Vanguard FTSE Developed Markets: Avoid Home Country Bias

Ben Holden-Crowther profile picture
Ben Holden-Crowther
236 Followers

Summary

  • Unfortunately, the U.S. stock market continues to be very expensive by historical standards, even taking into consideration the recent pullback.
  • In spite of this, "Home Country Bias" means that U.S. investors tend to maintain a disproportionate allocation towards domestic stocks.
  • Investors can lower their portfolio risk by investing in Vanguard Developed Markets, a low-fee index ETF consisting of companies in developed markets outside of the U.S.

Investment Thesis

The U.S. Stock Market has done extraordinarily well over the past decade. Unfortunately, trees don't grow to the sky and this outperformance versus the rest of the world can't continue forever. Notwithstanding this fact, too many American investors expose themselves to unnecessary risk by maintaining a disproportionately large weighting towards their home stock market. Vanguard FTSE Developed Markets (NYSEARCA:VEA) is a low cost index ETF which I would argue can act as an effective counterbalance to this common bias.

Home Country Bias

Home Country Bias is a well-documented phenomenon in which investors prefer to own shares in companies from their own country versus the rest of the world.

In fact, research has shown that the average U.S. investor allocates around 70% of their equity portfolio to U.S. stocks, despite the fact that the country accounts for just 25% of GDP and represents around 36% of the total market capitalization of global equity and bond markets.

While diversification through a selection of U.S. stocks is good, investors should optimally try to reduce risk by constructing a portfolio that depends to a lesser degree on the success of just one country, especially one whose markets are significantly overvalued by historical standards.

Relative Value

Over the last ten years, U.S. stocks (as measured by the S&P 500) have offered an incredible total return of almost 9.7% annually (even including the recent downturn).

This massive increase in the price of equities has seemingly got ahead of the real values of the companies underlying the shares, as supported by a number of popular market valuation metrics.

(Source: multipl.com)

One example of such a metric is the cyclically adjusted price-to-earnings ratio (CAPE) for the S&P 500. This is still at a very high level (around 23.5x) versus its long-term mean of approximately 17x and median of 16x.

ChartData by YCharts

This article was written by

Ben Holden-Crowther profile picture
236 Followers
I am a global investor aiming to identify companies with durable competitive advantages and excellent management teams. My goal is to acquire shares in these high-quality businesses when they are available for prices below their intrinsic value. Through this simple philosophy I strive for long-term outperformance versus market averages.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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