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How to reap the rewards of foreign investments in
your RRSP
By
Jim Middlemiss • Bankrate.com
Most investors don't take advantage of foreign investment
opportunities and are too heavily weighted in Canadian investments.
Although the federal government allows 30 percent of an RRSP to
be invested in foreign companies based on book value, most RRSP
holdings don't even come close to that amount.
"That's probably not a good thing," says
Dennis Tew, senior vice-president and chief financial officer of
Franklin Templeton Investments in Toronto. "They're really
missing out on a lot of opportunities out there. Many major industries
operate outside of Canada."
Canada accounts for less than 3 percent of the world's
capital markets, so investors who hold mostly Canadian stocks and
bonds are putting a lot of their investment eggs in one economic
basket and exposing themselves to the vagaries of the Toronto Stock
Exchange (TSX) at the expense of 97 percent of the world's markets.
Part of the problem is Canadians don't understand
the foreign content rules. A 2002 survey by RBC Financial Group
found the average RRSP portfolio had only 9.9 percent foreign content,
well below the 30-percent cap (investors must pay a one-percent
tax per month for any amount that exceeds 30 percent). Only 12 percent
of Canadians maximize their foreign content holdings, and more than
one-third say they don't have any foreign content at all.
Those who don't invest outside of Canada are missing
out. One only needs to look at the Morgan Stanley world performance
indexes (www.msci.com) to appreciate the opportunity foreign markets
present. At the end of April, the TSX was down about 0.2 percent.
However, Austria was up 24 percent, Greece was up 14.6 percent and
Japan was up 13.7 percent.
However, there are some risks to investing offshore,
says Adrian Mastracci, financial adviser at KCM Wealth Management
Inc., in Vancouver. You expose yourself to foreign currencies, which
can be volatile. "For those who don't have the stomach for
it, it may not be a good idea to be fully maximized in terms of
foreign content," he says.
But if you want to expand beyond Canada's border and
not be held back by the 30-percent rule, here are some simple-and
perfectly legal-strategies:
Double-dipping
You can skirt the 30-percent cap by engaging in what is known as
double-dipping, effectively hiking your foreign content to 51 percent
without feeling the wrath of the tax police. Double-dipping hinges
on the fact that mutual funds can also avail themselves of the 30-percent
foreign-content rule.
First, invest 30 percent of your portfolio in foreign
equity. Then, invest the remaining 70 percent of your portfolio
in RRSP-eligible mutual funds that maximize their 30 percent foreign
content exposure. This hikes your total foreign exposure by an additional
21 percent (30 percent of 70).
Labour funds
Another way to hike the limit is by investing in Labour Sponsored
Investment Funds (LSIFs). The federal government allows you to increase
your foreign content holdings by $3 for every $1 invested in an
LSIF, up to a maximum of 50 percent of your RRSP. However, be aware
that LSIFs are risky ventures that invest in early development companies,
so they may be too dicey for investors with low risk tolerance.
Clone and index funds
You can sidestep the foreign content restrictions all together by
investing in a growing number of specialty products created specifically
to deal with the limitations.
First, there are clone funds, 100-percent RRSP-eligible
mutual funds that maximize their 30-percent allotment in foreign
stocks and then use derivatives to mimic the performance of an actively
managed fund within the same fund family, such as a U.S. equity
fund or international fund. For example, the Templeton International
Stock RSP Fund mimics the popular Templeton International Stock
Fund.
By using derivatives, clone funds qualify as Canadian
content, but mirror the returns of the foreign mutual fund they
copy. You should only consider clone funds once you've hit your
foreign-content ceiling of 30 percent. That's because the management
fees are usually 0.4 to 0.6 percent higher than the Management Expense
Ratio of the underlying fund, which means their overall performance
will fall short of the funds they mimic.
If you want to maximize foreign content and are looking
for lower fees, then consider a 100-percent RRSP-eligible index
fund, such as the iIntR fund from Barclays Global Capital. It tracks
the popular international MSCI EAFE Index, but is fully RRSP eligible.
Foreign indexes have traditionally outperformed the
TSE. Like clone funds, index funds use derivatives and short-term,
fixed-income instruments to mimic the index, and management fees
are normally less than 1 percent.
One caveat: there are some risks to the hedge techniques
used by clone funds. Future contracts are short-term, so there's
no guarantee they will be available down the road. As well, futures
and derivatives are purchased through third parties and therefore
are exposed to insolvency issues should the third party go bankrupt.
If you prefer sticking closer to home, you can always
look at leveraging foreign exposure through the Canadian content
of your RRSP. For example, many Canadian companies, such as Sherritt
International, Bombardier and Alcan Aluminum, earn much of their
revenue outside our borders, but still count as Canadian content.
As well, Canadian bonds issued in foreign currency also qualify
as Canadian content in RRSPs, but provide foreign exposure.
Jim Middlemiss is a freelance
writer and lawyer based in Toronto. He's a frequent contributor
to National Post, Investment Executive and Wall Street & Technology.
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