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? Q3 2015 September 2014 Canadians Hop Aboard Strategic-Beta Bandwagon Contents 12 10 8 6 4 2 Mar-15 Jul-14 Nov-14 Nov-13 Mar-14 Jul-13 Mar-13 Jul-12 Nov-12 Nov-11 Mar-12 Jul-11 Nov-10 Mar-11 Jul-10 Mar-10 0 Jul-09 39 Market, category, and fund data Exhibit 1: Canadian Strategic Beta ETF Assets, CAD billions Nov-09 35 Stewardship report: RBC Global Asset Management 11.5% from 11.1%. Nov-08 34 Analyst Rating updates Strategic-beta’s share of the nearly $85 billion invested in Canada listed ETFs ticked up modestly to Mar-09 30 Analyst Report: Sionna Canadian Small Cap approximately $2.1 billion flowed into strategic-beta ETFs over the period—a 26% organic growth rate. Jul-08 24 Floating-rate funds: Weapon against rising rates? growth owes more to strong investor interest rather than performance, which was weak overall. Indeed, Mar-08 20 When are target-date funds the right choice? 30, 2015, rising from 88 over the 12-month period. Assets rose 23% to $9.8 billion from $8 billion. Such Jul-07 11 How conservative are "conservative" target-risk funds? beta") ETFs in Canada. The number of such offerings stood at 122 (including all share classes) on June Nov-07 7 Indexes can be passive and active, but passive can't be active Over the past year, asset managers raced to launch strategic-beta (commonly referred to as "smart Mar-07 1 Canadians hopping on the strategic-beta bandwagon Source: Morningstar Direct, Data as of June 30, 2015 Long-term asset growth has been strong, also thanks to burgeoning investor interest. Of the $8.2 billion increase in assets over the five-year period, $7.2 billion, or 87%, stems from inflows. In all, strategicbeta assets rose 38% annually over the period, more than twice as quickly as the 17% growth rate for Page 2 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 6 Healthcare Observer | 28 October 2015 ETFs overall. With much faster growth, strategic-beta’s share of the ETF pie has more than doubled from 4.8% in June 2010. It is important to note that these numbers understate Canadian investment in ETFs. Canadian investors commonly hold U.S.-listed ETFs either to lower costs or to gain access to strategies not available at home. We don’t know the exact dollar value, though, or the extent that Canadians choose strategic-beta strategies listed south of their border. Exhibit 2 Strategic beta ETF monthly flows, CAD billions 500 400 300 200 100 0 -100 Apr-15 Dec-14 Apr-14 Aug-14 Dec-13 Apr-13 Aug-13 Dec-12 Apr-12 Aug-12 Dec-11 Apr-11 Aug-11 Dec-10 Apr-10 Aug-10 Dec-09 Apr-09 Aug-09 Dec-08 Apr-08 Aug-08 Dec-07 Apr-07 -200 Aug-07 Christopher Davis Director, Manager Research, Canada +1 416-484-7823 [email protected] Source: Morningstar Direct, Data as of June 30, 2015 Dividend-Oriented ETFs lose altitude; equal-weighted approaches gain steam In all, 13 of 18 of strategic-beta subcategories are represented in Canada. The launch of four new ETFs over the past year brought three subcategories—nontraditional fixed income, multiasset, and buyback/shareholder yield—to the Canadian strategic-beta universe for the first time. Exhibit 4 (next page) depicts the number of strategic-beta ETF launches by calendar year. The dividend-screened/weighted group remains the largest subcategory (see Exhibit 5 on page 4 and Exhibit 6 on page 6) of the Canadian strategic-beta universe at 37% of the assets. That’s a far smaller share than in June 2014, when it stood at 47%. (See Exhibit 3 on next page.) This isn’t because investors fled from the group, however; inflows grew less quickly than the strategic-beta strategies as a whole, if at a still-healthy 7% rate. iShares S&P/TSX Canadian Dividend Aristocrats CDZ was the only one to shrink meaningfully, with $48 million in outflows, though it remains the second-largest strategic-beta ETF in the country, along with the largest, sibling iShares Canadian Select Dividend XDV. The iShares offering’s loss was Vanguard’s gain, as Vanguard FTSE Canadian High Dividend Yield VDY took in $60 million. Page 3 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 6 Healthcare Observer | 28 October 2015 Exhibit 3: Strategic Beta ETFs' Share of the Overall Canadian ETF Market 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% Nov-14 Mar-15 Jul-14 Nov-13 Mar-14 Jul-13 Mar-13 Jul-12 Nov-12 Mar-12 Jul-11 Nov-11 Mar-11 Jul-10 Nov-10 Mar-10 Jul-09 Nov-09 Mar-09 Jul-08 Nov-08 Nov-07 Mar-08 Jul-07 Mar-07 0.0% Source: Morningstar Direct, Data as of June 30, 2015 The gap between equal-weighted and fundamentally weighted ETFs, which vied for a distant second place in June 2014, widened over the ensuing year. The former’s share of strategic-beta assets grew to 24% from 21%, while the latter’s shrunk to 16% from 22%. Fund-of-funds managers appear to have driven much of the shift. Fund of ETFs BMO Global Tactical ETF bulked up its stake in equal-weighted strategies like BMO Equal Weight US Banks ETF ZBK, for example. BMO fund-of-funds' investments in other equally weighted ETFs, such as BMO S&P/TSX Equal Weight Banks ETF ZEB, explain why such offerings account for four of the largest 10 strategic-beta ETFs. Exhibit 4: Number of Surviving Canadian Strategic-Beta ETFs by Vintage 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 0 5 10 15 20 25 30 35 40 Source: Morningstar Direct, Data as of June 30, 2015 Meanwhile, the largest holders of fundamentally weighted iShares US Fundamental (CAD-hedged) CLU and iShares Canada Fundamental pared their exposure to the strategies, pushing the fund out of the top 10. IShares dominated the fundamentals group along with Invesco, who launched three FTSE RAFItracking ETFs in late 2014. Its suite of RAFI ETFs has enjoyed strong inflows over the past year. Page 4 of 50 Manager Research Canada Observer | Q3 2015 Page 4 of 6 Healthcare Observer | 28 October 2015 Exhibit 5: Canadian Market Share by Strategic Beta Attribute 2.9% 0.6% 36.4% Dividend Screened/Weighted Equal-Weighted Fundamental 0.7% Growth Multi-Asset 10.5% 5.8% 0.5% Multi-Factor Non-Traditional Fixed Income Quality Risk-Weighted Value 24.0% Source: Morningstar Direct, Data as of June 30, 2015 Lastly, the relatively young minimum volatility/variance and risk-weighted subcategories approximately doubled their market shares, albeit from low levels, over the 12-month period. Risk-weighted assets went to 1.3% from 0.6% of the strategic-beta universe, all to the benefit of First Asset, the only Canadian asset manager offering risk-weighted ETFs. The firm took in $137 million across the sevenstrategy suite of its ETFs that it launched in 2014. The share of strategic-beta assets in minimum volatility/variance ETFs went to 5.8% from 3.2%, with the spoils split between iShares and PowerShares. iShares slips; BMO, First Asset, and Vanguard gain All seven Canadian providers of strategic-beta ETFs enjoyed asset growth in the 12-month period. IShares continued to dominate the space, though to a lesser extent, with its share falling sharply to 49% from 60% despite healthy asset growth. Its lead over second-place competitor BMO narrowed as its share of strategic-beta assets rose 4 percentage points to 26% in large part thanks to strong flows into funds of ETFs. First Asset’s share went to 11% from 9% as investors streamed into a mix of value, momentum, and risk-weighted ETFs. Despite its strong emphasis on conventional market-cap-weighted benchmarks, Vanguard made inroads in the strategic-beta arena; its three Canada-domiciled dividendscreened strategies rose to 4% of strategic-beta assets, up from 2% the year before. Exhibit 7 (next page) ranks firms by strategic-beta assets. It is worth noting that our tally doesn’t include BMO’s domestic and U.S. low-volatility and dividend strategies. It also excludes Royal Bank of Canada’s broad lineup of dividend ETFs, which it launched in late 2014. These funds are designed to follow rules-based strategies, but because they do not track a published public benchmark, Morningstar considers those ETFs actively managed. If included, they would add another $780 million to BMO’s strategic-beta asset pile and $290 million to RBC’s. Page 5 of 50 Manager Research Canada Observer | Q3 2015 Page 5 of 6 Healthcare Observer | 28 October 2015 Exhibit 6: Canadian Ranking of Strategic Beta ETFs by Secondary Attribute Secondary Attribute # of ETFs Assets (CAD) % of Assets Buyback/Shareholder Yield 1 4,013,654 0.0% Dividend Screened/Weighted 21 3,531,088,914 36.4% Earnings Weighted 0 0 0.0% Equal-Weighted 15 2,325,870,580 24.0% Expected Returns 0 0 0.0% Fundamental 21 1,564,859,186 16.1% Growth 2 48,304,580 0.5% Low/High Beta 0 0 0.0% Low/Minimum Volatility/Variance 10 559,729,931 5.8% Momentum 0 0 0.0% Multi-Asset 2 68,526,367 0.7% Multi-Factor 9 1,021,820,017 10.5% Non-Traditional Commodity 0 0 0.0% Non-Traditional Fixed Income 1 124,685,283 1.3% Quality 3 280,091,438 2.9% Revenue Weighted 0 0 0.0% Risk-Weighted 14 121,816,862 1.3% Value 12 58,984,420 0.6% Source: Morningstar Direct, Data as of June 30, 2015 Exhibit 7: Canadian Largest Strategic-Beta ETP Providers Provider AUM ($) # of ETPs Market Share (%) iShares 4,782,228,851 28 45.4% BMO 2,594,021,657 13 24.7% First Asset Investment Management 1,110,849,975 40 10.6% Invesco 855,655,914 18 8.1% Vanguard 369,943,858 3 3.5% First Trust 796,571,041 14 7.6% Questrade 12,859,658 6 0.1% Source: Morningstar, Inc., Data as of June 30, 2015 Discount broker Questrade became the seventh Canadian asset manager to join the strategic-beta bandwagon with the launch of a handful of equally weighted sector funds, though, with $12.8 million in assets, its share is minuscule. Page 6 of 50 Manager Research Canada Observer | Q3 2015 Page 6 of 6 Healthcare Observer | 28 October 2015 Exhibit 8 Canadian Largest Strategic-Beta ETFs Name Ticker Inception Secondary Attribute MER AUM (CAD) iShares Canadian Select Dividend XDV 12/19/2005 Dividend Screened/Weighted; 0.55 1,411,620,587 iShares S&P/TSX Cdn Div Aristocrats CDZ 9/8/2006 Dividend Screened/Weighted; 0.66 1,075,870,878 BMO S&P/TSX Equal Weight Banks ETF ZEB 10/20/2009 Equal Weighted; 0.62 689,712,337 iShares US Dividend Growers(CAD-Hdg) CUD 9/13/2011 Dividend Screened/Weighted; 0.67 434,299,240 BMO Equal Weight REITs ETF ZRE 5/19/2010 Equal Weighted; 0.62 384,265,433 BMO Equal Weight US Banks ETF ZBK 2/10/2014 Equal Weighted; 0.39 346,259,892 BMO Eq Wght US HlthCare Hdgd to CAD ZUH 5/19/2010 Equal Weighted; 0.4 311,039,978 First Asset Mstar US Value ETF CADH XXM 10/11/2013 Value; 0.68 265,083,867 First Asset Mstar US Value ETF Uhgd XXM.B 10/11/2013 Value; 0.68 264,239,089 iShares International Fundamental CIE 2/14/2007 Fundamentals Weighted; 0.72 255,338,316 Source: Morningstar Direct, June 30, 2015 For strategic-beta investors, costs matter less One would expect strategic-beta ETFs to charge a premium price tag, and that’s the case in Canada. The equal-weighted average management expense ratio for the strategic-beta universe clocks in at 0.86%, versus 0.62% for the broad ETF universe. The many leveraged and exotic ETFs, which tend to be relatively expensive and light in assets, skew the broad universe average upward. The asset-weighted MERs are lower, with non-strategic-beta ETFs remaining far cheaper. The average MER for the broad universe falls to 0.33% on an asset-weighted basis and to 0.59% for strategic-beta ETFs Exhibit 9: Canadian Fees Under the Microscope All ETPs ETPs without Strategic Beta Strategic Beta Average Combined (%) Equity (%) Fixed Income (%) Weighted Average 0.33 0.32 0.26 0.51 0.96 Simple Average 0.62 0.55 0.34 0.82 0.93 Weighted Average 0.34 0.32 0.26 0.51 0.96 Simple Average 0.65 0.59 0.33 0.82 0.93 Weighted Average 0.59 0.59 0.67 NA NA Simple Average 0.86 0.84 0.67 NA NA Commodities (%) Alternative (%) Source: Morningstar Direct, Data as of June 30, 2015 The averages are distorted by higher-cost “advisor” share classes, which tack on an additional 0.50% to 0.75% fee as an ongoing sales commission to the MER. Excluding these share classes, strategic-beta investors don’t appear especially price-conscious. These ETFs average 0.54% MERs on an asset-weighted basis, only a touch lower than the 0.56% equal-weighted average. The universe of nonstrategic-beta funds is about as expensive as their strategic-beta counterparts on an equal-weighted basis, averaging 0.60% MERs. Investors favor cheaper offerings in this case, however; the assetweighted MER weighs in at 0.33%. K ? Indexes can be Active and Passive, but Passive can't be Active Indexing: From One to Two Historically, active and index investing have been viewed as binary events. A fund is one or the other. And for some purposes, that simplicity suffices. If we wish to measure the public's dissatisfaction with traditional fund management, then the active/index dichotomy works well. It is fine to place exchangetraded funds and indexed mutual funds into the index group, put all remaining mutual funds into the John Rekenthaler Vice President, Research +1 312-696-6350 [email protected] active group, and calculate the flows. Although even then, a third set is helpful. There's a difference between indexes that weight securities according to market capitalization, such as Vanguard's offerings or any company's S&P 500 funds, and indexes that incorporate viewpoints. One example of the latter is Research Affiliates' Fundamental indexes, which allocate to companies according to economic attributes rather than stock-market worth. Another would be a low-volatility index that favors an investment sector's less-risky securities. Companies that sponsor such funds make arguments for their superiority that sound suspiciously active. The suspicion increases with the funds' self-described label: smart beta. Ummm, ... no. That's a name even a