From today's edition of the Financial Post:A bad time to bet against CanadaRichard CroftFinancial Post Rumour has it that Paul Martin, the Federal Finance Minister, is feeling pressure from Canadian investors to raise foreign content limits within RRSPs. Best guess has the limits rising to a maximum of 30% of book value phased in over a period of years. Too little, too late? Many Canadians have already taken matters into their own hands, having jumped on the foreign content bandwagon long ago. This year, RRSP-eligible clone funds have been selling briskly, despite their higher costs. These "shadow funds" are really bank-issued GICs or other investment attachments where returns are linked to the performance of a well-known foreign mutual fund. Mind you, these clone funds are really just a new twist on an old theme. For years, Canadians have been able to buy RRSP-eligible index funds that use derivatives to maintain their 100% eligibility. In both cases, the idea is to gain exposure outside Canada without using up the foreign content room within your RRSP. And with these products Canadians can gain as much foreign exposure as they want, effectively rendering any change to the foreign content rule moot. That being said, investors may be jumping off the Canadian bandwagon just as our markets start to heat up.This year, for example, the performance of the Canadian stock market has been red hot. The TSE 100 index is up better than 26.5% (including reinvested dividends) so far this year, compared to just over 15% for the S&P 500 Total Return index -- the two proxies FPX uses for the Canadian and U.S. stock components. Canadians who opt for a heavy foreign content weighting are also exposed to currency risk. This year's numbers make the point. When you convert the S&P total return into Canadian dollars, it comes in just under 10%. So the strength in the Canadian dollar negated 33% of the total return. To shun Canada at this point is to leave after 10 years of poor performance relative to the G-7 countries. To play devils advocate, if you sell Canada to buy abroad, are you now selling low to buy high? The only way that makes sense is if you believe that the Canadian market will continue to under perform. Before you jump to that conclusion, ask yourself why the Canadian dollar has performed so well this year, especially when our interest rates are below comparable U.S. rates. Obviously, foreign investors have faith in Canada. Often, currency performance is a preamble to the performance of financial markets. Most analysts agree that the strength in the loonie has been tied to rising oil and commodity prices. Because the world believes -- rightly or wrongly -- that higher prices for raw materials are good for Canada. And they may be right. Canadian oil exploration companies can ratchet up their production schedules, knowing that at these price levels, they can ring up some decent profits competing against members of the Organization of Petroleum Exporting Countries (OPEC) especially if they can generate these profits without triggering inflation. The U.S. Federal Reserve is concerned about the inflationary impact of higher commodity and oil prices. If those price increases cause a dramatic shift if the consumer price index, look for the Fed to raise rates and dampen economic expansion. But I'm not convinced commodity and oil prices will cause a major shift in the U.S. consumer price index. Over the past year, the oil price has doubled, yet there has been no discernable impact on the consumer price index. Productivity increases have more than offset higher prices for raw materials, and that should continue. Moreover, many analysts, including myself, believe that OPEC is not particularly interested in seeing the price of oil rise much above current levels, for fear of losing market share to non-OPEC countries who can compete aggressively at these price levels. Given that, it doesn't look as though the price of oil will double again in 2000. If we assume oil prices remain relatively stable in 2000, then most of the impact on the U.S. CPI numbers should already be behind us. And assuming the U.S. "growth without inflation" scenario continues, Canadian resource companies will be able to keep spinning decent profits without triggering inflation-- the best of all possible scenarios for our economy.Something to think about as the crusade to increase the foreign content limit heats up.palsan
This article caught my eye as well. First because Martin is feeling pressure over the 20% limit (in part due to the people who post on this board!) and second, because of the suggestion that the Canadian market is about to heat up. However, the "Market Eye" column in the same edition of the Post points out that the TSE record high has only been reflected in two of 14 sub-indexes, and that most of the rise in the TSE is due to our two friends JDU & NT.I'm not sure I see evidence to let up the pressure for more foreign content yet.Mo.
