TORONTO - A group representing more than 135 Canadian pension funds is pushing to abolish Canada's foreign property rule.
But the rule, which limits foreign investing by Canadian pension funds to 30% of assets, is strongly supported by Minister of Finance Paul Martin and probably won't be changing soon.
The general manager of the Pension Investment Association of Canada, a Toronto-based lobbying group that represents more than 135 pension funds with more than C$500 billion (US$ 315 billion) in assets, says the rule must go. "We've worked with the Department of Finance to have the limit increased; now our objective is to convince the department to eliminate the rule entirely," said Keith Douglas, general manager.
Pension funds that have spoken out against the rule include the C$125 billion Caisse de Depot et Placement du Quebec, Montreal; the C$71 billion Ontario Teachers' Pension Plan, Toronto; the C$34 billion Ontario Municipal Employees Retirement System, Toronto; the C$62 billion British Columbia Investment Management Corp., Vancouver; and the University of Toronto Asset Management Corp., which runs the C$4.5 billion endowment of that university.
However, Jean Michel Catta, a spokesman for the Department of Finance, insisted the rule is fair and will remain in effect.
"The purpose of the limit is two-fold: one, it is to ensure that there is a significant portion of tax-assisted retirement savings invested in Canada, and two, to provide a proper amount of opportunities in which Canadian pension funds can invest."
Mr. Catta also pointed out that the limit was just raised to 30% of assets from 20% last year.
Returns suffer
Dale Richmond, chief executive officer of the Ontario Municipal fund, called it "a rule not in keeping with the free trade and movement of capital and goods and services. We have repeatedly spoken out about it and been involved in a number of studies that show investment returns suffer from the 30% rule."
A report calling the foreign property rule "regulation without reason," written in 1999 when the rule capped foreign investments at 20%, estimated the rule reduced the returns on Canadians' tax-deferred investments by 16-32 basis points a year, causing a reduction of retirement income of 6.3% to 13%, or C$2 billion to C$4 billion annually.
The two economists from the University of Western Ontario who wrote the study, Joel Fried of the economics department and Ron Wirick of the Ivey School of Business, also said the rule acts as a payroll tax on individuals' earned income, discouraging job creation.
Still compelling
In a recent interview, Mr. Fried said the arguments to abolish the foreign property rule "are just as compelling now." He estimated that raising the limit to 30% "probably costs a reduction of retirement income of C$2.5 billion annually." However, he said his numbers now are guesses since he hadn't done any work in this area since his 1999 study.
Moreover, "having it on the books is an administrative nightmare that costs C$1 billion or C$2 billion a year," said Mr. Fried.
One of the main arguments made for keeping the foreign property rule at 30% - that the Canadian dollar, already weak against the U.S. dollar, would weaken further - does not hold water, he added. "It's very trivial. People use it as an excuse but it has no bearing on it at all," said Mr. Fried.
Mr. Fried said managers for the University of Western Ontario's C$800 million defined contribution plan use derivatives to get around the 30% rule for investment in U.S. stocks and stocks in the Morgan Stanley Capital International Europe Australasia Far East index. He said in Canada, "if you're going to own U.S. assets such as in a fund based on the S&P 500 ... you're going to have to use the futures market and do it in a roundabout way."
In fact, all large Canadian pension plans circumvent the 30% rule by using derivatives to gain exposure to international stocks. Mr. Fried estimates Canadian pension funds are probably among the biggest users of futures contracts on the Standard & Poor's 500 index.
Michael Goren, managing director of North American equities at University of Toronto Asset Management, said one of the biggest drawbacks of the 30% cap is that "pension funds are unable to seek active returns from foreign managers."
The only way to circumvent the rule is "through a synthetic process" using derivatives, which gives index fund-like returns, according to Mr. Goren. "We believe we can pick foreign managers who can add value," he said. "It's a clear cost to pension funds."
Severe restrictions
Critics of the foreign property rule also point out the Canadian equity market represents only about 2% of world stock markets, which puts severe restrictions on the investments of Canadian pension funds.
According to Darryl Jones, vice president-policy and research at BC Investment Management, because of takeovers of Canadian companies by foreign companies, such as the recent takeover of Seagram Co. by Vivendi Universal SA, there is a "shrinking marketplace" of companies in which to invest. Many Canadian pension funds were forced to sell their Seagram stock when it was taken over by Vivendi because of the rule.
Keith Ambachtsheer, chief executive officer of KPA Advisory Services Ltd., Toronto, a pension fund consultant and one of the most outspoken critics of the foreign property rule, said the asset growth of the Canada Pension Plan Investment Board, Toronto, could prove to be the death knell for the foreign property rule. The CPPIB's assets are expected to grow from its current C$14 billion to C$130 billion by 2010. The CPPIB is run independently of the government and the only rule for its board of directors is to get the best return on investment for its participants.
Mr. Ambachtsheer believes that within a few years, the board of directors of the CPPIB will tell the Canadian government's Department of Finance that the foreign property rule is making their position as fiduciaries impossible because of the restrictions on investments.
John MacNaughton, chief executive officer of the CPPIB, declined to comment.
