© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the April 2005 edition of BENEFITS CANADA magazine.
 
The proposed elimination of the FPR will allow Canadian pension sponsors to implement more efficient and cost-effective portfolios.
 

With no foreign property investment constraints, Canadian pension investors will have the opportunity to review their long-term asset mix allocation and investment manager structures. For defined benefit(DB)plans that already have higher foreign exposure through synthetics or pooled fund trust structures, the removal of the FPR may only result in fine tuning. For all other DB plans and sponsors of capital accumulation plans(CAPs), the removal of the limit will allow for enhancement of overall portfolio management. There are five key considerations:

1. Better diversification, but not uniformly – Opportunities provided by unrestricted access to foreign markets allow for better diversification in the equity component of a pension portfolio over the fixed income component. Global equity markets provide a significantly broader opportunity set from which to generate investment ideas and would mitigate trading challenges. Foreign fixed income markets may provide a useful source of diversification. Sponsors should consider whether a better role of the fixed income component of a DB plan is to provide a closer matching to liabilities.

2. The end for synthetic products? – Synthetic index funds will in many cases be replaced with lowercost stock index funds. Rumours of their demise are greatly exaggerated. Synthetic structures can play a role in DB plans by providing liability matching strategies that preserve the additional expected return from equity markets—“beta transport”— and to enhance return in combination with alternative investments— referred to as “alpha transport.”

3. Alternatives, anyone? – For sponsors using or considering alternative investments such as private equity, hedge funds and real estate to be included in the pension portfolio, the elimination of the FPR will facilitate the allocation and therefore access to a broader range of foreign alternative investments.

4. Currency spoils the party – The FPR’s demise will increase the spotlight on currency risk management. Currency impact has had a material effect(positive and negative)on foreign investment returns. Currency risk management will be an even more important issue for pension plans to consider, and the ‘active vs. passive investment’ debate should be extended to the currency management program.

5. Simpler communications – For capital accumulation plans(CAP), the elimination of the FPR will allow sponsors to focus member communications on the merits of diversification, rather than on foreign limit compliance.

The implications for balanced funds and lifecycle funds that are popular with CAP investors will need further consideration, as will appropriate Canadian and non-Canadian allocations and currency exposure implications. Plan sponsors will need to monitor the developments and communicate implications to members.

Peter Muldowney is a principal and Brian Dayes is a consultant at Mercer Investment Consulting in Toronto. Peter.Muldowney@mercer.com; Brian.Dayes@mercer.com

 

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