Investing should be based on Opportunity not Historical Returns

When was the last time you considered investing in companies listed on the stock market in Iceland? Would you consider investing 60% or more of your portfolio in Iceland? Probably not, yet Icelanders do invest 60% of all their investments in Icelandic companies.

Can you name one Icelandic company? It would surprise me if you could think of one, because there are only 15 listed companies on their exchange.

As silly as investing in Iceland seems to a Canadian on a world market Canada isn’t that much different. Canadians similarly have 70% of their investments in Canadian companies. Albeit a larger stock market than Iceland, on a global basis the Canadian market only makes up 3%. This is a home bias phenomenon.

The pie chart below shows how on a worldwide basis the size of the Canadian stock market is relative to the rest of the world.

For the past two years the Canadian market has been one of the best performing markets in the world for a couple of reasons: 1) declining US$ and 2) natural resources.

Canadian markets have enjoyed strong relative performance and client portfolios have benefited from over weighting domestic holdings. As of November 3 2005, the TSX composite index has returned +15.42% year to date. This gain has not been without some significant volatility. The index declined 628 points in the month of October and in the first 3 days of November gained back 289 points.

Increasing global exposure can serve to lock in some of these recent domestic gains and lower portfolio risk.

Having said that investors continue to behave badly, chase fads, returns and invest in what just went up not considering the opportunity or what lies ahead.

Think back to 1999. Most, if not all investor’s, were investing primarily in the tech sector in both Canada and U.S. Most investors insisted on it. Most investors were not investing in natural resources, real estate or gold. Both locally and internationally real estate was under performing. In fact locally the real estate market declined in value from approximately 1994 through 1999. The real estate investment market was non-existent and over looked. Typically an investment recommendation in real estate fell on deaf ears in the late 90’s.

Today is not any different then 1999 except that the hot investments have changed. Natural resources, real estate are the hot commodities now. Even the rise in these investments will come to an end. The question you should be asking yourself is where is the next opportunity?

The following information is from IFIC (Investment Funds Institute of Canada):

The net sales for foreign equity funds were higher than the overall sales for the industry. Why is that? Investors moved their Canadian portfolios over to foreign equities at the very top of the market in 2000. Since the year 2000 the Canadian dollar has risen steadily against the US dollar, creating losses in foreign investments. A steady decline of foreign markets for 5 and half years.

Have we all learned our lesson? Would we make the same mistake twice? Well let’s look at January 2005 IFIC sales (000)

Restated, investors are once again moving their investments to what has historically done well not to where the opportunity lies. The movement from foreign investments to Canadian investments are at an all time high. Five years after the Canadian market has grown, investors are now switching from foreign investments to Canadian.

When looking at history, in order for Canadian equities to have out performed US equities over the past 5 years, the move from foreign equities to Canadian equities would have had to happen in 1999, six years ago at the height of the tech bubble and at the exact time everyone was selling their Canadian holdings to buy foreign. After five years into a substantial gain in the Canadian market retail investors are switching from foreign to Canadian investments.

Earlier this year restrictions on investing in foreign markets were removed from pension plans and RRSPs. Today you can invest 100% of your investments outside Canada. It is worth noting that when other countries removed restrictions on foreign investments the domestic market contracted. Pension plan managers started searching the world for the best companies to buy rather then the best in Canada.

Institutional investors started investing outside their country because of opportunity and liquidity in foreign markets. Reducing supply in other world markets, and excess supply in their own country. In discussions with some of Canada’s leading institutional investors they are already looking outside Canada for investments. Remember 97% of the world’s stock market and business is outside Canada it is safe to say that the largest opportunity for investment is outside Canada.

We currently are enjoying a stronger currency, mainly brought on by a declining American currency. A stronger Canadian dollar isn’t all positive. Companies that manufacture and sell on the world market are becoming less competitive due to the strength of the dollar.

The original value investor 500 year old advice, Jacob Fugger the Rich 1459-1525, quote:

“Divide your fortune into four equal parts: stocks, real estate, bonds, and gold coins. Be prepared to lose on one of them most of the time. During inflation, you will lose on bonds and win on gold and real estate : during deflation, you lose on real estate and win on bonds, while your stocks will see you through both periods, though in a mixed fashion. Whenever performance differences cause a major imbalance, rebalance your fortunes back to the four equal parts.”

Although the theory is over simplified the basics are as true today as they were 500 years. The first part of the quote sets out what you should expect, part of your portfolio will lose money, the other part tells you what will perform during different economic times. The last part really is the key, balance your portfolio regularly, move from the out performers, take profit and move to where the opportunity for growth lies.

We are enjoying growth in natural resources and real estate today, this will come to an end. When it does how will your portfolio be positioned, will you be holding yesterday’s winners or will you be in a position to take advantage of the next cycle of growth? Pay close attention to the opportunity, and less to historical returns.

This article was prepared by Terry Fay who is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst*. The views (including any recommendations) expressed in this article are those of the author alone, and they have not been approved by, and are not necessary those of Dundee Securities.

The particulars contained herein were obtained from sources which we believe reliable but are not guaranteed by us and may be incomplete. The opinions expressed have not been approved by and are not those of DundeeWealth Inc., its subsidiaries, or its affiliates, including, but not limited to Dundee Securities Corporation, Dundee Private Investors Inc. / Ltd., Dundee Insurance Agency Ltd., Dundee Bank of Canada and Dundee Mortgage Services. This website is not deemed to be used as a solicitation in a jurisdiction where this Dundee representative is not registered.

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