From the March 2012 issue of Investment Advisor • Subscribe!

March 1, 2012

Going Small With Our Neighbor to the North

Investors fleeing domestic investments for safety needn’t travel far

Maintaining diversification in an international portfolio has not been an easy job over the last few years. While there are a number of opportunities in emerging markets, the picture has become far more muddled on the developed market front, as the continued uncertainty in the eurozone leaves investors and advisors understandably wary of allocating significant assets to a region facing the very real threat of widespread defaults. So where should one look in the search for opportunities in the developed world? You don’t even have to leave North America for the answer: Canada.

Canada’s position in the global commodities markets tells the bulk of the story. The country is currently the world’s fifth largest energy producer, third largest natural gas producer and seventh largest oil producer. It is also a leading producer of gold, nickel, copper and lead, as well as a major source of potash, an important component in fertilizer and thus a key part of the global food chain. 

Looking ahead, the country’s resource reserves appear strong. For example, with its 180 billion barrels of oil reserves, Canada ranks second in the world, behind only Saudi Arabia. Solid trade relationships with the United States and Canada’s status as the largest supplier of energy products to the United States also would seem to bode well for the country’s economy going forward. And this is to say nothing of the fact that while the United States has seen its sovereign credit rating hit in the past six months, Canada remains one of the few countries to have maintained its AAA rating.

Like all developed nations, Canada is not without its challenges, including the threat posed by a potential slowdown in China and the tangential risk that any nation runs should Europe not be able to pull itself back from the brink. But the country’s leaders and banking system have thus far done a commendable job of steering the Canadian economy relatively unscathed through the global slowdown of the past five years.

The question then becomes, if one is interested in adding or building exposure to Canada, how to go about doing so? Selecting individual equities comes with its own pitfalls and a significant commitment to research and analysis, and relying solely on large-cap-focused fund products can leave a portfolio more closely correlated to the global markets than may be ideal. Instead, for those willing to take on a bit more risk, Canada’s small-cap sector may be worth a closer look.

Many of the most innovative and fastest-growing Canadian companies in the energy, materials, industrials, E&P and mining spaces can be found in the country’s small-cap ranks. The financial sector, with TMX Group being one example, and many of the country’s leading emerging technology firms are small-cap names as well. These are the sectors and firms likely to provide the kind of direct exposure to the Canada story going forward, yet in many large-cap-focused products they are either missing or replaced by large multi-national names, which come with their own sets of risks, correlation to global market movements and close ties to issues out of Europe being chief among them.

It’s a brave new world indeed when a flight to safety leads investors to emerging markets even as they overlook a potential opportunity closer to home. In these strange and unpredictable times, the small-cap sector of our neighbor to the north is certainly worth a look.

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