Restriction of investment to Canada, harming Canadian retirement investors

There’s plenty to love about this country on Canada Day weekend but a new report from Vanguard says we’re overdoing it when it comes to investing for our retirements.

 

It finds Canadian investment portfolios are 18 times overweight in their Canadian holdings; increasing exposure to domestic risks and decreasing exposure to a world of opportunity outside our borders.

 

The term is “home bias”. According to the report, Canadian securities account for about half of Canadian portfolios despite the fact that Canadian securities account for only 2.6 per cent of the global market.

 

Of that tiny sliver of global securities, roughly two-thirds of the stocks listed on Canada’s Toronto Stock Exchange are tied to the finance and resource sectors.

 

In addition, the report says the top ten holdings in Canada constitute more than 38 per cent of the S&P/TSX index. That’s a high concentration compared with the global market where the top ten securities make up approximately 12 per cent.

The right mix for the right portfolio

The good news, according to the report, is that Canadian investors are gradually reducing levels of home bias from 67 per cent in 2012. The trend is likely a holdover from before the 1990s when registered retirement savings plans (RRSPs) were restricted to 30 per cent foreign holdings.

 

There are currently no foreign content restrictions on RRSPs or tax-free savings accounts (TFSAs).

 

Vanguard says a more balanced investment portfolio for Canadians would hold 30 per cent Canadian equities and 70 per cent international equities. However, that weighting could be different for individuals, such as snowbirds, if they spend more of their retirement dollars outside Canada.

 

How to achieve global diversification in your portfolio

While it’s important for Canadian portfolios to diversify beyond Canada, it is just as important to diversify among foreign holdings. That means including a wide array of sectors and geographic regions.

 

There are three basic ways for retail investors to get access to foreign equities but the cost of dealing in foreign currencies is a hidden risk many don’t consider.

 

Most foreign equity funds sold in Canada have a version that hedges the Canadian dollar at a cost much higher than the U.S. dollar version.

 

To avoid having to pay currency traders for an ongoing labyrinth of foreign transactions it’s best to buy foreign equities in U.S. dollars, which is the global standard currency. That means banking up U.S. dollars in trading accounts such as a registered retirement savings plan (RRSP) and tax-free savings account (TFSA).

 

There are three basic ways for Canadians to invest globally.

 

Global and international mutual funds

Most Canadian mutual fund providers offer a wide variety of global funds including broad global funds (all countries), international funds (all countries minus Canada and the U.S.), or funds that concentrate on specific countries, regions, or global sectors like technology.

 

Many foreign equity funds are actively managed by investment teams with vast research capabilities and experience in the focus area. Some funds are sub-managed by firms located in the specific geographic region.

 

Annual fees for that sort of reach and expertise can be two per cent to three per cent of the total amount invested, which is ultimately drawn from the total return.

 

Global exchange-traded funds (ETFs)

It’s no coincidence that Vanguard Canada is ringing the alarm bells about global diversification. Vanguard is one of the leading providers of exchange-traded funds (ETFs).

 

ETFs generally have the same reach as mutual funds in terms of geographic regions and global sectors. The big difference is that they are passively managed. That means holdings are bought and sold according to a preset formula such as market weighting in the underlying index.

 

ETFs are not as effective as actively managed mutual funds at adjusting to changes or nuances relating to specific foreign markets.

On the plus side, fees on unhedged foreign ETFs are usually much lower than mutual funds; often below 0.05 per cent on the amount invested annually.

 

Market-weighted ETFs that track an index are also more transparent. Holdings and changes mimic the underlying index while mutual fund managers are only required to provide scant information on what and how much the fund holds.

 

U.S. listed stocks

Stocks trading on overseas markets can be difficult for the average investor to buy directly but most Canadian trading accounts offer full access to major U.S. exchanges.

U.S. equities are also global equities because roughly 50 per cent of all publicly traded companies in the world are based in the United States. Many generate revenue and grow earnings around the world. That not only gives investors in U.S. stocks a global reach, but it also puts the onus on the company to hedge all other foreign currencies.

 

 

 

 

This article was first reported by BNN Bloomberg