David Gamble, a spokesperson for the federal Department of Finance in Ottawa, explained the motivation: “It was felt that the original Foreign Property Rule had already served its initial policy objective: supporting Canadian capital markets.”
The aim of abolishing the rule was to enable registered pension plans, as well as individual investors, to achieve diversification, reduce risk and enhance the retirement savings of Canadians. Did the efforts of organizations like PIAC help make the change? Gamble says consultations were part of the budget process and the government has been keenly aware of the issue for some time.
Whatever the motivation, the fact remains: plan sponsors are very happy. Montreal-based Russell Hiscock, chairman of PIAC’s Government Relations Committee and author of the January 2005 letter to Minister Goodale, was pleasantly surprised by the news. “PIAC has been advocating this for quite a few years,” he says. “I made a number of visits to the government over the years [and] we’ve written letters. We tried to make the case that this is not a very sensible rule. I believe they drew the conclusion they’d have to make the decision some day.”
He believes that, amidst research and arguments advocating the elimination of the rule, the decision became a “when” rather than an “if ” scenario. Hiscock applauds Ottawa for having the courage to make the decision now, rather than waiting. “They deserve full credit for that,” he says.
SO WHAT NOW?
Now that the pension industry has what it’s always wanted, the question remains: what happens now? Stanley Hamilton, Philip H. White Professor Emeritus, Urban Land Economics at the Sauder School of Business in Vancouver, believes that the next step for plan sponsors is to look at their investment policies and see what makes sense. On the most basic level, he says, some defined benefit(DB)plans have internal investment policies that dictate that they invest to the maximum permitted foreign investment limit. “A change of this magnitude means everybody has to sit down and ask themselves, ‘what’s the right number?’” he says.
Mary DePaoli, Sun Life Financial Canada’s vice-president, Group Retirement Services in Toronto, agrees that plan sponsors are going to have a lot of new information to absorb, particularly on the defined contribution(DC)side. “Plan sponsors need to get prepared for an onslaught of new investment vehicles to consider,” she says. “They’re going to have to go back to their pension committees and determine whether or not their current fund line-up is appropriate, given the fact that the world has changed.”
DePaoli believes the onus is now on plan sponsors to have the right options ready for their DC plan members. “The Canadian market represents between just 2% and 3% of the world market capitalization,” she asserts. “It’s now really incumbent on plan sponsors to review the foreign equity options offered to plan members to ensure they have the opportunity to properly diversify.”
While the budget still has to pass through a few more hoops to become law, many plan sponsors are already looking at making some changes. “We are going to look at global fixed income right away,” says Terri Troy, director of pension investments with Royal Bank of Canada in Toronto, referring to RBC’s DB plan.
“All of a sudden, the opportunity set has increased exponentially,” she points out. “For example, Canadian investors now have more room to invest in foreign corporate bonds and real return bonds, such as U.S. Treasury inflation-protected securities. This is all very positive. Plan sponsors are going to have more opportunity for higher risk-adjusted returns net of fees which can only help the funded status of plans.”
DePaoli also sees more DC plan sponsors taking a look at adding global bond funds. “Plan sponsors have historically looked at the 30% cap as a foreign equity issue on the premise that investors might want to keep their bond assets in Canada. This might change too.”
PROCEED WITH CAUTION
Like many others, John Poos, director, Global Pensions, with Nortel Networks in Brampton, Ont., says the company will be taking a close look at the asset mix in its DB plan in an effort to determine how much foreign content is right. In particular, he’s looking at the issue of currency risk.
“We will be making a greater commitment to global assets,” Poos confirms. “The issue for us is how much is the right amount and what is the appropriate hedging amount for Canadian currency.” There’s also the asset-liability dilemma. “We’ve moved our assets to more closely match liabilities— and that means Canadian long bonds.” He says the decision to invest in the global market runs counter to the firm’s decision to hedge the plan’s liability growth. “We’re going to have to be very careful in terms of how quickly we move away from that decision.”
Slow and steady seems to be par for the course for many plan sponsors and how fast they move depends on the plan, says Troy. “There’s no one right answer for anybody.” For example, synthetic funds have been a mainstay for some plan sponsors looking to increase foreign exposure. Many look to replace these with the real deal: actual foreign content.
“The people who really wanted foreign already have it,” says Hamilton. However, plan sponsors who shied away from derivatives in the past might now choose to move money into foreign content because they can do so directly. “[The elimination of the FPR] just makes it all simpler—so it’s beautiful,” says Troy.
THE DC CHALLENGE
There will also be changes to be made on the DC side. For example, how should plan sponsors be communicating this information to their DC plan members? “Whenever we speak to employees, we always talk to them about the advantages of maximizing the foreign content limit to properly diversify,” DePaoli says. “If they follow the rule of thumb that Canada is only between 2% and 3% of world cap, does that mean plan members should now interpret that as needing to invest 97% of their assets outside the country? No, but it leaves the big education question: what really is the appropriate amount?”
Poos agrees the DC side of the plan will be a challenge. “We need to first revisit our DC option to determine whether or not we have reasonable investment vehicles for plan participants that will allow them to invest internationally,” he says. “Having done that, there will be some risks we’ll need to address in terms of education.”
Poos says he’ll also be looking to his recordkeeper to be more involved in education and monitoring: “We will have some challenges ahead in monitoring along with the CAP guidelines and we’ll be looking to our providers to be more active participants in the international market field for us.”
INDUSTRY-WIDE CHANGES
While some changes will happen at the plan level, many believe there will be even more changes industrywide as plan sponsors look for money managers with international capabilities and contacts. While non-Canadian managers see this as a huge opportunity, Canadian managers without the necessary global product line-up could see a huge outflow of assets, says DePaoli.
Terri Troy agrees that big changes could await money managers: “I think there’s going to be consolidation in the industry,” she points out. And there will be new needs; global credit capabilities and currency overlay strategies will be top of mind for many, says Troy.
So, as the investment village becomes more global for Canadian investors, it is certain that plan sponsors will be making changes to their asset mix to reflect the new options they have. From fixed income to equities, the world is now definitely their oyster.
Caroline Cakebread is a freelance writer in Toronto. ccakebread@yahoo.ca
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