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Financials likely dominate more of your portfolio than you think

You're richer than you think - in financial stocks, anyway.

Financials permeate the global stock indexes to a surprising extent, which means they're probably a major factor in your portfolio, too. Thinking of adding some financial stocks or sector funds to your mix? You probably don't need to and, in fact, you could end up overdosing.

Let's start at home, where about 30 per cent of the S&P/TSX composite index was accounted for by bank, insurance company and investment firm stocks as of late summer. That was about 3.5 percentage points ahead of energy, which was the top-ranked sector during the 2007-09 period in which banks around the world were being thrashed by investors because of their role in creating the global financial crisis.

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Banks have since been rehabilitated to a large extent, and not just in Canada. Financials were the top-ranked sector in the global benchmark index, the MSCI World Index, accounting for about 21.5 per cent. Take North America out of the equation by focusing on the MSCI Europe Australasia Far East (EAFE) Index and you get a dominant 26.5-per-cent weighting. Even the MSCI Emerging Market Index had financials ranked first in the late summer, at 25.4 per cent. Only in the United States, where the banking sector was slammed especially hard and hasn't fully recovered, were financials less dominant. The weighting in the S&P 500 was 16 per cent, just behind information technology.

Financials are even more dominant in a few market subsectors. In the S&P/TSX Dividend Aristocrats Index, the sector had a weighting of just over one-third. In the S&P/TSX Preferred Share Index, financials led with a weighting of almost 60 per cent.

Regardless of whether you own index-tracking exchange-traded funds or conventional mutual funds, you probably own a lot of financials. The top three holdings of the country's largest mutual fund, Investors Dividend, were Royal Bank of Canada, Bank of Nova Scotia and Bank of Montreal as of the most recent portfolio update with In total, financials accounted for 52 per cent of the holdings. The largest Canadian equity fund, RBC Canadian Equity, had a 31-per-cent weighting in financials. RBC and Toronto-Dominion Bank were the top holdings here.

If you own either of these funds, or a popular exchange-traded fund like the iShares S&P/TSX 60 Index Fund, the last thing you should do is add some bank stocks or a financial sector fund to your portfolio. Examples of these financial-focused funds include the iShares S&P/TSX Capped Financials Index Fund (XFN-TSX), or the CIBC Financial Companies Fund. Beware, also, of pairing up funds in the Canadian and global categories that are heavy on financials. With a 37-per-cent weighting in financials, the AGF Global Value Fund would not be an ideal match with RBC Canadian Equity.

You can impose limits on your financial exposure by not owning multiple funds with heavy concentrations of financials, and by favouring certain funds over others within the same category.

If you're in the market for a dividend-focused ETF, you might go with the Claymore S&P/TSX Canadian Dividend ETF (CDZ) over the iShares Dow Jones Canada Select Dividend Index Fund (XDV). The Claymore product's underlying index had a 36.4-per-cent weighting in financials, the iShares fund a weighting of about 60 per cent. Underweighting financials is a gutsy thing for a mutual fund manager to do because it creates the risk of lagging the benchmark. One large fund that accepts this challenge is Mackenzie Ivy Canadian, with just under 12 per cent of its holdings in financials.

Of course, you certainly want some exposure to financials. Canadian investors have happily been scooping up dividends from bank stocks for decades, and the financial crisis passed comparatively lightly here. In case we're not that lucky the next time financials get slammed, keep a limit on how much you have in these stocks.

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998.Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More

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