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Boosting RRSP’s foreign content will bring better opportunities for growth

by Wayne Cheveldayoff, 2005-02-03

If you have no foreign funds or stocks in your RRSP, you are shortchanging yourself on opportunities for growth.

The Canadian stock market accounts for only 3 per cent of world stock market capitalization and among its listings are relatively few companies that have a dominant position globally and therefore the potential for ongoing high profitability.

Also, except for energy and other resources, Canadian companies are poorly represented in the industries that will benefit from the expected rapid growth in Asian economies in the coming years.

The rising Canadian dollar in the past two years has meant that foreign holdings in RRSPs have been poor performers in some cases. For example, the U.S. S&P500 Index including dividends was up 28.7 per cent in 2003 and another 10.9 per cent in 2004 but was up only 6.2 and 2.8 per cent, respectively, in Canadian dollars.

However, not all investors were exposed to the exchange rate. It all depends on how the money was invested, as some funds, such as the TD International RSP Index fund, which is insulated from exchange rate movements, was up 10.8 per cent in the year ended December 31, 2004 whereas the exchange-rate-exposed TD International Growth Fund was up only 4.8 per cent – the difference essentially being the rise in the Canadian dollar.

If you have been avoiding or pulling money out of foreign investments because of their recent poor performance, you are likely are making a mistake for a couple of reasons. First, the Canadian dollar is unlikely to appreciate much further. The Bank of Canada has clearly signaled that it has no stomach for a Canadian dollar above 85 cents (U.S.) for any length of time.

Even as the U.S. Federal Reserve raises interest rates, our central bank will likely manoeuvre Canadian rates below U.S. rates in the coming months to discourage capital inflows. This will put a lid on the Canadian dollar, even if the U.S. dollar continues to sink against other major currencies.

Second, stock market returns in Canada will be limited because the sharp rise in the Canadian dollar is hurting many Canadian companies. Contrast that with the more-favourable situation for U.S. companies, many of which are benefiting greatly from the slide in the U.S. dollar.

Instead of reducing foreign content, RRSP investors at this time should be increasing it to at least 50 per cent of their total exposure to equities.

The formal limit on foreign holdings in an RRSP is 30 per cent but there are several ways to get beyond that.

If you put 30 per cent of a portfolio in foreign funds and the remaining 70 per cent in domestic funds that routinely maximize their foreign content, you will have as much as 51 per cent foreign exposure.

Another route would be to use ‘clone’ funds, which are structured to mimic the returns of actively managed foreign equity funds or international indices but still be considered Canadian content. Using clone funds, you can get to 100 per cent effective foreign content in an RRSP.

A third (though less-attractive) way of boosting foreign content in an RRSP is to invest in Labour Sponsored Investment Funds (LSIFs). For every $1 invested in LSIFs, you can boost foreign content by $3, up to a maximum of 50 per cent total foreign content. The problem is that LSIFs generally have been poor performers, even after taking into account the tax incentives.

Picking foreign stocks for an RRSP is not easy. So for most investors, choosing a number of actively managed and index-linked funds would be the best approach.

While a quick check of fund listings shows there are numerous specific country or region funds, the bulk of foreign content in an RRSP should be placed with fund managers who can shift money around the world to seek out the best opportunities, rather than being stuck in an area that may become depressed.

For those concerned with fund management costs, Barclays Global Canada offers TSX-listed exchange traded funds, with maximum MERs of 0.35 per cent annually, that track the S&P500 Index (consisting of the 500 largest U.S. companies) and the MSCI EAFE Index, representing stocks from Europe, Australasia and the Far East.
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Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.


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©2005 Wayne Cheveldayoff