by Tom Bradley

Stock markets are going down these days and there’s lots of analysis about why and what’s next. One of the statistics that’s getting attention is the performance of the Canadian stock market, as represented by the S&P/TSX Composite Index. The TSX is down 6% this year and has underperformed the rest of the world over the last few years.

One commentary came from Rob Carrick of the Globe and Mail. He wrote a piece about the degree to which various investment products hold Canadian stocks. He reviewed indexed ETFs (exchange traded funds), balanced portfolios from robo-advisers and two mutual funds, including our Founders Fund.

Note: The numbers in the article should be used with care. Some of the products hold only stocks while others are balanced portfolios. In each case but one, Rob shows the Canadian stock weighting as a percentage of total assets. The exception is the Founders Fund, which he shows as having, “49 per cent of its stock market holdings in Canada, compared with 25 per cent for the United States and 26 per cent internationally.” If he used the same methodology as the other funds, the number would be 27%, but that’s not the point of this post.

In the piece, Rob says, “Next to the overall stocks/bonds breakdown, this [Canadian stock market exposure] may be the most important matter of diversification for investors to answer.”

I think we need to put some caveats on this statement, particularly when it comes to Canadian investors and their penchant for home country bias.

• First, investors need to be careful generalizing about the Canadian market. It’s not a truly diversified market — it’s heavy on financial and resource companies and thin on technology, healthcare and consumer products. Comparing the TSX to other markets is suspect, particularly when it comes to valuation. In my view, Canada’s price-to-earnings ratio is meaningless given its mix of stocks.
  
• Another qualification on Rob’s analysis relates to be the type of investor you are — passive indexer or active undexer. Index portfolios, like the ETFs and robos he mentions, own all of the Canadian market, including a heavy slug of resources. Undexers, like Steadyhand, are not obligated to own all the sectors. They can pick the Canadian companies they want and go elsewhere for diversification and additional return.
• At Steadyhand we try to ignore borders as much as possible. Indeed, we are one of the few firms that doesn’t offer a Canadian-only equity fund.
  
• The Founders Fund gets its Canadian stock exposure from three of the underlying funds (as a reminder, it’s a fund-of-funds). The Income Fund owns stable, dividend-paying companies, including banks, insurance companies, utilities and REITs. The Equity Fund owns a selection of growth companies and the Small-Cap Equity Fund holds small and mid-sized companies.
  
• In the Founders Fund and our other balanced portfolios, we have a bias toward owning more foreign stocks. This is driven by the types of businesses and quality of companies available. In the last year, however, we have been equally balanced between Canada and foreign because of our subdued outlook for stock returns. We prefer to hold more stable, income-oriented stocks, of which Canada has a good selection.

We agree with Rob that diversification across geographies is important, but the type of companies and industries is more important, as is the type of investment approach.