This article appears in the March 2021 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.
Advisors are often warned to avoid home bias when selecting stocks for their client portfolios. Canadian equities represent just 3% of global listings, implying that a lopsided investment in Canada may mean clients are missing out.
Yet, home bias is a global phenomenon. U.S. investors, for instance, hold disproportionately more in domestic-listed equities than Canadians do. Investors in Japan and France also invest domestically on a disproportionately greater level than Canadians.
Canadians’ affinity for Canadian-listed securities comes largely from systemic factors. Canadian financial institutions help local issuers raise funds; they place that equity largely through networks of Canadian advisors, whose clients are mostly Canadian. Research and media coverage, geographic proximity and general exposure strengthen the bond.
These anchors also create a comfort level that sits well with investors and shouldn’t be wholly unappreciated in terms of qualitative value for clients.
The major downside is the perceived performance for Canadian investors. The S&P 500 index has outperformed the S&P/TSX composite over one, three, five, 10 and 20-year periods ended in 2020, in both Canadian and U.S. dollars.
To be fair, the Canadian index is tilted too far in favour of the financials, energy and materials sectors. While index investing offers the best combination of the lowest fees and least work, returns can lag on a relative basis.
Active portfolio management means veering away from passive index weights. Can home bias be addressed through active management?
That brings up another problem, which is measuring home bias to start with. The main domicile of a stock listing can mean little in terms of where corporate revenues and profits are generated.
Many Canadian-listed companies are global in terms of their revenues and operations, including convenience store owner Alimentation Couche-Tard, engineering firm WSP Global, materials firm CCL Industries, insurer Manulife Financial and automaker Magna International. Should owning any of these be considered harbouring a home bias?
Another example: Restaurant Brands International (owner of Tim Hortons, Burger King and Popeyes) generates almost half its revenue outside Canada, trades in greater volume on U.S. exchanges, and is covered by more research analysts south of the border.
On a related note, some Canadian firms have recently been eschewing domestic investors when issuing new equity. E-commerce firm Shopify relied mostly on U.S. underwriters to place its share offerings last year, opting for broader advisory expertise and more receptive markets. Others have sought U.S. exposure to escape a home-country discount. Canada-based transportation firm TFI International pursued a NYSE listing and equity offering last year to gain more favourable comparisons to U.S. trucking firms, which garner higher valuations than Canadian peers.
For advisors, it comes down to what avoiding home bias really means. If the aim is to create a diversified portfolio of companies that derive their profits from around the world, that’s easy to accomplish with holdings that are three-quarters or more Canadian in name. The balance can be filled with exposure to U.S.-listed global firms in health care, technology and other areas where Canada lags in terms of public listings.
Portfolio holdings should still be considered on an individual basis, as certain names and sectors can suffer from home bias and overvaluation (consider Canadian renewable power stocks in 2020).
And don’t disregard the positive aspects (for both advisors and clients) of having a comfort level with domestic companies. Investing in unfamiliar names and countries can expose investors to unknown regulatory environments, accounting standards, enforcement regimes, social norms and other risks.
If the valuation case can be made for Canadian stocks with global footprints, don’t fall victim to a fear of missing out on international equities. In over 20 years of helping advisors, we haven’t met one who owns just 3% Canadian equities for clients. Take comfort in that.
Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP, and Mark Rosen, MBA, CFA, CFE, run Accountability Research Corp., providing independent equity research to investment advisors across Canada.