Oh Canada! For investing opportunity, look north

By Mark Jewell AP Personal Finance Writer BOSTON (AP) -- Building a truly diversified portfolio means going global. Many advisers suggest investors supplement their U.S. investments with stocks and bonds from fast-growing nations like China and Brazil. Growth prospects are grim in Europe, but there may be bargains to be found in the continent's depressed markets. But it can be easy to overlook opportunities much closer to home. Think Canada. Many foreign stock mutual funds focus on developed markets in other areas of the world, but overlook our northern neighbor. Instead foreign diversified funds may include investments from heavily indebted nations. That's too bad, because the Canadian stock market has long been one of the world's top performers. The lone U.S. mutual fund specializing in Canadian stocks, Fidelity Canada (FICDX), has earned its investors an average annualized return of 12.2 percent over the last 10 years. By comparison, funds tracking the Standard & Poor's 500 index averaged about 3 percent a year. Fidelity Canada's five-year record ranks first among more than 100 of its foreign large-growth fund peers, according to Morningstar. Bond investors may also be missing out on an opportunity to the north. Although, 10-year government bonds in Canada and 10-year Treasury notes in the U.S. both offer yields of around 1.9 percent, the risks to achieve that return are arguably much smaller with Canada's bonds. Canadian leaders have proved more fiscally adept than their counterparts in Washington, where partisan dysfunction has left the U.S. government owing roughly as much as the nation's economy produces in a year. In contrast, Canada owes less than half the value of its economic output. Canada's fiscal strength and political stability are key reasons why one top U.S. multisector bond fund holds about 9 percent of its portfolio in Canadian government bonds, while avoiding U.S. Treasurys. "Canada is very much in a sweet spot now," says Elaine Stokes, a co-manager of Loomis Sayles Bond (LSBRX), which Morningstar currently gives a gold-medal rating. Stokes views the U.S. Treasury market as "scarier" than Canada's government debt market. She cites Treasury market volatility, in part because of steps the Federal Reserve has taken to prop up the economy, and uncertainty over the Fed's next moves. Then there was last summer's downgrade by Standard & Poor's, which cut the U.S. government's credit rating to AA+ from the top rating, AAA. Canada remains AAA. Stokes sees plenty of other reasons to like Canada: -- The economic recovery from the recession has been more rapid in Canada than in the U.S. Canada's unemployment rate is 7.5 percent, a percentage point below the U.S. -- Canada's outlook is improving because the U.S. recovery is gaining momentum, with unemployment at its lowest level in nearly three years. The nations' fortunes are strongly linked because Canada is the largest trade partner of the U.S. It sends more than 70 percent of its exports across its southern border. Says Stokes: "As the U.S. goes, so goes Canada." -- She likes the long-term outlook for energy and materials producers, which make up about half the market value of Canada's major stock index, the S&P/TSX Composite. Canada has a wealth of oil, natural gas, minerals and agricultural staples, and boasts companies such as oil and gas producer Suncor Energy and gold miner Barrick Gold. Global demand for those commodities has been rising because of strong economic growth in emerging markets like China. It's a trend that's expected to continue, making Canada an attractive investing option. However, slower short-term growth prospects in emerging markets hurt commodities demand last year. That's a key reason why the Canadian stock market fell 11 percent last year. Despite those selling points, mutual fund investors have relatively few options to invest in Canada. Besides the Fidelity Canada mutual fund, five exchange-traded funds track segments of Canada's stock market. A sixth ETF, recently launched by PIMCO, invests in Canadian bonds. The biggest is iShares MSCI Canada Index (EWC), with $4.6 billion in assets. There's plenty of emerging competition, however. Five of the Canada ETFs have been launched within the past two years. Here are some considerations for U.S. investors: -- Think small: Canada's stock market represents about 4 percent of the value of stocks globally. Investors seeking broad diversification probably shouldn't allocate more than that amount to their portfolio. It's important to remember that investors may already hold some Canadian investments within diversified international funds. Certain index funds, such as those tied to the MSCI World index, include Canada among the developed markets they invest in. But funds tracking another popular index, the MSCI EAFE, invest in countries such as Greece and Portugal, but not Canada. If you're concerned about your mix of investments, check the list of countries in the index the fund tracks. -- Avoid overdoing it on commodities: Canada's economy is very dependent on commodities, so its stocks closely track those of commodities producers globally, Morningstar analyst Samuel Lee says. An investor who already has substantial investments in companies that produce energy and raw materials should probably avoid a Canada-focused fund. -- Buckle up: Expect volatility north of the border. That's because Canada's many commodities stocks typically rise faster and fall harder than other stocks. -- Don't get overexposed to North America: Because economic links between Canada and the U.S. are strong, stock markets in the two countries often work in sync. The bigger role that commodities play north of the border differentiates Canada, but correlation between the two markets can still be tight. So the diversification benefit of investing in Canada can be limited. Loomis Sayles' Stokes also cautions that Canada is vulnerable to risks from the European debt crisis. One of her fears is that the crisis worsens, sending Europe into a deep recession. That could jeopardize the U.S. recovery, and in turn Canada's. But she still likes Canada's solid fiscal health, and strong prospects for its energy and materials producers to profit from long-term global economic growth. "We understand there will be volatility," she says. "But if you take a long-term view, it's hard to not make a case for a country like Canada." ---------------- Questions? E-mail investorinsight@ap.org. Published: Mon, Jan 16, 2012