About $67-billion could flow out of the country over two years as a result of the Liberal government's decision to remove limits on the amount of foreign assets that Canadian pension funds and registered retirement savings plans are allowed to own, an internal study says.
The Finance Department report, obtained under the Access to Information Act, tries to predict the impact of the Feb. 23 budget announcement that removed a 30-per-cent cap on the foreign content of pension funds.
The removal was confirmed last Thursday when the House of Commons finally passed Finance Minister Ralph Goodale's budget.
Two weeks after the budget was tabled, Finance officials produced a study -- marked "secret" -- that tried to determine whether the Canadian dollar and equity markets will be affected as funds attempt to take advantage of the unrestricted freedom to invest abroad.
Researchers found that the last time Ottawa relaxed the limit -- in 2000-2001, moving it to 30 per cent from 20 per cent -- about $105-million of capital flowed out of Canada over three years as a direct result of the policy change. The outflow happened even though Canadian equity markets generally performed better than did U.S. markets.
At the same time, pension funds added only about 8 percentage points of foreign content, on average, rather than the full 10-point increase allowed by the new rules.
The heavily censored March 8 study says pension funds and RRSP holders are again likely to add only moderately to their foreign content, even though there's no longer any legislated ceiling.
That's partly because of an international phenomenon known as "home-country asset preference." Investors show a strong bias for stocks and bonds in their own backyard because it's often more difficult to get information about investments in a foreign country.
"The gains from a completely diversified portfolio do not compensate for the higher information costs of investing in foreign countries," says the report.
Drawing on published studies, the authors assume that Canadian pension funds will, on average, raise their foreign content to about 33 per cent from the current average of about 26 per cent.
That would mean about $67-billion will leave the country over two years as a direct result of the new policy, the study concludes.
Other Finance Department research carried out before the Feb. 23 budget determined it was unlikely the policy change would hurt the Canadian dollar, just as the previous increase in the limit apparently had minimal effect.
The old limits were damaging pension funds -- many of which are struggling with solvency problems -- by denying them the better returns available through diversification in global markets, departmental researchers noted.
No other industrialized country imposes foreign-content limits on pension investments.
The budget announcement in February did have an immediate impact on foreign-exchange markets, where some investors bet the loonie would fall in value because of the removal of the foreign content cap. The dollar dipped briefly, but recovered quickly.
Mr. Friesen agreed that "home-country asset preference" is likely to moderate foreign-content levels, perhaps to about 40 per cent -- as is the case in Australia, whose economy is similar to Canada's.
So far, there's no clear evidence in capital markets that much pension money is heading abroad.
"It's hard to distinguish that from all the other noise," Friesen said.
A spokesman for the Finance Department said domestic capital markets have matured, and the rule change won't make it more difficult for Canadian companies to raise capital.
"We don't see the removal of the FPR [foreign property rule]significantly affecting either the exchange rate or the ability of Canadian companies to access capital," David Gamble said in an interview.