fund marketer should be ashamed to use. At Morningstar, smart beta is redubbed strategic beta. By our reckoning, the active/index duo should expand to three: 1) actively managed funds, 2) index funds weighted by market cap, and 3) strategic-beta index funds. (There is some gray area between the second and third items. Specialized indexes, such as U.S. small value or high-dividend stock, use market-cap schemes but are active in intent; the funds are sold as being better than index funds that invest more broadly. Morningstar currently calls these funds strategic beta, but they could reasonably be categorized as market-cap indexes.) This is what the 20-year U.S. stock-fund flows look like for the three groups, as well as the current assets, shown in the pie chart. Page 8 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 4 Healthcare Observer | 27 October 2015 Exhibit 1: Canadian Strategic Beta ETF Asset Growth Source: Morningstar Active: From One to Three Let's switch from discussing active/passive to active/index. Those are not the same things, because passive is not a synonym for indexing. A passive fund is a fund that does not express a viewpoint. An index fund is a fund that mimics a list of securities. Those are two different things. Thus, a strategic-beta fund is an index fund, but it is not a passive fund. Exhibit 2: Flavours of active and passive management Source: Morningstar Page 9 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 4 Healthcare Observer | 27 October 2015 (This formal distinction between passive and index is new at Morningstar, at least from the sense of being consistently applied, so if you look through our materials, you may see the term "passive" used otherwise.) By Morningstar's definitions, there is one flavor of active and two flavors of index (that is, market-cap and strategic-beta) with the active/index classification, but three varieties of active and only one of passive with the active/passive classification. Yes, that sounds confusing. (And it does suggest that the word "active" is being stretched to cover too many meanings.) But a picture, created by Morningstar's Tom Idzorek based on a commentary by Don Phillips, should clarify. Think of green as meaning neutral and orange as meaning an active attempt at improvement. Passive funds are green across the board, because they start with the neutral position of weighting by market capitalization, and then implement passively, by copying that weighting without attempting to improve upon it. The other three fund types are either partially or totally orange, meaning that they cannot qualify as passive.. Strategic-beta funds echo passive funds in their implementation, so they score green on that column (and qualify as index funds). However, their weighting schemes are active, as befits a group that touts itself as "smart." Strategic-beta funds are the modern equivalent of the quantitative fund. Popular in the 1970s and 1980s, quantitative funds mined databases in the attempt to pick stocks. Strategic-beta funds similarly mine databases, but to select factors--or betas, as they call them. Traditionally active funds also echo passive funds, but with their weightings rather than in their implementation. Traditional active funds begin with the market's capitalizations. From there, they will deviate based on the managers' decisions, sometimes fairly substantially but often not. Examples of the latter include "closet index" stock funds that ape the market without admitting to the fact; "enhancedindex" funds that explicitly control for industry exposure but give the manager the freedom to pick stocks; and many plain-vanilla bond funds. Alternative active funds have no green. (They may also end up with a new name; this label is provisional.) They do not begin with a common, market-cap-weighted benchmark, as they either limit their investment universes or mix their assets so as to create unusual starting points. (A fund that invests solely in U.S. small-value stocks is an example of the former--at least provisionally, as Morningstar mulls over this gray area--while a long-short equity fund is one of the latter.) They then implement actively. These funds are pure orange, and they charge accordingly, typically levying the industry's highest management fees. Summary And now, why you should care. For one, it's nice to speak the same language. Most people have only a vague idea what is intended by the term "smart beta." Morningstar would like to nail that concept down with precision (as well as change the name). If we all write about strategic beta, indexing, passive, and Page 10 of 50 Manager Research Canada Observer | Q3 2015 Page 4 of 4 Healthcare Observer | 27 October 2015 active using the same meanings, we'll have much better conversations. We won't be talking past each other, as so often happens today. Also, this taxonomy demonstrates that strategic beta substitutes for active management, not passive. Strategic-beta funds cost more than passive index funds and have greater ambition. They are purchased by investors--or recommended by advisors--to do what active managers have traditionally been hired to do, but who no longer are fully entrusted with the task: to add value. Strategic-beta funds will not slip between the lip and the cup, in the sense that they will deliver what they promise. But what they promise is far from a neutral event. K ? How conservative are "conservative" target-risk funds? Investors must look beyond the label to judge risk Like carmakers that produce zippy sports cars, trusty mid-sized vehicles, and roomy sedans, more than two dozen Canadian asset managers offer one-stop solutions in some variation of aggressive, moderate, and conservative flavours. Usually referred to as target-risk funds, investors select the investment package coinciding with their risk tolerance. Christopher Davis Director, Manager Research, Canada +1 416-484-7823 [email protected] This isn’t as simple as it sounds. Investors are imperfect judges of their ability to cope with losses. Their choice of target-risk fund will depend upon when you asked them: The same person may define themselves as an aggressive in the midst of a bull market but conservative after suffering wounds they thought they could handle. Supposing they identified themselves as the latter from the get-go, they would find the 50-plus conservative target-risk funds aren’t painted with the same brush. As you’d expect, conservative target-risk strategies are designed more for capital preservation than growth. Their portfolios universally favour bonds and cash over stocks. But beyond this generalization, the funds make up a diverse lot. With varying stock/bond and domestic/foreign exposures, they span four Morningstar categories. As such, investors must look beyond labels to evaluate these funds. One provider’s “very conservative” offering can be more aggressive than another’s merely “conservative” one: CIBC Conservative holds 24% in stocks, versus RBC Select Very Conservative’s 28% stake. Of course, there’s no single approach that works for all. Even among loss-averse investors, there’s bound to be differences in their willingness to hold stocks or foreign investments—underscoring the importance of knowing what’s under the hood of conservative target-risk funds before embracing one of them. Page 12 of 50 Manager Research Canada Observer | Q3 2015 Same label, different ingredients How a fund splits its portfolio across stocks, bonds, cash and other asset classes will likely have a bigger impact on performance than any other decision its management makes. On the whole, conservative target-risk funds' asset allocation looks like what you'd expect. The median fund holds just under 30% in stocks, with the balance mostly in bonds and some cash. Somewhat surprisingly, the funds only modestly favour Canadian stocks, with slightly smaller U.S. and international stakes of roughly equal weight. There's no typical asset allocation, though. In exhibit one, we show asset allocations across the conservative target-risk universe. Funds' stock and bond exposures range from 14% to 51% and 29% to 74%, respectively. One fund holds no cash, while another keeps 36%. Stock-heavy, bond- and cash-light portfolios are more vulnerable to losses during downturns--a turn-off for conservative investors. Nearretirees may be able to take more risk than they realize, however. A steady stream of pension income could give some more room to hold stocks. Longer life spans also means they may have decades of life ahead of them, and stocks' higher growth potential improves their odds of beating inflation. A too-tame asset allocation could result in the worst possible outcome: Outliving one's savings. Other conservative target-risk funds play more cautiously, holding larger bond and cash weightings. These funds will likely fare better in market swoons, though these aren’t immune from turbulence either, as bond-heavy portfolios are susceptible to rising interest rates. CIBC Very Conservative, for example, is as its name implies geared toward the most risk-averse investor and its shows: Its 14% equity stake is the lowest in the universe, its 60% bond weighting well above median, and its 28% cash exposure is nearly the highest. Within asset classes, conservative target-risk funds also take different approaches. AGF Elements Conservative, for example, sports one of the smallest Canadian equity weightings but the largest and second largest U.S. and international stakes, respectively. Foreign fixed income also predominates, representing 40% of the portfolio, versus 15% in Canadian bonds. Such positioning reflects economic reality: Canada accounts for a small portion of the global stock and bond markets. Canada’s heavy reliance on financials, energy, and mining firms makes home-country bias potentially dangerous. NonCanadian securities also offer currency diversification, though many target-risk funds hedge their Canadian dollar exposure or hold funds that do, at least in part mitigating this benefit. Investors with shorter time horizons may find heavy foreign exposure more curse than benefit, as currency volatility can more than offset the returns earned from the security itself, especially in bonds. Holding the bulk of your investments in the local currency makes sense if most of your financial obligations are priced in Canadian dollars. TD Target Risk Conservative draws upon this reasoning with its overwhelmingly Canadian portfolio; it holds 30% in domestic equities, versus a combined 11% in the U.S. and international bucket. Sentry’s conservative target-risk offering ignores international stocks altogether, with 29% in Canada and 15% in the U.S. Pairing Canadian and U.S. dollars together, as the Sentry fund does, has appeal from a diversification perspective—one currency tends to zig when the other zags. Page 13 of 50 Manager Research Canada Observer | Q3 2015 Not only do target-risk funds’ asset allocations vary across funds, it varies over time. While the median equity stake has ranged between 26% and 29% over the past five years, most funds’ allocations have shifted meaningfully around the median, as exhibit 2 demonstrates. Overall, the median conservative target-risk funds’ equity weighting fluctuated between 20% and 33% over the period. Exhibit 2: Conservative target-risk equity exposure, 5-year range CIBC Very Conservative Portfolio CIBC Very Conservative Index Portfolio MD Precision Conservative Portfolio Compass Conservative Portfolio SEI Conservative Monthly Income Class P RBC Select Conservative Portfolio Sr A Compass Conservative Balanced Portfolio CIBC Conservative Portfolio National Bank Conservative Strat Port National Bank Conservative Diversified Allegro Conservative Portfolio C Meritage Conservative Income Portfolio Standard Life Conservative Port A Desjardins SocieTerra Conservative A Manulife Simplicity Conservative Adv RBC Select Very Conservative Port Adv Harmony Conservative Portfolio Embed Ser Allegro Moderate Conservative Port C Meritage Conservative Portfolio NEI Ethical Select Conservative Port A Counsel Conservative Portfolio Distinction Conservative Class Sr A AGF Elements Conservative Portfolio Alto Conservative Portfolio Ser A NEI Select Conservative Port A CIBC Conservative Index Portfolio La Capitale Conservative Profile AGF CI Portfolio Series Conservative Quadrus Conservative Folio Alto Moderate Conservative Port Ser A BMO SelectTrust Conservative Port F Jov Hahn Conservative ETF Portfolio 0 10 20 30 % Equity Exposure Source: Morningstar Direct, Data as of September 30, 2015 and only includes funds with a five-plus year track record. 