Many investors, including HNW clients, need to be educated about the world of opportunity in global markets
Running up against the preference of Canadian investors for their own country is nothing new: despite years of effort by the investing community, many still show a strong bias in favour of their own markets.
But there are signs this so-called “home country bias” is beginning to abate. While acknowledging that clients often are more comfortable investing in familiar companies, Ian Riach, chief investment officer at Fiduciary Trust Co. of Canada in Toronto, notes that global investing is beginning to resonate with more Canadian investors. Recognition that global markets offer far more opportunities than Canada does is more common now, he says. “It comes down to showing clients how narrowly focused the Canadian market is,” says Riach, adding that the discussion also should include the pros and cons of global markets. “[Clients] have to recognize the risks as well as the rewards.”
However, if you expect your high net-worth clients to tolerate more offshore risk compared with other clients, you are likely to be disappointed. “There is not much difference in the way both sophisticated and less sophisticated investors view global investing,” Riach says. “A lot of people think that high net-worth investors are more sophisticated, but, in fact, they are more risk-averse.”
One of the best ways to overcome the bias, says Ron Fox, chairman and CEO of Glidepath Portfolio Services Inc. in Toronto, is to tell your clients that investments will be chosen on the basis of superior risk-adjusted rates of return. Fox, whose firm offers separately managed portfolios to high and ultra-high net-worth clients, constructs portfolios that aim to achieve specific objectives without regard to country selection. Most clients do not care about their asset mix, he says, if their investment objectives are achieved.
At the core of the issue with sticking to Canadian investments is the relatively narrow range of Canadian markets. With only three key sectors making up 68% of the public markets – financials, energy and materials – your stay-at-home clients will miss out on potential global growth opportunities in a range of robust industries, such as technology, health care, telecommunications, industrials and consumer staples.
Indeed, says Heather Holjevac, fellow of the Financial Planning Standards Council and senior wealth advisor with TriDelta Financial Partners Inc. in Toronto, staying too close to home can actually increase investing risks. When clients diversify globally, they are more likely to lower their investment risk, says Holjevac, by exposing their portfolios to a range of opportunities in which losses are offset by gains. This strategy, she notes, tends to provide a smoother ride in markets over time.
Riach notes that you should explain that by investing in a global portfolio that holds assets with low correlations, a client’s overall portfolio will tend to carry less overall risk than the weighted-average risks of the portfolio’s individual parts. This can lead to higher returns over time, and allow investment goals to be achieved more quickly.
One way to make these points with your clients is to use historical averages, which show how global markets have performed over time relative to the Canadian markets, says Holjevac. Model portfolios with different asset allocations also can be used to illustrate the benefits of global diversification within different scenarios.
Currency risks also need to be explained to clients who have decided to invest globally. Investing in stocks priced in a foreign currency can either increase or reduce portfolio returns, depending on market movements of both the Canadian dollar (C$) and the foreign currency. If, for example, a client invests in stocks priced in U.S. dollars (which currently trade at a premium of 30% over the C$), those stocks would have to gain more than 30% before the portfolio realizes a positive return in C$.
In addition, foreign investments priced in C$ may change in value independent of share levels. For example, if the C$ weakens against the currency of the investment’s foreign jurisdiction, the value of your client’s foreign investments as priced in C$ will increase (all other things being equal).
Some funds may hedge currency risk by using forward contracts or other derivative strategies to eliminate most of the risk associated with currency fluctuations. This strategy helps provide unitholders with returns closely related to the performance of the stocks held by the fund, independent of currency fluctuations.
Other funds may hedge currency risk only partially, or even not at all, on the assumption that currency movements even out over time.