Canadian equity mutual-fund managers have developed an interesting strategy as they strive to beat performance benchmarks and their own peers: buy U.S. stocks.
According to a recent report from CIBC World Markets, drawing on its own proprietary database, 20 per cent of all equity assets in Canadian equity mutual funds aren’t Canadian stocks, up from 12 per cent a decade ago. About three-quarters of these foreign holdings are U.S. stocks.
“Over the past decade, there has been a consistent drive to diversify beyond Canadian borders,” CIBC analysts Ian de Verteuil, Shaz Merwat and Christopher Siemiaszko said in their report.
They added: “We are not talking about global mutual funds, we are talking about ‘Canadian’ mutual funds. Remember, the restrictions on mutual fund portfolio managers are set by the prospectus, and generally do not require 100 per cent of the assets to be in Canada, even for a ‘Canadian Equity Fund.’ ”
Turns out, buying U.S. stocks has been a winning strategy.
The U.S. stock market has been outperforming the Canadian market handily. Over the past 10 years, the S&P 500 has delivered a total return (with dividends) of 238 per cent, or more than 2 1/2 times the 92-per-cent return for the S&P/TSX Composite Index over the same period.
When the S&P 500’s performance is expressed in Canadian-dollar terms, the differences are even more pronounced: The S&P 500 has gained 330 per cent, or more than 3 1/2 times the return for the TSX.
Even better, Canadian fund managers have taken a particular shine to U.S. technology and health-care sectors, which are underrepresented in Canada.
These two U.S. sectors have been particularly strong over the past 10 years. U.S. health-care stocks are up 271 per cent (in U.S. dollar terms), beating the S&P 500. U.S. technology stocks are up 377 per cent, led by Nvidia Corp. (up 1,299 per cent), Mastercard Inc. (up 1,240 per cent), Intuit Inc. (up 915 per cent) and Apple Inc. (up 867 per cent).
“Whenever a bout of selling occurs, speculation has it foreigners are selling Canadian stocks. While this may be true episodically, the reality is the biggest challenge for Canada’s stock market is not foreigners selling Canadian equities, it is Canadians selling Canadian equities,” the CIBC analysts said.
But will Canadian fund managers continue to look abroad?
Despite the decade-long trend, the CIBC analysts argue that the home market is now looking more appealing than the U.S. market, which should begin to draw investors back to Canada.
For one, Canadian stocks are cheaper. According to Bloomberg, the price-to-earnings ratio for the S&P/TSX is 16.7, compared with 19.3 for the S&P 500. The CIBC analysts note that the valuation spread between the two indexes is close to its widest point since 2000.
Yes, Canadian energy producers have been reporting lacklustre profits since the collapse of oil prices in 2014. But stable pipelines and integrated energy producers now generate about 70 per cent of the energy sector’s profits, implying steadier results ahead. And, hey, oil could recover.
And lastly, the analysts argue that oligopolies – sectors with relatively few competitors – now have a bigger presence in the S&P/TSX, making the index more attractive. Banks, railways, telecommunications companies and grocers account for about 35 per cent of the index’s market capitalization, up from 20 per cent to 25 per cent in the 1990s.
“In our opinion, the valuation gap between Canadian and U.S. equities should actually be shrinking, not increasing,” the analysts said.
David Berman