40 50 Page 14 of 50 Manager Research Canada Observer | Q3 2015 Even where there are modest fluctuations at the asset class level, there can be sizable shifts in subasset class weightings. Sentry Canadian Income’s overall equity exposure didn’t change much over the five-year period, but its composition did: The fund’s Canadian equity stake stood at 43% at its early 2011 launch and has fallen to a low of 25%, while its U.S. equity holdings have risen from an 8% low to an 18% high. Meanwhile, RBC Conservative broadened its fixed income holdings to include small weightings in global corporate and high yield bond funds while maintain consistent exposure to the asset class overall. Same label, different ingredients Not surprisingly, the group’s diverse approaches to asset allocation lead to a wide dispersion of risk/reward profiles, as the scatterplot in Exhibit 3 illustrates. Not surprisingly, funds with the highest volatility (as measured by standard deviation) and returns over the five-year period, such as BMO Select Conservative, also had among the highest equity weightings. Others performed according to script as well. CIBC Very Conservative historically has had the smallest stock weighting in the group, and it would’ve mapped further southwest on the scatterplot. Exhibit 3: Conservative target-risk funds risk/reward profile, 5-year period 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Source: Morningstar Data as of Sep 30, 2015 It’s also not surprising funds with higher volatility/higher return profiles were more vulnerable to losses in down markets. BMO SelectTrust Conservative Portfolio turned in the worst bear-market showing of any conservative target-risk fund, suffering a 22% cumulative loss from October 2007 to March 2009. The fund has rallied 90% since then--the second best return in the conservative camp. Meanwhile, CIBC Very Conservative, which had the best bear market showing with a 1.2% cumulative loss, has been the biggest laggard since then, with a modest 25% cumulative gain. This tale of two records is easy to explain: BMO's equity exposure, currently at 40%, is among the highest in the group and four times CIBC's, giving it more ammo in up markets but making it vulnerable in down ones. But the CIBC fund has consistently held 14% in stocks--the lowest weighting in the group--providing ballast in down markets. Page 15 of 50 Manager Research Canada Observer | Q3 2015 Investors shouldn't take the BMO fund's strength in up markets and the CIBC fund's resilience in downturns as signs of manager skill. Such performance is the natural outcome of how differently the funds were built. Yes, you'll probably get better long-term returns from the BMO offering given its much higher equity weighting, but the approach leads to much higher volatility. Indeed, its five-year standard deviation, a measure of volatility, is 80% higher. Conservative investors with shorter time horizons may find such volatility difficult to stomach. The BMO offering still outperforms the conservative target-risk universe once volatility is taken into account (using the Sharpe Ratio), but so does the CIBC fund. Which approach you choose should be driven more by your risk appetite than returns alone. Other asset allocation decisions also drive performance. TD Target Return Conservative has been the poorest performer in the conservative target-risk lot this year. One big reason why is its Canada-heavy portfolio, which has put it at a disadvantage recently given the Canadian market's weakness. By contrast, Sun Life Granite Conservative has been one of the strongest performers even with nearly the same equity allocation as the TD fund. The Sun Life fund, though, has nearly three times the U.S. exposure. With already decent U.S. returns getting an added boost from the falling loonie, U.S.-heavy portfolios have a built-in advantage. You'd likely see the opposite performance pattern when Canadian stocks outperform. Exhibit 4 (page x) features the performance of funds in the conservative target risk grouping. Same label, different ingredients Of course, past isn’t always prologue. Just because a fund’s risk has yet to materialize doesn’t mean it’s not there. A seemingly-safe portfolio heavy with high-quality bonds (which generally are the most sensitive to interest rate fluctuations) will have benefited handsomely from historically low interest rates, for instance. In a rising rate environment, these funds may not offer the same kind of downside protection as they have in prior downturns (though they should still outperform equity-heavy portfolios). Lastly, nearly half of our sample launched in 2009 or later. Younger funds will not have been tested by a downturn. Success, especially over shorter time periods, may simply be an artifact of the fund’s asset allocation, not management strength. K Page 16 of 50 Manager Research Canada Observer | Q3 2015 Exhibit 1: Conservative Target-Risk Funds Asset Allocation Name Net Assets ($) % Candian Equity % US Equity % International Equity % Total Equity % Cash % Fixed Income % Other AGF Elements Conservative Portfolio 280,148,576 8.80 18.94 15.18 42.93 3.64 52.89 0.54 Allegro Conservative Portfolio C 451,047,001 6.19 8.25 10.69 25.12 18.16 50.34 6.39 Allegro Moderate Conservative Port C 479,229,000 10.16 15.94 13.62 39.72 14.86 38.68 6.74 Alto Conservative Portfolio Ser A 282,836,000 11.72 7.04 7.84 26.60 14.48 52.02 6.90 Alto Moderate Conservative Port Ser A 261,712,000 14.64 17.30 9.17 41.11 11.54 40.31 7.04 BlackRock Conservative Portfolio A 18,543,536 20.96 7.46 11.47 39.89 1.45 53.88 4.78 BMO Conservative ETF Portfolio A 155,049,000 9.66 19.41 9.95 39.02 4.60 54.34 2.04 BMO Retirement Conservative Port Srs A 14,790,000 7.21 6.88 0.80 14.89 0.80 0.00 85.74 BMO SelectTrust Conservative Port F 1,113,015,000 11.65 17.74 12.12 41.51 7.53 45.14 5.82 CI Portfolio Series Conservative 1,293,087,179 10.20 18.92 13.40 42.53 9.79 45.18 2.50 CIBC Conservative Index Portfolio - 19.85 4.88 0.24 24.98 24.58 50.31 0.13 CIBC Conservative Portfolio - 17.58 5.99 0.14 23.72 29.41 46.11 0.77 CIBC Very Conservative Index Portfolio - 14.90 0.05 0.07 15.02 24.54 60.33 0.11 CIBC Very Conservative Portfolio - 14.37 0.00 0.00 14.37 28.43 56.97 0.23 Compass Conservative Balanced Portfolio 3,370,644,636 16.82 13.65 8.84 39.31 1.82 56.38 2.50 Compass Conservative Portfolio 1,488,944,787 10.45 6.54 6.93 23.92 1.88 71.00 3.21 Counsel Conservative Portfolio 324,652,354 7.72 9.52 11.21 28.45 27.07 43.80 0.68 Desjardins Chorus II Conservative 1,012,898,190 7.74 7.03 9.85 24.62 4.60 66.39 4.39 Desjardins SocieTerra Conservative A 309,408,780 8.08 10.12 9.58 27.78 2.02 0.00 70.20 Distinction Conservative Class Sr A 70,921,115 26.24 13.84 11.96 52.03 10.55 29.85 7.56 Dynamic Edge Conservative Cl Port Ser I 174,364,073 7.78 18.15 9.72 35.64 11.26 52.71 0.38 Empire Life Emblem Conservative Port A 15,669,112 17.57 15.16 6.16 38.89 6.43 54.56 0.12 Fidelity Conservative Income Fund A 184,620,470 5.40 8.74 6.40 20.53 5.50 73.52 0.44 FMOQ Conservative balanced Fund 85,349,147 15.32 12.41 4.02 31.75 11.49 54.20 2.56 Harmony Conservative Portfolio Embed Ser 101,063,157 13.04 10.53 4.42 27.99 5.32 66.66 0.03 Jov Hahn Conservative ETF Portfolio 50,418 11.33 5.14 18.70 35.17 5.68 58.25 0.90 La Capitale Conservative Profile (NBSI) 3,389,080 12.02 3.93 0.88 16.83 7.13 73.30 2.74 La Capitale Conservative Profile AGF 25,569,127 4.46 11.71 12.05 28.22 6.27 65.10 0.41 Manulife Cdn Conservative Balanced Adv 35,377,021 19.98 7.29 0.00 27.27 7.15 64.94 0.64 Manulife Simplicity Conservative Adv 434,164,004 5.69 6.76 5.29 17.74 8.80 71.70 1.76 MD Precision Conservative Portfolio 460,165,631 18.65 0.75 10.15 29.56 5.60 55.77 9.07 Meritage Conservative Income Portfolio 304,922,289 12.02 3.95 0.88 16.85 7.12 73.27 2.76 Meritage Conservative Portfolio 147,206,971 10.01 4.69 5.36 20.06 6.33 72.72 0.88 National Bank Conservative Diversified 140,526,604 8.58 5.57 5.06 19.20 19.51 59.65 1.64 National Bank Conservative Strat Port -- 11.61 5.33 4.40 21.34 17.37 55.54 5.75 NEI Ethical Select Conservative Port A 137,598,663 11.37 15.46 11.85 38.67 7.03 54.17 0.12 NEI Select Conservative CC Portfolio A 24,311,743 7.32 11.45 11.72 30.49 18.86 50.54 0.11 Page 17 of 50 Manager Research Canada Observer | Q3 2015 Name Net Assets ($) % Candian Equity % US Equity % International Equity % Total Equity % Cash % Fixed Income % Other NEI Select Conservative Port A 154,268,734 8.68 13.98 13.03 35.69 6.29 57.90 0.12 O'Leary Conservative Income Sr A 96,129,204 23.40 4.34 0.46 28.20 21.56 49.39 0.85 Quadrus Conservative Folio 230,164,967 10.92 6.34 5.97 23.23 5.08 70.86 0.82 RBC Conservative Growth & Inc Ser A 82,684,442 9.49 8.03 7.55 25.08 6.38 66.76 1.79 RBC Select Conservative Portfolio Sr A 19,267,987,518 15.77 12.06 14.98 42.80 5.74 51.08 0.38 RBC Select Very Conservative Port Adv 9,708,598,797 11.47 7.12 9.14 27.72 7.98 63.95 0.35 SEI Conservative Class E 1,666,600 6.05 6.75 5.50 18.30 35.57 45.99 0.14 SEI Conservative Monthly Income Class P 486,948,054 9.75 7.41 5.88 23.04 26.72 50.06 0.18 Sentry Conservative Balanced Income 1,934,502,560 28.75 0.51 0.00 29.26 8.28 46.80 0.51 Standard Life Conservative Port A 171,472,096 12.39 13.16 9.31 34.87 5.28 59.66 0.19 Sun Life Granite Conservative Class A 71,976,439 6.16 14.91 10.30 31.37 12.29 51.44 4.90 Sun Life Managed Conservative Port A 418,056,406 6.51 15.14 10.66 32.31 16.29 46.95 4.45 TD Comfort Conservative Income 1,379,693,911 8.46 6.02 3.42 17.90 4.73 71.89 5.48 TD Target Return Conservative I 2,513,994,635 11.93 11.14 3.57 26.64 0.75 30.19 42.42 11.33 8.03 7.84 27.20 7.15 54.20 1.64 Median Source: Morningstar Direct, Data as of August 31, 2015 Page 18 of 50 Manager Research Canada Observer | Q3 2015 Exhibit 4 Conservative Target-Risk Fund Performance Name Return (1YR) Return (3YR) Return (5YR) AGF Elements Conservative Portfolio 5.16 6.48 4.87 Allegro Conservative Portfolio C 4.51 4.98 4.18 Allegro Moderate Conservative Port C 5.02 6.99 Alto Conservative Portfolio Ser A 1.98 3.77 Alto Moderate Conservative Port Ser A 2.40 BlackRock Conservative Portfolio A 1.89 BMO Conservative ETF Portfolio A 4.71 Return (10YR) Sharpe Ratio (3 Yr) Sharpe Ratio (5YR) 1.10 0.91 2.95 1.18 1.07 5.43 3.14 1.36 3.28 2.67 0.95 5.95 4.86 3.14 Sharpe Ratio (10YR) Max Drawdown (3YR) Max Drawdown (5YR) Max Drawdown 10YR -3.94 -4.03 0.35 -2.76 -2.76 -9.49 1.02 0.29 -3.98 -5.49 -18.32 0.85 0.28 -2.85 -2.85 -11.13 1.37 1.07 0.31 -3.74 -4.25 -16.23 1.42 1.50 -3.69 -3.69 BMO Retirement Conservative Port Srs A BMO SelectTrust Conservative Port F 5.41 7.62 6.94 CI Portfolio Series Conservative 3.81 7.61 6.27 4.48 1.45 1.18 0.47 -3.99 -6.09 -20.90 CIBC Conservative Index Portfolio 0.56 3.13 3.02 3.29 0.87 0.89 0.48 -3.18 -3.18 -10.27 CIBC Conservative Portfolio 1.42 3.22 3.40 3.13 0.89 1.06 0.44 -2.66 -2.66 -11.56 CIBC Very Conservative Index Portfolio 0.33 1.91 2.06 2.91 0.52 0.66 0.50 -2.40 -2.40 -5.39 CIBC Very Conservative Portfolio 0.35 2.01 2.18 2.61 0.57 0.73 0.38 -2.18 -2.18 -6.65 Compass Conservative Balanced Portfolio 2.78 7.18 6.71 5.57 1.65 1.52 0.74 -3.76 -4.24 -16.45 Compass Conservative Portfolio 1.59 4.90 5.19 4.66 1.33 1.48 0.76 -3.33 -3.33 -9.90 Counsel Conservative Portfolio 2.60 5.87 4.87 3.43 1.07 0.86 0.32 -4.03 -5.87 -19.68 Desjardins Chorus II Conservative 1.94 4.45 Desjardins SocieTerra Conservative A 3.18 4.11 Distinction Conservative Class Sr A -0.42 Dynamic Edge Conservative Cl Port Ser I 5.85 7.88 1.73 -3.36 Empire Life Emblem Conservative Port A 2.63 5.69 1.20 -3.92 0.89 4.00 0.75 -3.86 0.84 -3.85 -3.85 Fidelity Conservative Income Fund A FMOQ Conservative balanced Fund 2.37 Harmony Conservative Portfolio Embed Ser 1.77 3.89 3.50 Jov Hahn Conservative ETF Portfolio 8.50 4.96 La Capitale Conservative Profile (NBSI) 0.61 La Capitale Conservative Profile AGF 2.87 Manulife Simplicity Conservative Adv MD Precision Conservative Portfolio 2.70 0.75 0.78 3.82 0.84 0.72 4.98 4.35 0.89 0.89 3.12 4.17 3.91 0.83 0.88 1.18 5.15 4.18 1.07 0.89 Meritage Conservative Income Portfolio 0.61 2.07 3.20 0.39 Meritage Conservative Portfolio 2.39 3.81 3.72 National Bank Conservative Diversified 2.14 3.22 3.20 National Bank Conservative Strat Port 0.49 3.36 3.41 NEI Ethical Select Conservative Port A 3.16 4.99 4.25 NEI Select Conservative CC Portfolio A 3.28 4.18 NEI Select Conservative Port A 3.44 4.31 O'Leary Conservative Income Sr A -1.87 4.18 0.25 -4.19 -4.19 -14.06 -2.98 -2.98 -3.61 -3.61 -4.18 -4.18 0.84 -3.39 -3.39 0.86 0.93 -2.90 -2.90 2.78 0.73 0.86 0.35 -3.16 -3.16 -6.49 2.87 0.79 0.93 0.32 -3.96 -3.96 -11.11 0.96 0.88 -4.09 -4.09 Manulife Cdn Conservative Balanced Adv 3.59 0.78 4.32 0.81 0.87 0.46 -3.72 0.92 -3.66 -4.68 -3.66 -10.81 Page 19 of 50 Manager Research Canada Observer | Q3 2015 Name Return (1YR) Return (3YR) Return (5YR) Return (10YR) Sharpe Ratio (3 Yr) Sharpe Ratio (5YR) Sharpe Ratio (10YR) Max Drawdown (3YR) Max Drawdown (5YR) Max Drawdown 10YR Quadrus Conservative Folio 1.19 3.35 3.30 2.91 0.68 0.78 0.32 -4.17 -4.17 -10.19 RBC Select Conservative Portfolio Sr A 3.69 6.65 5.41 4.12 1.36 1.18 0.49 -3.65 -3.73 -16.34 RBC Select Very Conservative Port Adv 3.02 4.60 4.15 1.10 1.14 -2.91 -2.91 SEI Conservative Monthly Income Class P 1.78 4.39 4.04 0.96 0.95 -3.68 -3.68 Sentry Conservative Balanced Income -2.27 6.40 7.23 1.29 1.62 -5.72 -5.72 Sentry Conservative Balanced Income Cl A -2.28 6.23 Standard Life Conservative Port A 2.53 5.12 Sun Life Granite Conservative Class A 3.86 Sun Life Managed Conservative Port A 3.86 5.97 1.17 -3.63 TD Comfort Conservative Income 1.61 3.45 0.86 -3.33 TD Target Return Conservative I -5.44 -0.64 -0.50 -7.17 RBC Conservative Growth & Inc Ser A SEI Conservative Class E Source: Morningstar Direct, Data as of September 30, 2015 1.27 4.67 3.66 1.02 -5.74 1.09 0.47 -3.62 -3.62 -10.60 ? When are Target-Date Funds the Right Choice? Investors taking their first steps on the road that will eventually lead to retirement have myriad choices at their disposal. One increasingly popular form of saving for retirement is investing in target-date funds. Indeed, many employers now offer target-date funds as an option within defined contribution plans and further, many plans are using them as the default option when employees enroll. Gaining a better understanding of this retirement option will help you decide if it can help you reach your retirement Jeffrey Bunce Analyst, Manager Research, Canada +1 416-484-7821 [email protected] goals. The growth and appeal of target-date funds is easy to understand. These professionally managed funds represent an all-in-one, diversified mix of stocks and bonds, the asset allocation and overall portfolio risk of which evolves over time as the fund's "target-date" approaches. Target-date funds typically include a year in their name to indicate that it is suitable for an investor expecting to retire in that year. For