It's a Big World out There, and You Should Own a Piece of It
09/07/2010 3:24 pm EST
Even though global diversification didn’t protect investors from the last market meltdown, you ignore it at your peril, says Globe and Mail columnist Rob Carrick.
It’s back to business for Canadian global equity funds in 2010, which is to say they’re losing money again.
Mackenzie Cundill Value C, the largest fund in the category, lost four percent for the year to September 1. Mackenzie Ivy Foreign Equity, as conservative as they come, was down 1.9 percent. Templeton Growth, one of oldest funds in the business, was down 6.7 percent.
Global funds did well in 2009, but that was an anomaly. On average, they lost 2.6 percent a year over the decade ended July 31, bad enough to turn $1,000 into $768. And yet, the financial industry keeps the faith in global investing.
A selection of online portfolio-building tools were tested for this column and each suggested a weighting in global stocks that was close to or greater than the weighting in Canadian stocks. Anything out of line here? Money managers and academics say no.At Hahn Investment Stewards, the bond and stock segments of the flagship international balanced portfolio are split 50-50 between domestic and global securities. What about all the losses sustained by investors in global funds?
“That’s looking into the rearview mirror,” said Tyler Mordy, director of research at Hahn. Investors have been doing a lot of that lately as they selectively pare down their exposure to the stock market. Selling of global and international funds (global funds invest anywhere, while international funds avoid North America) in the 12 months to July 31 exceeded new purchases by $3.6-billion, according to Credo Consulting. By comparison, net selling of Canadian equity funds totaled $3.1-billion over the same period.
Total holdings in domestic equity funds at July 31 was $129.9-billion, while US, global and international equity fund assets totaled $83-billion. And yet Canada represents only about 4.5 percent of the world’s stock market.
“Canadian investors have this ridiculously strong home bias,” Mr. Mordy said. “It’s observed in every country, but it’s particularly acute in Canada.”
The expert view is that global content is a vital portfolio building block. To gauge the emphasis on global content, I used several asset allocation calculators offered by online brokerage firms to build a portfolio for a long-term growth-oriented retirement portfolio. Total suggested foreign content, including both bonds and stocks, ranged from 50 to 57.5 percent.
For a more conservative balanced portfolio, the suggested foreign weighting ranged from 25 percent to 35 percent.
Sean Cleary, a finance professor at the Queen's School of Business in Kingston, said that if he wasn’t so bullish on Canada right now he would go with a breakdown of 20 percent Canadian stocks and 80 percent global. Instead, he now suggests a 50-50 split.
“I kind of like Canadian equities right now—they’re a little pricier than global markets, but the factors that are driving our economy have long-term potential.”
Professor Cleary was referring to the heavy weighting that oil and other commodities have in the Canadian market. There’s growing demand for raw materials from emerging economies like Brazil, China, and India, which have not been subject to the same economic slowdown as the developed world.
Of course, the skew toward commodities—and financials—in the Canadian market is an argument for diversifying globally. Almost three-quarters of the S&P/TSX composite index is accounted for by the energy, materials and financial sectors.
Global diversification has severe limitations, mind you. “As we saw in the financial crisis, all global stock markets moved in the same direction,” Professor Cleary said.
Investing experts call this correlation—the tendency for market and other kinds of assets to move up and down at the same time (for more on correlation, check out this recent Portfolio Strategy column: tgam.ca/kl2). At IceCap Asset Management in Halifax, their goal in portfolio building is to work around the high correlation between global stock markets.
They do this by using six types of assets: Cash, currencies, gold, bonds, stocks and commodities. “When we talk about asset allocation, it’s not all about Canada and the US or international—we put all that in the equity bucket,” said Keith Dicker, IceCap’s president and chief investment officer.
So how does IceCap build portfolios if not by considering geography? By using a selection process that considers the overall economic environment, corporate earnings trends and sentiment toward the stock market.
“When we put that altogether, it’s going to tell us whether we want to be in risky assets, stocks and commodities, or in more defensive assets, primarily bonds and cash,” Mr. Dicker said.The Canadian stock market has been one of the best performers in the developed world in recent years, but that’s not the only reason global funds have lagged. A sharp rise in the value of the Canadian dollar against currencies from the United States and elsewhere has also undermined returns from outside the country.
The investment industry offers many currency-neutral global mutual funds and exchange traded funds, which more or less track the returns of the underlying securities while blocking the impact of currency fluctuations. Or, you can hold for the long term and hope for the ups and downs in our dollar to cancel each other out.
Both IceCap and Hahn Investment Stewards make the decision on whether to use hedging based on their view of the Canadian dollar at a point in time. Currently, IceCap is not using hedging, while Hahn is using it for investments denominated in euros.
There are two final points worth noting in Hahn’s approach to global investing. One, faster-growing emerging markets should play a role in your global exposure. True, emerging markets are riskier than developed markets. But Mr. Mordy noted that emerging markets largely avoided the global financial crisis, and they had nothing to do with its causes.
A second point is the usefulness of global bonds, which Mr. Mordy sees as adding additional diversification to a portfolio that will reduce risk and add to returns. Note: Global bond funds soared in 2008, and they’re doing pretty well this year.
“International fixed income is one most neglected asset classes in Canada for sure,” Mr. Mordy said.
Here are four different takes on how much foreign content to put in a portfolio suited for long-term retirement saving by someone who is primarily interested in building the value of their holdings as opposed to income and has a reasonable tolerance for risk.