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Slip into something more comfortable and delve into personal finance with Josh Sheluk and Colin White, experienced portfolio managers at Verecan Capital Management. Each episode demystifies complex financial topics, stripping them to their bare essentials. From investment strategies and financial planning to economic headlines and philanthropic giving, delivered with a blend of insight, transparency, and a touch of humour. Perfect for anyone looking to understand and navigate their financial future with confidence. Subscribe now to stay informed, empowered, and entertained.
Verecan Capital Management Inc. is registered as a Portfolio Manager in all provinces in Canada except Manitoba.
Welcome to Barenaked Money, the podcast where we strip down the complex world of finance to its bare essentials, with your hosts, Josh Schallick and Colin White, portfolio managers with VariCam Capital Management Inc.
Josh Sheluk:Welcome to the next episode of Bear Naked Money. We got Matt here fresh off vacation, so he's gonna have more energy than usual filling in for a call in today. And, Matt, you brought this topic to me a few weeks ago, something that piqued your interest. Why don't you, why don't you introduce the topic?
Matthew Kempton:Sure. Thanks, Josh. Yeah. I spotted the study that came out well, this year's study from Vanguard, which is a large asset, asset company here in Canada and globally, and they they specifically looked at Canadian investors. How do Canadian investors invest?
Matthew Kempton:Where do they invest their where do they invest their dollars? And what what do our portfolios look like versus the other countries they operate into? How versus how does an American invest in Australian? And what we found is what they've found over every year, basically, is that here in Canada, we exhibit something called home bias. We like to invest in the things we know.
Matthew Kempton:Canadian companies, Canadian stocks, Canadian bonds. This is a phenomenon called home bias. And it while it's true here in Canada, there's their results show most most countries have similar biases. They invest more so in their own markets. And there's there's reason for this.
Matthew Kempton:Again, it's familiarity. And when you operate in a country like Canada, you you know the rule of law exists. There are occasionally there are some tax benefits to investing in Canadian companies, by the way, of dividends, especially. So there's there's some reason to show to to know and and some comfort to put maybe to feel to invest more into Canada, but their numbers are quite staggering in terms of how concentrated Canadians are in a market like ours, a small market globally. It'd be very strange to go to a country like the US or or any other and for to find someone who would say, I want to put 50% of my assets in Canada.
Matthew Kempton:I think you're you're not going to find that very often, but here we'd we're very comfortable doing that. Our market represents only 2.6% of the global stock market, but the findings of this study show that our Canadian investors invest about 50% of their Canadians of their stocks into Canada. So, you know, from a purely theoretical basis, we might be 19 times over allocated to Canada. Now there are reasons again why we might show more than just our natural weighting to, to the globe for for stocks for what we might allocate. I think we've gone might have gone a little too far, and we could talk about the risks as part of that because I think it's you know, we'd like to think about Canadian dividend paying stocks is quite safe.
Matthew Kempton:But there's there's there's data that shows that it's not quite so safe and especially in such a concentration. So that's sort of what piqued my interest here. Just a latest update of the numbers, a continuation of a trend, I suppose, and maybe something to opine on here where we might we know diversification is important. Canadians on average don't necessarily show it to the extent they should.
Josh Sheluk:Right. Right. Right. So yeah. So this is something that's been going on a long time.
Josh Sheluk:It's persisted across many, many years or decades, and it persists based on the evidence that Vanguard is showing us across many different countries as well, which you highlighted. So I think that's important to mention. Now you you you touched on it a couple times there, reasons why this happens. So do you think it's it really is just a familiarity or a comfort level thing? Is that is that what why people have more of their assets in Canada than they they should, quote, unquote, should?
Matthew Kempton:I I think it comes down to I think that's a big component of it. And then I think of further I think a pretty meaningful component is, an idea that investing in a lot of these Canadian industries is safer. And that if you own what you might consider some blue chip type businesses, if you own a collection of these, that's a safe portfolio, and that's a good one to allocate to because you'll get an income stream from it. And it should it should be safer than those risky stocks that exist beyond our borders. Now that has been disproven, especially, again, in this in this study here that has shown that owning Canada and the weight that we do is actually riskier than had you diversify more properly globally.
Matthew Kempton:So it's I think that is the bigger component. It's just this, you know, this misinformation that when you owned there to own Canada stocks is is safe and to to overweight it, it can only be safer, but that's not necessarily the case.