example, if you envision retiring in the year 2040, you may select a fund like BMO LifeStage 2040. As your retirement date is 25 years away, the fund will have a growth focus, holding mostly stocks to help you build capital. The fund gradually shifts to bonds and other lower-risk assets such as real estate and mortgages as the need for stable retirement income nears. This evolution is automatic and occurs without your involvement. As such, it represents a simple, low-maintenance approach, especially if you don't want to monitor and adjust your asset allocation throughout your working life. Nevertheless, investors need to do their homework before diving in. Breaking the buy high, sell low cycle A benefit of target-date funds is that they’ll likely protect you from yourself. Frequently, investors are their own worst enemy, buying securities at market tops and selling in downturns. Often, this leads to subpar returns compared with a buy and hold strategy. Because changes in the asset mix of a target- Page 21 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 4 date fund is done for you on a gradual basis over a number of years, the risk in timing asset allocation changes is reduced. A key finding in Morningstar’s 2015 Target-Date Fund Landscape report on U.S. target-date funds showed that their asset-weighted average investor returns, which take fund flows into account to estimate a typical investor’s experience in a fund, are 1.1% higher than the funds’ average total returns. Investor returns typically lag total returns in other investment categories, suggesting that target-date funds do improve investor behavior. A one-size-fits-all option While target-date funds are a relatively simple and complete retirement option, they aren’t for everyone. The biggest shortcoming is the lack of customization available within them. They are an all-in-one, onesize fits all proposition and because of that there is no ability to adjust the asset allocation to align with your specific risk tolerance. Just because you are 25 years away from retirement and theoretically possess a high risk capacity, doesn’t mean you are personally comfortable or willing to accept a volatile asset mix that may be as high as or higher than 90% equity. For instance, at the end of July, the MFS LifePlan Retirement 2040 fund is entirely invested in equities. An aggressive mix such as this could lose 20-30% or more in another scenario like 2008. If that possibility makes you sick to your stomach, then a more customized solution with less risk makes more sense. Certain investment managers have attempted to address this concern with the launch of target-risk, target-date funds. For example, with Franklin LifeSmart funds you can choose between a Conservative, Moderate or Aggressive version of its 2040 fund. Further, if your financial situation changes due to a change in career or health, starting a family, receiving an inheritance, going through a divorce, etc., there is no way to reflect your changing life circumstances with a target-date fund. Say in five to ten years you realize you’ll likely need to work another five to ten years beyond your original target retirement date to reach your goals. In that case, the 2040 fund that you chose, may no longer be appropriate. It will likely shift into a conservative asset mix too soon for your revised retirement outlook and the risk of possibility outliving your retirement savings becomes a real concern. Same target date, different allocations It’s important to note that not all target-date funds with the same end year have the same asset mix. The glide path, defined as the rate at which the asset mix shifts from predominately stocks to a greater mix of bonds, varies across managers/target-date series. For instance, the rate at which equity is transitioned to fixed income may start out slowly and accelerate as the target-date approaches or it may gradually and consistently decline through time. Similarly, the split of equity vs fixed income will also vary across managers at different points along the glide path. Some funds will have a consistently higher allocation to equity through time than others and some will start out with a lower allocation but maintain a higher level at the end of the glide path. Refer to the chart below to see the differences in the equity glide paths for a sample of target-date fund managers. MFS LifePlan, for example, has a glide path characterized by an all-stock approach early on (100/0 split between stocks and bonds) but rapidly transitions into bonds by retirement (30/70 split). In Page 22 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 4 contrast, PH&N LifeTime starts out more conservatively (80/20 split) but maintains a higher level of stocks at retirement (40/60). Exhibit 1: Equity glide paths for a sample of target-date managers Source: Morningstar These allocation differences have consequences. A fund with more equity will be more volatile than another fund with the same target-date but it will also potentially generate greater returns. For the one year ending July 31, 2015, MFS LifePlan Retirement 2040 returned 21.0% gross of fees versus Manulife Retirement Date 2040 which returned 11.8%. What this illustrates is that two funds with the same target date will not necessarily provide the same results nor have the same risk profile, especially over shorter time periods. Another drawback of target-date funds is that it is very difficult to benchmark performance. Each manager has their own glide path so peer comparison is tough and because the asset mix is always changing, calculating a custom benchmark quickly becomes a nightmare. With this challenge, it’s easier for the manager to get a free-pass of sorts as it relates to the performance of the funds. However, because most funds are in a fund-of-fund structure, you can look up the underlying holdings to see if the manager has held strong or poor performing funds. That should provide insight into whether the manager has added or detracted value. If the underlying funds have done well but the fund itself stills lags peers, then the asset mix may be to blame. Page 23 of 50 Manager Research Canada Observer | Q3 2015 Page 4 of 4 Fees matter Fees are another issue to watch out for as a 1% difference in fees over a long time horizon will have a big impact. For instance, assume you’ve chosen your 2040 fund and put $10,000 into it initially and didn’t contribute any further amount and that the fund earns 8% annually, gross of fees. If you pay 1% in fees per year, your stake will grow to just over $58,000 by the end of 2040. However, if you pay 2% per year, you’ll end up with about $45,500 or $12,500 less. This gap widens over larger sums and longer time horizons so don’t underestimate the impact of fees. If you’re interested in target-date mutual funds, fees vary depending on the distribution channel. For doit-yourself investors, PH&N offers its LifeTime target-date series and fees range from 0.96% for the 2015 fund to 1.31% for the 2045 fund. Funds sold through fee-based advisors carry similar charges and funds available from commission-based advisors will cost roughly 1.00% more, reflecting the embedded trailer fee. These fees are not cheap by any means but are not out-of-line with pricing in other balanced categories. The best deal on these funds may be available through your employer’s defined contribution platform (if applicable) where the fees have been negotiated on your behalf by your employer. Typically, on these platforms there will only be one target-date series available to choose from. If this is the case, try to ensure the management fees on the target-date funds are consistent with the other balanced or targetrisk funds offered in the plan. Be aware though that the fees for each fund in the series is usually the same, meaning that fees will represent a larger portion of your return through time as the allocation to lower returning fixed income increases. Lastly, some managers, such as the BlackRock, build their funds using passively managed strategies and should provide a cost advantage over a manager like Fidelity, which uses its own actively managed strategies within its funds. Stewardship counts One of the most important things to keep in mind when selecting a target-date fund is the manager’s reputation as a steward of investor’s capital. Remember, you could possibly own your target-date fund for twenty-five years or more and that means your investor experience is an important consideration and shouldn’t be taken lightly. If possible, try to invest with a manager who has experience running these funds, is in the business for the long term and has a history of putting investor interests ahead of its own. To gauge this, you can refer to Morningstar’s stewardship grades which rate, on a grade from A to F, some of the largest fund managers in Canada, many of whom have target-date funds. Examples of good stewardship practices include manager co-investment alongside unitholders, closing funds to new investments when they become large and compensation practices that reward long-term performance. Just do it for me The structure of target-date funds and the differences between series are important to understand to so you can gain comfort in the investment you make and assess the likelihood it will help you reach your retirement goals. To determine whether they are right for you though, the real question you have to ask yourself is whether or not you’re unlikely to monitor your investments and adjust your asset mix through time. If the answer is no and you fall into the do-it-for-me camp, then a target-date fund is an appropriate option for you. K ? Floating Rate Funds: Answer to Rising Rate Threat? A prevalent theme among fixed-income managers in recent years has been the expectation that interest rates will rise. Contrary to those expectations, rates have remained low for longer than anticipated, and the short-duration positions taken by the majority of active managers have been a significant driver of their underperformance relative to passive index trackers. Although the industry’s anticipation of higher interest rates may have been premature, the truth is that rates cannot go much lower than where they stand today, though it’s possible for them to stay where they are for a while. Because their coupons Achilleas Taxildaris Analyst, Manager Research +1 416 484-7013 [email protected] fluctuate along with interest rates, floating-rate loans have garnered increasing attention in recent years. Since funds that invest in floating-rate loans have almost no interest-rate risk, they have experienced significant inflows since early 2013. (See Exhibits 1 and 2.) Assets have almost doubled in the United States and increased several-fold in Canada compared with three years ago, though the recent pullback could suggest investor fear of rising rates has fallen. (It is instructive to look in the U.S., as this asset class involves mainly loans issued for U.S.-based corporations. These funds, which fall into the Bank Loan category, also have a longer history in the U.S. Only in 2015 was the group large enough in Canada to warrant a separate category.) What Are Floating-Rate Loans? Floating-rate or bank loans are denoted high-yield because the firms issuing them are highly leveraged. Companies with this kind of debt profile can get there either intentionally (because of a leveraged buyout, debt-fuelled acquisition, or recapitalization) or unintentionally (because of a deterioration of the underlying business of an erstwhile investment-grade firm). Some examples of top holdings in the widely used bank loan benchmark S&P/LSTA Leveraged Loan Index include widely-held names such as Valeant Pharmaceuticals and Burger King, but also more challenged ones like TXU and Dell. Either way, the risk from leverage is the same, even if the businesses may be moving in different directions. With increased leverage comes the increased probability of default and bankruptcy. Page 25 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 7 Healthcare Observer | 28 October 2015 Exhibit 1 After 2013 surge, assets float out of Canadian floating rate offerings (CAD billions) 250 200 150 100 50 (50) (100) 2010-10 2010-12 2011-02 2011-04 2011-06 2011-08 2011-10 2011-12 2012-02 2012-04 2012-06 2012-08 2012-10 2012-12 2013-02 2013-04 2013-06 2013-08 2013-10 2013-12 2014-02 2014-04 2014-06 2014-08 2014-10 2014-12 2015-02 2015-04 2015-06 2015-08 (150) Source: Morningstar Direct, Data as of August 31, 2015 Exhibit 2 After 2013 surge, assets float out of US floating rate offerings (USD billions) 500 400 300 200 100 0 -100 Apr-15 Dec-14 Apr-14 Aug-14 Dec-13 Apr-13 Aug-13 Dec-12 Apr-12 Aug-12 Dec-11 Apr-11 Aug-11 Dec-10 Apr-10 Aug-10 Dec-09 Apr-09 Aug-09 Dec-08 Apr-08 Aug-08 Dec-07 Apr-07 Aug-07 -200 Source: Morningstar Direct, Data of August 31, 2015 What Are Floating-Rate Loans? Bank loans have a variable interest rate that is reset every 30 to 90 days; since it is reset so frequently, the interest-rate sensitivity of the loan is near zero. The interest rate paid on the loan is a predetermined premium over the current floating base rate being used--typically, the London Interbank Offered Rate, or Libor. More recently issued bank loans include a "Libor floor," and rates are set to a spread above the Page 26 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 7 Healthcare Observer | 28 October 2015 greater of that floor or Libor; eventually, though, a sustained increase in Libor would translate into rising yields. Bank loan holders receive the highest priority in the case of a bankruptcy and are secured by collateral such as equipment, real estate, or accounts receivable. As a result, bank loans are considered