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Poor returns, tax jitters hurt sales of labour capital funds


Labour sponsored venture capital funds are losing traction.

Sales of these investments, which do not include redemptions, plunged 58 per cent to $164-million in the first quarter from $396-million last year, according to figures from Thomson Reuters.

Market jitters, disappointing long-term fund performance and uncertainty created by Ontario's plan to reduce and yank its tax credit by the 2012 tax year sent sales tumbling in the key RRSP-selling season.

"When you take away the tax credits, you are really going to limit the ability of the funds to raise money," said Dan Hallett, an independent fund analyst. "It just becomes tougher for them to operate. They are going to need to get bigger to survive."

That means that some of the small- to mid-sized funds are going to be taken over in the future, predicted Mr. Hallett, who no longer recommends them in Ontario because there is "too much uncertainty."

"Who knows who is going to buy who? If you are buying a fund today - unless it is one of the very biggest - you don't know who you are going to end up with over eight years."

Labour funds, also known as retail venture capital funds, have an eight-year holding period, and offer tax credits to investors to compensate for their higher-risk investments.

Ottawa provides a 15-per-cent tax credit, and participating provinces add at least another 15 per cent. But Ontario plans to chop its tax credit to 10 per cent by 2010, and 5 per cent by 2011.

Juicy tax credits have not been enough to stem the declining popularity of the funds, particularly outside of Quebec. Compared to 2005, this year's first quarter sales are off 73 per cent from $603-million. Last year, overall sales plummeted to $754.6-million from a peak of $1.86-billion in 2001.

While there are no industry redemption figures available, many investors do leave after eight years. The Canadian Medical Discoveries Fund saw its assets decline by nearly $20-million to $137.7-million since the end of December with about $7-million evaporating due to redemptions.

The industry's record sales year came just after the Internet bubble burst in 2000. The dazzling returns of some labour funds, fuelled by soaring technology and biotechnology stocks, began to deflate.

Like conventional mutual funds, the declining appeal of labour funds in the first quarter was undoubtedly affected by turbulent stock markets.

Still, the poor long-term track record of many labour funds has been so weak that "you can't expect strong sales," said Peter Loach, managing director of fund research at BMO Nesbitt Burns Inc.

Unlike private venture capital funds, which will close a fund after raising money, Mr. Loach said that retail labour funds typically allow money to keep flowing in. That ends up "diluting the performance for the people who have already been in them," he said.

"There have not been that many proven, perennial performers," and the performance of existing ones have a "survivorship bias," since there's no way to track the return of those funds that may have performed poorly after being merged with rivals, he said.

For instance, Vancouver-based GrowthWorks Capital Ltd. bought Working Ventures Canadian fund in 2002, and renamed it GrowthWorks Canadian. It has since swallowed First Ontario, Capital Alliance Ventures and Canadian Science & Technology Growth funds. Ensis Growth Fund will soon be merged into this fund.

The Canadian Retail Venture Capital Association, which represents labour funds, agrees there is a survivor bias in performance numbers. But it argues that the disappointing returns - some funds have been in the red for 10 years - should be viewed in the context of these investments being closer to technology funds.

Unlike the $7.4-billion Quebec Solidarity Fund, which will invest in the traditional manufacturing sector, most labour funds tend to be a "proxy for technology," said association president Les Lyall.

"Fundraising is down from the peak years, but that is what you should expect from an asset that goes through a [down] cycle," Mr. Lyall said. "If you look at performance of the asset class prior to 2000, you will see that performance was very good, and that attracted a lot of capital."

Because there is no small-capitalization technology index, his association maintains that most labour funds should be compared to a tech-oriented Nasdaq composite index in Canadian dollars even though the Nasdaq contains names of giant firms like Microsoft, Cisco and Dell.

Since the Nasdaq hit a record of 5,048.62 points in 2000, it has been at "roughly 50 per cent of its high, and it hasn't really changed," said Mr. Lyall, also chief operating officer of GrowthWorks Capital.

Labour funds should be considered as an "early-stage tech fund," he argued. "The sector has been down for eight years now. It hasn't come back yet, but it will come back. All asset classes do."

But Ontario's decision to wind down its tax credit "casts a dark cloud over the asset class," he said. "We haven't found a way to attract investors without the benefit of a tax credit. That's just the plain truth."

Labour-sponsored venture capital funds

Funds are listed in Globefund that have at least a five-year track record and assets of more than $25-million (as of April 30, 2008).

Fund nameNet assets ($million)Returns: 1-yrReturns: 3-yrsReturns: 5-yrsReturns: 10-yrs
.E.S.T. Discoveries I$49.40 6.90%7.6%3.6%1.0%
Canadian Medical Discoveries Ser I$137.70 - 24.0%- 14.4%- 10.8%- 7.8%
Covington Fund II$110.60 - 15.3%- 0.9%- 1.9%-
Dynamic Venture Opport Series I$49.30 - 24.3%1.30%1.6%6.2%
Dynamic Venture Opport Series II$66.10 - 24.4%1.1%1.4%6.1%
ENSIS Growth Fund Inc.$93.10 - 1.7%- 3.0%- 2.2%- 2.0%
Golden Opportunities Fund Inc.$133.10 5.30%3.8%3.9%-
GrowthWorks Canadian$201.90 - 1.5%2.8%3.6%- 3.4%
New Generation Biotech Equity-I$47.50 - 14.4%- 10.5%- 5.5%-
Return on Innovation I$97.10 - 2.0%2.1%1.7%-
Return on Innovation II$61.30 - 2.3%1.8%1.5%-
VenGrowth Adv Life Scie ClA SrA$230.80 - 4.6%- 3.1%- 0.8%-
VenGrowth II Investment Fund Inc.$326.90 - 19.5%- 9.1%- 7.9%-
VenGrowth Invst Fund Inc. Cl A SrE$57.30 - 25.3%- 8.6%- 8.0%- 3.3%
VentureLink Financial Serv Innov I$63.60 - 8.9%3.0%3.2%-
Working Opporty Balanced Ser 1$135.40 - 5.3%- 1.4%- 1.9%1.4%
Working Opport Growth Ser 1$74.80 - 4.0%3.9%3.5%-
NASDAQ Composite ($Cdn.)-- 12.8%0.3%3.0%- 0.9%
S&P/TSX Small Cap-- 13.7%4.1%9.6%-
BMO Nesbitt Burns Cdn. Small Cap Index-- 11.4%11.9%18.2%8.2%

Note: The Quebec Solidarity Fund, which has $7.4-billion in assets, only reports its one-year results at the end of its fiscal year ended May 31. Only 60 per cent of its assets are in venture capital investments. For fiscal 2007, it posted a return of 7.1 per cent over one year; 6 per cent over three years; 3.3 per cent over five years and 2.9 per cent over 10 years.


© 2007 The Globe and Mail. All rights reserved.

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