Ontario freezes labour funds

The recent Ontario budget has been a flashpoint for voter outrage and could conceivably be the tipping point for the federal Liberals in the June 28 election. But there was one initiative that has been largely overlooked in all the furore that is positive for investors.

Buried on page 140 of the Budget Papers is the news that the Ontario government has declared a moratorium on the creation of any new labour-sponsored investment funds (LSIFs) and is planning to overhaul the whole system. This is especially significant because the overwhelming majority of LSIFs sold in Canada are registered in Ontario.

The budget zeros in on several key issues that have plagued LSIFs in recent years. Most important is the proliferation of new funds, some of which are simply too small to operate effectively.

“In the last several sales seasons, a number of newly registered LSIFs have failed to raise sufficient capital to be viable investment companies for the long term. LSIF capital is spread too thinly among too many LSIFs and many of the existing LSIFs are too small to be viable long-term investors,” the document states.

Right on! In fact, the LSIF landscape is cttered with tiny funds that will be incapable of generating any meaningful venture capital investment and will burden shareholders with extremely high management fees.

A review of the list of LSIFs on Globefund shows the extent of the problem. Of the 68 stand-alone funds on the list, only 10 show assets in excess of $100 million. A total of 16, including several launched for the 2004 RRSP season, have less than $20 million in assets and in a few cases, such as the three Terra Firma funds, the asset base is less than $1 million which is simply not viable. Another 21 funds do not show their assets under management, which suggests they too are very small.

The Ontario government did not put a time limit on the moratorium, saying only that it would remain in place “while the Province works with the federal government and venture capital community to determine appropriate changes to the LSIF program”. While those consultations are taking place, Ontario plans to move ahead with amendments to its own laws governing LSIFs that are designed to achieve these goals:

· Make it easier for funds to merge. Under current rules, the investment requirements created when funds merge are onerous. “This has created a disincentive to amalgamate LSIFs, and resulted in smaller and less successful LSIFs being unable to grow or leave the program through amalgamations,” the paper states. To fix this, the government plans to allow the merger of LSIFs through asset purchases.

· Allow more investment in public companies. Ontario wants to encourage more LSIF money to flow into smaller public companies so the Community Small Business Investment Funds Act will be amended to allow 25 per cent of the money invested each year to be used in this way.

· Ease the burden on older funds. The existing law never contemplated the capping of LSIFs (e.g. VenGrowth I) and imposes investment requirements on them even though they have no new capital available. Some technical amendments are planned to correct that.

There is no question that the whole sector needs a complete review. The budget states that it is essential that both the province and shareholders “are receiving value for their investments”. Whether Ontario feels that the $220 million invested by LSIFs last year is good value in relation to the tax concessions offered remains to be seen. But shareholders should certainly question whether they are getting value for money.

Over the past three years, the average LSIF has lost 8.6 per cent annually in value. So $1,000 invested in 2001 is worth only $764 now. That means a 30 per cent tax credit granted at the time of purchase has been almost eaten up by investment losses.

In fact, of the 31 LSIFs with three-year records, only three show gains over that period, the best of which is a mere 0.6 per cent. The worst performer had an annual loss in excess of 30 per cent.

The McGuinty government has come under heavy fire for its budget of broken promises. But this is one move that we should applaud. Labour-sponsored funds are overdue for a rethink, and it appears we are finally getting one.

Adapted from an article that originally appeared in the Internet Wealth Builder.