The members of the Legislative Assembly of Manitoba in Winnipeg were in for a surprise this Christmas: a two-page letter from the Crocus Investment Fund asking the Canadian provincial government for its “understanding and support” while the fund undergoes a controversial internal review.
Crocus, one of Canada's numerous labour-sponsored investment funds (LSIFs), halted sales and suspended redemptions in the early part of December in order to “complete important voluntary initiatives to advance stakeholders' interests”.
As part of the review, Crocus is examining the valuation of its holdings and whether some of its management suffered any lapse in investment judgment. Laurie Goldberg, its president and COO, resigned in January.
But more than just answering the questions of this particular fund's investors, the investigation is spotlighting the many problems plaguing Canada's LSIF programme.
LSIFs – whose origins go back to the 1983 formation of the Solidarity Fund in Quebec – were launched as alternatives sources of early-stage venture capital funding and ostensibly designed to stimulate local economic growth. Promoted by the now-defunct Canadian Federation of Labour, they gained their identity by being affiliated with the country's labour unions. Instead of drawing on institutional and high net-worth individual capital, LSIFs are retail funds marketed to individual consumers and offering up to 35 percent annual tax credits.
Crocus, which started operations in 1993, currently has C$34 million in cash and marketable securities; a net asset value of C$154.3 million; 33, 786 shareholders and investments in some 50 Manitoba companies.
In the past two decades, the government has shelled out tens of millions of dollars in tax credits, but critics of the programme say LSIFs have failed to produce any noticeable impact on Canadian job creation and business growth. In addition, the downturn in the tech markets half a decade ago fouled IT-heavy investment portfolios and left the venture capital landscape in Canada littered with too many small-end LSIFs whose overall performance outside of the top ten largest funds has been mediocre at best.
The case for doing away with LSIFs has many supporters, particularly among institutional venture capital funds who argue that tax breaks create low return expectations. Pacing rules which mandate 70 percent of an LSIF's funds raised in any given year be invested within two years' time also bring into question whether sub-par companies are being financed in order to get money out the door and avoid penalties.
LSIF critics also find fault with the compensation structure at these funds – GPs at labour funds are paid a percentage fee based on the net asset value of the fund's portfolio, just like at a mutual fund, and receive no carry as is standard in private equity. Investments in LSIFs are meant to be held longterm, but individual investors can cash out after a certain period of time. As a result, LSIFs must update their net asset value on a regular basis, and many industry observers believe the valuations of portfolio companies are artificially inflated in order to assure higher management fees.
In its letter to the provincial assembly, Crocus claimed to have “helped create or maintain more than 14,000 jobs in the province” alone. As part of the letter, the fund also included some LSIF statistics issued in a study conducted by the province of Ontario: in 2004, an estimated 437,840 Canadians held shares in LSIFs, and labour funds have had an “annual impact” of C$2.6 billion on the national GDP.
Crocus is trying to allay any fears that there will be a “run on the bank” when shares resume trading again – most investors are locked in for a required eight-year period. (At the time of writing this article, press time, shares were supposed to resume trading in January.) According to the letter, no new shares will become eligible for redemption until February 2006, so if there is any mass sell-off, the assembly will have to wait and see what will happen at that point.
However, many venture capitalists and politicians are wondering whether the LSIF needs a sunset clause. According to one observer, the main problem with LSIFs is an endemic lack of investment expertise: “[Their boards often] know diddly about investing, let alone private equity investing. Union members and political apparatchiks are being valued more highly than people with relevant experience and scar tissue.” Should this charge turn out to be justified, an overhaul of the programme would seem a sensible move.