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Stacks of $100 (U.S.) bills sit on a desk at a bank in South Korea.
Stacks of $100 (U.S.) bills sit on a desk at a bank in South Korea.

Portfolio Strategy

Here's how to use U.S. stocks to diversify Add to ...

We do rocks and banks very well in the Canadian stock market, but the sectors involving real brain power are puny and insignificant.

Technology, the sector of the Internet, and of Google and the Apple iPad, has all of a 3.4-per-cent weighting in the S&P/TSX composite index. Health care, where they're fighting disease and finding ways to prolong the life of an aging population, is even worse. At 0.5 per cent, you almost need an MRI machine to find the sector's weighting in the composite index.

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Care to fill in these gaping holes in the Canadian market? With our dollar hovering around parity with the U.S. buck, it's an ideal time.

Let's start with health care, a sector that on the S&P 500 comprises 51 companies and includes such venerable names as Johnson & Johnson (JNJ-N), Pfizer (PFE-N), Merck (MRK-N), Abbot Labs (ABT-N) and Amgen (AMGN-Q). In the S&P/TSX composite index, you get just four stocks of, um, lesser stature - Biovail (BVF-T), CML Healthcare Income Fund (CLC.UN-T), MDS Inc. (MDS-T) and SXC Health Solutions (SXC-T).

Owning U.S. health care stocks is a subtle way of adding global diversification to your portfolio. Pfizer, for example, is the world's largest drug maker. U.S. health care stocks are also strong dividend plays. Pfizer's yield as of late April was 4.4 per cent, the same as Merck. Eli Lilly paid 5.6 per cent, while Bristol Myers Squibb offered 5.3 per cent. Johnson & Johnson's yield was 3.4 per cent, and it has annually increased its dividend since 1972. Here in Canada, Biovail pays a small dividend yielding about 2.2 per cent, while CML, an income trust, pays a distribution yielding about 9 per cent.

Canada's technology sector is equally sparse, with the notable exception of Research In Motion (RIM-T). Besides RIM, the S&P/TSX information technology index includes Celestica (CLS-T), CGI Group (GIB.A-T), Open Text (OTC-T) and MacDonald Dettwiler & Associates (MDA-T). There are some solid names here, but they lack the global heft and influence of U.S. tech giants such as Microsoft (MSFT-Q), Apple (AAPL-Q), Google (GOOG-Q) and Cisco (CSCO-Q).

An easy way for investors to zero in on a sector is to use exchange-traded funds (ETFs), although sector mutual funds can do the job as well. Stack up the Canadian tech sector ETF against its U.S. counterpart and you clearly see the benefits of buying American. The iShares S&P/TSX Capped Information Technology Index Fund (XIT-T) was up a cumulative 12 per cent over the past five years, and 3.9 per cent for 2010 through late April. Its closest U.S. counterpart, the heavily traded PowerShares QQQ (QQQQ-Q), was up 48 per cent in U.S. dollar terms over the past five years and 10 per cent for the year to date.

The Canadian health care sector is so stunted that there's no applicable sector ETF. In the U.S. market, you can choose from such options as the Health Care Select Sector SPDR (XLV-N), the iShares Dow Jones U.S. Healthcare Sector Index Fund (IYH-N), the PowerShares Dynamic Healthcare Sector Portfolio (PTH-N) and the Vanguard Healthcare ETF (VHT-N). One-year gains from these ETFs range from 28 per cent for XLV to 45 per cent for PTH. Each is down in the area of 10 per cent in total over the past three years, so it's hard to argue that they're overvalued. Want a simpler approach to muscling up on health care and technology? Just buy an S&P 500 ETF or index fund. Tech is the largest sector in the S&P 500 at 19 per cent and health care is third-ranked at 11.4 per cent.

Rocks and banks have served the Canadian stock market well over the years, and there's no sense of a dramatic shift in 2010. But there's a lot more to the investing world, and the U.S. market has a much bigger share of it than we do.

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