RRSP Foreign Content

Since the 20% foreign content limit is based on book value, does anyone know if, over time, you can systematically crystalize the Canadian parts of your RRSP and thereby increase its book value causing additional room to be available for foreign content?

Thanx in advance for any feedback.

Of course.

By realizing the gains on your Canadian investments, the foreign content you have will become a smaller percentage of your overall total. Just be careful when you realize the gains on your foreign investments and try to reinvest all of the proceeds into new foreign investments.

No, I don't have ESP :-)

Hey Librarian, how about synchronizing the clocks on your servers?

To Bylo -

I've been impressed with your postings in many other threads, but your prescience re my question has me floored. You're not really Jo Jo Savard are you?

BTW, thanx for your response and if you answer the above question in advance i'll be REALLY IMPRESSED.

Bylo, I'll have a question for you tomorrow. Can you send me an answer tonight?

How does one 'Crystalize' his/her canadian content in an RRSP to increase foreign content ?

Can Bylo or anyone else make this clear ?

Curious, just sell the Canadian fund (move it to a money market fund) and then buy it back.

If I have a $50,000 portfolio and $10,000 book value in a U.S. Fund which has grown to $15,000, then I move to a money market fund, you say I now realize those profits?

My book value is 20% of $55,000?

You all talking about qa 20% foreign content, I guess you were all out of the room when they were talking about ones ability to actually go as high as 40%.

And no I am not talking 20% direct, and than 20% of the remaining 80% via a Cdn fund investing 20% outside Canada.

Holding certain labour sponsored funds allows you to hold $3 in foriegn content for every $1 in certain qualifing investments, to a max of 40% directly, plus the extra throught a Cdn fund...

So... ones foriegn content can actualy get as high as 56% directly and indirectly.

Mayber this only is available in BC!

To Curious -

Just to elaborate a little more on what Rob said in his above note. Take the following initial investment and assume for simplicity no distributions.

4K in a Canadian Fund and 1K in a foreign content fund.

The book values of the above are simply 4K and 1K. Now over time lets say that the market value of both investments double. So now the market value is 8K Canadian and 2K foreign. Without doing anything the book values (what you bought the funds for) are still 4K and 1K. Now, if you sell and immeadiatly rebuy the Canadian fund it's book value becomes 8K. So your new total book value becomes 8K (from the crystalized Canadian fund transaction) plus 1K from the original foreign purchase. This represents only a little more than 11% in foreign content so you could rebalance to get to 20% or put 1,000 more in the foreign fund to get to 20%.

I hope this helps.

Interested - Thanks for a great post.

Bylo - Thanks for this great information.

PK - Thanks for the straight forward example. Even I'm able to grasp the concept.

Clumpy

PK,

"So your new total book value becomes 8K (from the crystalized Canadian fund transaction) plus 1K from the original foreign purchase. This represents only a little more than 11% in foreign content so you could rebalance to get to 20% or put 1,000 more in the foreign fund to get to 20%."

Would it be correct to say that the $1000 that goes into the foreign content could be added only if there's earned income/RRSP room to add that amount?

What if -- in the case of a pensioner, for example -- there was no RRSP room. How would one go about "re-balancing" the portfolio you describe?

Hello Scanner98 -

When I said put 1K more into foreign content I did assume additional contribution room would be available. If you are not accumulating more contribution room you could not put net-new money into foreign content.

But you could rebalance. Use the above figures and get to the stage where you crystalized your Canadian content. You would now have book values of 8K Canadian and 1K foriegn, for a total of 9K. Your 1K foriegn represents 1/9 or 11.11% foreign content. So, transfer $800 out of the Canadian and into the foreign. Now you have book values of 7,200 Canadian (ie 8000 - 800) and 1800 foreign (ie 1000 + 800). This represents foreign content based on book value of 20% (ie 1800/9000).

I hope that clears things up!

Thanks PK,

That's what I thought, but was not up to the math at that point!

