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News is now well-spread among the Canadian financial community that Dalton McGuinty’s Ontario government has decided to axe the 15% tax credit it has offered to Ontarians who invest into labour sponsored investment funds (LSFs).

I do not like this tax law change because it has all but sealed the fate of LSFs in Ontario. At one time, I was interested in using this tax credit for myself, but after doing the math it was clear that my money would be able to work harder elsewhere. Here’s my analysis.

LSFs are terrible investments from a performance stand point. Few funds have a long history, and those who do, simply are barely breaking even or are still losing money since inception. LSFs are also highly volatile and trendy because of their nature to be sector-focused, and industry oriented. Check out the long term performance comparisons with this chart courtesy of GlobeFunds.com.

When it comes to choosing mutual fund, I always advocate a positive long track record as one of the key criterias of decision. Why then, would I initially consider getting into LSFs? When I first flirted with the idea of LSFs, the tax advantage was key to my strategy, Previously, LSFs were renewable in 5 year cycles rather than the 8 year cycles - which makes a big difference!

Assume a LSF was only able to break even (as the majority are not even able to do so) over the 8 years that you had to remain in the fund, Ontarians were getting 15% tax credit from the Federal government, and 15% (previously as high a 20%) from the Provincial government. You would only be able to claim the tax credit up to $5000 each year. If you maximized the tax credit contribution amount in a LSF within a Registered Retirement Savings Plan (RRSP), you also get the $5000 tax deduction for the RRSP contribution. As well, when you renew/reinvest in the LSF program after the 8 year period, you get another 30% of tax credit.

Divide the 30% tax credit over 8 years and you get a paltry 3.75% annually. With the 5 year renewal cycle, the average annual return is 6%. However, remember these returns are tax credits are should be regarded as after-tax returns; making the small figures look more attractive. You are also getting the tax credit as a lump sum up front. Calculate the future value of $1500, assuming it is invested into a bond fund returning 6%, means the 8 year return would be approximately $2,390.77 or 47.8%. The time adjusted returns for 8 year and 5 year renewal cycles would be approximately 5.97% and 8.86% respectively on an annual basis. Any capital appreciation from the fund would be regarded as a bonus.

Conclusion: If LSFs were still under 5 year renewal cycles and the tax credits still exist, LSFs may warrant a look under asset allocation principles. LSFs have not been attractive since the institution of 8 year renewal cycles. The elimination of the Ontario tax credit has clearly raised the red flag for any Ontario investor wishing to invest in LSFs. LSFs are now only as attractive as Ontario bonds, which is simply not an ideal place for a young investor looking to make their money work hard for them.