Small Cap Provides Diversification

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    Small cap stocks can be a diversification vehicle for Canadian investors, says Joseph H. Chi, co-head of portfolio management and vice-president at Dimensional Fund Advisors. In its session ‘Canadian Equities ‒ Outside the Box,’ he said Canada is now an important market for investors. It stands at 4.3 per cent of world market capitalization, up from 2.2 per cent in 2002. This puts it behind the U.S., UK, and Japan. However, while the U.S. accounts for 46.2 per cent of world market capitalization, the UK and Japan are only 8.2 per cent and 7.9 per cent respectively. While the common understanding is that Canadian markets are highly correlated to the U.S., they are, in fact, more closely correlated to emerging markets, likely due to their dependence on natural resources. However, he said the S&P/TSX index is not a good proxy for the Canadian market due to concentration issues. The S&P/TSX currently lists 252 issuers and it has been as low as 200. This means a lot of companies are not included so investors need to look beyond the index to small cap stocks for returns and diversification. However, he cautioned care needs to be taken when constructing Canadian portfolios.