Lorne Zeiler, VP, Portfolio Manager and Wealth Advisor at TriDelta Financial was interviewed by Joel Schlesinger of the Globe and Mail on how Canadian investors can use ETFs to reduce specific Canadian market risks in their portfolios. (Article printed on September 26, 2017).
In the investing world, you can have too much of a good thing. This especially applies to many Canadian investors, who often have too much home cooking in their portfolios for their own financial well being.
“Typically, Canadian equities make up two-thirds or more of investors’ equity investments and, in some cases, all of them,” says Lorne Zeiler, wealth advisor with TriDelta Investment Counsel in Toronto. He often sees this problem with the portfolios of new clients.
According to a 2015 study from Vanguard, Canadian investors have on average 60 per cent of their equity portfolios invested in Canada.
That likely means they are overconcentrated in just a handful of sectors, says Paul Taylor, chief investment officer at BMO Global Asset Management. “The reality is we here in Canada are a trees, rocks and banks-based economy and market.”
About two-thirds of the Canadian equity market, for example, is made up of companies involved in the energy, mining and financial sectors, meaning many investors probably have too much exposure to them.
That isn’t to say Canadian exposure hasn’t served investors well. The TSX Composite Index doubled in value from 1999 to 2015, for example.
But the home country bias has hurt more recently, Mr. Zeiler says. Consider in 2015, “when energy prices dropped substantially, energy stocks fell roughly 20 per cent, but the TSX as a whole was also down over 10 per cent.” Given oil’s uncertain future, this Canadian bias now appears less beneficial by the day.
What’s more is that by sticking mostly to Canada, we are missing out on a whole world of investment – given Canada’s stock market makes up only about 3 to 4 per cent of the global equity marketplace, Mr. Taylor says.
That may leave some investors asking how they can create a truly diversified portfolio.
One strategy they shouldn’t pursue is radically altering their allocation to reflect Canada’s actual share of the global markets, says portfolio manager Michael Job with Leith Wheeler Investment Counsel in Vancouver.
“I think that’s unreasonable, because it assumes people are completely agnostic to currency risk,” he says. “The reality is for most Canadians, our living expenses are predominantly in Canadian dollars.”
The more foreign content you own, the more currency risk you need to manage – and that comes at a cost, Mr. Job adds. A better option is aiming to have half the portfolio allocated to Canadian investment with the other half split between the United States and non-North American investments, he says.
Investors should first look to the U.S. market – the world’s largest – because it is the easiest to access. The United States also offers the widest variety of investments to choose from, including technology and health care – two sectors that are not well represented in Canada’s marketplace.
One way investors can find the lowest-cost, most broadly diversified access to markets beyond our borders is by using exchange-traded funds, or ETFs, Mr. Zeiler says.
“For the U.S., clients should look at ETFs that mimic the S&P 500 for broad-based exposure … or invest in specific sectors that are lacking in Canada, like technology or health care.”
Here are a few ETF picks that can help you dilute any Canadian overconcentration in your portfolio.
SPDR S&P 500 ETF: This fund tracks the performance of the S&P 500, one of the more diverse indices in the world, providing access to large companies based in the United States in a variety of sectors including tech, health care and consumer staples, most with global reach. “SPDR has one of the lowest management fees among all ETFs and provides broad exposure to the entire U.S. market,” says Mr. Zeiler.
iShares Global Healthcare Index ETF (CAD-hedged): This ETF provides diversified exposure to the health-care sector. About two-thirds of its holdings are listed in the United States, and the rest mostly consist of European listings. The “MER fee is higher at approximately 0.65 per cent, which is common with many sector- or style-focused ETFs,” Mr. Zeiler says. “For investors wanting exposure to U.S. dollars, a non-currency-hedged version of this same ETF can be purchased on the New York Stock Exchange.”
Vanguard Information Technology ETF: This New York Stock Exchange-listed fund offers low-cost access to some of the largest companies in the world, let alone the tech industry. It is a “great, single investment solution to gain exposure to the IT industry,” Mr. Zeiler says. The investment consists of more than 300 holdings, “but the top 10 make up over 50 per cent of total weight.”
PowerShares LadderRite U.S. 0-5 Year Corporate Bond Index ETF: This Canadian-listed ETF provides investors with fixed-income exposure to the U.S. corporate bond market, which is the largest in the world. Using a laddered bond strategy, it aims to reduce interest-rate risk. Mr. Zeiler notes the management expense ratio, or MER, is a reasonable 0.28 per cent, but while distribution yield exceeds 3 per cent, yield to maturity is only 2.1 per cent, “meaning many of the bonds in the portfolio are priced at a premium.”
Vanguard FTSE Emerging Markets All Cap Index ETF: This Canadian-listed ETF attempts to reflect the performance of the FTSE Emerging Markets All Cap China A Inclusion Index, providing exposure to large, mid-sized and small-cap companies based in emerging markets. Investors gain access to a diversified basket of stocks across many regions for a relatively low cost – an MER of 0.24 per cent, Mr. Zeiler says. The fund also has fairly good liquidity compared with similar offerings and has more than $600-million in assets under management.
BMO MSCI Europe High Quality Hedged to CAD Index ETF: This one offers exposure to European equities but uses a return-on-equity screen to ensure companies are of high quality while hedging back to Canadian dollars. The ETF provides investors with the opportunity to participate in the euro zone’s most successful firms spread evenly across many sectors including consumer defensive, health care and industrials, Mr. Taylor says.
iShares MSCI EAFE Index ETF (CAD-hedged): This ETF aims to track the performance of the MSCI EAFE Index, which encompasses the largest publicly traded companies in the developed markets of Europe, Australia and the Far East. Mr. Zeiler says the fund is a good way to get “broadly diversified exposure to non-North American developed markets without taking on currency risk.”