Morningstar analysis shows diversification remains critical for investors

New market research from Morningstar Canada, measuring the performance of equity and fixed income markets within Canada and globally, suggests that Canadian investors ignore bond and global equity diversification opportunities at their own peril.

They say high quality bonds in Canada and around the world have repeatedly proven their worth during equity market crashes, while the divergent behaviour of stocks and bonds in the first quarters of 2020 and 2021 show the value of asset class and global diversification, particularly for Canadian investors who may have a home country bias.

“Morningstar index analysis across Canada and global equity and fixed income markets clearly points to the benefits for Canadian investors of looking across asset classes as well as across borders,” says Morningstar Index strategist, Dan Lefkovitz. “Spreading one’s bets is typically a good strategy, particularly in Canada, due to its relatively narrow sector representation and small percentage of global market capitalization.” 

The study of six different indexes shows the benefit of asset class and equity diversification and provides a good argument for investors to minimize home country bias, the report adds. While Canadian stocks lost more than 20 per cent in the first quarter of 2020, the Morningstar Canada Core Bond Index gained more than 1.7 per cent. “This was not the first crisis in which bonds cushioned the losses of stocks for investors diversified across asset classes,” they write. “Fast forward to the first quarter of 2021. Depressed yields and significant interest rate sensitivity resulting from the pandemic-driven downturn left bonds vulnerable.” But, they add, bond losses were more than offset by strong gains for equities. “In short, diversification worked.”

For Canadian investors in particular, they encourage a close look at any home country bias that might exist, as the Canadian market has become more concentrated with the top 10 companies accounting for roughly 40 per cent of the market. “Unsurprisingly, given this concentration, Morningstar’s Canadian equity index has been more volatile over the past decade – measured by standard deviation of returns – than benchmarks measuring the U.S., developed markets outside North America and even emerging market equities,” they write. Banks, in particular, have become an even larger share of the Canadian equity market in recent years, they add. “Their outsize share of the Canadian equity market increases the need for investors to diversify.”