Reports urge end to Asian home-country bias

Institutional investors in Asia should adopt a more systematic approach to their equity allocations, which have continued to favor domestic stocks despite the risks of heightened short-term volatility, reports by MSCI Index Research and BlackRock Inc. show.

While it's tough to make generalizations about the 10 or more markets in Asia ex-Japan, the reports note institutional investors in some countries, such as the Philippines and India, still invest strictly in domestic stocks.

Other big investors — including Taiwan's Labor Pension Fund, South Korea's National Pension Service and China's National Council for Social Security Fund — put between 50% and 80% of their equity allocations in domestic stocks, a significant “home bias” in a region whose combined share of a market cap-weighted global portfolio comes to roughly 10%, according to BlackRock's report.

Asia-based investors have trailed their U.S. and European counterparts in an ongoing shift to more global equity market weightings from home bias — in part because of expectations that Asia's stellar growth prospects will mean superior returns for equity markets in the region, the reports note.

The evidence for any nexus between economic growth and equity market returns remains mixed at best, according to analysts at MSCI and BlackRock.

Available data are ambiguous as to whether a home bias “will reward you or be bad for you,” said Chia Chin Ping, a managing director and head of equity research, Asia-Pacific, with MSCI Hong Kong Ltd.

Lacking such evidence, institutional investors in the region have to make a “conscious, active decision” for staying at home, evaluating the risks and opportunity costs of that decision, Mr. Chia said in a telephone interview.

“There's no clear right or wrong” answer — just a matter of balancing the risks, agreed Stephen Hull, BlackRock's Hong Kong-based director of multiasset strategies, in a separate interview.

“Every institutional investor has to consider what its primary objectives are,” and part of that process will include determining “the level of underperformance they're willing and able to tolerate” vis-a-vis a global, market cap-weighted benchmark, “and over what time horizon,” he said.

The past two decades have seen periods during which home bias has helped and hurt Asia-based institutional investors.

For the 1990s, when the Asian financial crisis of 1997 and 1998 devastated stock markets in the region, only Hong Kong, among the 10 largest Asian markets outside of Japan, enjoyed annualized returns that exceeded those of the MSCI All Country World index, the MSCI report showed. Six of the 10 lagged the ACWI by double digits.

For the next decade, when developed markets bore the brunt of the global financial crisis of 2008 and early 2009, the 10 biggest markets in Asia ex-Japan all handily outperformed the MSCI ACWI, half by double digits.

Today, the liquidity that has flooded in from developed markets to faster-growing markets in Asia (contributing to the latter's past decade of outperformance), is poised to reverse. That could again affect the returns of local markets compared with a broader global portfolio, Mr. Chia said.

BlackRock's report estimated that annualized long-term returns for Asia ex-Japan could exceed the returns for an MSCI ACWI portfolio by roughly 1.7 percentage points, but said those gains have to be weighed against the risks posed by short-term volatility.

For example, among the 10 biggest equity markets in Asia ex-Japan, BlackRock's report noted Taiwan's was the only one where the top 10 stocks, at 47%, accounted for less than half of the market's total capitalization. The top 10's share in the other markets ranged from 51% for India to 74% for the Philippines.

Meanwhile, the MSCI report said markets in Asia provide far heavier exposure to financial stocks or information technology stocks than an ACWI portfolio.

That sort of exposure leaves institutional investors at risk during severe market retreats — an environment where liquidity calls could force selling, further exacerbating a market plunge, according to the MSCI report.

Both reports conclude that institutional investors in Asia can improve their risk-return profiles by lowering home-country bias.

According to BlackRock's calculations, an Asia-based institutional investor looking to avoid trailing a global benchmark by more than five percentage points in a year could limit its home-market allocation to 20% of its equity allocation or less, or a 30% allocation to the Asia ex-Japan region.

Asked how institutional investors in Asia have responded to that analysis, BlackRock's Mr. Hull said a number of them welcomed the focus on the risks to which they're exposed as a result of sector and stock concentrations in their domestic equity markets. BlackRock's recommendation of a more diversified regional bias as an interim step to a global equity allocation likewise resonated well, he said.