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LSIF Commentary 2003/2004 | |
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LSIFs Continue to ChangeFor 2003/2004 there are now over 50 funds listed in Bellcharts/Morningstar, with over a dozen new funds being announced for this tax season. The deadline for an LISF investment to use against your 2003 taxes is March 1, 2004. Labour Sponsored Investment Funds (LSIFs) have evolved dramatically over the years since they were first reported on in the Managed Money Reporter in 1995. Their recent performance has had challenges, but as we reported last summer in our newsletter, Issue 196, after tax, they continue to be worth looking at for a portion of your portfolio. LSIFs now account for more than 40% of all venture capital raised in Canada. Venture capital has been a popular asset class in the US, and is now emerging as a viable asset class in Canada. More than a million Canadians now hold LSIFs in their portfolio, and through these investments several hundred technology companies have been born, and thousands of jobs created nationwide. Venture capital has played a significant role in many modern breakthroughs in today’s society among the medical and technology sectors. Two key examples of venture capital that has handsomely rewarded investors: Microsoft and Intel. We do have some concerns about a recent OSC policy change, which changes the nature of fund acounting for LSIFs. We will continue to monitor this change and advise our clients as affected. Recent Performance ChallengesIn the last couple of years, the return on LSIFs has been negative for the most part, as were the majority of many equity mutual funds, foreign and domestic. Investors who have been disheartened with the performance of their LSIFs over the last few years may be in for better times in the near future. LSIFs are a viable option for investors looking to hedge their risk by diversifying their exposure to the fluctuating publicly traded tech stocks. Investing in LSIFs is also a way to get into the IPO market (Initial Public Offerings), since the majority of investments in a labour fund are in private companies on the verge of going public. If there is a place for Small/Micro Cap equities in your portfolio, LSIFs may be a suitable option for you. Private equity and venture investing diversifies a client’s portfolio by investing in private assets, assets which are not exposed to the day to day volatility of the public markets. To compensate for risk on private investments, LSIFs commonly perform several months of due diligence, sit on the board of directors of all investee companies, and invoke protective mechanisms in shareholders’ agreements. One technique is to invest through a preferred-share procedure that involves anti-dilution protection and minimum liquidation preferences - i.e. guaranteed return on initial investment. For example, if an LSIF were to invest $5 million, and they incorporate a minimum liquidation preference of 2 times, the LSIF receives the first $10 million of any $$$ value on an exit situation. Sector Specific FundsLSIFs have evolved over the years from being basic broad-based traditional investment funds, to now providing options with respect to risk and sector. LSIFs may specialize in certain sectors of the economy such as biotechnology, information technology, finance, and energy. Internet, biotechnology, and energy funds are available for the more aggressive investor. In exchange for this added risk, some of these funds offer a 35% total tax credit. According to recent research with respect to the energy sector, global demand for energy is forecasted to increase by approximately 60%. It is estimated that approximately $10-$15 trillion will be directed towards renewable energy projects and technologies in the next two decades. Also anticipated is a significant demand for expenditures towards resource efficiencies and upgrades to current drinking water infrastructures in North America. Deregulation has re-shaped the competitive energy environment which causes established energy providers to re-evaluate existing business plans and models, and adapt to today’s current market landscape. Underlying all these factors is the environmental concerns involved with energy delivery and production. Complying with various rules and regulations will have a direct impact on profitability, thus companies must create and impose new technologies to maximize output, yet minimize environmental and production costs. Biotechnology and Heath Care is another sector which has come to the forefront of today’s society, and one which may provide investors with tremendous return potential. Genomics (the discovery and mapping of the human genome) and the aging population (the 65+ age group is the fastest-growing segment of the population in Canada) has and is providing the platform and need for new technologies, translating into tremendous investment opportunities in this economic sector. The result of the advances in genomics will provide us with improved drugs and diagnostic, prognostic, and monitoring equipment, and the demand for these new products and services will force increased expenditures in this area. Several LSIFs specialize in this sector. Growthworks has launched a series of funds, which will allow investors to switch twice a year during the 8 year holding period, to take advantage of changing market conditions. Balanced Funds offered Capital Repayment in 12 years.In 2002 and 2003, several LSIFs took advantage of rules that allowed for a 12 year capital repayment option. Those funds are no longer available, and LSIF investing for 2003/2004 is back to funds with real risk, but potential for returns in the future. LSIF Market Set to Rebound?Another factor which plays into the investment return potential for LSIFs over the next few years has been the recent downsizing and cost cutting that several public companies have undertaken recently. As large public companies have reduced staff (many bright, innovative, and seasoned employees such as analysts, scientists, engineers etc.) and spending on R&D continues to decline, LSIFs stand to reap the rewards of this lost talent and expenditure. New ideals and technological advances cut loose by the large public companies will be acquired and nurtured by various LSIFs who in turn will aide in the development and launch of these innovative products and technologies. As well as developing these new technologies and entrepreneurs, large cash positions currently held by LSIFs today give them an abundance of capital to invest in today’s declining valuations. Some LSIFs will invest a part of their capital in Nasdaq 100 Stock Index or S&P/TSX linked notes along with their various investments. Here is a recent MoneySense article on LSIF investing. The above information demonstrate some of the potential for LSIF investing. Ultimately, the appropriateness of LSIFs for your account will depend on your tax situation and individual investor profile. Contact us for specific recommendations for your portfolio. Return to Annual Review
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