Canadian investors may be becoming less domestically biased, according to a recent report from Vanguard Canada, but experts say Canadians are still overinvested in the country. (Getty Images) (Photo via Getty Images)
Canadian investors may be becoming less domestically biased, according to a recent report from Vanguard Canada, but experts say Canadians are still overinvested in the country and not reaping the full benefits of portfolio diversification.
The report found that Canadians allocate 50% of their stock holdings to domestic stocks, down from 67% in 2012. But Canadian stocks account for just about 3% of the global stock market, so there remains a domestic bias.
“Overallocation can increase portfolio volatility,” Ashish Dewan, portfolio consultant at Vanguard Canada and author of the report, said in an interview with Yahoo Finance Canada.
The Canadian stock market is heavily concentrated in financial services, energy and materials, with the top 10 Canadian stocks accounting for nearly 40% of the market.
At the same time, Canadians will likely underestimate sectors like technology and health care that have “high growth potential,” he said. The U.S. technology sector, for example, has driven about 40% of the S&P 500’s gains since the start of 2023.
“We’re not saying Canada is a bad place to invest, a bad place to live, a bad place economically or anything like that,” Josh Shelk, portfolio manager and chief investment officer at Bellecan Capital Management, said in an interview with Yahoo Finance Canada.
“But it’s a relatively small part of the overall global market.”
The solution, they agree, is greater global diversification. But what is the right mix of domestic and international stocks in a Canadian portfolio?
Vanguard says a 30% allocation may be optimal
Based on 10,000 simulations using its proprietary modelling tool, Vanguard concluded that Canadian investors would be best served by allocating 30% to Canadian stocks and 70% to international stocks to “minimise long-term portfolio volatility”.
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This applies not only to an 100% stock portfolio, but also to the stock portion of a 60/40 balanced portfolio of stocks and bonds, according to the report.
“Of course, people like upward volatility — they want higher highs — but what they really want to avoid are lower lows,” Dewan said. “The benefits of diversification essentially allow you to lower the risk in your portfolio without sacrificing too much.”
Schelk says he tends to stick to the 20% to 25% range for Canadian stocks, but 5% to 30% is a reasonable range for most Canadians. He says he wouldn’t be “strongly opposed” if someone wanted to be closer to the lower end, but he wouldn’t go any higher than that, and he would never avoid Canada altogether.
“Sectors like materials and energy, which are somewhat concentrated in Canada, tend to offer diversification benefits when looking at a global portfolio,” Shelk said.
Schelk and Dewan note that Canadians who invest in Canadian companies may also be able to access tax benefits, particularly through dividend incentives.
There are lots of nuances to consider — for example, how dividends are taxed varies depending on the type of account they’re held in and the country of the holding company — but generally, in a taxable account, “Canadian dividends are taxed at a lower rate than comparable foreign dividends,” says Shelk.
Timescale may also be a factor
As with most investment decisions, there’s no one-size-fits-all solution to home bias. Dewan suggests that investors adjust their home bias depending on their investment time horizon, as there are tax benefits to investing in Canadian stocks.
Younger investors may want to invest “a little more globally,” Dewan says, while retired investors who rely on distributions for income could benefit from increasing their allocation to Canadian stocks to 30% or more.
“Canadian equities are biased towards value stocks, and value stocks generally pay higher dividends but also pay lower taxes on those dividends,” he said.
According to Vanguard’s analysis, a Canadian in the top tax bracket would pay $37,813 in taxes on a $100,000 distribution from Canadian stocks, while the same amount from global stocks excluding Canada would pay $53,492 in taxes.
Shelk said there is also an argument for a more domestic bias in the fixed income portion of the portfolio: People typically invest in bonds for their “safety,” and the biggest risk Canadians could face is economic distress within Canada, he said.
“Canadian government bonds would be the best hedge against a weakening of the Canadian economy,” Schelk said. “But it’s a different part of the portfolio and overall I think it still benefits from diversification.”
Farhan Devji is a Vancouver-based freelance journalist and author. You can follow him on Twitter. @farhandevji.