Curb Your Home Bias for Better Investment Health
August 11, 2017
Senior Investment Director
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.
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 period||Standard deviation|
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.
|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.