We’ve all heard stories of entrepreneurs becoming very successful because of large, concentrated bets in a particular sector or asset class. Their success can be attributed to a strong local knowledge of their country and sector. However, their strength could turn out to be a weakness when it comes to investing.
Many entrepreneurs, whilst successful in their business, may not have segregated their business risk sufficiently from their investments. When it comes to their investments, they tend to gravitate towards the sectors and countries they are familiar with.
Home bias, especially in a Southeast Asia context, remains a major impediment for investment returns when it comes to wealth preservation for the long haul.
Why People Prefer to “Stay Home”
A home bias is driven by behavioural traits and occurs when investors over-invest due to familiarity with their home assets, potentially missing out on better global opportunities from a risk-reward perspective.
For many entrepreneurs in Southeast Asia, their wealth was amassed through a strong knowledge of the local business conditions. For them, applying their local knowledge made sense, and their past experience honed their instincts when it came to assessing domestic assets. However, it is a double-edged sword, which may lead them to overestimate their judgements.
Home bias seemingly gives investors a sense of control, hence they may attach more risk to investing globally than is deserved simply because overseas opportunities are less understood.
However, is this behavioural bias justifiable?
Benefits of Stepping Out
Academic studies show home bias is prevalent across the world and more importantly, it is not optimal when one invests with home bias.
Home bias will likely lead to heavy exposure to certain sectors in the local economy. The implication of a higher concentration in a portfolio is increased risk, as well as a possible drag on returns over the long haul.
By being overly concentrated on one region versus another, an investor can miss out on particular sectors that play an important role in global economic growth.
The evidence is stronger when we apply it from a Southeast Asian investor context.
For example, investing in a typical global market index today will provide exposure to more than 1,000 stocks; however, the Indonesia market index, for example, will only have about 20 stocks.
Specifically, if an investor bought into a global equity index a decade ago, they would have gained by more than 113%. However, if that same investor bought into an Indonesia equity index, that investor would only be up by 21% (Chart 1).
The divergence in performance becomes stark when we look over longer periods of time such as over the past three decades (Chart 2).
Clearly, if there is a stronger Indonesia home bias, it would likely have resulted in lower-risk adjusted returns when we look at five to 10 years’ time frames.
It is important to note that home bias for Southeast Asia fixed income investors can be detrimental for investment returns.
Over the past few decades, Southeast Asian currencies are highly sensitive to the global economic cycle. Historically, Southeast Asian currencies typically suffer while USD outperforms during periods of global market turmoil and stress. Therefore, Southeast Asia fixed income investors without a USD-biased currency overlay tend to underperform when it comes to investment returns. This is due to the extreme exchange rate volatility of Southeast Asian currencies that historically underperforms the dollar over long periods of time. Hence, for Southeast Asia investors, there is a need to consider dollar-biased diversification for their currency overlay strategy (Chart 3).
2024 and Beyond: Multi-Speed and Global Diversification
Looking at 2024 and beyond, the impact of ever-changing growth-inflation dynamics will play out at different speeds among countries.
It seems that inflation has peaked, while growth is going to slow down for most of the developed world. The extent of this slowdown remains uncertain and will vary across economies.
The gradual decline in inflation means that central banks are unlikely to come to the rescue quickly to revive growth. Major central banks are at the end of their tightening cycles but will likely proceed judiciously with rate cuts even in 2024. Clearly, there is plenty of room for monetary policy divergence, especially between the developed markets and emerging world. Therefore, there will be greater differentiation in terms of investment returns across countries.
Historically, global diversification has led to higher returns per unit of volatility. This is especially important looking to 2024 and beyond, given the divergence in expected returns and the range of possible economic outcomes.
Step Out of Home and Go Global
Diversification across geographies is just as important as diversification across asset classes.
While over- or under-exposure to a region may boost returns for some time, for reasons specific to that time period that are likely to be clear only in hindsight, this is unlikely to be in the best interests of long-term investors.
Benefits of global diversification are particularly evident for investors based in Southeast Asian markets that are either relatively small (in terms of market capitalisation), or under-diversified (in terms of sector concentration).
Geographical diversification is important, but this should be considered in relation to a company’s wider exposures, such as the location of its customer base and supply chain, rather than the location of its stock exchange.
Southeast Asian investors, for example, not only achieve better diversification across economic sectors but also broaden the opportunity set by expanding the number of eligible securities when moving from local to global markets.
While home bias may provide a sense of comfort and security, it can hinder the optimisation of investment portfolios. Neglecting international opportunities may result in missed chances for higher returns and exposure to industries and sectors not available in the domestic market.
Global diversification is not just about returns, it is grounded in the adage “don’t put all your eggs in one basket,” emphasising the importance of spreading risk. Diversification acts as a risk management tool, aiming to reduce the impact of poor-performing assets on an investment portfolio.
Despite the benefits of diversification, home bias often creeps into investment decisions. Investors must strike a balance between the benefits of diversification and the allure of familiar domestic investments.
Clearly, there is a need to step out of the comforts of home-bias investing and go global.
About James Cheo
James Cheo is a member of the Global Investment Committee for Global Private Banking and Wealth and also a member of the Regional Investment Committee in Asia. In his role, he spearheads the development of investment strategies across all asset classes for HSBC Global Private Banking & Wealth clients in Southeast Asia and India.
With his knowledge and wealth of experience, his investment views are frequently sought after, with appearances on notable financial media including BBC, Bloomberg, CNBC, and Channel News Asia.
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