The removal of the foreign property rule (FPR) in 2005 enabled tax-deferred retirement plans to diversify outside of the country. But many large pension plans are still significantly invested in Canada. Home-country bias is one reason that the status quo has continued well after the FPR disappeared.
The elimination of the FPR meant plans no longer had to look to the Canadian market—which represents a small percentage of the world’s economy—for 70% of their assets. They could stop paying additional fees to gain foreign equity returns through derivative products. And they would no longer have to closely monitor the 30% limit and rebalance assets to avoid penalties.
Although many expected the FPR’s removal would kick foreign-assets ownership into high gear, most Canadian pension assets are still heavily invested in Canada.
Of eight large pension plans interviewed, all continue to invest at least half of their assets in Canada.
Most agree home-country bias is one of the key reasons Canadian DB plans are still significantly invested in Canada. “Don’t underestimate the effect of home-country bias,” says Jeff Norton, president and CEO of Teachers’ Retirement Allowances Fund Board (TRAF) in Winnipeg. TRAF’s foreign content has increased to 33%, up from 25% in 2004.
Norton cites a few reasons for this bias: the cost of hedging currencies, especially illiquid ones; some tax inefficiencies with foreign real estate and infrastructure; and higher fees for certain foreign asset classes. “You need to weigh diversification against these higher costs and tax inefficiencies.”
Foreign content holdings in the United Church of Canada’s pension plan have increased slightly since 2004. But the total sits at 24%, still below the old ceiling.
“It’s not a priority to move out of Canada,” says Dan Foster, the fund’s investment manager. He explains that the church’s investment committee has not expressed a strong comfort level in directing a more significant percentage of its assets overseas.
According to Tanya Lai, vice-president, public markets, with the Ontario Pension Board (OPB), home-country bias is definitely a main reason why Canadian plans don’t invest more heavily internationally.
But there’s more to it: since plan liabilities are in Canadian dollars and move with Canadian interest rates, keeping a higher level of exposure to Canadian bonds helps protect part of the portfolio, as assets and liabilities move in tandem.
That’s the situation at the Royal Bank of Canada (RBC). “We are conscious that our liabilities are mostly in Canadian dollars, so our fixed income allocation will remain heavily weighted in Canada,” says Toza Siriski, manager of pension investments. The plan’s foreign content has doubled following the rule change, from about 20% before 2005 to about 40% now, with global equities and alternatives making up the bulk of those assets.
Hydro- Québec also aims to match investments with currency. “It is important to keep in mind that Hydro-Québec’s long-term obligations are primarily in Canadian dollars,” says Charles Doucet, general manager of the plan. “This fact limits the foreign currency exposure that we take on.” Foreign investments represent about one-third of pension assets—up just slightly from 30% in 2004.
Other plans indicated that while they don’t expect substantial shifts, their foreign allocations could increase. “We are more likely to increase our foreign content than to decrease it,” says TRAF’s Norton.
At RBC, where foreign content is now 40%, “we could move up a little bit higher,” says Siriski, “perhaps another 5% to 10%.”
Foster expects the United Church’s foreign content will increase by 3%—all in emerging markets. In addition, he says there is a possibility that 5% to 10% of Canadian fixed income asset holdings could be reallocated to foreign fixed income markets in the next year or two.
George Haim is a writer and financial services marketer based in Toronto. firstname.lastname@example.org