Writing in the wake of the striking failure of the misnamed “Super Committee” and following months of highly volatile markets due in no small part to dysfunctional governments on both sides of the Atlantic, we have been looking about for some islands of stability and reasonably good governance. One candidate lies to our north: Canada.
The Canadian government isn’t perfect – witness the difficulties confronting efforts to reform Canada’s appointed Senate, which is little changed from the time of Queen Victoria – but it does appear to function. The central bank, the Bank of Canada, has a record of sound management of Canada’s financial system. The government’s debt as a percentage of GDP, at 36.1%, is just a little over half the figure for the US, 61.3%. Canadians have done a better job living within their means.
It is revealing to look at some measures that provide international comparisons of the quality of governance. Governance Metrics International periodically publishes a table of country rankings of the quality of corporate governance. In the latest edition (September 27, 2010), Canada ranks second, behind only the United Kingdom. The USA is ranked fourth, after Ireland, and is followed by New Zealand, Australia, Netherlands, and Finland. The World Bank, in its annual Doing Business reports, includes a country ranking with the heading “Protecting Investors,” which covers the extent of disclosure, the extent of director liability, and the ease of shareholder suits. In the 2012 report, recently published, Canada is ranked fifth globally, tied with the USA, Ireland, and Israel, following New Zealand, Singapore, and Hong Kong. France is down the list at 79, Germany is further down at 97, and Greece (no surprise here) is at 155. There is also the Transparency International Corruptions Perception Index, a measure of domestic public-sector corruption. In the 2010 index, Canada ranked 6th, following Denmark, New Zealand, Singapore, Finland, and Sweden. Surprisingly, the USA is found down at position 22, tied with Belgium, following Chile and just before Uruguay and France. In sum, Canada is among the top-ranked countries globally with respect to the quality of its governance.
The Canadian economy is closely linked to that of its much larger neighbor to the south, the USA. Last year, the Canadian economy, as measured by real (constant-dollar) GDP, advanced a little faster than that of the US (3.2% vs. 3.0%). That pattern looks likely to repeat this year as well (2.4% vs. 1.8%). Next year we are expecting similar 2.5% growth rates. The respective equity markets are also closely connected, but investing in Canada can provide more diversification than may seem likely. The correlation between the iShares ETF that tracks the S&P 500, IVV, and the iShares ETF that tracks the MSCI index for the Canadian equity market, EWC, is .86. While high, it is less than the .92 correlation between IVV and the iShares ETF that tracts the MSCI index for advanced economies outside of North America, EFA. Even the German market is more correlated with the IVV, at .90. One of the differences is the importance of natural resources industries in Canada (energy and materials have a combined weight of 48.8% in the Canadian EWC ETF, as compared with only 15.9% in the IVV (S&P 500) ETF.
So far this year the Canadian equity market, as measured by the MSCI Canada Index, at -15.46% has underperformed the MSCI US equity market index, at -3.41%, though it has almost matched the benchmark MSCI advanced-economy ex North America benchmark (EAFE) at -15.07%. One factor may have been investor concerns about China’s economy, a very important market for Canada. Longer-term performance of the Canadian market is impressive. The annualized 3-year total return for Canada has been 23.26%, as compared with 17.26% for the US and 13.05% for the advanced markets of Europe and Asia-Pacific. We give weight to Canada’s history of good governance and economic stability in our investment strategy. Moreover, with China’s apparent success in achieving a soft landing for its economy and the easing of its monetary policy, and with the pace of the US economy beginning to strengthen, Canada’s export prospects are improving. We are maintaining a moderately overweight Canadian market position in our international and global portfolios.