A new report from senior investment strategist Bilal Hasanjee reveals Canadian investors are massively overweight domestic equities
Many Canadians are losing out on maximizing potential returns by having a poor balance of equities in their portfolio which overly favours domestic stocks.
According to a new report from Vanguard Investments Canada published today (June 29) investors should be looking at global market capitalization indices for a steer on allocations, given that they are based on investor consensus.
Senior investment strategist Bilal Hasanjee gives an example of allocations on June 30, 2022, when Canadian equities made up 3.4% of the global equity market.
On that basis, “a forward-looking efficient portfolio should only allocate about 3.4% of equities to Canadian stocks,” as of that date, Hasanjee said.
However, the data shows that their actual allocations to domestic stocks were 55.6% of their total holdings of equities – more than 16 times overweight.
Having such strong domestic bias could stop investors benefitting from broad diversification across global markets.
"While Canadians still have a high allocation to domestic equities, the good news is that they are moving in the right direction,” Hasanjee told Wealth Professional. “Over the past decade, we have seen Canadian investors gradually moving to global equities and increasing the level of international diversification within their portfolios. This diversification to global securities has been observed among investors outside of Canada as well."
He added that this is a positive step given that high levels of domestic equity exposure have led to greater risk and volatility in a portfolio, without a corresponding increase in returns.
Risk in overweighting Canadian stocks
That doesn’t mean being overweight Canadian equities at all is a bad thing and there are many reasons for doing so, Hasanjee acknowledges, including familiarity, tax considerations, hedging domestic liabilities and currency risk, and future return differentials.
However, Vanguard’s optimal portfolio allocations mix for equities is 30% Canadian and 70% international because it has shown to minimize the long-term volatility of their portfolio.
"We believe that the optimal investment mix for Canadians is 30% allocation to Canadian equities and 70% allocation to international equities since it has shown to minimize risk, volatility and sector exposures that are peculiar to the Canadian market, namely the energy and financial sectors,” added Hasanjee.
Another element to this though is the concentration of allocations to Canadian equities vs. the global market, which reduces diversification among Canadian portfolios.
Vanguard’s research shows that the top 10 Canadian equities make up 37% of Canadian market weight (1% of global weight). These stocks are heavily concentrated around financials (RBC, TD, Bank of Nova Scotia, BMO, etc) and energy (Enbridge, Canadian Natural Resources, etc) based on the FTSE Canada All Cap Index on May 31, 2023.
Looking at the top 10 holdings globally, which are heavily dominated by tech firms (Apple, Microsoft, Alphabet, Amazon, Tesla, etc.) based on the FTSE Global All Cap Index on May 31, 2023 – these stocks make up just 16% of the global equity market.
Improving mix
Vanguard’s analysis looks back at a decade of portfolio allocations and found that, in line with many other developed markets, Canadians’ domestic equity allocation bias has improved.
Investors appear to be increasingly valuing international equity allocations for their diversification effect.
However, allocations to domestic stocks remain elevated.
“This bias results in security and sector concentration, leading to an inefficient portfolio allocation and exposure to considerable idiosyncratic risk that can be diversified away by allocating to both Canadian and global equities in a portfolio,” concludes Hasanjee.
