On IMCO's Focused Approach to Investing Outside Canada

IMCO's President and CEO Bert Clark posted a comment on LinkedIn on their focused approach to investing outside Canada:

At IMCO, we believe that investing outside Canada can bring very important benefits to client portfolios. However, we also believe that it is important to ensure that geographic diversification is pursued for the right reasons and that all the implications of doing so are considered and planned for in advance. This is particularly the case today, because we expect that the coming years will be shaped by a number of forces, including higher geopolitical risk, deglobalization and the growing importance of ESG, necessitating a focused approach to investing outside of Canada.

As a result, we invest a significant percentage of the funds we manage on behalf clients outside Canada (the percentage varies over time – but today it is approximately 65%), and mostly in developed markets (approximately 93% today). This allows us to provide our clients with more diversified portfolios and access to a much broader opportunity set, while at the same timing avoiding some of the heightened currency, ESG and geopolitical risk inherent in some jurisdictions. 

The Era of Increasing Globalization and Low Geopolitical Risk

Many larger Canadian pensions significantly increased the amount they invested outside of Canada in recent decades, driven by the elimination of federal tax restrictions, and the widely shared perspective that large parts of the world were converging towards free markets and democracy (or at least greater levels of political freedom).

Up until 2005, Canadian federal income tax legislation restricted foreign investment by Canadian pensions. This limit had been raised through a series of changes, from 10% in 1971 to 30% in 2005. In 2005, this restriction was completely removed, leaving it to pensions to determine how much to invest outside Canada.

In the period leading up to the elimination of this restriction — the 1990s and early 2000s — globalization was on the rise and geopolitical tensions between the world’s major powers were relatively low. Francis Fukuyama captured the zeitgeist in his book The End of History, where he argued that liberal democracy represents the end point in the evolution of forms of government and that it was becoming the dominant form of government worldwide.

There was ample evidence at the time for the argument that we had come to the “end of history.”  Tectonic shifts, things that had seemed unthinkable, were happening regularly. For example:

  • The Berlin Wall came down in 1989.
  • East and West Germany were reunified in 1991.
  • Soviet leader Mikhail Gorbachev won the Nobel Peace prize in 1990 after introducing a series of changes that brought greater freedoms for the press and citizens and a rapprochement with the US and Europe.
  • Foreign direct investment into Russia grew from USD$2.6B in 2000 to USD $74.7B in 2008.
  • NAFTA was enacted in 1994.
  • Apartheid ended in South Africa between 1990 and 1994.
  • Hong Kong was peacefully returned to Chinese government control in 1997 and the Chinese government committed to protecting Hong Kong’s legislative system and the rights of its citizens for 50 years.
  • China joined the WTO in 2001.
  • Fourteen countries joined the European Union between 1994 and 2005.
  • From 1994 to 2008, global trade grew faster than global GDP.
  • Between 2000 and 2010, both the number of state-based conflicts and the deaths resulting from such conflicts were lower than anytime in the prior 20 years or since, according to Uppsala Conflict Data Program (UCDP)

There was a perspective by many investors at this time that if history had indeed ended, it made sense to invest more outside Canada, including in countries that were growing quickly and seemed poised to benefit the most from high growth rates and trade liberalization (e.g., China and Russia). And this was now possible because the federal tax restrictions on foreign investment that were in place up until 2005 had been removed.

Recent Trends in Globalization and Geopolitical Risk

In retrospect, it is hard to believe that so much progress occurred in such a short period of time. And it may have been too optimistic to believe it would be permanent. The sad postscript to the era that was thought to be the end of history is well known to us today. In recent years, globalization has waned, and geopolitical tensions and risk have risen:

  • The United Kingdom withdrew from the European Union in 2020.
  • The US withdrew from the TransPacific Partnership in 2017.
  • Over the course of 2018 to 2022, the US imposed significant tariffs on Chinese exports to the US.
  • Russia invaded Ukraine in 2022 and the US, the EU and various other counties and international organizations imposed severe sanctions on Russia.
  • UCDP recorded 55 conflicts with over 200,000 deaths in 2022, compared to 37 conflicts and fewer than 50,000 deaths in 2009.

