TORONTO (GlobeinvestorGOLD) - The sudden abandonment of the foreign content rule that was announced in last month’s budget is still causing confusion among both investors and money managers. But some mutual fund companies are starting to take steps to remove the financial disadvantage imposed on clients who have invested in “clone” funds, which were originally created to get around the 30-per-cent foreign cap within registered plans.
On March 9, HSBC Investment Funds announced that it has reduced the management fees on two of its clones, retroactive to Feb. 28. They are the HSBC Global Equity RSP Fund and the HSBC US Equity RSP Fund. In the latter case, the difference is significant. Prior to the roll-back, the fund had a management expense ratio (MER) of 2.57 per cent compared to 2.23 per cent for the parent HSBC US Equity Fund. That differential of 34 basis points is on the high side for clones and investors paid the price in lower returns. Over the six months to Feb. 28, the parent fund gained 1.94 per cent while the clone was ahead only 1.4 per cent. Eliminating the MER differential will bring the two into closer alignment until they are eventually merged.
The next day, Fidelity joined the parade by announcing that the MERs on all its clones will be reduced to the level of their parent fund. By my count, Fidelity has 17 clone funds with total assets approaching $1-billion so the loss in fees to the company is significant. Fidelity said the move is effective immediately.
There was a paragraph in the announcement that caught my eye. It read: “This decision is in anticipation of the eventual elimination of RSP funds. Fidelity will proceed to eliminate the funds as soon as the Government’s proposed policy change comes into force. This, however, is expected to take several more months. In the meantime, Fidelity expects to continue managing the RSP funds without any significant changes to their structure or tax eligibility.”
This is an example of the utter confusion gripping the industry. Fidelity says it will act “when the policy change comes into force.” Actually, it is already in force. Historically, the practice has always been that when a finance minister makes an announcement of a tax change that is to take effect immediately, the Canada Revenue Agency treats it as if the legislation were already approved. That’s why a tax increase can be implemented at midnight on the same day it is announced. The details are tidied up later.
In his speech, Ralph Goodale said the removal of the 30 per cent foreign content cap is effective as of 2005. That means right now and the CRA will act accordingly. The fund companies are obviously worried because this is a minority government. They fear the Liberals might be defeated and an election called before the amendments to the Income Tax Act are passed. It would then be up to the new government whether or not to proceed. So they are protecting their backsides.
I received an e-mail last week from a reader asking whether individual investors should take the same attitude. The answer is no. If it should happen that the government were to be defeated before the budget bill is passed, it is a virtual certainty that no one who acted on the basis of the announcement would be penalized. So my advice is to proceed as if the foreign content rule is gone.
However, that does not mean that you should immediately rush to the phone and order a lot of foreign securities for your RRSP. Much will depend on your circumstances and how your plan is positioned now.
For example, if you are close to retirement and expect to continue to live in Canada, you should emphasize Canadian securities so as to reduce currency risk and protect the buying power of your retirement fund. Conversely, if you plan to spend a lot of time in the U.S. when you stop work, adding more American securities might not be a bad idea.
In an article in the March issue of my Mutual Funds Update newsletter, I discussed in detail how to revaluate an RRSP now that the foreign content restriction is gone. My recommendation for a well-balanced plan was 5 per cent each in U.S. and Canadian cash-type securities, 20 per cent in Canadian bonds, 20 per cent in foreign bonds, 25 per cent in Canadian equities, 15 per cent in U.S. equities, and 10 per cent in overseas equities. That’s a 50-50 Canada/foreign split.
But that is only a model. Everyone will have to assess their plan to determine the right mix for them. If some major changes are indicated, don’t rush into them. Wait for the right opportunities to buy and sell.
But don’t wait for Parliament to pass the enabling legislation. The finance minister says the cap is gone and that’s all you need to get started.
Gordon Pape is one of Canada's most respected financial authors and the nation's leading expert on mutual funds. This article first appeared on GlobeinvestorGOLD.com. If you'd like to profit from the insight of more than 30 financial experts and columnists, including Gordon Pape — sign up for a free trial to GlobeinvestorGOLD.com.
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