As an investment option the Canadian stock market can take a lot of heat. Canada is only 3% of the world economy. The Canadian stock market is concentrated in financials, energy and materials. Should Canadian investors avoid those laggard energy and materials stocks?
While the Canadian banks and insurance companies have been terrific investments, the energy producers and the materials stocks have been a drag. They’ve been a real drag on investment returns.
This Financial Post article detailed how even Canadian pension managers have a Canadian home bias.
Only three percent of the FTSE index is attributed to Canadian stocks while Canada-based pension plans, the report said, held 21 per cent of their equity portfolios in domestic stocks.
The article goes on to expand on the source of the Canadian stock market’s underperformance.
Canada, the report outlined, is strongly dependent on three sectors — oil and gas, basic materials and financials — which account for 70 percent of the market. If one or two of these sectors are doing comparatively well, it’s enough to drive the local markets up. The problem is that two of them have underperformed their foreign peers.
So maybe Canada is not the problem. Maybe the problem is related to the fact that a sizable percentage of Canadian companies live in that cyclical world. Canadian energy producers rely on Canadian oil prices.
I knew they were crap, but this was surprising …
From Dec. 31, 2007, to June 28, 2019, the Canadian oil and gas sector yielded negative returns of more than one percent while the international oil and gas companies in the FTSE All World ex Canada Index netted investors more than two percent.
Yikes, that’s not good news in either oil camp. The bad news was delivered for the materials sector as well.
Financial stocks rock.
Here’s the returns for BMO’s Equal Weight Banks.
For the 10 year period they beat ‘the market’ by over 4% annual. The beat of the total Canadian financial sector is generous and consistent through the last 2 market cycles. The financial sector even had the nerve to beat the market through the Financial Crisis.
Thank you oligopolies.
Oligopolies and lack of competition are not good for consumers, but they certainly are good for investors. See the telco sector as well. Perhaps you should own the sectors of the companies that bug the heck out of you?
A consistent theme of this site is that you do not want to feed those big Canadian banks. You might turn the tables. Here’s how you want to own the big Canadian banks, not their high-fee funds.
Here’s a related post on Larry Bates’ Beat The Bank – an investment staple read.
You cannot feast on banks alone?
Well historically you could. You could feast like Henry VIII.
Here’s me In England just a few months ago at the King’s feast table. The trip made possible partially (ironically) thanks to those big Canadian bank dividends.
But of course we need to ‘diversify’. So what other sectors typically can work very well? Consumer staple stocks have been known to perform very well and they can be at the other end of cyclical. With consumer staples you own the companies that make the stuff we need most every day. We might even need their products through a recession.
iShares offers a consumer staples index fund ticker XST.
Here’s the index (no fees taken into account) vs the TSX 60 for a 10 year period.
Currently that’s a concentrated portfolio of just 10 companies.
Everybody loves real estate.
You don’t have to be a home owner to be in the real estate game. You can own commercial real estate by way of Exchange Traded Funds. You’ll find real estate ETFs at BMO, iShares, Vanguard and all of the major ETF providers.
Once again you’ll find a very nice beat of the Canadian markets by way of that real estate angle.
Get paid with utilities.
Stock investors love the generous dividends they receive from their Canadian utilities. If you’re an ETF investor you can certainly access that sub sector. iShares offers XUT. Utility companies are known to be more defensive as they deliver basic amenities and the income is more predictable. BMO’s ZUT has delivered a slight beat of the TSX Composite from inception. I’ll look into the longer term performance of the index in a future post.
The 4-sector portfolio?
Should you get rid of the cyclical ‘crap’ and create a 4-sector portfolio? That’s a very personal decision. And this is certainly not a recommendation. We read, we decide, we invest. I’d have no problem with financials, consumer staples, real estate and utilities. That approach can be at the core of many Canadian investors who build individual stock portfolios.
Mark Seed of myownadvisor offered on Twitter that he holds just one energy producer.
Mike The Dividend Guy is not a fan …
The Connolly report that had an extended streak of thrashing the Canadian market listed the energy producers as the the #1 sector to avoid.
The one-ETF solution.
ETFs that have a habit of finding more quality and stability will remove or greatly limit the exposure to energy and materials. I recently wrote of BMO’s Low Volatilty ETF and the Dividend Aristocrats.
Ditch that asset allocation portfolio?
The reason for why you bought that one ticket portfolio likely remains the same. You want a managed portfolio. There is no exaggerated Canadian home bias in the asset allocation portfolios. Don’t sweat it at all, those investments are incredible. They are game changers.
If you’ve constructed your own ETF portfolio you might once again stay the course. But it would be a little easier for you to switch your Canadian holding. Again, I’ll leave that to you.
I could be wrong.
I don’t like the energy and materials sectors due to the cyclical nature. But energy and materials have had periods of good returns. And perhaps there is now great value in these sectors. Often there is great value in areas where no one wants to invest. International investors and the Canadian retail investor have bailed on energy and materials. Perhaps investors will be rewarded for running into the burning barn while the horses run the other way.
Full disclosure; I made very good monies from energy companies back in the day. Thank you Eric Sprott and his Canadian ‘Equity’ Fund.
Once again, whether or not to avoid energy and materials and other sectors is a personal choice. This fits right into the theme of personal finance. And the best way to manage the sector concentration risk of the Canadian market is to invest generously in the US and International markets.
Thanks for reading. Please fire away in the comment section.