Labour-Sponsored Rip-off

The union labour movement likes to think of and to portray itself as fighting for the common man, for fair dealing, for social justice, for honesty in business and so on. At times it does, witness its support of an expanded Canada Pension Plan.

Why on earth then would it continue to allow its name to be besmirched with one of the unmitigated disasters of investing for the common retail investor, the horribly exploitative abomination known as the Labour-Sponsored Investment Fund (LSIF), also called the Labour-Sponsored Venture Capital Corporation?

The history of LSIFs according to Wikipedia had a naively noble origin - fledgling companies need capital to thrive and grow, so the labour movement pushed the government to give generous tax breaks to average joe retail investors putting money into funds that would invest in these companies. It would stimulate the economy and create jobs. Professional managers in the funds would research and figure out which were the best small companies to choose. So the theory went.

The reality is that putting money into any old small company doesn't work. Many, indeed, most companies don't survive and grow, they unfortunately wither and die. And when the incentive structure is such that the fund managers make a lot more money a lot more easily from collecting high fees than on choosing future star companies, which is hard to do at the best of times, while the managers have none of their own money at stake, putting money into any old company with a cool story is the easy way out. The recipe was set for LSIFs to fund weak companies and provide little or no lasting job creation in the real economy while uniformly losing money for investors and allowing financial managers to systematically strip money through exorbitant fees (like 5, 6, 7, 8% annually).

The proof is in the pudding, and it has been for a long time. Go to Morningstar Canada and pull up a table of current LSIFs. There are seven with a positive 10-year return out of 82 funds, not bad you might say since they outnumber the six with a 10-year loss. It's not so good, however, when we remember that many long term losers disappear through being bought and merged into other funds. Two examples are the Capital Alliance Ventures Inc and Canadian Medical Discoveries Fund, both of which started back in the 1990s and have ended up folded into the GrowthWorks Canadian fund (I traced the history of these funds in this post last year). Here's a telling chart from Morningstar that shows the downward slump of CMDF and of the overall Retail Venture Capital Index compared to the BMO Small Cap index.

The CMDF is now in dire straits. Thanks to Ken Kivenko sending on the news published here and here in the Financial Post, we learn that CMDF is essentially insolvent. Fundholders are caught between the proverbial rock of not being allowed to withdraw funds and the hard place of being asked to approve CMDF taking on a loan merely to pay the managers' fees. It's inevitable that fund investors will lose big time, sooner or later. Yet the show is allowed by government (by the feds and some provinces continuing to offer a tax credit) and regulators to go on.

Why for example, has the Canadian Federation of Labour, the labour sponsor of the GrowthWorks Canadian Fund, not intervened through its majority (it nominates 8 of 12 directors) control of the Fund's Board, to say enough is enough, it's time to liquidate and wind up the fund before all the investors' money is sucked out of it? I'd like to see how differently labour Directors like Joseph Maloney and Edward Power, both of the International Brotherhood of Boilermakers, Iron Ship Builders, Blacksmiths, Forgers and Helpers and both on the Board since 2006, would react if they had more than their share ownership of exactly zero. (None of the labour directors have a big stake in Fund shares.) Of course, if the fund were wound up, messers Maloney and Cole would not collect the $16,000 or so in director fees they got last year.


Though the Canadian Federation of Labour doesn't take a fee from the GrowthWorks fund, in some cases the union itself does collect an on-going trailer fee. For example, the Canadian Police Association and the Association of Canadian Financial Officers are co-sponsors of the Covington Fund II. They collect an annual fee of 0.16% of the fund's net asset value, which turns out to be a tidy $480,000 based on the Fund's $300 million NAV (as of February 2012, per the Semi-Annual Report filed on www.sedar.com). All that for lending their name. Of all labour groups, one would think that police and financial officers would recognize and not want to take part in a rip-off scheme.

Disclosure: I am not neutral on this topic since I owned shares of both CAVI and CMDF and lost most of my investment before I managed to sell out a few years ago.