The Canadian equity market is highly concentrated in three sectors - and is relatively small compared to other markets. Yet investors choose to maintain a “home country bias,” foregoing the opportunity to diversify their investments and enhance their returns.
The case for global investing is two-fold: diversification and greater opportunities. In the case of diversification, the Canadian stock market accounts for just over 3% of total global stock market capitalization, meaning that it offers limited investment opportunities.i
In addition, the Canadian market is highly concentrated in three sectors - financial services, energy and materials – which comprises of apprximately 70% of total market capitalization.ii Therefore, investors who hold a high percentage of their assets in the Canadian equity market are getting overexposed to these three sectors and adding concentration risk to their portfolios.
Comparatively, global markets offer exposure to a range of sectors with strong growth potential, such as health care, industrials, information technology and telecommunications, all of which are underrepresented in Canada.
Emerging markets, for instance, which are the fastest growing segment of global market, represent 35% of global market capitalization. Yet investors continue to maintain undiversified portfolios by investing almost half of their assets in Canada and only about 4.5% in emerging markets – amplifying the risk of being undiversified.iii
By holding a diversified portfolio, investors can also reduce portfolio volatility and obtain inflation protection, while enhancing their returns.
Historically, foreign equity markets have on average outperformed the Canadian market, albeit with a greater degree of risk. However, the trade-off is greater returns over the long-term.
As the chart below shows, global markets have outperformed the Canadian markets over the 5-year period ending July 31, 2015.
Another reason why investors should invest more of their assets globally is because the Canadian economy represents less than 3% share of the global economy, which means that that there are significantly more opportunities in foreign markets. As well, global economies are on average growing faster that the Canadian economy, led by emerging markets which represent approximately 70% of global GDP.iv
It is therefore prudent for investors to increase their exposure to global markets to obtain higher risk adjusted returns regardless of their risk profile.