Bias: COVID-19 vaccines and investment in China
Liang Yin of the Thinking Ahead Institute examines omission bias as an explanation for vaccine resistance and underweight investment in China. It offers a framework to overcome this bias.
Recently I had my first COVID-19 vaccine (Oxford / AstraZeneca) and the excitement quickly turned to concern as the media linked a small number of deaths to this vaccine and the drug regulator of the ‘EU has announced that unusual blood clots should be listed as one of its side effects.
This focuses the mind on the importance of perspective and understanding biases. While this side effect is very rare (about one in 100,000 people) and the risk of dying is even smaller (significantly lower than the risk of dying from COVID), knowing that this doesn’t necessarily make my experience any less troubling. After all, I am only human and suffer from a cognitive bias that many people are prone to: omission bias.
Omission bias describes our tendency to focus more on the risks of our actions (me actively choosing to take a vaccine) while paying less attention to the risks resulting from our inactions (I do nothing to protect myself from ‘a potentially fatal virus). Omission bias can cloud our judgment. It is often considered one of the plausible explanations for vaccine resistance, when science shows very clearly that the benefits of any approved vaccine far outweigh the risk, including that produced by Oxford / AstraZeneca.
We have studied this subject within the framework of the work of the Institute on asset classes of tomorrow which also revealed that most institutional investment portfolios are highly concentrated geographically. Indeed, the MSCI ACWI index currently weighs the United States at around 58 percent, while China – the world’s second-largest economy – is weighted at less than 5 percent.
In our article on Chinese capital markets above, we show that in the 31 years since the establishment of two major stock exchanges in 1990, Chinese capital markets have grown rapidly, supported by an expansion fast economic. Today, China is home to the world’s second largest stock market and also the second largest bond market. Since the beginning of the 21st century, barriers to foreign ownership have been gradually reduced. Some investors believe that recent programs such as Stock Connect in 2014 and Bond Connect in 2017 have revolutionized accessibility to this huge market. Billions of dollars in Chinese onshore assets are now within the reach of foreign investors.
As such, there is a strong case for global investors to add or increase exposure to Chinese assets in their portfolios, based on:
- Its role as a diversification and return enhancer in a global portfolio
- Opportunities for active managers to add value, and
- Improve portfolio resilience to a changing, albeit uncertain, world order.
On the last point, over the past few years there have been growing concerns about the setbacks of globalization and rising trade / geopolitical tensions between the US and China. These events have often been seen as negative for China’s economic outlook and have led to high market volatility. Some investors see this as reasons not to invest in China. It could be omission bias stake.
While the future is impossible to predict, it looks like we are heading towards a new world order and in doing so, the use of storylines can be helpful in making dispassionate decisions and overcoming omission bias. Here is a simple thought experiment where the world is shaped by only two key dimensions: global economic integration and global geopolitical order, and from which we can build five future scenarios (2030).
We can then assign an estimated probability to each scenario, as well as a portfolio weight to Chinese assets that would make sense in that scenario (see our paper for our probabilities and weights). Only in the fifth scenario would it make sense to have a 0% weighting in Chinese assets. And in all other scenarios, we think a much higher weighting than the 5 percent implied by the MSCI Index, or current average exposures, would be appropriate. By combining the probability of the five scenarios, we end up with an allocation to Chinese assets that is a multiple of current levels.
The utility of this simple concept is that it is flexible and helps investors overcome their omission bias.
A useful historical perspective is that US economic output surpassed that of the entire British Empire for the first time in 1916 and, if investors had not seen this coming and diversified accordingly, the capital market under -performing UK should have been a lasting index.
Over 100 years later, the world could be at another point of similar flow and yet many investors today hold highly concentrated portfolios built for the past, rather than thinking about integrating the asset classes of the future. .
Liang Yin, CFA, PhD is a senior investment consultant with Thinking Ahead Group, an independent research team from Willis Towers Watson and an executive at the Thinking Ahead Institute.