Canadian pension plans have an inherent home country bias in their equity portfolios that has led to them underperforming their international peers over the past 12 years, according to a FTSE Russell study.
The study examined the equity portfolios of public and private pension plans in Canada, the United States, Japan, Australia and the United Kingdom and determined their home biases by comparing their weights in domestic stocks to that of the country’s weight in the FTSE All-World Index.
After Australia, Canadian pension plans were found to have the second-highest ratio — seven times — of domestic stocks to their weight in the index.
Only three per cent of the FTSE index is attributed to Canadian stocks while Canada-based pension plans, the report said, held 21 per cent of their equity portfolios in domestic stocks.
“There’s still some home bias tilt,” Paul Bowes, the head of FTSE Russell Canada, said. “I was surprised by the high degree. I thought we moved beyond that … you keep reading about some of the larger pension funds who keep making international investments.”
Canada, the report outlined, is strongly dependent on three sectors — oil and gas, basic materials and financials — which account for 70 per cent of the market. If one or two of these sectors are doing comparatively well, it’s enough to drive the local markets up. The problem is that two of them have underperformed their foreign peers.
From Dec. 31, 2007, to June 28, 2019, the Canadian oil and gas sector yielded negative returns of more than one per cent while the international oil and gas companies in the FTSE All World ex Canada Index netted investors more than two per cent. The same disparity occurred in basic materials, where Canadian companies lost three per cent and their global competitors gained four.
BMO senior economist Robert Kavcic said the devotion Canadian investors still have toward these struggling sectors is likely due to familiarity.
There’s still some home bias tilt. I was surprised by the high degree
Paul Bowes, the head of FTSE Russell Canada
“I wouldn’t be surprised if typical balanced portfolios in Canada have 30-, 40-, 50-per-cent Canadian equity in them,” he said. “I would argue that’s way overweight Canada, especially when you consider that you’re losing a lot of industry diversification that you would in the S&P 500 as an example.”
Domestic investors also lose out on better growth opportunities, especially in the tech sector where Canada sorely lagged its global competitors. Tech stocks in the FTSE All World ex Canada Index returned about 13 per cent over the past 12 years. In Canada, they lost more than four per cent of their value.
Despite Canada’s high domestic stock ratio, the country’s pensions had the lowest exposure to their domestic markets based on raw assets alone at 23 per cent. The reason the multiplier is higher is because of Canada’s small weight in the FTSE index, which is mostly made up of U.S. stocks.
Even then, most of the home bias the report attributes to Canadian pensions must be coming from the private sector, since none of the public pensions that disclose their asset mix had 23 per cent of their equities portfolio in Canada.
The prudent thing to do is to have a much more diversified portfolio to make sure there isn’t an undue concentration in Canada
CPPIB spokesperson Michel Leduc
Both the Canadian Pension Plan Investment Board and Ontario Teachers’ Pension Plan invest six per cent of their equities portfolio in domestic stocks. However, their total net asset exposure to Canada significantly increases to 15 per cent and 40 per cent, respectively.
CPPIB spokesperson Michel Leduc said the pension fund does not implement country-specific targets or have internal rules about how much of its portfolio must be attributed to Canada.
“It’s not like every country is the same, we’re not going to spread peanut butter across 180 countries,” he said. “We’re going to have a bias to different countries we believe have strong risk-adjusted returns.”
The CPPIB’s only mandate is to maximize returns for pensioners and going global appears to be the preferred route of doing so. Over the past 20 years, CPPIB fund managers have taken a fund that was completely invested in Canada and given it a global focus, Leduc said, with strong investments in China and emerging markets.
But even regional public pension plans, which are typically more devoted to investing locally, do not have a Canadian bias that reaches the levels outlined in the FTSE report.
For example, Alberta Investment Management Corp. has about 21 per cent of its equities portfolio in Canada, while the Caisse de dépôt et placement du Québec and British Columbia Investment Management Corp. have 18 per cent.
As with the CPPIB and Teachers’, their respective exposures to Canada rise when total net assets are taken into consideration, but they are still dwarfed by foreign investments in every case except AIMCo’s.
“The prudent thing to do is to have a much more diversified portfolio to make sure there isn’t an undue concentration in Canada,” Leduc said.