Gyroscopic Investing

Is there a convincing, logical case to be made for exposing the Canadian HBPP to US$ assets?

Arguments:

- The U.S. Permanent Portfolio is, perhaps, inherently superior to any foreign version, because the U.S. controls the world reserve currency... It seems to me that the U.S. HBPP therefore has a built-in 'edge' that any foreign version would lack the capability to emulate. There are defiantly some considerable benefits to being the holder of the world reserve currency.

For example, during periods of deflationary crisis, the international "flight-to-safety" is more likely to be US long-term treasuries than Canadian long-term federal bonds. Case in point, 2008: US long treasuries gained 30%+, while CDN long federal bonds only responded to the crisis by popping 8%.


- The Canadian economy is highly commodity dependent compared to the better diversified US economy. The Canadian economy responds better-than-average to global inflationary booms, for example, but also experiences similar worse-than-average deflationary busts (or extended periods of stagnation) when oil and other commodities nose-dive. The US, which is better diversified economically, seems to prosper more evenly and consistently from periods of economic growth compared to the Canadian economy.


- Dividing the equity, long bond and cash allocations between CA$ and US$ denominated assets would allow for internal allocation rebalancing based on USD/CAD fluxuations. In other words, when the US$ gains in value compared to the CA$, you could sell off a portion of your US treasuries and rebalacing into Canadian federal bonds. Sell off the gains from US equities and put them into cheaper CDN equities. Sell off the US T-Bills and buy the lagging Canadian Ultra-Short bonds.

One could argue that exposing the CDN HBPP to so much US$ driven assets exposes the portfolio to substantial currency risk. But, perhaps, one could also argue that it actually diversifies the portfolio, and allows for re-balancing opportunities within the classic HBPP asset allocations, based on the fluctuating values of the respective currencies.


Backtesting

2007-2016 Canadian HBPP
25% XIC [CDN Total Stock Market]
25% XGB [Long CDN Bonds]**
25% XSB [Short CDN Bonds]**
25% GLD

**(not an ideal ETF as it is a mix of federal, provincial and corporate long bonds, but back testing for the preferable ZFL only goes back to 2010, and I want to include 2008 for obvious reasons)

CAGR: 5.63% (real 3.69%)
SDEV: 6.96%
Worst-Year: -4.25%
Max Drawdown: -13.35%
Sharpe: 0.73
Sortino: 1.16
US Market Corelation: 0.38

***

2007-2016 Canadian/US Hybrid HBPP
12.5% XIC
12.5% VTI [U.S. Fundamental]
12.5% XGB [Long CDN Bonds]
12.5% TLT [Long US Treasuries]
12.5% XSB [Short CDN Bonds]
12.5% SHY [Short US Treasuries]
25.0% GLD

CAGR: 6.62% [real: 4.66%]
SDEV: 6.93%
Worst Year: -3.19%
Max Drawdown: -12.55%
Sharpe: 0.86
Sortino: 1.47
US Market Co-relation: 0.38

***

The Canadian/US Hybrid HBPP preformed better than the straight Canadian portfolio in every metric.

Better return. Less volatility. Dampened losses. Superior risk/reward metrics. And, fascinatingly, exactly the same co-relation to the US market. Despite being considerably exposed to US assets, as a portfolio, the CDN/US Hybrid HBPP corelates to the US economy not even slightly more than the pure CDN HBPP (at least during this sub-decade long backtesting period).

***

I don't see the merit in such a hybrid HBPP with any other country than the United States. Controling the world reserve currency makes the U.S. unique. Its sort of like gold is a unique currency. The U.S. is a unique economy, and they control a unique currency compared to every other option out there, save for gold. Is there not, then, an argument for exposing a non-U.S. HBPP to the unique, positive, diversifying influence of the world-reserve-currency controlling United States?

THOUGHTS?

Cool analysis. Some thoughts as requested.

Canadian stocks are generally a bet on commodities. US stocks are generally a bet on technology. That's a pretty diverse pair.

The CAD/USD currency cross is going to have a significant impact on home currency realized gains, so most analysis of this type would adjust returns to the home currency. You know this but I wasn't sure if the returns were adjusted back to the CAD.

