• Portfolio Construction + Management

Ask Bender: Canadian Stocks vs. Global Stocks (Part II)


In my last blog post, we found that overweighting Canadian stocks by about 30% (relative to a global market capitalization equity weight of about 3%) had historically resulted in a less risky portfolio.  Obviously, this analysis gave no guarantee of the minimum risk portfolio going forward, but it did provide a useful starting point for discussion.

This week, we received our first email from an investor who wanted to know why our model ETF portfolios didn’t have a higher allocation to Canadian stocks.  As Canadian stocks have outperformed global stocks by a wide margin during 2016, we figured that it was only a matter of time before investors started to favour Canadian stocks once again.

This brings me to my next argument for overweighting Canadian stocks:

Reason #2: Behavioural biases may be reduced with a 30% (or more) overweighting to Canadian stocks.

This is one of the most important, but often most underappreciated aspects of the global equity mix decision. Over the past five calendar years, global stocks have outperformed Canadian stocks by an impressive 11.54% per yearRecency bias (the tendency to base our investing decisions on more recent events) has caused investors to question why on earth they would have any portion of their portfolio invested in Canadian stocks (or even more recently, why they don’t have more invested in Canadian stocks).

Global stocks have not always been the investor darlings that they were at the end of 2015. If we look at the fifteen calendar years prior to 2011, we find that Canadian stocks outperformed global stocks by an average of 6.52% per year.  During that time, it was not uncommon for Canadian investors to dismiss global stocks entirely and instead opt for a 100% allocation to Canadian stocks.

Annual Return Differences in Canadian Stocks vs. Global Stocks: 1988 to 2015


Source: MSCI Indices

Between 1996 and 2010 (the same fifteen year period), a $100,000 investment in Canadian stocks would have grown to $453,510.  During the same period, a $100,000 investment in global stocks would have grown to only $182,207 (for a difference of $271,303).  Most Canadian investors that chose a market capitalization-weighted portfolio (with only about a 3% weighting in Canadian stocks) would have been kicking themselves for their decision.  This would have been especially true if they knew how their friends and family had been invested.

Using 2014 year-end data from the International Monetary Fund’s Coordinated Portfolio Investment Survey and the World Federation of Exchanges, Morningstar estimated the average Canadian equity content of a Canadian investor to be around 62% (Vanguard Canada estimated this figure to be around 59% at the end of 2012).  If the average Canadian investor had a similar home-bias to these figures between 1996 and 2010, it would have made the cocktail discussions even more intolerable for a market capitalization-weighted investor.

Sure, maybe the returns of Canadian stocks will soon fall short of their global counterparts once again. But what if they continue to outperform over the next five, ten, or even fifteen years?

Fifteen years is a long time to be consistently wrong. Investors need to choose an asset mix that they can stick to through the good times and bad.  Personally, I’m comfortable with overweighting Canadian stocks by 30%, but I would never argue with an investor who allocated 50% of their stock allocation to Canadian stocks and 50% to global stocks, for behavioural reasons.



By |2016-12-20T03:24:02+00:00September 12th, 2016|Categories: Portfolio Construction and Management|Tags: , , |22 Comments


  1. apare January 21, 2017 at 5:10 am - Reply

    Hi Justin,
    Does VXC captures the MSCI ACWI INDEX returns?
    And what’s the advantages of using VUN, XEF and XEC over that single etf?

    • Justin January 21, 2017 at 11:17 am - Reply

      @apare: VXC tracks the FTSE Global All Cap ex Canada China A Inclusion Index. XAW tracks the MSCI ACWI ex Canada IMI Index (which is similar to the MSCI ACWI Index, but it includes small cap companies and excludes Canadian companies).

      Breaking up the holdings between US (VUN/VTI), international (XEF/IEFA) and emerging markets (XEC/IEMG) can make sense for taxable investors that are trying to be as tax-efficient as possible. For example, they may hold US equities in their taxable account as they have a lower dividend yield, and hold international equities in their RRSP, as they have a higher dividend yield.

