The Canadian market
Canada has provided excellent returns to investors over the years, but the Canadian market occupies a tiny place on the world stage, and its supply is limited. The World Federation of Exchanges reports that its 58 regulated exchanges had a market capitalization of US$54.672 billion at the end of 2012. TMX Group, which includes Toronto Stock Exchange and TSX Venture Exchange, represented less than 4% of this figure.
And that’s only part of the pie. Researchers Todd Moss and Ross Thuotte point out that more than 120 countries have stock exchanges. Either way, Canada remains a relatively small player.
The Canadian market also offers limited opportunities for investors. Its leading indicator, the S&P/TSX Composite Index, comprises more than 70% of companies from three industries – financial services, energy and materials (including significant mining companies). The index covers 95% of the equity market. So if you believe that tech stocks are the way of the future or that with an ageing population, healthcare companies are a safe bet, you have few investment options in Canada. Tech stocks make up just 1.65% of the index and healthcare just 2.91%. This means that you need to look beyond Canadian borders to take advantage of potential opportunities.
The international market
“There are some great companies in the international marketplace headquartered in Europe or Japan,” says Graham, an experienced portfolio manager with an enviable track record. In the United States, Europe or Japan, you have access to investments that are not available in Canada.”
So by investing globally, you can do two things: potentially increase returns by taking advantage of opportunities that don’t exist here and reduce risk. If oil and mining stocks fall, the entire Canadian market – and your portfolio, if it’s made up entirely of Canadian stocks – suffers. These two sectors of activity account for nearly 40% of the composite index. Or, if an economic crisis causes a sharp drop in markets in Canada, your financial well-being will be at risk. However, if your eggs are spread across multiple baskets and problems arise, you may lose one egg, but the others will not be affected.
This is where the concept of correlation comes in. Markets follow cycles, but in general, they do not all progress in the same way. Some, those with a “correlation coefficient” of +1, evolve in parallel: if one of them goes up or down, the other does the same. Canada and the United States are good examples. As the 2008 crisis showed, the markets of all developed countries have become highly interrelated and often move in tandem.
Emerging Markets
Other markets, those with a correlation coefficient of -1, move in opposite directions: if one market goes up, the other goes down, and vice versa. Specific markets are, of course, not subject to any correlation, and this is what MM. Emid and Graham see the advantage of emerging markets, which are a subset of emerging markets. There are about 40 countries, including Vietnam, Kenya, Nigeria and the United Arab Emirates, which are considered emerging markets according to established indices, and which are located where emerging markets such as China or India were 10 or 15 years ago.
“Emerging markets are not correlated with any developed or emerging markets,” says Graham. Because they are uncorrelated, they reduce the overall volatility of your portfolio.”
So how much of your portfolio should you invest in the international market? Graham suggests between 15% and 25%, with 5% to 10% in nascent markets (or 0.75% to 2.50% of your total portfolio). It also depends on your age and where you are in life. If you’re still young and can let your savings grow, you could be at the higher end of the range. If you are in or nearing retirement and need to dip into your investments, you will be at the bottom of the range. And what would be the easiest way to make these investments? You can opt for mutual funds or, in the case of developed and emerging markets, exchange-traded funds (ETFs). Thus, you can leave the choice of stocks and countries in the hands of professionals.
