Periods of heightened volatility tend to reveal structural vulnerabilities within portfolios. For Canadian investors, one of those vulnerabilities appears to be concentration risk – when a portfolio is weighted toward a single security, a specific industrial sector and a single geographic region.
In Canada, this often appears to manifest as home country bias, the tendency for investors to over-allocate to domestic companies. While investing in familiar markets is common, it may create imbalances. Because Canada represents only about 3% of the global stock market, portfolios that are heavily invested in Canadian equities may be more exposed to domestic economic conditions, commodity price fluctuations, and changes in Canadian government policy.
Understanding Portfolio Sensitivity
A concentrated portfolio — whether in a limited number of securities or a single sector — aims to be understood as having increased sensitivity to economic events. This sensitivity is generally categorized in two ways:
Correlated Risk
Assets within the same sector often respond to the same catalysts and are therefore susceptible to correlated risk. When investments are exposed to the same underlying forces, they tend to move in the same direction. In these instances, correlation can accelerate both gains and losses.
Idiosyncratic vs. Market Risk
All investors may be exposed to market risk — the broader forces that move markets up and down, such as interest rates, economic growth, or geopolitical developments. This type of risk cannot be diversified away. What diversification attempts to reduce is idiosyncratic risk — the risks specific to a company or sector.
In a diversified portfolio, these company-specific shocks aim to be diluted. In a concentrated portfolio, they are absorbed directly. The result can be more pronounced and less predictable price swings relative to the broader market.
Risk Management Considerations
Volatility is a standard feature of equity markets. While it cannot be eliminated, it may be managed through structured portfolio construction and consistent oversight.
Assessing Domestic Exposure
There is no universal allocation that suits every investor. The objective is ideally to ensure domestic exposure is intentional and aligned with a defined risk profile.
Managing Portfolio Drift
Market fluctuations naturally cause asset allocations to shift over time. Periodic adjustments can help maintain the intended risk profile and may reduce reactive decision-making.
Reviewing Underlying Holdings
Diversification across investment products (such as ETFs or mutual funds) does not always guarantee diversification across individual securities. Reviewing underlying holdings is recommended to assist in identifying overlapping positions and unintended concentration.