Investors usually begin their investing journey by investing in stuff they are most familiar with – most often domestic companies. As investors grow more savvy and experienced, they may have an insatiable desire to look beyond what their domestic markets offer. But while some famous market commentators in the city now argue that investors should avoid Hong Kong entirely and invest in the U.S. market instead, I think that would be a big miss for investors.
Let the long-term returns speak…
Proponents of this “look overseas” strategy have put forward two arguments:
- As of 19 Jan 2019, the U.S. equity market had surpassed its pre-Great-Recession peak of 12 Oct 2007 by a whopping 71%. Meanwhile, the Hong Kong equity market has still lagged its pre-crisis peak of 30 Oct 2007 by 17%, as measured by each country’s respective benchmark indices (the S&P 500 and the Hang Seng).
- The U.S. equity market far leads its Hong Kong counterpart in terms of market depth and capitalization. Thus, it’s irrational to invest in only 5.5% of the world market (Hong Kong) while neglecting another 40.5% (the U.S.)[i].
[i]Market caps of the Hong Kong and U.S. equity markets as a percentage of the world equity market. From World Bank (2017):
But despite its small size, Hong Kong equity market actually outperformed all other developed markets in America, Europe, and Asia over the 30-year period from 1989 to 2018, returning an annual compound rate of 7.8% (excluding dividend) to investors. Consider the following table[ii]:
[ii]Standard deviation is calculated as deviation from mean annual returns.
|Country||Benchmark||World Market Cap Weight (2017)||Standard Deviation||Annual Compound Return|
|Hong Kong||Hang Seng||5.5%||33.2%||7.8%|
Source: CEIC, World Bank
Hong Kong is crowned the best-return market probably because a large number of Mainland Chinese enterprises have listed and become constituents of benchmark market index in the past 30 years; many such Mainland constituents have returned handsomely due to the rapid economic growth of China during the same period.
But there’s a catch: The Hong Kong equity market is also the most volatile (with a standard deviation of annual returns of 33.2%) among developed markets. The high volatility is attributable to the increasing participation of Mainland investors (who are usually retail investors with short-term horizons) in the Hong Kong market. This implies that Hong Kong investors need to take a longer-term horizon to wait out the ups and downs in the market.
The above difference in annual compound returns may seem small at first glance, but this small difference can translate to giant gaps in long-term total returns. For instance, the 7.8% annual compound return of the Hong Kong market versus 6.6% annual compound return of the U.S. market actually means that the Hong Kong market has returned roughly 270 percentage points more overall than its U.S. counterpart over the last 30 years.
Taxes matters, too
If long-term returns alone do not convince you that Hong Kong is a market you cannot miss, let me remind you of another monster that often eats your returns in other markets: tax. As Hong Kong prides itself as one of the freest markets in the world, investors in the Hong Kong market – residents or foreigners – are accustomed to zero-capital-gain tax and zero dividend tax (except for the H-Shares in Hong Kong, which are subject to a 10% dividend tax from the Mainland side). But such is not the norm for many other markets, particularly the U.S.
U.S. residents have to pay taxes on both capital gains and dividends. Even if you are a Hong Kong-based investor with no U.S. residence, you still have to pay a 30% dividend tax on U.S. stocks. If we factor in a 2% dividend yield – pretty typical for a stock investment – then you’ll lose 0.6% of your annual return to tax if you invest in the U.S. instead of Hong Kong – again, not an insignificant amount for long-term investors.
Observing the above characteristics of the Hong Kong equity market, I would advise Fools to invest in it – but be prepared to hold on the stocks for a long enough period to enjoy its benefits.
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