As a Canadian, how much should you invest in the stocks of your own country? Should you do as the average Canadian does and invest over 50% of your equities here? Should you invest a proportionate amount to Canada’s share in the global stock market at just 3.4%? Or is the answer somewhere in the middle?

Home country bias refers to an investor’s tendency to hold a disproportionate amount of their portfolio in domestic equities relative to their country’s share in the global market. This is a widespread phenomenon that impacts investors around the world, with Canadians allocating an average of 52.2% of their equities to Canadian stocks. Given that Canadian stocks only account for 3.4% of the global index weight, this implies that Canadians are overweight in Canadian equities by nearly 50%.

Notes: Data as of June 30, 2022 in U.S. dollars from the International Monetary Fund or IMF. Domestic investment is calculated by subtracting total foreign investment (as reported by the IMF) in each country from its market capitalization in the MSCI All Country World Indec. There may be some discrepancy between the market values in the survey and the MSCI ACWI.

Sources: Vanguard, based on data from IMF’s Coordinated Portfolio Investment Survey (2022)

 

While it may feel more comfortable to invest in familiar companies and markets, home country bias taken to an extreme can lead to reduced diversification, and missed global opportunities. Canada in particular is relatively concentrated in energy, and financial sectors, with very little exposure to industries such as technology or healthcare. Investors who ignore U.S. and international equities are likely to miss out on opportunities in these sectors.

There are several reasons why investors tend to favor their home country’s stock market. These reasons include currency exposure, costs, taxes, familiarity biases, and perceived stability of one’s home country. While some of these reasons are valid, they shouldn’t overshadow the benefits of global diversification.

 

Historical Examples: The Risk of Over-Reliance on a Single Market

Some of my favorite movies as a kid (and still today) include the Back to the Future trilogy. In the third movie, Doc (from 1955) says to Marty (from 1985), “No wonder this circuit failed, it says made in Japan”. Marty then says “What do you mean doc, all the best stuff is made in Japan”. I think this is an interesting pop culture example of how dramatically public opinion can change in a matter of a few decades, which was seen in the massive rise and subsequent fall in the Japanese stock market.

Source: New York Times

 

The chart above shows the meteoric rise in Japanese stocks during the 1980s, reaching 42% of the total global market capitalization in 1989, the same year that Back to the Future Part 3 was filmed. Japan’s stock market began to crash by the end of the decade, falling by over 80% taking decades to recover just reaching all-time highs again in 2024. Given how little most Canadians had invested in Japanese stocks at the time, this isn’t something that impacted many Canadian investors. An investors who held only Japanese stocks at this time would have suffered losses that hadn’t been seen in a global portfolio since the Great Depression.

This example highlights the danger in assuming the economic growth of the past of any single country will last forever, and why global diversification is critical to give the best chance of meeting your investment goals.

 

A Case for Home Country Bias: The Treatment of Foreign Investors

International diversification is great when things are good and the world is largely peaceful, but throughout history we have seen times where foreign investors are treated unfavorably when conflict arises. Major events like wars can cause markets to close, and foreign investors to receive poor treatment. In the early 1900s, investors from around the world were encouraged to diversify globally. During World War 1, markets began to contract with market closures, foreign exchange restrictions, and market nationalizations. Foreign investors experienced a lack of access to their investments, and had meaningful and at times total losses in these holdings.

This isn’t purely an example from distant history. In 2022, Russia enacted restrictions that impacted the ability of investors in “unfriendly countries” to transact in the shares in Russian companies. In 2019 Argentina instituted restrictions on the flow of capital that continue to be a challenge for foreign investors today. These risks are avoided by investing in domestic markets and provide some benefit to having some home country bias.

At the end of the day, nations want to protect their own citizens, and are less likely to prioritize foreign investors, especially when things get ugly. Canada has had good relations with most major economies historically, but there’s no guarantee that this will continue to be the case throughout our lifetimes. While it’s unlikely that this risk would impact Canadians significantly, the likelihood is not zero and should be considered in one’s asset allocation decision as a reason to invest a greater amount in your home country than you otherwise might.

 

What’s the Right Balance Between Domestic and International Equities?

While there’s no universal formula applicable for everyone, understanding the advantages and risks associated with investing more in Canada can help make a more informed decision for your own portfolio balance. Here are some considerations that I keep in mind when making allocation recommendations:

 

Benefits of Canadian Home Country Bias

• Tax Advantages: Canadian equities can receive preferential tax treatment for Canadian investors.
• Treatment of Foreign Investors: When conflict arises, nations tend to protect local investors at the expense of foreign investors.
• Access and Cost: Generally, investing globally is more expensive than domestic investment as a greater and more diverse team of analysts are required for active portfolio management.
• Lower Currency Volatility: If most of your spending is in Canadian dollars, investing in Canadian dollars will reduce volatility in what you’re actually able to buy relative to investing in a foreign currency.

 

Detriments of Canadian Home Country Bias

• Lack of Sector Exposure: Canada has relatively few technology or healthcare stocks to invest in.
• Concentration in Energy and Financial Sectors: These two sectors make up about 50% of the Canadian stock market weight.
• Correlation With Other Lifestyle Factors: If you work in Canada, your employment may be somewhat dependent on the Canadian economy. The same applies to the value of your home, or other property.

 

This is a subject that has been studied extensively, with most studies recommending between 30-35% of equities allocated to Canadian Equities. Vanguard’s global research team assesses that 30% is the optimal allocation that they recommend in 2024, while a 2023 paper from Anarkulova, Cederburg, and Doherty found that in a large sample of developed markets from 1890-2019 that a 35% domestic allocation was optimal for investors in most developed countries. Considering both the quantitative evidence and qualitative rationale presented, I typically advise my clients have between 25-40% in domestic equity allocation depending on their personal circumstances and at times, market environment.

The key to smart investing isn’t about making a bet on one particular country whether or not it’s your home country, it’s about striking the right balance. If you’re unsure about your portfolio’s diversification, let’s review it together to ensure you’re positioned for long-term success.