Josh Sheluk:And it's funny because Canadians are sitting here thinking, well, if I own Canadian stocks, I'm safer. And Americans are sitting in the US saying, well, if I own American stocks, I'm safer. And the Japanese are sitting in Japan and saying the same thing, and Australians are sitting, what? This is is saying, if I own Australian stocks, I'll be safer too. So we can't all be right.
Josh Sheluk:We we can't all be right. And and maybe none of us are right. Maybe that's the point.
Matthew Kempton:Humans are funny. Right? We we all come to this similar conclusion, but in our different countries.
Josh Sheluk:Yeah. Yeah. So I and I guess true to the the the term bias there. So you mentioned I I I wanna stick on the potential reasons or benefits of it before we go to some of the risks and drawbacks that that you highlighted as well. But you mentioned tax.
Josh Sheluk:So so is this a real financial, numerical, mathematical benefit of a Canadian investing more in Canada?
Matthew Kempton:I mean, all things being equal, if you could choose between a similar performing total return stock, I suppose, from Canada or beyond after tax, given the dividend treatment of a Canadian stock, you'd be better off owning that business. Now we know there's a lot more to consider when making an investment decision. And we know all things are not equal. So there is a benefit that does exist there if your if your return is comparable in in this country versus another, but it's not a reason to to make a, well, a a significant overweight as, you know, on the basis of it is a it is a small factor, though, that does result in, I think, some further bias to Canada just knowing, well, there's less there's no withholding tax on that dividend, and I get to keep the full thing. And and even favorable treatment upon it at that tax time.
Matthew Kempton:So Yeah. There's there's something to that, but in the end
Josh Sheluk:So you said small. How how how small is it? Can you give our listeners some context as to how material or immaterial the difference is?
Matthew Kempton:Well, it should be. And I get I suppose it does depend on province as well. Yeah. But you will find that foreign dividends are tax liking. So that should follow more to your your bond income or your other your other income coming in, where dividends receive a dividend tracks credit.
Matthew Kempton:And you might see in the neighborhood of accurate to say 15 10 to 15% or so of a discount to her or more in your pocket, I suppose,
Josh Sheluk:based on the dividend. Of the dividend.
Matthew Kempton:Of the dividend. Yes.
Josh Sheluk:Yeah. Exactly. Yeah.
Matthew Kempton:So There's a benefit there.
Josh Sheluk:Yeah. So I threw you kind of an impossible question because
Matthew Kempton:it it it
Josh Sheluk:it differs Thank
Matthew Kempton:you for saying that.
Josh Sheluk:Yeah. It differs depending on which country you're coming from as well because you invest in the US, there can be foreign dividends, tax credits, and reduced withholding taxes, and all these things. So I I I threw you a question that was basically impossible to answer, but I I think it it's probably safe to say that the difference is probably minor to your overall after tax return. And we're probably talking basis points, like, 10, 15, 20 basis points, maybe. Probably not a whole lot more than that.
Josh Sheluk:Is that very thick?
Matthew Kempton:I mean, that's very fair, and I suppose that's all assuming that every dollar you invest is taxable and that Yeah. We know that isn't necessarily the case. There is no longer a foreign investment restriction in your RRSP, in your RIF account. And they they're fully you're fully able to allocate wherever you like globally and end of your tax deferred or or accounts like that. Tax or savings accounts, first time home savings accounts.
Matthew Kempton:All of these accounts can be invested to any in any country within the globe, and there's no restrictions there. And and then, of course, no taxes applied on the on the returns. So maybe it's even less than that.
Josh Sheluk:Yeah. Maybe. Maybe. And okay. So moving on to the risks.
Josh Sheluk:So you mentioned diversification. So how how is it that being too exposed to Canada I know there's a variety of different ways, but how is it that having too much of your portfolio in Canada reduces your diversification aside from the obvious, just being too allocated into one country?
Matthew Kempton:Well, the big reason for that, it it comes by way of where our where our our market is based up on in terms of sectors. And then really when you dive down even deeper, where are the concentration lies in terms of company? And so when our market here in Canada is significantly concentrated in in those two spaces. So by way of the top ten companies, they represent 37% of the of the market here. When you compare that globally, the top ten companies in most global markets represent about 16% of the market.
Matthew Kempton:So when you're over allocated to Canada, you're also over allocated to these top 10 largest companies within our country. You're also over allocated and these top ten companies would represent many of these sectors to financials, materials, and energy, these three sectors. These three sectors, by the way, are very are quite economically sensitive and generally very volatile as well. So when you are overweight Canada, you're overweight a handful of companies and also a handful of sectors and most of them are quite quite volatile. So you're bringing about more risk than than maybe you realize by overweighting in Canada with a concentrated small market that we are.
Josh Sheluk:Yeah. Yeah. I get so, again, just it's the composition of the market that does it. And just to take it a step further, add a portfolio manager say to me one time, just look at your opportunity set as well. So if you look think of I'm a Canadian investor, and I'm investing only in Canada.
Josh Sheluk:You have probably several 100 viable investment options here in Canada. I think that's probably fair to say. And as soon as you look outside of Canada, he said, now I have 30,000 viable investment options. So if you think that a larger field, to choose from is going to result in better outcomes, then it's kind of a no brainer that looking outside of Canada's borders are gonna add some some new and interesting opportunities to you. And I think that that makes total sense.
Josh Sheluk:But I also I I I think just to emphasize how concentrated the Canadian market is. So it's not only top the the top ten companies that make up 37%, I think you said was the number of the market. But all these companies are very similar companies. Not all of them, but a lot of them. Like, you're gonna see a lot of the big banks in there.
Josh Sheluk:Financials definitely dominating that that top 10. So it's even maybe a little bit more egregious than at first blush. And I think those 3 sectors now, correct me if I'm wrong, is it, like, 70% or so of the Canadian market that are made up, by financials, materials, and energy?
Matthew Kempton:Yeah. That sounds about right.
Josh Sheluk:Yeah. So so, yeah, as you said, these are all industries or sectors that tend to be a little bit more economically sensitive. So if you start looking abroad, maybe you can just reduce the volatility of your portfolio a little bit. Or, even if it's not a volatility thing, the perceived safety of having a better cross section of different sectors or industries is probably gonna help, from an overall risk management perspective.
Matthew Kempton:I think you're very right. And Vanguard showed that by way of a chart, and I love when they show information by charts. So we have here them showing up, you know, where you'd sit on a risk return basis, essentially, if you define risk as volatility, which they have here, and marking where a Canadian portfolio would sit in terms of its recent performance or historic performance on a absolute return basis and then on a on a volatility basis where that would leave them on in that in that chart. And then where would it have where would the ex investor have experienced if they had invested in a diversified way, in a global way? And you can, without question, see that return stays in the same range, but volatility has moved down materially.
Matthew Kempton:So there there's without a doubt over time, of smoothing of returns, a better just experience for investors, and a derisking, you might say, to to reducing that Canadian exposure.
Josh Sheluk:Yeah. I I did some research on this last year. I don't know if I shared this with you or not. I can't remember. But we were debating amongst ourselves on our investment team whether Canada has, worst returns, a worse return outlook than global markets would.
Josh Sheluk:And I think there's still some debate internally whether this is true or not. Because historically and I went back about 70 years and did find that, yeah, the global market tends to outperform Canada. But it wasn't for the nerds out there, it wasn't statistically significant. So it might not be something that you can actually rely on, and it might not be something that you would expect going forward. And I think that's that's maybe the the the beer point here is maybe the returns are similar between Canada and the rest of the world.
Josh Sheluk:Maybe there's no return difference to be expected whatsoever. But if you think that you can get either better diversification or less economically sensitive businesses or less concentration by going globally, there can still be benefit even if you're not getting better returns. Even if you're getting the same returns by reducing the variability of those returns, that's still a benefit to to the portfolio. And and that's kind of what I saw with with the numbers when I looked back as well, so it's interesting to see them kinda replicated by Vanguard.
Matthew Kempton:Yeah. I think Vanguard agrees with you to an extent. In fact, they're saying it's not not they're not saying all investors go to only 2.6% of your portfolio in Canada. In fact, they've run a study that said for Canadians, it'd be reasonable to be invested about 30% in Canada. Mhmm.
Matthew Kempton:The remainder to be invested and diversified globally. So, you know, there's good businesses in Canada. There's reason to have investment in Canada. There's maybe a more of a comfort that comes to some of us and to some investors by doing so. But there is, you know, there's risk when you put half of your eggs in in one basket.
Josh Sheluk:Yeah. Did you see where they came up with the 30% number? Because that from the the numbers that I saw, I saw the number, but I didn't see how they actually landed on that 30% number.
Matthew Kempton:I did not see, you know, the data behind that. I I've seen the chart with the with the results of their their 30% allocation. But how did they come up with that exactly? I Yeah.
Josh Sheluk:Not sure. It's hard to say this is the exact number for anybody, I think. Because we do Mhmm. Again, we don't really know exactly what's gonna happen going forward. So it's kind of like, yeah, maybe accommodate the bias to some extent and adjust and understand some of the tax factors to some extent that may move the needle a little bit.
