Alibaba Stock Price In Canadian Dollars

[Shawana Kallhoff]

Diversification is often called the only free lunch in investing. A portfolio made up of building blocks capable of moving in different directions can have better risk-adjusted returns than its component parts. Allocating to different asset classes can also minimize pain during market crashes.

The pattern of bonds holding up during a crisis is consistent with a long-running trend. In a study of asset class behaviour during bear markets, Ian Tam, Morningstar Canada's director of investment research, examined a series of equity market crashes over the past 25 years using Morningstar mutual fund category averages. As displayed in Exhibit 2, Tam observed that Canadian fixed income and global fixed income were incredibly resilient as stocks were selling off, often gaining significant ground in flights to safety.

Equities across geographies are more correlated to each other than stocks are to bonds. Several factors help explain this, from the influence of global capital flows to the interconnectedness of the global economy. For example, less than half the revenue of the Canadian equity market is actually sourced from Canada, according to Morningstar estimates.

Then there are sector dynamics. Energy and basic materials are deeply influenced by global commodities prices. Canada's Barrick Gold (ABX), South Africa's AngloGold Ashanti (ANG), and the United States' Newmont (NEM) will all move together, while oil prices will affect Canadian Natural Resources (CNQ), Australia's Woodside Petroleum (WPL), and Saudi Aramco similarly. Technology companies across geographies benefited from the shift to working and shopping from home during the pandemic.

But just because equities in different geographies don't diverge to the same extent as stocks and bonds doesn't mean they don't make essential contributions to a diversified portfolio. Canadian investors, like their counterparts everywhere, tend to exhibit home country bias, where preference for the familiar local market can leave them overexposed to Canadian equity and fixed-income assets.

Some home country bias can be justified on the basis of currency. When investors purchase an asset outside their home market, they take on currency risk. If the Canadian dollar appreciates against the U.S. dollar, the euro, or the yen, and so on, assets purchased in foreign currency will be worth less when converted. Hedging is an option, but an investor who earns and spends in Canadian dollars and plans to retire in Canada can be forgiven for wanting to minimize currency risk.

On the other hand, currency risk can also be viewed as currency diversification. When the Canadian dollar weakens, foreign assets are worth more to an unhedged Canadian investor. For example, the Canadian dollar's steep decline against the U.S. dollar between 2011 and 2015 amplified the gains of U.S. equities from an unhedged Canadian investor perspective.

Market leadership could certainly look different in the future. But regardless of one's outlook, there are several structural reasons to diversify globally. Canadian equities represent less than 3% of global market capitalization as of April 30, 2021. That compares with nearly 57% market share for U.S. stocks, roughly 27% for developed-market stocks outside North America (Japan and the United Kingdom as two largest contributors), and roughly 13% for emerging-market equities. A Canadian equity investor with significant home country bias has a portfolio that does not reflect the global opportunity set.

Also, consider sector weights. As displayed in Exhibit 5, the Canadian market has almost no exposure to healthcare stocks and far less technology representation than the U.S., with its FAANG stocks, or emerging markets, which contain the Chinese technology giants and the likes of Samsung in Korea. Meanwhile, Canadian investors are overexposed to energy and basic materials relative to the global equities universe.

Shopify joins companies like Facebook and Tesla that have gone from small players five years ago to among the largest companies in their home markets, and similarly for Chinese technology phenoms Alibaba, Baidu, and JD.com. From its IPO in 2015, the Canadian e-commerce platform operator is now the second-largest public company in its market, larger than Bank of Montreal, which traces its history back to 1817. Shopify hopes to enjoy the staying power of BMO, and avoid the fate of previous Canadian technology darlings like Nortel Networks, which accounted for more than one third of the Canadian equity market during the tech, telecom, and media bubble of the late 1990s before becoming the largest bankruptcy in Canadian history in 2009, or Research in Motion, which was the country's largest public company in 2008, when its BlackBerry device owned roughly 20% of the global smartphone market, but is a much smaller player today.

