Investment experts caution against overreacting, letting external pressures dictate domestic asset allocation
With the looming possibility of tariffs, Canadian institutional investors are reevaluating their exposure to domestic markets.
Despite US trade policies in flux, BeiChen Lin is quick to highlight that tariffs have historically been a negotiating tool for the Trump administration rather than an outright economic weapon.
“Even though Canada and the US have been long standing allies, there are still some points of disagreement between the two countries. I think a notable point of disagreement has been defence spending,” said the senior investment strategist and head of Canadian strategy for Russell Investments.
He underscored that NATO typically requires its members to spend 2 per cent of its GDP towards defence.
“Canada in recent years has not met that goal. Some estimate Canada's defence spending at closer to 1.5 per cent of GDP. I think there's a lot of voices in the US administration that would like to see Canada speed up its commitment,” he added.
Still, this begs the question: should institutional investors increase domestic allocations in response to tariff threats or should they stay globally diversified to optimize returns?
Even before tariff concerns, Canadian institutional investors already lean heavily on domestic markets, Lin highlighted.
“Some institutional investors even have 20 per cent of their holdings in Canada,” he said. “Remember that Canada is about 2 per cent of the world’s equity market and about 2 per cent of global GDP, so to some extent, there is already a home country bias in place.”
Meanwhile, Christine Tan, portfolio manager at Sun Life Global Investments acknowledged that home bias has been debated for years and tends to resurface in times of uncertainty, particularly under tariff threats.
“In the last year or so, even before current geopolitical tensions, there was sort of a push by certain institutional investors to say, ‘Let’s do more in Canada,’” she said.
“It’s predominantly around just increasing more domestic investment, supporting domestic industries, and making sure capital is available for public and private Canadian companies.”
However, while Tan agrees that home bias is a long-running discussion in Canada, she cautioned against overreacting and letting external pressures dictate asset allocation.
“We’re an open economy, it’s important to really recognize that as a commodity producer, and as an active participant in global trade, we’re not resilient in and of itself. We will be affected by what's happening globally around us,” said Tan.
Likewise, Lin asserted that institutional investors need to remain focused on their core mandate.
“It’s about generating the most optimal set of risk-adjusted returns for the people whose assets they're managing,” he said. “That means looking for the best opportunities, whether they’re in Canada or abroad, emphasizing that while political tensions may create pressure to invest locally, the economic fundamentals should drive the decision.
From a cyclical perspective, Canada’s economy is under strain, he said.
“The economy is likely to underperform the U.S. economy this year, and the Canadian economy could have a higher chance of tipping into a recession compared to the U.S.,” added Lin.
Even so, he pointed out that many Canadian companies generate revenues globally, which has helped the S&P/TSX Composite Index hit all-time highs despite weak economic growth indicators.
Tan noted that diversification remains a critical consideration, highlighting that alternative assets are also gaining traction among institutional investors looking for uncorrelated returns.
“Alternative assets continue to grow, including allocation to private infrastructure assets and liquid alternatives,” Tan said, acknowledging that as the correlation between public markets has increased over the last decade, institutional investors are looking for differentiated sources of alpha.
Despite trade uncertainty, neither Lin nor Tan advocated for a reactionary shift toward an all-Canadian portfolio. Instead, both underscored the importance of long-term objectives over short-term political reactions.
Lin acknowledged that “there is a good chance that these tariffs are more of a negotiating tool,” but he also warned that if implemented, “Canada would probably be more vulnerable from an economic perspective than the U.S.”
With roughly 20 per cent of Canadian GDP tied to exports, any disruption to cross-border trade could have a significant impact, making the economy particularly sensitive to trade disruptions.
While some may argue that a push toward home bias is a show of economic patriotism, Lin remains sceptical of short-term overcorrections.
“Canadians have always been very patriotic,” he said. “In recent months, we’ve seen more headlines about Canadians choosing to buy more locally made products. But I think it’s still very early to say exactly how much consumer habits are shifting.”
He ultimately doesn’t believe equity sentiment to be particularly stretched in Canada. While it's important for institutional investors to have strategic allocation to Canada, “I don’t see a compelling enough tactical case to overweight Canadian equities,” said Lin. “Even though there might be some external pressure for these institutional investors to do so.”
