Canadian investors are overweight in their domestic holdings at the expense of foreign equities, leaving them with increased exposure to certain risks, according to a new report.
Ashish Dewan, a portfolio consultant at Vanguard Canada, said in a report Tuesday that many Canadian investors exhibit too much of a “home bias,” referring to a global phenomenon where investors favour domestic equities. The report says that Canadian securities make up only 2.6 per cent of the global market, but account for about half of Canadian portfolios.
“Canadian investors have a significantly high home bias, allocating 50 per cent of their total equity allocation to Canadian equities, which is over 18 times overweight,” the report said.
“This bias results in security and sector concentration, leading to an inefficient portfolio allocation and exposure to considerable idiosyncratic risk that can be diversified away by allocating to both Canadian and global equities in a portfolio.” ‘
As many Canadian investors remain overweight in domestic equities, the report said “Vanguard maintains that 30 per cent Canadian equities and 70 per cent international equities is a reasonable asset allocation for Canadian investors.”
The report noted Vanguard’s recommended asset allocation is based on factors like historical evidence, the benefits of diversification, a trend of falling domestic preferences among individual investors and pension investors and more.
In an interview with BNNBloomberg.ca on Monday, Sal D'Angelo, the head of product for Vanguard Canada and a contributor to the report, said individual investors have unique circumstances and potentially differing needs.
However, he added that generally “Canadians need to continuously consider their exposure to Canada and continue increasing their global diversification.”
“As a result, we would encourage clients to think globally (and) invest globally. Don't over-concentrate in Canada…that can lead to unintended biases and overexposures to certain sectors, which ultimately can increase the level of risk for a portfolio,” D'Angelo said.
Canadians reducing domestic holdings
Amid home bias concerns, the report said the “good news” is that investors in Canada and other developed countries are “gradually reducing the levels of home bias in their portfolio.” The report highlighted that many of those investors are “going global in their equity allocations.”
Canadian investors appear to be moving toward global diversification at a faster rate when compared to peer nations, according to Vanguard.
“Canada leads the way in decreasing home bias from 67 per cent to 50 per cent since 2012 whereas Australia and Japan have reduced their home bias by four per cent and six per cent respectively,” the report said.
“U.S. investors have only marginally reduced their home bias from 83 per cent to 81 per cent since 2012.”
Consequences of home bias
The report also outlined some specific risks for Canadian investors who are overweight in domestic securities. It said that Canada has a “greater level of concentration” when compared to the global stock market.
“Specifically, the top 10 holdings in Canada constitute more than 38 per cent of the index. Conversely, the top 10 global securities make up approximately 12 per cent of the global market,” the report said.
This level of concentration in one geography or market could lead to “idiosyncratic risk,” the report said, which refers to risks that the investor is not compensated for taking.