This is how a lot of Canadians think when it comes to their investment portfolios, even if it is complete instinct. Canadians, just like the majority of at-home investors around the world, are guilty of having home bias in their portfolios but knowing what it is can help deter you from making it worse. Home bias is one of the many emotional biases that are natural to human behavior but can end up being a determent to your investment performance over a long period of time. Home bias simply means that an investor has a natural inclination to invest in domestic securities rather than foreign securities. The average Canadian has around a 30% allocation to Canadian securities in their investment portfolio but the performance of the Canadian economy only makes up about 3% of the global economy. One of the many reasons why this occurs is the fact that we feel more comfortable with familiarity. We feel more comfortable when we are investing in household names that we see often in our day-to-day lives.

The FTSE (Financial Times Stock Exchange Group) All-World Index and the MSCI (Morgan Stanley Capital International) All-Country World Index are two different indices that are meant to replicate the performance of approximately 99% of all equity markets around the world. Delving deeper into the percentage breakdown by country across both of these indices, it is found that Canada makes up about 3% of the overall weighting. This means that the creators of these indices allocate 3% of the entire world’s stock market performance to Canada so, if you are looking at your portfolio from simply an asset allocation standpoint then, anything over a 3% weighting in Canada would be considered over-weight. Even our own Canada Pension Plan only invests 16.6% of their total assets in Canada.

The rationale as to why you have to be careful when you have a higher allocation in your portfolio to one specific country is due to the fact that not every country’s stock market is the same. If we look at the S&P/TSX Composite Index, Canada’s benchmark index, then you’ll find that Financials (31%), Information Technology (12%), Energy (12%), and Industrials (12%) are the largest 4 sectors and they make up 67% of the overall index. The smallest 4 sectors are Customer Staples (4%), Consumer Discretionary (4%), Real Estate (3%), and Health Care (1%) and only make up 12% of the overall index. The MSCI All-Country Index’s top four sectors are Information Technology (22%), Financials (14%), Consumer Discretionary (13%), and Health Care (12%), which makes up 61% of the index. The bottom four sectors of that index are Materials (5%), Real Estate (3%), Energy (3%), and Utilities (3%), which only make up 14% of that particular index.

The result shows us that by investing only in the S&P/TSX then you are overweight Financials by 17% and Energy by 9%. You are underweight Healthcare by 11%, Information Technology by 10%, and Consumer Discretionary by 9%. All that this means is that Canada’s economy is not an exact replica of the world economy. By having a higher allocation in your investment portfolio to Canada then you may feel more comfortable but you will also have a heightened level of risk due to the fact that your investments will have a heightened reliance on the performance of Canada. You are already reliant on the Canadian economy for your income (if you are working) or your pension (if you are retired) so, as a result, wouldn’t you want to minimize your investment portfolio’s reliance on the Canadian economy too?   

As a Canadian, there are many reasons as to why you would have a higher allocation to Canadian securities in certain accounts. Everyone knows the level at which interest rates are at currently (record lows) so investor’s don’t have many alternatives to investing in equities when the average long-term inflation rate in Canada is around 3%. This means that if you aren’t earning more than 3% per year (after-tax) on your money then you are effectively losing purchasing power over time. Another reason is due to the fact that the S&P/TSX provides approximately 2x the yield (dividends) compared to the S&P500 so Canadian investors that are searching for dividends don’t have to look far to find some high dividend paying companies. Lastly, Canadian dividends provide a tax-efficient source of yield for Canadians. If you are receiving your dividends in a non-registered investment account then the difference in marginal tax rates between Canadian eligible dividends and foreign dividends can be as high as 20% in some provinces (without even taking the additional withholding taxes applied against foreign securities into account).

Understanding the benefits and drawbacks of having an investment portfolio that is guilty of home bias is a step in the right direction for any investor. The goals of every investor are different and there is no one-size-fits-all solution so due diligence is recommended before making any changes to your portfolio.

All percentages and sector allocations discussed are as of August 31, 2021 and are subject to change.

Want to chat about it? Email me at info@financerx.ca