ETF transparency helps investors overcome the risks of home country bias

By Lori Bamber

If you’re looking for an indicator of the world’s perception of Canada’s economy, you might consider the exchange value of our currency, hovering around 75 cents U.S.

But if their equity portfolios are an accurate gauge, Canadians are much more enthusiastic about the future performance of the TSX. “The average investor has some 60 per cent of their assets invested in Canadian equities – and yet Canada’s weight in the global equity market is around four per cent,” says Pat Dunwoody, executive director of the Canadian ETF Association. 

While this concentration has paid dividends in the past as commodity prices climbed, it is also a significant – and completely avoidable – risk factor. “Home country bias is a hazard to long-term returns,” says Reg Jackson, a portfolio manager with the JMRD Wealth Management Team at National Bank Financial. “Regardless of the country in question, too much of anything can be detrimental.” 

Intensifying the risks of geographic overweighting is the composition of the Canadian market, heavily concentrated in energy, financial and materials and underweight in all other sectors, says Dunwoody. “This has sometimes been profitable for investors, but it has become an issue with energy and mining – and it could become much more of an issue in the future.”

Canadian investors are already leaving potential returns on the table as U.S. and some European markets outperform, along with several asset classes that are inadequately represented on the TSX, notes Jackson. 

Part of the challenge is that many Canadian investors think their portfolios are far more diversified than they really are, because they own a variety of mutual funds. “It looks like diversification, but it is so common to own a number of mutual funds that own the same companies,” he explains. 

In fact, Jackson recently analyzed seven Canadian mutual funds spread across a variety of management companies, and found that the top 10 stocks in each of those seven mutual funds were the same. 

“This compounds the home bias issue,” says Dunwoody. “Rather than being adequately diversified geographically and by sector, you may be investing in the same stocks over and over again.”