RRSPs: Consider your foreign content

We’re now allowed to hold up to 30 per cent foreign content in our RRSPs-officially, that is. But is that enough? And if not, can you add more?

The answer to those questions is no and yes. No, it is not enough. Yes, you can easily add more.

While there are no hard and fast rules, every study I have seen suggests that the so-called “efficient frontier”-the point at which the risk/return ratio within a portfolio is at maximum effectiveness – occurs with a foreign content position in the 40 to 60 per cent range. That allows for proper geographic diversification.

Key points
If that seems like a lot of foreign content, remember three key points:

• Our equity markets represents only about 2 per cent of the world’s total.

There are some industry sectors that are not represented in Canada in any major way (think about entertainment since the loss of Seagram). Others have only one or two world-class players (e.g. Bombardier in transportation manufacturing).

• Over the past decade, Canadian equity funds have under performed U.S. and global equity funds.
• The Canadian dollar has been steadily losing grou against the U.S. buck for many years.

Since the early 1990s, it has lost about a third of its value. That in part helps account for the superior performance of U.S. equity funds over that time.

Although economists generally agree that our dollar is undervalued against U.S. currency, they’ve been singing the same song for years and the loonie has continued to decline.

Unless the federal government makes it a policy to pump up the value of our currency (which seems unlikely as long as Jean Chretien is in power), the loonie is more likely to track down than to move up.

Go beyond limit
These are all good reasons to go beyond the 30 per cent limit in your RRSP. Of course, the results of the past aren’t a predictor of the future. But there isn’t any strong reason to believe that when 2010 rolls around, the investment returns over the decade will show a significant change from the pattern of the 1990s (and earlier).

Adding clone funds is one way to go beyond the 30 per cent limit, of course. But if you go that route, check first to see how closely the clone you’re considering is tracking the parent fund. If the difference was more than half a point in 2001, choose something else.

Next page: Adding foreign content

Adding foreign content
Here are some other ways to add to your foreign content.

• Use labour-sponsored funds.

They offer a foreign content bonus – $3 extra foreign content room for every $1 invested. You can take your RRSP to a maximum of 50 per cent foreign content using this bonus.

• Choose Canadian equity funds that maximize foreign content in their own portfolio.

This is “free” content as far as your personal 30 per cent limit is concerned. Some domestic funds now make it a policy to maximize their U.S. and international positions.

For example: Phillips, Hager & North recently revamped what was previously called the Canadian Equity Plus Fund. It’s been renamed as the Canadian Growth Fund. And as part of its revised mandate, it will keep its foreign component at or near the 30 per cent limit.

Over the long haul, the foreign content portion should make Growth the superior performer in relation to the companion PH&N Canadian Equity Fund.

• Don’t waste foreign content room on foreign bond or money market funds.

While I endorse the idea of holding such funds in an RRSP for purposes of currency diversification, there are lots of these funds that are considered to be 100 per cent domestic. That’s because they invest in bonds or short-term notes issued by Canadian governments or corporations denominated in U.S. dollars, or other currencies.

• Don’t use foreign content to invest in foreign index funds.

Again, there are many funds that qualify as Canadian content that will do that job for you.

The bottom line is that you can easily build your foreign content to 40 per cent or more without using clones at all. This is not a condemnation of clone funds by any means. But they are more expensive, so before you look in that direction, check the alternatives.