Watch out for labour funds trap

The first half of this year is a period that many labour fund investors would rather forget.
Most of the funds in this category were clobbered, including some of the largest ones.

The six-month losses ran as high as 34 per cent. Only a few funds made a profit, and the biggest gain was less than 4 per cent.

What went wrong? High tech, that’s what.

Here’s a bit of background. Labour-sponsored funds invest mainly in start-up businesses. That makes them high-risk by nature, so they come with some tax breaks to encourage people to invest.

The federal government gives an annual credit of 15 per cent on investments up to $5,000. Many provinces also add credits of their own. Also, owning these funds in an RSP boosts your foreign content room.

Those incentives have served to attract hundreds of millions of dollars to these funds. And last year many investors got a big bonus when some of the junior tech companies in the portfolios were taken over at premium prices or went public.

Reversal of fortunes
But this year we’ve seen a reversal of fortune. As part of a merger or a public offering, many funds were required to hold thr shares for a period of time to avoid flooding the market. When tech stocks fell out of bed, they were caught with these inflated shares in their portfolios, and nowhere to hide. The results were devastating.

Not every fund was hit. Funds like Canadian Science and Technology, Capital Alliance Ventures, First Ontario, and Retrocom Growth came through relatively unscathed.

But others, like Working Ventures Canadian, VenGrowth I, Triax Growth and Centerfire Growth were badly hurt.

However, you have to look beyond the raw numbers here. Some of the funds that show the biggest losses have been adjusting the valuations of their private holdings to reflect the changing market conditions.

Ask questions
If you’re planning to invest in one of these funds in future, you need to be sure that’s the policy they’ve been using. A fund that maintains its private holdings at book value may be artificially inflating its share price, especially if there is a large high-tech component there. So you would end up paying too much for your units.

Don’t let that happen to you. Ask very pointed questions before you put any money into labour funds this year. Otherwise, you could find yourself with an unexpected loss.

There’s enough risk with these funds as it is, without adding more.

Adapted from a recent CBC radio broadcast.