      It can also be more tax-efficient to hold the US-listed versions of VUN/XEF/XEC (VTI/IEFA/IEMG) in your RRSP account, in order to lower costs and mitigate the tax drag from foreign withholding taxes. Holding VXC or XAW will be more costly to hold in an RRSP account than their US-listed underlying ETFs: https://www.canadianportfoliomanagerblog.com/perfecting-the-perfect-portfolio/

  2. Rick-J September 29, 2016 at 9:48 pm - Reply

    One follow up question. What is your advice about buying international stock ETF during the North American market hours. Is there a time that is less susceptible to stale prices due to time zone differences? In particular I am thinking of VEA and VWO.

  3. Jim September 20, 2016 at 1:40 pm - Reply

    Hi, Justin,

    It is a very nice discussion. I believe, personally, some of home bias is all about the personal behavior. You indicated ” But what if they continue to outperform over the next five, ten, or even fifteen years?”. We can also ask “But what if they continue to under-perform over the next five, ten, or even fifteen years?” As I have learned from Bill Berstein’s book, the most important thing for the asset allocation is (1) the ratio of fixed to equity and the specific allocation within the equity does not matter too much; and (2) stick to your plan always regardless of thick and thin. I believe, it would be a disaster to chase the recent hot asset, and change our allocation based on the recent performance of the assets of the interests, rather than based on the changes in our personal financial conditions. For a long-term investing for retirement, it would be very hard to judge a country-specific asset based on a short-term data, such as 5 years, 10 years, and 15 years.

    • Justin September 21, 2016 at 12:41 pm - Reply

      @Jim: William Bernstein would definitely agree that an investor’s bad behaviours can ruin their investment plan:

      “Discipline matters more than allocation. Almost all advisors will tell you that what separates successful from unsuccessful investors is the ability to stay the course, irrespective of what that precise course is.”

      But I think he would also agree that diversifying the equity portion of your portfolio away from just a single stock market could mitigate a “Japan” scenario if it were to arise:

      “In short, resign yourself to the fact that diversifying yourself among risky assets provide scant shelter from bad days or bad years, but that it does help protect against bad decades and generations, which can be far more destructive to wealth.”

  4. Tim September 14, 2016 at 8:01 pm - Reply

    Hi Justin, this is an interesting series. Thanks for it.

    How would you address the argument that Canadians should reduce their Canadian investment exposure due to the financial exposure of a Canadian-based job and the value of their home? Both are would be generally positively correlated with the Canadian economy.

    • Justin September 15, 2016 at 9:55 am - Reply

      @Tim: I’ve always viewed a home as a lifestyle asset, and not something to include in portfolio investment decisions.

      I view Canadian investment exposure vs. financial exposure of a Canadian-based job in a different way. Developing your human capital is something that Canadians should be more focused on. It is something that they can control to some extent by increasing their employability (unlike the stock market, which they have no control). If you have the choice between taking a course that may help your career, or investing in the stock market, I would opt for the first choice.

      At the very least, if you have a job that could be at risk during market downturns, you should have a greater portion of your portfolio invested in safer fixed income securities.

  5. Rick-J September 14, 2016 at 7:40 pm - Reply

    Thanks so much for writing these two posts. Home country bias is an issue I wrestled with for a long time. I find the issue especially daunting for us Canadians given the small proportion of the global economy we represent and how concentrated the sectors are in Canada (Energy, Materials and Financial).

    Without the benefit of your thoughts I settled on increasing over weighting Canada by a factor of 7 to 21% (from 3% of the global market) of my equity allocation.

    The next question I wrestled with was where to take the extra 18% allocation from. After looking at the high correlation between US and Canadian markets, I opted to under weight my US holdings from 50% of my equity allocation to 30% of my equity allocation.

    The remainder of my portfolio is held in VEA (in RRSPs) or XEF (in RESPs) (42.5%) and VWO (7.5%). I realize the numbers are over 100, but that is because VEA and XEF has Canadian exposure and I actually have 20% in XIC. Looking at the graph in your previous post that is not far off the optimal historical ratio.

