Check labour funds before you buy

It’s natural for investors to jump at a chance to save on taxes and maybe even generate a tax refund. You can be sure that fund marketers recognise the attractiveness of such possibilities. The push on tax-directed securities, such as labour funds, generally peaks around RRSP season.

Labour-sponsored venture capital corporations (LSVCC), the technical name for labour funds, are extremely enticing if you’re concerned about cutting taxes. In Ontario in 2000, for example, several labour funds offer federal and provincial tax credits that add up to 30 per cent. The maximum tax saving you’re allowed is $1,500 on a $5,000 investment.

But no matter how attractive the tax breaks, leaping into a labour-fund investment for the sole purpose of saving on tax could mean taking on more risk and accepting a lower level of returns — at least in the shorter term — than you hoped for.

Job creation is goal
Although they routinely appear together in performance surveys, labour funds are a different breed from mutual funds. At least in theory, labour funds are designed to promote economic growth, primarily by funding job creation either witn a certain industry or specific geographic region of Canada.

As such, some funds and tax credits are available in specific provinces only. A few are registered for sale across Canada but Ontario residents have the greatest number of choices — though British Columbia, Manitoba, New Brunswick, Quebec and Saskatchewan all have funds specific to those provinces.

Typically, labour funds invest in young — usually unlisted — companies with the aim of capitalizing on their impending growth. But philanthropic objectives aside, you should tread carefully as there are some unique considerations for labour-fund investors. Here are some points to consider before you invest:

Check out the fund’s objectives
It’s important that the fund’s objectives will help you reach your own investment goals and suit your philosophy about investing. Some labour funds focus on a single sector — such as healthcare or communications — while others invest in a cross-section of industries. Still others restrict their investments to a specific region or province. Generally, the more diversified a fund, the less risky it is.

Look at the track record of the fund.
As a group, labour funds have a relatively short history in Canada. The oldest national fund is Working Ventures Canadian Fund Inc., which has been around since 1990.

And you’ll have to be patient with your labour-fund investment. Bear in mind that, by nature, labour funds focus on emerging companies or industries and are likely to take more time to realize gains than conventional mutual funds, which tend to invest in more established companies. In fact, the ideal investments for labour funds are young, often private, enterprises that will eventually hit the big time by becoming exchange-listed companies.

Another consideration for past and future performance is the size of a fund since a fund that’s especially popular with investors may have a hard time finding suitable investments. And this will affect its returns.

Strangely enough, success with investors can be a problem for labour funds since funds that fail to invest the required portion of accumulated assets within a specific time are penalized by regulators. For investors, the result of their labour fund would be low returns that reflect the fact they’re holding cash.

Assess the impact of tax credits on your taxes

How much you benefit from tax credits depends partly on your level of income. In general, people with higher taxable income have more to gain from investing in a labour fund than moderate earners.

You should be aware that there’s a mandatory holding period for labour-fund investments if you’re to qualify for the tax breaks: If you redeem your investment before the eight-year holding period has expired, you’ll have to pay back both the federal and provincial tax credits.

Check out the fund’s management team

The work involved in checking out start-up companies is generally more intensive than what’s involved in looking at larger listed companies making regular filings to the authorities. It helps if portfolio managers are knowledgeable about the field(s) on which the fund focuses.

Review the management costs

The extra effort involved in finding investment-worthy emerging enterprises is reflected in higher costs. Some labour funds have management costs that are substantially higher than the cost of regular mutual funds.

If you’re thinking about investing in a labour fund, remember that a bad investment won’t get better because of the tax breaks. Above all, be sure to look at the intrinsic qualities of the investment, just as you would scrutinize a potential investment without the bells and whistles of tax credits.