Going global: Investment community welcomes the elimination of the foreign property rule

(February 23, 2005) The federal budget tabled Wednesday could result in a dramatic shift in Canada’s investment landscape, as foreign content limits for registered retirement plans were dropped altogether. Most investment industry experts agree the move represents an important opportunity for investors.

"I think it’s very positive," says Don Reed, president and CEO of Franklin Templeton Investments and lead portfolio manager of the Templeton International Stock Fund. "It affords more opportunities to investors and more choice to invest outside of Canada. It’s a very forward looking move by the Minister of Finance and demonstrates to people that we are forward looking and global in nature."

Investors who remain strictly domestic are limiting themselves to less than 3% of the global investment opportunities. The question is: will Canadian investors jump at the opportunity?

"I think this is great news. But judging by fund flows, I’m not sure Canadians will take much advantage of it — not yet," says Dan Hallett, president of Dan Hallett & Associates in Windsor, Ont. "Investors have been dumping foreign funds for some time and recent figures have hit record redemption territory."

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Hallett says Canadians tend to stick to the investments with which they are comfortable and, for most, that means investing domestically. Canadian markets have posted fairly solid returns for the past few years and the yield they crave can always be found at home.

"People always tend to emphasize familiar investments but I’m not sure that people really know much more about income trusts, for instance, as compared to foreign stocks," he says. "They may think they know more but realistically they may not."

One thing is certain: The move makes an entire class of investment funds archaic. "RSP clone funds are now obsolete. I suspect that they will be merged into the respective foreign funds they are designed to track," says Hallett. "This should result in some cost efficiencies at the fund level and reduce costs to individual fund investors as they need not bear the extra costs of forwards and swaps used in clone funds.

"If this is the case, fund holders need only sit tight as they get merged into the underlying funds. If that doesn’t happen, investors will be free to move without worry about foreign content limits."

Reed says investors in clone funds will be able to switch from the clone fund to the main fund, while the fund manufacturers plan on how best to unwind the clones. Considering the investment industry has been pushing for the elimination of the foreign property rule for years, it’s not inconceivable that such contingency plans are already in place.

"The expectations were that there was going to be some increase [to the foreign content limit] if not abolishment," Reed notes. "That’s what the rumour mill said late last week and early this week, but when the shoe drops, it’s always a shock."

Shoes weren’t all that dropped, though. The Canadian dollar fell on international markets, as foreign currency traders bet on decreased investment-driven demand for the loonie.

"When you get rid of a rule like that it does cause certain disruptions," says Eric Lascelles, an economist with TD Economics. "I wouldn’t be shocked if Canada’s stock markets perhaps saw a small drop tomorrow. I know the Canadian dollar did decline a little bit. There’s certain to be a little bit of exit of capital from Canada, but it’s not likely to be huge."

Such a downward move is expected to be rather short-lived, especially while the world demand for commodities remains strong. And there are still significant trade-offs that come with the expanded investment universe.

"The Canadian environment hasn’t changed that much — I think it’s as positive as it was yesterday," says Guy LeBlanc, manager of the Bissett Bond Fund. "Aggressive pension plans will be able to invest more abroad, but let’s not forget that if you’re a Canadian company, most of your pension liabilities are in Canadian dollars. There’s a cost to hedge your exposure to foreign currencies."

Reed agrees that Canada remains a favourable investment environment for both Canadians and foreign investors looking to cash in on the country’s commodity riches.

"I don’t think it’s going to be necessarily negative for the Canadian market. There has been good demand for Canadian equities; it’s a good resource-based economy for investors," says Reed. "I think the advisor takes a look at their overall investment profile and tries to make sure the assets are invested in line with the overall plan. This just opens up an avenue a little bit more in the retirement area."

Lascelles adds: "It’s a win-win for investors, because they’re no longer restricted in the way they invest. It didn’t really make a lot of sense when you look at other countries around the world … they’ve removed [these limits] years ago."

He says countries that dropped similar rules saw little appreciable change in investors’ foreign allocations.

Lascelles lauds the government move to cut personal taxes, as some of those savings could reach the investment market. Cuts to corporate income taxes and the elimination of the corporate surtax will also benefit investors, as companies they hold use the extra cash to fuel growth or increase dividends.

"It does match the sort of tax cut the U.S. initiated not too long ago, so it does keep Canadian corporations in good standing," he says.

But there are other tax code changes Lascelles would have liked to have seen. "I thought perhaps there would be changes in the manner in way dividends are taxed," he says. "When you look at the relative tax rates between capital gains and dividends they’re not taxed at quite the same rate. Economic theory suggests perhaps they should be.

"It is an issue worth considering, when income trusts are gobbling up a share of the picture and dividend taxes are part of the double taxation that occurs when you invest in a company that is not an income trust."

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(02/23/05)

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