I think you are right on flight to quality and literally by definition most commodities are highly negatively correlated to the US dollar. So again, some nice baked in diversification.

Generally diversification is deemed to be free lunch goodness, I would just ensure your analysis is truly buying a Canadian lunch. That's easy enough on an annual basis...adjust US returns by adding or subtracting the USD/CAD return for the year.

proximity to the US border and the ease/feasibility of spending American bucks in America, might also be a factor in the CAD/USD currency risk calculation..

I'm personally not a fan of taking on currency risk, especially in a stable country like Canada. Looks like from the beginning of 2007 through today the CAD has fallen in value from 1.13 for every 1 USD to 1.3 for every 1 USD.

But, as you probably already know, that masks a lot of volatility in the exchange rate. From 9/18/12 to 1/17/16 (just a little over three years) the USD went from 97 cents to $1.45. So you are going to get great gains on the US side of your ledger during a fall in the CAD.

But it can obviously go the other way as well. A USD denominated portfolio held by a Canadian between February of 2002 and November of 2004 would have lost more than 25% just due to the exchange rate.

In recent years the USD has done well against the CAD so you may be feeling a bit of recency bias. Just my .02 (Canadian funds!) worth.

I've split my equities half TSX, half SP500 and EAFE. I have no idea if this is a good thing or not, but I'm trying to hedge against the cyclical commodity economy of Canada. Bonds don't worry me too much. Yes, people pile into US Bonds during crises but regular interest rate changes tend to happen at the same time in both countries. Gold in 2008 went up only 5% USD but 28% CAD.

(Sorry for the poor formatting...)

This is the data for VTI, TLT & SHY annualized returns, converted to CA$.

There appears to be a trend, a recent trend, towards favorable returns for Canadian investors. i.e. If I put my CA$ into a US$ securities in 2007, then cashed them out in 2016, and converted the capital back into CA$, that you would have overall profited from the strong US$.

But I suppose a chart produced in 2022 might highlight the opposite trend, if oil and commodities were to trend upwards, or the US$ ran into trouble. And there's no reliable way to predict either way which way the USD/CAD will go.

Perhaps, significantly exposing the CDN HBPP to the US$ within the stock, bond and cash allocations simply produces too much currency risk (well...duh!, I guess you could say)

***

However, there does seem to be a long-term positive diversifying effect to exposing the CDN HBPP to, at the very least, 50% US equities.

50% CANADIAN EQUITIES 50% U.S. (within 25% HBPP equities allocation)
Overall Portfolio Stats (1971 to 2015)
Average Gain (Geometric) 5.258%
Average Gain (Arithmetic) 5.469%
Median Annual Gain 4.875%
Standard Deviation 6.742%
Total Growth (%) 903%
Total Value of a $1000 Investment $10034.12
Total Down Years 6 years (13%)
Total Years < 5.00% 23 years (51%)
Total Years < 10.00% 36 years (80%)
Total Time Span 45 years

Worst Drops (1971 to 2015)
Drop Starts Drop Recovery Time
1981 -16.12% 3 years
1974 -3.47% 2 years
1975 -3.29% 1 year
1990 -2.84% 1 year
1988 -1.99% 1 year

100% CANADIAN EQUITIES (within 25% HBPP equities allocation)
Overall Portfolio Stats (1971 to 2015)
Average Gain (Geometric) 4.977%
Average Gain (Arithmetic) 5.227%
Median Annual Gain 4.500%
Standard Deviation 7.376%
Total Growth (%) 790%
Total Value of a $1000 Investment $8895.81
Total Down Years 9 years (20%)
Total Years < 5.00% 24 years (53%)
Total Years < 10.00% 35 years (78%)
Total Time Span 45 years

Worst Drops (1971 to 2015)
Drop Starts Drop Recovery Time
1981 -16.65% 4 years
1974 -5.92% 3 years
1975 -5.83% 2 years
2013 -4.83% 1 year
1990 -4.25% 1 year

The Canadian HBPP with 50% exposure to US stocks (within the 25% equity allocation) produced better returns with less volatility and smaller max drawdowns, going as far back as backtesting allows.