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© Copyright 2000 Rogers Media. The following article first appeared in the April 2000 edition of
BENEFITS CANADA magazine.
Bending the rules
Three tools to get around the Foreign Property Rule.
By Barbara Clapham
The recent change to the foreign property rule is good news for pension funds, which have been restricted
to holding 80% of their assets in Canada for several years now. The majority of pension funds intend to
take full advantage of the announcement in the Feb. 28 federal budget and increase their foreign content to
25% for 2000 and 30% in 2001.
The Workplace Safety and Insurance Board in Toronto is actively considering moving the foreign content of
its employees' pension fund to 25% in relatively short order.
"We had already considered moving it up from the 20% anyway, of course having to do it the derivatives
route," says Harry Gibbs, vice-president of investments. "We may still move it up beyond even 25%."
How can the foreign exposure be increased beyond the limits set in the budget?
USING DERIVATIVES
For a plan whose investment policy has a mandate to increase global content, there are several quite
legitimate ways to circumvent the Foreign Property Rule. Perhaps the simplest method is to use index
futures.
To increase exposure to the U.S. market, for example, a pension fund could buy Standard & Poor's
(S&P) 500 index futures and put up the required margin, investing the margin in Canadian treasury
bills. Since the cash is invested in a Canadian investment it is considered Canadian content, but the
return is derived from the S&P 500.
Another technique often used is a total return swap. Once again, the fund manager purchases Canadian
treasury bills. The manager then enters into an over-the-counter derivative called a total return swap.
The basic concept of a swap is for two parties to exchange cash flows on a periodic basis. This is done
through the services of a Canadian bank, which pays the fund the total rate of return on a given stock or
bond index, or even another mutual fund, in exchange for the return on the treasury bills. As with the
index futures strategy, the pension fund holds Canadian securities, while the returns are received from
foreign sources.
There are many combinations and permutations of these two basic strategies. While the decision to use
synthetic investments may be straightforward, implementation is often complex, necessitating the hiring of
professional staff. As well, lack of liquidity can be a problem with these types of investments. Because of
these drawbacks, pension funds that use such strategies normally limit their exposure to 10% or less of
assets.
Larger pension funds may be interested in a new product on the horizon. Carl Otto Associates of Montreal
has developed the International Finance Participation Trust (IFPT). An investment in the IFPT will
represent an indirect investment in loans to projects in foreign countries, yet will be considered Canadian
content under the Income Tax Act.
The trust will also benefit pension funds in that it is expected to yield higher risk-adjusted returns than
those currently available in the mature debt markets. Again, lack of liquidity may be an issue, however.
Not every plan sponsor is interested in increasing the foreign content beyond the stipulated amount. For
those that are, though, strategies are available.
Barbara Clapham is contributing editor with BENEFITS CANADA.
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CONFERENCES
Due Diligence Best Practices
May 2 to 4, 2000, Toronto
This conference will address how an integrated process can accelerate and facilitate the due diligence
process, as well as avoid the pitfalls and oversights that lead to bad acquisitions. Call (800) 363-0722 or
fax (416) 665-7733.
Optimizing Asset Allocation
June 5 to 7, 2000, Toronto
Alternative asset classes, monitoring investment performance and outcomes of pension fund activism are
topics on the agenda at this conference. Call (416) 928-1078, ext.118.
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