Research summary
November 10, 2022
Investor proclivity for locally owned companies may point to a need for greater portfolio diversification. So says recent Vanguard research, which looks at local bias in individual stock portfolios.
Do investors tend to own individual stocks of companies whose headquarters are geographically closer to home? That’s what Vanguard researchers Xiao Xu, Thomas J. De Luca, and James J. Rowley Jr. examined in their paper, Buying Local: Local Bias in Individual Stock Portfolios.
The authors explored trends across four years: 2018 through 2021. They found that, overall, investors live about 84 miles closer to the companies they own than to those in the benchmark CRSP Total Market Index. Further, investors appeared to live slightly closer to their portfolios in 2020 and 2021 than they did in 2018 and 2019. The authors also found that local bias has been consistent across the U.S.; meanwhile, when researchers zoom in on specific regions, there appears to be less geographical difference in the amount of local bias over time.
Although the paper didn’t explicitly pursue drivers of local bias, it noted that investors may gain some degree of psychological utility from investing in local stocks. That is, they might get an emotional boost from investing locally or where friends or family might work.
Previous research conducted outside of Vanguard suggests that U.S. fund managers or individual investors may prefer local stocks merely because they are familiar or because the investor may attempt to exploit local knowledge.
Vanguard’s research found that local bias is associated with greater levels of concentration within an investor’s portfolio of individual stocks. Local bias also was associated with smaller, more levered, less liquid, and value-style stocks.
Does that mean investors should take action? For those who are comfortable with those positions, perhaps not. But for those who aren’t, perhaps a diversified mutual fund or exchange-traded fund with similar investment exposures could decrease portfolio concentration while maintaining a tilt toward smaller-cap value holdings.
The paper identified four different size-and-style exposures that offer substantially less concentration than did the sample’s individual stock portfolios.
Notes: The chart shows concentration—as measured by HHI—for four style-box categories and our sample of individual investors. The style-box categories of small-cap value, small-cap blend, mid-cap value, and mid-cap blend are proxied by the CRSP U.S. Small Cap Value Index, the CRSP U.S. Small Cap Blend Index, the CRSP U.S. Mid Cap Value Index, and the CRSP U.S. Mid Cap Blend Index, respectively. The figure is shown in logarithmic scale for visual acuity. Data are as of December 31 for each year.
Sources: Vanguard and FactSet.
In short, some investors may exhibit a bias toward local companies and may be introducing an unexpected level of risk into their portfolios. A similar asset allocation can be achieved, but with a lower risk profile. A solution to consider: Replace the stocks with a broadly diversified mutual fund or exchange traded fund with a similar investment tilt.
All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Diversification does not ensure a profit or protect against a loss.
Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks.