Customized forwards, which allow investors to select their own individual basket of stocks to be used in forward contracts, provide a new way for Canadian pension funds to get around that country's tight rule on foreign equity ownership, now limited to 25% of a pension fund's portfolio.
The Ontario Teachers' Pension Plan Board, Toronto, has indicated interest in the new contracts.
"We're beating the bushes to look for products that are not too expensive," that will allow the fund to increase its foreign equity exposure, said Leo de Bever, vice president of research and economics at the Ontario fund, which has C$70 billion (U.S. $48 billion) in assets.
"We're looking at a number of vehicles (to work around the restrictions) and this is something we'd consider, depending on the overhead," he added.
"We ultimately believe we should optimize our equity exposure in North America and need a structure like that (customized forwards) to do it."
The Ontario fund's price limit is 0.5% per year, which is what it has cost Arrowstreet Capital LP, Boston, which is using customized forwards to manage the Clarington RSP Select Global Balanced Fund, a mutual fund recently launched by Clarington Funds, Toronto.
The Clarington fund is for Canadian individual investors using retirement savings plans, which are similar to the United States' individual retirement accounts.
Jim Thames, senior portfolio manager for Arrowstreet, said the customized forward "behaves as if you were invested in the exact stocks you wanted to invest in."
"It includes all the stocks we want to include, conceivably it could have one stock or 50 stocks in it," he added.
Most Canadian pension funds that use forwards or futures to get foreign equity exposure are making country bets or index bets. Using customized forwards, they could get exposure to the exact group of securities they want.
(A forward contract gives the buyer the right to receive the proceeds from the performance of the underlying index, or in this case the customized basket of stocks, at a predetermined future date.)
When a pension fund can select its own basket of securities "it can invest outside of Canada and do it in such a way that it can pick and choose from foreign equity markets," said Mr. Thames.
"Over time, as more (pension fund sponsors) invest outside of Canada, we'll see a shift from top-down to bottom-up type strategies," which is the way customized forward stock baskets are put together, he said.
Building the portfolio for the global balanced fund with customized forwards "allows us to add value from the bottom up and top down, vs. if you just used futures (index) contracts you could only add value from the top down," Mr. Thames noted.
Customized forwards could "potentially have value for a fund that wanted specific (foreign equity) exposure beyond the limits" of the law, said Ross Steeves, director of investments for the C$1.8 billion pension fund of the IWA Forest Industry, Burnaby, British Columbia.
"I do see the benefit of it for some plans," said Perry Skalenda, who was manager of corporate finance for Vancouver-based Macmillan Bloedel Ltd.'s C$561 million pension fund before the firm was bought by Weyerhaeuser Co., Federal Way, Wash. Macmillan's pension plan will soon be merged into the approximately C$500 million pension fund of Weyerhaeuser's Canadian operations.
There is the benefit of the customized index. "If you don't want to buy the S&P 500 index, you can customize with certain stocks and get the exposure you want," he said.
Lehman Brothers Inc., New York, is providing the customized forwards for Arrowstreet, but declined to discuss its involvement with the product.
