A lot of popular all-in-one asset allocation exchange-traded funds (ETFs) in Canada overweight Canadian stocks, often allocating 20% to 30% of the portfolio. At first glance, that seems odd. Canada represents only about 3% of the global stock market. So what gives?
The short answer is currency risk and tax efficiency. Both matter far more than many investors realize, especially when you’re building a do-it-yourself portfolio inside a Tax-Free Savings Account (TFSA). These two factors go a long way toward explaining why Canadian equities punch well above their weight in Canadian portfolios, and why they should still form a meaningful core holding for most investors.
Below is a closer look at each, followed by one Canadian ETF that fits this role well from BMO Global Asset Management.
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Currency risk
When you invest outside Canada, whether in the U.S. or international stocks, you usually introduce currency exposure. That means your returns are influenced not only by how the underlying stocks perform, but also by how the Canadian dollar moves relative to foreign currencies.
Sometimes that works in your favour. A weaker Canadian dollar can boost returns from foreign investments. Other times, it hurts. A strengthening loonie can offset solid market performance elsewhere. Over long periods, currency effects tend to even out, but in the short and medium term, they can add volatility that has nothing to do with the quality of the investment itself.
By owning Canadian stocks denominated in Canadian dollars, you remove that variable entirely. There is no currency conversion and no foreign exchange drag or boost to worry about. For investors with shorter time horizons, or those who simply prefer fewer moving parts, that simplicity can be valuable.
Tax efficiency
Tax efficiency is where Canadian stocks really stand out for Canadian investors.
In non-registered accounts, many Canadian companies pay eligible dividends, which benefit from the dividend tax credit. This makes them more tax efficient than dividends from U.S. or international stocks, which do not qualify for the same treatment.
Even inside a TFSA, where most income is sheltered, U.S. dividends face a notable exception. Dividends from U.S. stocks or U.S.-listed ETFs are subject to a 15% withholding tax, taken at source. There is no way to recover this inside a TFSA. That reduces the amount you can reinvest or spend.
Canadian stocks and ETFs holding Canadian stocks do not face this issue. Dividends are received in full, allowing for maximum compounding inside the TFSA or tax-free withdrawals when you need the income.
A Canadian ETF that fits the role
One Canadian ETF I have a soft spot for is the BMO S&P/TSX Capped Composite Index ETF (TSX: ZCN)
For a very low 0.06% expense ratio, or about $6 per year on a $10,000 investment, it provides exposure to more than 250 Canadian stocks representing the broad domestic market.
The “capped” structure means no single stock can exceed a 10% weight, which helps limit concentration risk while still allowing larger companies to play a meaningful role.
The ETF also offers a solid 2.2% annualized yield with quarterly distributions. Most of that income comes from eligible Canadian dividends, making it well suited for a TFSA from a tax perspective.
