Session 4 – The Importance of Global Equities in DC Plans
Global equities offer diversification and growth opportunities for Canadian investors.
By Alan Daxner, Executive Vice-president, McLean Budden
Global equities have become a larger part of Canadian pension plans, a trend partially attributable to gradual increases and the removal of foreign content limits. It is interesting to note that for the last two decades (ending in 1999), both U.S. and international stocks outperformed Canadian equities—likely a contributing factor to increased allocations to these asset classes. However, the most recent decade has seen Canadian equities dramatically outperform U.S., international and global equities, with nearly half of the shortfall attributable to the historic recovery in the Canadian dollar from its early decade lows. It is interesting to note that taking a longer-term perspective over the last 20 years shows comparable performance between Canadian equities and their foreign counterparts.
A longer-term view and investment theory remind us that Canada is a relatively small market within a global context and is also quite a dynamic market in terms of its sector composition. While in 2000, technology stocks represented more than 40% of the S&P/TSX Composite Index, basic industries including the commodity-related energy and materials sectors are now 55% of the index. Significant commodity exposure creates greater short-term volatility, which results in a higher beta or volatile Canadian market versus its global peers.
As previously noted, the dramatic appreciation of the Canadian dollar versus the U.S. dollar accounted for approximately half of the performance shortfall in the last decade. In fact, a look at the history of the Canadian/U.S. dollar exchange rate back to the 1930s demonstrates this unprecedented move. It is instructive to look at a published source of hedged versus unhedged performance—namely, the MSCI World Index in U.S. dollars (unhedged) versus the MSCI Hedged World Index in U.S. dollars, the latter used as a proxy for currency hedging back to the U.S. dollar.
The basic takeaway here is that the last 10 years have seen a secular decline in the U.S. dollar. This would, of course, imply an unfavourable environment for U.S. investors to hedge their foreign currency exposures, with the read-through to Canadian investors that the timing of implementing a currency hedge is important and acting at periods of domestic currency strength can have multi-year material negative impacts on performance. In some ways, this can be viewed as return-chasing and a reaction to past exchange rate moves, from the perspective of how much value could have been preserved had a hedge been in place.
The long-term diversification benefits and much broader opportunity set offered by global equity markets will be of critical importance to Canadian pension savings. The last 10 years of comparative performance should not dictate the elimination or reduction of foreign equities. Both a longer-term historical view and anticipation of a slower economic growth environment, which may dictate less commodity price volatility and $C/$USD exchange rate volatility, suggest the next 10 years may deliver less disparity in equity returns. BC
Continued on the next page…
Session 5 – Global DC Strategies
Lessons for Canada from other DC programs around the world.
