Canadians have 15x More Exposure to Canada Than They Need to

Key Takeaways on Home Country Bias

• There are three main risks involved with home country bias – security and sector concentration, and inefficient portfolios.
• Optimal home bias for Canadian equity portfolios is 30% Canada and 70% international.
• 60-40 portfolios work in the long run.

Ruth Saldanha: Home country bias is a common global phenomenon where investors overweight domestic securities at the expense of foreign holdings. In a recent study, Vanguard found that Canadian investors have a significantly high home bias, allocating 52% of their total equities to Canadian equities, which is about 15 times overweight. Vanguard maintains that 30% Canadian equities and 70% international equities is the optimal asset allocation for Canadian investors. But why? Bilal Hasanjee, senior investment strategist for Vanguard Investments Canada, is here today to talk about this. Bilal, thank you so much for joining us today.

Bilal Hasanjee: You're welcome and thanks for having me here, Ruth.

The Three Risks Associated with Home Country Bias

Saldanha: So let's start by talking about why home bias is such an issue for Canadian investors.

Hasanjee: Sure.So home bias is a common global phenomenon due to preference for the familiar, the need to hedge domestic liabilities, perceived exposure through multinationals and managing currency risk. However, these reasons are also -- they add risk and they add consequences for Canadians.

1. The first and foremost is security concentration.
2. The second one is the sector concentration and
3. The third one is inefficient portfolios in a risk return framework.

So to sum up there are three implications for overexposure to Canadian equities, so I'll go through in a bit more detail through three of those. The security concentration essentially means that Canadian equity markets exhibit a greater level of concentration compared to the global equity market. Specifically, the top 10 holdings in Canada constitute almost 37% of the index. Conversely, the top global securities make up less than 16% of the global market. This could contribute to idiosyncratic risk, a form of risk, which is peculiar to investing in a certain geography or market and can be avoided by diversification.

The second one is the sector concentration. So Canadian equity market is significantly overweight in the energy and financial sectors as we know. With relatively smaller, overweight in materials, in industrials. However, this also results in information technology, healthcare, consumer discretionary and consumer staples, being underweight sectors relative to the global market. The third one is the inefficient portfolio allocation. So although investors have unique reasons or justifications for home bias. Its direct implication for security and sector concentration is that Canadian investors are exposed to a considerable amount of risk that could have been diversified away by investing globally.

Exactly How Much do Canadian Investors Love Canada?

Saldanha: So you recently conducted some research on how Canadian investors are dealing with home country bias. Can you tell us a little bit about some of your findings from that research?

Hasanjee: Absolutely. So home bias, as I said, is a global phenomenon, but it's declining for a number of reasons, including the ease of movement, advancement in trading technology and significant growth opportunities in technology stocks has resulted in, we looked at data for over 30 years and we found out that there's a distinct trend of declining home bias across not just in Canada, across all developed and major capital markets. Secondly, Canadians have home bias of over 52% based on the data as of June 30th 2022, which is lower by historical standards, but still is much higher than the optimal allocation as our models suggest. The optimal home bias, the third finding that we have Ruth is the optimal home bias for Canadian equity portfolios is 30% Canada and 70% international. And I'll probably explain that in a bit. And then the fourth long term trend is that home bias, as I said is declining. That said, there have been some uptakes recently, recently by me like including the 2022 data. So because of those – the uptakes are due to the shift to value stocks, dividend paying stocks and the dividend tax credit specifically applicable to Canadian investors.

How Should Investors Manage Home Country Bias Right Now?

Saldanha: How should investors manage their home bias in this current market environment?

Hasanjee: So based on our research, we would advise that Canadian investors maintain about 30% allocation to the local equities and 70% allocation to international equities. If we combine this advice with our time tested investment principles of setting up appropriate investment objectives or goals, develop a suitable asset allocation using broadly diversified funds, whilst mindful of home bias, minimize costs and maintain perspective and long-term discipline. We essentially create a framework or philosophy for investing success over long term. Minimizing cost is key here. So Vanguard Asset Allocation ETFs, essentially our largest product suite over 10 years -- with over 10 billion in the AUM, essentially express our view on Canadian home bias of 30% overweight to Canadian equities and 60% overweight to Canadian bonds at a low cost of just 22 basis points of management fees on average. In addition, our model portfolios which represent our best thinking for asset allocation across index passive and active passive also have our research driven overweight for Canadian home bias built into those models. So this is because we believe that this is the right approach and represents the crux of our research philosophy and best thinking.

How to Build a Diversified Portfolio?

Saldanha: So how should investors construct a diversified portfolio, keeping in mind both home country bias as well as the current market dynamics?

Hasanjee: Great question, Ruth. Apart from geographical diversification, we at Vanguard are big proponents of asset allocation and asset class diversification, particularly having a balanced portfolio between stocks and bonds to diversify the asset class risk. Our research shows that a typical 60-40 portfolio has withstood market shocks and has provided investors a stable risk adjusted return over long term. The typical 60-40 portfolio declined about 16% in 2022. Admittedly, a painful period for balance investors, balance portfolio investors that has raised doubts about the viability of this strategy, but it helps to put things in perspective. The annualized return for 10 years through 2022 was 6.1% for a globally diversified 60-40 portfolio even after taking into account the negative returns in 2022.

Saldanha: Great. Thank you so much for joining us today with your perspectives, Bilal.

Hasanjee: You're welcome, Ruth. And thank you for having me. Have a good day.

Saldanha: For Morningstar, I'm Ruth Saldanha.