Financial Focus: The benefits of global diversification

By Craig Elder on February 22, 2020.

Canadians are guilty of what is called “home bias” when it comes to their investments. Those that have all their equity exposure, or a significant portion of their equity exposure, in Canada, are not taking advantage of the global growth opportunities that exist outside of our country.

To prove a point about the benefits of global diversification, our own national pension plan, the Canada Pension Plan, has only approximately 15% exposure to Canada. That includes exposure in both bonds and stocks.

The Canadian benchmark S&P/TSX Composite index is heavily weighted in three sectors of the global economy, energy, materials and financials. While the financial sector has traditionally been strong and consistent in Canada, both the energy and material sectors are deeply cyclical and go up and down with the economy and commodity prices.

Canada only represents 3% of the investment opportunities available worldwide. That means the vast majority of investment opportunities are beyond Canada’s borders, in places like the U.S., Europe and Asia. In addition, with Canadian markets strongly weighted in just a few sectors, you may not necessarily be able to find quality companies in certain sectors, if you want to diversify by sector to reduce risk. By going global, you can choose from a larger pool of quality investments in a wider range of sectors.

The global economy is grouped into 11 economic sectors. Those sectors are financials, industrials, energy, consumer staples, consumer discretionary, materials, technology, health care, telecommunications, real estate and utilities. Just as you can diversify by geographic area, you can also diversify by industry sector to reduce risk. Therefore, when you forgo global stocks in your portfolio, you not only forgo the risk-reduction benefits offered by global diversification – you also forgo the risk-reduction benefits offered by sector diversification.

By investing in companies that have operations all over the globe you increase your chance of riding out economic downturns in one geographical area. If a company is only doing business in Canada and we enter into a recession then it will affect that Canadian focused company substantially.

If on the other hand you invest in a company that has operations all over the globe, a recession in Europe will affect European operations and not necessarily other parts of their global operations or overall profits. Companies that are only Canadian based, and do business only in Canada, can only sell to a small population compared to the population of the planet.

Several international markets have historically performed better than Canada over the longer term.

Even with the drop in the Canadian dollar, by taking advantage of the diversification offered by global markets, you can enhance your portfolio’s return potential and reduce the risks of being concentrated in a market that is concentrated in a few sectors of the economy. If you feel your portfolio is too concentrated in Canada it may be time to review the alternatives.

A. Craig Elder, CFP, FMA, CIM, FCSI, is a Vice-President, Portfolio Manager and Wealth Advisor with RBC Dominion Securities Inc. in Medicine Hat. Source material provided by RBC Wealth Management. Contact a financial advisor before you act on any or all of the strategies mentioned above. RBC Dominion Securities is a member of the Canadian Investor Protection Fund. For more information on this and other financial strategies, contact Craig at http://www.acelder.ca or 403-504-2723.

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