Big easy,
big easy wrote: ↑21 May 2017 12:12
The consensus amoung some here seems to be that the TSX60 and other Cdn indices are highly concentrated in banks, oil and mines (roughly 70%). Furthermore, oils and mines are highly cyclical. While you may be indexing, you aren't diversified. So it may be best to avoid indexing the Canadian market.
Incidentally there is an equal weight version of the TXS60 tracked by the Horizons HEW etf. However it is still skewed towards banks, oil and mines but perversely, oils and mines have a higher weighting than the banks in the equal weight index.
I've heard that argument before. When I hear it, my brains believes that it sounds reasonable. But, unfortunately, as soon as I take the time to confront the statement with arithmetics, I'm reminded that beating the market is a zero-sum game, before costs; there's no escaping it.
One way to see the
fallacy in the "equal weight" argument, is to pick two companies in the Canadian stock market and think how we could invest equally in both and achieve lower risk through this weird equal-weight definition of "diversification". Let's pick the biggest and the smallest companies, based on VCN's current holdings:
- Royal Bank of Canada, ticker: RY, weight: 6.98239%
- Concordia International Corp., ticker CXR, weight: 0.00001%
Would I have a more "diversified" portfolio by investing my money 50% into RY and 50% into CXR, or 99.9999% into RY and 0.0001% into CXR?
Before answering, one should not forget that the market capitalization of RY is 700,000 times the market capitalization of CXR. Yes, seven hundred
thousands times!
Of course, one could still think that CXR is a great company. Here's how it describes itself:
http://concordiarx.com/about-us/
Concordia is a diverse, international specialty pharmaceutical company focused on generic and legacy pharmaceutical products and orphan drugs. The Company has an international footprint with sales in more than 100 countries, and has a diversified portfolio of more than 200 established, off-patent molecules that make up more than 1,300 SKUs. Concordia also markets orphan drugs through its Orphan Drugs Division, consisting of Photofrin® for the treatment of certain rare forms of cancer. Concordia operates out of facilities in Oakville, Ontario and, through its subsidiaries, operates out of facilities in Bridgetown, Barbados; London, England and Mumbai, India.
What if RY was to break itself into 9 mini-RYs. Would that mean that I would have to rebalance my portfolio, reducing the weight of CXR from 50% to 10%?
And what if all investors into the Canadian market wanted to buy as much of CXR as they have in RY? What would happen to the prices of RY and CXR?
Here's my take. The price of RY would drop and the price of CXR would increase until they would lead to equal (free-float) market capitalization. This would bring the price of RY way lower than its intrinsic value and that of CXR way above its intrinsic value. An investment into CXR would be much riskier than an investment into RY.
No. This does not hold up to scrutiny.
The way to diversify away the narrowness of the Canadian stock market is to put parts of one's portfolio into other assets, such as bonds (nominal and inflation-indexed) as well as international stocks.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)