Amid expectations that global growth will be led by foreign markets moving into 2020, portfolio managers believe it’s increasingly important for investors to wean themselves off of “home bias” and diversify outside of North America.
Canadian investors overwhelmingly make investment decisions based on home-country bias, with Canadian equities making up 60 per cent of domestic equity portfolios, according to a 2018 report by Vanguard Group Inc. And with the domestic stock market making up about 3 per cent of global markets, Canadian-biased investors are missing out on opportunities in foreign markets.
“There are many different types of companies and sectors which don’t exist in Canada, like the tech stocks in the U.S.,” says Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel Inc. in Calgary. “But I don’t think the growth of these tech stocks is going to last forever, so you have to start thinking about where else you can go.”
By overinvesting in companies at home, Canadian investors risk concentration in certain sectors as energy and financials, which account for nearly 50 per cent of the S&P/TSX Composite Index. To shift toward global equities while mitigating the added complication of navigating unfamiliar markets and currencies, Mr. Shaunessy points to exchange-traded funds that track a broad global equity index focused on developed and emerging markets, such as the iShares MSCI ACWI ETF (ACWI) and Vanguard’s FTSE Global All Cap ex Canada Index ETF (VXC), the latter of which excludes Canadian stocks.
While half of the fund is comprised of U.S. companies, they also provide exposure to large foreign markets through Japanese, United Kingdom and Chinese stocks. ACWI climbed 23.5 per cent over the past year with US$11.4-billion in assets under management, while VXC rose 21.3 per cent with US$912.3-million in assets, according to Bloomberg data as of Jan. 9.
“If you’re new to this, and you’re reluctant to go outside of Canada because you’re not really sure, then you could have half in the TSX and the other half in VXC,” Mr. Shaunessy says.
Canadian-biased investors tend to believe that holding international stocks means taking on greater risk, but data show that volatility increases when portfolios are concentrated in Canadian stocks, according to Justin Bender, a portfolio manager at PWL Capital Inc. in Toronto.
Similarly, the Vanguard report states that security and sector concentration in an all-Canada stock portfolio has historically been more volatile than portfolios with international diversification, with the range of lowest volatility sitting between 30 per cent and 40 per cent exposure to domestic equities.
And investors expecting to reap the benefits of high-flying U.S. stocks may be disappointed heading into 2020.
“Looking back, the U.S. has outperformed over the past 10 years, and people are looking at that performance and expecting it to continue going forward, which might not be the optimal choice,” Mr. Bender says.
For equities in developed markets, excluding both the U.S. and Canada, Mr. Bender cites the iShares Core MSCI EAFE IMI Index ETF (XEF), of which about half of the fund is rooted in Japan, the U.K. and France. The fund rose 16.5 per cent over the past year and manages US$3.7-billion in assets, according to Bloomberg data as of Jan. 9.
To invest in emerging markets that are expected to undergo the greatest growth, Mr. Bender points to Vanguard’s FTSE Emerging Markets All Cap Index ETF (VEE), which predominantly holds larger stocks from China, Brazil and India, as well as smaller exposure to mid- and small-cap companies in Pakistan, Greece and Chile.
When considering funds outside of North America, Mr. Bender weights developed international stocks at around 75 per cent, with the other 25 per cent allocated to emerging markets. Overall, investors working on staving off home bias should include an even mix of North American and international stocks, Mr. Bender says.
“I would say 50/50 should be the starting point or minimum that they should have in home bias, and then they could consider increasing the risk of their portfolio,” he says.
But some portfolio managers say that U.S. stocks will continue to provide enough foreign exposure for investors, with the American stock market making up more than 50 per cent of the global market.
“With close to half of the revenues of the S&P 500 coming from outside North America, you can get exposure to global markets just by investing south of the border,” says Colin Ryan, executive vice-president and senior portfolio manager at Wellington-Altus Holdings Inc.
“Companies like [Apple Inc., PepsiCo, Inc. and Procter & Gamble Co.] are global businesses that will benefit from growth outside our borders,” he adds. “So, some people find that is enough global exposure for them as they are more comfortable investing with some of the biggest and best companies in the world in a strong economy versus investing in areas abroad that may have more economic or political risk.”
Beyond North America, Mr. Ryan points to the iShares MSCI EAFE Value ETF (EFV), which tracks developed-market equities in Europe, Australia, Asia, and the Far East that are considered to be undervalued.