When it comes to investing, it’s not surprising that many Canadians tend to favour domestic companies whose products and services they are most familiar with. This inclination is called “home-country bias.” It is the tendency to invest close to home and is not unique to Canada. In fact, as this chart shows, it is a worldwide phenomenon.
Home country bias by country
Source: Global index weight reflected by country’s weight in the MSCI All Country World Index as of May 31, 2019. Investor holdings in domestic market sourced from the IMF, as of December 2014.
Although investors may feel more comfortable choosing investments that are close to home, home-country bias can leave them at greater risk if their domestic economy falters. There are two reasons for this higher risk:
1. A smaller field of opportunity
Canada represents only a small fraction of global GDP and just over 3%1 of the world’s capital markets. This means that 97% of the world’s investment opportunities are to be found outside of Canada. An overemphasis on one country is the financial equivalent of having all your eggs in one basket.2. Concentration risk
Canadians who only invest at home risk limiting their opportunities and face a greater concentration risk in their portfolios. For example, unlike the rest of the world, the Canadian stock market is heavily dominated by companies in three sectors: Energy, Financials and Materials.
Concentration risk: Canada in comparison to the world
To counter this, investors can look abroad to achieve greater diversification.
Canada can be a great place to invest. But many Canadians may not realize just how much of their personal wealth is in Canada or tied to its economy. In fact, the average Canadian has approximately 90% of their total assets in Canada. These assets can include a home, savings, investments, employment income and pensions (both private and government).
| 40.6% | Real estate | ||
| 18.6% | Funds, stocks and bonds (Domestic) | ||
| 26.5% | 7.9% | Funds, stocks and bonds (Foreign) | |
| 15.8% | Pensions, insurance, CPP/QPP | ||
| 11.4% | Cash and GICs | ||
| 5.6% | Private mortgages and businesses |
Source: Investor Economics Household Balance Sheet Report 2019, data as of December 2018
An easy way to start is to invest some of the new contributions you make to your investment account(s) in other geographical regions and sectors. By diversifying globally, you may increase your return potential, while also lowering volatility, as the historical chart below illustrates:
Source: RBC GAM, Morningstar, as of June 1, 2009 to May 31, 2019. Composition of global balanced portfolio: 35% Bloomberg Barclays Global Aggregate Index (Hedged), 1% FTSE TMX Canada 30 Day T-Bill Index, 4% JPMorgan EMBI Global Diversified Index, 7% MSCI Emerging Market Index, 22% MSCI World Index ex Canada, 30% S&P 500 Index, 1% S&P/TSX Composite Index. Indexes used to represent each of the asset classes shown: Cash = FTSE TMX Canada 30 Day T-Bill Index, World government bonds = FTSE World Global Bond Index (Hedged), Canadian government bonds = FTSE Canada All Government Bond Index, Emerging market bonds = JPMorgan EMBI Global Diversified Index, Global equities = MSCI All-Country World Index, Canadian equities = S&P/TSX Composite Index, U.S. equities = S&P 500 Index, Emerging market equities = MSCI Emerging Market Index. An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes, which would reduce returns. Past performance is not a guarantee of future results. All performance in $CAD.
A broadly diversified global portfolio has the potential to smooth out your investment experience. It can reduce the risk of losses and enhance your potential returns over the long term.