This advice appeared in a recent special feature by Calgary-based Mawer Global Investment Research in the December/January 2014 issue of MoneySense magazine. Mawer is a strong proponent of global diversification and believes that our investor home bias is risky. It was the Don’t Be A Turkey analogy that got my attention…
The article highlights a cautionary turkey tale from Nassim Nicholas Taleb’s 2007 book, The Black Swan. He tells a story about a turkey that is fed by a farmer every morning. Eventually the turkey expects that every visit by the farmer simply means food. This seems logical because it’s the turkey’s only experience, so it figures this is all that will and can happen. But two days prior to Thanksgiving, the farmer shows up as usual, but this time carrying an axe. The turkey quickly learns his expectations were catastrophically wrong.
The same happens with investing; no we won’t get our heads cut off, but the things that we have become very accustomed through experience can suddenly change. Despite expanding opportunities for investors to diversify globally, Canadians have a tendency to focus on Canadian markets and companies, an investing trait called “home country bias”.
You might well ask why? As with all investments, past performance in any country or sector is no guarantee of future returns. Yet many investors continue to hang onto Canadian investments based on inductive reasoning, where conclusions are built based on experimental or factual evidence. The problem with this is that we tend to jump to the wrong conclusions, as they are provisional at best and has significant negative implications for managing our investment risk.
One example of this is fracking, which abruptly opened vast new supplies of natural gas, thereby completely changing the natural gas market. Another local example is the overnight changes that happened to income trusts, and the income that pensioners were relying on from these investments.
So how do you avoid becoming a turkey? Do your homework and ask lots of questions. If you’re a turkey, question why the farmer is sharpening his axe. If you’re an investor, ask why insiders are selling. Why are inventories building in certain sectors? Why are unit sales in some industries slowing?
This is where looking beyond Canada makes sense in today’s global world. Regardless of what you invest in there will be risks, so the only defense is diversification. Even this is tricky as you need to look for systemic and inconspicuous risks. The risk today in Canada is we have too many of our seemingly well diversified industries that rely heavily on natural resources in one way or another. Yes, we have had a great run for 10 years, but if your equity holdings are 100% Canadian you’re running a high risk of a downside shock.
One thing to consider is currency risk. For example, in the last year our dollar has gone from $1.04 to $0.94 U.S. That’s a 10% drop in value, so look for investments that hedge currency risk for your protection.
That’s not to say that Canada’s resource sector run is over, but the folks at Mawer are not betting on it continuing and neither should investors. Global diversification is important, in finding more opportunities to invest in those boring companies that make money.
Review your portfolio with a trusted advisor who has his eyes open for future problems and opportunities. And, look beyond Canada and make the world your investment arena.
Image used by permission from Zethara