safer than traditional high-yield bonds because this secured collateral protects the investor more than bonds in the event of a default. This higher safety comes with a slightly lower yield. As of the end of June 2015 the S&P/LSTA Leveraged Loan Index had a 5.35% yield, versus 6.76% for the Barclays U.S. Corporate High Yield Index. That is still a lot higher than the U.S. broad bond benchmark Barclays U.S. Aggregate Index 2.39% yield or the Canadian FTSE TMX Canada Universe Bond Index 2% yield. What Are the Risks? Floating-rate loan funds have considerable appeal in our low-rate environment given their attractive yields and low interest-rate sensitivity. Beyond the positives of this type of product, investors still need to understand the risks behind these funds and invest in them for the right reasons. Credit Risk Despite their seniority in the capital structure, floating-rate funds are still a long way from cash or even high-quality bonds. Even so, their seniority in the capital structure means they tend to have better recovery rates than typical high-yield bonds (on average around 70% versus below 50% for high-yield unsecured bonds). These firms can still default. Since the early 2000s, the default rate in the index has been above the relatively high 5% mark twice. They will suffer more during a prolonged economic downturn compared with investment-grade government or even corporate bonds. Therefore, investors should consider these funds as part of their high-yield fixed-income exposure. Liquidity Risk Bank loans don’t have the liquidity of standard corporate debt. The market for floating-rate loans has experienced significant growth in the past decade and now, with more than USD 800 billion in assets, is about half the size of the more established high-yield bond market. Despite the increased size of the market and the number of participants, bank loans don’t trade as much. Liquidity has become a general issue in the fixed-income space since the 2007-08 crisis, as tighter capital requirements for dealers mean smaller inventories. That raises a problem for floating-rate managers to find buyers for a position that wouldn’t affect the price negatively. Another concern with bank loans is that they can have long settlement times, up to six or eight weeks. That poses a significant risk in managing a fund, especially if there are large redemptions at any given time. This problem was particularly apparent during late 2014 in the U.S., when bank-loan funds' performance sagged; combined with general “risk-off” mentality, this led to rapid redemptions from the asset class. Many of the larger bank-loan funds that faced heavy redemptions had to use lines of credit to meet those redemptions, which illustrates the challenges of managing a limited-liquidity asset class in a daily liquidity format. In fact, Morningstar analysts in the U.S. downgraded recently two of the largest funds in the category because of these concerns. Page 27 of 50 Manager Research Canada Observer | Q3 2015 Page 4 of 7 Healthcare Observer | 28 October 2015 Interest-Rate Risk This is the one risk that investors are trying to avoid when investing in floating-rate loan funds, and generally they will, but they may be negatively surprised on the short term if they don’t read the fine print. Because of "Libor floors,” which set rates to levels to the greater of the floor or Libor (the overnight bank lending rate), many loans won’t have an increase in yield until short-term yields rise by more than 75 basis points. Thus, there will be a lag that may surprise investors who thought they were getting greater protection against rising rates than they are. Morningstar strategist John Gabriel discussed Libor floors in May 2015 and noted that, at the end of 2014, the weighted average Libor floor on the S&P/LSTA U.S. Leveraged Loan 100 Index was 0.85%. This essentially creates a fixed coupon on a floating-rate security until Libor exceeds many bank loans' Libor floors and introduces some, albeit limited, rate risk to bank-loan funds. Currency Risk For Canadian investors, the effect of currency changes is also an important risk they need to consider. In recent years, the returns of an unhedged strategy invested in U.S. floating-rate loans would be dominated by the currency movements. Over the long term, the impact could be smaller, but the volatility in unhedged fixed-income strategies tends to be much higher than in hedged ones. Investors looking only to decrease the duration of their fixed-income exposure should consider strategies that are hedged to the Canadian dollar. How Have Floating-Rate Funds Behaved? In the past decade, except for a short period in its start, there hasn’t been a sustained increasing interest-rate environment during which floating-rate funds could prove their worth. It is still instructive to look the past decade and see how the different asset classes in the U.S. bond market behaved. Exhibit 3 measures the floating-rate (leveraged loan) index against broader bond benchmarks over trailing periods. Exhibit 4 on page X puts the index's performance into a broader context on a year-by-year basis. From this small sample, we can identify that floating-rate loans seem to do well when the economy is strong and rates are rising or there is heightened concern about rising rates (2005, 2013), but they will struggle when economic conditions are worsening, resulting in raised corporate spreads (2007, 2008, 2011, and 2014). We can also see the high correlation with high-yield bonds, but despite the higher seniority in the capital structure they failed to provide better capital preservation when needed, mainly because of illiquidity issues. In fact, the only year that bank loans have posted a negative return in the past decade was in 2008, when they lost 29%. The losses suffered by the sector that year stemmed from overissuance of new loans in the wake of the leveraged buyout boom of 2006 and 2007. During that period, USD 667 billion in deals were completed, which is more than 4 times the USD 164 billion in bank-loan issuance tied to LBO deals struck during the past year and a half. Deals today are being completed at lower purchase price multiples and with a larger amount of equity than those in 2007. In the past, to help secure lucrative underwriting deals, banks regularly committed capital in the form of bridge loans. Bridge loans are a form Page 28 of 50 Manager Research Canada Observer | Q3 2015 Page 5 of 7 Healthcare Observer | 28 October 2015 Exhibit 3: Floating-rate (leveraged loan) versus other bond benchmarks Annualized trailing returns (USD) Name YTD 1 Yr 2 Yr 3 Yr 5 Yr 10 Yr Barclays US Aggregate Bond TR 1.38 2.17 3.6 1.74 3.02 4.72 S&P/LSTA Leveraged Loan TR 1.31 0.84 2.21 3.07 4.31 4.64 Barclays US Corporate High Yield TR -0.48 -1.25 2.38 3.98 6.21 7.63 Source: Morningstar Inc., Data as of August 31, 2015 Exhibit 4 Periodic table of bond market returns, 2005-2015 (USD) Source: Morningstar Direct, Data as of June 30, 2015 of short-term financing that bridges the gap between the time a deal is completed and the point at which more permanent funding is secured. According to J.P. Morgan, at the buyout boom's peak in in 2007, banks had committed USD 330 billion in the form of such bridge loans. When the crisis hit, the banks were unable to raise long-term financing to redeem these bridge loans. Regulatory concerns led the banks to dump the bridge loans onto the market at the height of the crisis. This served in part to Page 29 of 50 Manager Research Canada Observer | Q3 2015 Page 6 of 7 Healthcare Observer | 28 October 2015 push bank-loan prices down nearly 40%. Today, bridge loans are a minor part of the overall bank-loan market. We will inevitably move through a normal economic cycle in the coming years, and bank-loan defaults will rise if economic activity softens. That said, we are unlikely to see a dramatic collapse in prices in the bank-loan sector similar to that witnessed in 2008. This is because there is dramatically less leverage within the system given that LBO deals are much smaller in size today, bridge loans now play a relatively minor part in the financing market, and many leveraged hedge funds have retreated (or disappeared) from the market. Available options In Canada, investors looking to invest in floating-rate loans had only two options available before the financial crisis: Trimark Floating Rate Income and BMO Floating Rate Advisor. Both have been around since 2005, though they each got new management teams in 2013. The majority of the funds were launched in 2013 or later. That is not to say that the managers of these funds are rookies in managing the asset class. Shops like Fidelity and Manulife leveraged their U.S.-based expertise and have put managers in place that have considerable experience and supporting resources in the space. Fidelity’s Eric Mollenhauer manages the U.S. fund Fidelity Advisor Floating Rate High Income, which has a Morningstar Analyst Rating of Bronze. Other firms chose to out-source the expertise, partnering with specialists in the space. For example, AGF Floating Rate Income is managed by Eaton Vance and run by a team that has decades of experience in the asset class; the team also manages Bronze-rated Eaton Vance Floating Rate. Finally, there are the firms that, by bolstering their fixed-income capabilities with bank-loan expertise, appear adequately resourced to provide market-beating returns for their shareholders. Trimark, IA Clarington, and Mackenzie Investments have chosen that path. Exhibit 5 (next page) is a good representation of the available options in the commission-based distribution channel suitable for purchase through an advisor. Most of the funds are either mostly hedged to the Canadian dollar or have a fully hedged version (Fidelity, O'Leary). Renaissance Floating Rate Income is mostly unhedged. Additionally, most of the funds have U.S. dollar versions, available for investors that maintain U.S. dollar accounts. For do-it-yourself investors, there are three funds that have a D series and four exchange-traded funds (see Exhibit 6 on next page), only one of which aims to replicate the performance of an index: PowerShares Senior Loan CAD Hdg ETF (BKL) provides exposure to the U.S.-domiciled BKLN, the most widely held ETF in the space with close to USD 5 billion of assets, negating the currency impacts. BKLN seeks to replicate the performance of the S&P/LSTA U.S. Leveraged Loan Index by investing in its largest 100 loans. Exhibit 5 lists options in this group. Page 30 of 50 Manager Research Canada Observer | Q3 2015 Page 7 of 7 Healthcare Observer | 28 October 2015 Exhibit 5 Sampling of advisor-sold floating-rate funds Name AUM MER Return 1 Yr Inception Date AGF Floating Rate Income 365,799,257 1.83 -1.02 5/1/2012 BMO Floating Rate Income Sr A* 71,415,000 1.63 2.28 8/16/2015 Fidelity Floating Rate Hi Inc B 150,875,559 1.62 16.31 10/16/2013 IA Clarington Floating Rate Inc A 461,969,498 1.82 3.77 11/11/2013 IG Mackenzie Floating Rate Inc A 147,343,000 1.96 0.98 7/16/2014 Mackenzie Floating Rate Income A 463,141,357 2 -0.59 5/6/2013 Manulife Floating Rate Income Adv 423,807,940 1.73 -2.26 8/20/2010 O'Leary Floating Rate Income Series A 128,761,600 1.91 15.82 6/25/2013 Renaissance Floating Rate Income 704,884,189 1.83 16.02 9/16/2013 Trimark Floating Rate Income 274,905,540 1.66 4.82 1/25/2005 *The series with the oldest inception date is BMO Floating Rate Income Advisor, which has a slightly higher MER Exhibit 5 Do-it-yourself floating-rate funds Name AUM MER Return 1 Yr Inception Date BMO Floating Rate Income D 71,415,000 1.54 2.2 4/7/2014 Mackenzie Floating Rate Income D 463,141,357 1.29 0.15 3/19/2014 Trimark Floating Rate Income Ser D 274,905,540 1.35 5.16 12/9/2013 BMO Floating Rate High Yield ETF 499,959,027 0.45 3.41 2/10/2014 FT Senior Loan ETF CAD Hdg ETF 101,552,893 0.95 2.9 8/27/2013 Horizons Active Floating Rt Sr Ln ETF 53,093,333 0.83 N/A 10/14/2014 PowerShares Senior Loan CAD Hdg ETF 43,665,196 0.82 -0.45 4/13/2012 Source: Morningstar Direct, Data as of August 31, 2015 The FT Senior Loan and Horizon Active Floating Rate ETFs are both actively managed but have a significant leg up on their competition when it comes to fees. The BMO Floating Rate High Yield ETF at 0.45% is by far the cheapest in the category, but it is structured very differently from its peers. Instead of buying floating-rate loans, it buys 90-day treasuries and rolls them over to shield against interest-rate moves. Then it writes credit default swaps on high-yield bonds to provide the exposure and higher income that comes with the underlying securities. This is not a passive fund, as it doesn’t track an index, even though it has the ability to sell insurance, or write CDS for an index (CDX). This structure is untested in a down market, and, as with all decisions, investors need understand the risks before including this fund in their portfolio. This is a tougher exercise with this fund given the minimal disclosure of the underlying firms that the CDS are written for. K Page 31 of 50 Manager Research Canada Observer | Q3 2015 Sionna Cdn Small Cap Eq Cl A Analysis A hidden gem in the small-cap category. By Jeffrey Bunce, CFA 9/23/2015 As is sometimes the case in the small-cap realm, promising companies with strong management teams that are focused on executing over the long term can go unnoticed and unloved for extended periods of time. The stocks of these companies likely offer compelling risk/reward opportunities. Similarly, this appears to be the case with Sionna Canadian Small Cap Equity. A consistent and repeatable investment process executed by an experienced team has resulted in solid performance since the fund's inception at the end of 