So if I understand this correctly I could do it in reverse as well and crystalize foreign content that has just taken a big hit (that is now worth less then purchase book value) increasing foreign content purchase ability?

Also...RB an IA...to take advantage of the increased foreign content room that VenCap rules give for RSP's do all the funds have to be in a SDRSP?

Thanks

gb

Greg B,

Yes indeed, you "could do it in reverse as well and crystalize foreign content that has just taken a big hit (that is now worth less then purchase book value) increasing foreign content purchase ability?"

Holding some Asia-Pacific funds are we? :-(

PK: Thanks for the clarification, however one more question. If I go ahead and use this method, flip to a MM fund in the same fund damily and then add to my foreign content when buying back in, does my DSC schedule start over for my BE load funds ?

Sorry Curious I don't know that one cause I only deal with no-load funds like PH&N and Bissett. You'll have to check with your fund company directly (or maybe someone else knows?)

What's the rationale for using book value? Market value seems more straightforward. The only thing I can think of is that if your foreign content takes off relative to your Canadian content, you are not forced to rebalance.

I've read about 100% RSP eligible S&P 500 index funds which don't count as FE content. Did I read this right? If so, how can they do this? That means I can build a portfolio that is 100% non-Canadian!

To GQ -

The rationale (I think) is derived from two points. First Revenue Canada only cares about valuation at the time of purchase and at the time of sale. These events trigger your capital gain and loss and even though RRSPs are tax sheltered the rules originate from this background. Probably more importantly, market value changes everyday while book value is established at time of purchase and sale. If market value were used, adherence to the 20% foreign content rule would require constant rebalancing -- a pretty onerous task.

Re your second question, you read right. The type of funds you refer to use index options, bought in Canada, to mirror a benchmark like the SP500. I think the real question that comes out of this is why do 20% foreign content rules exist in an environment where financial products are available that completely make the rule worthless? But this question has to be addressed in the arena of politics and, as far as I can tell, politics and rationality are more coincidence then design.

Nobody seems to want to discuss the TAX implications of this "crystalization" process. Every time you do this, you'll attract a tax hit based on the increase in value above book. It might be a great idea to increase foreign content room, but it isn't costless.

To thbox -

We're talking about doing this inside an RRSP, which is the only place 20% foreign content rules apply.

thbox: There is no tax implication, we're discussing funds in registered plans (hence the name Foreign Content)

What tax implications? This is an RRSP. See the very first, er second post.

For those who are interested, research shows that portfolios on the so-called "efficient frontier" consist of about 35% foreign securities. This to say that the maximum benefits of diversification to a domestic portfolio are realized at that level of foreign investment. Beyond that level, you are taking on added risk without receiving a commensurate return.

For those who are interested, research shows that portfolios on the so-called "efficient frontier" consist of about 35% foreign securities. This to say that the maximum benefits of diversification to a domestic portfolio are realized at that level of foreign investment. Beyond that level, you are taking on added risk without receiving a commensurate return.

To Phil -

Just curious Phil, but is this research Canadian or U.S.? If its US, they make up a much larger percentage of the world's wealth, so their need for foreign exposure would be less.

Greg B - yes you need to be in a SDRSP to go to 40%.

You do need a trustee that accepts the tax arguments which permit the 40% foreign content when utilizing certain funds. Only know of one that will as prospectus of fund outlines the right to do so. And its only in BC

I understand that there's a situation when the value of the foreign content fund decreases, you end up exceeding the 20% limit so you have to sell some foreign portion to keep it under 20%. This happened to me a couple of times when my foreign fund lost some money so the the agent (Royal Mutual) automatically sold some of my foreign fund to keep it under 20%. I don't quite understand how the numbers work.

Could someone show me a simple example with some numbers on how this works.

Thanks.

To: P.K.

Most of the literature is US oriented, but given the relatively high correlation between the TSE 300 and S&P 500, it should be more or less the same. The idea here is not the relative size of the domestic vs. global market cap but the diversifying benefits of holding securities with low correlations to your own market.

