Goodale shocks fund industry

The announcement by Finance Minister Ralph Goodale in his Feb. 23 budget speech that the foreign content limit for registered plans has been scrapped has left the mutual funds industry scrambling, trying to figure out what to do next.

“It’s a victory that, quite frankly, we were not expecting to happen all at once,” said John Murray, a vice-president of the Investment Funds Institute of Canada (IFIC), referring to the immediate elimination of the foreign content limit for registered plans. “We had hoped the government might reduce the restrictions incrementally.” He added that IFIC is “very pleased” with the move but the suddenness of the decision has left the fund industry in a quandary.

A whole sub-set of funds was created several years ago to circumvent the foreign content limits. Known as “clone” funds, they have a complicated structure that involves investing in futures which track the rise and fall in the value of the parent fund. Now these funds have suddenly become redundant and the industry faces a lot of paperwork and legal filings to merge their assets back into the parent funds.

Timing still in question
At this point, none is quite sure when that process should begin. The technical papers released with the budget state that the foreign content limit is to be repealed “effective as of 2005”, which means the legislation will be back-dated to Jan. 1.

However, because the Liberals are in a minority position it cannot be taken for granted that the amendments to the Income Tax Act needed to translate a policy statement into law will actually ever pass. It can take as long as a year to steer budget-related bills through the Commons (the measure enacting the 2004 budget plan was only tabled in December). In a minority Parliament, a lot can happen in that time. The last thing the fund industry wants is to unwind a complicated structure and then have the bill die because a new election is called.

Fortunately, individual investors don’t face the same problem. They can immediately transfer any assets they have in clone funds to the parent funds without undue concern. If the proposal should fail to pass, an accommodation would almost certainly be made by the Department of Finance and the Canada Revenue Agency to ensure that investors who acted in good faith would not be penalized.

Switch sooner rather than later
If you own any clone funds, you would be advised to make the switch sooner rather than later. The clones often fail to match the returns of the parent funds, for a variety of reasons. For example, AGF European Equity Class (the parent) returned 9.6 per cent annually over the three-year period to Jan. 31. The AGF RSP European Equity Fund (the clone) averaged 8.4 per cent a year over the same period. That is a significant difference. This clone fund has about $278 million in assets under management. Smart investors should begin moving that money into the parent fund immediately.

However, be sure that your fund is actually a clone fund before you give the instructions. The letters RSP in the name are a tip-off, but not every fund with RSP is a clone. For example, TD offers a US Index Fund and a US RSP Index Fund. At first glance, the latter might appear to be a clone but it is not because it is denominated in Canadian dollars. The TD US Index Fund is denominated in American dollars so the returns are very different.

There is one other interesting implication in this that investors should note. The elimination of the foreign content rule means that limited partnership units can now be held without restriction in a registered plan. Previously, some of them were considered foreign content even if most or all of their business was within Canada. One example is TransCanada Power LP (TSX: TPL.UN), a popular and widely-held income fund that is structured as a limited partnership. Shares of this and similar funds can now be put into a registered plan without limit.