‘Ottawa’ Emerging Market ETFs Can Help Investors Beat the Home Bias Trap
With the significant bounce the S&P/TSX Composite Index has enjoyed since its early February lows and the equally impressive reversal of fortune for the loonie in recent months, it is tempting for investors to take a deep breath and revert to the familiar — by doing nothing to expand their portfolios beyond Canada and North America.
Canadians perennially suffer from home bias — moreso than most investors worldwide, if the anecdotal evidence is to be believed.
So, it’s domestic exposure all the way, relying on the notion that the rebound in oil prices will continue and be sustained and that precious metals and even some basic metals will prove the kicker to outperformance going forward.
That is one way to look at it.
In fact, if you consider the massive outperformance enjoyed by the oil and precious and base metals sectors thus far in 2016 a harbinger of further gains, you might even opt to “diversify” by emphasizing these areas in your portfolio via some of the ETFs providing instant access.
Several prominent hedge fund managers have recently expressed their belief that gains in gold bullion and by extension gold equities should continue — bolstered by central banks’ seeming endless quest to devalue their respective paper currencies with unconventional policies such as Negative Interest Rate Policies.
As for oil, well, Goldman Sachs, which earlier suggested $20 was quasi inevitable, has since turned more constructive on its future price path, noting that the inventory overhang was shrinking faster than earlier believed.
You’d certainly be in decent company, if that is what you are after, if you dove back into energy and materials, even if there are some conflicting signals out there. (For example, the famed investor George Soros has gone long Barrick, while hedge fund manager John Paulson has further reduced his SPDR Gold Trust holdings.)
There is another option, however.
Consider emerging markets, which like Canada, depend a lot on energy, but beyond this, provide a significantly greater breadth of exposure than our domestic market offers.
Why EM? Because in a way, it is diversifying while remaining highly correlated with the market you are leaving behind, since the S&P/TSX has a high degree of correlation (0.88 trailing 5 years) with emerging markets.
Emerging markets have been underperforming significantly for some time. They have also generally been shunned — a reflection of market participants’ reluctance to invest in those that are overly dependent on resources and/or those plagued by corruption scandals due to fears that any kind of economic deleveraging could hurt equity investors.
These concerns subsist, to be sure, much as the risk of experiencing renewed volatility and possibly downside if and when the U.S. Federal Reserve opts to raises rates further in 2016. For those who think, however, that the Fed’s bark regarding raising rates will prove worse than its bite in actually doing so, EM, like Canada, could deliver decent relative returns — even if with attendant greater risks.
As pertains to volatility, note that there are several low-volatility ETFs providing access to EM exposure (XMM, for instance, which outperformed on a 1-3 years trailing basis, and also a low volatility EM ETF launched by BMO this week).
Some investors favour dividend stocks in EM to again address some of the risk-side of these markets, while those looking to fundamental underpinnings could opt for a RAFI smart beta ETF (CWO).
If Canada’s sleeping market can be awakened — and RBC Capital Markets recently proclaimed the end of a five year stretch of underperformance for Canadian equities (TSX target 15,200 ) — why not consider the possibility of some respectable showings on the part of emerging markets, too?