    That said when I offer investment suggestions to friends I suggest they simply go with 1/3 XIC and 2/3 XAW for their equity portion and keep it simple.

    Personally I think that if you are fortunate to have a large portion of your net worth in a pension and your principal residence and plan to travel abroad having a significant exposure to foreign currencies hedges your future currency risk.

    It used to be that the significantly lower costs of US based ETFs was another point in favor of reducing Canadian exposure, but this has virtually disappeared over the years and now foreign withholding taxes weigh heavier on my mind as I strive for the cheapest portfolio possible (my blended MER is 0.08 not counting the effect of foreign withholding taxes)

    Lastly, one often overlooked advantage to minimizing your home country bias is that the performance of the Canadian economy can pose taxation, housing market, and currency risks that you cannot avoid other than by investing abroad. Of course you have to be a believer in the value of hedging these risks if you are to survive the opposite behavioural risks.

    Any thoughts or suggestions on my thought process are welcome.

  6. J Palmer September 13, 2016 at 6:45 pm - Reply

    This posting seems an appropriate time to ask something that has always puzzled me: How does one categorise stocks that are multinational in scope, when it comes time for asset allocation. For example are Apple or Coke classified American or should they be considered international?
    How about Brookfield Infrastructure? Is is considered Canadian or global, considering most of their operations are outside of Canada?

    • Justin September 14, 2016 at 9:33 am - Reply

      @J Palmer: I’ve often heard similar arguments concerning international diversification and whether it’s necessary now that some companies earn a large portion of their income overseas. While this may be true, the stock market returns and currency returns still tend to differ across economies (which is expected to lead to diversification benefits): http://awealthofcommonsense.com/2015/07/is-international-diversification-worth-the-risk/

      As for how BIP.UN/BIP is classified, I took a quick glance at a few broad-market ETFs (XIC, IEFA, ITOT) and didn’t see it included in any of them. For what it’s worth, I would likely classify it as a “global” investment.

  7. D September 13, 2016 at 11:47 am - Reply

    Wow, thanks Justin! As always, I am impressed by your thorough and complete answers.
    My accountant and my wife’s financial advisor had diffculty answering clearly some of the past questions I have asked on this blog. You really are a national treasure for Canadian DIY investors!

    • Justin September 13, 2016 at 4:29 pm - Reply

      @D: You’re very welcome! I wouldn’t be too hard on your accountant – with tax questions, it’s difficult to give a response that is accurate in all situations.

  8. D September 13, 2016 at 7:47 am - Reply

    As Jaz, I wonder if your asset allocation/home bias change depending on where you mainly hold your invesments and your age near retirement?

    Other advantages of Canadian equities are:
    – no foreign tax withholding for registered and corporate accounts
    – tax advantage of Canadian dividends in taxable accounts
    – no currency fluctuation for people nearing retirement

    When do these advantages overtake the point of minimum volatility argument from your first blog?

    Let’s take for example a person 30 years from retirement with maxed out assets in registered accounts and with 3 times more asset in corporate account. Is 33% Canadian in equities a reasonable percentage of equities or is a higher % needed since most of the savings are in his taxable corporate accounts and that Canadian equities have a significant tax advantage in corporate accounts?

    • Justin September 13, 2016 at 10:33 am - Reply

      @D: You’ve brought up a number of great discussion points – here are some additional thoughts.

      – No foreign tax withholding for registered and corporate accounts. Foreign withholding taxes in registered plans can be eliminated or mitigated by investing in US-listed ETFs. The foreign tax drag from foreign dividend income in a corporation can be mitigated by applying asset location strategies.
      – Tax advantage of Canadian dividends in taxable accounts. As mentioned earlier, the annual income tax on US-equity ETFs is not expected to be higher than the annual income tax on Canadian-equity ETFs (even with the tax advantages of Canadian dividends) – this is due to the higher dividend yield of Canadian stocks. International and emerging markets equity ETFs could be held in RRSPs/TFSAs to mitigate the taxation of their higher yielding foreign dividend income.
      – No currency fluctuation for people nearing retirement. As mentioned in the comments from my previous post, the currency diversification actually reduced the volatility of the portfolio further (in addition to the benefits from the global equity diversification). For retirees, a better way to reduce the risk of the portfolio is to hold more fixed income (not to “undiversify” their portfolio by holding more Canadian equities).

