O Canada: Does Your Portfolio Show ‘Home Bias’?

There’s a lot about Canada to celebrate, especially when it comes to our finances and markets. Our financial system is one of the safest and strongest in the world. Canada is renowned for its stable, reliable and efficient financial system. According to the IMD World Competitiveness Centre, Canada ranks second in the G7 on the competitiveness of its financial system.

Canada is an attractive place to invest, but it doesn’t have to represent the entirety of your portfolio. Our country only makes up about 3 per cent of the global equity market, just a small slice of the pie. Despite this, most Canadians invest more than half of the investments domestically¹.

This challenge isn’t unique to Canada – investors around the world have what’s called home bias, where most of their assets are invested in local stocks. For instance, a 2020 survey² by the Australian Securities Exchange found that 60 per cent of Australians owned domestic shares directly, while only 15 per cent owned international equities.

Although Canada has a lot to offer investors, investing abroad offers additional diversification benefits and opportunities you can’t find at home, says Kee-Hong Bae, a professor of finance and Bob Finlayson Chair in International Finance at York University’s Schulich School of Business.

One reason why, he notes, is that if you only invest domestically, you’ll be overexposed to financial, energy and industrial companies, as these three sectors alone make up almost two-thirds of Canada’s market. “If your bias is toward your home market then you’re giving up the diversification benefit,” he explains. “Here, where we’re not as diversified, it makes a lot of sense to look abroad.”

Breaking down the bias

There are plenty of reasons why home bias exists, even if investors know that allocating too much to one country can introduce “concentration risk.” For starters, people tend to invest in what they know. We hear about brand-name Canadian companies from our television ads, we get information about these businesses from the news we consume, we all know people who work at various publicly listed companies and so on.

“You tend to invest in stocks you are more familiar with,” Bae says. “It has nothing to do with information about a company, it’s just that you’re more familiar with Canadian stuff, so you invest in Canadian stocks.”

But there’s another reason why Canadians tend to shop local for their investments: If you buy stocks in other countries, you usually have to purchase them in that nation’s currency, which can introduce foreign currency exchange risk into your portfolio. As RBC Global Asset Management³ puts it: “A declining Canadian dollar versus foreign currencies can add to the returns of mutual funds and ETFs that invest in foreign markets, while a rising Canadian dollar can negatively impact returns on foreign investments.”

For example, “the U.S. stocks you own are at risk of price fluctuations, but foreign exchange rates change all the time, too,” Bae says. “So, you’re taking on an added risk.”

A world of opportunity

Shedding that home bias can be challenging, but it may be worth the effort. The U.S. is home to the biggest and broadest market in the world, with many big-name companies and brands you already know. Avoiding or limiting your exposure to this market could mean missing out on opportunities that you just won’t get if you only invest in Canada.

For instance, if you want to own the big technology names that have driven markets higher over the last few years, you have to look south. While the technology sector makes up 8.3 per cent of our market, it accounts for 29.2 per cent of the S&P 500. “There’s a lot to buy outside of Canada,” Bae says. “We don’t have a lot of tech companies here so if you don’t go abroad then you’re giving up opportunities.”

It’s a similar story in other sectors, such as healthcare, which accounts for 0.3 per cent of the market here, but 12.3 per cent of the U.S. market.

There’s no magic allocation percentage an investor should have to Canada. How much you might own will depend on several factors, including your financial goals, time horizon and risk-tolerance levels. You may even want to factor in where you work. For instance, if you work for a large oil and gas company, it could make sense for you to think twice about owning only energy stocks to avoid linking too much of your total financial security to one industry.

What’s most important is that you recognize your potential home bias and consider diversifying, whether that’s in terms of geography, industries or individual companies. As Bae puts it, the whole idea of diversification is that you might decrease risk without necessarily giving up return and that can be a good thing to help you reach your financial goals.

¹_{Source: Financial Post, "Why solving home bias in investing is more complicated than it sounds", August 2023}

²_{Source: ASX Australian Investor Study 2020}

³_{Source: RBC Global Asset Management, "How to manage currency risk in a portfolio"}