What is home bias?
Home bias is the inclination for investors to invest the majority of their savings into local equities and bonds.
The phenomenon was first highlighted by a research paper made by Kenneth French and James Porterba in 1991.
They concluded that most investors still hold most of their assets in local assets, despite research-backed benefits of international diversification. Home bias led to higher risk in their investment portfolios over the long-term.
This phenomenon has been observed recently, and in Singapore as well. As evident from the chart below, despite how Singapore equities only represent 0.4 per cent in global equity indices, on average, Singaporean investors have 39 per cent of their portfolio in Singapore’s stocks.PHOTO: Endowus
Three reasons why home bias is prevalent in Singapore
There are several reasons why investors tend to favour investing in domestic equities and bonds, and many of the reasons are consistent across nationalities.
1. Preference for investing in familiar companies and brands
For many people starting out, investing in the equities market can be intimidating: they have to set up a brokerage, understand how to trade and invest, and come to terms with how share prices are divergent from company performance and outlook.
With all the uncertainty involved, there is greater comfort in investing in familiar companies and brands whose services and products that we use and interact with on a day-to-day basis.
This is especially true for the Singaporean banks, local telecommunications companies, and Real Estate Investment Trusts (REITs).
As Warren Buffett famously said,
“Never invest in a business you cannot understand.”PHOTO: Reuters
Want to know how well a shopping mall REIT is doing? Just waltz into to a shopping mall and have a feel of the crowd and the shopper traffic.
Want to monitor blue-chip companies’ strategy and growth plans? Just flip through The Straits Times and one may get insights on the innovations the companies have projected to accomplish.
The ease of access to information and the sense of security to be able to physically gauge operating performance gives investors more confidence to hold local equities relative to foreign stocks. This contributes to home bias in portfolio allocation.
2. Concerns around transaction costs and security of assets
Traditional Singapore brokerage firms charge a confusing array of fees for overseas investments, including brokerage charges, foreign currency conversion, stamp duty, custodian and security management fees.
Investing in the overseas market seems intimidating and expensive relative to the simpler fee structure when investing locally.
There are also concerns surrounding the safety of their investment assets. Investors may be uncomfortable that their investments are not secure as it is regulated by a foreign regulator or that they aren’t held under a CDP account.
3. Lower FX exposure
Investing overseas usually requires the transactions to be made in foreign currency. Given the appreciation of the Singapore Dollar (SGD) over the past few decades, it is a due concern that investing overseas, with foreign currency exposure, will lead to poorer returns.
In contrast, most of the share price of the equities listed in SGX is in SGD, so investors do not need to buy/sell other foreign currencies to invest in this market
How does home bias affect investors' investment portfolio and retirement?
1. Higher portfolio volatility and lower returns
An investment portfolio which has a huge domestic exposure can lead to greater risk and here are the reasons why.
Diversification gives investors lower portfolio volatility and can contribute to more consistent investment returns. On the contrary, high volatility in portfolio value can lead many investors to abandon their long-term investment strategy during trying periods in the financial markets.
During the Covid-19 crisis, the Singapore economy slipped into a technical recession in Q2 2020, with GDP shrinking by 41.2 per cent .
On a year on year basis, the Straits Times Index has dropped by 21 per cent in Q2 2020. In contrast, while the US economy shrunk by 32.9 per cent , the major US stock market index, the S&P 500 has crept up by 4 per cent year on year in Q2 2020.
Much of the gains have been attributed to the growth of the US giant tech companies, such as the the likes of Amazon and Netflix which thrived during the pandemic.PHOTO: Endowus
This highlights the lack of sectoral diversification in Singapore’s equities market. There is a lack of technology and healthcare companies in our exchange and in the Straits Times Index that have done well during this Covid-19 crisis.
In the same vein, the lack of exposure to high-growth sectors such as technology/healthcare and lack of revenue streams from the emerging markets can also lead to lower returns, similar to what Japan’s stock market has gone through in the 2000s through the lost decade.
Domestic companies may find challenges in growing revenue locally and sustain growth.
2. Imported inflation risk from SGD depreciation
Imported inflation is a phenomenon where a higher cost of living arises from an increase in the cost of imported products. This price increase can be due to the weakening of the local currency relative to foreign currency.
While investing in global markets comes with FX risks and volatility, it can also hedge against Singapore’s dependency on imports and the risk of imported inflation.
As the Singapore economy is highly dependent on imports, being highly SGD-exposed is an issue, especially if the SGD weakens against major currencies. This can lead to a loss in purchasing power in the case if the SGD weakens during retirement.
This was what British retirees experienced from 2016 to 2017 when the pound depreciated drastically due to Brexit , with inflation surging from 0 to 3 per cent.PHOTO: Reuters
Given the risks involved when an investment portfolio is heavily weighted in Singapore’s market, Singaporeans should consider being globally diversified in their investments, especially since the Singapore stock market takes up a minuscule portion of the global stock market (<1% by most measures).
By investing in a portfolio which is weighted by global market capitalisation, one can obtain global exposure while not neglecting the Singapore market.
This article was first published in Endowus.