When the foreign-property rule was removed in the February 2005 budget, there were cheers all around. Although it has taken a bit of time, it now seems as though people are taking advantage of the FPR’s demise.

Following 21 straight months of net redemptions, foreign equity sales finally began making their climb, reaching $133 million in January. In February, net sales of foreign equity funds were $771 million, the highest sales in that category since February 2002. The increases came as advisors and investors took heed of predictions of a red-hot Canadian market that can’t last forever.

Diversifying investors’ portfolios among different regions of the world to minimize geographical risk is as important as diversifying among asset classes. Canada’s equity market represents only about 3% of the world’s equity market. Global investments provide currency diversification and the potential to earn greater returns by investing in foreign stock and bond markets.

And diversifying with a mix of global and domestic investments has the potential to increase returns while reducing risk. In particular, the lack of diversification in an investor’s portfolio can result in higher risks, especially for Canadian pensions and RRSPs.

Nowadays, baby boomers are demanding balanced and income products that better suit their lifestyles. But there was a time, not so long ago, when sales of foreign equities topped the charts. The FPR was the push behind the sales.

The FPR was created in 1971. Institutional and individual tax-shielded investments were not allowed to put more than 10% of their assets in what was deemed foreign property. At the time, the FPR was meant to ensure there was sufficient domestic financing for Canadian governments and businesses.

Trend shifting

The restriction was slowly eased over the years, with the threshold rising to 14% in 1991, 16% in 1992, 18% in 1993, 20% in 1994, 25% in 2000 and 30% in 2001. As the FPR restriction was loosened, Canadians bought up more foreign securities.

For example, from 1991 to 1998, the percentage of sales in equity mutual funds that were foreign equities hovered between 41% and 58%. From 1999 to 2002, the proportion rose even higher, to more than 76% of total sales.

A solid Canadian market, rich in natural resources stocks, turned those numbers around in 2001, and it wasn’t until early this year that the trend appeared to be shifting. Monthly sales of foreign equities in February were at their highest in four years; the trend appears to be pointing higher.

Right now the biggest-selling foreign funds are in Asian, Japanese and emerging markets in which there are signs that a five-year bear market is turning around. Some countries, such as China, have tightened their accounting rules as their economic growth continues in an effort to entice increased foreign investment.

What does this all mean for advisors? Selling foreign equities to investors who have enjoyed double-digit gains in domestic funds will not be easy, that’s true. But Canada’s markets have been propelled by the natural resources sector (especially oil and gas) as well as the financial services sector over the past couple of years.

Canada is due, the experts say, for a correction. Momentum in some corporate profits is slowing and a higher Canadian dollar will have a stronger negative impact on exports.

For the average investor, there is only one way to lessen a downturn at home: global diversification, plain and simple. With some knowledge of their own and the aid of an advisor, investors will be able to determine where and how that diversification should take place. IE



Joanne De Laurentiis is president and CEO of the Investment Funds Institute of Canada.