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Home bias in investments: What it is and how to avoid it

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Investors by and large hold too little of their wealth in foreign assets, an effect called the home bias or local bias.

Generally speaking, investors are well aware of the benefits of diversifying their investments beyond their home country. In the world of listed equities, the modern portfolio theory posits that diverse portfolios both increase total returns and lower volatility, which historically has been the case (despite increased correlation between markets in recent years). That diversification is beneficial is one of the commonly accepted truths in the world of retail investing. 

We investors like to think we know better than to put all our eggs in one basket, yet on average, people still overinvest too close to themselves. For example, a good 35% of all my equity investments are in Finland, and within Finland most of my investments are in companies headquartered in Helsinki, where I happen to live. Furthermore, at Invesdor we see the effects of home bias clearly in cross-border funding rounds: an outsized proportion of almost any given funding round’s investors are from the country that the target company is registered in. What gives?

 

Familiarity and distance are likely explanations

Although the root causes for home bias aren’t fully understood, researchers have found several factors that can partially explain home bias in investors. The factors include distances of the geographic, institutional, cultural and even linguistic varieties.

Greater distances negatively affect the flow of information, which increases information asymmetry. The information asymmetry, the theory goes, leads to investors being less comfortable with investment opportunities the further away they are – both literally and figuratively. If you're interested in reading more about the home bias, the article by Mark Grinblatt and Matti Keloharju published in the Journal of Finance in 2001 is a good place to start (you can find the pdf on Google Scholar).

In any case, it’s important for us investors to realise that home bias is a thing, and that most of us have investment portfolios that aren’t as diversified as we would like them to be.

 

Which country should an investor bet on, then? 

At Invesdor, we’ve always tried to position our platform as a tool for international portfolio diversification, for beating the home bias. This is why we currently accept companies from five different European markets onto our platform, and why our platform is used by investors from 74 countries. Over the years we’ve had more than a hundred companies from Finland, the UK, Norway, Denmark, and Sweden raise investments from investors around the globe. We’ve found that while on paper the UK is the obviously attractive market in alternative investments, the reality is that the country’s investor tax breaks – albeit applaudable – only reinforce home bias.

Of the five markets that we operate in, we’ve found Sweden the most dynamic and open to cross-border flows of information and capital. This is why this year we will be focusing heavily on Sweden.

From an investor’s point of view, Sweden is extremely interesting. Stockholm has produced the second-most unicorns (companies with valuations of $1bn or more) per capita in the world, beaten only by Silicon Valley. Housing such international powerhouses as Spotify, Klarna, and iZettle, Stockholm is home to 134 of Europe’s fastest-growing companies. 

As a sign of our commitment to bringing Swedish investment targets to all investors using our platform around the world, we’ve fired off this year’s first batch funding rounds of extremely interesting Swedish companies:

  1. Tingent
  2. Terrace
  3. Melobee
  4. Seabased
  5. to be announced in June

The remaining names will be unveiled during the months of May and June. Read up on the cases – and show your home bias who’s boss!

Tagged: sweden, home bias

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Mikko Savolainen

Written by Mikko Savolainen

Head of marketing at Invesdor