Homeland affinity

“Administratively, it was torture. It was something you had to track and there was a penalty if you went over the limit,” says Abboud, an advisor with Wealth Strategies/Raymond James in Orleans, Ontario, recalling the additional paperwork involved in complying with the rule, especially for offbook accounts.

“It was a real pain for us as planners because the book value of registered plans was recalculated on a monthly basis and there was a 1% penalty applicable when the 30% threshold was exceeded,” adds Jeanette Brox, a CFP with Investors Group in Toronto. “That’s a nightmare for someone with a big book.

“It was a challenge, and you really had to be organized,” Brox says.

The rule was scrapped in 2005, opening the door to international investing. But getting clients to accept the idea of more international content in their portfolios remains a challenge. Despite the termination of the foreign content rule, Canadian investment in foreign securities remains surprisingly low.

Home country allocations of non-U.S pension plans

A survey conducted earlier this year by Environics Research for Brandes Mutual Funds found Canadians with more than $250,000 in investable assets hold only 15% of their equity portfolios in international markets—Canadian markets accounted for 66% and 19% were in U.S. markets.

“You would of course expect Canadians to have a home-market bias, but when two-thirds of their equities are here, along with their real estate and jobs, that’s putting a lot of eggs in one Canadian basket,” says Oliver Murray, President and Chief Executive Officer of Brandes’ Canadian operation.

Nearly 80% of the 1,000 affluent investors surveyed said they believed Canada offers enough diversification—about the same percentage said they’re more familiar with Canadian investments. Meanwhile, 67% said they believed global markets are riskier; and a similar percentage said Canadian markets would outperform international markets.

This strong belief that Canada will always outperform global markets is a concern, says Murray. “Always is an imprudently long time when you consider that Canada is the most resource-heavy stock market in the world.We are concerned that affluent Canadian investors are focused entirely on how good Canada is.”

And home bias is not limited to Canada. Researchers at the Australian School of Business found evidence of home bias in 38 financial markets.

One major influencing factor is that clients simply have access to more and better information about domestic securities than foreign ones. “They can drive to work and they see Tim Horton’s and Imperial Oil and Canada Western Bank, so there’s a certain amount of familiarity there,” says David Salloum, vice-president and portfolio manager with RBC in Edmonton.

Perhaps surprisingly, studies have shown portfolio managers exhibit home bias even at the level of mutual funds, where detailed information is available from numerous sources.

“I think there’s a home bias in all investors around the world because we’re more familiar with the things we understand, like our currency and our banks,”Abboud says. “If you’re going to retire in Canadian dollars, you want to have a bias to Canadian dollars in your portfolio. There’s always home bias just for comfort.”

And it’s true investing in Canada does have advantages—despite some ups and downs, the Canadian stock market is performing as well or better than any other market in the developing world. However, making forward-looking investment decisions based on historical returns is fraught with danger.

The disadvantages of an investment portfolio heavily weighted in Canadian securities are clear. For instance, Canada represents just 5% of the world’s total equity market capital.And there are limited investment opportunities in a number of sectors, such as healthcare and consumer goods. Canadian companies in those sectors tend to be smaller than their international counterparts, which increases risk.

“On the investment side, it’s really hard to look just at Canada because of all the great companies abroad,” Abboud notes. “We are pretty focused in Canada on financials and things that come out of the ground so we’d be missing out on a lot of other sectors.”

Given the turmoil in the markets over the past few years, Abboud admits encouraging more foreign investment for the sake of diversification is a difficult proposition. “Certainly adding other countries is a benefit long-term, but over the next couple of years, who knows?”

Part of the reason Canadians might be reluctant to invest outside of the country is currency risk, Salloum points out. A surging Canadian dollar might begood for cross-border shopping but it makes foreign investments—particularly in the United States—much less attractive.

Abboud says he has been using currency-hedged international funds for clients in need of international exposure. Such funds are considered less risky than other international funds since the currency is stripped out of the equation.

So how much is enough when it comes to foreign investments? That depends on the client, Salloum says. “Generally, we try to have some exposure outside of North America, but I arrive at the percentage by asking a series of questions. Where’s the money going to be spent in retirement? What’s the risk tolerance? What kind of time horizon do they have? I’ve got a 40-page questionnaire I go through with clients. There’s a lot involved with how we get to that diversification number.

“We try to encourage foreign investment opportunities and diversification. Then you work with the clients in terms of how many eggs should be outside the North American basket.”

Abboud’s approach also involves a thorough review of clients’ financial plans. “And when we get to foreign holdings over the last couple of years, it’s explaining why they haven’t kept up with some of the Canadian ones,” Abboud says. “But we always get back to the underlying securities, and how they are quality companies that we just can’t replicate in Canada. It might not feel right currently, but it does appear to be the right thing long-term. It would be too risky to be focused on just Canada.”

“You have to look at the ups and downs of the market,” Brox adds. “There will always be dips and corrections, so you want to capitalize on the downs. Everything comes down to a client’s comfort level and time horizon.”