Why Canadian investors need more technology exposure

Canadian investors need more tech in their stock portfolios, regardless of risk tolerance.

Canadians are impacted by the same technology and consumer influences as the U.S., yet Canadian stock indexes are dominated by financial services and natural resources: 35.2% and 30.4%, respectively, of the S&P TSX Capped Composite Index. Information technology represents only 3.5%, compared with 24% of the S&P 500 Index.

Since the global financial crisis, oil prices have declined 48% in U.S. dollar terms. An accompanying 20% decline in the Canadian dollar (vs. the U.S. dollar) contributed to the S&P/TSX Composite returning a modest 5% annually over the 10 years ended Jan. 31, 2018.

Yet in CAD terms, the S&P 500 returned 9% annually over the same period, and the technology-rich NASDAQ Composite Index (CAD-hedged) returned a stunning 15.5% annually.

The case for more technology exposure

• Capital, labour and innovation are the three engines of economic expansion.
• Investors buy stocks to participate in economic growth.
• Technology is an increasingly important driver of productivity gains. Research from Oxford University and PwC tell us technology will significantly impact 38% of all U.S. jobs and 61% of all financial services jobs by 2030.

Investors of all ages and risk tolerances looking for capital gains or an offset to inflation should consider adding more technology than the 3.5% represented in Canadian indexes.

Volatility and concentration

Volatility and concentration are common excuses for limiting exposure to tech indexes. The 10-year daily volatility of the tech-heavy NASDAQ 100 was higher than the S&P 500—24.8% vs. 21.6%—but has been the same for the last five years, at 16.8%. The five largest stocks—Apple, Microsoft, Amazon, Facebook, and Alphabet—account for 44% of the NASDAQ 100, but that’s similar to the 40.9% financials concentration in the S&P/TSX 60.

Canada’s expanding technology sector still lacks depth. Nortel and BlackBerry remind investors about the hazards of concentration. The iShares S&P/TSX Capped Information Technology Index ETF (XIT) launched in March 2001 with 20 companies and dwindled to only five by 2009. XIT’s 10-year performance has been better than the broader Canadian indices, but with fewer than 10 holdings from 2007 to 2013, the return requires an asterisk.

XIT’s largest five stocks (CGI, Constellation Software, Shopify, Open Text, and Blackberry) also offer a different vibe than those in the U.S.: leading U.S. companies present integrated and multifaceted technology opportunities that address consumer, commercial and industrial applications.

Horizons Robotics and Automation Index ETF (ROBO) and Evolve Automobile Innovation Index ETF (CARS) are new specialized products. Blockchain ETFs are also coming, but rules and definitions are still being established for this frontier technology.

First Trust Indxx Innovative Transaction & Process ETF (LEGR) has registration pending in Canada (BLCK). Evolve Blockchain ETF (LINK) and Harvest Blockchain Technologies ETF (HBLK) have launched active funds in Canada. Make sure to review index and sponsor integrity, as they are important factors in ETF viability.

Combining a Canadian ETF (which has more financials and less technology), with a NASDAQ 100 or other technology ETF (which has zero financials and more technology) can improve diversification. Use a low-volatility ETF like BMO Low Volatility Canadian Equity (ZLB) to reduce risk if that is a concern.

Note, however, that there is no free lunch. In 2000, tech represented more than 30% of the S&P 500 (it was 8% in 1990). In the same year, Nortel represented over 36% of the TSX 300 Composite—that’s why they capped it. Overexuberance warrants monitoring, but more tech is still better than less.

Table 1: Tech indexes (as of Jan. 31, 2018)

Table 2: Tech ETFs

Mark Yamada

Investments

Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies.