Dan Hallett

From Our Canadian Bureau: Barclays Helps Retirees With New ETF

New Barclays RSP-Eligible EAFE ETF Barclays Global Investors Canada Limited has finally announced the launch of the much anticipated fully RSP-eligible EAFE ETF it has been promising for several months. This offering, originally planned for a February 2001 launch, now rounds out Barclays' Canadian ETFs family (called iUnits). Canadian index enthusiasts can build truly global portfolios without using up the precious foreign content room in registered plans.

RRSP Eligibility

Recall that Canadian registered tax deferred savings plans, such as RRSPs (registered retirement savings plans), RRIFs, (registered retirement income funds), and other variations thereof can have no more than 30% of their book value in foreign content holdings. The use of index futures makes this possible since the combination of futures contracts and cash provides full index exposure while keeping most of the fund's assets in cash to qualify as 100% Canadian content.

The leveraged nature of futures contracts is what allows such funds to gain full exposure to EAFE markets yet remain fully RSP-eligible, as defined by Canadian tax laws. The futures contracts count as foreign content, but since only about 10% of the fund's total assets need to be invested in futures, these funds each qualify as 100% Canadian content. This innovation was first developed for Canadian investment funds nearly ten years ago.

ETF Details and Fund Industry Competition

The basic details of this new ETF are highlighted below.

There exist less than a dozen investment funds based on index futures tracking the MSCI EAFE index and only a couple with fees low enough to give this new Barclays offering a run for its money. The table below illustrates the six cheapest EAFE index funds using index futures currently available to Canadians.

*Minimum of $150k in CIBC index funds is required to qualify for reduced MER. **The assets of the A and e series are aggregated and total $ million. The e-series of funds are only available over the Internet (i.e. paperless transactions).

As with the RSP-eligible S&P 500 index offerings, the MSCI EAFE index products don't all track the same index - at least not in the same currency. Some have full exposure to the U.S. dollar while others don't. Barclays' new iIntR fund is an unhedged index fund, thereby providing investors with full currency exposure to go along with EAFE stock exposure. CIBC is the only one of the RSP-eligible EAFE funds profiled in the above table that actually provides investors with full currency exposure to the EAFE countries.

It can't be stressed enough that all funds using futures contracts to skirt Canadian foreign content rules are suited only for tax-deferred accounts, like RRSPs and RRIFs, because of the high amount of taxable income thrown off by such funds.

Indexing the EAFE regions has been anything but a no-brainer for Canadian investors, given the very limited choices over the years (EAFE index funds first appeared in Canada in 1997). The MSCI EAFE index in Canadian dollars has returned 5.58% and 9.01% per year over the past five and ten years, respectively, ending July 31, 2001. Three out of seven active funds beat the five-year number, while eighteen of the thirty-five active international equity funds with ten-year track records beat the index - numbers which make it impossible to prove the statistical case for either passive or active managers. (Making adjustments for fees and other factors affecting tracking error, the numbers move more in favour of active EAFE managers.)

Update on Taxation of Foreign Investment Entities (FIEs)

In my debut column for IndexFunds.com just over a year ago, I wrote about a controversial tax proposal with potentially catastrophic consequences. In short, this legislation would have forced Canadians to mark-to-market each year holdings in foreign investment funds, including U.S.-based ETFs. A grassroots campaign forced lawmakers to take the proposals back to the drawing board. Last fall, changes were made to exempt funds, defined by the IRS Tax Code, as U.S. Registered Investment Companies from this mark-to-market regime. About a month ago, the Department of Finance took another crack at it when they released newly drafted proposals on the taxation of FIEs. The proposals are open for comment until the end of next month. The Investment Funds Institute of Canada's (http://www.ific.ca) tax steering committee is assigning a special team to review, analyze, and interpret the 244-page document released last month. This will also be one of the hot topics discussed at IFIC's annual national conference next week in Toronto. I'll keep you posted.

Dan Hallett, B.Comm., CFP is Senior Investment Analyst with Sterling Mutuals Inc. Sterling Mutuals Inc. is registered as a Canadian mutual fund dealer in Ontario, British Columbia and Manitoba.