Mutual Funds that Invest in Private Equity? An Analysis of Labour-Sponsored Investment Funds

This paper considers the structure, governance and performance of a unique class of mutual funds that receives capital only from individuals, and reinvests this contributed capital in private companies, as opposed to traditional mutual funds that invest in publicly traded companies. We consider the particular class of mutual funds known as Canadian Labour-Sponsored Investment Funds (LSIFs). In contrast to expectations, we show that LSIFs have artificially low betas (the average beta is 0.10), returns that have significantly underperformed industry benchmarks (including risk-free 30-day T-bills), average management expense ratios (quot;MERsquot;, or management expenses/assets) greater than 4%, and have collectively accumulated $10 billion ($4.3 billion) to 2005 since their statutory inception in various Canadian jurisdictions in the 1980s and 1990s. We show that these incongruous data are directly attributable to the LSIF statutory governance structure. LSIF legislation mandates episodic valuations that determine share prices, an 8-year investor lock-in period, and onerous constraints on capital reinvestment. LSIFs also afford to their investors tax-generated returns in excess of 100%. The LSIF structure provides generalizable insights into the relation between organizational governance and performance, and the unsuitability of mutual fund structures for private equity investment. We compare and contrast the LSIF governance structure with structures in the UK, US and Australia to draw lessons for the appropriate design of government sponsored venture capital funds