The Foreign Property Rule is on its way out. What is the mindset of plan sponsors as they look to reassess their asset allocation mix?

With the surprise announcement by the Liberal government eliminating the foreign property rule(FPR) from pension investments, plan sponsors have been given a whole new investment world to consider. And with that have come issues concerning the ways in which employers will use their newfound freedom.

Dire predictions of Canadian investors and pension plans fleeing the domestic equity market may be premature. Many of the Top 100 pension funds found ways of circumventing the 30% limit on foreign property and increasing foreign content in their portfolios through alternative investing, clone and synthetic funds and double trust arrangements. The FPR was in fact a larger issue for smaller sponsors.

So what now? Will larger plan sponsors immediately ramp up their portfolios and try to get the maximum foreign investment possible? Or will there be a more gradual approach to investment and asset allocation shifts? The answer is that plan sponsors will likely not implement any extreme measures in the near future. However, portfolios will change, managers will certainly have to alter the way they do business with plan sponsors and employers themselves will have to navigate new markets that will hopefully increase their revenue and decrease risk.


Despite the noise created by the elimination of the FPR in the last federal budget, there is a conventional wisdom in the investment community that plan sponsors will only take the investment potential so far. In fact, a survey was conducted between March 30 and April 7, 2005 among plan sponsors planning to attend the Canadian Investment Review Global Investment Conference in Whistler, B.C.

Among the 30 respondents to the survey, the average investment in non-domestic properties 12 months from now is expected to be 37% of total funds. Looking down the road 18 months from now, the average investment in a foreign portfolio is expected to increase only another two percentage points to 39% of total funds.

Robin Pond, partner in charge of asset management consulting with Morneau Sobeco in Toronto, says any movement will be relatively slow. “I would expect a gradual migration to higher foreign limits with the larger plans,” he says. And the more a plan invests in foreign markets, he adds, the more they have to worry about currency hedging. “It’s a two-edged sword,” notes Pond. “The best reason for going to foreign markets is not better returns, it’s better diversification.”

Of course, it’s no secret that many, if not most, of the Top 100 pension funds in Canada were circumventing the foreign property rule with alternate investments. As a result, pension managers turned to synthetics and clone funds to get around the rule. “What they’ll be able to do now is unwind that somewhat and presumably get it cheaper for a less expensive implementation approach,” notes Steve Bonnar, principal with Towers Perrin in Toronto. “But I don’t think a rise in the foreign property [limit] will be a trigger for greater foreign investment in this group, in and of itself.”


Many of the plans in the Top 100 ranking look similar in terms of their asset-mix portfolio breakdowns. A typical plan looks something like Canada Post Corporation’s pension plan(ranked 16th with $10.2 billion). According to Doug Greaves, the fund’s vice-president and chief investment officer, the asset mix is about 65% equities and 35% bonds. About 31% or 32% of equities are in foreign property.

He says that the plan’s policy statement allowed the mix to have 40% in foreign property. “The way we look at it is, ‘how do the Canadian markets look relative to the foreign markets?’” Greaves says that because the Canadian markets have outperformed, his plan has not increased its foreign asset allocation. “My guess is that you wouldn’t see much of a change on the part of the bigger pension plans who may already be over 30%. Where you could see some change is on the part of the smaller pension plans,” he says.

Greaves says the move into foreign property really puts the focus on currency hedging and liabilities, moving into the governance realm. He says board members and committees will likely have to look at these issues in a new light and possibly re-educate themselves. But he admits it’s probably not a huge educational issue for them.

Greg Malone, a partner with Eckler Partners in Toronto agrees. “Obviously, any of the fiduciaries will have to be comfortable talking about the different types of investments they’re overseeing. So there may be a significant education aspect to this and maybe that needs to happen before a significant increase in the foreign asset allocation [occurs].”

Greaves also points out that in the past, plan sponsors have been more concerned with equities, especially in the foreign property sense. But with the rules gone, he says alternative investments like fixed income are “worthy of more thought.”


It seems the removal of the FPR in Canada will likely be a boost to global bonds and fixed income. Not only do plan sponsors like Greaves think so, but money managers are also seeing the directional winds change.

Paul Malizia, investment consultant with James P. Marshall, a Hewitt Associates company in Toronto, reiterates Greaves’ point about global fixed income products. In a survey the firm conducted with money managers in March called Implications of the Removal of the Foreign Property Rule: An Investment Manager Survey, Malizia says, “the biggest thing we saw was that the majority of respondents believe that the biggest beneficiaries are going to be foreign bonds.” He adds the survey’s finding is a far cry from the widely-held view of many managers that equities would be the biggest winners in a foreign property world.

