The recent decision by Vancouver-based GrowthWorks Capital Ltd. to suspend sales and distributions of its GrowthWorks Canadian Fund may signal more than just the cash crunch for a single investment vehicle — it also symbolizes the significant headwinds facing the once-booming labour-sponsored investment fund sector.
GrowthWorks says its decision to halt sales and distributions of the fund is based on its inability to exit many of its investments in two dried-up U.S. markets — mergers and acquisitions and initial public offerings. The firm has proposed a “redemption management plan” to securities commissions in Ontario, Manitoba and Saskatchewan under which investors in those provinces could redeem their funds either semi-annually or annually and up to some capped amount.
The proposed plan would ensure GrowthWorks has sufficient cash flow to fund redemptions, says Tim Lee, chief investment officer, venture capital, at GrowthWorks. “Our intent is to return all exit capital to shareholders as efficiently and quickly as possible. We need the structure to make sure we don’t redeem more than we exit.”
In all likelihood, once the investments have been sold off and the shareholders paid back, GrowthWorks Canadian Fund will cease to exist. Most VC funds, Lee says, fulfil their mandates in 10 to 15 years.
In 2002, GrowthWorks Canadian Fund took over a fund called Working Ventures, which was 10 years old at the time. GrowthWorks Canadian Fund currently has a net asset value of about $200 million, down from $350 million two years ago.
“This is consistent with the VC model,” Lee says. “[GrowthWorks Canadian Fund] is at the end of its lifespan, and we’re focused on returning capital to shareholders.”
But Dan Hallett, vice president and director of asset management with Oakville, Ont.-based HighView Financial Group, notes that the LSIF sector overall is looking at big challenges.
The LSIF program had been designed to encourage investment in small and medium-sized businesses; Ottawa and most provinces had provided tax credits to reduce the investor’s risk. If investors redeemed their investments within eight years, the tax benefits would be clawed back.
Hallett believes LSIFs, barring any major changes in either policy or performance, could soon fade to black, in part because of policy changes in several provinces.
“It’s clear that all the labour funds, particularly those in Ontario,” Hallett says, “have liquidity issues because there really isn’t any meaningful money coming in.”
That’s a far cry from the late 1990s and early 2000s, when it wasn’t uncommon for single LSIFs to raise upward of $100 million during the final two months of the RRSP season.
There are several contributing factors to LSIFs’ predicament, Hallett says. First, the scandal surrounding the 2004 cease-trade order on Winnipeg-based Crocus Investment Fund and its subsequent shutdown amid overinflated values of its holdings and a scathing report from Manitoba’s auditor general had poisoned the well for investors across the country.
Second, the 2005 decision by the Ontario government to phase out its tax credit for LSIFs (originally 15%) — leaving only the 15% federal tax credit — had eliminated half of the primary reason why many investors bought LSIFs in the first place.
Third, the performance of LSIFs has been poor virtually across the board for many years. For example, for the 10 years ended Jan. 31, the LSIF sector posted an annualized loss of 1.7% vs a 10% annualized return over the same period for the S&P/TSX small-cap index.
Hallett says it then became abundantly clear that unless LSIFs produced “incredible” performance, the funding was simply going to dry up and funds would be forced to merge. “Now,” he says, “we’ve been seeing liquidity challenges for a number of years. Unless something changes, we could be writing the obituary [for the sector]. Some might say it’s already a dead sector, in that there isn’t a lot of sales.”
Much of the appeal of LSIFs had to do with their tax-friendliness, Hallett says, but many financial advisors have long since found a superior alternative in flow-through shares.
Bill Watchorn, former president and CEO of Winnipeg-based Ensis Growth Fund, which merged into GrowthWorks Canadian Fund in 2007, says there’s no doubt the sector is taking a hit, but it’s worth noting that the federal government has maintained its LSIF-related tax credits. Ontario’s move, he admits, was a “big blow” to the VC sector in Canada.
“I don’t think [LSIFs] have been aggressively marketed in the past few years,” Watchorn says. “Part of the problem is brokers don’t really like handling [the] $5,000 [minimum LSIF] order. Some brokerages don’t take a commission on an order that size. It’s very inefficient. If you were selling [blocks of] $20,000, that would be different.”
The smaller minimum targets small investors, who should have no more than 5%-10% of their portfolios in LSIFs; the larger amount would appeal to wealthier people, Watchorn says, who would understand the inherent risk and for whom it would represent a smaller portion of their portfolio.
Meanwhile, GrowthWorks’ actions should not be viewed in the same light as the now-defunct Crocus, Lee says: “When you’re winding down or you’re in liquidation mode, you have a complete disregard for value optimization; you’re just working against the clock. For us, it’s not that kind of process.” IE