Investing strictly in Canadian stocks wins you no points for diversification, but there are definite upsides.
One is that the companies are familiar and easy to follow, while another is that you avoid the sometimes destructive, sometimes helpful effects of currency fluctuations on returns from U.S. and international stocks.
Can it be possibly be a net win to ignore the 96.6 per cent of the global stock market outside Canada? Maybe if you’re investing strictly for dividend income and are taking advantage of the dividend tax credit in a non-registered account. Otherwise, you want global diversification to contribute returns at times when the resource- and financials-dominated Canadian market underperforms.
A Globe and Mail reader recently asked about a portfolio that is primarily devoted to Canadian stocks. “I know I should diversify more into U.S. and other global companies, but the currency exchange is holding me back,” she wrote. “Do I need to worry about exchange rates, or should I just ignore them and invest when there is a good buying opportunity? Note that I already own a couple of Canadian exchange-traded funds with U.S. holdings.”
Given that this reader is familiar with ETFs, an obvious way to deal with currency fluctuations would be to buy funds that use currency hedging. These ETFs offer the return of the underlying index, with currency distortions muted. Many investing pros avoid hedging in the belief that currency’s impact on returns over 10-plus years from foreign stocks tends to fade away. But in the shorter term, hedged ETFs remove any worries related to currency fluctuations.
Regardless of whether currency hedging is used, holding ETFs or stocks from outside Canada is a crucial means of diversification. For example, the Canadian market has only trace exposure to vibrant sectors like technology and health care, while the U.S. market is rich in both.
Investors who buy foreign stocks will need to have their Canadian dollars converted to other currencies at unfavourable rates. Forex is a big profit centre for brokerage firms. Still, the diversification benefits outweigh the negatives.
To reduce costs related to currency conversion, consider using ETFs for hedged and non-hedged foreign exposure. The exchange rate applied by the ETF company should be more competitive than the one your broker applies when you buy foreign stocks directly.
-- Rob Carrick
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Stocks to ponder
Constellation Software Inc. Constellation has become by far the country’s best-performing tech stock over the past decade-plus by sticking to a rather unglamorous business model – acquiring hundreds of niche industry software providers that are typically too small for private equity firms or venture capitalists to consider. But a healthy level of potential deals at good prices is crucial for any growth-by-acquisition strategy, and Constellation has increasingly faced questions about its acquisition pipeline - especially given its sky-high valuation. Tim Shufelt reports
Automotive Properties Real Estate Investment Trust While the REIT has provided limited capital appreciation to investors since its initial public offering in 2015 (priced at $10 per unit), it offers investors an attractive yield, currently yielding 7.7 per cent with a payout ratio of 82 per cent reported in the first half of 2019. Low but steady earnings growth is anticipated to continue, driven by acquisitions. Jennifer Dowty reports
This indicator suggests U.S. stocks are in big trouble
U.S. equity markets are priced for a sharp recovery in profit growth that at least one leading indicator suggests is unlikely to happen. The end result is a notable increase in portfolio risk, as a continuation in sluggish earnings growth would likely result in a significant market correction. Scott Barlow explains
Investors, don’t give up on the Big Six
Canadian bank stocks have failed to generate any meaningful gains over the past two-and-a-half years, but don’t give up on them now. One reason to embrace this going-nowhere era: Dividend yields are above 4.6 per cent on average for the Big Six bank stocks, making the quarterly payouts hard to ignore at a time when bond yields are falling. Another reason: The banks’ third-quarter results, which rolled out at the end of August, suggest that these financial giants are doing okay even in challenging times – making the stocks looking curiously cheap. David Berman reports
Others (for subscribers)
Friday’s Insider Report: CEO invests approximately $250,000 in this Big 5 bank stock
Thursday’s Insider Report: Chairman invests nearly $1-million in this soaring REIT
Number Cruncher: You can still find safety and value in the hot Canadian REIT sector
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Ask Globe Investor
Question: I am trying to manage the equities mix in my portfolio based on sector. My holdings include Brookfield Asset Management Inc. (BAM.A) and Brookfield Renewable Partners LP (BEP.UN). I assume the latter is a utility but what sector does Brookfield Asset Management fall under?
Answer: As an asset manager, BAM is included in the financials sector under the GICS (Global Industry Classification Standard) system. Brookfield Renewable and fellow BAM subsidiary Brookfield Infrastructure Partners LP (BIP.UN) are both classified as utilities. Brookfield Property Partners LP (BPY.UN) falls under real estate and Brookfield Business Partners LLP (BBU.UN) is classified as an industrial. Tip: To find the GICS classification of any stock in the S&P/TSX Composite Index, look up the holdings of the iShares Core S&P/TSX Capped Composite Index ETF (XIC). The list includes the GICS sector for each constituent.
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What’s up in the days ahead
Most investors know they’re supposed to diversify internationally. At the moment, though, that seems like a notion only a daredevil could love. Ian McGugan will take a fresh look at the argument for international diversification in Canadian portfolios.
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Compiled by Globe Investor Staff