Malizia says the survey shows that 86% of managers adjusting their discretionary asset mixes said they would increase their foreign bond holdings. And when asked which assets will become more prevalent as a result of the removal of the FPR, 79% said foreign bonds. He notes that many of the managers surveyed did not necessarily have expertise in fixed income, yet still believed it will become the preferred investment choice going forward.


Growth continued for Canada’s largest pension plans as the Top 100 funds totalled $584.6 billion as of Dec. 31, 2004: an increase of 10.7% or $56.6 billion over 2003. Within the top 10 funds, the Ontario Teachers’ Pension Plan remained at the top with $81.7 billion and showed gains of more than $7 billion.

The Ontario Pension Board jumped one spot from eighth place to seventh place with just over $13 billion in assets. The Quebec Teachers’ Superannuation Plan with $12.5 billion fell to 10th spot from sixth spot in 2003. That squeezed out Canadian National Railways, which was ninth in 2003 but eleventh in 2004 with $12.3 billion.

All actively managed investment classes fell slightly in 2004. Canadian equities dropped to $68.2 from $78.1 billion the year before and Canadian bonds also dropped to $74.3 billion from $98.1 billion a year prior. It’s important to note those declines were the result of several larger plans not providing their asset break-downs.


There are similarities between defined benefit(DB) plan foreign property allocation and what will happen at the member level of defined contribution(DC) plans. Barry Noble, vice-president, group pension distribution for Manulife Financial in Toronto, says there will likely not be huge increases in foreign investment content.

“The main reason we’re not expecting a lot of movement is even when the foreign content was limited at 30%, the average plan member in DC plans was well under that limit…and I don’t think we’ll see a significant change,” he notes.

Noble does differentiate, however, between members of different-sized plans. He says participants in smaller plans who have access to an insurer’s full fund platform often select asset allocation funds and don’t deviate too much from these funds. The members in larger plans, who frequently have a more restricted fund platform, may take a different approach.

Says Noble, “The foreign property rule is not something our financial education specialists would dwell on in a member financial education session. It would typically be covered briefly and would at most take one minute in a 45-minute presentation.”

Much like their DB cousins, the most significant change for DC plans, as far as fund offerings go, will be in the world of fixed-income products, adds Noble. And because Canada represents only about 2% of the fixed income market globally, he says there will be new entrants in the line-ups offered to plan members.

Not only will domestic managers seek to expand their offerings into more global investments, but, says Noble, there will be more competition from U.S. players who have the expertise and “marquee value” of having a brand name behind them. Adds Noble, “This is going to open up competition and may generate consolidation in the industry.”


One of the more interesting aspects of the FPR fallout may be changes to benchmarking. Under the FPR’s limits, plan sponsors essentially had very similar asset allocation mixes. As a result, benchmarking was done on a peer-to-peer basis. “I think that pension plans have been paying attention to their total fund returns as compared to other pension plans and, in particular, to plans like the Ontario Teachers’ Pension Plan and the Canada Pension Plan,” notes Malone. But, he adds, in the future we might see a wider range of total returns because of the diversity of strategies and asset allocation mixes than have been seen in the past.

According to Malone, the new, unrestricted environment will refocus attention away from what the “other guy” is doing, which he says has been too influential. In the future, it will give sponsors the opportunity to look at their own goals will help them make decisions that will best achieve those objectives.


The Numbers

• In 2004, the Top 100 pension plans in Canada had amassed $584.6 billion in assets, up 10.7% from the 2003 total of $527.9 billion.

• The total market value of the Top 100’s Canadian equity assets(active and passive)was $97.2 billion, a 9.7% decrease from the $107.6 billion held in the asset class in 2003.

• U.S. equity: $51.1 billion, down from $55.9 in 2003(an 8.6% decrease).

• EAFE equity holdings: $54.6 billion, down from $58.9 billion in 2003(a 7.3% decrease).

• Global equity holdings: $12.3 billion, down from $13.4 billion in 2003(an 8.2% decrease).

• Canadian bond holdings: $98.1 billion, down from $120.7 billion in 2003(an 18.7% decrease).

• Average asset mix: Canadian equities 25.4% (2003: 26.6%); U.S. equities 12.5%(2003: 12.7%); EAFE equity 10.8%(2003: 10.8%); emerging markets equity 0.5% (2003: 0.6%); global equity 4.4%(2003: 4.0%); Canadian bonds 30.0%(2003: 31.3%); international bonds 0.2%(2003: 0.3%); high-yield bonds 0.5%(2003: 0.3%); real-return bonds 3.0% (2003: 2.7%); hedge funds 0.9%(2003: 0.7%); managed futures 0.3%(2003: 0.3%); private equity 0.4%(2003: 0.4%); real estate 3.5%(2003: 3.0%); mortgages 1.8%(2003: 1.6%); GICs 0.0%(2003: 0.02%); private placements 0.4% (2003: 0.5%); venture capital 0.1%(2003: 0.04%); cash 1.8%(2003: 2.1%), non-marketable securities 0.5%(2003: 0.3%), infrastructure 0.2%, income trusts 0.2%.

