Is home bias costing you? December 27, 2022
A common concern among investors with regard to home bias is that they are earning inferior returns when compared to those holding a global portfolio. But what is home bias? Home bias is the propensity to cling onto what is familiar. In investment terms, home bias is the reluctance to invest in foreign markets despite the benefits they present, such as diversification. An example will be investors being more familiar with DBS and UOB when compared to JP Morgan and Goldman Sachs. A quick way for an investor to determine if he exhibits home bias is through his investment portfolio. An investor with a portfolio consisting of mainly Singapore stocks would have exhibited a high degree of home bias.
Why is home bias prevalent?
In the past, information on foreign stocks was not as freely available as it is now. Compared to local stocks where information is more readily available, investing abroad was seemingly riskier due to the lack of information. Now, obtaining information is much easier and should not hinder a smart investor from investing in foreign shares. However, even with information so easily accessible, there are still things that cannot be ascertained online. For instance, the quality and service provided by a company can only be correctly perceived first hand; most individuals prefer to believe what they see as opposed to information gathered online.
With that said, even with equal information access, home bias still exists. Based on the research article by Stijn and Laura (2009)1, home investors, despite having the same knowledge as their foreign counterparts, still preferred to invest in domestic stocks. The reason for such behaviour was the mental frame of familiarity and optimism towards domestic assets. According to a research by Manag (2020)2, investors were generally more optimistic about the domestic market and assumed athat it would avail a higher return. Framing the domestic market as the one with a higher expected return, investors with home bias tend to stick to domestic stocks.
Thus, home bias is caused by information disparity and the investors’ mindset of having higher expectations from their home market.
In this discussion on home bias, the most important question still remains unanswered – Will this bias lead to an inferior risk-return? To answer this question, below is a comparison of the performance of 3 portfolios.
The first portfolio invested in the SPDR Straits Times Index ETF (ES3.SP); the second portfolio invested in the SPDR S&P 500 ETF Trust (SPY.US), and the third portfolio invested equally in both the ES3.SP and SPY.US.
|Portfolio 1||Portfolio 2||Portfolio 3|
|Weightage||100% ES3.SP||100% SPY.US||50% ES3.SP
|1 year annualised return||0.3%||-14.67%||-7.19%|
|3 year annualised return||1.96%||10.08%||6.02%|
|5 year annualised return||1.72%||10.29%||6.01%|
|10 year annualised return||3.38%||12.64%||8.01%|
Source: Bloomberg, PSPL. As of 31 October 2022
A global exposure allows investors to access investment opportunities with higher returns. With Portfolio 2, investing in the US market brings in higher returns than when investing solely in the SG market. With regard to Portfolio 3, a mixed exposure of both SG and US markets allows investors to gain better returns as opposed to solely holding SG stocks. A diversified portfolio can potentially double one’s returns as seen in the 3, 5 and 10 year annualised returns.
Thus, home bias can potentially lead to an inferior risk-return.
With the US portfolio (Portfolio 2) earning superior returns, some investors may be thinking of solely investing in the US market. But doing so is not encouraged as investing purely into a single market can lead to larger losses. An example is shown in Portfolio 2 where a loss was made in its 1-year annualised return. Therefore, while holding a portfolio of SG stocks may be relatively safe, investors may lose out on achieving higher returns.
Ultimately, the key is to add a global mix into the SG portfolio to help increase returns and achieve diversification.
As of September 2022, there were a total of 6366 listed stocks on the Nasdaq and NYSE3. With so many stocks to choose from, picking out a few may be difficult. To narrow down their choices, investors can consider picking from the banking industry. The reason for this is a rising interest rate environment. Most industries are facing a slowdown, except for the banking industry. Banks benefit as higher interest rates increase their margins. This is evident as major banks such as JPM.US, WFC.US and BAC.US have topped estimates over this earnings season.
Aside from investing directly in individual stocks, investors can also consider ETFs with exposure to the banking industry such as SPDR S&P Bank ETF (KBE.US); First Trust NASDAQ ABA Community Bank Index Fund (QABA.US) and Invesco KBW Regional Banking ETF (KBWR.US).
