Foreign Investing 101: Where Canada fits in

With our domestic market trading at historic highs investors are wondering how long it will last.  It may be a good time to consider increasing exposure to foreign markets, which is a component to a properly diversified portfolio.

How does Canada measure up?

Canada represents approximately 2.6 per cent of the world’s market capitalization.  Does this suggest that a diversified portfolio should have only 2.6 per cent invested in Canada?  Canada’s market capitalization represents the value of Canadian stock exchanges divided by the total value of approximately 50 stock exchanges around the world.  The market capitalization of the world’s largest stock exchanges are as follows:

United States

49.4%

Brazil

0.5%

Australia

1.2%

Switzerland

2.6%

Japan

10.8%

Mexico

0.5%

Finland

1.0%

Netherlands

2.3%

United Kingdom

8.8%

India

0.4%

Hong Kong

1.0%

Italy

1.9%

France

4.9%

China

0.4%

Taiwan

0.7%

Sweden

1.4%

Germany

3.7%

Russia

0.2%

Korea

0.6%

Spain

1.3%

Canada

2.6%

All Others

3.8%

Source:  Morgan Stanley Capital International – MSCI All Country World Free Index.

The MSCI indexes are widely used by investment firms and investors for benchmark purposes.  Among their indices the MSCI All Country World Free Index includes approximately 50 countries.

Why look beyond Canada?

If Canada’s relatively small size in world market capitalization doesn’t convince investors to consider looking beyond our border then let’s consider a few other factors.  First, why limit investment opportunities to the best companies in Canada when investors can expand that to the best companies in North America or the world?  Canada is very strong in financials and resources; however, other countries may dominate in other sectors.  Other reasons to look beyond our border are the relative strength of our dollar to other currencies and the rate of growth our economy is expected to grow relative to others.

Growth in 2006

At the end of every year economists around the world are busy generating reports.  They provide opinions on the outlook for the upcoming year for various economies such as the United States, Canada, Japan, China, India, etc.  Summarizing some interesting points regarding growth rates (real GDP – Gross Domestic Product) from a recent “Global Economic Research – Global Outlook” report written by Warren Jestin and Mary Webb:

  • Overall trend is global growth is slowing down
  • Emerging markets will continue to lead

North America

  • Canada’s growth rate is expected to be near three per cent, in line with the trend over the last couple of decades
  • The expected growth rate for the United States is forecasted to be slightly less than three per cent
  • Mexico is expected to outpace both Canada and the United States by at least half a percent

Europe and Japan

  • Canada’s three per cent growth rate may not sound that exciting unless you compare it to the 1 ½ to two per cent growth rate expected in Japan and many European countries

China and India

  • China is expected to top world charts with annual growth rates between 8 ½ to nine per cent
  • India’s growth rate is forecasted between seven to 7 ½ per cent this year
  • Both economies are growing at more than three times the average rate in the G7 (the seven leading industrial countries include US, Germany, Japan, France, UK, Canada, Italy)
  • Each nation has more people than the combined populations of the United States, the Euro Zone and Japan

Considering Foreign Opportunities

Although investors are comfortable investing in domestic companies that are close to home (known as “home country bias”), a properly constructed portfolio should contain foreign investments.   The next two columns discuss the additional risks and methods of investing in foreign securities.