Why do US retirement funds typically have way more US assets than international assets?

Question

I have noticed that US retirement funds generally seem to allocate far more space to US stock than international (non-US) stock. Of course, there is not really any such thing as a prototypical retirement fund, but this is what I see when I look at target date funds by major US mutual fund vendors, which seems as close to a "typical" retirement fund as anything.

For example, Vanguard's Target Retirement 2050 Fund (VFIFX) currently allocates 62.1% to VTSMX (US equities) but only 27.9% to VGTSX (international equities). Fidelity's Freedom 2050 Fund (FFFHX) currently allocates 65.42% to various domestic equities but only 27.56% to international equities. As of Dec 31, 2014, Charles Schwab's Managed Retirement Trust Fund 2050 allocated 67.27% to various domestic equities but only 21.46% to international equities. Roughly the same proportions hold for the fixed-income/bond parts of those funds.

Why is so much more asset space allocated to US assets? The US is certainly a major economy (GDP about 16 trillion), but it's nowhere near two-thirds of the global economy (which is somewhere above 60 trillion, it appears). Would vendors based in other countries allocate a similarly large amount of space to assets from their own countries? That is, would a vendor in, for example, Brazil allocate a larger amount of asset space to Brazilian equities/bonds? If so, why?

Answer 1

There are a few main economic reasons given why investors show a strong home bias:

• Added currency risk which MSalters explains very well in another answer
• Local investors may have superior information about local economies and be looking to profit from it
• Tax burden on foreign investment can be larger in some countries
• A number of countries limit foreign investment by many in their public institutions and a few even in their citizens

Interestingly, though if you ask investors about the future of their home country compared with other countries they will generally (though not always) significantly overestimate the future of their own country. It is difficult to definitively say what drives investors but this psychological home bias could be one of the larger factors.

Edit in response to the bounty: Maybe this Vanguard article on their recommended international exposure is what you are looking for though they only briefly speculate about why people so consistently show a home bias in investing. The Wikipedia article mentioned above has some very good references and while there may be no complete answer with the certainty that you seek (as there are as many reasons as there are investors) a combination of the above list seems to capture much of what is going on across different countries.

Answer 2

It's likely that the main reason is the additional currency risk for non-USD investments. A wider diversification in general lowers risk, but that has to be balanced by the risk incurred when investing abroad.

This implies that the key factor isn't so much the country of residence, but the currency of the listing. Euro funds can invest across the whole Euro zone.

Things become more complex when you consider countries whose currency is less trusted and whose economy is less diversified. In those cases, the "currency risk" may be more due to the national currency, which justifies a more global investment strategy.

Answer 3

To expand a bit on @MSalters's answer ...

When I read your question title I assumed that by "retirement funds" you meant target-date funds that are close to their target dates (say, the 2015 target fund). When I saw that you were referring to all target-date funds, it occurred to me that examining how such funds modify their portfolios over time would actually help answer your question.

If you look at a near-term target fund you can see that a smaller percent is invested internationally, the same way a smaller percent is invested in stocks. It's because of risk. Since it's more likely that you will need some of the money soon, and since you'll be cashing out said money in US Dollars, it's risky to have too much invested in foreign currencies. If you need money that's currently invested in a foreign currency and that currency happens to be doing poorly against USD at the moment, then you'll lose money simply because you need it now.

This is the same rationale that goes into target-date funds' moving from stocks to bonds over time. Since the value of a stock portfolio has a lot more natural volatility than the value of a bond portfolio, if you're heavily invested in stocks when you need to withdraw money, there's a higher probability that you'll need to cash out just when stocks happen to be doing relatively poorly. Being invested more in bonds around when you'll need your money is less risky.

Similarly, being more invested in US dollars than in foreign currencies around when you'll need your money is also less risky.

Answer 4

You need growth in your retirement fund. Sad to say but the broad U.S. marks still has better growth perspective than the emerging markets.

Look at China they are only at 6.7% growth for next year the same as this year.

Russia's economy is shrinking. These are the other two super powers of 2015. The USA is still the best market to invest in historically and in the present. That's why the USA market tends to be overweight in most retirement portfolios.

Now by only investing in the USA market do you miss out on trends internationally? Well you do a bit but not entirely. Many USA companies are highly international in regards to their growth. Here are some:

1. Caterpillar - when China's construction grows they benefit
2. Colgate Palmolive and Bristol Meyers - their goods are all over the place
3. Pepsi (and the energy drink companies) - less diverse than coke and breaking out into the emerging markets
4. Starbucks - breaking into the Chinese market and poised to benefit from international consumer growth
5. Hell Bidu and BABA are traded on the NYSE and they are highly married to China.

So in short the USA market still seems to be the best growth market and you still get some international exposure.

Also by investing in USA companies they sometimes are more ethical in their book keeping as opposed to some other markets. I don't think I'm the only one that is skeptical of the numbers China's government reports.

Answer 5

1. Where companies are domiciled isn't very relevant any more- many "US Companies" have significant non-US business earnings i.e. Coke, MacDonalds, Walmart, 7-Eleven, Cisco, Apple. US companies have been investing overseas for years, and have very profitable subsidiaries.
2. The US economy is the largest in the world, though China is now a close second. If you want investment opportunity and diversity, size is your friend.
3. The US market is the most liquid i.e. more buyers and sellers means smaller spreads between bid and ask, and should result in fairer prices.
4. The New York Stock Exchange has very high "listing" requirements. This means that audited financial statements, a minimum number of shares, among other requirements means that lower quality companies aren't admitted. Many companies want to list on the NYSE because of the perceived higher quality, though recently standards have been raised so high that Chinese companies are choosing Hong Kong Stock Exchange rather than New York.
5. Investing in international companies on overseas exchanges is more expensive: foreign currency exchange, higher due diligence costs, among other potential costs. Many retirements funds are selected on the basis of expense ratio- the cost of doing business borne by the shareholder. To the extent that mutual funds increase their international equities, their costs will rise.
6. Many foreign investors perceive the US dollar to be a safe haven in times of local stress. They buy US bonds,