In the current context, Canadian investors need to have a well-considered approach to where and why they are pursuing geographic diversification. The era when it was plausible that investors could ride a powerful long-term trend by investing outside of Canada in countries that seemed poised to benefit from consistent growth in trade, democracy and peace has ended.

As a long-term optimist, I hope this is part of the “two steps forward, one step back” trend of global progress, but a quick return to the optimistic years at the turn of the millennium seems unlikely today. 

The Importance of Investments Outside Canada for Many Larger Investors

The decline of globalization and the rise of geopolitical risks does not mean that there aren’t still significant benefits to investing outside Canada for most larger Canadian investors. There most definitely are.

Geographic Diversification and Public Markets 

Geographic diversification is very important for many Canadian investors given the size and concentration of Canadian capital markets.

The Canadian public equity markets are relatively small. The total market capitalization of the MSCI All-Country World Index (“MSCI ACWI”) is US$82 trillion. For comparison, the market capitalization of the TSX is only about 3% of that of MSCI ACWI.

In addition, the Canadian public equity market is highly concentrated in two sectors: financials and energy. Together, these two sectors account for approximately 50% of the S&P TSX index.

The public equity markets are also concentrated in a small number of companies. The 10 largest companies in the TSX represent more than 35% of the index. For comparison, the top 10 companies in MSCI ACWI (which include behemoths like Apple and Microsoft) represent only 18% of that index. One would need to include the top 50 companies in the MSCI ACWI to get to 35% of the index.

An investor that only invests in Canadian public equity is investing in a very narrow subset of global equities, with a high concentration in financials and energy and a high concentration in a small number of companies.

In addition, some important public debt market investment opportunities in Canada have been getting smaller. For example, the federal government recently announced it would stop issuing real return bonds – an important liability matching asset for many defined benefit pensions in Canada. Many Canadian pension must now consider non-Canadian alternatives, such as US TIPS.

Geographic Diversification and Private Markets

One of the other advantages of geographic diversification is the access it provides to a larger investment opportunity set, particularly in private assets. For larger Canadian investors, such access may not just be advantageous from a diversification perspective, it may be essential to make meaningful allocations to some asset classes.

For example, the nine largest Canadian pensions have reported investments of over $400-billion in private equity and $100-billion in private credit. The Canadian private equity and credit opportunity set simply would not have accommodated this level of investment.

The vast majority of the types of infrastructure that have been privatized in many other jurisdictions (and are in many cases now owned by Canadian institutional investors) – airports, ports, power utilities, electricity transmission and distribution companies, water and wastewater systems, roads and bridges – are owned by governments in Canada. While investments in these types of infrastructure are often very attractive to Canadian pensions, with very few exceptions (e.g., the 407), they simply aren’t available in Canada.

Geographic diversification will continue to play an important role in the portfolios of many Canadian investors. It allows them to build more diversified portfolios and expands the investment opportunity set in very important ways. 

The Fallacy of Pursuing Geographic Diversification on the Basis of Projected Economic Growth Rates, Especially in Emerging Markets

Once investors determine that geographic diversification would benefit their portfolios, the question becomes “where?”

In answering this question, it is important not to fall into a common investment fallacy – that strong projected future GDP growth in a country ensures strong future investment returns. The correlation between economic growth and equity market returns is not strong enough to be the sole driver of investment decisions, especially in the Emerging Markets. For example, from 2003-2021, Chinese GDP grew at an annualized rate of 8.55% vs. 1.95% in the US, but equity market price returns (based on MSCI indices) in the two countries were essentially the same over that period.  Higher GDP growth did not result in higher equity returns.

Many factors other than GDP growth drive equity market returns, including relative central bank policy, valuations, tax policy, competition policy, foreign investment and currency restrictions, the size and efficiency of domestic pools of capital, location of revenue source, international tax treaties, labour policy, geopolitical risk and ESG considerations.