2006. What's puzzling is the fund's relatively small asset base, especially considering the capacity-constrained nature of the asset class and the closed status of many of the fund's top peers. While the fund has gone mostly unnoticed, a sound process executed by a strong team earns it a Silver Morningstar Analyst Rating. The fund is run by Sionna Investment Managers using a value investing philosophy. The firm targets underpriced companies with the expectation that stock prices will return to their intrinsic fair value over the long term. The team, led by industry veteran Kim Shannon, narrows its focus by first quantitatively screening the Canadian market for potentially mispriced stocks and then delving into the fundamentals of names that appear attractive and possess defensive traits. The team uses a standard questionnaire to evaluate a company's competitive position and its ability to generate steady earnings and cash flows, providing for consistency and repeatability in the research. At the portfolio level, they build a benchmark-agnostic portfolio with an emphasis on quality metrics, believing that stable companies will lead to compounding growth over time. The team is disciplined, though, and captures value by actively trimming or adding to names as they move closer to or further from intrinsic value. The fund can lag its more aggressive peers in up markets but should protect value in falling markets. Its 31.2% loss in 2008 was less severe than what the majority of its peers suffered, stacking up nicely against the median manager's 42.1% decline. Similarly, the portfolio performed well when the benchmark experienced negative returns in 2011 and 2014 and has only experienced 45.7% of the benchmark's downside since the fund's inception. Further, the strategy has been a consistent performer. Over rolling 36 month periods, the fund has outperformed the benchmark 73% of the time and finished in the first or second quartile in the Canadian small/mid-cap equity category 78% of the time. It has achieved these results with a low standard deviation that ranks in the bottom quartile. Process Pillar: ∞ Positive While there isn't one part of the process that sticks out as having a competitive advantage, Sionna gets its edge from the consistency with which it plies its trade, earning it a Positive for Process. The team employs an intrinsic value model which screens and ranks the Canadian universe on the basis of book value, historical return on equity, and relative price/earnings ratios. The team then focuses its attention on those stocks trading 30% below their intrinsic value. Despite the model being fairly basic, it is effective at focusing the team's attention on the most attractive opportunities. Sionna typically embraces companies experiencing cyclical or operational troubles as they claim these firms are often misunderstood by the broader market. The team eschews high levels of financial risk and will avoid companies with too much debt, resulting in a portfolio with a quality bent. Morningstar’s Take „ Morningstar Analyst Rating Morningstar Pillars ∞ Positive ∞ Positive Process Performance People Parent Price ∞ Positive ∞ Positive ¶ Neutral Morningstar Analyst Rating Morningstar evaluates mutual funds based on five key pillars, which its analysts believe lead to funds that are more likely to outperform over the long term on a riskadjusted basis. Analyst Rating Spectrum Œ „ ´ ‰ Á Fund Performance YTD Total Return % +/- Category — — Stocks that screen well are examined under a fundamental lens to develop a full understanding of a company's prospects and risks. Importantly, the team leverages a singular research questionnaire and seeks to answer the same questions about each company providing consistency and comparability. The whole team then debates potential buys in a group setting and strives for consensus before making a decision. Notable in this process is Sionna's desire to avoid common behavioural biases that can undermine group decision-making. ©2015 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. ® ß Page 32 of 50 Manager Research Canada Observer | Q3 2015 Sionna Cdn Small Cap Eq Cl A Analysis In a category mixed with mid- and small-cap funds, Sionna builds a true small-cap portfolio of 30 to 55 names. The weighted average market cap of the fund as of June 30, 2015, was $768 million, which was less than the BMO Small Cap Index and among the lowest in the category. The large majority of positions have a market cap less than $2 billion; solidly in the small cap arena. Even though Sionna generates and researches ideas in the same manner as its large-cap names, the smallcap portfolio looks slightly different. While the fund will have value characteristics because of its process, the team emphasizes quality over value in the small-cap space. This results in the portfolio easily exhibiting higher returns on equity, returns on invested capital, and lower debt/capital than the benchmark and category average. For example, the fund's return on invested capital is 10.1%, which compares favourably to the Index at 3.0% and the category average at 7.1%. Meanwhile, value characteristics are less prominent. The price/earnings ratio of 16.5 is less than the benchmark's 18.6 but price/book and price/sales ratios are higher than the benchmark. In another departure from its large-cap sibling, the team constructs the portfolio in a benchmark-agnostic manner; avoiding exposure to junior oil and gold companies with little to no revenue and instead concentrating on companies with morestable, long-term track records. This corresponds to a greater than 20% overweighting in the financials sector and close to a 6% overweighting in the industrials sector while underweight positions in the materials and energy sectors amount to approximately 12% and 4%, respectively. The portfolio is also absent holdings in health care and utilities. Further, Sionna prizes owner-operators where management has a significant ownership stake in the business and has a history of growing shareholder wealth. These management teams are also more likely to be conservative and have a longterm orientation; aligned with investors. Examples of owner-operator stocks in the portfolio include Home Capital Group and FirstService Corp both of which are in the top 10 holdings. Performance Pillar: ∞ Positive The appeal of the small-cap strategy comes from its low volatility, which ranks in the lowest quartile of the category. Further, the fund has consistently outperformed the category and benchmark in down markets such as 2008, 2011, and 2014. The defensive, quality-oriented approach has worked well in the small-cap space during the last number of years. Since inception in late December 2006, the fund has an annualized return of 7.2%, outperforming the BMO Small Cap Index by 5.9% and the category average by 2.7%. During this period, Morningstar's attribution shows that stock selection in the materials, energy, and financials sectors has been a strong contributor of outperformance, a credit to the team's bottom-up, fundamental process. Investors should keep in mind that this performance record was achieved in an environment that has generally been conducive to Sionna's strategy, so expectations going forward should be tempered. Indeed, the fund's up-capture ratio of 67% ranks in the bottom quartile, so expect the fund to lag the benchmark and peers if low-quality stocks or commodities rally. Despite this, returns on an absolute basis should remain attractive. joining Sionna in 2003, Lee ran a small-cap value strategy for seven years at Royal & Sun Alliance. Shannon and Lee are also supported by portfolio managers Marian Hoffmann, Mel Mariampillai, and David Britton. Further, Sionna adds to its depth by hiring analysts fresh out of school or with only a few years of experience to be groomed in the Sionna discipline. With the exception of Shannon, all investment team members conduct research. Analysts start off as generalists before settling on specific sector coverage that spans the entire market-cap spectrum. Shannon remains the gatekeeper of the firm’s culture, philosophy, and process, so we would be concerned with any change in her role. However, a strong cast of talent is emerging to eventually take the reins of the firm. Shannon's experience and her deep and growing team, all of whom share in the same value discipline, result in a Positive for People. Parent Pillar: ∞ Positive Bridgehouse Asset Managers is fully owned by San Diego-based Brandes Investment Partners--an independent advisory firm founded by Charles Brandes in 1974. The firm first launched a suite of mutual funds in Canada in 2003. Bridgehouse distributes funds run by Brandes, Sionna Investment Managers, Lazard Asset Management, and Greystone Managed Investments. People Pillar: ∞ Positive President and CIO Kim Shannon oversees the investment team. She is the face of Sionna and is highly engaged in the portfolio management process. Shannon's 30-plus years in the industry and experience managing portfolios through numerous market cycles is invaluable. Prior to founding Sionna in 2002, she built a solid track record as CIO at Merrill Lynch Canada. Shannon's wealth of experience provides her with a long-term perspective that not many in the industry can match. Because of this, she has a good appreciation of market mispricing and how it tends to revert to historical averages over time. Teresa Lee is the lead portfolio manager for the fund, having managed it since inception. Prior to Brandes' Graham-and-Dodd value approach has had some bumps along the way. While the execution of this strategy historically has been consistent, the firm's large-cap committee appeared reluctant to make the aggressive moves that we would have expected given the opportunities that abounded through the market downturn in 200809. The firm has experienced a dramatic slide in its asset base since then, primarily because of market performance, but client outflows have also been hefty. The Canadian fund lineup was strengthened following an alliance in December 2006 with Sionna, an employee-owned boutique manager focused on Canadian equity. Sionna's investment style is also ©2015 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. ® ß Page 33 of 50 Manager Research Canada Observer | Q3 2015 Sionna Cdn Small Cap Eq Cl A Analysis value-oriented, although its products could be characterized as more mainstream. Bridgehouse further expanded its lineup in 2013 and 2014, adding alliances with Lazard and Greystone. Overall, Bridgehouse and its strategic partners seem to put a greater focus on performance than product creation or marketing. The firm has also shown discipline by closing funds to new investment in periods where their asset bases have grown. Price Pillar: ¶ Neutral The fund falls in the middle of the pack in the Canadian small/mid-cap equity category, resulting in a Neutral rating for Price. The A share class, with a 2.56% management expense ratio, is 0.08% cheaper than the median. The F share class though, with an MER of 1.51%, is slightly more expensive relative to its distribution channel. Portfolio turnover has ranged between 30% and 60%. This modest level of turnover gives the fund one of the lowest trading expense ratios in the category, averaging 0.12% during the last five years. Ranking MER and TER together, the fund looks more attractive, placing in the secondcheapest quintile. Bridgehouse has absorbed fees and expenses during the past few years, making the MER more competitive. As the fund has grown, the amount the manager has absorbed has declined but still amounted to 0.22% in 2014. ©2015 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. ® ß ? Manager Research Canada Ratings Update Recent Analyst Rating Changes Source: Morningstar Direct, Morningstar Research ? Better Disclosure, Low Fees Earn RBC an A Stewardship Grade Corporate culture: B The 2008 purchase of Vancouver-based Phillips, Hager & North (PH&N) signalled the start of a new era at RBCGAM. Prior to its purchase by the Royal Bank of Canada-owned investment firm, PH&N was one of Canada's largest independent investment managers and had established itself as one of the premier Canadian fixed-income managers. Shehryar Khan Analyst, Manager Research +1 416-484-7015 [email protected] Stewardship Grade Scorecard RBC Global Asset Management Corporate Culture: B Fund Manager Incentives: A Fees: A Regulatory History: Neutral Overall Stewardship Grade: A Despite some initial personnel turnover immediately before and during the aftermath of the acquisition, both RBC AM and PH&N's investment teams have largely stabilized and grown since 2010. Additionally, over 2012 and 2013, RBCGAM continued to build its U.K.-based emerging-markets investment team, adding five new members, and in early 2014 it added 10 new members to its U.K.-based global equity team. RBCGAM also purchased U.K.