This week, the 2020 major-league baseball season starts officially, but no one knows how many fans will get to see a game in person. In light of the recent resurgence of COVID-19 across the U.S., most baseball lovers will have to watch from the relative safety of their homes. The idea of a stadium filled with cardboard cutouts of fans or canned crowd noise makes me wonder what effect this stark new reality might have on the so-called home field advantage. Without real fans who cheer in person, will playing on a familiar field make any difference?
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Lee Ainslie's Maverick Fund USA enjoyed its "strongest quarter in the fund's history" during the three months to the end of June. According to a copy of the firm's second-quarter letter to investors, which ValueWalk has been able to review, Maverick Fund USA gained 18% in the second quarter. Following this performance, the fund was Read More
Turns out, like many things in life, it’s complicated. As I attempted to research the benefits of a home field advantage (sometimes also called “home cookin’”), I learned that it doesn’t exist for every sport. One study published in 2018 studied cross-sport comparisons to find that home cookin’ works in major league basketball, but not so much for baseball or hockey. And another article by Konstantinos Pelechrinis discusses that officiating bias and travel have much more to do with providing a home field advantage than crowds of fans at the game.
However, this month, a study by the New York Times told a different story. German soccer teams playing to empty stadiums during the pandemic have seen the number of home victories slump by 10 percent, prompting one expert to call fan-free matches a sort of “negative home advantage.”
Whatever the data say, we are humans, after all, with favorite players, favorite teams, and even favorite countries. We bring the context of our life experience to every situation, so it’s not unreasonable to expect that some level of favoritism may influence how a referee might call a play, or how a player might be motivated when there’s no one to cheer for them. Those gut-level reactions are just a part of life.
Still, there are times when those gut-level reactions don’t serve your best interests, and there’s one example I see often as a financial adviser. It occurs when clients want to apply the theory of home field advantage — home cookin’ — to their portfolios.
It's Not Home Cookin', It's Home Bias
Some people just feel better about investing where they live. If the home field advantage works for athletes, they figure, why couldn’t that same advantage apply to investors? Unfortunately, when it comes to the markets, good home cookin’ can turn into a case of bad indigestion overnight. Behavioral economists refer to this phenomenon as home bias.
Home bias reflects our natural tendency to go with what we know. U.S. residents know U.S. companies, like Apple and Amazon, Ford and GM. So, when it comes to investing — which is inherently risky anyway — it’s natural for us to choose the companies and industries we know, to avoid being surprised by something that might occur at an unfamiliar company.
Research by the Investment Company Institute shows this is true for Americans who hold mutual funds. Around this time last year, ICI found that just 37% of mutual fund-owning U.S. households held global or international equity funds.
But plenty of non-U.S. based companies are household names that could elicit as much comfort to an investor as Apple or Amazon, and a simple trip to the grocery store helps illustrate my point. Need cat food? Purina is a trusted brand. It’s also owned by Nestle, which is based in Vevey, Switzerland. How about some ice cream? People love the taste of Ben and Jerry’s, created by Vermonters Ben Cohen and Jerry Greenfield. But British-Dutch conglomerate Unilever now owns the company. Finally, how about that all-American beer, Budweiser? Its current owner, AB InBev, is a Belgium-based drink and brewing company.
As of 2020, the U.S. holds about 54% of the value of global equity markets. If you were to invest only in U.S. companies, you would be missing out on the opportunities presented by the international and emerging markets that make up the other 46%, any one of which could outperform the U.S. in any given year. That’s because the best performing countries or asset classes may be in any region around the world, and there’s no way to predict ahead of time which ones will rise to the top.
The Case for Diversification
With diversification, no one needs to know which countries will be better performers. Instead, you can simply trust your globally diversified portfolio to capture the returns of all the world’s markets. Doing so will deliver more reliable outcomes and stabilize the effects of volatility.
Dimensional Fund Advisors (DFA) illustrates the benefits of global diversification in a 2018 article entitled, “Why Should You Diversify?” The article describes what some U.S. investors have termed the “lost decade.” During this period, from 2000 to 2009, the S&P 500 recorded its worst-ever 10-year performance with a total cumulative return of -9.1%. But, as the article explains, most equity asset classes outside the U.S. during that time generated positive returns. Was it an anomaly? Nope. When DFA expanded the data set to include 11 decades beginning in 1900 and ending in 2010, it found that the U.S. market outperformed the world market during only six decades. In the other five, it had underperformed. An investor who held a globally diversified portfolio during the U.S. market’s down years would have been able to capture returns from other markets during that time, potentially easing the strain of losses by the S&P.
Another example shows how unpredictable the markets can be. In 2015, Denmark experienced the best performance of all developed markets, with a return of 9.1%. (That year, the U.S.’s annualized return was only 4.9%, landing it in ninth place.) The next year, Denmark went from first to worst, and Canada took the top spot. (The U.S. placed sixth in 2016.)
Countering Home Bias
When investors fall prey to their own home bias, it’s like betting all their money on one team. Diversification spreads the risk, acting more reliably over the long term and softening the blow if one market has a bad year. Investing with home bias concentrates risk, adds volatility, and can leave you feeling like a Philadelphia Phillies fan in 1961. While a diversified portfolio will never be the best or worst performing compared to its components, it will reward you by being a solid player over time. And ultimately, it’s not whether you win or lose, it’s how you play the game.