Given that the article covers several different topics, it's hard to know where to begin.First, though, for me the foreign content issue is about personal freedom. Arguments about relative investment performance of Canadian versus foreign markets are beside the point. I am willing to accept an RRSP deal that says: Give me tax deferral, and I'll give up tax preferential treatment on capital gains and Canadian dividends. I am not willing anymore to accept the Government's rider that says I must keep 80% of my money in companies that trade on a Canadian stock exchange.Second, we had strong currency at the beginning of the 1990s. Remember the allegations that people made saying there was a conspiracy to keep a high Cdn$ to help US companies when NAFTA was adopted? And in 1994, the Cdn$ rose against the US$ (I know, I was in Chevron at the time, whose roughly 20% gain I gave back because of the currency). Canadian markets were strong in years subsequent to 1994, but that doesn't imply that other markets will be weaker than they have been.Further, currency risk is a possibility, but the 20 year trend has been against the Cdn$. Croft is using one year's worth of data to put a fright into people. Foreign investment by Canadians does face a currency risk, but that risk depends on the time when people actually cash in their US$ holdings, and we have some control over that.Also, what "strength" is there in the loonie? Oil prices have doubled since last year: that's d-o-u-b-l-e-d: 100%. The loonie has risen 5% (65 cents to 68 cents): f-i-v-e percent. Hello!!! (Palsan: this isn't directed against you, but against the arguments Croft makes.) Why have people become so accepting of a 68 cent dollar?I can't speak to inflation, but from what I've read Greenspan is raising rates now to counter the inflationary forces that will show up in 12 to 18 months from now. So I question Croft's assertion that inflation is behind us -- or at least the US.His point about the resource companies becoming profitable is probably worth following up on, if one is interested in investing in resource companies. But I'm typically not one of those persons. (I do watch a few though. I note that Renaissance Energy is down again into the $17 range, from a high of around $24 earlier this year, as the price of oil rose. Oil is still high; why has Ren dropped?)And what is his argument: that I should forego the Ciscos of the world so I can invest in Teck? Is something wrong with that picture?Lastly, his comment on the rise of the TSE100 versus the S&P500. Cherry-picking again. The S&P100 is up 28% (not currency adjusted) versus 19% for the S&P500. Nasdaq100 is up 95%. He neglects to say that probably most of that TSE100 gain is from Nortel and BCE. This weekend's Financial Post says that the "unweighted" TSE300 return is 4.3% year over year (compared to 20.3% in its proper, weighted form). Why doesn't he comment on that?Don
Don,I do not disagree with you in general. I posted the article because I think that hearing both sides of an argument is usefull.The performance of the TSE this year is better than the S&P 500 (especially after currency conversion), but as someone pointed out, the majority of the performance has been turned in by the likes of NT, BCE, JDSU.The TSE will probably also outperform the S&P 500 in the near future. However, I'm not willing to invest in CYCLICAL stocks (rocks and trees). Therefore, I will still put most of my money in US stocks.As for "personal freedom", outside registered plans one can invest up to 100% in foreign content. Furthermore, since no one is forced to invest inside a registered plan, everyone already has the freedom to invest outside Canada.palsan
Hey palsan,I sure liked that last reply of yours!Norm
<I posted the article because I think that hearing both sides of an argument is usefull.>Richard Croft is a smart guy. I read a lot of what he says on investment, and it's good. I just think in this case, his argument is scattered. By the way, if his main point is not to overlook the Canadian market, then that's ok. But I'm not in danger of doing that, anyway, regardless of foreign content limits.<As for "personal freedom", outside registered plans one can invest up to 100% in foreign content. Furthermore, since no one is forced to invest inside a registered plan, everyone already has the freedom to invest outside Canada.>True enough. (And I have read Norm's following comment, too.) But why should I accept yet another restriction on what I can do with part of my life? Especially one that serves no purpose that is related to what an RRSP is all about: saving for one's own retirement.I guess one would have to go back to the original debates surrounding creation of RRSPs, and see what the government thought it was accomplishing in imposing the restriction. I would guess that there was some bumpf about keeping money in Canadian companies. But except for those of us who invest in stock offerings, that argument doesn't go anywhere. Most of us buy and sells stocks on the secondary market. Maybe the person on the other side of the trade is Canadian, but maybe not. The account I have stays in Canada, a Canadian broker or mutual fund company gets my business, and in order to cash out, I'll eventually have to turn the investment in Canadian dollars.I think that some of the RRSP