“Invest in what you know.”
It’s common advice that most investors follow. It’s natural to want to invest in the companies whose products you use every day… or whose office buildings you see on your way to work. But only investing in your “neighbourhood” companies could be putting your portfolio at risk…
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It’s even more unbalanced in Japan, which makes up just 7 percent of the world’s stock market – but where Japanese investors allocate 55 percent of their portfolio locally. Or Singapore, where investors have about 39 percent of their portfolio in domestic equities, even though Singapore’s stock market is only 0.4 percent of the world’s market.
That’s a lot of eggs in one basket.
From a diversification perspective, it’s dangerous too. That’s because investing an entire portfolio at home (even if it’s spread across stocks, bonds, gold and cash) is like having eggs in lots of different baskets… but all on the same truck. If the egg truck crashes… that’s going to be one scrambled portfolio.
“Neighbourhood” bias
Now here’s the thing: Home country bias isn’t just about investing only in your country. Many people also tend to invest heavily in the sectors that are prevalent in their area, too.
So, if I live in New York, one of the world’s biggest financial centres and home to international financial institutions like Citigroup and American Express… there’s a good chance I’ll be overweight financial stocks. Many people in this area work in the finance industry and they’re familiar with the sector… so that’s where they invest.
In fact, investors in the northeast of the U.S. are 9 percent more likely to hold financial sector shares in their portfolio than the national average, as the chart below shows.
And over on the west coast, investors are just a little less likely than the national average to hold financial companies – but 10 percent more likely to hold tech stocks. That’s because California is home to some of the world’s biggest tech companies like Apple, Google and Facebook (not to mention thousands of start-up companies, too). So a relatively higher percentage of the population works in the tech sector. They see it mentioned in the news, they pass these companies’ office buildings every day and they know and use their products.
But if I live in the southern United States, on average I’d instead be 14 percent more likely to be invested in energy than the national average. That’s because oil and natural gas are big sectors in this part of the country. Many people in this area work on oil and natural gas rigs. And they’re familiar with companies in the sector, so that’s where they put their money.
Why we back the home team
We’ve talked before about investing in what you know. And given how important these industries are to each part of the country, backing the home team is understandable. I’d bet a lot of the people who invest in their dominant sectors work in those industries, too… or at least have friends and relatives who do. So these investors have a lot of skin in the game.
But why does this matter? Well, just think about what happened to all the investors who were overweight tech stocks when the dot com bubble burst. Or those who had most of their portfolio invested in financials (or real estate, for that matter) before the great financial crash. Or even if you’re not overweight, if you both work in the financial sector, and have a substantial portion of your portfolio dedicated to finance stocks, your portfolio is a lot more concentrated than you might think.
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Being over exposed to one market or sector is a recipe for disaster. If that sector underperforms, the investor who put more of his eggs in that basket is going to be hit hardest.
What does this mean for Asia?
Neighbourhood bias isn’t just a problem in the U.S. It’s natural to invest at home… and Asia is no different. If (like me) you live in Singapore, ask yourself if your portfolio is overweight financials or telecom stocks? In Hong Kong, are you over-investing in financials or technology firms?
Local benchmark equity indices in Asian countries can be very skewed towards a particular sector as well. So if you are long Hong Kong’s Hang Seng Index, for example, you should know that over 48 percent of that index is in financials!
Be aware of bias. Even if your friendly neighbourhood sector has been performing well for a while… nothing lasts forever, and sooner or later mean reversion will come into effect. So if you’re overweight your dominant local sector, it might be time for your portfolio to look further afield.
