Should you still maximize your RRSP foreign content limit?
Back in the 1990’s it was said that global investing was absolutely necessary for investment success. Canada only represented about 3% of the world’s investment opportunities. Most of the biggest, most profitable companies were outside the Canadian borders and that diversifying investment outside of Canada would not only enhance returns but also reduce portfolio risk.
The trends were distinct. In the late 1990’s there was a huge proliferation of RRSP eligible global funds that allowed investors to get more than 20% of their RRSPs into global investments. In 2000 the government increased the RRSP foreign content limit from 20% to 25% and it was further increased in 2001to 30% where it stands today.
A different story today
While all the reasons for global investing remain solid and true, the environment has not been so beneficial for global investments mostly due to currency changes. With a stronger Canadian dollar and a weaker US dollar, investors have seen bigger payoffs by staying in Canada.
For many years, currency has helped Canadian investors. In the last 11 years, The Canadian dollar was falling compared to the US dollar and many other currencies around the world. In fact, in only four of those 11 years, did the Canadian dollar strengthen to the US dollar. Why is this important to investing? Simple. If the global currencies like the US dollar strengthen, Canadians benefit by getting a premium on their return. For example, in 1998, the S&P500 returned 28.6%. However, Canadian investors got a return of 37.8%, once you convert from US to Canadian dollars. That 9.2% premium was because the US dollar appreciated against the Canadian dollar by 9.2%.
For the last two years, a falling US dollar (or a rising Cdn dollar) worked against Canadian investors. In 2004, Canadians investing in US dollar based investments lost about 7%. For example, the S&P500 had a 10.9% return last year. However, Canadian investors only got a 3.3% return after converting to Canadian dollars. 2003 was even worse for Canadian investors because the US dollar dropped about 20% to the Canadian dollar.
Concern over the US debt levels
Today, many experts are very concerned about the government and consumer debt levels in the US. The problem with debt is that it can really put pressure on currency. That being said, projected debt levels look like they are set to get bigger and not smaller and that will put more pressure on the US dollar. In fact, Bill Sterling , Chief Investment Officer for Trilogy Advisors writes “Our best estimate is that the dollar (US) will fall another 10% over the coming year but will eventually stabilize thanks to higher interest rates.”
As a result, Canadians investing in US investments may face the risk of lower returns simply due to currency. While there may be US companies that are bigger, better and more profitable, a 10% drop in the US dollar for example will knock 10% off returns for Canadians.
Add the fact that the Canadian stock markets has done pretty well our economy and fiscal situation seems to be good, lends itself to less global investing and more domestic investing. So that brings us full circle. Should we continue to invest globally to maximize returns and minimize risk?
Global vs domestic
Over the long term, data shows that global investing still wins. There is no doubt that in the short term, anything can happen. Despite the arguments, global investing does have one added risk that Canadian investments don’t and that is currency risk. Currency risk can help us but also at times, like the past few years, hurt us. Contrarians today will tell you that do what others are not doing – buy global. Some experts suggest that it is tougher to find bargains in Canada today and easier to find them in the global markets. In the short term, there are very logical arguments to underweight the US and overweight Canada but the bottom line is you should diversify and that means having some global exposure is better than not.