As a results of its aggression and actions in Ukraine, Russia has become an international pariah. Part of that impact is that their stock market is closed, and the value of their publicly traded companies has fallen to nearly zero. You can see the suddenness of the decline by looking at ETFs that invest in Russian Stocks. For example, the iShares MSCI Russia ETF (ERUS) has lost 99.83% of its 2022 starting value through March 8, and is no longer trading. ₁ Thankfully this is of little direct financial impact to investors with firms like ReFrame Wealth. Our most exposed clients had only thousandths of a percent of their assets invested in Russian companies. ₁₀
There is a group of investors that feel this decline much more keenly, individual Russian investors. Among all of the other financial devastation Russians are feeling they are also suffering from the nearly universal tendency to invest most of their money in companies where they live. Behavioral finance calls this the ‘Home Country Bias’. Schwab data suggests that Russian domestic investors held almost 95% of their stock exposure in Russian stocks. ₂ Before this year they were probably feeling pretty good about that choice. Returns had averaged over 10% per year over the last five years and there was little reason to think that couldn’t continue. ₃
Russians are not unusual in this preference to invest within their own borders. Greeks hold about 70% of their wealth in Greek stocks.₄ French investors are bit more cautious with only about 60% of their portfolios in stocks of French companies.₅ Americans hold about 80% of their equity portfolio in US stocks even though the US makes up about 58% of the world market capitalization.₆
I am reminded of a study by the wonderful academic Wade Pfau called “Does the 4% Rule Work Around the World?”. ₇ The 4% rule is the generally accepted idea that you can withdraw 4% of your portfolio, adjusting for inflation, over a thirty-year retirement time horizon and not exhaust your capital. I shudder to think of how abruptly that heuristic would have failed for a Russian retiree. In fact, it has only worked historically if you had the good fortune to be American, Canadian or Swiss. Most world economies, even the ones we consider highly developed, have gone through terrible catastrophes or convulsions that forced investors to drastically reconsider their retirement plans.
I often think of Japan. In 1989 the Japanese stock market, the Nikkei, closed just short of 37,000. ₈ I am sure that Japanese investors, like investors everywhere, assumed that prices would continue to march forward indefinitely. Instead, in hindsight, that represented the peak of the largest asset bubble in modern history. After that returns just stagnated. The Nikkei, as of this blog’s publishing date, is just over 26,000. ₉ What is curious about the Japanese case is that there was no dire catastrophe. The Japanese people lead good lives with high incomes and a high level of financial security on the global scale. There are a lot of reasons for the poor performance of the Japanese market that are beyond the scope of this discussion, but it highlights the risks of relying on past performance to look forward to the future.
I agree that investors should be globally diversified with assets held in a portfolio that generally matches the world’s market capitalization. That is the approach I would take if I were an advisor in any economy other than the United States. The Home Country Bias does make some sense though to US investors. You are paid in dollars, and you generally benefit from investing in companies denominated in your own currency. Investing in foreign assets adds a currency risk that you either can hedge away or accept, but either way there is a cost either in terms of added risk or direct cost. The United States has a uniquely diverse economy with a vibrant and relatively transparent free market. Our political system is messy and sometimes chaotic, but it has proven resilient and stable with little state interference in the running of American corporations.
The portfolios we build for our clients hold about 75% of equities in the United States with relatively small allocations to emerging economies.₁₀ This represents a moderate overweight to the US over foreign economies. This is a topic of constant monitoring over time and will evolve as global economic conditions evolve. For now, the US markets are indeed exceptional. They have an array of benefits that are unmatched around the world, and we believe that some overexposure to those markets is a benefit to our clients.
To me the lesson of the Russian collapse and the Japanese experience is that we cannot take our experience and past for granted. All great economies eventually decline. Sometimes that happens quickly due to war or catastrophe. At other times there are long slow declines; at one time Belgium and Portugal were great world powers. As investors in the United States, we need to appreciate our unique advantages, but also be willing to adapt if conditions change.
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