Josh Sheluk:When we did the numbers earlier this year or last year, I can't remember what it was, We kind of, arrived at somewhere around the 5 to 25% range, and it kinda depends on what your, your objective is. Because actually, funny enough, even though the rest of the world is more diversified than Canada, Canada actually does still provide some diversification benefits to a global portfolio because it is a little bit more resource heavy, a little bit more commodity heavy, which is something that tends to perform a little bit at, may maybe off times with the rest of the portfolio, you know, when you're looking at it from a global perspective. So it's almost, like, mutually beneficial to have some global and a bit of can Canada in there as well.
Matthew Kempton:Yeah. Exactly. And you hear of times when managers are saying they're going overweight Canada, and often what they're doing when they or what they're thinking when they say that is we think it's a time to be in industrial or to be in materials, to be in energy, maybe to be in financials. And that's really what they're saying when they say go overweight Canada. Now is it always time to be overweight these sectors that I'm not so sure of that?
Josh Sheluk:Yeah. So one of the other things I think we always approach this from a very stock specific focus. Like, it's always about equity markets. It seems to be anyway. Do you think do you think it it's a different conversation if we're talking about bonds versus stocks, or do you think we approach it the same way?
Matthew Kempton:I think I think there's almost more risk when you think about the bond market. When you think about the major borrowers in this country, and you can look at top 10 borrowers, it's even more concentrated, but but have similar sectors. You financials, energy companies Right. Maybe telcos would sort of would sort of round out the very big borrowers in this country. And if you look at the bond portfolio of managers in Canada, they look like the space.
Matthew Kempton:I mean, there's the opportunity set is quite concentrated. And if things things were to tighten up in any of those sectors, it would be felt quite quickly by by Canadian bond holders. So concentration absolutely exists in in both the stock and the bond market, but maybe even more so in in the bond market.
Josh Sheluk:Yeah. So that's interesting. You immediately went to corporate bonds, and I hadn't been thinking of it from that perspective, but I I think you're you're probably right. There might be some more, like, telecoms and utilities exposure, just off the top of my head in in the Canadian bond market. But, they're like, the high yield bond market, for example, is almost nonexistent in Canada.
Josh Sheluk:That's that's something you really need to go globally for. So there there's, I think, some some truth to that for sure. One of the things that I've I've been thinking about and one of the things that we've been talking about with our portfolios on the bond side is, the global exposure, I still for the record, I still think is extremely important on the bond side. But maybe depends what you're trying to do with this specific bond allocation, because a lot of times, bonds are meant to hedge your risk or to reduce the risk of the equity part of your portfolio. And that risk tends to rear its head when there's an economic downturn.
Josh Sheluk:So economic downturn, stocks go down. And if you're exposed to stocks in Canada, you're and to the economy in Canada, both of those things are bad. But if you had government bonds in Canada, for example, and your economy downturns, that's hurting your stock portfolio, your government bonds are probably going to do quite well. So if we look at bonds from, perspective of it's strictly there to reduce the risk of my stock portfolio, There could be some argument to have more exposure to Canadian, say, for government bonds or low risk bonds. I'd still won't think 50% maybe is still a bit too high, but you have more of an argument, I think, on the bond side if we're talking about some of the more the safer, more government focused areas.
Matthew Kempton:Yeah. I completely agree with you there. I mean, you know, when you talk about these times when things turn down, the other big issue in the bond market is liquidity. And so, you know, if you if you risk, if you found yourself ventured into the the high yield space in Canada, you know, it's hard enough in in the easiest of times. It's extremely difficult when when things are tighter.
Matthew Kempton:And and so even in the corporate space, it's similar. Government space still remains generally outside of, you know, very extreme events like, let's say, you know, spring of 2020. These markets remain quite liquid. And, you know, we continue to have a triple a credit rating here in Canada as much as there is a lot of debt that exists at the government level. When compared to other developed nations where on the federal basis were were reasonable.
Matthew Kempton:The debt has been kind of just pushed down to the other levels more so. So I I think to have a a good allocation to Canadian government bonds is not or an overweight to them. Yeah. There's there's good reason to do so.
Josh Sheluk:Yeah. And maybe it's that that's the simplest way to look at this whole home country bias thing is what happens when there's a downturn or a significant market shock or recession. What happens in that situation is the Canadian stock market tends to get hurt a little bit more than global stocks, just based on the nature of the the concentration and the sector exposures. By the way, global currencies tend to do, especially US dollars, tend to do generally pretty decently under that scenario. So you get a little bit of a boost from that.
