Canada as an EM substitute

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ochotona
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Canada as an EM substitute

Post by ochotona » Sat Jul 13, 2019 10:10 pm

I could not help but notice the high correlation between Emerging Market funds like Vanguard VEIEX and Canadian equity funds like Fidelity FICDX. I guess it's been known for a long while that Canada's stock market performs like an Emerging Market, due to its reliance on oil, mining, timber, etc.

My question is, could I use Canada as a EM substitute in my allocation? Why would I want to do that? Consider - EM funds nowadays are 30% China (ugh). They have lots of Russia (ugh), along with other garden spots like Brazil, S. Africa, etc. These are not safe jurisdictions with transparency nor rule of law. I'm thinking Canada is a safer way to get EM-like performance in the years to come when hopefully this asset class comes back to life.

I think if the performance is going to be similar going forward, and no reason to think the EM-Canada correlation which has existed for multiple decades will die off soon, why not use Canada? Any thoughts?

drk
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Re: Canada as an EM substitute

Post by drk » Sat Jul 13, 2019 10:30 pm

ochotona wrote:
Sat Jul 13, 2019 10:10 pm
Any thoughts?
I think you're using a spurious correlation to arrive at a desired conclusion. You're allowed to not invest in EM. There are other people on the board who do that. Besides, VEA/SCHF are pretty strongly correlated with VXUS, so you don't need to feel bad about doing it.

rkhusky
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Re: Canada as an EM substitute

Post by rkhusky » Sat Jul 13, 2019 10:35 pm

If Canada strongly correlates with EM, then you could go with either one with equivalent results. So, choose the fund that is cheaper. FICDX has an er of 0.89%. My EM fund is much cheaper.

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JoMoney
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Re: Canada as an EM substitute

Post by JoMoney » Sat Jul 13, 2019 10:41 pm

I'm not sure what the need for EM is to begin with, let alone why you would need a "substitute" for it.
I'm sympathetic with your concerns about the makeup of some EM stocks. I imagine the risk profile of Canadian stocks is a lot different than many EM countries. If you want to own Canadian stocks, go for it, but it seems silly to me to call it a "substitute"... it is what it is.
What I wouldn't like about FICDX is the .89% expense ratio.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

lack_ey
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Re: Canada as an EM substitute

Post by lack_ey » Sat Jul 13, 2019 10:45 pm

First of all, correlation in of itself doesn't necessarily mean that much. The net movement of the stock market over the course of years is a small fraction of the total movement through all the ups and downs, even at a monthly (or yearly) level. You can easily have two highly correlated assets going in different directions in net. EM could do well and Canada not as much, even if on any given day they're likely to go in the same direction. It's still possible that this adds up to 10% a year up for one and -5% for the other. In fact, if you look at relatively recent history, the US stock market did go up at the same time the Canadian market went down in USD terms, despite fairly high monthly returns correlation:
https://www.portfoliovisualizer.com/ass ... &months=36

You can use Canada as a substitute for EM, but how well that might work would depend on what you're trying to capture. The stocks are not the same. The region of the world is different. The currencies are different. The markets are significantly different. Why do you think EM might come back to life? If you're going to pick stock (markets) as an active investor, you need to have in the very least a detailed investment thesis for why that would be and why that would consequently lift up Canada as well. Assuming you have that—and I'd be interested in reading that, not that I have some special insights of my own to be able to evaluate anything you write—then of course you also need a plan and some reasonable expectations. And even then it's not necessarily the case that using Canada is the best way to achieve that. You may just want to hold EM anyway, or perhaps overweight certain sectors, or something else like that. In other words, maybe there's some better way to implement that idea.

Also keep in mind that economies and markets change, and so do correlations. U.S., global, Canada, and EM sector balances are significantly different from before. If you count Taiwan and South Korea as emerging, TSMC and Samsung are more like high tech or at least industrial/electrical. Tencent is a tech/software/services/media empire. Naspers and Alibaba... just go down the list, and what do you see now in EM? It's not quite what it used to be.

bluquark
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Re: Canada as an EM substitute

Post by bluquark » Sat Jul 13, 2019 11:44 pm

It's correlated in large part because it sells those raw materials to EM, a voracious net consumer of raw materials.

Re: rule of law, MSCI has quite strict criteria on that front about what gets included in their indices. That's one reason the country distribution is so unrepresentative of world GDP. In many cases, the companies are listed on a foreign stock market (especially Singapore) rather than a local one. With a frontier fund, it's more worrying, but in my opinion the name "emerging" is obsolete and these markets are not a wild west.

I'm Canadian and I find the idea that Canada is a safe haven a bit humorous. Canadian stocks are full of bloated large caps exposed to commodity swings. I hold some Canada because my strategy is to just hold world market cap, but if I had to choose one or the other, I'd rather put my money in a diversified bunch of mostly Asian economies.
FICDX has an er of 0.89%.
I think the lowest-ER Canada-specific fund is BBCA @ 0.19%. That's reasonably cheap, albeit still twice as expensive as a good EM fund.

