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Controversial labour fund study misses the mark

by Wayne Cheveldayoff, 2003-07-07

A recent report on Canadian labour-sponsored venture capital funds by two university professors stirred up considerable controversy with its conclusion that despite the associated tax breaks, labour funds are not worth investing in because of high annual management fees. Such fees are normally in the 3 to 5 per cent range, rather than the 2 to 3 per cent range for regular equity mutual funds..

After examining the study, labour fund officials have pointed out numerous flaws in the study’s research methodology, which, among other shortcomings, relied on a hypothetical model rather than the actual returns produced by existing labour funds.

If the professors had instead studied the real world, they would have found that some labour funds have produced decent returns (after fees) for investors, while others have been laggards—no different than for regular equity mutual funds.

One problem in evaluating labour funds is that the return statistics published on websites and in newspapers do not factor in the healthy tax breaks involved.

For individuals in Ontario, for example, an investment in a labour fund generates a 15 per cent tax credit from the federal government and another 15 per cent tax credit from the Ontario government. On the maximum $5,000 investment permitted each year, this combined 30 per cent credit results in a tax saving of $1,500, for a net investment cost of $3,500. (The investment has to be held for eight years or the tax saving will have to be repaid to government.)

This $3,500 net cost should be the starting point for anyone wanting an accurate picture of the actual after-tax return on investment for Ontario investors. However, the published return calculations start at $5,000, which is what the fund managers received. In other words, the published return statistics measure what the fund manager was able to produce, not the actual after-tax return to the investor.

Investing venture capital in private companies is supposed to be riskier than investing in public companies traded on stock exchanges. But some managers, through skill or luck, have been able to produce very good long-term returns.

For example, the Working Opportunity Fund, available only to B.C. residents and the best-performing of the labour funds that have been around at least a decade, has achieved an 11.6 per cent annual return on investment over the past 10 years after factoring in the tax break, compared with only 7.8 per cent for the TSX composite index. (The published return for the fund, which excludes the impact of the tax credit, was 5 per cent per annum.)

By comparison, the 10-year average annual return for Canadian large cap equity funds was 6.2 per cent, for Canadian dividend funds 9 per cent, and for Canadian small cap equity funds 4.5 per cent.

Such comparisons of actual performance were missing from the above-mentioned research paper, entitled Incentive Fees, Valuation and Performance of Labour Sponsored Investment Funds and published in the Canadian Investment Review Magazine. Instead, the authors, Scott Anderson of Ryerson University and Yisong Tian of York University, constructed a theoretical model using a typical fee structure and simulated variable investment returns based on the performance of seven publicly traded shares held by one unidentified labour sponsored fund. The study focused on publicly traded shares even though most holdings in labour funds are private companies that haven’t yet gone public.

Using this hypothetical approach, the professors concluded that labour funds “have substantially underperformed alternative investments available to Canadians” and the main culprits are the fees, including performance fees, paid to the managers.

The actual returns or fee structures of individual funds were not addressed, which makes the study of little use to individual investors contemplating an investment in labour funds.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at

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©2003 Wayne Cheveldayoff