The ETFs experience the same benefits as the individual banking stocks in a rising interest rate environment. Additionally, an added benefit of ETFs is survivorship bias. Investing in ETFs reduces the losses from companies that may go under, as companies that no longer meet the requirements to be on the index are replaced by another stock. This way, only financially sound companies stay on the index.
An example is the dropping of General Electric (GE.US), the last original member of the Dow Jones Index Average (DJI), in 20184. The reason was that GE.US no longer met the requirements to stay on the DJI. GE.US was replaced by Walgreens Boots Alliance (WBA.US) which is a better representative of the US economy.
From a valuation perspective, the shares of the US market seem to be more competitively priced.
|P/E||12.63||11.58||10.40||10.97||12.44||11.44||5 years Average P/E||12.320||11.754||11.34||12.701||18.515||13.021|
|5 years Average P/B||1.299||1.146||1.075||1.634||1.217||1.201|
- P/E: DBS seems to be the most overvalued.
- Comparing 5 years average P/E with current PE, US banks are currently trading at a higher discount than SG Banks
- Price/Book: DBS and JPM.US are priced above their peers which suggests a stronger asset base.
- Generally, US banks are priced at a better valuation than SG banks
One of the reasons why US banks are at a better valuation is due to the bearish sentiment of US investors. The bearish sentiment is mainly caused by the Federal Reserve’s war against inflation. Inflation is still running high despite the numerous rate hikes this year, but signs of slow down appeared in October’s headline inflation. October’s headline inflation came in at 7.7% Year-On-Year (YOY)5 which was a sharp decline from September’s headline inflation of 8.2% (YOY)6. Although October had a lower inflation level, many Fed Governors still think that more rate hikes are needed before pausing. Some of the members are San Francisco Fed President Mary Daly7; St. Louis Fed President James Bullard8 and Minneapolis Federal Reserve Bank President Neel Kashkari9. Hence, there will probably be more rate hikes in the future reducing the odds of a soft landing, causing many investors to stay away from the market.
Apart from the banking sector, investors can explore some of our popularly traded stocks.
“Be Greedy When Others Are Fearful.”
The above quote is by Warren Buffet, one of the world’s most renowned investors. Even though many are staying away from the market, investing now may be a good “bargain” with stock prices at their recent lows. Also, according to a market historian, Jeffery Hirsch, the fourth quarter of 2022 may be a good entry point10. An occurrence in1964 offers precedent to the current situation. After falling for the first three quarters in 1964, the S&P 500 gained an average of 28.2% over the following five quarters. Hence, buying during this quarter may actually bring about a much higher return.
In summary, home bias is just one of the many psychological factors that affect investment performance. There are many other common mistakes made by investors and traders. Aside from the mental aspect of investing, focusing solely on SG stocks has its benefits but also has the opportunity costs of giving up potentially higher returns. In the long run, investors are better off holding onto a diverse portfolio with global exposure.
-  “Information Immobility and the Home Bias Puzzle – 2009.
-  “Information Immobility and the Home Bias Puzzle – 2009.”
-  “NYSE and Nasdaq: listed companies comparison Q3 2022 – Statista.” 1 Nov. 2022
-  “10 Biggest Companies That Were Dropped From the Dow Jones….” 4 Feb 2022,
-  “US Inflation Slows More Than Forecast, Gives Fed Downshift Room” 10 Nov 2022
-  “Inflation rate for September 2022: 8.2%. CPI up by 0.4% – NBC News.” 13 Oct. 2022
-  “Fed’s Daly sees rates rising at least another percentage point as ‘pausing is off the table’ 16 Nov. 2022
-  “Bullard Sets Tone for Fed Officials Signaling Hikes Will Roll On” 17 Nov 2022
-  “Fed’s Kashkari: not stopping rate hikes until inflation peaks” 18 Nov 2022
-  “Now is ‘the best buying opportunity’ for stocks, says market historian.” 14 Oct. 2022
About the author
Chan Zi Quan
Zi Quan is a US Equity Dealer in the Global Markets Team and specializes in the US and Canadian markets. He is an avid crypto fan and is adept in macro analysis.