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Rule change opens whole new world to investors
Limit on foreign holdings lifted, but look before you leap
LIBBY ZNAIMER
For the first time this year, the world is the RRSP investor's oyster. The government has removed the limits for foreign content in registered portfolios, and investors should take a hard look at hiking their holdings beyond the 30 per cent that was allowed until now.
"Of course, foreign content is important for diversification," says Gavin Graham, vice-president and director of investments at the Guardian Group of Funds in Toronto. "But you should be sure that you will match Canadian returns before you go above 15 or 20 per cent."
The way Mr. Graham sees it, it's a safe bet that the Canadian dollar will go up at least 4 or 5 per cent, and you can get 5 to 7 per cent on a government bond or an income trust. "Unless you're confident that a non-Canadian investment will give you more than 10 per cent, there's no point in allocating more money there."
The Canadian market has been on a tear. For the 5 years ending in 2005, it beat every other market in Canadian dollar terms, thanks to energy and other commodities.
But the big question for investors and their advisers is: how long will this run last?
Mr. Graham thinks the trend will continue for the second half of the decade, based on his belief that commodity prices and the loonie will continue to rise. He's predicting a 90-cent (U.S.) dollar in a matter of months and earnings growth of 10 per cent for TSX stocks.
"We're only three per cent of the world market," he says, "but it's the right three per cent."
Not everyone is as bullish.
Laura Wallace, managing director of the Coleford Investment Fund in Toronto, believes the Canadian market's recent performance has lulled investors into the mistaken belief that they don't need much foreign content. She says it's important to diversify - not just geographically, but by industry.
"A lot of industries just aren't available here," she says. "I'm referring to health care and large global pharmaceuticals, and consumer-staples companies. We focus on large multinational corporations, and we just don't have companies that size here at home."
Multinationals do business around the world - they give investors exposure to foreign markets and currencies without the risk of direct investment. It also means these companies have a better chance of doing well even if the American markets do not.
Mr. Graham agrees with that strategy. He favours some European multinationals because they are a bit cheaper than their American counterparts.
But the volatility of the euro can eat into profits. Last year, the currency was down 20 per cent compared with the loonie, so many European investments were a bit of a wash even though the market was up 25 per cent.
This year the market is unlikely to go up that much, he says, and the euro is unlikely to drop that much. Mr. Graham's picks for European investments include Nestlé SA, Novartis AG, Sanofi-Aventis Group, Unilever PLC, Cadbury Schweppes PLC and Diageo PLC. The Guardian Group of Funds holds all these companies in their funds. Mr. Graham personally owns Cadbury Schweppes and Diageo.
Mike Young, a 36-year-old self-employed real-estate agent in Toronto, would rather invest in developing countries than in multinational corporations.
He will be paying special attention to his choices this year because he plans to borrow about $40,000 to top up his unused RRSP contribution room. Only about 10 per cent of his portfolio is made up of overseas investments, but that will likely change.
"I want to take advantage of opportunities in developing nations. If 97 per cent of the world's markets are elsewhere, why would I miss out on that?" Mr. Young says.
China and India are the world's most celebrated GDP growth areas, but many advisers believe investing directly in their markets is too risky. Mr. Graham says the best way to play the boom in those countries is by investing in two other countries that are major beneficiaries: Japan and Korea.
"Investors need to be in Japan," he says, "and Korea looks excellent. Last year, the KOSPI [Korean market] finally broke through 1,000, a level it hit way back in 1988."
How much should Mr. Young put into non-Canadian holdings?
Ms. Wallace usually recommends a weighting of 50 per cent of equities outside Canada. But since most of her clients have balanced portfolios, the foreign content usually adds up to 25 per cent, well within the previous limit.
Greg Phillips, an investment adviser with Edward Jones in Calgary, wants to see those percentages raised. He is recommending that his clients increase their foreign holdings to 35 or 40 per cent.
The strategy of staying almost exclusively in Canada because of recent gains is shortsighted, Mr. Phillips says. A good mix of foreign investments will help clients achieve sustainable growth over the long-term without having to go to the United States, he says.
When he invested in foreign markets in the past he usually chose niche investments in specific sectors. Now he's taking a broader approach, including small-cap stocks that cover China, South America and India as well as Germany and the United Kingdom.
Like many others, he is wary of investing directly in China and India. Mr. Phillips says he is more amenable to South and Latin American markets despite their volatility - he says they are a good long-term hold for investors who are willing to take on some risk.
He also sees Mexico as a strong petro-driven market with good potential.
Mutual funds are the best vehicle for these investments, he says, although he wouldn't rule out putting a maximum of 10 per cent in an index fund for any of these countries.
"A global index fund or small-cap fund will give you better diversification," he says.
Mr. Phillips isn't shy about recommending his favourite picks. He likes the AGF Emerging Markets Fund, which holds 30 per cent in the Americas, 20 per cent in Europe and 48 per cent in Asia.
With REITs starting to catch on in Europe, Mr. Phillips also says he likes global real estate and recommends the AGF Global Real Estate Equity Fund.
Mr. Phillips' target for foreign content seems much more bullish and aggressive than that of his colleagues, but he says his goal is reducing volatility and achieving consistent long-term returns.
"We've had a great ride in Canada," he says.
"But I want to be entrenched elsewhere if and when the Canadian economy goes down."
Special to The Globe and Mail
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