This is why IMCO does not choose to invest in a country simply because the GDP growth rate of the country is forecasted to be stronger than elsewhere. Projected GDP growth is a factor we consider, but so are a number of other considerations which are set out below.

Factors to Consider When Investing Abroad

Investors Need to Carefully Consider Whether They Have Any Real Advantages in the Countries They Are Considering Investing In

In answering the question “where” to invest outside Canada, investors should consider whether they have any real advantage investing in the jurisdictions they are contemplating.

Real investment advantages include things like operational leverage (e.g., the ability to leverage centralized risk, legal, HR, IT, back and middle office capabilities), relevant sectoral expertise, the ability to leverage scale (e.g., by making large commitments to best-in-class partners to reduce fees) and the ability to invest directly and effectively oversee investments in the geographies being contemplated.

Just as only a very few companies can operate effectively in many jurisdictions, most investors can only leverage real investment advantages in select geographies.

Not having the ability to leverage any real advantage in a geography doesn’t mean it should be entirely excluded from an investor’s portfolio. But, because the opportunities for outperformance are less, it should mean investing less in those places and more in jurisdictions where they can leverage their advantages.

This is why IMCO tends to focus its investments outside Canada in select jurisdictions, including the US, Europe and Australia. These are places where we are able to leverage our investment advantages, particularly our ability to partner with best-in-class investors, invest directly alongside our partners in private assets and participate in energy transition investments. 

Investors Need to Consider the Foreign Currency Exposure Implications of Investing in Countries, Particularly Emerging Markets

Investors considering “where” to invest outside Canada need to be mindful of, and plan for, the impacts of foreign currency movements because these can have material impacts on investment risks and returns.

While geographic diversification allows investors to gain access to investments in other markets, it also involves exposure to foreign currency gains and losses from those countries. Over the longer-term, most currency exposure, theoretically, does not generate positive or negative investment returns. However, the reality is that longer term foreign currency losses can sometimes be material (e.g., the Argentine Peso has declined by 97% vs. the USD over the past 10 years) and in the near-term, movements in exchange rates can create material investment gains and losses that need to be planned for.

Near-term currency gains and losses for most developed market currencies can be efficiently mitigated through straightforward currency hedging transactions. But, Emerging Market currencies are more difficult to efficiently hedge. Investing in Emerging Markets often brings both exposure to those asset classes, as well as local currencies, which can be more volatile than developed markets. Investors need be prepared for and accept this added risk.

Even in jurisdictions where hedging is more feasible, hedging currency requires access to liquidity to post as collateral. Investors who invest in foreign markets and hedge the related currencies will need to consider the liquidity requirements of doing so, which may mean owning more liquid low return assets like government bonds.

At IMCO, our investments are focused in developed markets and only approximately 7% of the funds we have invested are in Emerging Markets. And in developed markets, we only hedge a portion of foreign asset values.

Investors Need to Consider the ESG, Political and Geopolitical Risks Associated with Investing in Some Countries

Today, investors who pursue geographic diversification also need to consider their ability to do so in a way that is consistent with their ESG beliefs. In some countries, particularly in Frontier and Emerging Markets, the laws and practices relating to environmental, labour, corporate disclosure, corruption and corporate governance make that more difficult.

Investors also need to consider the political risks associated with investing in some countries. In many Frontier and Emerging Market countries, there is less political and policy stability, less ability to rely on the courts to protect property and efficiently settle commercial disputes, and the barrier between the government and private enterprise is more fluid. These are risks that are very difficult to analyse and mitigate.

A subset of Frontier and Emerging Market countries are also involved in geopolitical disputes that make them more risky places to invest. Correctly predicting the escalation of geopolitical disputes and their impact on investments is not something most investors can reliably do. For example, we believe that the geopolitical risks associated with investing in some countries, Russia being an obvious one, as well as China, are much higher today than they have been in recent decades. Investors need to consider whether these geopolitical risks are ones they are willing to accept and are adequately compensated to take.

