The removal of the 30% cap on foreign content in registered portfolios will have a minimal effect on equity allocations and the strength of the Canadian dollar, but it will change the way investors hold foreign content, suggests a new report from CIBC World Markets.

“There is less than meets the eye here, and the financial market implications will be more ‘micro’ than ‘macro’,” the report says.

“Ottawa dropped the caps because their raison d’être had disappeared,” the report explains. “With a current account surplus, Canada had already become a capital exporter.”

“The other rationale is the coming build-up of pension assets ahead of the baby-boomers’ retirement. Too much money chasing too few stocks could water down returns and miss risk-reducing diversification opportunities,” it adds.

The report notes that Canada’s existing foreign content is already higher than that of most other countries with similar degrees of home bias in their overall investment behavior. “So we would expect that the current foreign content of Canadian pensions isn’t that far from where it will settle in the absence of restraints,” it says.

What will shift is the way in which pensions and RRSPs hold foreign equity content, CIBC says. Canadian financial institutions will see reduced flows on the total return swaps and other transactions designed to clone foreign returns during the period in which non-Canadian content was capped. Canadian fund managers might also, to some degree, face a greater challenge from foreign managers that specialize in non-domestic assets, as investors become less inclined to buy clones tied to foreign indexes.

Also, some Canadian equities could also see a reduced bid, as they have to compete head-on with foreign names in their space, the report suggests. “In high tech and health care, for example, the TSX has many fewer liquid listings, and a very large share of the total market cap in the two largest names relative to what’s available on the S&P 500. With no content restraints, pension and RRSP investors might now be more inclined to take a closer look at the richer list of choices abroad,” it says.

Within Canada, the report suggests that limited partnerships, previously treated as foreign content subject to the 30% cap, might also become more attractive vehicles. “But Ottawa might try to close that door before it opens too widely. Having earlier backed away from proposed restraints on pension holdings of business trusts, Ottawa is again going to launch “consultations” with the private sector on the issue of pension investments in both trusts and limited partnerships, which have similar tax revenue implications for governments,” it notes.

Pensions are unlikely to raise foreign, non-Canadian dollar weightings in fixed income, the report predicts, “judging by both their limited current interest and the experience in other countries”.

“Dwindling Government of Canada bond supply and low overnight rates will continue to push yields below those on Treasuries, and pensions will be looking to high-grade domestic corporates as a substitute. At some point, if government bond supply continues to dry up, we could see foreign entities increase their issuance in Canadian dollar product to appeal to the Canadian market. If so, they would provide competition in the market for Canadian corporates and Yankees,” it says.