My pro rata slice of the global market portfolio would probably be a fine choice for my portfolio if my preferences and circumstances matched those of the global average investor. But they don’t.
The differences help me think about how my portfolio should differ from the global market portfolio. I illustrate this framework with a few examples of how I differ and the implications of the differences for my portfolio.
I live in the United States, almost everything I buy will be denominated in US dollars, and I may not be treated as well as local investors in foreign markets. All three facts lead me to overweight US investments.
First, economists talk about something we call “keeping up with the Joneses” and younger readers know as FOMO, fear of missing out. If your neighbors overweight US investments, you can reduce your risk of suffering while they prosper by also overweighting US investments.
Second, since the things I expect to consume are priced in dollars, investments denominated in other currencies have an extra risk; the dollar payoff from a foreign investment will be smaller if the foreign currency depreciates.
Third, local investors have an advantage over foreigners in some markets. Foreigners sometimes pay higher effective tax rates than locals, and in some countries capital controls make it difficult for foreigners to repatriate their wealth.
Argentina, for example, instituted restrictions on the flow of capital in 2019 that continue to challenge foreign investors. These and similar factors push me and other US investors to overweight US investments and underweight foreign investments. And this seems to be a universal result.
As a group, locals overweight the investments in their home market.