Home Bias
Home bias is the tendency of investors to overweight domestic assets in their portfolios relative to what global diversification principles would prescribe, observed prominently in India where retail investors overwhelmingly concentrate equity and debt holdings in domestic instruments despite the Liberalised Remittance Scheme (LRS) enabling up to USD 250,000 per year in overseas investments.
Home bias is a well-documented phenomenon in behavioural finance and international portfolio theory. Classical portfolio theory — building on Markowitz's mean-variance framework and extending it to international assets — suggests that investors should hold a globally diversified portfolio to maximise risk-adjusted returns. The optimal international allocation, based purely on market-cap weights, would mean Indian investors holding approximately 97% of their equity in non-Indian markets, given India's share of global market capitalisation. In practice, Indian retail investors hold close to 100% domestically.
Several factors explain the persistence of home bias among Indian investors. Information asymmetry is significant: investors understand domestic companies, regulatory environments, and economic cycles far better than foreign markets. Language barriers, different accounting standards, and limited access to foreign research reinforce this informational advantage for domestic assets. Transaction costs — currency conversion fees, foreign custody charges, and the administrative burden of LRS compliance — also reduce the attractiveness of international diversification.
The RBI's Liberalised Remittance Scheme permits resident individuals to remit up to USD 250,000 per financial year for permissible capital account and current account transactions, including overseas direct investment and purchase of foreign securities. Despite this headroom, LRS equity investment data showed that actual international equity investment by Indian retail investors remained very low as a proportion of their total financial savings. The bulk of LRS outflows were historically for travel and education rather than financial investment.
Mutual funds have partially bridged this gap by offering international fund-of-funds and ETFs tracking global indices such as the S&P 500, NASDAQ 100, or Hang Seng index. However, SEBI's restrictions on overseas investment limits for domestic mutual funds — capped at USD 7 billion for the industry as a whole for equity — created allocation pauses when the limit was approached, highlighting a structural constraint on international diversification through the mutual fund route.
From a portfolio construction standpoint, home bias represents a missed diversification opportunity. Indian equities have relatively low correlation with developed market equities in the long run, meaning international allocation would reduce portfolio volatility without proportionally reducing expected returns. Periods when Indian equity valuations are stretched relative to global markets also argue for global diversification as a valuation management tool.