At IMCO, we do not invest in Frontier Markets and just 7% of the funds IMCO manages are invested in Emerging Markets. We do not invest in Russia, and we restrict our investments in China almost exclusively to public equities and to a very small percentage (2%) of the total assets we manage.


Geographic diversification can bring important benefits for Canadian investors. It can allow them to build more diversified portfolios and access larger opportunity sets. However, it would be too simplistic to say that any incremental geographic diversification always improves portfolios. And forecasts of GDP growth rates is not a good enough reason alone to invest outside Canada. When contemplating geographic diversification, it is important to consider whether an investor can leverage real investment advantages in the countries they are contemplating, the impact of foreign exchange exposures and hedging activities, as well as ESG, political and geopolitical risks and longer-term trends such as deglobalization.

As a result of all these considerations, at IMCO we focus on investments in Canada, the US, and other developed markets—93% of our funds are invested in these markets. This allows us to diversify client portfolios and expand our investment opportunity set. These are the markets where we believe we can leverage our real investment advantages by investing directly and alongside our strategic partners, often in private assets as well as in energy transition opportunities. These markets also tend to be much simpler in terms of currency, ESG political and geopolitical risk.

This is an excellent comment, a bit wordy but it captures the importance of geographic diversification and why IMCO is going about it in an intelligent way.

There's been a lot of discussion lately on why Maple 8 pension funds do not invest more in Canada, specifically in Canadian equities.

I'm going to discuss this again later this week but it's important to note that investing more in Canada isn't always in the best interests of contributors and beneficiaries of these large pension funds.

In fact, I would argue that there is a fiduciary duty to invest outside of Canada in markets which attract the vast majority of global capital flows: ie the US, Europe, UK, Japan, Australia and  some Asian powerhouses like India and South Korea.

I get it, it's "unpatriotic" for these large Canadian pension funds to invest most of their assets outside Canada but let's be realistic and frank, that's where the bulk of opportunities reside.

And I like what Bert says, GDP growth doesn't correlate with great market gains, China is a perfect example.

The problem? Well, to be blunt, China is a communist country which admittedly is growing fast, but it doesn't have the transparency and rule of law of other countries to attract serious international investment flows.

So, having some passive equity or fixed income exposure to China is fine if it's small but let's get real, nobody in their right mind would have a very high exposure.

Most of Canada's large pension funds including CPP Investments are rethinking their investments in China.

I agree with AIMCo's CIO, Marlene Puffer, there are better ways to play China's growth story via US multinational companies.

What else? Yes, currency exposure to emerging markets is volatile but let me be brutally honest, most of Canada's large pension funds, if not all, do not have great currency managers even when it comes to developed markets.

It's really tough making money in currencies consistently, you need people with experience and a long track record, not young kids with fancy industry accreditation.

Lastly, no doubt about it, geopolitical risks have soared especially after Russia invaded Ukraine but I'm a little skeptical on this whole de-globalization story.

You hear that a lot -- "the world has changed forever' -- but take it with a pint of salt, the world has NOT changed nearly as drastically as some make you believe.

Alright, those are my quick thoughts on geographic diversification and IMCO's focused approach to investing outside Canada.

One key recommendation I will make to IMCO, CPP Investments and all of Canada's large pension funds is to be a lot more transparent as to where you invest your assets, especially within Canada but elsewhere too.

This means providing details on sector, industry, and geographic exposure by country and asset class.

In fact, there should be two or three pages on Diversification Details in every annual report and on their websites starting with Canada and it must be detailed covering public and private markets.

If I want to know exactly how much AIMCo, BCI, CDPQ, CPP Investments, OTPP, OMERS, HOOPP and IMCO are investing in Canada, I should be able to get this information in detail in their annual report and on their website (updated every quarter).

Those are my quick thoughts, more to come later this week.

One more tidbit from Gavekal on why  investors should be more careful investing in Canada or Australia:

Below, Gunjan Banerji, Lead Writer at the Wall Street Journal, discusses the market rally and the FOMO trade.

And Anastasia Amoroso, iCapital managing director, joins 'Closing Bell' to discuss the market rally and how long she believes it'll have steam.