In my practice, I speak with investors from Vancouver to St. John’s, and the fear of a bear market is a universal constant. However, the conversation in Canada is uniquely shaped by our market structure: a heavy concentration in financials and resources, the tax-sheltering power of registered accounts, and a distinct set of investment vehicles available to us. When a Canadian investor asks me about “bear market mutual funds,” they are often seeking a solution that fits within their RRSP or TFSA and acknowledges our home-country bias.
I tell them that the goal is not to find a single magic fund that avoids all losses—that fund does not exist. The goal is to construct a portfolio of mutual funds and ETFs that, as a whole, is resilient. It’s about building a financial fortress using bricks available on the TSX and beyond, designed to protect your capital and provide the emotional fortitude to wait out the storm.
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The Canadian Bear Market: A Unique Beast
A bear market, defined as a 20% decline from recent highs, feels different in Canada. Our market, represented by the S&P/TSX Composite Index, has inherent structural traits that influence its behaviour during a downturn:
- Concentration Risk: The TSX is heavily weighted towards three sectors: Financials (~30%), Energy (~15%), and Materials (~12%). This means a Canadian equity fund is often a concentrated bet on commodity prices and interest rates. A bear market driven by a recession will hammer financials. One driven by a slump in global demand will crush energy and materials.
- The Resource Curse and Blessing: Our market’s fate is often tied to global commodity cycles. This can be a source of outperformance in inflationary times but a massive anchor during global slowdowns.
- The Role of the Loonie: The Canadian dollar is a commodity currency. It often weakens during global risk-off periods. This has a crucial implication: it provides a natural hedge for Canadian investors holding unhedged U.S. or international assets, as their value in CAD terms increases when the CAD falls.
Understanding this context is the first step in building an effective defence. You cannot protect a portfolio if you don’t understand what you’re protecting it from.
The Defensive Toolkit for the Canadian Investor
There is no single “bear market fund” on the shelf at your bank’s branch. Instead, we look to allocate to specific types of funds that have characteristics which historically provide stability or negative correlation to equities. Here is the toolkit I use with clients.
1. The Capital Preservation Squad:
These are the safest holdings, designed to protect principal above all else.
- Canadian Money Market Funds: These invest in short-term Canadian government and corporate debt. The NAV is typically stable. They are the ultimate safe harbour within a registered account like a TFSA or RRSP, offering liquidity and safety. The yield is low, but the peace of mind is invaluable.
- Short-Term Canadian Bond ETFs/Mutual Funds: Many providers, such as iShares and BMO, offer low-cost funds like XSB.TO (iShares Core Canadian Short Term Bond Index ETF) or equivalent mutual funds. These hold high-quality Canadian government and corporate bonds with short durations, minimizing interest rate risk.
2. The Fixed-Income Anchors:
This is where the most powerful defence often lies.
- Canadian Long-Term Bond Funds: Funds like XLB.TO (iShares Core Canadian Long Term Bond Index ETF) hold long-term Government of Canada bonds. When panic hits and stocks fall, investors rush to the safety of government debt, driving prices up. This negative correlation is the bedrock of a defensive strategy. This is a critical holding for any Canadian investor looking to mitigate equity risk.
- Real Return Bond Funds: Funds that hold Canadian Real Return Bonds (RRBs), such as XRB.TO, are specifically designed to protect against inflation, which can be a feature of certain bear market environments (e.g., stagflation). Their principal value is adjusted for CPI.
3. The Defensive Equity Allocators:
These allow you to stay invested in equities but consciously reduce risk.
- Low Volatility ETFs/Funds: Products like ZLB.TO (BMO Low Volatility Canadian Equity ETF) or XMV.TO (iShares MSCI Min Vol Canada Index ETF) are specifically engineered to hold Canadian stocks with lower historical price swings. They are typically overweight in less cyclical sectors like utilities, consumer staples, and pipelines, and underweight in volatile financials and energy.
- Dividend Aristocrat Funds: Funds focused on Canadian companies with long histories of growing dividends (e.g., CDZ.TO – iShares S&P/TSX Canadian Dividend Aristocrats Index ETF) can provide a stream of income during a downturn. Companies strong enough to maintain and grow dividends are often financially robust.
- Global & U.S. Equity Funds (Unhedged): This is a crucial diversifier. Holding a low-cost U.S. equity index fund like XUS.TO (iShares Core S&P 500 Index ETF) or a global fund like XAW.TO (iShares MSCI All Country World ex Canada Index ETF) provides exposure beyond our concentrated TSX. Crucially, holding the unhedged version means you benefit if the CAD weakens during a market panic, which often happens.
Building a Sample Canadian Defensive Portfolio
Let’s consider a hypothetical investor, “Marie,” who is 55 years old and wants to reduce the volatility of her RRSP as she approaches retirement. Her current portfolio is 80% Canadian equity funds and 20% cash. We work to build a more resilient allocation.
| Fund Type | Example Ticker (ETF) | Allocation | Rationale for a Bear Market |
|---|---|---|---|
| Canadian Low Volatility Equity | ZLB.TO | 25% | Reduces exposure to volatile TSX sectors. Should decline less than broad TSX. |
| U.S. Equity (S&P 500, Unhedged) | XUS.TO | 20% | Diversification away from Canada. CAD weakness would boost returns. |
| Canadian Long-Term Bond | XLB.TO | 30% | Core defensive holding. Expected to rise when Canadian stocks fall. |
| Global ex-Canada Equity (Unhedged) | XAW.TO* | 15% | Further global diversification. |
| Short-Term Canadian Bond | XSB.TO | 10% | Capital preservation and lower interest rate risk than XLB. |
| 100% |
Note: XAW.TO includes the U.S., so a pure play would be something like XEF.TO (EAFE) for international developed markets. This is a simplified example.
Table: A Sample Defensive Canadian Portfolio Allocation
Why this works: In a scenario where the TSX drops 30%, the low-volatility fund (ZLB) might only drop 20%. The long-term bond fund (XLB) could rally 10%. The U.S. and international holdings, if unhedged, might see their losses mitigated or even reversed by a falling loonie. The overall portfolio decline is therefore significantly cushioned. This relative outperformance is the key to staying the course.
The Behavioural Component: Your TFSA and RRSP as Tools
The greatest risk in a bear market is not the decline itself; it is the investor who panics and locks in losses by selling. The structure of Canadian registered accounts can be a behavioural advantage.
- TFSA (Tax-Free Savings Account): This is an ideal account for your defensive holdings. Any capital gains or dividends earned within the account, even from rebalancing, are entirely tax-free. This allows you to adjust your strategy without tax consequences.
- RRSP (Registered Retirement Savings Plan): While withdrawals are taxed as income, the tax-deferred growth is powerful. A bear market can even present an opportunity: continuing your contributions according to your plan means you are buying units of your funds at lower prices, a concept known as dollar-cost averaging.
Final Verdict: Defence is a Strategy, Not a Product
The quest for a bear market mutual fund is a search for a unicorn. True defence comes from a holistic strategy built with specific types of funds readily available to Canadian investors. It is built on the pillars of high-quality bonds, low-volatility equities, and intentional global diversification—all held within the tax-efficient framework of your TFSA and RRSP.
My role as your advisor is not to promise gains during a downturn, but to help you construct a portfolio that declines less, provides psychological comfort, and positions you to participate fully in the eventual recovery. By understanding the unique quirks of the Canadian market and using the tools at our disposal, we can build a plan that is not just about growing wealth in the good times, but about protecting it through all seasons.
