The mutual fund industry seems to be sending advisors a not so subtle message about where their clients’ assets should be invested. “Go global” is the advice coming in loud and clear, thanks to a recent flurry of launches of globally focused funds.
Part of the reason for the wave of new products is the removal in 2005 of the 30% foreign-content limit on registered accounts. Also, there has been growing realization among clients that the market capitalization of Canadian equity markets — booming for the past several years — represents just 3% of global market cap. Thus, focusing on Canadian investments may not allow for adequate diversification.
Among those fund companies offering new funds are Investors Group Inc. of Winnipeg, which recently announced the addition of two versions of IG Mackenzie Cundill Global Value Fund to its lineup, and Mackenzie Financial Corp. of Toronto, which launched Mackenzie Cundill Emerging Markets Value Class Fund (see page 34). Manulife Mutual Funds, part of Manulife Financial Corp. of Toronto, has added five new global mandates to its lineup, including a monthly income fund, a global real estate fund and a U.S. value fund. Toronto-based Fidelity Investments Canada Ltd. has announced three new global funds.
Now with unlimited scope to scour the world for investment opportunities, clients and their advi-sors must decide how much foreign content is appropriate.
“We used to be told how much foreign content to have,” says Bill Bell, president of Aurora, Ont.-based financial planning firm Bell Financial Inc. “Now the question is: what’s the right number? The issue is all over the map, with some value seekers and market-timers probably steering outside Canada or even North America right now. But for global investors, the unpredictability of currency exchange rates is a very real risk. Hedging strategies can be used to reduce the risk — but that means if it’s not a risk, it’s a cost.”
For the past several years, Cana-dians have benefited by confining themselves to their own backyard.The global commodities boom fuelled demand for Canadian resources and materials, and big Canadian financial services companies thrived on strong economic growth and low interest rates. But, as a result, the S&P/TSX composite index is significantly weighted in just three sectors — financial services (at 32%), energy (28%) and materials (5%).
This narrow focus makes it difficult to be diversified across sectors when invested exclusively in the Canadian market. Then, there’s the size of the Canadian market relative to global markets.
“Canada may account for only 3% of world markets, but it’s the right 3%,” says Ross Kappele, president of Guardian Group of Funds Ltd. in Toronto (see page 26). “Nevertheless, while Canada continues to do well, there is a strong move to global investing. And with the removal of foreign-content limits, that trend is here to stay.”
But how much global exposure is appropriate? Tina Tehranchian, branch manager for Assante Capital Management Ltd. in Richmond Hill, Ont., stresses that each client’s situation is different but that global content is averaging 30%-50% in most of her clients’ portfolios.
“The Canadian market has been on a winning streak for the past few years, but even if we are in a long-term bull market for resources, there will still be pullbacks,” Tehranchian says. “The addition of global content provides additional depth and diversification, and broadens the range of opportunities.”
When calculating her clients’ foreign content, Tehranchian says, it’s important to look at the foreign content already included in funds that call themselves Canadian, as many have significant foreign holdings.
AGF Funds Inc. of Toronto, for example, recently announced it is increasing the foreign-content limits in six of its Canadian equity funds to up to 49% of assets, to give managers “another tool to gain greater access to the numerous attractive opportunities abroad” and more securities and sectors from which to choose.
AGF’s move follows a similar decision by Mackenzie and Toronto-based AIM Funds Management Inc. in several of their Canadian equity funds.
Warren Baldwin, regional vice president of T. E. Financial Consultants Ltd. in Toronto, says his rule of thumb for the equities portion of client portfolios is one-third Canadian, one-third U.S. and one-third international, which could include a small portion of emerging markets if suitable for the client. The fixed-income allocation is typically left in Canadian assets.
@page_break@“Most people hold the bulk of their assets in Canada, including any company pension plans, Canada Pension Plan, their home and their cottage,” says Baldwin. “They need to coun-terbalance their Canadian assets with international. No one knows what the next 10 years will bring, or where the best place to invest will be, but it’s better to have a diversified portfolio structure than to be overweighted in one area or asset class at the expense of all others.”
Toronto-based Franklin Tem-pleton Investments Corp. produces a chart each year that shows the relative performance of key global market indices. The most recent chart shows that during the 20 years from 1987 to 2006, inclusive, emerging markets — as measured by the MSCI emerging markets free total return index (in Canadian-dollar terms) — was the top performer in five of these years, while the Brazil/Russia/India/China region — as measured by the MSCI BRIC index (in C$) — was the top performer for another five-year period.
None of Canadian stock indices have been the top performer in Templeton’s chart, although Canadian bonds topped the list in 2000, the year the technology implosion dragged down stock markets around the world. The charts show no single asset class has been a top performer for more than two consecutive years, indicating the inconsistency of markets.
“Emerging markets are much more stable than they were 10 years ago,” says Brent Smith, chief investment officer at Franklin Templeton’s Calgary-based subsidiary, Fiduciary Trust Co. of Canada. “Many are benefiting from growing demand for their products from China. It’s not just the U.S. driving world growth anymore.”
Smith says that one of best diversification opportunities is in global fixed-income, including emerging-market debt. He says many emerging countries have had their credit ratings adjusted upward in recent years, and about half are considered investment-grade. “Emerging-market debt is a true portfolio diversifier, due to its low correlation to Canadian and U.S. stock and bond markets,” he says. “It offers the potential for incremental returns, due to interest rate differentials. And some countries still have the opportunity to benefit from credit re-ratings.”
Ted Rechtshaffen, president of Toronto-based TriDelta Financial Partners, is concerned about the extra risk that currency fluctuations add to international investing. He approaches global investing cautiously, and is currently optimistic about the prospects for the Canadian stock market and currency. He isn’t overly eager to stray too far from home and take the exchange-rate risk.
Clients should also be reminded that dividends received from non-Canadian companies are not eligible for the dividend tax credit that applies to dividends from Canadian corporations held outside of a registered plan, which can impact after-tax returns.
“At the moment, we are not shifting out of Canada in any great measure,” says Rechtshaffen. “That could change if inflation increases or interest rates go up. Although there are no restrictions on international investing, we wouldn’t recommend more than 25% for an aggressive or younger client prepared to take more risk, and foreign content could be as low as zero for a conservative client.” IE
New opportunities to go global with mutual funds
With clients looking to take their portfolios global, the big issue for advisors is how much they should send overseas
- By: Jade Hemeon
- May 29, 2007 October 30, 2019
- 11:53