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Experts say tax credits should not drive your investment decisions and that labour-sponsored investment funds have been a risky proposition with a history of disappointing performance.

Getty Images/iStockphoto

The federal government is restoring the tax credit for labour-sponsored investment funds, but investment experts urge caution for investors who may be considering them.

They say tax credits should not drive your investment decisions and that labour-sponsored investment funds have been a risky proposition with a history of disappointing performance.

Eric Kirzner of University of Toronto's Rotman School of Management says they are complex investments, hard to understand and carry high management fees. "Would I recommend these as investments: No," he said.

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Labour-sponsored funds or labour-sponsored venture capital corporations were introduced in the 1980s as a way for small investors to invest in small- to medium-sized businesses.

Prof. Kirzner, who holds the John H. Watson Chair in Value Investing and teaches investment finance, says the idea was that investors would do well and companies that otherwise would not have been able to raise capital would get needed investment.

But investing in early-stage small businesses can be speculative and risky. "There has been the occasional success, but in general the performance of these funds has been awful," Prof. Kirzner said.

He noted that for most individual investors, the venture capital sector is not an asset class he would recommend. "It is not until you get to very large portfolios that there's a place for it," he said.

The funds also have a holding period that can be as long as eight years. That means if the fund is sold before the end of the hold period, investors may face penalties and lose their tax credits. Many funds also have higher fees than those associated with conventional funds and that can also eat away at investment gains.

Peter Bowen, vice-president of tax and retirement research at Fidelity Investments, said that, historically, performance has been a challenge for many labour-sponsored venture capital corporations.

"Tax efficiency is great, but you have to start with good solid investment performance and this has been an area of the market, the labour-sponsored funds, where that has not been the case in many situations," he said.

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Before investors make a decision to invest their money in any sort of security, they need to look at the merits of the investment, Mr. Bowen said.

"Just buying something because there's a tax credit or other benefit associated with it, we don't think is a good idea."

Ontario ended its tax credit for labour-sponsored investment funds in 2012. However, the investments have remained popular in Quebec, which continues to offer a credit.

The Conservatives had moved to phase out the federal tax credit by next year, but the Liberals restored the incentive to 15 per cent on purchases of provincially registered funds this year. Ottawa's credit applies to eligible investments of up to $5,000, making it worth up to $750.

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