Why Diversification in Your Portfolio Works.
Investing in the land of opportunity
Here’s what makes U.S. equities attractive to Canadian investors. Canadian investors have been increasingly looking south towards U.S. markets, investing a record $82 billion in U.S. securities between January and November 2021. What’s attracting them? And should you be paying attention, too?
Stock market performance is likely one of the big factors contributing to the flow of money into U.S. equities. Over the past two decades, the U.S.-based S&P 500 Index has averaged an annual compounded rate of return of 9.5 per cent, beating the 8.0 per cent return of Canada’s S&P/TSX Composite Index. Investors who ignore U.S. equities are missing out on a potential growth opportunity.
Diversification is another major reason Canadians have been embracing international opportunities. After all, the world beyond our borders accounts for more than 97 per cent of global equity market capitalization and offers the possibility of investing in sectors that aren’t strongly represented in Canada. For example, a large proportion of Canada’s equity market is tied to resources, and when the energy sector ran into headwinds in 2020, so did the S&P/TSX Composite Index. The S&P 500 Index gained 16 per cent in 2020, compared to only a 2.2 per cent return for the S&P/TSX Composite Index.
On January 31, 2022, the three most dominant sectors in the S&P 500 Index were information technology (28.7 per cent of the index), health care (13.1 per cent) and consumer discretionary (12.0 per cent). The top three sectors in the S&P/TSX Composite Index on that date were entirely different: financials (33.5 per cent), energy (14.8 per cent) and industrials (11.7 per cent). Investing in both markets, rather than just one, enables investors to diversify into parts of the economy that tend to experience ups and downs at different times.
Furthermore, investing in U.S. equities can provide exposure beyond the domestic U.S. market. That’s because many multinational companies have their headquarters in the United States and are listed on U.S. exchanges. These businesses have a foothold in multiple countries, so they can benefit from local economic growth wherever they do business – and their investors can too.
When to invest in U.S. equities There’s no time like the present, according to Sandy Sanders, head of the U.S. Core Value Equity team at Manulife Investment Management. He says that carefully selected U.S. equities are well positioned to benefit from the U.S. economy’s current strengths.
Sanders points out that American consumers are in better shape than Canadian consumers, paying less interest relative to their income than they have in decades. There’s huge demand for housing from millennial renters, who have increasing purchasing power and hold 40 per cent of all jobs in the United States. Furthermore, Sanders believes that demand in the system from back-ordered goods that were less available during the pandemic should help sustain revenue and earnings growth over the next several years. All of this should help support U.S. equity returns through 2022 and beyond.
How to invest in U.S. equities How investors go about accessing the growth potential of U.S. equities depends on their risk profile, goals and time horizon. Often, trading accounts allow Canadian investors to buy stocks listed on U.S. exchanges directly. Or for built-in diversification, exchange-traded funds (ETFs) aim to replicate the performance of U.S. benchmark indexes.
Many investors prefer to know that experienced portfolio managers are overseeing their investments. To access the professional expertise of specialists who spend all day, every day analyzing U.S. equities, investors can invest in mutual funds that focus primarily on U.S. equities or mutual funds that include U.S. equities as part of a balanced portfolio of stocks and bonds.
When selecting a mutual fund, it’s important to look for a disciplined research process with a track record of identifying companies that have sustainable competitive advantages. Some funds concentrate on a specific company size (e.g., small-cap, mid-cap or large-cap), a specific industry (e.g., technology or health care) or a specific investment style (e.g., growth or value). Others have more flexible mandates that allow them to seek out the best opportunities whatever their size, industry or style. If you’re interested in investing in U.S. equities, speak with your advisor about which opportunities work best in the context of your overall financial plan. Small, medium or large? In the United States, as elsewhere, companies come in all different sizes. There are small-caps, often just starting out and more volatile but with the potential for high growth. There are large-caps, established and relatively stable but with lower growth potential. And then there are the companies in the middle – mid-caps – that have achieved a certain scale and presence in their industry and that, if chosen with care, may become the household names of tomorrow.
Whether investors choose one size, two sizes or a mix of all three, they can benefit from exposure to the largest equity market in the world, representing more than half of global equity market capitalization.