      In your portfolio example, let’s assume you have $100,000 in an RRSP and $300,000 in a corporate account. For simplicity, we’ll also assume that you have a 25% fixed income, 75% equity mix. An investor who decided on a 1/3 allocation to Canadian equities may set-up the portfolio in this manner:

      – 25% Fixed Income = $100,000 (corporate account)
      – 25% Canadian Equities = $100,000 (corporate account)
      – 25% US Equities = $100,000 (corporate account – slight tax drag from foreign dividend income)
      – 25% International and Emerging Markets Equities = $100,000 (RRSP account – possibly using US-listed ETFs)

      Another investor might prefer to invest 1/2 of their equity allocation in Canadian equities:

      – 25% Fixed Income = $100,000 (corporate account)
      – 37.5% Canadian Equities = $150,000 (corporate account)
      – 18.75% US Equities = $50,000 (corporate account), $25,000 (RRSP account – possibly using US-listed ETFs)
      – 18.75% International and Emerging Markets Equities = $75,000 (RRSP Account – possibly using US-listed ETFs)

      Again, I don’t see a huge issue with either of these portfolio allocations (they each have their positives and negatives – as long as the investor is aware of them and can stick to their plan, they should do well over the very long term).

      • gsp September 13, 2016 at 5:54 pm - Reply

        Hmm, 200/300 is more than half, some might even call it two thirds. 😉

        • Justin September 13, 2016 at 9:23 pm - Reply

          @gsp: Thanks, for the catch! (not sure what I was thinking when I typed that 😉

      • Sue September 23, 2016 at 9:28 am - Reply

        Justin- would it not be better to put the fixed income portion into the Registered account rather than the corporate account because of the tax inefficiency with interest income bearing a higher tax liability than if the corporate account had equities in it instead (assuming Canadian equities-stocks)?

        this speaks of the need for not only asset allocation but asset class location across a person’s various accounts

        • Justin September 23, 2016 at 12:25 pm - Reply

          @Sue: Asset location is not as big of a decision as it once was. Fixed income yields are at record lows, so as long as you avoid traditional “premium” bond ETFs in your corporate account (i.e. VAB, VSB, XQB, XSQ, ZAG) and opt for more tax-efficient alternatives (i.e. ZDB, BXF, HBB, 1-5 year GICs), this can generally make sense. Another benefit of having fixed income in taxable accounts is for rebalancing purposes or unexpected calls on capital. If you have all equities in your taxable accounts that have large unrealized gains on them, you may be forced to realize the taxes when rebalancing or selling the ETFs for liquidity.

          Over the years, I have come to realize that there is no perfect solution for asset location – too many factors arise that will offset the benefits of even the most well-thought out strategy.

  9. Jaz September 12, 2016 at 11:48 pm - Reply

    If you hold your investments only, or mainly, inside taxable accounts, would this affect your asset allocation / home bias? Since canadian eligible dividends are more tax efficient than foreign dividend income, would it make sense to overweight Canadian equities compared to global equities (ex 50% instead of 30% )?

    • Justin September 13, 2016 at 10:00 am - Reply

      @Jaz: This could have an impact on an investor’s asset mix decision.

      However, it’s important to keep in mind that Canadian stocks had a dividend yield of 2.83% (as of August 31, 2016). If eligible dividends are taxed at 39.34% for an Ontario resident in the highest tax bracket, then an investor would pay 1.11% in annual taxes.

      US stocks had a dividend yield of 2.03% (as of August 31, 2016). If foreign dividends are taxed at 53.53% for an Ontario resident in the highest tax bracket, then an investor would pay 1.09% in annual taxes (slightly less than our Canadian equity example). So investing in a US-equity ETF in a taxable account would not be expected to increase the annual income tax bill, relative to holding the same amount in a Canadian-equity ETF.

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