End of RRSP limit on foreign content a test of fund firms' greed

Tuesday, March 1, 2005


The demise of the foreign content limit for RRSPs offers a chance to watch the financial industry balance the best interests of investors against the drive to maximize profits.

Fund companies and investment dealers will save money on administrative functions as a result of the elimination of the 30-per-cent limit on foreign stocks and bonds in registered retirement savings plans, while advisers have a chance to make more money as they readjust client portfolios. How these financial players actually respond will tell their clients a lot.

The fund industry is under the most scrutiny because it has created a higher-cost category of foreign mutual fund to help investors get around the 30-per-cent limit. The word from fund companies is that these so-called clone funds will disappear and the assets folded into traditional foreign funds with lower fees.

This is a basic business decision and nothing that warrants any praise for fund companies. To earn that, the industry will have to lower fees on their big U.S., global and international equity funds.

The key measure of how expensive a fund's fees are is the management expense ratio (MER), where the continuing costs of running a fund are expressed as a percentage of the total amount of money in the fund. Now, consider the imaginary XYZ global equity fund. It has $1-billion in assets and $25-million in fees, which means an MER of 2.5 per cent.

If you fold in a $250-million clone fund, the assets rise to $1.25-billion. Even if fees rose to $28-million as a result of the fund's increase in assets, the MER of XYZ Global Equity falls to 2.24 per cent.

The key thing to remember here is that a fund's MER is invisibly scooped off the top of its gross returns before a net return is reported to investors. So a drop of 0.26 of a percentage point in a fund's MER means an increase in returns of the exact same amount. Over time, this can add up.

Own any clones? If you do, mark down the MER of the regular fund version of your clone and then check back on in six months or a year to see if the MER has gone down. If it has, your fund company has served you well; if not, consider your fund company to have made a definitive statement about caring for its clients.

The end of the foreign content limit also means that brokerages, banks and financial planning firms no longer have to report to the Canada Revenue Agency about the level of global investments in client accounts. This continuous monitoring was one of the few tangible things investment dealers did to earn those annoying annual RRSP administration fees they charge.

These fees typically range from $50 to $125 a year plus GST, so they're not inconsiderable. Will these fees come down, now that there's no foreign content limit to bother with? Stay tuned.

Financial advisers have a perfect opportunity to make some money as the barriers to global investing fall. All they have to do is go to clients who have owned deferred sales charge (DSC) funds in the Canadian equity category for many years and start talking up the benefits of investing internationally.

DSC funds cost nothing to buy, but you pay a redemption fee if you cash out in the first six or seven years after you invest. DSC funds are popular with advisers not only because clients don't face a purchase commission, but also because fund companies offering them pay an upfront sales commission of as much as 5 per cent.

Let's say you've owned some DSC Canadian equity funds long enough for the redemption fee to disappear. Along comes your adviser telling you to switch into some wonderful DSC global equity funds from another company.

Many investors could use more foreign content in their RRSPs. But a knee-jerk shift of Canadian assets into global equity funds sold with a deferred sales charge is all about scoring a 5-per-cent commission for the adviser and his or her firm, not helping the client.

Any move to increase your global exposure should begin with your adviser looking at your overall mix of investments, risk tolerance and goals. If it turns out that more global exposure would be useful, have your adviser show you the various funds and fee options available. Don't be hustled.

The elimination of the foreign content limit is a major win for investors because it opens the possibility to earn greater returns through exposure to the 97 per cent of the global stock market that lies outside Canada.

The financial industry benefits as well in ways that can cut costs and increase sales. Let's watch and see if they get greedy about it.