Hi Phil -

If the research is US you cannot extend a result that says 35% of your investments should be foriegn. You could however suggest that an efficient portfolio for a Canadian and an American investor be roughly the same in terms of asset mix. There is a major difference between these two points.

To illustrate, Canada is 3% of the worlds market cap, so 97% of the worlds investments are foreign. In the US, their market cap is at least 10 times Canada's. So an Americans 35% foreign investment target excludes the US, while a Canadian's target includes the US. Therefore, a Canadian's foriegn content target HAS to be higher then an American's.

Bylo...yup

RB an IA...thanks for the clarification...If I read correctly it's WOF...right?

gb

Greg B Page 21 - 22.

Hi P.K.

I would argue that the size the of the Canadian and US markets relative to the global market cap isn’t a consideration.

Let’s say I’m a Canadian investor with a portfolio of CA$ 1,000 and you’re a US investor with US$10,000.Our portfolios represent proportionate shares of our domestic markets.

Let’s define optimal foreign content as the percentage of foreign assets that each of us must hold to achieve the most efficient portfolio, i.e. highest return for lowest risk. You will search for investments in non-US markets, while I’ll be looking in non-Canadian markets. We are both looking for international investments with the lowest correlations to our own domestic portfolios. Since US and Canadian markets are fairly highly correlated, this means that we both will mostly be looking outside North America.

Your analysis of the correlations indicate that to maximize the efficiency of your portfolio, you need to sell about US$ 3,500 of your portfolio and buy the USD equivalent in non-US securities. Similarly, my results show the need to sell CA$ 350 of mine and buy the same equivalent in non- Canadian securities. In so doing we have both reduced our overall risk by substituting the same proportions of foreign securities in our portfolios. Even though the aggregate amount that you purchased is much larger than that which I did, the proportions to our portfolios was equal.

Hi Again Phil -

I don't know if anyone else is enjoying this discussion, but I am. I understand your points, but I think they fall short. I'll try to illustrate this as cogently as I can.

You state that because US & Canadian markets are highly correlated we will both be mostly looking outside of North America. If the correlation were 1 (I know your not saying that, but bear with me for a moment) then I would agree with you. In this case neither of us would have to hold both Canadian or US secutities -- one or the other would do fine. But the correlation is not 1. I'm looking down as I write at stats that show the correlation "r" between the TSE and the SP500 during March94 to Sept95 was .568. I think this this is lower than historically "normal", so lets say "r" is really .7. This coefficient suggests that about half the variability in TSE returns can be accounted for by SP500 returns (ie. .7 x .7 = 49%). With this "r" you would have to agree that an optimized portfolio would have to contain some US, some Canadian and some other securities.

Now the research you cited stated that for an American, the optimium portfolio had 35% foriegn content (thus implying 65% US content). A Canadian's optimal portfolio would also have to have 65% US content. This result has to be true because foreign content weightings are a consequence of other inputs in the optimization equation -- they are not a cause. The needed inputs are the expected returns of the securities (in this case US, Canadian and other) the variances of these returns, and the 3 pairs of covariances. These are the inputs that would have been used to arrive at the 65% US content figure. So, from a US citizens perspective, 65% US content implies a minority of foreign content, while from a Canadians point of view it implies a majority of foreign content is needed to optimize the risk/return characteristics of the portfolio.

BTW, your points made me reconsider my knee-jerk response that Canadians require alot of foreign content merely because we make up only 3% of the world's market cap -- this is not true at all. The reason we need a majority of our investments foreign is because of the optimization model you illustrated.

One other thing, the above discussion does not factor in the tax benefits of Canadian investing in Canadian (for example, the dividend tax factor). This government imposed reality also makes a difference.

PK - Thanks for the thoughtful reply. Lots of food for thought there.

There was talk in the financial post the other day that the budget might consider raising the foreign content in RRSP's. Has anyone heard anything about this? I think it is about time