Diversification: key to investment success

I spend a lot of time thinking, talking and writing about the benefits of taking a diversified approach to investing. In fact, it was one of the first topics that I wrote about on LinkedIn and I have since written several articles on the subject. At its most basic level, diversifying a portfolio means spreading investments across various asset classes, geographies and sectors in an effort to achieve the optimal balance between risk and return. In my view, this is a critical driver of long-term investing success. While the principles of diversification haven’t changed over the years, how we diversify our portfolios has.

 The launch of our new RBC Global Portfolios has provided me with a great opportunity to revisit why I think it is important to take a globally diversified approach to your investments.

The evolution of global diversification

With the trend towards globalization of the world’s economy and financial markets, the way investors achieve diversification has changed over the past few decades. Today, being effectively diversified has taken on new meaning and a new level of importance given globally integrated economies and close linkages across capital markets. In a modern-day context, diversification means having exposure to opportunities in many different regions while also holding a broad range of fixed income investments.

Our active approach to asset allocation means that we are continually looking for ways to evolve our investment solutions to reflect these changes. For example, we have been adding more global exposure across both equities and fixed income in many of our portfolio solutions. This ensures that our clients remain broadly diversified and well positioned as market conditions change.

Canadians are heavily invested in Canada

Canadians tend to hold a significant portion of their assets in Canada, an investing tendency referred to as home-country bias. In fact, the average Canadian has 90%[1] of their assets tied to Canada, resulting in significant country-specific risk. This is not unusual or surprising; it is a worldwide phenomenon and certainly not unique to Canadian investors.

This bias is understandable. After all, we recognize and value domestic brands. We trust in their ability to perform well. However, there is a growing awareness among Canadian investors of how much they rely on Canadian assets for their long-term financial goals. Many are looking for ways to increase their investments outside of Canada.

The downside of investing locally

There is no doubt that Canada can be a great place to invest. But investing locally can limit your opportunity set. Canada is the 10th-largest developed economy and represents a relatively small portion of the world’s investment opportunities. For example, Canada accounts for only 2.8% of the global equity market and 3.1% of the global bond market. 

Going global provides more opportunities for diversification

By taking a more global approach, investors have many more investment options to choose from. This means more opportunities to diversify, which ultimately leads to a smoother investment experience. That’s because when one region is performing poorly, another could be enjoying stronger performance.

We call the diagram below the “quilt.” It shows the annual returns for various global asset classes and markets in each of the past 10 years. Even a quick glance shows that all of these markets go up and down in the short term and that no single market has outperformed the others consistently. Investing in a globally diversified mix of equities and fixed income can help steer you through various market conditions including short-term market declines in any one asset class or region. 

In any given year, the global balanced portfolio has landed near the middle of the rankings, or sometimes closer to the top. This is what you would expect as the components of the portfolio rise and fall.

For the calendar year ended December 31, 2018, a global balanced portfolio generated a return of 0.2% despite the sell-off in risk assets, including equities and high yield bonds. Within equities, there was a significant dispersion in returns, with U.S. equities producing the best return and Canadian and Emerging Market equities performing the worst. But once you blend all of these results together into a global balanced portfolio, your result is flat performance. 

Don’t forget the other 97%

As investors, you want to take advantage of all of the opportunities that are available to you. The more options that you look at, the greater your ability to diversify. By investing beyond the concentrated Canadian market, you tap into the other 97% of the world’s available investment opportunities. This improves diversification, which ultimately leads to a smoother investment experience.

As I have always said, and will continue to say, diversifying globally is critical to investment success and a key driver of long-term investment performance.

[1] Investor Economics Household Balance Sheet Report 2018, data as of December 2017, www.investoreconomics.com/our-services/

Please consult your advisor and read the prospectus or Fund Facts document before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. RBC Funds, BlueBay Funds and PH&N Funds are offered by RBC Global Asset Management Inc. and distributed through authorized dealers.