Why the recent slump in Chinese stock values demonstrates you should avoid investment home bias

23/08/2021
By David Snelling

An article on the BBC website caught my eye recently.

Titled “China stocks see biggest slump in the US since 2008”, it set off a train of thought that led to consideration of the whole financial relationship between China and Hong Kong.

Here are my thoughts on how the Chinese slump impacts Hong Kong markets, and how it flags up the issue of “home bias” when it comes to your investment strategies.

The golden dragon is losing its shine

The BBC article highlighted the dramatic fall in the NASDAQ Golden Dragon Index since 1 January 2021.

Source: Google.com

The index is comprised of companies whose common stock is publicly traded in the United States and the majority of whose business is conducted within the People’s Republic of China.

The index peaked at 20,688 in February 2021, but by 27 July it had fallen to 10,672 – a loss of 48% of its value. It’s recovered slightly since that low but is still only hovering around 9,800 at the time of writing (20 August).

Behind the simple figures is the quite remarkable fact that over $750 billion was wiped off the value of US listed Chinese stocks over the five-month period.

The Hong Kong “bridge”

Hong Kong has long been seen as the financial bridge between China and the rest of the world. Any business looking to invest in China will most likely use Hong Kong as an entry point.

So, such a dramatic fall in the value of many of China’s biggest companies can’t fail to have an impact on the Hong Kong economy.

But Hong Kong’s role as the link between China and the world doesn’t stop there.

Much of the money that flows out of and into Chinese business is routed through Hong Kong. This is to “take advantage of the territory’s favourable regulatory environment and available professional services,” according to the Washington-based think tank, Peterson Institute for International Economics.

The importance of “one country, two systems”

Going back to the BBC article, one of the key reasons it noted for the sudden fall in business value was the moves made by the Chinese authorities on technology, online services, and education industries.

This level of intervention dramatically illustrates the contrast between China and Hong Kong. China still has extensive controls on capital and is often prepared to intervene in its banking system and financial markets. Set against that, Hong Kong has been of the most open economies in the world and, while not totally supine, its financial regulation is far more “light touch”.

Such regulation is possible because of the “one country, two systems” formula agreed as part of the 1997 handover. This means that Hong Kong has benefitted from liberties such as an independent judiciary and free speech.

These freedoms gave Hong Kong a special status, allowing it to negotiate international agreements independently from Beijing.

A co-dependent relationship

The biggest factor that has helped Hong Kong’s status under the system agreed, was that both Hong Kong and China were dependent on it surviving.

China uses Hong Kong’s currency, equity, and debt markets to attract foreign funds, while international companies use Hong Kong as a launchpad to expand into mainland China.

The bulk of foreign investment into China comes through Hong Kong. Nearly all of China’s biggest companies have listed on Hong Kong markets, seeing that move as a key first step to expanding elsewhere around the world.

On top of that, Chinese banks hold substantial assets – a 2018 estimate was 9% of the Chinese GDP – in Hong Kong.

Highlighting the danger of “home bias”

Home bias is prevalent all over the world. It’s the inevitable effect of investors feeling most comfortable with the names they recognise in their own economy, even when clear signs are telling them that diversifying their investment portfolio would be the most prudent, and lucrative step.

If you’re based in Hong Kong, the names and performance of businesses based there, or in China, will understandably be in front of you on a daily basis and the temptation will be to channel a big proportion of your investments in that direction.

The precipitous fall in the value of Chinese stocks, therefore, could have had a big impact on the value of your holdings.

There’s an equally valid argument about the dangers of home bias when it comes to the UK. There has been a lot of investment commentary recently about how markets have recovered all the ground, and more, since the “Covid crash” in March 2020.

If you look at this table, you can see that on the face of it, that’s a true assertion. All four indexes here have risen substantially between the floor of the market on 20 March 2020 and now. However, the FTSE 100 hasn’t bounced back anywhere near as far as other indexes and is still not even back to its pre-Covid peak.

Source: Google.com

As the saying goes, “a rising tide lifts all boats”, but even as markets continue their post-Covid recovery, when your home market is on the up it could well be that markets elsewhere are demonstrating better performance.

This demonstrates the importance of regularly reviewing your investments to ensure that you’re maximising growth potential, and not restricting your opportunities for growth through home bias.

Get in touch

We can help you put together an investment portfolio designed to meet your requirements, and help you avoid home bias.

Please contact us by email or, if you prefer to speak to us, you can reach us in the UK on +44 (0) 208 0044900 or in Hong Kong on +852 39039004.

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