Don't root for the home team too much

Over-investing in Canada can be a 'double-whammy' when it comes to risk, among other reasons to diversify geographically, explains Morningstar's Ian Tam

Ian Tam, CFA 7 April, 2020 | 1:56AM

 

 

Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.

Ian Tam: As retail Canadian investors we are susceptible to a problem in our investment portfolios known as home country bias. So, in short, home country bias is a disproportional investment in securities that are domiciled here locally in Canada. But this is not a phenomenon that's specific to Canadians, but actually most developed markets around the world. The reason for this may be because Canadians are more familiar with Canadian-based companies, perhaps giving the impression that they have more information, or perhaps there is a certain pride in ownership of Canadian-based securities. But this pride also comes along with some significant costs.

For one, under-diversifying means that you're missing out on opportunities for growth outside of Canada, a concept that's well understood by institutional investors like the Canadian Pension Plan which manages $420 billion of Canadians' pension assets.

If you have a look at the chart, I looked at CPP's annual report from March of last year. And here, you'll see that only 15% of their assets are invested in Canada. That's likely a stark contrast compared to your own retirement portfolio. By the way, the 10-year annualized return on CPP's portfolio at the end of last year was 10.4%. Certainly, not too shabby.

Secondly, over-investing in Canada represents a double whammy when it comes to risk. So, if you think about a worst-case scenario where the economy in Canada goes south, maybe your bonus gets cut or even worse, you lose your job. That situation is made much worse if your portfolio value also goes down. So, diversifying your portfolio across different countries helps eliminate that risk.

So, if you take a look at this second table, you'll see that as the global COVID-19 pandemic wreaks havoc across Canadian portfolios, several non-Canadian categories of mutual funds are on average performing much better than the S&P/TSX Composite Index. Specifically, if you have a look at funds that manage to an Asian Pacific and Chinese equity mandates, which are highlighted in dark green, are faring much better than the S&P/TSX Composite on a year-to-date basis ending March 31st. So, having some exposure to these types of funds might help you reduce your losses as well.

So, along the theme of diversification, it's worthwhile paying attention not only to the mix between stocks and bonds, but also the geographic exposure of your portfolio for diversification. Now more than ever, it's much easier to expose your portfolio to global markets through low-cost index ETFs. For a few well-rated ETFs in this space, feel free to consult the table attached to the transcript to this article.

For Morningstar, I'm Ian Tam.

About Author

Ian Tam, CFA  is Director of Investment Research at Morningstar Canada. 

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