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ochotona
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Re: Canada as an EM substitute

Post by ochotona » Sun Jul 14, 2019 3:00 am

Image
The picture tells the story. I don't like FICDX from the expense point of view, but it's an old fund, the data is useful. There are cheaper ETFs now.

My investment thesis is basically to own it as a play on commodities, which have been mercilessly beaten down... mining since 2011, oil since 2014. I think there has been substantial underinvestment (conventional oil & gas) plus malinvestment (shale). Someday the supply will be tighter and prices will go up, not soon, but someday. But I like the idea of buying a whole economy basically which has this exposure rather than a couple of narrow sectors: XLE and miners (gawd).

adrift
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Re: Canada as an EM substitute

Post by adrift » Sun Jul 14, 2019 3:39 am

ochotona wrote:
Sun Jul 14, 2019 3:00 am
My investment thesis is basically to own it as a play on commodities, which have been mercilessly beaten down... mining since 2011, oil since.
You should look at the current Canadian government policy risk here as well. Currently, the Canadian government is exerting as much effort as it can to eliminate fossil fuel development. That may change in the October election. But, the election is currently a coin flip.
ochotona wrote:
Sat Jul 13, 2019 10:10 pm
They have lots of Russia (ugh)
Russia is betting on oil. If you are too, you might be better off betting on Russia.

petulant
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Re: Canada as an EM substitute

Post by petulant » Sun Jul 14, 2019 6:52 am

ochotona wrote:
Sun Jul 14, 2019 3:00 am
Image
The picture tells the story. I don't like FICDX from the expense point of view, but it's an old fund, the data is useful. There are cheaper ETFs now.

My investment thesis is basically to own it as a play on commodities, which have been mercilessly beaten down... mining since 2011, oil since 2014. I think there has been substantial underinvestment (conventional oil & gas) plus malinvestment (shale). Someday the supply will be tighter and prices will go up, not soon, but someday. But I like the idea of buying a whole economy basically which has this exposure rather than a couple of narrow sectors: XLE and miners (gawd).
Have you checked Australia and South Africa? Very similar resource-extraction focus (although Naspers is now by far the largest part of the South Africa index and is basically a shell company for holding Tencent).

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ochotona
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Re: Canada as an EM substitute

Post by ochotona » Sun Jul 14, 2019 7:20 am

Australia resembles Canada very much but with more volatility. It's also on my radar. Maybe I'd use that one also. In a way, I'm cherry-picking countries out of EAFE that have high-growth potential based on how they pace EM, for better or worse. I'm saying, Europe, Japan, thanks but no.

I could make a basket of the three... that would reduce the China exposure relative to an EM-holding alone by 2/3. Sure, Aus is heavily China dependent... but it isn't China. I just have a problem buying a security that is so heavy on one country, and not a free one at that.

So, in the VEU ETF... Aus is 5%, Can ios 6.1%, EM is 21.7%. If you combine EWA, EWC, and VWO and keep the VWO at 22%, and EWA, EWC in the same relative proportions as in VEU, you get a synthetic ACWI ex-US security composed of:

22% EM
35% AUS
43% CAN

I'm going to ponder that one for non-US exposure.

Image
AUS, CAN, EM
Last edited by ochotona on Sun Jul 14, 2019 7:59 am, edited 1 time in total.

Valuethinker
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Re: Canada as an EM substitute

Post by Valuethinker » Sun Jul 14, 2019 7:39 am

ochotona wrote:
Sun Jul 14, 2019 7:20 am
Australia resembles Canada very much but with more volatility. It's also on my radar. Maybe I'd use that one also.
Australia has more big cap mining stocks and less oil and gas.

Both countries have large domestic banking and finance sectors ( c 40% of index) heavily exposed to domestic housing "bubbles". Toronto had more construction cranes than any other city in North America. Vancouver's housing costs (far higher than Seattle but no multinational HQs etc) are well known. Relative to income Vancouver is one of the most expensive cities in the world.

I gather Melbourne Sydney are similar. Remember Canada and Australia are more (sub) urbanised than even USA.

Canadian oil and gas is a difficult positioning. On the high end of the cost curve and the very dirty end: oil sands producing heavy oil which often has to be shipped by rail because of pipeline issues. Fracking has squeezed much of it out of US markets.

To play EM resources I would go for Australia over Canada. CAD currency e economy and stock market are far too influenced by US (speaking as a Canadian). Very little mining in Canadian market v Australia.

In fact UK FTSE100 probably has as much EM exposure through oil and gas, mining, tobacco, banking (HSBC, Standard Chartered), consumer goods (Diageo, Unilever).

I would for preference use an EM value fund or ETF. Thus avoiding the China overweighting problem.

mchampse
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Re: Canada as an EM substitute

Post by mchampse » Sun Jul 14, 2019 10:54 am

The Canadian market is 1/3 financial services, 1/3 natural resources and 1/3 other stuff. Buying a Canadian market fund resembles 2 sector funds plus a miscellaneous grab bag of stocks (plus some currency risk thrown in) more than emerging markets or anything else.

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