Labour-Sponsored Venture Capital Corporations – Beware the Siren Call
“Don’t even think about it.” That’s what I would like to say to anybody who is drawn to these funds due to their prodigious tax-saving opportunities.
When I was working at a discount brokerage, there seemed to be regular inquiries about these products from people who had invested in them only to find that they were locked up in money-losing propositions for eight years and that when the eight years were up, the fund organizers didn’t have the resources available to allow for their redemption. Although not always the case in every province, it seems like these investment products have been high-probability losers for most investors.
What are Labour-Sponsored Venture Capital Corporations (LSVCCs)?
These products, which also go by the names Labour-Sponsored Funds or Labour-Sponsored Investment Funds, are investment funds, usually using a mutual fund structure. Typically they invest in smaller, unlisted companies of the type that are not available to be invested in through regular mutual funds. As their name indicates, they usually have sponsorship, and consequently board membership, from labour unions.
What is the Investment Appeal of an LSVCC?
The Appeal for Governments and Labour: Investment Capital
Governments, in general, wish to encourage investment in their areas of jurisdiction to foster entrepreneurship so that their economies will grow. Labour also wants to see industry grow so that employment opportunities will increase.
The Appeal for Investors: Tax Credits
Investors like the opportunities presented by these funds for the available tax credits. Since these funds are typically eligible for purchase inside an RRSP, the tax credits from both the provincial and federal governments as well as the tax deduction for the RRSP contribution can make for a fairly hefty reduction in taxes.
Below is an example of such an arrangement. Imagine you are in a 31% combined federal and provincial marginal tax bracket. That would be your rate if you are earning about $95,000 in taxable income in British Columbia. You take $5,000, contribute it to your RRSP and use the money to purchase a fund that qualifies for both the provincial and federal tax credits based on the rules for LSVCCs. First, by putting $5,000 into the RRSP, you get a tax deduction of $1,550 ($5,000 x 31%). Next, you get a 15% provincial tax credit or a $750 ($5,000 x 15%) reduction in your taxes, which is matched with a federal tax credit of another 15% or $750. That works out to a $3,050 reduction in taxes. Not bad.
Of course, these are investments and the goal of investments, especially in smaller companies, is a hoped-for return that is significantly greater than one might expect in a less risky investment.
The Disadvantages of LSVCCs for Investors
The first one to be aware of is that, in exchange for the tax credits, you must remain invested in the fund for eight years. In that sense they are illiquid.
Second, your investment is limited to $5,000 in any given year. If you have a greater appetite for tax-advantaged investment risk, you will have to go elsewhere.
Third, you could lose all your money. These funds are high-risk investments, and the probability of failure needs to be recognized. The tax credit and, if you invest inside an RRSP, the tax deduction, help to mitigate that risk, but it is seldom sensible to accept a total loss in exchange for a tax advantage. With that risk in mind, there is something to be said for forgoing the deduction from purchasing inside an RRSP so that you can use the potential capital loss to offset capital gains in a non-registered account.
Fourth, these tend to be expensive investments. The Management Expense Ratios (MERs) of some of the LSVCCs, tend to range from high to egregiously high. Of the few funds I could find any information on, the lowest cost fund had an MER of 1.95%. The average is an incredible 5.14%.
The governments seem to not be overly concerned about investment returns. Their main goal appears to be to encourage investment. The tax incentives certainly do offer encouragement and also help to mitigate the potential losses. I would say, however, that these are not consumer-friendly products.
What has been the History of LSVCCs?
The table below compares the returns of Retail Venture Capital, the mutual fund industry’s term under which LSVCCs best fit, against Canadian Small Mid/Cap Equity, the category of listed Canadian stocks that most closely fits that of LSVCCs, and Canadian Equity, the broadest category for equities within Canada. The results are not very pretty.
As much as one might think that encouraging investment in Canada, or more specifically, the province in which you live, is a good thing, this particular category of investment is one to be wary of.
This is the 145th blog post for Russ Writes, first published on 2022-04-25.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.