Home bias in theory
Home country bias is a global phenomenon, as most investors hold the vast majority of their wealth in the form of domestic assets. In a 2019 study, Vanguard found that in each case they examined, investors exhibited a strong home-country bias.
Exhibit 1: Home country bias
Regardless of where they live, investors have a significant opportunity to diversify their equity portfolios by investing outside their home market. Despite this opportunity, investors on average have maintained allocations to their home country that have been significantly larger than the country’s market-capitalization weight in a globally diversified equity index.
Investing outside one’s home market has diversified the returns of what had been a purely domestic market portfolio, on average and across time. The rationale for diversification is clear - domestic equities tend to be more exposed to the narrower economic and market forces of their home market while stocks outside an investor’s home market tend to offer exposure to a wider array of economic and market forces. These differing economies and markets produce returns that can vary from those of an investor’s home market.
There is no reason to have a home country bias - other than perhaps a small bias to take into account that investing in U.S. stocks is a bit cheaper than investing in international stocks. On the other hand, if you are still employed, it is likely your labor capital is more exposed to the economic cycle risks of the U.S. than to foreign market risks. If that is the case, once you include your labor capital as part of your portfolio, you should consider overweighting foreign markets to offset your labor capital risk.
“In theory there is no difference between theory and practice. In practice there is.” Yogi Berra.
Home bias in reality
As we saw above across the world, investors suffer from “ home bias.” That is, they tend to put too much into their home country, and take on insufficient exposure to the rest of the world.
The sheer historical outperformance of U.S. equity markets since the Global Financial Crisis has resulted in a home bias (i.e., over-allocation) to U.S. equities for many investors.
Exhibit 2: US outperformance
Many US investors allocate to international equities in the belief that it diversifies portfolio risk without compromising long-term returns. But ever since the Great Financial Crisis, any addition of EAFE to a portfolio of US stocks has resulted in both less total return, but more importantly, also less risk-adjusted return.
To maximize an equity portfolio’s risk-adjusted returns, the percentage you needed to allocate to US stocks has slowly drifted toward 100%. This means that not only have international stocks lagged their US counterparts over the last several decades, but their diversification benefits have also deteriorated.
Exhibit 3: % allocated to US stocks to maximize an equity portfolio’s risk-adjusted returns
What’s next?
Will US stocks continue to outperform and do we have to allocate our portfolio 100% to US stocks to maximize the risk-adjusted returns?
Economist Edward Yardeni, president of Yardeni Research, notes that historically in periods when the Federal Reserve has been loosening monetary policy, it has corresponded with outperformance by foreign markets.
“Having underperformed for more than ten years, non-US stocks are set to gain the upper hand over their US peers,” Peter Berezin, chief global strategist at BCA Research, said in a note. “A reacceleration in global growth, a weaker US dollar, and favorable valuations should all support non-US stocks next year.”
We now turn our attention to real estate stocks. Have US REITs also outperformed their global peers? And do global REITs deliver diversification benefits when added to a portfolio?
US REIT outperformance
US REITs have also outperformed their international counterparts. Research by Cohen & Steers shows that US REITs have outperformed global REITs in every period from the past year to the past 25 years.
Exhibit 4:Performance US and Global REITs
The question now is the same for REITs: what’s next?
The case for global REITs
In theory, a global REIT strategy offers an additional layer of diversification by providing access to countries with different currencies, monetary policies, and economic cycles.
A global approach also offers diversification because real estate markets are not monolithic - they reflect different levels of maturity, growth rates and stages of the real estate cycle.
Exhibit 5 shows how in reality private real estate markets have diverged between the U.S. and other developed markets over time. During the financial crisis, for example, U.S. private real estate dropped 22% in 2008- 2009, compared with much smaller declines of 2% in Australia and 8% in Japan, and 5% appreciation in Germany.
Exhibit 5: Private real estate index annual returns 2001-2008
Limiting exposure to a single market, even the sizeable U.S., can undermine diversification and pose additional risk, particularly during periods of market stress. Moreover, investors should consider markets where faster economic growth may create better opportunities in the future, rather than relying only on developed markets based on their historical performance.
Performance differences across countries and regions contribute to global real estate’s ability to diversify portfolios of global stocks and bonds. Exhibit 6 shows the low correlations between global private real estate and stocks and bonds (-0.53 and -0.47, respectively).
Exhibit 6: Correlation
Based on Nuveen’s real estate outlook, the most promising regions are located outside the US.
Exhibit 7: Real estate outlook
Also regarding valuation things are more sunny outside the US.
Exhibit 8: Valuation
We can conclude that adding global REITs looks interesting; they should be able to outperform, they add diversification benefits and they offer a higher yield. It would be great if we would be able to access those global REITs with a discount through a dedicated closed end fund.
Aberdeen Global Premier Properties Fund
Aberdeen Global Premier Properties Fund (NYSE:AWP) is such a fund. It aims to provide capital appreciation and current income through global real estate securities. The fund has $622 million of assets under management, uses 7.8% leverage and an expense ratio of 1.19%.
The fund pays a monthly dividend of $0.04 and offers a yield of 7.44%.
AWP focuses on companies that benefit from strong real estate fundamentals, combining cyclical factors and long-term secular trends. At this stage in the capital cycle, stocks benefiting from rental growth and value-adding development should outperform against the backdrop of a benign interest-rate environment according to the fund managers. In a slowing economic environment, they expect rental-growth sustainability and balance sheet strength to become increasingly important.
The fund also invests in real estate development and operating companies and mortgage REITs.
Exhibit 9: Sector allocation
Exhibit 10: Top-10 country allocation
CEF discounts and premiums
The differences between the share price and the NAV create discounts and premiums. Shares are said to trade at a "discount" when the share price is lower than the NAV.
Efficient market hypothesis believers have tried to explain discounts and premiums for years with myriad explanations. Most commonly, the reason a CEF trades at any given discount or premium is related to the fund's distribution rate, regardless of the source of the distribution.
Other typical reasons for premiums and discounts include:
- Overall market volatility.
- Recent NAV and share price performance.
- Brand recognition of fund family.
- Name recognition (or lack thereof) of the fund manager.
- Recent changes in distribution policy.
- An asset class or investment strategy falling out of market favor.
- An asset class or investment strategy rising in the market's esteem.
If we compare a CEF's discount to its average historic discount, this is what we refer to as a "relative discount." When considering valuation, it's important to look at relative discounts/premiums.
Exhibit 11: AWP premium/discount
Currently the fund is trading at a discount of 10.4%, while on average the fund was trading at a discount of 12.8% the past 5 years.
Exhibit 12: AWP average premium/discount
Conclusion
After a decade of outperformance for US stocks, the tide could be turning. Historically, in periods when the Federal Reserve has been loosening monetary policy, it has corresponded with outperformance by foreign markets. A re-acceleration in global growth, a weaker US dollar, and favorable valuations could also support non-US stocks. The same goes for global REITs.
Adding to global REITs looks interesting; they should be able to outperform, they add diversification benefits and they offer a higher yield.
A great way to access those global REITs with a discount is through a dedicated closed end fund like Aberdeen Global Premier Properties Fund. The fund trades at a discount of more than 10% and offers a yield of almost 7.5%.
This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor.
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