Fund companies should be prepping their troops to deal with the massive task of eliminating their RRSP-eligible clone funds.

In today’s federal budget, the government announced the immediate elimination of foreign content restrictions on registered portfolios. The foreign property rule — which restricts investors to a maximum 30% foreign-content allocation in their retirement accounts — will certainly not be missed by the fund companies, but its elimination will pose a huge operational challenge.

RRSP clone funds were contrived solely to circumvent the FPR with the help of derivative contracts on underlying foreign assets. With the lifting of the restriction, the rationale for those products evapourates.

These products hampered returns by adding administrative costs and introducing tracking error. Now, investors will presumably prefer the cheaper, more efficient option of holding the underlying assets directly.

For fund companies, this will likely mean eliminating their clone funds. Jamie Golombek, vice president of tax and estate planning for AIM Trimark Investments, suggests that many firms may decide to collapse these funds into their underlying funds. In the meantime, many investors may seek that change themselves. And that’s where the administrative and communications challenges come in.

As a result, fund companies must immediately prepare themselves to deal with the influx of clients and advisors looking to abandon RRSP clone funds, counsels Golombek. He advises fund firms to decide how to deal with the task immediately, and to cobble together a communications strategy for investors and advisors who will be wondering how the change affects them. He also suggests advisors and clients consider the outside chance the budget might not pass and not rush to make changes.

Notwithstanding the administrative headaches, Golombek says the elimination of the FPR is an extremely welcome change for fund companies and retail investors. Chiefly, the move should improve investment returns.

Advocates for its elimination have pointed out that Canada represents only about 2% of world equity markets and 3% of debt markets. As well, Canadian markets are heavily concentrated in a few sectors. So forcing investors to hold 70% of their retirement portfolios in Canadian assets represents an undue burden.

Indeed, a pre-budget paper by the economics department of TD Bank Financial Group calls for the government to scrap the FPR. It estimates that raising the limit from 20% to 30% adds 0.31% in annual portfolio returns; that opportunity increases with its outright elimination.

TD claims that the rule was patently unfair because only large pension plans could afford the strategies required to circumvent it; and, that it was solely a protectionist policy designed to provide cheaper funding for Canadian firms. “Factor in the underperformance of the S&P/TSX [composite index] vs other major global equity indices over the last 25 years, and it’s clear that the FPR triply compromises Canadian investors’ ability to construct well-diversified portfolios that maximize risk-adjusted returns,” TD’s paper argues.

The rule’s protectionist pedigree is confirmed by the fact that the government doesn’t forecast that its elimination will cost it anything on the revenue side.

Some have worried that the move could hurt the Canadian dollar. But given the strong run-up in the C$ over the past couple of years, that hardly seems as worrisome as in the past.

While the elimination of the FPR is the big news from the budget for fund companies, there are also a number of other important items. The increase in RRSP contribution limits from $18,000 in 2005 to $22,000 in 2009 is a welcome change. As is, news that investors who convert locked-in RRSPs to life income funds will no longer be required to buy an annuity at age 80. Another indirect positive is the news that it won’t be making any changes to the treatment of income trusts (although it’s planning further consultations on that issue); as these are the only mutual funds selling well these days.

On the downside, the government has apparently backed away from the idea of introducing tax-prepaid savings plans, which could have enticed more low-income workers to save for retirement. It also declined to raise RESP limits, and it didn’t make any meaningful personal income tax cuts.

Overall, Golombek says, while the fund industry would like to see more options for retirement savings, far higher RRSP contribution limits and far lower personal taxes, it has to be pleased with the unexpected elimination of the FPR.