Canadian investors regularly hear that a globally diversified portfolio is essential to investment success, although the results of following that advice have been disappointing over the last decade. Andy Filipiuk, an investment adviser with National Bank, answers questions about investing outside of Canada.
Why is it essential that Canadian investors look beyond Canada’s borders when building their portfolio?
One of the most important reasons is that our market is very small – just two to three per cent of the world. In addition, the Canadian market is largely concentrated in just three sectors: 31 per cent of the TSX is financials, 26 per cent is energy and 19 per cent is materials, such as commodities. If you add that up, it’s over 80 per cent in three sectors. We don’t have the major corporations in other sectors, such as the pharmaceutical industry leaders that are found in the U.S. and the rest of the world. It makes it impossible to create a diversified equity portfolio.
In addition, Canada’s overall economy is heavily reliant on energy and commodities. We’ve experienced a long commodity boom, largely fuelled by China. With the economy in China starting to correct somewhat, there is a good possibility that global markets will perform better than the Canadian market over the next several years.
Many Canadians focus more on the risks of foreign investment than on the potential benefits – is that a valid concern?
When the commodity markets are very strong, as they have been in the last five years, our currency tends to increase in value compared to the currencies of the countries in which we might be investing. A lot of the benefits of the movement you might get on portfolios outside of Canada are therefore offset by our strong currency. It’s a significant concern.
In 2000, for example, there was a strong emphasis on the importance of investing in international funds, and many Canadians invested in the U.S. Since then, the U.S. market has done almost nothing for 12 years, and the Canadian dollar went up 30 to 40 per cent from its lows in the previous decade. As a result, some people have lost 50 per cent or more on their U.S. holdings. It’s quite staggering.
You have to be careful when you invest abroad, but it is still important to do so.
Is foreign investment significantly riskier than domestic investment?
It may be more volatile, because you add currency volatility. If I invest in Canada and all my stocks are priced in Canadian dollars, I get the ups and downs of the market. If I invest globally, I get the ups and downs of the market, plus the built-in currency fluctuation, too. If the global markets happen to be going down at a time when the Canadian dollar is going up, you can experience wild volatility.
We also see a lot of advertisements encouraging Canadians to invest in emerging markets, because they have better growth rates. But each time there is a crisis, emerging market currencies are sold off. In 1998, for example, investors took enormous losses on their Asian holdings.
Are there ways to mitigate the risks of foreign investment, while still reaping the benefits?
One of the ways that we invest abroad for clients is with the Morgan Stanley Composite Index, which is widely diversified and hedged to the Canadian dollar, so that our clients receive “absolute return.” This broad-based index includes Europe, Asia, South America and Africa, so that investments are spread out across the entire globe. And because it is hedged, it removes the fluctuations of the Canadian dollar, which might otherwise lower overall return.
When investing outside of Canada, in particular, you have to pay attention. It adds another element of volatility and risk that you have to be prepared for. It important to remember that, of all the so-called “emerging markets,” the only one that has truly emerged is Israel. The others continue to be emerging. So it’s important to understand the risks.