Canada to end limit on foreign holdings

By Angela Marion Lee

OTTAWA — Canadian institutional investors can now glean returns from anywhere in the world, thanks to the surprise lifting of a 34-year-old policy limiting foreign holdings.

On Feb. 23, the government released its proposed 2005 budget, unexpectedly blowing the 30% ceiling on foreign investment, much to the surprise of investment professionals. The proposed budget must be passed in the House of Commons for its provisions to become law %BE; a move anticipated around March 9.

"The elimination of the foreign content rule is a great step forward," said Paul Pugh, senior vice president, public investment at the Ontario Municipal Employees Retirement System, Toronto. The rule "has restricted pension funds for a long time. Pension funds have used various methodologies to ‘Canadianize' products to have exposure to foreign markets but still beat the content rules."

OMERS is the fourth largest pension fund in Canada with C$35.7 billion (US$28.7 billion) in assets.

"The big windfall for us is in terms of saving time and money, resources in order to manage the plan properly," said Lee Fullerton, director of communications for the C$80 billion Ontario Teachers Pension Plan, Toronto.

"It's a great opportunity to have weighting in the international markets," said David Feather, president of Mackenzie Financial Services, Toronto, which manages C$43 billion.

It is estimated, according to recent academic findings, that the limit on foreign investment cost Canadian pension plans up to $3 billion annually in lost revenue.

The cap, which was lifted to 30% from 20% just a few years ago, also pushed pension funds and asset managers to use derivatives and swaps to effectively boost their international holdings while remaining within the letter of the law.

The unexpected change by the government is a boon for OMERS' long-term outlook. The pension fund changed its asset mix early last year to reflect more illiquid-type investments %BE; particularly private equity, infrastructure and real estate.

"In our plans, we were going to look at the foreign markets to fill some of that strategic decision," said Mr. Pugh. "(The elimination of the cap) allows us to do that with less fuss and muss. It also gives us an ability to add value to the pension fund.

"I don't think there will be much of a change over the next two years," continued Mr. Pugh. "Long-term, people may push their exposure to 40% or 45%. We're going to be examining what we think is the ideal exposure. We have an increased opportunity set. We'll allocate capital where we get the best risk-adjusted returns for the pension plan to meet the pension promise. And part of the risk assessment will be going into foreign jurisdictions."

For the Ontario Teachers plan, "the big difference for us is not having to manage the plan to 29.99% foreign content anymore," said Ms. Fullerton. "And every time we make a big investment — we have to look for investing (let's say) C$500 million. We have to clear out room and sell off things in order to bring that in, or we have to use derivatives to get the exposure we want."

Money managers expect to see more money flow out of Canadian domestic equity and into non-Canadian investments.

"Institutional and even retail investors will move up to the next level, settling in at 40%," said Victor Dodig, managing director for North American institutional asset management at UBS Global Asset Management (Canada) Co., Toronto. "Now, in terms of dollars, the institutional market in Canada is C$600 billion. So, a 10% move would be a C$60 billion shift out of Canadian fixed income and equities. I think that will happen over a period of three years."

UBS Global Assets Management (Canada) manages more than C$20 billion in Canadian equities and fixed income, with another C$500 billion managed globally.

"We're one of the largest foreign managers with a significant footprint in Canada," Mr. Dodig said. "We're giving more thought to asset allocation policies that are most appropriate for clients. From a risk-management perspective, we're working with clients to understand how they should be evolving their balanced portfolios ... "

Up to this point, mutual fund managers such as Mackenzie Financial offered clone funds to exceed the 30% threshold and still remain technically within the law. Clones are versions of foreign funds that are considered domestic content for pension plans because they use derivatives.

Mackenzie Financial's Mr. Feather thinks most Canadian equity mutual fund managers agree on adding foreign content to improve the overall performance of portfolios.

He cited the health-care sector as a good foreign investment opportunity: "It's such an important sector that is well-developed throughout the world. But it's hard to find meaningful health-care stock in Canada."