The sorry state of retail investor portfolios
We all know that institutional investors have more diversified portfolios than retail investors, but two studies shed light on just how poorly diversified the average retail portfolio really is.
The first study I came across was done by Ines Chaib from the University of Geneva and two collaborators. They built a comprehensive global database of share ownership. There is tons of interesting information in that study but I want to focus on a couple of findings regarding retail portfolios.
First, I was surprised how large the share of retail ownership is even in this day and age of fund investing. Even in 2020, most developed countries show a retail share of ownership close to 50% of the stock market. Note that this excludes ownership of stocks via mutual funds which are counted as institutional ownership. In some countries like the US, the UK, and Australia, retail investors holding stocks outright are much more important than others (e.g. Spain and Portugal). But no matter the exact share of retail investors, in every country they are the most important group of owners by volume.
Firm ownership by investor type
Source: Chaieb et al. (2024).
Unfortunately, with so much direct ownership of stocks come a lot of bad habits. First, retail investors remain incredibly home-biased. Typically, retail investors invest 85% or more of their stock investments in domestic shares. One may argue that retail investors get their international diversification through fund investments, but if direct investment account for some 40% of total firm ownership and some 90% of that are domestic shares, then this implies that retail investors typically hold about 30% to 40% of their portfolio in single domestic stocks. That still is a huge home bias and a lack of diversification.
Home bias of retail investors
Source: Chaieb et al. (2024)
Which brings me to the second study, done by the VZ Vermögenszentrum in Switzerland based on portfolios of Swiss investors.
One result that stood out to me was the number of individual positions held in portfolios. On average, Swiss retail investors held six to seven actively managed funds, three ETFs, two index funds and seven single stocks. The problem just is that these seven single stocks account for 36.6% of the portfolio.
Average number of positions in Swiss retail portfolios
Source: VZ Vermögenszentrum
Meanwhile, the rest of the portfolio consists of funds and structured products issued by different institutions. Or rather by one institution. You see, in Switzerland, the regulator changed the rules some time ago. Since 2012, customers in Switzerland have the right to demand all sales commissions from third party funds to be paid out to them. I have written here how that changed the advice given by banks from an open architecture that recommends the ‘best fund’ anywhere to a house-based architecture where products issued by the bank are preferred. This has become extreme in recent years with about two thirds of the products in a Swiss retail portfolio issued by the investors house bank.
Share of customer’s own bank’s products
Source: VZ Vermögenszentrum
This is clearly a situation that is less extreme outside of Switzerland but since most retail investors get their advice from a financial adviser or a house bank that is at least somewhat biased, I fear there is also a ‘house bias’ in other countries.
In short, retail investor portfolios are not very well diversified both in terms of countries as well as asset managers and often highly concentrated in a few stocks that drive most of the performance. Essentially, retail investors pretend they are great stock pickers and let their stock picking skills dominate their lifetime investment outcomes.
Great observations, as usual. There may be some patriotism at work, there may be a misguided sense of familiarity ("I can check up on my investment in Hornbach Baumarkt by shopping at my local Hornbach Baumarkt!"), and local banks clearly want to encourage sale of domestically-focused investment products, but I am convinced that regulatory and tax reporting/preparation burdens contribute to both the home- and single-stock-bias your piece reveals.
Before Big German Bank kicked me and my kids out of our German brokerage accounts for being "US persons", I was negatively impressed at the paucity of funds the "Depotkonto" could allegedly accommodate ("Please buy me some low-fee dollar-denominated Vanguard Index 500."; "Sorry, no can do, but I can offer you this high-fee euro-deonominated Big Bank Investment Arm fund that's kinda-sorta-but-not-quite-Vanguard Index 500"), but was positively impressed by how one would receive a reasonably straightforward tax statement at the end of the year ... it had all the numbers the Finanzamt wanted in all the right boxes.
I will save you sob story on the specific plight of US citizen investors abroad (a "catch-22" situation where one can't have a local brokerage account nor own foreign mutual funds due to US regulator over-reach, but one then also needs a permanent US address to maintain a US brokerage account, and are then restricted from buying even US mutual funds and ETFs because one is not US-resident), but even a German citizen investor trying to open up a non-German account and/or buy non-domestic mutual funds faces massive friction costs.
When I ask my tax preparer why they can't simply use our annual US 1099s and apply 25% flat to ony dividends or capital gains, they cite a German rule change in 2018 that no one has ever been able to satisfactorally explain to me that apparently now requires byzantine calculations involving poring through each monthly brokerage statement for each fund to somehow de-construct the returns. The fact that they're set up for automatic dividend investment (that's how the magic of compounding really works over time!) seems to complicate things even more. I'm stuck with a *massive* tax preparation bill each year that's a *huge* drag on all-in investment performance.
Own individual stocks? Magically, all those problems go away! Both in Germany and the US. Sadly, ETFs don't count as individual stocks, which I find a bit weird ... so why is Berkshire Hathaway okay? One can sort of understand the regulatory drivers: Non-1940 Act-compliant overseas mutual funds are viewed by the US authorities as tax dodges at best, and money laundering vehicles at worst, and the same suspicions apply the other way 'round for the Germans. However, there is delicious irony in that much of government regulation is ostensibly set up to protect small retail investors from runious losses, but the regulatory/tax system ends up encouraging underdiversified single-stock ownership over mutual funds.
Joachim
I always appreciate your notes. This article struck a chord with me, since 3 decades ago I looked at share ownership patterns across 25 countries. Research was sparse then, but a few truths were evident.
Retail ownership is quite volatile and has deleterious impact on market liquidity, as individuals are primarily takers of liquidity. Markets in Asia, such as Taiwan and HK, were remarkably volatile and still are. Markets such as the US had a "backbone" of institutional investors, notably pension funds, who stayed in the markets. Other developed markets were lacking that backbone but were building them. Public markets were impeded by a limited numbers of listings with a great amount of private ownership, e.g. Germany.
Individuals are obviously not well diversified. The ability to assimilate more information that is available in public markets is still limited. Thus, greater transparency alone has not made them investors. More have become traders as they have witnessed great wealth created by share ownership.
The majority of markets still lack viable domestic institutional ownership holding patient capital. In the US public pension funds and large endowments have shifted allocations to private markets. The UK I believe has also seen a decrease in domestic institutional ownership. Reliance on foreign capital inflows has been a curse for many markets, as this capital typically flees at the sign of trouble. Foreign share allocations by US institutions have broadly decreased in the last 3 decades.
Corporates have stepped in to some degree with larger cash piles available. Buybacks have supported the US market. FDI has generally increased. On the other hand, US pension funds and endowments have allocated considerably more capital to private markets. ZIRP contributed to both VC and PE growth, but that has disappeared. Valuations are being challenged and secondary market trades are heavily discounted. Where does that capital go now and how much will be lost to defaults.
Speculative activity by retail and hedge funds consequently have more impact on public share prices. The articles you cite highlight the conflicts-of-interest inherent in sales to retail. Open architecture has been discussed but not executed for 3 decades. As retail investors awaken to the costs of those conflicts and impact on their wealth, shifts will occur but not overnight. Indexed ETFs that emulate the larger market at a low cost are better for the long term and potentially stabilizing for the public markets.
These factors do not bode well for capital formation through public markets for the time being Your note has underscored challenges for the public markets in the next few years.