Home bias among GCC Funds – Preference for Domestic Stocks in Regional Funds

Institutional constraints such as barriers to invest across boundaries, limitations on repatriation of investment income, varying corporate governance standards, higher transaction costs and currency risk have been put forth as possible reasons. Interestingly, closer to home regional mutual funds in GCC markets suffer from home bias as well, despite the region being largely homogenous and frictional costs to invest across the region are largely non-existent.

The primary goal of a fund manager is to maximize returns while minimizing risk. However, the presence of varying country-level exposures among fund portfolios in achieving a common goal – to outperform the benchmark index (S&P GCC Composite Index for conventional equity funds and S&P GCC Composite Sharia Index for Islamic equity funds) – is puzzling, as this bias is a result of conscious and intentional move made by the fund manager. Indeed by overweighting domestic exposure the fund managers are adding on to the risk that they could have diversified away.

Possible explanation for such behaviour could be attributed to the perceived informational advantage of fund managers over their country stocks. Fund managers are more familiar with domestic stocks and thus have a higher degree of confidence in their ability to generate outperformance through active management. For instance, local fund managers could talk with employees, managers, and suppliers of the firm, they could obtain key information from local media, social events, and the close personal ties with senior management, all of which could provide them with better information than their regional peers and provide a distinct advantage. In part, home bias could also be an extension of “confirmation bias” as fund managers may simply feel more comfortable about their domestic investments when they keep hearing about them in local media. Country specific systemic risk factors such as political risk or poor corporate governance practices could also influence the fund manager allocations resulting in home bias.

An analysis of the GCC funds
In our analysis we observe that the level of home bias among GCC mutual funds (equity) is heterogeneous in nature. Funds in markets such as Saudi Arabia and Kuwait exhibit significant home bias (greater than 10% overweight to home market) while United Arab Emirates (UAE) funds have been observed to exhibit moderate home bias (greater than 5% but less than 10% overweight of home market). Funds based out of Qatar and Oman exhibit relatively minimal home bias. Based on our observation, Bahrain funds did not exhibit any home bias. In fact, GCC funds domiciled in Bahrain had underweighted their domestic country.

Table: Degree of Home bias witnessed among GCC Funds

Source: Marmore Research, Standard & Poor’s, Respective Fund Factsheets;
Note: Cells denote over weightage of domicile country in fund compared with benchmark;Liquidity, Trade Costs & Home bias
In general, home bias, especially by Saudi Arabia and UAE fund managers could be justified due to their larger size and presence of multiple sectors. Greater size and diversified nature of their markets enable them to be relatively liquid in comparison with other markets in the region. Higher liquidity would also reduce direct transaction costs and market impact costs. On the other hand, fund managers based in Kuwait and Oman with home bias should reassess their portfolio allocation due to illiquid nature of their markets on account of relatively smaller market size and concentrated sector exposures.Impact on Performance
All the funds considered in our study that exhibit home bias has underperformed their respective benchmark in the past 1year. Though GCC markets are largely inefficient and have greater scope for alpha generation through active management, the results suggest that excessive home bias could take a toll on the fund performance. Interestingly, the Qatar-based fund with least home bias had also underperformed the benchmark.

Table: 1Yr Performance of the funds with respect to their benchmarks

Source: Marmore Research, Reuters, Respective Fund Factsheets;
Note: Performance as of April, 2017Conclusion
As per our analysis, funds exhibiting home bias have underperformed the benchmark index. In light of this finding, fund managers of GCC funds should avoid the temptation of overweighting their country of domicile as they run the risk of being over-run by foreign funds that need not have home bias. Additionally, fund investors especially the institutional investors could have home bias as an additional parameter of analysis while selecting regional fund managers.