Josh Sheluk:And also when you have this sort of recessionary or big downturn in the stock market, government of Canada bonds would tend to do pretty well also. So if you're looking at it and a lot of this this, try to trying to avoid home country buys, a lot of it's about risk management. And so if you think of it from that lens, government and Canada bonds tend to do pretty well. Global stocks tend to do better. But certainly, I think we're advocates for diversification.
Josh Sheluk:We're right across the board.
Matthew Kempton:Yeah. For sure. But, you know, you touched on something there that we hadn't gotten into before, but I think it's another cause of this home bias and that's currency. And just the view that and others, this is reasonable to think that if I invest in a country outside of Canada, well, I've not only introduced the idea that I don't know if the stock price is going to go up or down, but I also have to now factor in the currency. How's that going to move as well?
Matthew Kempton:And that's that's that's a that's a reasonable then that's a realistic part of the total return now. You've added another component. Though, really, many of these Canadian businesses do business globally and deal in multiple currencies. So those factors are kind of still at play. You just don't see them, as as much in your face when you're you're investing in a Canadian stock.
Matthew Kempton:So I I think that would find its way into creating this home bias, not in our con not just in our country, but in others as well as to say, get to operate in the currency that I transact in. Don't have to worry about it potentially taking a big hit when I sell the investment. And the return I thought I made all disappearing. So I I I bet you that's a part of where our home bias comes from too.
Josh Sheluk:Yeah. Yeah. And just to emphasize again, I you're you're probably very right on that. But Canadian investors tend to benefit more often than not, especially on the risk side of things by having some exposure to foreign currency. So if that is a fear for people, I would probably say just dial down the the fear gauge a little bit because you should look at it as an opportunity, not as much as a risk.
Matthew Kempton:Yeah. And I agree with that. And and, you know, we've seen how our dollar has done over the last while even just as the case in point. So it's,
Josh Sheluk:you
Matthew Kempton:know, pretty evident that way.
Josh Sheluk:Yeah. I guess the other thing because as you talk about how our dollar's done recently, the other thing we should probably mention is these the leadership for these global markets will tend to last and persist for long periods of time because, it it came to mind because he mentioned Canadian dollars hasn't hasn't been done so well recently. But there was a long time there kinda in the mid 2000, 2000 to 2,000, 10 or so when the Canadian dollar was really strong relative to the US dollar. And so this can kinda ebb and flow. It can go for multiple years where Canada is doing quite well.
Josh Sheluk:And stocks have done this as well where the Canadian market has gone gone for long times and outperformed global markets, outperformed the US market. So that certainly hasn't happened recently, not anywhere close. Actually, it's been probably good 15 years now since that's really been a story, but we can't ignore that possibility either. And I wonder how much of this, propensity recently for Canadians to invest more globally is a function of better performance globally.
Matthew Kempton:Yeah. I think that's I I think you're right. You know, we're looking to our neighbors and seeing the returns that they've seen versus what we've seen. But to that point on the current the periods when our currency has been strong, I think it's often periods where commodities have also been strong. And so that component within our markets doing so, you know, maybe you get a benefit both ways when you do find yourself in one of those periods.
Matthew Kempton:It's been a while since we've been there. We've been really outside of that for quite some time. But, yeah, the our dollar has had periods of great strength. Often feels like coincided with periods of commodities being quite strong. Right.
Matthew Kempton:Right.
Josh Sheluk:Any final thoughts, Matt?
Matthew Kempton:I have final thoughts. I think it just encourage investors to view to look at diversification, view it less as risky. You stepping away from home less as risky and and more of a an effort into expanding your portfolio into industries that don't exist here into very, very good companies that sit beyond our borders and that there's there's rewards not only in terms of expect in terms of expected return, but maybe even a smoother ride getting there as well.
Josh Sheluk:Yeah. Certainly, if you asked us kinda to boil down our investment philosophy to one tenant as hard as that is, it would probably be diversification is the one thing. And a big part of that is we just don't know what's going to happen in the future. And having some exposure to a bunch of different things that you think can be successful over the long run is going to lead to long run investment success.
Colin White:Couldn't agree more. If you're breaking a sweat trying to figure out what your financial advisor's talking about, you're not getting the service you need. You probably hate trying to get an answer from them, but you also think moving your accounts will be a headache, and it might be. But working with don't rock the boat wealth planning.comor.ru isn't exactly stress free, is it?
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