We Canadians may love our country, but we adore it a little too much when it comes to investing.
While our stock market makes up about 3 per cent of global markets, and our bond markets make up even less of the bond universe, Canadian securities on average make up more than 75 per cent of our portfolios, according to research by the exchange-traded fund provider Vanguard.
But Canadians have plenty of ETF options to invest in globally, and the list is growing in number and diversity, from ultra-low-cost passive strategies to active management overlays to hedged and sector-specific approaches.
Here are a few recommendations from experts.
Kyle Prevost is a millennial investment educator and author of the popular personal finance blog Young and Thrifty. He urges investors seeking a simple, diversified strategy to consider low-cost, passive ETFs that track the performance of global markets, excluding Canada.
For equities, try Vanguard's FTSE Global All-Cap ex-Canada ETF (VXC) or iShares' Core MSCI All Country World ex-Canada ETF (XAW).
"You can debate back and forth between the two with regards to small differences in holdings and MER," he says, adding their management expense ratios are 0.27 per cent and 0.20 per cent, respectively. "But the bottom line is … both offer a very easy way to instantly invest in thousands of companies from all around the world."
For fixed income, Mr. Prevost says investors should try a combination of two ETFs: Vanguard's Total Bond Market Index ETF (BND) and its Total International Bond ETF (BNDX).
The first provides access to the U.S. market – the largest in the world – while the other offers exposure to global bond markets, excluding the U.S. (Canadian bonds make up about 5 per cent of its holdings). Both are traded on the New York stock exchange, which Mr. Prevost prefers over Toronto stock exchange-listed offerings. Toronto-listed offerings are generally currency hedged, he says, and he is "skeptical that the higher management costs and tracking error associated with currency-hedged ETFs make them worth it."
To hedge or not to hedge
Currency often has a significant impact on the returns for Canadians investing abroad. For this reason, whether to hedge presents a dilemma for many investors, says Yves Rebetez, managing director and editor of ETF Insight in Oakville, Ont.
Consider investing in Europe. The euro is expected to strengthen against the U.S. dollar as its economy is forecast to improve while the United States is expected to wallow in ongoing political turmoil caused by Donald Trump's administration. If you buy a U.S.-listed European ETF, a rising euro can be a boon for its value based on currency alone as the U.S. dollar weakens.
But the case could be different for ETFs listed in Canada trading in Canadian dollars if, for example, oil recovers. Fortunately Canadians can choose from plenty of low-cost ETFs, hedged or not. These include iShares MSCI Europe Investable Market Index (XEU, or XEH if hedged is desired), and Vanguard's FTSE Developed Europe All Cap (VE, or the VEH for hedged version).
Another plus is that the management cost of hedging is minimal.
"Once upon a time, currency hedging used to cost an extra 15 basis points," Mr. Rebetez says. "In recent years, if you look at the offerings of iShares, Vanguard and so forth, you will see that you can get unhedged without any additional cost."
Some ETF providers also offer dynamic currency management ETFs that aim to hedge to varying degrees depending on macroeconomic factors. Among the options is WisdomTree's Dynamic Currency Hedged Europe Equity Fund (DDEZ).
The MER is about twice the cost of conventional European equity ETFs. This extra cost may not be worth it if the currency strategy proves wrong, Mr. Rebetez says. "The second you move away from [passive management] and strap on factors that entail elements of active decisions, the potential is there to detract from returns relative to the market."
While broad-based global ETFs provide diverse exposure, you can also invest in sector-specific or geography-specific funds to take advantage of conditions unique to certain regions or sectors. Portfolio manager Tyler Mordy, who is also president of Forstrong Global Asset Management, offers two selections.
While Canadians often have plenty of exposure to banks through Canadian equity ETFs, a market dominated by financials, the U.S. sector could be facing a bright future as the Trump administration loosens regulations. One option here is Financial Select Sector SPDR ETF (XLF), which tracks "an index of S&P 500 financial stocks, weighted by market cap," Mr. Mordy says.
"Even if the congressional Democrats block specific changes, such as Dodd-Frank [Wall Street Reform and Consumer Protection Act], the administration has room to weaken regulations simply by reinterpreting existing laws."
While the upside is presumably higher profit in the short-term, one note of caution is that the existing rules aim to avoid the market excesses that led to the financial meltdown in 2008. If those regulations are pushed aside, one might ask whether another crash is in the making.
Investors seeking regions that could outperform can look to Japan. Once a nation of savers, more of its citizens are turning to the stock market. "Contrary to popular belief, Japanese savers have never been wealthier, having a net worth that is double what it was at the peak of the 1980s bubble," Mr. Mordy says.
The percentage of the population investing in its stock markets remains low relative to other developed markets, but this could be interpreted as a trend with lots of room to grow. To capture this potential, Mr. Mordy recommends the iShares MSCI Japan ETF (EWJ), tracking a market-cap-weighted index of roughly 85 per cent of all Japanese stocks.
Another plus: The Japanese yen is "dramatically undervalued … the cheapest it has been in 32 years," so buying the ETF today could benefit from a currency tailwind if the yen rises, boosting the total return.