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moneysense.ca, 15/05/12
Sector Breakdown of Diversified Portfolios
In a recent column, The Globe & Mail’s Rob Carrick (see Beware the limitations of buying the index, May 11, 2012) pointed out that investing in just the TSX Composite index might leave an investor with an unbalanced portfolio because of the index’s concentration in just three sectors: financials, energy and materials. The criticism is a valid one because, as you can see from the chart below, resource companies make up more than half the index and financials make up another one-third of the index. (As an aside, the sector breakdown of the S&P/TSX 60 index, which is tracked by the iShares S&P/TSX 60 ETF – TSX: XIU is pretty much the same as the broader Composite index).
This limitation of the TSX Composite Index is one reason why passive investors diversify their portfolios globally. The US Total Stock Market, for instance, offers much better diversification. The three dominant sectors in the Canadian market make up less than a third of the US stock market. The US stock market also offers exposure to sectors such as Information Technology, Healthcare and Consumer goods that have a much smaller representation in the Canadian index.
The MSCI EAFE Index which provides exposure to developed stock markets in Europe and the Pacific region is also well diversified across sectors. Financials and resources make up just 40 percent and the index has significant allocation to stocks representing Consumer goods, Utilities and Telecommunication services.
A globally diversified index portfolio such as the Sleepy Portfolio, which is split between Canadian, US, EAFE and Emerging Markets has a much better balance between sectors when compared to the Canadian stock market. The allocation to financials and resources drops to less than half the portfolio compared to three-quarters for the Canadian-market only index investor. And the allocation to sectors such as Consumer goods, Information Technology and Healthcare is also boosted substantially.
moneysense.ca, 15/05/12
What should the balance between sectors be? A sectoral balance equal to domestic market capitalization would be one possible answer, and international market cap. another. Alternatively, you might look at the ‘economic activity’ of each sector, choose a split based on backtesting and expected intra-class correlations and returns. Or, you could choose a somewhat arbitrary number of sectors, and a desired allocation based on an arbitrary acceptable ‘balance’ level.
In Canada we don’t have a great deal of ‘Healthcare’ equities in the TSX 60, as pharmaceutical companies are largely headquartered overseas, health insurance is a relatively small market in Canada compared to the United States (and is likely classified as Finance), and there is minimal potential for direct investment in the delivery of healthcare services. It’s not clear to me why Canadians should want to invest in the for-profit American healthcare industry in the interest of ‘balance’.
I wonder if an ETF like Canadian Fundamental Index Fund (CRQ) may be a better choice for the Canadian market since it has a little more diversification across sectors and not quite as much in Energy/Materials than say XIU?
Your portfolios still seem overly weighted towards resources and financials, even considering your international exposure. Please give me the satisfaction of acknowleging this weakness in your index-religion.
@Michael: CRQ does have a lower allocation to resources at 33% but on the downside, its allocation to financials is much higher at 42%. And these two sectors together again make up 75% of the index. So, it seems to me that CRQ suffers the same problem as XIU/XIC.
@Dr. Dale: That’s the reality of investing in Canadian markets. If an investor doesn’t like it, she always has the option of dialing down exposure to the Canadian market.
Is the MSCI then the better index for Canadian equities and so would VSE be a better choice?
@Jon Evan: Unfortunately, the answer is no. The MSCI Canada Index is also a cap-weighted index and hence, the sector breakdown is very similar to that of the TSX Composite and TSX 60 indices.
Financials: 34.4%
Energy: 26.6%
Materials: 19.6%
https://www.vanguardcanada.ca/documents/literature/F9324EN.pdf
[...] Capitalist reminded readers about the benefits of market diversification, citing limitations in holding only the TSX Composite Index in your portfolio. “The US stock [...]
[...] Sector Breakdown of Diversified Portfolios @ Canadian Capitalist [...]
XTF has a couple of new Canadian equity ETFs that use rules-based methodologies to build diversified portfolios of Canadian equities. FXM is their value fund, and has a more reasonable sector weighting than the TSX.
@Andrew F: FXM looks really interesting both from a value point of view (P/B is 1.4) and from a sector diversification point of view. 0.60% is a bit too high for an ETF though.
How about using these two ETFs to complement a main index fund like XIC or VCE?
XST iShares S&P/TSX Capped Consumer Staples Index Fund
XUT iShares S&P/TSX Capped Utilities Index Fund
Dear CC:
I think that you present yourself as an expert, and many people follow you. They ask you questions. You answer them.
I would posit that you don’t really have the experience or know-how to do this. You are fixated on a single strategy and talk as though it is the best one.
I think it would be more honest of you to say that you follow one strategy (not sure why btw) and that there are many other ways of investing out there.
The beauty of sites like this is that it is an open Forum, different thought patterns are presented that encourage dialogue.
The most important question an Investor needs to answer is Why am I investing, what is my motivation to save and not spend, and then act accordingly?
The people i know are investing primarily to leave an estate, they are financially solvent and have spent a lifetime living within their means, excess cash is not wasted, it is set aside for an era when their children will face a future with No DB Pensions, high Real Estate charges, exorbitant Tuition Fees for professional education, etc etc.
CC is one of the better informed posters that I have read.
CC should monetize his site, why not make money from a forum,get paid for your time.