restriction is tied to restrictions on what Canadian-based pension plans can do. I don't know much about that side of things. And again, I don't see the usefulness of having this kind of restriction there, either.I do acknowledge that in the short term we would need a graduated increase, because of foreign exchange troubles. And I'd be interested to see the numbers on that topic, to see what kind of gradation would work best for the economy. I'll bet it's not as restrictive as the government is suggesting.Having the restriction does allow tax policy in some areas: for example, it allows labour union funds to encourage investment in small Canadian companies; it also allows direct investment into privately held companies. In both cases the foreign content is increased up to 40%; in the first case, you usually get a further tax break; in the second case, you don't, and there are restrictions as to the kind of business the privately held company can do (ie, the main operations must be in Canada), and the investment can't be for a very high percentage of the issued shares. Take away the foreign content restriction and one benefit to invest that way would be taken away. But does anyone make such an investment solely in order to increase foreign content limits? It's possible, but I doubt it. I've looked into doing both, but shied away, because of concerns of the quality of the investment. The main reason for the labour-sponsored stuff is the tax break; the main reason for an investment in a small company is that you trust the principals; though I will admit that in the latter case, the foreign content limit sweetener does help.And at the moment the restriction has also provided a lot more work, and increased fees, for the lawyers, accountants and mutual fund companies who set up the clone funds to get around the rules. Just what the world needs: more investment in derivatives! I suspect the energy of all those people involved could be put to better use.I just don't see anything in the foreign content rules that helps me, as a small investor, someone without any pension plan, save for my own retirement.Don
Don, excellent post.For the sake of continuing the discussion I will stay the "devil's advocate".But why should I accept yet another restriction on what I can do with part of my life? Especially one that serves no purpose that is related to what an RRSP is all about: saving for one's own retirement.Restrictions of freedoms are a necessary evil of modern society. Some restrictions are more onerous than others and they affect people differently. My argument is that the foreign content limits are minor restrictions and at worst affect only individuals who rely on group pension plans.I hope the following makes sense.1. People have the choice to invest inside registered plans (RRSPs) or not.2. RRSPs, as they exist today, benefit mainly high income individuals (those in the ~40%+ marginal tax braket).3. The average Canadian is better off in the long-run by investing in stocks OUTSIDE of RRSPs - where there are no foreign content limits.4. For the individuals that benefit from RRSPs, the VAST MAJORITY, have investments far beyond the RRSP (which have a contribution limit of ~$13K per year). Therefore, most of them can max out the RRSP and still have significant savings to invest outside the registered plan. The investments outside the plan can then be made outside Canada.5. Therefore, the limits do not present a real restriction for individuals that do not rely on group pension plans.The 20% limit, OTOH does affect pension plans. Here, a participant is restricted from having his/her pension funds invested more than 20% outside Canada. So, on the surface, the individual seems to face undue restrictions on how his/her pension money is invested. BUT, here the individual faces an EVEN BIGGER restriction - s/he has NO CONTROL over how the funds are invested in the first place - let alone whether they are invested in Canada or abroad.And at the moment the restriction has also provided a lot more work, and increased fees, for the lawyers, accountants and mutual fund companies who set up the clone funds to get around the rules. Just what the world needs: more investment in derivatives!Hey, are you trying to put me out of work! If all of a sudden all those mutual fund accountants had to look for other jobs I'd be facing some tough competition for my job (and probably lower salary as a result of the demand/supply shift). :-)I suspect the energy of all those people involved could be put to better use.Yeah, they could bring us more dot.com IPOs.lol :-) lolpalsan
3. The average Canadian is better off in the long-run by investing in stocks OUTSIDE of RRSPs - where there are no foreign content limits.Palsan,Have you seen any research that demonstrates this? I have heard this sentiment expressed before, most recently in the last issue of The Moneysaver. I see the disadvantages of RRSPs(20% FC, having returns taxed as income and not being able to use capital losses being the main ones) but wonder what type of return would be necessary to overcome the advantages of the initial tax refund plus tax-free compounding for the life of the account(especially for those in the highest income bracket). I would be very interested to see a comparison of returns for RRSP vs. non-RRSP investing.Mo.
