Portfolio Allocation to Canadian Stocks

By Admin on March 31, 2010
Estimated reading time: 2 minutes

Though the Canadian market makes up just 3.6% of the World stock markets, Canadian investors are justified in being overweight in our stock market for the following reasons[...]

Though the Canadian market makes up just 3.6% of the World stock markets, Canadian investors are justified in being overweight in our stock market for the following reasons:

A Canadian investor who is saving for her retirement in Canada needs to fund her liabilities in Canadian dollars and having too much exposure to foreign markets introduces foreign exchange risk. Since valuations among developed markets are comparable and earnings growth in these markets is similar, the expected returns from Canadian stocks isn’t materially different from other developed countries. Therefore, the purpose of foreign stocks in a Canadian investor’s portfolio is diversification. One study by money manager Leith Wheeler found that Canadians can get most of the benefits of diversification by allocation 50% of their stock portfolio to overseas markets. Some could reasonably argue that the 70% allocation to foreign markets in the stock portion of the Sleepy Portfolio is too much, not too little.
In taxable accounts, eligible dividends paid by Canadian stocks receive favourable tax treatment. Assuming a 2.5% yield, investors in some tax brackets may find that more than 40% is lost to taxes for international stocks but only 20% in the case of Canadian stocks. Over the long term, all things being equal, a Canadian investor will earn greater after-tax returns with Canadian stocks than international stocks.
Canadian investors capturing exposure to global markets through ETFs listed in the US stock markets will experience additional leakage through withholding taxes. These taxes add to the cost of foreign investments and act as a drag on a portfolio return.

What’s your take? Is the 70% allocation to US, EAFE and International stocks in the Sleepy Portfolio too much diversification? Or is it too little, considering Canada makes up less than 4% of global markets?

PS: Spring has sprung and this weekend promises fine weather for an Easter Egg Hunt and just hanging out on the patio. Hope everyone has a great Easter weekend.