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Funds skirt foreign limits while lobbying for change

The Investment Funds Institute of Canada (IFIC) has stepped up its campaign against the Canadian government's 20 percent limit on foreign content in registered (retirement) plans, with the goal of getting the restrictions eased by next year. In the meantime, industry players continue to find creative ways around the content quota.

Unwilling to rely on whether lobbying will be successful, fund managers are increasingly taking steps to circumvent the four-year old 20 percent rule. One of the loopholes fund companies have been able to exploit is the quirk in the tax legislation that allows individual funds to hold up to 20 percent in foreign securities, while still being counted in retirement plans, as if they were 100 percent invested in domestic securities. The foreign content law holds that individuals' retirement plans can maintain their tax-deferred status only if they maintain at least 80 percent of their assets in domestic securities.

Synergy Asset Management, one of the most successful startup companies of 1998, is among the companies that have exploited this loophole and has turned the foreign content rule into a marketing pitch. It promises to make full use of the 20 percent limit in its domestic category funds. Other money managers that routinely keep their foreign holdings close to the upper limit include independent BPI Mutual Funds and bank fund complex TD Asset Management.

"We're just trying to maximize and keep it up to 20 percent as much as we can," said Fred Dally, executive vice president of portfolio management at BPI of Toronto.

Through the use of derivatives-based funds and bond funds investing in foreign- denominated currency- issues of Canadian governments and corporations, fund companies have even more leeway to get around the 20 percent rule. At Mackenzie Financial, the market share leader in funds sold through independent brokers and dealers, these types of funds are used to substantially increase foreign exposure in its popular STAR asset allocation portfolios. The number of so-called international bond funds that actually invest in Canadian companies with foreign currency denominated bonds has increased considerably in recent years.

Foreign exposure in the five STAR portfolios for registered accounts ranges from 40 to 60 percent, said James Friseur, senior vice president of marketing. The high exposure to foreign markets has meant higher returns this year for the portfolios than would otherwise have been the case, Friseur said.

Other fund companies continue to come out with derivatives-based funds. Direct seller Altamira Investment Services and Royal Mutual Funds, the market leader among bank funds, each recently introduced new foreign equity index funds that are fully eligible for registered retirement savings plans (RRSPs).

The latest tactic to boost foreign exposure involves investing in labor union- sponsored venture capital funds, a specialty open- end fund similar to regular mutual funds. In late 1998, the federal tax department confirmed that these funds qualify as "small business property." The key advantage afforded by the small business designation is partial relief from the foreign content quota. Investors in labor funds can increase the proportion of foreign property in their portfolio to as high as 40 percent, or double the regular rate. Among the first to turn this new wrinkle into a sales pitch has been BPI Mutual Funds, which markets the VenGrowth Fund. A mailing earlier this month to clients announced that Ven Growth shares now qualify as small business property and that therefore, by investing in the VenGrowth Fund, customers can increase foreign content limits to 40 percent.

Segregated funds, which are similar to variable annuities offered in the U.S., currently are exempt from the foreign content rule which applies to mutual funds. But Ottawa has announced that policyholders of segregated funds held in registered plans will have to comply with the 20 percent rule by January 2001.

Because of the pending change in the rules, very few insurance agents are selling policies for registered accounts which exceed 20 percent in foreign content, said James Witol, vice president of taxation and research at the Canadian Life and Health Insurance Association.

Meanwhile, IFIC has sent appeals to the more than 150 members of the governing Liberal Party in Parliament, urging them to increase the permissible foreign content level to 30 percent. The foreign content restrictions are considered onerous because Canadian securities account for only three percent of the world's market.

Through member firms, IFIC has last month also been distributing leaflets urging individual investors to write their members of Parliament to request that the rule be amended. IFIC president Tom Hockin said the trade group is trying to "raise awareness with the politicians" that greater global diversification in registered plans will enable Canadian investors to reduce their risks and increase their returns.

The performance of the Toronto versus U.S. stock market this year underscores the value of international investing. Through the first 11 months of this year, the benchmark Toronto Stock Exchange total return index is down four percent, compared with a 21.6 percent gain for its U.S. counterpart, the Standard & Poor's 500 index. When adjusted for this year's drop in the exchange rate of the Canadian dollar, the gap is even wider.