While panic was not the order of the day, there was a real sense that there would be a shift out of Canadian assets and into foreign-based assets, and that this would have an impact on domestic markets and investment strategies.
More than two years hence, what’s brewing? Clearly, domestic assets have not suffered since the 2005 announcement. In fact, the markets took it with barely a hiccup. On the day after the announcement, equities fell 0.19%, bonds sagged 0.50% and the Canadian dollar dropped 0.68% against the U.S. dollar. All of these assets recovered within mere days and have gone on to reach much higher levels.
But do the managers’ predictions in 2005 ring true more than two years later? Hewitt conducted a follow-up survey in June 2007 to find out.
In the 2005 survey, 54% of managers expected to change their asset mix within discretionary balanced mandates. Of the 25 managers who responded to the follow-up survey, 52% had changed the asset allocation of their balanced funds or discretionary mandates. Of these, all had increased the allocation of foreign equities. However, many made only a 2% to 3% shift from Canadian to foreign equities.
While 40% of managers believed the Canadian equity market was overvalued due to the FPR’s removal in 2005, clearly, they were wrong. There never was any evidence of a rush to the exits from the Canadian equity markets. If anything, there’s been increased foreign buying of domestic assets.
In 2005, respondents identified foreign bonds, global equities and international equities as the asset classes that would gain the most prevalence as a result of the FPR’s removal. While the vast majority of the asset allocation changes for balanced mandates have been from Canadian to foreign equities, there’s been a marked increase in the marketing of foreign bond strategies(often taking the form of “Core Plus”)in the past two years.
In 2005, while almost one quarter of managers surveyed believed the removal of the FPR would have a noticeable impact on the Canadian market within two to four years, this has not been the case. Removal of the FPR has had no arguable negative impact on the Canadian markets.
Two years ago, 60% believed that, over time, the average pension plan would have a foreign allocation above 30%. The jury is still out on this. Many pension plans were already exceeding the 30% limit using synthetic structures prior to the 2005 announcement. Against that backdrop, the shift to an increased foreign allocation has been a modest one and has most often involved plans in which the allocation was well below the limit prior to 2005.
Where the removal of the FPR has had an impact is in the increased flexibility plans have in considering strategies that are often domiciled elsewhere, such as hedge funds and infrastructure.
So, the initial reaction was like so many others within the financial markets: an overreaction. It’s likely that this helped to sell newspapers and created opportunities for investment management industry participants to call clients and discuss the issue. But, looking back, it all seems to have been a bit of a tempest in a teapot.
Chris Kautzky leads Hewitt Associates’ investment consulting office in Vancouver. chris.kautzky@hewitt.com
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