The Globe and Mail, Report on Business
Published April 6, 2007

As we take Steadyhand on the road over the next few weeks, we anticipate that one of the most frequently asked questions we’ll face will be: Why don’t you have a pure Canadian equity fund? It’s certainly a legitimate question. We are a Canadian mutual fund company, after all. When we made the choice to not include a Canada-only equity fund, we expected to get some flack for it.

But we had reasons for making the choice we did. Some were specific to our firm, including the fact that we didn’t want a long list of funds in our lineup. A Canadian equity fund would fill a valuable slot that could be used for another fund. Also, we had looked extensively at how high-end wealth management companies managed money for rich people, and they rarely limited their equity managers to Canada only. They usually had the scope to complement their Canadian holdings with foreign stocks.

Beyond our specific reasons, other factors weighed heavily on our decision, and these have an impact on how all investors must think about the Canadian equity market. We felt that the Canadian market was too limiting for our managers. We also didn’t think the makeup of the Canadian market was an appropriate starting point to properly diversify a portfolio. Both reasons are related, but I’ll tackle them one at a time.

If you are a portfolio manager charged with managing a large Canadian equity fund, your choices are limited. Of the top 10 stocks on the S&P/TSX Composite Index, seven are financial services companies and three are oil and gas producers. Of the top 25, you get a few other types of companies, but it’s still pretty limited. In that 25 there’s only one technology company (Research in Motion) and no health care, consumer product, retailing or manufacturing companies.

The full impact of the narrowness of our equity market has not been fully felt yet because the sectors that make up virtually the whole market – financial services, energy and mining – have been performing exceptionally well.

But if you do some what-if scenarios, it gets downright scary. What if energy and/or mining go out of favour for a few years? What if we lose Shaw or Ma Bell to further consolidation in the telecommunications industry? Or RIM gets swallowed up by Nokia? If Canadian equity portfolio managers want to reduce or eliminate their fund’s holdings in energy, mining or banks, where do they go?

Personally, I don’t want our talented portfolio managers forced to hold stocks that don’t meet their criteria because they have to stay in the Canadian market.

Ask yourself the question - would my manager be dabbling in Nortel if he or she could be buying Cisco or Intel or Nokia? Perhaps if he or she were a deep value manager in search of broken companies, but for a mainstream Canadian portfolio manager, it’s a bit of a stretch. If your equity manager weren’t limited to Canadian stocks, would he or she be considering Biovail or MDS to gain exposure to the enormous and growing health care industry? I think not.

The limited opportunities in the Canadian market relate to the second reason we decided not to have a Canadian equity fund. The shape of the Canadian market, as determined by the market capitalization of our public companies, is not a proper basis for portfolio diversification.

As noted above, our market is dominated by a few industries where Canada has a competitive advantage. But our overall economy doesn’t reflect that industry mix, nor should our portfolio managers’ choices.

In other words, the shape of the S&P/TSX Composite Index is not a proper basis for diversification. In Canada, that will always be the case, but right now the market index is particularly distorted and therefore of limited use.

Looking back, the Canadian stock market has gone through an unusually prosperous time in the past few years. The commodity markets have been as hot as a cheap pistol and our currency has risen significantly against the U.S. dollar. Looking forward, however, investors have to structure their portfolio based on what makes sense. I don’t think the foundation of an equity portfolio should be a distorted market with limited choices.