Are Canadian Equities a Better Risk?

CIR Online Debaters discuss the home bias.

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story_images_Canada-flagCanada has supplied stronger returns than most markets – in both bonds and equities. It turns out that home bias was richely rewarded. But will it be in the future, as the global economy returns to something closer to a normal pattern of economic growth? And further, does Canada present a better risk/reward profile?

That’s the topic for the current debate on CIR Debates Online.

Certainly there’s room for doubt. Canada does not have a representative stock market. Instead, it is overweight in financials, energy and materials. Still the market may be more diversified than it looks, says Bob Decker, SVP and Portfolio Manager, Equities at Aurion Capital Management.

“The resource tilt in Canada’s equity market is often cited as a shortcoming. No doubt, the abundance of natural resource investment opportunities and the broad investment infrastructure derived from them has fostered some spectacular growth stories such as Suncor, Potash and Barrack Gold. On the non-resource side however, there exists a considerable balance between resources and non-resource earnings power that has dampened volatility and consistently lowered intramarket correlation. The Canadian banks and their stabilizing effect on the earnings power of the S&P/TSX has been a major factor in Canada’s superior performance. Our banks are widely recognized as the best capitalized in the world, while at the same time benefiting from Canada’s structurally stronger credit system. In other sectors, the oligopoly structure of major industries such as transportation, telecommunications and media, have created high barrier to entry businesses capable of generating sustained excess profitability.”

Against, that, Jonathan Jacob, Managing Director at Forethought Risk argues: “From a risk-adjusted perspective, global equities provide a tremendous opportunity for diversification. Different economic regimes, such as those of developed versus emerging markets described above, are one source of diversification. Another source of diversification is economic risk – the various individual economies within those regimes can vary in their performance. A third source of diversification is sector diversification – the different sectors of the economy can perform differently depending on what point in the business cycle one believes we are currently in. A final source of diversification can be found in individual stock selection.

“Unfortunately, Canada falls short with respect to potential for diversification on all four of these measures.”

Philip Falls, a board member, with the Association of Canadian Pension Fund Management and the Pension and Investment Association of Canada, is the moderator of the debate. He poses a set of questions worth reflecting on:

“How can it be that “investing mostly domestically” is okay for some economies like Canada, Australia, and Brazil, but not for others? What factors and assumptions need to be considered to conclude that domestic investing is less risky than international investing? How much is hindsight? Will these conditions persist in the future? Many foreigners who invested overseas saw their risk levels reduced and returns boosted than if they had stayed home — for Canadian investors it was the opposite. Shouldn’t the benefits of investing domestically be the same across most countries? And if not, which country will benefit from the right conditions and more importantly can anyone forecast that outcome correctly?”

To add your point of view, go to CIR Debates Online.

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