The Problem With Diversifying Your Investments In Canada

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It’s an adage almost literally stenciled onto sticky notes on computer monitors and bulletin boards of investment professionals everywhere: Diversification is key.

And it absolutely, unequivocally is. While few have ever made a career out of putting it all on black or red, history has proven time and again that a well-diversified basket of investments typically outperforms a portfolio that holds only a few similar types of securities.

The problem, as most in the Canadian investment community know all too well, is that true diversification — not only being in different types of investments beyond stocks and bonds but true diversification among sectors, companies and even geography — is a tall task in the Great White North.

Indeed, the reality is that the majority of Canadian investors have little choice but to invest in the same sectors that the rest of us do: Resources and Financials.

The reason is fairly simple: The Toronto Stock Exchange is by far the dominant market in the country. And the publicly traded sectors that dominate its makeup are those just described: resources and financials, including banks and insurance companies with close ties to the resources sector.

The answer to this is to look abroad, with the most obvious place to start being the United States. As the largest and most diverse market in the world, it makes sense to look at various publicly traded companies that not only look and act differently from Canadian stocks but also operate in a very different economic environment.

The issue here is the value of the Canadian dollar relative to the U.S. currency, and the kind of premium investors must now pay to buy a U.S. dollar-denominated asset. A few years back when the Canadian dollar was on par or even at a premium with the U.S. greenback, it made a lot of sense to scoop up U.S. investments. And over the past few years, investors have been paid handsomely simply by having the value of the U.S. dollar become worth more in Canadian dollars as the former has gone up and the latter down.

The problem now is that while there are likely more U.S. opportunities to be found from an investing standpoint, the odds of the Canadian dollar continuing its descent are significantly lower than what they used to be. In other words, the major decline in the Canadian dollar relative to the U.S. dollar is likely behind us, and at some point could reverse — which would see the Canadian dollar heading back up again, which in turn would erode any gains made in U.S. dollar-denominated stocks or other assets.

Of course, there are lots of opportunities to purchase equities and other assets right here at home without worrying about getting nicked by the exchange rate, or investing in a non-Canadian company that may or may not perform well. Indeed, the crushed Canadian dollar should eventually provide a boost to corporate earnings and trade, helping boost the value of some Canadian securities.

What’s more, for foreign investors with U.S. dollars to spend and a good cross-section of other securities already in their portfolio, Canada is looking more attractive from a currency standpoint. If resource prices find a bottom and rebound, then there could be even more upside to be had in Canada.

But for investors here at home, the bottom line is that if you’re looking to diversify your portfolio, there are still other regions that also offer strong upside potential and portfolio diversification benefits without such a large and scary exchange rate differential: namely Europe, where the value of the euro has declined slightly less dramatically against the Canadian dollar, and where stocks have generally not performed as well for a variety of economic, political and, obviously, geopolitical reasons. Parts of Asia as well offer the same kind of upside as well as diversification — without a currency hit.

To be sure, the U.S. is still an attractive market, and if played right can provide both diversification and upside irrespective of the exchange rate. While it may not make sense to buy U.S. equities with Canadian dollars, trimming existing U.S.-dollar investments and re-allocating them to other types of U.S. dollar securities that have growing dividends and additional upside potential can also help enhance returns and provide diversification.

The bottom line is that most Canadians feel they have little choice but to invest in Canada — especially with the Canadian dollar not stretching very far. The reality is that diversification can only happen one way: by investing abroad and by doing it in such a way that, irrespective of the value of the Canadian currency against the U.S. dollar and others your overall investment portfolio should perform well — especially in more volatile times.


Source: HP

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