The potential effect of taxes on the equity home bias in New Zealand PIEs

Abstract

This paper examines the effect of taxes on the international diversification benefits available to New Zealand investors who invest in equities held through a portfolio investment entity (PIE). Historical monthly index data for 34 markets denominated in New Zealand dollars from 1993 to 2018 is used with an in-sample mean-variance optimization approach to estimate the optimal domestic asset allocation and potential benefits of international diversification. Our findings suggest that New Zealand's dividend imputation tax regime and differential taxation rates on domestic and offshore investment can account for a 7%–11% weight shift towards the New Zealand domestic market compared to the case of no taxes. Monte-Carlo simulation analysis using different return patterns also provide support for home bias in the presence of higher taxes on offshore equity investment. Overall, our results provide a partial explanation for current investor home bias in New Zealand. In contrast, without dividend imputation and differential rates, taxes would suggest a weight shift to offshore equities of between 1% and 6% due to high dividend yields in the New Zealand market.