Investor Insights: Curb Your Home Bias for Better Investment Health | Mackenzie Investments

Investor Insights: Curb Your Home Bias for Better Investment Health


What is home country bias?

Home country bias is a tendency for individual investors to buy the securities of familiar companies that do business in the country where they reside.


We believe that Canadians have a tendency to focus too much of their equity portfolio in Canada, which has a small and narrow stock market relative to the rest of the world. This home bias may arise from a familiarity with companies that operate in our own backyard. Consider that the Canadian stock market represents around 4% of the global market, and Canada’s largest pension fund, the Canada Pension Plan, invests just 16.5% of its total portfolio in Canada.

You may be taking on unintended risks with a home country bias. When your house and employment income are both tied to Canada, investing mainly in Canadian stocks could add substantially to your overall concentration risk. These are important considerations and can become amplified during periods of recession in Canada. For example, your job might be at risk and if you were trying to sell your house, you might end up with less than you expected. Add in a weak Canadian stock market and you might have a recipe for poor investment health.

Expanding your exposure to global stocks provides access to different economic cycles and may reduce your overall investment risk.

Why you should care

Home country bias can keep investors from being appropriately diversified. Diversification is the practice of investing in different markets or asset classes so your portfolio is exposed to a larger number of performance drivers. Its importance in helping you reduce the amount of risk you take to meet your return objectives should not be overlooked. Because Canada’s stock market accounts for approximately 4% of total global market capitalization, this means the majority of the world’s best-managed and most profitable companies are domiciled outside of our borders.

Moreover, Canada’s stock market is highly concentrated in three sectors of the economy. In fact, Canada’s largest pension fund, the Canada Pension Plan, invests just 16.5% of its total portfolio in Canada (see chart below). This means that a bias toward investing in Canadian stocks can lead to investors putting all their “fiddleheads in one basket” and that’s a recipe for unintended risk, including sector concentration risk.

Canadian Stock Market Sector Weights
Sector S&P/TSX Composite
Financials 33.51%
Energy 20.68%
Materials 11.86%
Industrials 9.56%
Consumer Discretionary 5.41%
Telecommunication Services 5.06%
Consumer Staples 3.98%
Utilities 3.27%
Information Technology 3.08%
Real Estate 2.99%
Health Care 0.60%

Source: Mackenzie Investments, at June 30, 2017. Canadian Stock Market represented by S&P/TSX Composite Index.

Advantages of diversifying away from home

Investing globally can provide exposure to the world’s largest, most developed economies, such as the United States, Japan, Germany and the United Kingdom. Global investing also gives you access to faster-growing emerging economies, such as China and India. Of the 2,000 companies on the 2016 Forbes’ Global Leading Companies List, 1,947 are outside Canada. Only seven Canadian companies made it to Forbes’ shorter list of 130 Global High Performers in 2016.

More importantly, diversifying an investment portfolio to include stocks outside of Canada can reduce overall portfolio volatility and smooth out the ride. A smoother ride can help investors stay the course as they will often pull their money out of the market during periods of increased market volatility. From the chart below you can see that the Canadian stock market experienced higher levels of volatility than the broad world market over most five year periods for the last 25 years.

Five year rolling period standard deviations of the Canadian market as measured by the S&P/TSX Composite TR Index relative to the broad world market, as measured by the MSCI World Index NR (CAD) from July 1, 1992 to June 30, 2017
Five-year period Standard deviation
1992-1997 13
1993-1998 20
1994-1999 36
1995-2000 36
1996-2001 45
1997-2002 39
1998-2003 30
1999-2004 20
2000-2005 15
2001-2006 -3
2002-2007 -6
2003-2008 6
2004-2009 29
2005-2010 32
2006-2011 27
2007-2012 29
2008-2013 28
2009-2014 19
2010-2015 10
2011-2016 -4
2012-2017 -17

Source: Morningstar Direct, Mackenzie Investments. (For illustrative purposes only.)

Curb home bias by investing globally

Since investing predominantly in Canada can increase your investment risk through heightened volatility, one way for Canadians to gain more comfort investing outside the country is through high quality, dividend-paying companies. Canadians are already familiar with the advantages of dividend investing. From an investment in a dividend-paying bank, regional utility or telecom business, the idea of receiving a steady stream of income is what draws many Canadians to own domestic dividend-paying companies they know and trust.

Fortunately, Canada is not the only place where dividends account for a significant portion of an investor’s total return over time. In the table below, we see there are many countries where this is the case.

Dividend Contribution to Total Return in Global Markets
Return component UK US France Germany Australia Canada Japan
Dividend Yield 4.2 3.1 3.5 2.8 4.3 3.0 1.6
Inflation 5.8 3.7 4.3 2.9 5.6 4.2 2.6
Dividend growth 1.0 1.9 2.0 1.8 1.7 2.0 0.6
Multiple expansion -0.1 1.2 0.0 0.4 -1.7 0.3 1.6
Total annualised returns 11.1 10.1 10.0 8.0 9.9 9.8 6.4

Source: Societe Generale Quant Research using MSCI data

When investors do look outside Canada, they find many of the same characteristics in global dividend-paying companies which they find attractive in Canadian-based companies, such as strong corporate governance and prudent use of limited capital. The discipline instilled in a company from paying a dividend is borderless.


Notes

  1. MSCI World Index (USD), January 31, 2017. Canada is 3.68% of the world capitalization. ↩︎
  2. 2017 Annual Report, CPP Investment Board, 2017. ↩︎
  3. MSCI World Index. ↩︎
  4. Mackenzie Investments ↩︎

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

The content of this whitepaper (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) is not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.