Most individual investors tend to be ‘homers’ or ‘chauvinists’. As a result, they overweight their portfolios from their home stock market. It’s known as the equity ‘home bias’ puzzle. Buying the foreign stocks we recommend from time to time can raise your returns and reduce your risk. So can Canadian Key stocks that do business outside Canada.
Many individuals’ investment strategy suffers from the phenomenon of assigning an anomalously high weighting to their own domestic assets. That is, many investors’ home holdings are much larger than those stocks’ percentage of the world’s stock markets, giving rise to the equity ‘home bias’ puzzle. This is said to reduce their portfolios’ profitability and to raise their portfolios’ risk. It’s also said that by investing more in foreign stocks, individual investors could raise their returns and cut their risk.
There’s some truth to this. In fact, that’s why we regularly provide you with reports on foreign stocks. We publish issues on U.S. All-Star stocks. Most of these American stocks have generated higher earnings and sales and paid higher dividends than they did five years earlier. Similarly, we publish issues about ADRs (or American Depositary Receipts). While ADRs trade on U.S. markets, they give you ownership of overseas stocks.
There are sound reasons for home bias
At the same time, there are sound reasons for equity home bias. For one thing, it’s easier for Canadians to keep track of Canadian companies that are often in the news. It’s harder to keep track of foreign stocks that rarely, if ever, make it into the Canadian news. When things go wrong or right, by the time you find out about it, it’s usually too late to sell or buy. This is truer of overseas stocks than of American stocks, which often make the news in Canada.
Another reason for home bias is when your markets are transparent. Recently, for example, the Chinese government completely mishandled the drop of mainland Chinese stocks. They interfered in a heavy-handed manner. And if you decided to sell, you couldn’t, in most cases. Most mainland Chinese stocks were essentially frozen and off limits to sellers. Investing in markets like these is likely to hurt your returns and raise your risk.
Yet another reason for home bias is when your country is governed by the rule of law. Russia, by contrast, lacks it. We’ve read accounts of small Western businesses setting up in that country. If the business was successful, armed thugs might confiscate it. Unsuccessful businesses were left in the hands of foreign investors. Many countries suffer from corruption and no rule of law. Such cases are also likely to damage your returns and increase your risk.
Even where the rule of law exists, how do you enforce your rights? You could hire lawyers who know the legal system and customs. But the cost may exceed the value of your investment.
Multinational companies offer safety
That’s why we often advise that your strategic investment objectives should include investing abroad through a multinational company based in a developed market. They enable you to profit from fast-growing countries. And they usually have the resources to make foreign markets pay.
You can adopt a similar approach in Canada. Of our Canadian Key stocks, for instance, 43 generate part or even most of their revenue and earnings abroad. Consider, for instance, Montreal-based Key stock Saputo Inc. (TSX─SAP).
In Canada, Saputo earned $98.1 million on revenues of $918 million. But its total earnings were $259 million on revenues of $2.913 billion. It’s the third-largest dairy processor in Argentina and the fourth-largest in Australia. By far the company’s most important market is the U.S. There it’s one of the top three cheese producers and one of the largest producers of extended shelf-life and cultured dairy products.
Saputo earns most of its profit in the U.S.
On October 5, Saputo paid $80 million to acquire Woolwich Dairy. It generates revenue of $70 million from making, distributing and marketing goat cheese. Woolwich operates manufacturing facilities in the state of Wisconsin as well as in Ontario and Quebec. Saputo writes, “This transaction enables Saputo to increase its presence in the specialty cheese category in North America.”
In short, your investment strategy should include buying high-quality American and overseas stocks. Focus on manufacturing and consumer stocks with few or no counterparts in Canada. At the same time, you should buy Canadian Key stocks—preferably those that raise their dividends each year, such as Saputo. While Canadian Key stocks are based in this country, many of them generate part or most of their revenue and earnings abroad. This will further reduce the extent of your ‘home bias’.
The Investment Reporter, MPL Communications Inc.
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