Scrap foreign content limits, says TD

(February 9, 2005) The 30% foreign content limit on RRSPs, RPPs and the CPP is hurting Canadian investors and should be eliminated, says TD Economics.

The limit, officially known as the foreign property rule (FPR), means that Canadian pension managers and RRSP holders have to maintain at least 70% of their funds in Canadian assets, an allocation that is way out of line with the relative size of Canadian financial markets globally, TD argues.

“It’s clear the FPR compromises Canadian investors’ ability to construct well-diversified portfolios that maximize risk-adjusted returns,” according to TD chief economist Don Drummond.

Of course, there are a number of ways investors can circumvent the foreign content rule, such as putting 30% of a portfolio directly in foreign assets. The remaining 70% of the portfolio could be invested in funds that maximize foreign content, effectively boosting the foreign content level to 51%.

Investors could also purchase futures contracts that are backed by Canadian assets but linked to the performance of a foreign bond or stock market, or buy a clone fund, where the portfolio mimics the performance of foreign equities without actually taking on equity ownership.

Given that these options are available and that most Canadians don’t even come close to the 30% limit anyway, why bother scrapping the FPR? Because the strategies are complex, increase risk, limit the type of investments that can be made and usually involve higher fees, TD argues.

“Typically, only large pension plans have the resources to make use of these opportunities. As a result, the application of the foreign property rule is patently unfair for the vast majority of pension savers.”

In addition, there are significant financial benefits to removing the FPR, TD says, pointing to a couple of academic studies, one which estimated that when Ottawa raised the foreign content limit to 30% from 20% in 2001, annual revenue from pension savings climbed by $1 billion a year. At the same time, the study calculated that leaving the FPR at 30% depressed pension earnings by as much as $3 billion a year.

TD is hoping Ottawa will address the foreign content rule in the upcoming February 23 budget, noting that an addendum to the pre-budget consultation report by the Standing Committee on Finance recommended “immediately raising the RRSP and CPP foreign content limits.”

However, TD adds that the recommendation did not appear in the committee’s main report or in any of the other parties’ minority reports. “This suggests there may be some disagreement among party lines, which does not bode well in a minority parliament.”

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com