By Tom Bradley
It’s a great time to be a homer. Who isn’t pulling for Canada to do well in Sochi – Alex and Mik, the sisters, 3-2 over the Americans this morning …
Canadians have lots of experience being homers, because they’ve done it for a decade now in their investment portfolios. Even though Canada accounts for only 4-5% of the value of the world’s stock markets, it makes up the vast majority of individuals’ portfolios.
This local market bias is not unique to our country, but the magnitude has been extreme. In 2010 and 2011, I asked a number of brokerage executives about this and to a person they suggested the number was very high (over 90%).
The percentage has steadily crept up since the turn of the century, a time when Canadian investors were doing everything they could to get out of Canada (remember ‘Clone Funds’?). The last decade was characterized by a strong Canadian dollar (it bottomed in 2002), a long and powerful resource cycle and a golden period for our financial services and real estate stocks. The longer this outperformance went on, the stronger the commitment to home grown stocks.
Last week, I came across further evidence of local market bias when I was reviewing the year-end ETF statistics published by National Bank Financial. In the U.S. equity category, 74% of the assets (C$6.4 billion) were in funds that were hedged back to the Canadian dollar. In other words, funds that gave investors exposure to U.S. companies, but not the greenback.
(Note: The same trend shows itself with U.S. equity mutual funds as well, although the percentage of hedged assets is not as high. This is because most of the assets in these funds flowed in before the ‘hedging’ era started.)
In 2013, hedging had a negative impact on returns. Because of the loonie’s decline, unhedged U.S. equity ETFs outpaced the hedged versions by 7-8% (roughly 40% vs. 32% in C$ terms). This trend has continued into 2014.
Looking further back, it depends on the time period as to whether hedging the U.S. dollar had a positive impact or not. Over the last 5 years, it’s been pretty neutral.
I’m not big on currency hedging for most situations, but I think it’s particularly inappropriate for portfolios that have very little invested in foreign stocks. Exposure to other currencies is a part of the diversification you get from owning foreign assets. Hedging just increases the home market bias.
But for next 10 days, who cares. Go Canada Go!