“No place like home” has become “anywhere but here” for Canadian investment portfolios.
Canadians pumped $17.5 billion into foreign securities last November, up from $5.4 billion in October, according to Statistics Canada, dramatically accelerating a trend that has seen investment dollars flow out of the country since then. the start of the pandemic.
The bulk of those Canadian dollars — $7.4 billion — went into buying U.S. stocks, with a focus on big tech companies, and funds that track broad stock indices such as the benchmark S&P 500 index.
Canadian investors also bought $4 billion worth of non-US foreign stocks in November.
The massive inflows of foreign investment have been made by Canadian companies, governments and large institutional investors, but also include individual investors, either directly or through pension plans, mutual funds or exchange-traded funds (ETFs).
In the first 11 months of 2021, Canadians spent a record $82 billion on US securities, and it appears to have paid off. Last year, the S&P 500 Index gained 27%, compared to a more modest gain of 22% for the Canadian S&P/TSX Composite Index. The difference was even starker in 2020 when the S&P 500 posted a 16% gain and the TSX returned 2.2% after the energy sector crater.
The advantage of investing outside of Canada is not new to many long-term investors. Taking total returns over the past 20 years into account, the S&P 500 jumped 516%, compared to the TSX’s 372% rise. This translates to an average annual compound rate of return of 9.5% for the S&P 500 versus 8% for the TSX.
The tendency to invest abroad is a positive sign for Canadian investment portfolios notoriously attached to a domestic bias. Investment savings tend to be heavily skewed towards publicly traded Canadian equities despite the fact that they represent less than 3% of global equities. Of that three percent, about two-thirds are directly linked to the resource or financial sectors, which proved devastating when the energy sector crashed in 2020.
Global diversification can hedge this type of risk and expose an investment portfolio to a wide variety of opportunities in the sectors and geographies of the remaining 97% of the global stock market.
At the same time, a relatively strong Canadian dollar gives Canadian investors greater buying power in international markets. With the loonie nearing 80 cents against the U.S. dollar, Canadians who have bolstered U.S. dollar-denominated accounts in their Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) to buy foreign stocks can expect them to hold their value if the loonie heads below 70 cents as it did at the start of the pandemic.
Most Canadian trading accounts have easy access to directly purchase US-listed stocks, which can also provide exposure to the rest of the world since the US dollar is the global standard. About 50% of all publicly traded companies in the world are based in the United States, and many operate globally. This not only gives investors in US equities a global reach, but it also places the onus on the company to hedge all other foreign currencies.
Investing directly in markets outside of Canada and the United States can be difficult and expensive for the average investor considering the fees, but there are ways.
Most Canadian mutual fund providers offer non-US dollar hedged versions of foreign equity funds. You can invest in a broad global fund (all countries) or an international fund (all countries minus Canada and the United States), or funds that focus on specific countries or regions, or global sectors like technology.
Many foreign equity funds are actively managed by investment teams with extensive research capabilities and experience in the targeted area. Some funds are sub-managed by companies located in the specific geographic region.
The annual fee for this type of reach and expertise can be up to 3% of the total amount invested, which is ultimately drawn from the total return.
ETFs generally have the same reach as mutual funds in terms of geographic regions and global sectors. The big difference is that they are passively managed. This means that holdings are bought and sold according to a predefined formula such as the market weight on the underlying index. ETFs are not as good as mutual funds at adapting to changes or nuances related to specific foreign markets.
On the plus side, fees on unhedged foreign ETFs are generally much lower than mutual funds; often less than 0.05% on the amount invested annually.
While the vast majority of stocks are listed outside of Canada, the right mix of Canadian and foreign stocks in a typical Canadian investment portfolio depends on the individual investor. As a general rule, Canadians should own a large portion of Canadian assets because that is where they live and spend a large part of their retirement. Canadians who spend a lot of time abroad should have more of their portfolio invested in US dollars.
A qualified investment advisor should be able to help you determine the right combination for your portfolio.