Let’s try something out. Pick 10 people who invest in publicly listed companies and ask them on which markets are they vested in. Without much hesitation, our guess would be that on average, these 10 individuals would state a rather significant concentration in their homeland.
What Do We Mean By This?
For example, a Singaporean based investor may have a significant %, say north of 50% of their portfolio invested in Singapore based companies. Correspondingly a Malaysian citizen could have a sizable stake in Bursa listed entities. And a Hong Kong based individual might be highly vested in companies listed on the Hang Seng Index as well as the Shanghai Index.
I could go on and on, but I think at this stage you get my point. This behaviour is by no means an outlier. On the contrary, it is more prevalent than we give it credit for. It is so common that a term has been given to it – Home Bias Effect.
What Is This Home Bias Effect?
Investopedia defines Home Bias as the tendency to invest a large amount in domestic equities despite the potential benefits of diversifying over a global scale. Or simply put, we all tend to feel more comfortable closer to home.
Why Does Home Bias Come About?
This could come about for a variety of reasons, from the difficulties associated with investing in foreign holdings, from issues such as legal restrictions, additional transaction costs to even the time difference (For someone in Southeast Asia, the US market only opens at around 10pm)!
However one key concern is the issue of familiarity. We humans are creatures of habit and most of us have a tendency to stick to things that we can touch and see.
Let us take a Singaporean investor as an example. Say that if he is interested in a snack based company – One that instinctively comes to my mind would be Old Chang Kee Ltd (SGX:5ML). Rather than flying thousands of km to a foreign based snack company in a place like Taiwan, this Singapore investor could just walk down to a few of Old Chang Kee’s outlets near his neighborhood to do some on-the-ground research like the traffic, the location and even the quality of food! Whereas for a foreign based company, we would have to take management’s word (Hence integrity stands rather highly on our screening list but this is a story for another time).
But What’s The Downside?
One of the key downside would be the “putting all your eggs in a basket” issue. What they teach us in business school would be to diversify. This isn’t a bad theory at all; however we have to understand that if we diversify to be like the market, we can’t expect to “beat the market”. This is essentially because you ARE the market.
Why this theory makes sense is simply because we cannot be right 100% of the time. If all your eggs were in one basket and if that company goes kaput, that would be a huge hole for us to climb out of. Just ask Enron employees whom invested their life savings in their own company.
However Home Bias Isn’t As Bad As It Seems
However if we know the business operations of the company inside out, it totally makes sense to invest in what you know. Or as Warren Buffett says, “Keep all your eggs in one basket and watch that basket closely”.
For today we would stretch this Home Bias effect to include the tendency of investors to buy what they are familiar with i.e A doctor would inherently be more aware of developments in the medical field and might have a tendency to invest in medical-based publicly listed companies like Intuitive Surgical, Inc (NASDAQ:ISRG), Pfizer Inc (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ).
To set the record straight, we feel that diversification has a real benefit to everyone’s portfolio. However with that being said, we also feel that one should play to their strengths and not diversify for the sake of diversifying.
Put it this way. Why should a doctor not play towards his strengths and explore companies in the medical field but instead look towards a totally unrelated field like the gaming industry just for the sake of diversification?
Another angle to look at this issue would be to look at a property giant – CapitaLand Limited (SGX:C31). As mentioned in our earlier article “CapitaLand: A proxy For Property Investment In Asia!”, when we make an investment in CapitaLand that is listed in Singapore, we are not only exposed to the Singapore property market but we are also exposed to Europe through Ascott Residence Trust (SGX:A68U), China through CapitaRetail China Trust (SGX:AU8U) and also Malaysia through CapitaMalls Malaysia Trust (CMMT:MK)! With such giants like CapitaLand, one would already be exposed to a certain degree of diversification within the property sector.
Check out CapitaLand’s most recent Revenue breakdown:
Value In Action
When it is all said and done, it boils down to one’s investment objective and how comfortable with you in your holdings. There isn’t a hard rule to a number of companies to hold in your portfolio as long as you are comfortable with it to sleep well at night!
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All views and opinions articulated in the article were expressed in Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Mun Hong does not own any shares in the companies mentioned above.