3. The average Canadian is better off in the long-run by investing in stocks OUTSIDE of RRSPs - where there are no foreign content limits.Palsan,Have you seen any research that demonstrates this?There was alot of discussion on this topic early this year (Jan & Feb) over on the General Canada board. Check out the posts at that time and the referece in the FAQ.palsan
palsan:I agree with your points about RRSPs being of primary benefit to those who are in the highest bracket, particularly at the time of contribution. And that those people likely have significant investment capital outside their registered plans. (Hence the advice you sometimes see that such people should put interest bearing investments inside the RRSP and hold capital gains producing investments outside the RRSP.)You're also saying that perhaps the foreign content limits serve as a check on people before they commit to an RRSP.But I'll bet that there is a significant number of people such as myself, who already have money inside an RRSP, and that those funds represent the bulk of our capital for investment. While I can change my investment habits now, by foregoing RRSP contributions in favour of investing outside the RRSP, the restriction still rules for a signicant portion of my funds. Certainly, too, the financial planning industry is not doing anyone a big favour by promoting almost unquestioning acceptance of the idea that everyone must have an RRSP.As to group pension plan members having no control over their investments: Knowing what it's like not to have a pension plan, I think that I would willingly trade at least some freedom for security.Enjoyable discussion. Don
Don said:<quote>palsan: I agree with your points about RRSPs being of primary benefit to those who are in the highest bracket, particularly at the time of contribution. And that those people likely have significant investment capital outside their registered plans. (Hence the advice you sometimes see that such people should put interest bearing investments inside the RRSP and hold capital gains producing investments outside the RRSP.) You're also saying that perhaps the foreign content limits serve as a check on people before they commit to an RRSP. But I'll bet that there is a significant number of people such as myself, who already have money inside an RRSP, and that those funds represent the bulk of our capital for investment. While I can change my investment habits now, by foregoing RRSP contributions in favour of investing outside the RRSP, the restriction still rules for a signicant portion of my funds. Certainly, too, the financial planning industry is not doing anyone a big favour by promoting almost unquestioning acceptance of the idea that everyone must have an RRSP. As to group pension plan members having no control over their investments: Knowing what it's like not to have a pension plan, I think that I would willingly trade at least some freedom for security. Enjoyable discussion. Don </QUOTE>- absolutely right on, Don. I am in fact in the highest bracket, but having 4 kids and a wife who's just finished university doesn't leave a whole lot for investing outside an RRSP.In fact, the thing that annoys me the most about the 20% limit is that it distorts my investment strategy in maybe unexpected ways. Let me give an example. A couple of years ago, when Steve Jobs came back to Apple, I bought some stock. Back about February, I read an article in the Globe and Mail about JDS Fitel - sounded interesting, I did some DD and decided to invest. Now the 'Foolish thing to do' would be to just let that money ride, and enjoy the benefits of my equity increasing. However, what that means is that over time, the book value of the investment, which RC uses to measure my US content, gets further away from the market value.Now I like to add to my holdings of winners, and sell losers. But if my Canadian stocks are losers, and my US stocks are winners, I can't do either of those things without potentially incurring a penalty. So at various points in time I end up selling my Canadian winners, like JDS (now JDS Uniphase) and buying them back just to reset the bar on the book value. Sometimes I am lucky and I capture a small price dip so I don't lose on the commission, other times I am not so lucky and end up paying a little more for them than I got. I have been tempted to sell US stocks that are down (like Copper Mountain) and then buy them back (but so far resisted the temptation)._That's_ what I don't like about the 20% rule...Tom Frog
I would be very interested to see a comparison of returns for RRSP vs. non-RRSP investing.Mo. Mukluk,I don't have a fancy comparison but I do have personal experience. I believe the average return for a Canadian RRSP to be around 10 to 15%. Many of my friends in Canada are happy to reach double digits.I was shipped out to the US last year and so was forced into their market. Since February '99 I have have made 118% above and beyond my initial investment using the research and workshops here at the Fool. When I get shipped back home next year I am going to leave my money here. I have no problem paying full capital gains on a return like that. There is no way I will put my money back into the Canadian market. The returns just aren't there.tallships
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