Home > About Second Opinion > Investment Principles > Principle 4

Principle #4: Diversification

Investment policy decisions should be based on your investment goals. This will determine an appropriate asset mix that is consistent with your needs, risk tolerance and the long term capital markets outlook.

As a general rule, in an equity portfolio, broad geographic diversification is a sensible way to reduce volatility (risk) and increase the average rate of return by taking advantage of investment opportunities outside of Canada.

Investing outside of Canada also provides protection if the Canadian dollar falls dramatically in value. On the other hand, it also introduces an element of risk if the Canadian dollar appreciates, as it has recently against the US dollar. Since no one knows for certain which way the dollar will move, diversification is the best strategy. It should be noted that you can eliminate foreign currency risk by hedging your foreign investments back to Canadian dollars. One easy way to do this is to use Exchange Traded Funds (ETFs) that replicate foreign indices and are hedged back to Canadian dollars, thereby removing any currency risk.

Canada now represents just over 3% of global capital markets. At the moment the Canadian equity market is highly concentrated in the resource and financial service sectors that represent 70% of the TSX/S&P Composite Index by weight. Investing outside of Canada reduces risk by exposing you to a more diverse group of industries. Recently, Canadian equities outperformed the major markets worldwide, something that is unlikely to be repeated in the near future. Generally, periods during which Canadian markets significantly out perform the US markets are followed by periods when the Canadian markets under perform.

The geographic allocation for your portfolio should be set out in the Investment Policy Statement.