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For many Hong Kong local investors, who have had the majority of their portfolios invested in their favourite blue-chip stocks or the popular Hong Kong Tracker Fund would have been disappointed in the underperformance of the local equities market in the past few years.
The contrast could not be more stark, the MSCI World Index returned 22.2% (in USD terms) for 2023, while the Hang Seng Index fell 13.8% for the year. Many are now realising the problems of having an excessive home bias in their investment portfolios, particularly for building their long-term core wealth.
What is home bias?
Home bias is the preference by investors to invest the majority of their assets 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 is pronounced among Hong Kong investors as well. According to MPFA, 66% of all MPF equity investments were invested in Hong Kong funds as of June 2020, far outweighing other geographical markets.
3 reasons why home bias is prevalent in Hong Kong
There are several reasons why investors tend to favour investing in domestic equities and bonds, and many of the reasons are consistent across different geographies.
1. Preference for investing in familiar companies and brands
Investing can be intimidating and stock performances can be volatile. With all the uncertainty involved, there is greater comfort in investing in familiar companies and brands whose services and products we use and interact with on a day-to-day basis.
This is especially true for the big blue chip Hong Kong companies, such as HSBC Holdings, Hong Kong Stock Exchange and Tencent Holdings, many of which are stock darlings of local investors.
Having such familiarity and the sense of security in being able to physically gauge operating performance can give investors more confidence to hold local equities.
This contributes to their home bias in portfolio allocation.
2. Concerns around transaction costs and security of assets
Investing in overseas stock markets can incur costs such as additional brokerage charges, foreign currency conversion charges, withholding dividend taxes etc.
To some, therefore seems intimidating and expensive, relative to the simpler fee structure when investing in the home markets.
There could also be concerns surrounding the safety of investments due to unfamiliar regulatory regimes.
3. Avoiding FX exposure
Investing overseas usually requires the transactions to be made in foreign currency. In contrast, shares listed on the Hong Kong Stock Exchange (HKEx) are in HKD (and recently also introduced RMB denominations), which usually coincides with the currency of investors’ expenses.
How does home bias affect Hong Kong investors’ portfolios
1. Concentration risk
Most Hong Kong investors likely have their incomes and jobs tied to the fortunes of the local economy. For those who remember, Hong Kong was hit with SARS in 2003 and property prices plunged, while schools, bars and restaurants were shut.
Those who have all their investments tied to the local market might see both their incomes and assets hit with a “double whammy” impact.
On the other hand, overseas markets remained relatively intact as the outbreak was more of a regional phenomenon that mainly impacted Hong Kong and mainland China.
Hence, holding a diversified global portfolio can help to reduce risk, as performance of foreign markets usually don’t 100% march in step with local or China markets.
2. Lower performance
Diversification gives investors lower portfolio volatility and can contribute to more consistent investment returns. And when the portfolio value is highly volatile, it can influence many investors to abandon their long-term investment strategy during trying periods in the financial markets.
Imagine there’s a portfolio predominantly in Hong Kong stocks, proxied by the city’s flagship Tracker fund, what you are getting is 10% assets in Alibaba Group and another 10% in Tencent Holdings, and 80 more local and mainland Chinese businesses. With this, your money ended 2023 by 13.8% less.
Say you invested in another side of the world. Over 2023, the US market was oscillating between the Fed’s mantra of “Higher for longer” and the economy can pull off a soft landing. Thanks to a rally in Magnificent Seven stocks and the optimism around artificial intelligence, the S&P 500, a major US stock benchmark, crept up by 24% throughout 2023.
Does it mean we have to trail the winning market and double down on it? Back to the first principle - Do not put all the eggs in one basket.
Final thoughts
Given the risks involved when an investment portfolio is heavily weighted to a single market, whether it be Hong Kong or even the US, investors should consider making their investments globally diversified.
By investing in a portfolio that is weighted by global market capitalisations, one can obtain global exposure without neglecting the Hong Kong/China markets, while significantly diversifying your risk away from a single market.
Get started with Endowus to tap our suite of globally diversified portfolios. Our Endowus Global model portfolios are designed to give investors broad exposure to global markets in a strategic and passive asset allocation.
You can also choose to complement your core investments with satellite positions with our satellite portfolios, spanning across various themes, including Global Technology, China Equities, Future Trends and Sustainability - Equities.
Click here to learn more about the power of diversification and how to diversify correctly across portfolios.
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