How to avoid home bias in auto-enrolment funds
- To understand what home bias is.
- To learn how this affects auto-enrolment investments.
- To ascertain how best to structure portfolios to make them diversified.
- To understand what home bias is.
- To learn how this affects auto-enrolment investments.
- To ascertain how best to structure portfolios to make them diversified.
Home bias in the context of auto-enrolment is defined by pension schemes focusing their investments in domestic markets rather than global markets.
It poses a problem in that most investors, in whichever country they reside, are naturally drawn towards their own domestic market.
Given this natural behavioural bias, it is important to assess to what extent home investments should play a part in the mix of an investment strategy for auto-enrolment funds.
For Henry Tapper, pensions specialist and founder of auto-enrolment robo-advice service Pension PlayPen, home bias poses a significant risk of having all your investments exposed to your local economy and a local currency, for instance being invested in a UK equity fund.
He says: “It’s best to diversify your investments to avoid the risks of having all your eggs in one basket, you can do this either by investing in a global index, such as MSCI or FTSE, or in an actively managed fund that aims to diversify your investments according to a manager’s view of the world.”
The UK market is dominated by a number of key sectors such as banks, oil, gas and mining companies. A strong home bias means taking big bets on those sectors. Mark FawcettScott Gallacher, director and chartered financial planner at Leicester-based Rowley Turton, believes home bias is too much of a lazy option, when investors should be putting their money into a truly diversified global portfolio.
He says this is especially important when it comes to a pension fund that will provide most - or all - of a client's income in retirement.
He comments: “For example, the UK makes up 6.5 per cent of the MSCI World Index but traditional managed fund would typically have 24 per cent in UK equities (PN Mixed Investment 40 per cent to 85 per cent shares).
"Partly this is due to regulatory or sector constraints but arguably these constraints themselves are biased.”
While it may seem reasonable to invest in what you know, Mark Fawcett, chief investment officer at NEST, says some defined contribution schemes may have as much as 50 per cent of their equity allocation invested in UK stocks. This is too high an exposure.
This evidently can pose a problem, not just in terms of limiting your geographic exposure to one major market, but also to a particular currency.
Mr Fawcett comments: "UK equities, corporate bonds and property may still all be subject to the same headwinds when the economy takes a turn for the worse."
Historic home bias