-based BlueBay Asset Management toward the end of 2010, which helped it further broaden its lineup. BlueBay manages global investment-grade, high-yield, convertible, and emerging-markets bonds, as well as alternative strategies. RBC also hasn’t been afraid to take talent from the firms it acquires and place them in senior positions at GAM. Indeed, members of the senior PH&N and BlueBay leadership now occupy prominent roles at RBCGAM: Both co-CEO’s of GAM, Alex Khein and Damon Williams, joined the firm via the BlueBay and PH&N acquisitions, respectively, and Hanif Mamdani, who was PH&N's chief investment officer, is head of alternatives. RBC gets credit for not just retaining the talent and processes of many areas of PH&N but also sharing many of the practises with other groups within RBCGAM. RBC's domestic-bond managers, for example, now use PH&N's proprietary risk management and attribution tool, BondLab, though not to the same extent as PH&N managers, and are building out the capability to be able to use the software globally.IN Page 36 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 4 Healthcare Observer | 28 October 2015 In 2011, the firm also hired Bill Tilford, who helped build Connor Clark & Lunn Investment Management's quantitative team and process and was later at Canadian Pension Plan's Investment Board. Tilford strengthened RBC’s quantitative resources; he is the engine behind RBC's quantitative screening tools such as QUBE and its in-house quantitative funds, including its ETF lineup of low-volatility and dividendoriented ETFs. To serve its broad clientèle, RBCGAM takes a supermarket approach to its lineup, offering funds in most asset classes. It is tough to be good at everything, however. While the firm is strong in fixed income, through both RBC funds and PH&N funds, as well as in foreign equities through its U.K. teams, its domestically focused RBC funds generally are a lacklustre bunch. While there isn't a unifying theme across RBCGAM's funds, it has also generally stayed away from gimmicky products. The firm’s recent initiatives in launching a suite of low-volatility and dividend-focused funds and ETFs are driven by Tilford’s quantitative expertise, which is well-established, and all have longterm investment merit. RBCGAM also has improved areas of weaknesses at the firms it has acquired. PH&N’s Canadian equity team went through an overhaul in 2010 after a period of mixed performance, for example. The team, now led by Doug Stadelman, has made strides to make the investment process repeatable by bringing in elements of the RBC equity team's quantitative screening tool to help with idea generation. PH&N Canadian Equity's resource sleeve is also managed by RBC's Chris Beer and Brahm Spilfogel rather than PH&N's own equity team. Beer and Spilfogel specialize in resource stocks and have built an enviable record on their funds. Most of RBC’s assets reside in the advisor channel, though, with the lion’s share of its retail assets distributed in-house. The firm leverages its wide lineup and the Royal Bank's coast-to-coast bank branch network to bring in new money, helping it become the largest asset manager in Canada; RBCGAM manages more than $260 billion of assets in Canada, making capacity management crucial. RBC’s track record on this front is mixed. It has carefully managed capacity at $3.5 billion PH&N High Yield; aside from a brief reopening in late 2014 to allow management to take advantage of market turbulence, the fund has been closed to new investments since November 2010. Unfortunately, the same could not be said for RBC’s flagship Canadian equity offering, RBC Canadian Dividend, whose $16.7 billion asset base makes it the single largest mutual fund in the country. With limited flexibility, the fund has little room to make meaningful bets against its benchmark, leading to middling performance. A similar story has played out at RBC Equity Income. Thanks to rapid asset growth in recent years, the fund can no longer hold the small- and micro-cap stocks that fueled its early success, contributing to its mediocre returns ever since. RBC’s domestic-equity lineup could face additional capacity strains thanks to the success of funds of funds like RBC Select Conservative and Select Balanced, which have $19 billion and $17.7 billion in assets, respectively. These funds’ rapid growth could mean more new money flows into already-bloated underlying holdings like Canadian Dividend, though by broadening its lineup to include a larger number of Page 37 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 4 Healthcare Observer | 28 October 2015 underlying holdings, RBC can blunt the impact. RBCGAM aspires to join the ranks of the global elite, but the firm’s mixed record in capacity management undermines this goal. Capacity management is just one part of an assessment of a firm's culture, though, and overall RBCGAM’s strengths outweigh their weaknesses, earning it a B on corporate culture. Fund Manager Incentives: A Portfolio managers who invest alongside their fundholders not only show a conviction in their investment approach and portfolios but also are better able to share in a true fundholder experience as they endure the same consequences as their investors. For these reasons, Morningstar's Manager Incentives grade is determined primarily by how heavily and predominantly a fund family's managers own the funds offered by their firm. According to RBCGAM, 60% of its managers have at least two years' base salary invested in either RBC or PH&N funds--an industry-leading level of coinvestment. A manager's bonus is based on one-, three-, and five-year performance, with the three- and five-year numbers more heavily weighted. The performance is measured gross of fees and on a before-tax basis. Morningstar considers net-of-fees performance and aftertax assessment to be a best practise. Managers are also assessed qualitatively on things like communication and attitude toward colleagues. Senior investment members are also eligible for the profit-sharing plan. Bonuses and PSP are subject to a mandatory three-year deferral. Until this year, RBCGAM had disclosed its coinvestment levels as percentage of an individual’s investable assets, which did not provide us with the opportunity to make an apples-to-apples comparison with peers, resulting in a C grade in the past. Encouragingly, its disclosure has improved and can now be compared with competitors, resulting in firm getting an A grade for Manager Incentives. That upgrade pushed its overall Stewardship Grade to A from B. Fees: A Morningstar calculates a fund family's Fees grade based on the straight average and asset-weighted average percentile of all the family's funds. These percentiles compare each fund share class with similar distribution channels, ranging from 1 (for the cheapest in each group) to 100 (for the most expensive). RBCGAM offers funds targeted to investors using the services of an advisor or buying funds themselves through discount brokers. At first glance, the D series are not especially cheap--they land in the 40th percentile on an average basis. Encouragingly, RBC has made its biggest funds much cheaper--on an asset-weighted basis, the funds land in the 18th percentile, though this is a small universe in which RBCGAM is the biggest player. RBCGAM also has a low minimum initial investment on this series, generally $500. The bulk of RBC’s funds are sold through advisors. The firm’s pricing is competitive in the commissionbased channel, where most of its assets reside, ranking in the top quintile on an asset-weighted and equal-weighted basis. As in the DIY channel, RBC’s fee-only funds land in the 40th percentile on an equal-weighted basis, but, with the biggest funds relatively cheap, they fall in the 26th percentile on an asset-weighted basis. As formerly more-expensive rivals like Manulife and BMO slash prices in the fee- Page 38 of 50 Manager Research Canada Observer | Q3 2015 Page 4 of 4 Healthcare Observer | 28 October 2015 only channel in anticipation of increased advisory fee disclosure requirements, RBC will have to work harder to remain competitive. Overall though, most of RBCGAM's funds boast attractive prices, resulting in an A grade on Fees. Regulatory History: Neutral Because investors should expect fund companies to comply with laws and regulations, the highest Regulatory History rating a firm can receive is Neutral. Because RBC GAM has not had material regulatory infractions in the recent past, it gets full credit for Regulatory History. K ? Market Performance 3 Month YTD 1 Year 3 Yr 5 Yr 10 Yr 15 Yr S&P/TSX 60 TR CAD -6.74 -6.16 -6.50 6.89 4.88 5.14 4.08 S&P/TSX Capped Composite TR CAD -7.86 -7.02 -8.38 5.71 4.46 4.83 5.21 BMO Small Cap Blended (Weighted) CAD -14.74 -13.93 -20.18 -2.88 -0.49 2.78 5.46 S&P/TSX Completion TR -11.24 -9.64 -13.84 2.34 3.20 4.26 4.29 S&P/TSX Small Cap TR -15.17 -14.27 -21.75 -4.07 -2.74 0.10 2.61 S&P 500 TR CAD 0.47 9.63 19.23 24.61 19.57 8.35 Russell 2000 TR CAD -5.41 6.80 21.46 23.08 17.88 8.10 MSCI ACWI NR CAD -2.76 7.60 11.98 18.57 12.70 6.10 2.55 MSCI World GR CAD -1.56 9.24 14.49 21.04 14.88 6.84 2.97 MSCI EAFE GR CAD -3.55 10.07 10.05 17.61 10.19 4.94 2.68 MSCI EM GR CAD -11.70 -1.86 -2.81 5.39 2.07 6.12 6.96 FTSE TMX Canada Universe Bond 0.15 2.52 5.29 3.39 4.45 5.00 5.95 FTSE TMX Canada All Government Bond 0.27 2.70 5.82 3.26 4.30 4.85 5.80 FTSE TMX Canada All Corp Bond -0.16 2.07 3.98 3.73 4.85 5.45 6.39 FTSE TMX Canada ST Bond 0.00 2.11 3.05 2.42 2.66 3.79 4.59 FTSE TMX Canada MT Bond 0.79 3.84 6.64 4.19 5.27 5.73 6.61 FTSE TMX Canada LT Bond -0.12 2.13 7.49 4.08 6.70 6.53 7.72 FTSE TMX Canada Real Return Bond -1.26 2.05 3.40 0.14 4.41 4.79 7.24 S&P/TSX Preferred Share TR -12.89 -20.38 -19.64 -5.67 -1.21 0.37 Canadian Equity Market Indexes U.S. Equity Market Indexes Global Equity Market Indexes Canadian Fixed Income Market Source: Morningstar Direct, Data as of September 30, 2015 Page 40 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 3 Periodic Table of Historical Asset Class Returns Source: Morningstar Direct Page 41 of 50 Manager Research Canada Observer | Q3 2015 Page 3 of 3 Correlation Matrix Major Market Indexes October 2005-September 2015 Investment Name 1 2 3 4 5 6 7 8 9 10 11 12 13 1 S&P/TSX Composite TR 2 S&P/TSX Completion TR 93% 3 S&P/TSX Composite Dividend TR 99% 91% 4 S&P/TSX Small Cap TR 90% 96% 87% 5 S&P 500 TR CAD 47% 33% 44% 28% 6 Russell 2000 TR CAD 51% 47% 47% 44% 80% 7 MSCI ACWI NR CAD 64% 52% 61% 47% 89% 73% 8 MSCI EAFE GR CAD 57% 47% 54% 42% 72% 55% 94% 9 MSCI EM NR CAD 66% 63% 66% 60% 44% 47% 72% 67% 10 FTSE TMX Canada Universe Bond -15% -14% -18% -17% 11% -5% 13% 15% 9% 11 FTSE TMX Canada All Government Bond -18% -17% -21% -19% 10% -6% 10% 12% 7% 100% 12 FTSE TMX Canada ST Bond -17% -16% -21% -17% 13% -2% 17% 20% 12% 92% 91% 13 FTSE TMX Canada LT Bond -16% -14% -19% -18% 8% -8% 7% 8% 5% 98% 98% 84% 14 FTSE TMX Canada All Corp Bond -5% -2% -8% -6% 17% -1% 22% 24% 18% 97% 94% 90% 94% 15 FTSE TMX Canada Cdn Trsy Bill 91 Day -4% -10% -5% -12% 30% 25% 29% 30% 12% 47% 48% 55% 43% Source: Morningstar Direct, Data as of September 30, 2015 14 44% ? Morningstar Category Performance Name 3 month YTD 1YR 3YR 5YR 10YR 15YR Canada US Money Market 7.42 15.85 20.10 10.97 5.59 2.63 0.50 Canada Real Estate Equity 3.13 7.69 17.53 14.29 11.55 6.95 8.90 Canada Global Fixed Income 1.43 4.11 5.62 4.40 4.20 4.44 3.45 Canada Canadian Synthetic Money Market 0.00 0.17 0.26 0.29 0.30 1.15 Canada Canadian Long Term Fixed Income -0.07 1.52 6.24 2.78 5.93 5.24 6.48 Canada Canadian Short Term Fixed Income -0.11 1.43 2.05 1.82 1.83 2.55 3.03 Canada Canadian Fixed Income -0.22 1.68 3.50 2.66 3.40 3.90 4.63 Canada European Equity -0.27 13.00 13.44 16.77 9.92 5.04 2.55 Canada Floating Rate Loans -0.37 3.87 4.26 2.68 3.59 1.57 Canada Global Fixed Income Balanced -1.21 1.95 3.88 5.99 5.46 4.37 Canada 2015 Target Date Portfolio -1.35 1.84 4.00 6.46 6.01 Canada 2020 Target Date Portfolio -1.58 0.74 2.17 4.20 3.87 3.44 Canada Canadian Inflation-Protected Fixed Inc -1.64 0.70 1.79 -0.71 3.13 3.09 3.70 Canada Canadian Fixed Income Balanced -1.68 0.50 1.89 4.64 4.50 3.72 3.79 Canada US Equity -2.00 5.08 13.05 20.17 15.33 6.19 1.69 Canada Global Neutral Balanced -2.10 2.35 4.63 8.31 6.60 4.43 3.82 Canada 2025 Target Date Portfolio -2.19 0.20 2.35 5.68 4.91 4.09 Canada High Yield Fixed Income -2.63 1.07 0.69 3.93 4.99 4.60 4.72 Canada Financial Services Equity -3.10 2.88 6.37 16.53 10.00 3.20 3.55 Canada Global Equity Balanced -3.14 2.46 4.71 10.68 7.74 4.48 3.29 Canada Canadian Neutral Balanced -3.26 -1.27 -0.27 6.21 5.45 4.48 4.62 Canada 2025+ Target Date Portfolio -3.41 -0.15 2.22 7.07 5.79 Canada Global Equity -3.43 4.80 8.57 15.22 10.52 5.09 1.94 Canada Tactical Balanced -3.78 -0.96 -0.28 6.38 5.22 3.99 4.03 Canada North American Equity -4.07 1.62 4.82 13.41 10.11 5.06 3.16 Canada International Equity -4.68 7.90 8.24 14.39 7.90 3.31 1.13 3.61 Page 43 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 2 Name 3 month YTD 1YR 3YR 5YR 10YR 15YR Canada Canadian Equity Balanced -4.80 -3.42 -2.90 6.38 4.83 3.95 4.92 Canada US Small/Mid Cap Equity -4.95 3.95 13.66 18.71 15.19 7.21 3.71 Canada Global Small/Mid Cap Equity -5.03 6.30 8.95 17.34 11.05 5.63 3.56 Canada Canadian Dividend & Income Equity -5.77 -6.09 -6.80 6.73 6.19 4.86 6.64 Canada Canadian Focused Equity -6.20 -3.08 -1.86 10.00 6.73 4.43 5.11 Canada Canadian Equity -6.22 -5.87 -6.29 7.45 5.14 4.10 4.17 Canada Asia Pacific Equity -7.62 6.35 7.23 12.37 5.55 4.33 1.36 Canada Canadian Focused Small/Mid Cap Equity -9.21 -3.76 -2.54 7.82 6.73 3.75 5.62 Canada Asia Pacific ex-Japan Equity -9.56 3.31 5.89 7.99 4.40 6.71 3.92 Canada Preferred Share Fixed Income -10.50 -15.84 -14.30 -4.85 -1.45 Canada Canadian Small/Mid Cap Equity -11.01 -8.08 -11.52 6.18 6.13 4.47 7.18 Canada Emerging Markets Equity -11.11 -4.33 -5.86 3.41 -1.02 3.78 3.94 Canada Precious Metals Equity -15.30 -9.23 -17.40 -24.72 -17.81 0.38 8.09 Canada Greater China Equity -16.63 3.79 16.39 14.67 3.90 8.44 4.84 Canada Natural Resources Equity -19.57 -18.89 -33.81 -14.39 -12.87 -1.88 6.07 Canada Energy Equity -20.39 -22.55 -39.25 -5.78 -2.23 -1.93 5.73 Data as of September 30, 2015, Return ranking over 3 month period ? Largest Mutual Fund Performance Name AUM ($) Morningstar Category Morningstar Rating Overall % Rank Cat 1 Yr % Rank Cat 3 Yr % Rank Cat 5 Yr % Rank Cat 10 Yr % Rank Cat 15 Yr RBC Select Conservative Portfolio Sr A 19,660,596,320 Global Neutral Balanced ÙÙÙ 51 75 81 54 19 RBC Select Balanced Portfolio Sr A 18,479,872,037 Global Neutral