By Dale Jackson
The Globe and Mail
Report on Business
Thursday, June 8, 2006

If you've owned a labour fund for less than eight years, you're likely damned if you keep it and damned if you sell. Each day brings unitholders closer to 2009 when the government of Ontario begins phasing out its once generous 15-per-cent tax rebate. Most provinces are continuing the offer for now, in addition to another 15-per-cent rebate from Ottawa, but the writing is on the wall: Labour-sponsored funds are on net redemption street heading toward illiquid city, and all many unitholders can do is stand by and lose money.

Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, “Never buy anything based solely on tax credits.”

The average labour-sponsored fund has not returned a penny for over a decade. More recently, the average labour fund has devalued to the tune of 6.6 per cent annually for the past five years. To make matters worse, unitholders lured by the tax rebate must hold the fund for a minimum eight years and endure exorbitant management fees.

Labour-sponsored funds were introduced in the 1980s to help fledgling Canadian businesses raise much needed venture capital. When equity markets tanked in 2000, the high-risk venture market was hit especially hard, and the sector has yet to fully recover. Rick Nathan, president of the Canadian Venture Capital Association, says the declining values of labour funds have more to do with perception than reality. "The Ontario government's decision was a relevant factor, but not the only factor," he says.

Mr. Nathan says the federal government and remaining provinces are still committed to supporting the venture capital industry one way or another. "We may see consolidation, we may see restructuring... The Canadian retail market can support these venture funds."

Some labour funds are fairly successful over the long term. The best performer over the past 10 years, Dynamic Venture Opportunity Series I, has grown an average 6.3 per cent annually. That still pales compared with the benchmark BMO Nesbitt Burns Canadian Small Cap Index, which is up 11.3 per cent annually over the same period.

Factors that have hobbled labour fund performance are large cash holdings and huge management fees. The average management expense ratio (MER) on a labour-sponsored fund is 4.6 per cent, compared with 2.6 per cent for the average Canadian equity fund. In addition, most of the funds have hefty front-end loads, back-end loads, or both to help pay generous trailer fees to advisers drumming up retail clients. "The government-imposed regulations have created a lot of rules for these funds to operate under and that is reflected in higher fees" Mr. Nathan says.

The most expensive labour fund is the VentureLink Financial Services Innovation IV with an MER of 11.31 per cent -- plus a back-end load. VentureLink managing partner John Varghese attributes the high fee to a mix of performance, administrative costs and government regulations. "There's a lot more individual unitholders, a lot more reporting and more private companies," he says.

Mr. Varghese is holding out hope Ontario will reverse its decision, and feels labour funds are an effective part of an investment tax strategy regardless. Even without the tax rebates, he expects his fund to grow about 5 per cent annually. "We've created some large but yet unquantifiable benefits."

The VentureLink Financial Services Innovation IV fund has outperformed its peers since its inception in January, 2004, returning more than 9 per cent last year alone. It still lags the 43.3-per-cent gain for the small-cap benchmark. Other funds such as BEST Discoveries II have less to brag about. It has an MER of 7.26 per cent and it lost 17.8 per cent last year.

"I can't think of a good reason to buy those things,” says Adrian Mastracci, president and chief investment officer at KCM Wealth Management in Vancouver. He says most of the few clients of his with labour funds have seen the value of their investments drop well below the gains made through the tax rebates before the eight-year holding period. "It's really not an option to get out and return the tax credit. All you can do is hold on and hope it doesn't fall too low," he says.

Mr. Mastracci believes investors stung by labour-sponsored funds can at least reap one valuable lesson: "Never buy anything based solely on tax credits," he says.

Index laggards

The average labour-sponsored investment fund has not returned a penny for more than a decade. Even two of the top performers lag benchmark indexes.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.