What is home bias?
Home bias is the inclination of 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 this chart shows, although Singapore equities represent only 0.4% in global equity indices, on average, Singaporean investors have 39% of their portfolio in Singapore's stocks.
3 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 stock market can be intimidating. They have to set up a brokerage, understand how to trade and invest, and come to terms with why share prices may diverge from the 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."
Want to know how well a shopping mall Reit is doing? Just waltz into one of its malls and have a feel of the crowd and the shopper traffic.
Want to monitor blue-chip companies' strategies and growth plans? Simply flip through The Straits Times to get the latest news on these companies' innovations and what they are looking to accomplish next.
Having such an ease of access to information and the sense of security in being able to physically gauge operating performance can give investors more confidence to hold local equities, as opposed to foreign stocks.
This contributes to their 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 markets can therefore seem intimidating and expensive, relative to the simpler fee structure when investing in the home country.
There are also concerns surrounding the safety of their investment assets. Some investors are uncomfortable that their investments may not be secure, as those markets are regulated by a foreign regulator or the assets are not held under a CDP account.
3. Avoiding 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, could lead to poorer returns.
In contrast, most of the share prices of the equities listed on the Singapore Exchange (SGX) is in SGD, so investors do not need to buy or sell other foreign currencies to invest in the Singapore market.
How does home bias affect Singapore investors' portfolios?
1. Fewer options due to delisting of SGX companies
While the stock markets in other developed countries are vibrant, with many new local and foreign companies listing on their local exchanges, the same cannot be said for SGX.
The Singapore bourse has seen many well-known Singapore companies delisting or going private in recent years.
Moreover, many big Singapore tech companies, such as Razer and Sea Limited, are choosing overseas exchanges over SGX.
Market observers have attributed this trend to several reasons: low liquidity on SGX, poor valuations found in the market, and increased requirements around reporting standards. The significant premium offered in the latest restructuring of CapitaLand's business is an example of the poor market valuations in SGX.
What this means to investors who restrict themselves to only SGX offerings is that they will face fewer investment options if the trend of delisting continues.
2. Higher portfolio volatility and lower returns
An investment portfolio that has a huge domestic exposure can lead to greater risks.
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.
During the Covid-19 crisis, the Singapore economy slipped into a technical recession in Q2 2020, with GDP shrinking by 41.2%. On a year-on-year basis, the Straits Times Index dropped by 21% in Q2 2020.
In contrast, while the US economy shrank 32.9%, the S&P 500 (a major US stock market benchmark index) crept up by 4% 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.
This highlights the lack of sectoral diversification in Singapore's equities market. There are few technology and healthcare companies on the Singapore bourse and in the benchmark Straits Times Index that have done well during the Covid-19 crisis.
In the same vein, the lack of exposure to high-growth sectors such as technology and healthcare, as well as the lack of revenue streams from the emerging markets, can also lead to lower returns. This is similar to what Japan's stock market has gone through in the 2000s during the lost decade. Domestic companies may face challenges in growing revenue locally and sustaining growth.
3. Imported inflation risk from SGD depreciation
Imported inflation is a phenomenon where the cost of living rises due to an increase in the cost of imported products. Such price increases can arise from the weakening of the local currency relative to foreign currencies.
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 heavily dependent on imports, being highly SGD-exposed is an issue, especially if the SGD weakens against major currencies.
Inflation in general erodes people's purchasing power. It will be of particular concern if the SGD weakens during your retirement and you are hit by imported inflation.
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%.
Read more: Prepare for retirement amid higher inflation with the 4% rule
Given the risks involved when an investment portfolio is heavily weighted in the Singapore market, investors in the city-state should consider making their investments globally diversified.
This is especially considering that the Singapore stock market takes up just a minuscule portion of the global stock market — less than 1% by most measures.
By investing in a portfolio that is weighted by global market capitalisations, one can obtain global exposure without neglecting the Singapore market.
Get started with Endowus to tap our suite of globally diversified portfolios. For instance, the Endowus Flagship Portfolios are designed to give investors broad exposure to global markets in a strategic and passive asset allocation. Our allocation strategy for core portfolios means that we largely track the global indices over time.
Click here to learn more about the power of diversification and how to diversify correctly across portfolios.
Next on the Endowus Fin.Lit Academy
Read the next article in the curriculum: Learn about property investments
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