• In-house investment managers were responsible for $279.0 billion of the Top 100 pension plans’ assets, balanced managers accounted for $33.5 billion, and specialist managers accounted for $211.4 billion.

• The S&P/TSX total return index gained 14.5% in 2004.

• The S&P 500 total return index gained 10.9% in 2004 (but only 3.3% in Canadian dollar terms).

• The MSCI Europe, Australasia and Far East (EAFE)total return index gained 20.2% in 2004(but only 12.4% in Canadian dollar terms).

SOURCES: Great-West Life, CIBC World Markets, Scotia Capital, Russell Mellon, TD Asset Management, and Benefits Canada.

NOTE: 20 plans did not provide asset-level data, just total assets.


American Dreams

Now that the Foreign Property Rule is being removed, Canada is becoming more attractive to outside money managers. “My guess is that a lot of U.S. managers will take a closer look at this market and it probably means there will be a lot more U.S. marketers knocking on Canadian doors,” says Margaret Isberg, president of PIMCO Canada, a U.S. money manager with offices in Toronto. However, she says there won’t be a stampede into U.S. or global products and that the home country bias is still a relatively strong factor among sponsors and investors.

Isberg says opportunities will arise among large public plans which use synthetic products. She predicts some may go directly into equities, which would work well for outside managers. Also, there are plans that have maxed out their 30% limit and may now be seeking to ramp-up their portfolios. And finally, there are those plans that have not yet hit the 30% maximum and are looking to “feel a little more comfortable with it because there is no regulatory impediment now,” according to Isberg.

In fact, Isberg suggests it would actually be worrisome if Canadian plan sponsors were to migrate, en masse, towards investments such as global bond funds. She explains Canadian liabilities are measured against Canadian interest rates and a migration towards global benchmarks weakens the link between assets and liabilities. “It would worry me, from the standpoint of asset liability matching, if we saw an awful lot of increased demand,” she stresses. But, adds Isberg, it does allow sponsors to give their managers tactical discretion to invest in non- Canadian assets when they think it would offer relative value.


A Banner Year

Dan Goguen’s pension fund isn’t like the many defined benefit pension funds in crisis mode these days. Although the Fredericton-based New Brunswick Public Service Superannuation(NBPSS)fund faces a slight underfunding problem, it had an exemplary showing in the year ended March 2004.

“We had a return of 25%, which was the best return we’d had in the fund’s history,” says Dan Goguen, NBPSS’s vice-president, finance and administration. “Any time you can get those sorts of returns, you’ve got to be generally pleased—especially when your real return is decent as well.”

Goguen pins the fund’s solid performance— it’s ranked 35th in this year’s Top 100 Pension Funds survey—on its policy of being hedged on a currency basis and large Canadian investment. In the fund’s last fiscal year, the strengthening dollar, weakening foreign currencies and hedging policy all resulted in higher returns.

The $3.7 billion fund, part of the $7 billion under management of the New Brunswick Management Corp. , has focused on alternatives in recent years, allocating more to investments such as real estate and infrastructure. It’s also been sizing up commodities markets. “We’ve also looked at getting into commodities markets during the past year and are taking a slow, measured approach to getting some money in the category because commodity prices are quite high these days.”

Goguen feels the fund needs to cash in on alternatives now before more large funds begin moving heavily into the sector. “Once a certain path is beaten down, there is only so much that you can do,” he says. “So if you are looking for additional returns or areas that you can add value to by making decisions nobody else is making, you have to look for new frontiers—areas where few people have gone before.”

He says many large New Brunswick plans are recognizing that managing pension assets is not an auto-pilot endeavour, as was perhaps the case when stock market performance was stronger. “I think the other thing pension funds have recognized is that it’s more than just managing a bunch of assets—that we’re managing assets for a certain purpose, the purpose being pension liabilities.” He adds that realization has led sponsors to consider such investments as infrastructure, which offer stable cash flows. He predicts more activity in that area. —Anna Sharratt

Joel Kranc is associate editor of BENEFITS CANADA.

For a PDF version of this article, click here.

© Copyright 2005 Rogers Publishing Ltd. This article first appeared in the May 2005 edition of BENEFITS CANADA magazine.


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