As great as it is to travel in Canada, Canadian travelers know when they visit other countries they’ll enjoy an even wider range of experiences.
The same holds true for Canadian investors. Canada represents only 3% of capital markets in the world.1 The other 97% of investment opportunities lie in other regions. This means more opportunities to diversify, which ultimately leads to a smoother investment experience. Because when one region is performing poorly, another could be enjoying stronger performance.
The chart below shows that investing too narrowly in any single country like Canada can lead to a bumpier ride when compared to a geographically diversified portfolio. This principle is known as “concentration risk.” And if, like many investors, you don’t stay the course, it could limit your returns or lead to lower returns.
Performance of equity markets by country over the last four decades
| 2020s | 2010s | 2000s | 1990s | 1980s | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Korea | 45.2 | New Zealand | 12.1 | Brazil | 14.7 | Sweden | 18.9 | Sweden | 29.7 | ||||
| China | 43.5 | USA | 11.2 | Australia | 10.7 | Switzerland | 17.4 | Japan | 28.7 | ||||
| Taiwan | 42.0 | Switzerland | 9.3 | Norway | 10.2 | Brazil | 17.1 | Italy | 22.9 | ||||
| Sweden | 24.4 | Taiwan | 9.2 | Korea | 8.9 | USA | 16.1 | Spain | 21.3 | ||||
| New Zealand | 20.2 | Sweden | 7.8 | Canada | 8.2 | United Kingdom | 14.2 | United Kingdom | 19.3 | ||||
| USA | 19.2 | Japan | 6.9 | New Zealand | 6.8 | Spain | 14.2 | Equal weight portfolio | 18.2 | ||||
| Japan | 14.9 | France | 6.1 | Switzerland | 4.9 | France | 13.5 | France | 17.6 | ||||
| Switzerland | 12.8 | Equal weight portfolio | 6.0 | Equal weight portfolio | 4.2 | Germany | 12.9 | Germany | 16.7 | ||||
| Germany | 12.3 | Germany | 6.0 | Spain | 3.9 | Equal weight portfolio | 10.0 | Australia | 13.9 | ||||
| Equal weight portfolio | 9.7 | Korea | 5.6 | Sweden | 3.2 | Canada | 9.8 | Norway | 12.9 | ||||
| Australia | 8.9 | Australia | 5.2 | United Kingdom | 1.6 | Australia | 8.6 | Switzerland | 12.3 | ||||
| Canada | 6.2 | United Kingdom | 5.1 | Germany | 0.7 | Italy | 8.4 | USA | 12.1 | ||||
| Italy | 2.4 | Canada | 4.3 | France | 0.4 | New Zealand | 5.0 | Canada | 11.7 | ||||
| Norway | -0.9 | Norway | 3.3 | USA | -1.5 | Taiwan | -0.3 | ||||||
| Spain | -4.5 | China A | 2.4 | Italy | -1.6 | Japan | -0.7 | ||||||
| United Kingdom | -10.4 | Italy | 0.8 | Japan | -3.0 | Korea | -0.6 | ||||||
| Brazil | -18.9 | Spain | -0.5 | ||||||||||
| Brazil | -0.6 |
Source: Morningstar, RBC GAM, as of December 31, 2020. For illustrative purposes only. All performance in USD. An investment cannot be made directly into an index. The above does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Country performance represented by index Australia = MSCI Australia Index, Brazil = MSCI Brazil Index, Canada = MSCI Canada, China = MSCI China A Index, France = MSCI France Index, Germany = MSCI Germany Index, Italy = MSCI Italy Index, Japan = MSCI Japan Index, South Korea = MSCI Korea Index, New Zealand = MSCI New Zealand Index, Norway = MSCI Norway Index, Spain = MSCI Spain Index, Sweden = MSCI Sweden Index, Switzerland = MSCI Switzerland Index, Taiwan = MSCI Taiwan Index, United Kingdom = MSCI United Kingdom Index, United States = MSCI US Broad Market Index, Equal Weight Portfolio = equally weighted average of all countries represented
Investors may not realize how closely tied the performance of the Canadian market is to a limited number of companies. In Canada, the 10 largest companies in the S&P/TSX Composite Index account for more than a third of the total Index. That’s significantly more than the 10 largest holdings in most other major indexes around the world.
Total weight of top 10 holdings within their respective index (%)
Source: RBC GAM, Bloomberg. Data as of January 31, 2019
Relative to global equity markets, Canada is highly concentrated in three sectors: Energy, Financials and Materials. These three sectors collectively account for almost two-thirds of the value of the Canadian stock market. At the same time, Canada is significantly underweight in Information Technology and Health Care. These two sectors have been driving forces behind global earnings growth in recent years.
Note: As of May 31, 2019. Sources: MSCI Index - https://web.tmxmoney.com/indices.php?section=tsx&index=^TSX#indexInfo TSX Index – https://us.spindices.com/indices/equity/sp-tsx-composite-index
When you invest globally, you can more easily diversify by sector as your portfolio gains exposure to industries underrepresented in Canada. Some of these sectors are important sources of returns. Others offer defensive characteristics during cyclical downturns.
When diversifying your portfolio globally, it’s important to look beyond your equity holdings. Investing mainly in Canadian bonds or other fixed income securities can also pose some concentration risk. Whether markets are up or down, diversifying your fixed income holdings across issuers (i.e. government, corporate), credit quality (i.e. investment-grade, high yield) and countries can have many benefits. These include:
- reduce your portfolio’s sensitivity to interest-rate changes
- achieve a higher return potential
- add a potential income boost
Global bonds have generally been less volatile
Concentration risk also exists in the bond market. While it may seem counter-intuitive, a portfolio of global bonds has historically been less volatile than a portfolio of Canadian bonds.
Source: RBC GAM, Morningstar, annual standard deviation from Jan 1, 1999 to Dec 31, 2018 Canadian Government bonds: FTSE Canada All Government Bond, World Government Bonds (Hedged): FTSE World Government Bond Index Hdg ($CAD)
So while Canada is a great place to invest – and home to many great companies – it can pay to think globally. You’ll not only avoid the pitfalls of concentration risk, you’ll also enjoy the benefits of travelling as an investor to parts of the world where there is even more opportunity than you’ll find at home.
Investing too much in one region or sector could increase risk in your portfolio. Learn how diversification can help.