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Political firestorm burns mutual funds

Election could kill foreign content reform

The Canadian mutual fund industry has been left in the lurch by the growing political instability in Ottawa, where a possible spring election could derail a much anticipated proposal to lift foreign content limits for retirement plans.

Federal Finance Minister Ralph Goodale shocked fund companies when he delivered a budget in February that promised to scrap the current 30-per-cent ceiling on foreign investments for RRSPs, a move many described as the most significant event in the history of the $1-trillion mutual and pension fund businesses.

Firms have been scrambling to design new products, restructure their portfolios, and in some cases slash fees in anticipation of the new rules.

But they are now abandoning these plans as it appears increasingly likely the budget legislation will not make it into law.

"What a mess," said Bill Holland, chief executive officer of CI Fund Management Inc. "It's a huge pain in the neck. We've already [gone through] the issues of what we were going to do . . . Now, all of a sudden, we just throw our hands up. We don't have that much confidence in any government in Canada."

Mr. Holland said his company was planning to eliminate clone funds -- a type of fund that uses derivative products to provide investors with more foreign exposure -- by the May long weekend, but acknowledged that will not happen now. Even if the ruling Liberals are ousted by the Conservative Party, which is seen to favour eliminating the foreign investment limits, a new budget would not likely be tabled until the fall.

The legislation is still in the early stages of parliamentary readings and has not yet been sent for committee review. Typically, the budget would be passed into law by the summer, but if there is a spring election, it would be effectively killed.

"With everything on hold, it's clearly frustrating," said Jamie Colliver, a partner with Integra Global Advisors. "There's no doubt it's a bit messy. [Firms] have got programmers probably on hold, they've got brokers getting questions and they probably don't know how to answer them."

Mr. Colliver said his biggest concern is that the uncertainty surrounding the new fund rules could spill over into the financial markets and hurt valuations.

"Everyone is going to be in a bit of a quandary and I think returns may potentially suffer as a result -- returns to both investors institutionally and at a retail level."

Integra, like CI and the majority of other Canadian fund companies, has adopted a wait-and-see approach to the elimination of foreign content limits. Most firms have already spent a substantial amount of time developing strategies for the new fund landscape, but are loath to implement new products or practices until the restrictions are legally removed.

Few investors tend to exceed the 30-per-cent threshold and fund executives said they did not witness many Canadians attempting to take advantage of the proposed rules for RRSP season. Mr. Goodale suggested this week that investors who did break the limit could be penalized if the budget is shot down, but few in the fund industry believe Ottawa would actually follow through on this.

A handful of companies, such as Fidelity Investments Canada Ltd. and Brandeis Investment Partners & Co., have already cut fees on their clone products on the expectation that they would soon be rendered obsolete by the new legislation -- a move that observers say could be costly.

Others have reportedly begun unwinding derivatives contracts tied to their clone funds, and may face the expensive prospect of re-establishing them.

Officials at Fidelity and Brandeis did not return phone calls.

"That's going to be a nightmare," Mr. Colliver said. "It's right back to the drawing board."

Karen Fisher, head of mutual funds and fee-based products at Bank of Nova Scotia, said if the new rules do come into force, it will take "at least a year and a lot of money" to alter the bank's fund lineup, develop new prospectuses, and create marketing materials.

Scotiabank has done a strategic assessment on what moves it will need to make if the foreign content limits are eliminated, but is holding off until the legislation is passed.

"We are in limbo," Ms. Fisher said. "I think a lot of people are in the same boat."

The crumbling minority government of the ruling Liberals, which is under furious attack by opposition parties over the sponsorship scandal, has also created complications for the country's biggest institutional investors. The uncertainty surrounding the foreign content limits has forced major pension funds to adopt more short-sighted investment planning, said Paul Pugh, senior vice-president of public investments at the Ontario Municipal Employees Retirement Board, which manages $33-billion in assets.

"It's one of those difficult situations. You don't know whether to go forward, or step back, or stand still at the stop sign."

According to a recent study of nearly 1,700 investment advisers conducted by AGF Funds Inc., about 60 per cent said they plan to direct more than 30 per cent of their clients' portfolio into foreign content. Almost half of the respondents, however, said they would not make any major changes for the next few months.

AGF announced this week that it would chop fees on its clone funds, but said the reductions would not come into play until the rules on foreign content were made legal.

© 2007 The Globe and Mail. All rights reserved.

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