Break your home bias; go global for diversification

Investors worldwide tend to be comfortable with investing in their home countries and are happy to put most of their wealth there

The past couple of months have been tumultuous for global financial markets. First, it was the Greek crisis that grabbed the world’s attention due to a possible exit of the country from the euro zone. Even while the Greek crisis was still playing out, the sharp correction in the Chinese stock market took centrestage, with equities and commodities selling off globally.

For a large number of domestic investors, who have virtually all of their money invested in India, it must have been quite a relief to know that their money is invested here. However, they may still be worried about how these global events would affect their domestic portfolios.

For investors who do have some global exposure, which they may have only recently started to make through international funds or using the Reserve Bank of India’s Liberalised Remittance Scheme limit, these global events possibly had them thinking about whether investing abroad was such a smart idea, or whether they would have been better off having all their money invested in India. After all, while the world was worried about China and Europe, the International Monetary Fund (IMF) released a report indicating that India looked like an attractive economy in the longer term.

As a financial adviser, it is not unique to see investors who want to remain invested in their home country. When we meet other financial advisers at various forums across the world, we see the exact same behaviour—termed as home bias.

Investors worldwide tend to be comfortable with investing in their home countries and are happy to put most of their wealth there. This is very similar to the behavioural economic theory called the endowment effect, which essentially is a premise that people ascribe more values to things just because they own them. Therefore, because we live in India, we ascribe far more value to investments here and in Indian financial markets, and significantly lesser value to other investments.

Even many non-residents prefer to invest in India, even if they have access to multiple investment options from across the globe. This is because they have a familiarity to India, which they do not have with other countries.

Here are three reasons why Indian investors need to continue to have global portfolios, irrespective of what happens in China or Greece or any other part of the world.

Asset allocation matters: Dividing your assets and holdings in different asset classes such as equity, fixed income, bonds and real estate have gained popularity in India, especially after the global financial crisis in 2008. One of the key tenets of asset allocation, which essentially ensures that you do not have all your eggs in one basket, is to have money in different parts of the globe so that an adverse event in one country does not affect your entire wealth. Thus, having your investments across different asset classes across multiple geographies is more effective in terms of asset allocation, than just having money across asset classes in a single geography.

Financial goals are now global: Financial goals of investors have evolved over the past decade. From wanting to send children to study overseas to pursue just post-graduation courses, we are now increasingly coming across parents who are sending their children to international schools from a very young age. When we speak to such parents, they now seem to indicate that they wish to plan for an overseas education for their children much before post graduation. With the Indian rupee historically losing value against the US dollar due to the significant differential in inflation between India and the US, one of the ways to hedge currency risks for families wanting to send their children to study abroad is to have a portion of their wealth in US dollar-denominated assets. Similarly, international vacations are now common goals for many investors. Thus, with the European currency crisis now sees more Indians heading to holiday in Europe, as it is cheaper.

Winners rotate everywhere: Roger Federer is a seven-time Wimbledon winner, and has won 17 career grand slam titles. He, however, could not outplay Novak Djokovic in this year’s Wimbledon final. Just like winners rotate at Wimbledon, the same happens with financial markets.

Different indices do well at different points in time. For instance, over the past six months, the Japan’s Nikkei has outperformed other parts of the world, with Europe a close second. Over five years, the US’s S&P 500 index have outperformed the others with the MSCI World Index being the next best. And over 10 years, the CNX Nifty in India has been the best performer, and the MSCI Emerging Markets the next best.

Ultimately, while investors may have a home bias, having a globally diversified portfolio is better.

Vishal Dhawan, a certified financial planner and founder of Plan Ahead Wealth Advisors