Meanwhile, Canada's big banks have become an even larger share of the Canadian equity market in recent years. The banks benefit from many competitive advantages including high barriers to entry, switching costs, and regulation. Yet, their outsize share of the Canadian equity market increases the need for investors to diversify. The banks are all exposed to the Canadian economy and housing market. While it's hard to imagine threats to their entrenched positions, disruption could materialize, whether digital or regulatory. Australia, another market dominated by a small number of domestic banks, saw its banks shaken by a Royal Commission review.

It's said that in a crisis, correlations go to 1. This reflects the tendency of panicking investors to act indiscriminately, pushing asset prices down across the board. In the first quarter of 2020, equity markets across the globe fell in synchronized fashion, but high-quality bonds held up just fine. Investors diversified across asset class appreciated the fact that some of their assets were zigging while others were zagging.

Meanwhile, Canadian investors diversified across global equity markets would have achieved higher returns in recent years than with an all-domestic portfolio. While changing conditions might diminish the appeal of bonds or global equities, a strategic asset allocation helps protect investors from unexpected events. The pandemic showed that black swans can appear unexpectedly.

The Morningstar Medalist Ratings are not statements of fact, nor are they credit or risk ratings. The Morningstar Medalist Rating (i) should not be used as the sole basis in evaluating an investment product, (ii) involves unknown risks and uncertainties which may cause expectations not to occur or to differ significantly from what was expected, (iii) are not guaranteed to be based on complete or accurate assumptions or models when determined algorithmically, (iv) involve the risk that the return target will not be met due to such things as unforeseen changes in changes in management, technology, economic development, interest rate development, operating and/or material costs, competitive pressure, supervisory law, exchange rate, tax rates, exchange rate changes, and/or changes in political and social conditions, and (v) should not be considered an offer or solicitation to buy or sell the investment product. A change in the fundamental factors underlying the Morningstar Medalist Rating can mean that the rating is subsequently no longer accurate.

In the past, if you thought about diversifying your portfolio with U.S. stocks, it usually meant converting your Canadian dollars into U.S. dollars. This process could result in significant fees for currency conversion or commission costs from using a currency strategy such as Norbert's Gambit.

There's also some frustration among beginner investors here in Canada that are just learning how to buy stocks, particularly those with smaller portfolios, as they want exposure to companies like Tesla, Costco, Amazon, or Google but cannot afford the high share costs.

However, with the introduction of Canadian Depository Receipts, or CDRs, Canadians can not only buy US listed stocks in their home currency, with zero up front conversion fees, but they can also buy them on a fractional basis, allowing you to own Amazon without having to put up over $3000 USD.

Much like American Depository Receipts, which have been around for decades, Canadian Depository Receipts are a financial instrument that allows Canadians to gain exposure to stocks in foreign markets, while keeping the price in Canadian dollars.

The share of the underlying US stock is held in trust by the financial institution and then a set amount of CDR's are released for Canadians to buy. How much fractional ownership you have of that stock depends on the CDR ratio at the time, which are constantly being updated.

The CDR ratio is a reflection of the current exchange rate when it comes to CAD/USD. As the exchange rate fluctuates, the amount of shares of the underlying US company that back the CDR will fluctuate as well.

First off, these CDRs trade on the Neo Exchange, which is a senior exchange that competes with the Toronto Stock Exchange. You'll find the CDR information on a site like Yahoo Finance by typing in the ticker with a ".NE" at the end, representative of the Neo.

There are no management fees with CDRs. The only fees you will currently pay are up to 0.6% to execute currency hedging strategies. So, although it is ultimately a fee, there is a service provided for the fee.

We're seeing CDRs take off in a big way, with some exceeding volumes of 65,000 shares per day. As these products become more widespread, more and more Canadians will ultimately choose to own them over their US counterparts.

As we move forward, I have no doubt more and more products will become readily available to Canadians as well. Not too long ago, there were only four options that Canadians could buy. Now, there are 18 with more coming in the near future. What are those 18 options right now? Lets take a look.

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