dire demographics.

Global pension funds are now balking at investment in the country and Morgan Stanley’s latest tracker shows global long-only funds offloaded China equities at the fastest pace of 2023 in December as they rushed to meet redemption requests and to diversify away from the world’s second-largest economy.

The bruised retreat of what was more adventurous U.S. money merely reinforces an already significant home bias that has built up in U.S. investment funds.

ICI’s last full-year estimate for 2022 showed the share of world equity in the nearly $29 trillion of net assets held in U.S. mutual and exchange traded funds was just 13%, or $3.8 trillion. Some 44% of those assets, by contrast, were in domestic equity and the rest in a mix of bonds, money markets and hybrid funds.

In the $12.7 trillion U.S. mutual fund universe alone, the pullback over time is clear. Global equity funds accounted for less than 6% of the total net assets in equity funds – the lowest in almost 20 years and down almost 2.5 percentage points from the new century peak of 8.3% on the eve of the Lehman Brothers crash in 2008.

HUNKERING DOWN AT HOME

Perhaps, it’s time for a turn.

There is no shortage of investment analysts advocating a spreading of investment eggs beyond the home basket – mainly for reasons of valuations being cheaper than historically expensive Wall Street, or predictions for a falling dollar as the Federal Reserve eases credit.

But all those have caveats for an investor audience seemingly comfortable at home in a highly unpredictable world.

U.S. aggregate valuations have been above overseas markets for a decade and have proven the premium to be worth it. Leading U.S. companies on aggregate glean more than 50% of their revenues from overseas markets anyway, so exposure to the global economy is already there – but without the political or exchange rate risks.

And while the dollar may fall, it may not be that much given the likely urge of other central banks to match the Fed in cutting rates.

That’s why Japan – where expected Bank of Japan tightening as the Fed eases may well lift the yen sharply from historic lows – is most tipped for any brave enough.

For the academics, home bias is a puzzle in most markets as the diversification from relative small domestic markets makes more sense than overly concentrated risks often in a handful of stocks.

Some may make that argument about the U.S. last year, with the Magnificent Seven megacaps of digital and tech giants leading the way.

But the sheer size of U.S. market capitalization and the variety and depth of the exposure means U.S. home bias is harder to challenge.

An outsize dollar plunge, an exceptionally deep U.S. recession relative to the rest of the world or a major shock around November’s elections might jar local savers out of their comfort zones.

But on the basis of the past 10 years, don’t hold your breath.

The opinions expressed here are those of the author, a columnist for Reuters