Balanced ÙÙÙÙ 39 30 36 43 22 RBC Canadian Dividend Sr A 17,378,059,423 Canadian Dividend & Income Equity ÙÙÙ 52 26 40 38 20 Investors Dividend C 16,192,450,000 Canadian Equity Balanced ÙÙÙ 73 51 48 70 40 RBC Bond Sr A 13,139,643,418 Canadian Fixed Income ÙÙÙ 25 32 28 34 51 TD Canadian Bond - I 12,627,892,450 Canadian Fixed Income ÙÙÙ 28 49 42 36 13 Fidelity Monthly Income Series A 12,223,031,195 Canadian Neutral Balanced ÙÙÙÙ 30 34 17 10 TD Canadian Core Plus Bond - A 11,373,371,908 Canadian Fixed Income ÙÙÙ 46 50 32 Fidelity Canadian Bond Sr A 9,866,193,430 Canadian Fixed Income ÙÙÙ 39 70 59 RBC Select Very Conservative Port Adv 9,848,106,404 Canadian Fixed Income Balanced ÙÙÙ 37 53 68 CI Signature High Income 9,661,772,574 Global Neutral Balanced ÙÙÙ 91 85 Manulife Monthly High Income Adv 9,517,274,995 Canadian Neutral Balanced ÙÙÙÙÙ 14 RBC Monthly Income Sr A 8,718,263,067 Canadian Neutral Balanced ÙÙÙ 71 PH&N Bond Sr D 8,704,344,425 Canadian Fixed Income ÙÙÙÙÙ TD Mgd Income Portfolio I 7,928,018,477 Fixed Income Balanced TD Monthly Income - I 7,794,215,084 PIMCO Monthly Income A 7,765,311,736 PH&N Total Return Bond Sr D 60 47 39 12 1 3 6 21 1 83 71 39 8 7 13 15 6 6 ÙÙÙÙ 15 16 37 52 34 Canadian Neutral Balanced ÙÙÙÙ 78 60 40 28 6 Global Fixed Income ÙÙÙÙ 60 32 7,356,977,609 Canadian Fixed Income ÙÙÙÙÙ 9 10 12 7 2 Fidelity Canadian Balanced Sr A 7,258,124,522 Canadian Neutral Balanced ÙÙÙÙÙ 12 16 15 18 18 CI Income Class A 6,648,851,570 Global Fixed Income Balanced ÙÙ 68 83 Fidelity Canadian Asset Alloc Sr B 6,576,828,451 Canadian Equity Balanced ÙÙÙ 44 57 65 33 49 TD Comfort Balanced Port - I 6,442,529,559 Global Neutral Balanced ÙÙ 79 83 76 RBC Balanced Sr A 6,384,791,532 Canadian Neutral Balanced ÙÙ 48 54 75 81 77 RBC Select Growth Portfolio Sr A 6,312,349,796 Global Equity Balanced ÙÙÙ 38 43 49 53 24 TD Dividend Growth - I 6,171,242,937 Canadian Dividend & Income Equity ÙÙÙ 54 29 44 47 30 Manager Research Canada Observer | Q3 2015 Page 45 of 50 Page 2 of 2 TD Income Advantage Portfolio - I 6,052,653,524 Fixed Income Balanced ÙÙÙ 69 75 74 25 Investors Income Plus Portfolio C 5,973,624,999 Fixed Income Balanced ÙÙ 83 74 88 74 TD Global Low Volatility A 5,865,319,839 Global Equity ÙÙÙ 42 51 CI Signature Income & Growth 5,683,890,916 Global Neutral Balanced ÙÙÙÙ 89 61 50 17 Manulife Strategic Income Adv 5,611,388,085 High Yield Fixed Income ÙÙÙÙ 14 13 14 RBC European Equity Sr A 5,563,610,430 European Equity ÙÙÙÙ 30 20 28 70 Sentry Canadian Income 5,458,260,981 Canadian Focused Equity ÙÙÙÙ 26 41 14 9 Dynamic Strategic Yield Sr A 5,428,560,912 Global Neutral Balanced ÙÙÙ 73 78 40 Investors Real Property C 5,414,388,000 Income and Real Property TD Comfort Balanced Growth Portfolio - I 5,271,688,065 Global Neutral Balanced ÙÙÙ 77 65 64 RBC Global Corporate Bond Adv 5,260,277,618 Global Fixed Income ÙÙÙ 73 68 61 38 Investors Mortgage & Short Term Income 5,220,121,001 Canadian Short Term Fixed Income ÙÙ 73 88 84 79 78 Beutel Goodman Canadian Equity Class D 5,106,778,223 Canadian Equity ÙÙÙÙÙ 44 15 19 8 3 PH&N Short Term Bond & Mortgage Sr D 5,094,015,157 Canadian Short Term Fixed Income ÙÙÙÙ 16 17 22 11 1 CIBC Monthly Income 4,972,980,125 Canadian Neutral Balanced ÙÙ 92 95 91 82 21 TD Mgd Inc & Mod Growth Port I 4,916,301,190 Global Neutral Balanced ÙÙÙ 42 51 69 80 34 Scotia Canadian Dividend 4,911,231,954 Canadian Dividend & Income Equity ÙÙÙÙ 12 12 27 43 35 Fidelity True North Sr A 4,817,184,406 Canadian Equity ÙÙÙÙÙ 12 10 15 14 16 RBC Canadian Short Term Income Sr A 4,695,319,930 Canadian Short Term Fixed Income ÙÙÙ 46 57 53 53 48 CI Harbour Growth & Income 4,501,834,164 Tactical Balanced ÙÙ 69 68 64 83 1 TD Comfort Balanced Income Portfolio - I 4,472,908,636 Fixed Income Balanced ÙÙÙ 73 55 54 EdgePoint Global Portfolio Series A 4,398,667,109 Global Equity ÙÙÙÙÙ 9 1 2 TD Short Term Bond - I 4,336,824,610 Canadian Short Term Fixed Income ÙÙÙÙ 36 48 49 29 9 TD Dividend Income - I 4,293,143,384 Canadian Equity Balanced ÙÙÙ 62 38 32 30 4 Fidelity Canadian Large Cap Sr A 4,207,292,889 Canadian Focused Equity ÙÙÙÙÙ 16 10 9 4 4 Source: Morningstar Direct, Data as of June 30, 2015 24 83 ? Largest ETF Performance Name AUM ($) Morningstar Category Morningstar Rating Overall % Rank Cat 1 Yr % Rank Cat 3 Yr % Rank Cat 5 Yr iShares Canadian Select Dividend 1,370,165,958 Dividend & Income Equity ÙÙÙ 83 66 64 iShares S&P/TSX Cdn Div Aristocrats Adv 1,014,898,742 Dividend & Income Equity ÙÙÙ 58 68 54 BMO Canadian Dividend ETF 552,365,546 Dividend & Income Equity ÙÙ 88 85 % Rank Cat 10 Yr % Rank Cat 15 Yr 57 iShares S&P/TSX 60 10,018,082,677 Canadian Equity ÙÙÙÙ 47 60 57 25 iShares Core S&P/TSX Capped Composite 1,980,849,408 Canadian Equity ÙÙÙ 57 71 62 34 BMO S&P/TSX Capped Composite ETF 1,142,069,298 Canadian Equity ÙÙÙ 57 69 70 BMO Low Volatility Canadian Equity ETF 612,668,859 Canadian Equity ÙÙÙÙÙ 1 1 Horizons S&P/TSX 60 ETF 525,607,932 Canadian Equity ÙÙÙ 46 58 55 iShares CAN Fincl Monthly Inc Adv 429,411,827 Canadian Equity Balanced ÙÙ 83 48 41 86 iShares Canadian Universe Bond 1,928,882,964 Canadian Fixed Income ÙÙÙÙ 9 19 17 14 iShares Canadian Corporate Bond 1,555,887,692 Canadian Fixed Income ÙÙÙÙ 42 15 10 BMO Mid Corporate Bond ETF 829,572,555 Canadian Fixed Income ÙÙÙÙÙ 6 5 1 BMO Aggregate Bond ETF 804,805,479 Canadian Fixed Income ÙÙÙÙ 8 19 16 BMO Mid Federal Bond ETF 594,924,765 Canadian Fixed Income ÙÙÙÙ 3 14 8 Horizons Active Corporate Bond ETF Comm 545,018,352 Canadian Fixed Income ÙÙÙÙÙ 30 7 3 Vanguard Canadian Aggregate Bond ETF 454,252,989 Canadian Fixed Income ÙÙÙÙ 6 19 iShares Diversified Monthly Income 670,803,822 Canadian Fixed Income Balanced ÙÙ 95 95 PowerShares Ultra Liquid LT Govt Bd ETF 746,348,282 Canadian Long Term Fixed Income ÙÙÙ 25 23 iShares 1-5 Year Laddered Corp Bd Adv 2,269,906,958 Canadian Short Term Fixed Income ÙÙÙÙ 37 27 18 67 iShares Canadian Short Term Bond 2,172,588,794 Canadian Short Term Fixed Income ÙÙÙÙÙ 13 21 20 iShares 1-5 Year Laddered Govt Bd Adv 1,065,349,427 Canadian Short Term Fixed Income ÙÙÙ 17 40 36 BMO Short Corporate Bond ETF 936,219,968 Canadian Short Term Fixed Income ÙÙÙÙÙ 10 10 7 PowerShares 1-5 Yr Lad InvGr CorpBd ETF 736,937,064 Canadian Short Term Fixed Income ÙÙÙÙÙ 8 6 Vanguard Canadian Short-Term Corp Bd ETF 631,625,037 Canadian Short Term Fixed Income 11 6 Page 47 of 50 Manager Research Canada Observer | Q3 2015 Page 2 of 2 Vanguard Canadian Short-Term Bond ETF 582,785,457 Canadian Short Term Fixed Income ÙÙÙÙ 11 18 iShares S&P/TSX Capped Energy 860,559,975 Energy Equity ÙÙÙ 57 80 BMO Covered Call Canadian Banks ETF 1,043,858,311 Financial Services Equity ÙÙ 87 88 iShares S&P/TSX Capped Financials 991,673,605 Financial Services Equity ÙÙÙÙ 78 ÙÙÙ 95 97 84 67 57 7 76 81 BMO S&P/TSX Equal Weight Banks ETF 728,697,786 Financial Services Equity BMO Equal Weight US Banks ETF 434,392,872 Financial Services Equity 22 BMO Floating Rate High Yield ETF 505,869,184 Floating Rate Loans 56 BMO Mid-Term US IG Corp Bond ETF (CAD) 1,236,545,698 Global Fixed Income 2 BMO ST US IG Corp Bond Hedged to CAD ETF 430,769,332 Global Fixed Income BMO High Yld US Corp Bd Hdgd to CAD ETF 1,174,435,600 High Yield Fixed Income ÙÙÙ 93 73 43 iShares US High Yield Bond CAD-Hedged 592,902,275 High Yield Fixed Income ÙÙÙ 85 61 31 iShares MSCI EAFE CAD-Hedged 1,243,880,208 International Equity ÙÙ 88 75 57 ÙÙÙ 87 67 46 58 BMO MSCI EAFE Hdg to CAD ETF 956,280,553 International Equity BMO MSCI EAFE ETF 943,002,719 International Equity 37 iShares Core MSCI EAFE IMI 465,904,379 International Equity 28 iShares S&P/TSX Global Gold 465,450,300 Precious Metals Equity Ù 94 97 93 ÙÙÙ 94 67 60 75 100 iShares S&P/TSX Canadian Pref Share Adv 1,298,556,924 Preferred Share Fixed Income BMO Laddered Preferred Share ETF 1,043,243,359 Preferred Share Fixed Income iShares S&P/TSX Capped REIT 1,196,401,563 Real Estate Equity Ù 94 98 98 20 iShares Core S&P 500 (CAD-Hedged) 3,048,486,198 US Equity ÙÙ 91 89 81 65 BMO S&P 500 ETF (CAD) 2,341,615,280 US Equity BMO S&P 500 Hedged to CAD ETF 918,237,135 US Equity 90 82 Vanguard S&P 500 ETF 682,268,599 US Equity 25 iShares Core S&P 500 575,750,383 US Equity 19 Vanguard US Total Market ETF 569,650,271 US Equity 25 Source: Morningstar Direct, Data as of September 30, 2015 100 25 ÙÙ 91 ? Largest Pooled Fund Performance Name AUM ($) Morningstar Category Morningstar Rating Overall % Ran k Cat 1 Yr % Rank Cat 3 Yr % Rank Cat 5 Yr % Rank Cat 10 Yr % Rank Cat 15 Yr State Street S&P 500® Idx NL Comm Trust 12,101,760,773 US Equity SSGA MSCI EMkts Index NL QP Cmmon Trust 11,598,715,368 Emerging Markets Equity RBC Bond Series O 11,409,629,527 Canadian Fixed Income BlackRock CDN Long Bond Index Cl A 9,812,383,584 Canadian Long Term Fixed Income ÙÙ 46 73 80 83 62 BlackRock EAFE Equity Index B PH&N Bond Sr O 8,480,783,752 International Equity ÙÙÙ 60 57 59 69 56 7,741,939,598 Canadian Fixed Income ÙÙÙÙ 8 16 28 10 8 1832 Canadian Dividend 7,621,000,000 Canadian Dividend & Income Equity SSGA MSCI EAFE Index NL QP Common Trust 7,203,771,805 International Equity Manulife MMF Monthly High Income 6,257,582,000 Canadian Equity Balanced ÙÙÙÙÙ 7 1 5 3 BlackRock US Equity Index B 5,993,384,026 US Equity ÙÙÙÙ 33 37 24 34 38 PH&N Total Return Bond Sr O 5,846,794,840 Canadian Fixed Income ÙÙÙÙ 14 13 17 18 7 CI Signature Income & Growth 5,837,409,000 Global Neutral Balanced ÙÙÙÙ 90 60 29 3 Greystone Real Estate Fund 5,615,010,000 Income and Real Property TD Emerald Cdn Long Bond Broad Mkt PF 5,546,257,963 Canadian Long Term Fixed Income ÙÙÙ 50 46 61 Sprucegrove International Pool 5,451,100,000 International Equity ÙÙÙ 90 88 80 RBC Canadian Dividend Series O 5,213,281,600 Canadian Dividend & Income Equity RBC European Equity Ser O 5,185,688,039 European Equity ÙÙÙ 80 1 25 Beutel Goodman Canadian Equity-PF 5,105,528,564 Canadian Equity ÙÙÙÙÙ 53 12 TD Emerald Canadian Equity Index Fund 4,977,475,332 Canadian Equity ÙÙ 72 RBC Global Corporate Bond-O 4,811,860,169 Global Fixed Income ÙÙÙ TD Emerald Canadian Bond Index Fund 4,781,111,183 Canadian Fixed Income TD Emerald Canadian Bond PFT 4,739,761,541 Canadian Fixed Income JF Canadian Equity Fund 4,726,900,000 Canadian Equity 34 5 15 9 3 85 83 83 80 83 52 38 ÙÙ 31 71 77 88 84 ÙÙ 26 56 69 76 70 ÙÙÙÙ 39 26 27 38 7 Page 49 nof 50 Manager Research Canada Observer | Q3 2015 Page 2 of 2 PH&N Long Bond Pension Trust Sr O 4,676,700,000 Canadian Long Term Fixed Income ÙÙÙÙ 22 22 26 17 1 BlackRock CDN US Equity Index Class D 4,551,640,909 US Equity ÙÙÙ 43 54 37 51 57 PH&N Short Term Bond & Mortgage Sr O 4,385,297,655 Canadian Short Term Fixed Income ÙÙÙ 26 25 47 31 34 BLK CDN US Equity Index Non-Tax Cl A 4,136,143,017 US Equity ÙÙÙ 36 39 24 42 43 PH&N Long Investment Grade Corp Bd Trust 4,116,819,999 Canadian Long Term Fixed Income ÙÙÙÙ 91 7 16 39 BlackRock Universe Bond Index D 4,067,814,554 Canadian Fixed Income ÙÙ 29 58 67 78 73 PH&N US Multi-Style All-Cap Equity Ser O 4,000,274,947 US Equity GWL Canadian Real Estate 3,941,072,000 Income and Real Property GWL Real Estate (GRA)100/100 (PS2) 3,941,072,000 Income and Real Property GWL Real Estate (GRA)75/100 (PS2) 3,941,072,000 Income and Real Property GWL Real Estate (GRA)75/75 (PS2) 3,941,072,000 Income and Real Property BlackRock Canadian Equity Index Class D 3,911,797,378 Canadian Equity ÙÙ 74 88 85 73 84 Hexavest World 3,858,090,000 Global Equity ÙÙÙÙ 29 56 59 13 Mawer International Equity Series O 3,780,400,000 International Equity ÙÙÙÙÙ 9 21 9 3 Standard Life Canadian Bond Index 3,745,831,115 Canadian Fixed Income ÙÙ 34 68 76 82 79 CI Signature Select Canadian 3,742,834,000 Canadian Focused Equity ÙÙÙÙ 58 56 46 23 12 RBC Canadian Short-Term Income Series O 3,648,013,249 Canadian Short Term Fixed Income PH&N Investment Grade Corp Bond Tr Sr O 3,580,090,000 Global Fixed Income ÙÙ 70 61 95 78 13 Beutel Goodman Balanced-PF 3,481,590,452 Canadian Equity Balanced ÙÙÙÙ 41 40 39 20 25 Trimark Fund 3,475,394,000 Global Equity ÙÙÙÙ 58 72 22 21 10 CI Portfolio Series Balanced Series I 3,441,139,000 Global Equity Balanced ÙÙÙÙ 29 59 35 21 25 BlackRock Universe Bond Index A 3,382,626,763 Canadian Fixed Income ÙÙ 28 58 66 74 67 BlackRock CDN MSCI EAFE Equity Index D 3,355,868,857 International Equity ÙÙÙ 57 53 56 73 65 RBC Global Bond Ser O 3,345,397,195 Global Fixed Income ÙÙÙ 43 39 62 Sun Life Money Market Series I 3,174,100,000 Canadian Money Market 57 61 58 CI Signature Corporate Bond 3,173,645,000 High Yield Fixed Income ÙÙÙ 32 38 58 CI Signature Global Income & Growth 3,160,952,000 Global Neutral Balanced ÙÙÙÙ 2 1 7 Source: Morningstar, Inc. Data as of September 30, 2015 38 page 50 of 50 Morningstar Manager Research Canada Observer | Q3 2015 About Morningstar Manager Research Morningstar Manager Research provides independent, fundamental analysis on managed investment strategies. Analyst views are expressed in the form of Analyst Ratings, which are derived through research of five key pillars—Process, Performance, Parent, People, and Price. A global research team issues detailed analyst reports on strategies that span vehicle, asset class, and geography. About Morningstar Manager Research Services Morningstar Manager Research Services combines the firm's fund research reports, ratings, software, tools, and proprietary data with access to Morningstar's manager research analysts. It complements internal due-diligence functions for institutions such as banks, wealth managers, insurers, sovereign wealth funds, pensions, endowments, and foundations. For More Information Marc DeMoss Director of Research Distribution, Data & Research Products +1 312 384 4052 [email protected] 1 Toronto Street Toronto, Ontario M5C 2W4 © Morningstar 2015. All Rights Reserved. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. 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