The lifting of the foreign property rule for Canadian pension funds in the 2005 Federal Budget will not have any “big bang” effects, but it will yield long-term benefits, says a report from MFC Global Investment Management.

The report, released Friday, predicts that the lifting of the cap will move Canadian portfolios closer to an “optimized” exposure to foreign assets over the next couple of years.

Under the rule, Canadian pension plans could hold a maximum of 30% foreign content. But few Canadian pensions were maximizing their foreign exposure, holding less than 26% in foreign assets, on average. Larger plans used strategies such as derivatives to get around the rule, while smaller plans, which lacked the resources for these kinds of techniques, had significantly lower foreign exposure.

“The foreign property rule was a policy that only served to make accountants, brokers and lawyers busier than they needed to be,” says Leo de Bever, executive vice president of Toronto-based MFC Global, the investment management group of Manulife Financial Corp.

The report says the removal of limits will make foreign investments more attractive to institutional and, to an even greater extent, individual investors. It cites a study by Investor Economics Inc. of Toronto that found individual investors were paying up to 60 basis points per year for RRSP clone funds.

The relaxing of the rule will make it easier for managers of pension funds to diversify efficiently across sectors. The rule limited them largely to the financial, energy and materials sectors, which dominate the Canadian market. “Canadian pension funds will no longer be forced to own certain sectors or mediocre companies in the Canadian equity market to be properly diversified,” says Mark Schmeer, MFC Global’s senior vice president of North American equities, in the report. “Investment decisions will be more closely based on the construction of efficient portfolios, and that’s exactly how it should be.”

U.S. equities will get the most attention, the report predicts. The U.S. is already the most popular foreign market for Canadian investors, managers are familiar with U.S. generally accepted accounting principles and investors are familiar with U.S. companies.

Fixed income is the asset class most likely to be affected by the lifting of the rule, according to the report. Previously, equities took the lion’s share of foreign exposure; now bond managers will be free to go beyond the limited Canadian bond market and explore the deep U.S. market.