Are labour funds right for you?

Every year at this time, I sit down and review my various investment portfolios.

• I look at the asset allocation and decide if it’s where I want it to be positioned.
• I examine each security to see how it’s performing, and whether it should stay or go.
• And I look at each class of asset that I own, to determine what’s going on there.

This year, one particular asset class jumped out at me – the labour-sponsored venture capital funds. These are the funds that invest in start-up companies and research projects. They offer special tax credits to investors to offset the higher risk of such ventures and the long eight-year holding period that’s required.

I began investing in these in my RRSP many years ago, mainly because of the tax credits. Everyone gets a 15 per cent federal credit, and most of the provinces offer their own credit as well, although the amount and the terms vary across the country. For most Canadians, the total credit works out to 30 per cent on a maximum annual investment of $5,000. That $1,500 comes directly off the bottom line of your tax bill.

When I started buying units in these funds, I wasn’t expecting much the way of returns. But with the tax advantages, you didn’t need big gains.

No loser funds
However, when I looked through all my investments earlier this month, this was the only asset class apart from money market funds that didn’t show a single loser. Not one!

Of the eight different labour funds in my portfolio, the worst performer had gained just under 20 per cent since I bought it. The best was ahead by 59 per cent. The average gain for the eight was just a shade under 40 per cent.

I should stress, that’s not per year. That’s the total gain since they were purchased, so in some cases it’s spread out over several years. But nonetheless, that’s a pretty impressive record for a bunch of funds I bought mainly for the tax saving.

Perhaps that explains why I have become such a believer in these funds over the years. They’ve delivered everything I expected of them, and more. 

Extra risk?
But aren’t they more risky, you may be thinking. Especially now, with the stock markets being battered.
Actually, no. Most of the fund managers have been very careful to put together an investment portfolio that spreads the risk, and they’ve come up with some very big winners that have more than offset any ventures that went belly-up.

As for the stock market, many of the companies represented in these funds are not publicly traded, so they don’t respond the ups and downs of the TSE or the Dow.

Some considerations
On the negative side, you have to hold your units for eight years. If you cash in early, you have to repay your tax credits plus a deferred sales charge. That’s bad, because you’re locked in. But it’s good in another way, because it means you must have patience and you won’t be tempted to sell if things aren’t going well.

The bottom line is that I believe most people should take a close look at investing in one or more of these funds this RRSP season. I say most people, because there are some exceptions:

• If you’re about to retire, these funds aren’t a good idea because of the eight-year hold. Since they don’t generate any income, that’s a long time to tie up your money.
• Also, you shouldn’t invest here if you’ll have little or no taxable income. The tax credits are only deductible from your tax payable. If you can’t make full use of the credit, it’s lost.
• Finally, your decision may be based on where you live. If only the federal credit is available, you may decide that 15 per cent is not enough to compensate for the eight-year hold. But if you can get a provincial credit as well, that may change the whole equation.

Adapted from a recent CBC radio commentary.