Interim Management Report of Fund Performance

Transcription

1 Interim Management Report of Fund Performance 10AUG The following is an interim report on the performance of Top 20 U.S. Dividend Trust (the Trust ) and contains financial highlights but does not contain the complete financial statements of the Trust. This report should be read in conjunction with the unaudited interim financial statements for the six months ended June 30, 2014 and the audited annual financial statements for the year ended December 31, You can get a copy of the interim or annual financial statements at your request and at no cost by calling (416) , by writing us at 40 King St. West, Scotia Plaza, 26 th Floor, Box 4085, Station A, Toronto, Ontario M5W 2X6, Attention: Top 20 U.S. Dividend Trust Investor Relations or by visiting our website located at or SEDAR at You may also contact us using one of these methods to request a copy of the Trust s proxy voting policies and procedures, proxy voting disclosure record, or quarterly portfolio disclosure. The Trust s voting disclosure record for the annual period ended June 30, 2014 will be available on our website in August Any references to net assets or net assets per Unit in this report are references to net assets attributable to Unitholders determined in accordance with Canadian GAAP applicable to publicly accountable entities as presented in the financial statements of the Trust. Additionally, any references to net asset value or net asset value per Unit are references to values determined for valuation and transactional purposes. There are no differences between net assets per Unit and net asset value per Unit. Investment Objectives and Strategies The Trust is a closed-end investment fund established as a trust to provide holders (the Unitholders ) of units of the Trust with investment exposure, on a tax-advantaged basis, to an equally-weighted portfolio (the Portfolio ) comprised of the 20 highest yielding equity securities (the Portfolio Securities ) included in the Dow Jones Industrial Average (the Dow ). The Dow is a price-weighted average index consisting of 30 large and well-known U.S. blue-chip companies. The Trust s investment objectives are to: (i) provide Unitholders with stable monthly tax-advantaged distributions and (ii) provide Unitholders with the opportunity for capital appreciation, in each case through exposure by virtue of the Forward Agreement (as defined herein). The distributions are funded from dividends generated by the Portfolio and supplemented by premiums received on writing options on a portion of the Portfolio Securities. The net asset value for the Class A Units is calculated in Canadian dollars and for the Class U Units, in U.S. dollars. To pursue its investment objectives, the Trust entered into two forward purchase agreements (collectively, the Forward Agreement ) which the Trust entered into with The Bank of Nova Scotia (the Counterparty ) pursuant to which the Counterparty has agreed to pay the economic return provided by the Portfolio. The Portfolio is held by TTU Trust, an investment fund established for holding the Portfolio. Substantially all of the value of the Portfolio attributable to the Class A Units is hedged back to the Canadian dollar. The Class U Units are designed for investors wishing to hold their investment in U.S. dollars. As a result of the forgoing, the net asset value of the Units will vary depending on the performance of TTU Trust by virtue of the Forward Agreement and will also vary depending on the expenses allocated to, and distributions paid in respect of, the particular class of Units of the Trust. The Trust partially pre-settles the Forward Agreement in order to fund (i) monthly distributions on the units; (ii) redemptions of units from time to time; and (iii) operating expenses and other liabilities of the Trust. Highstreet Asset Management Inc. (the Portfolio Manager and Options Advisor or Highstreet ) provides any portfolio management services required by TTU Trust including currency hedging strategies and acts as the options advisor to execute and maintain the option writing strategy of TTU Trust. The Portfolio is reconstituted annually to include the top 20 highest yielding constituents included in the Dow and is re-balanced to an equal weight basis prior to the end of each calendar quarter. Highstreet writes covered call options from time to time in respect of not more than 33% of the Portfolio in order to earn income from option premiums to supplement dividends generated by the Portfolio. Highstreet will generally only write covered calls to the extent needed to increase the yield on the Portfolio to a targeted yield. This targeted yield will enable the Trust, by virtue of the Forward Agreement, to pay the targeted distribution. The Trust will purchase Units under the mandatory market purchase program to the extent premiums generated from writing covered call options are in excess of amounts needed to fund the distribution. Top 20 U.S. Dividend Trust 1 Interim Management Report of Fund Performance

2 Report from Portfolio Manager and Options Advisor Overview Highstreet manages an option overlay strategy that involves selling call options on up to, but not more than, 33% of the Fund. The percentage of write for each holding and the strike prices chosen are primarily a function of the Fund s income requirements. Highstreet may choose to close out option positions prior to their expiry, for options that are both out-of-the-money, and/or in-the-money, when prudent. Highstreet endeavors to avoid assignment, when possible, on any in-the-money positions. The overall investment objectives of the Fund are to provide targeted monthly cash distributions, to provide the opportunity for capital appreciation, and to provide lower overall volatility of portfolio returns than would otherwise be experienced from owning the equity securities on a stand-alone basis. Market Performance The US market had a very strong start to the year with the broad market index, as measured by the S&P500, up 7.14% in US dollar terms over the first six months. The US market started the year off on a positive note although mid-way through the first quarter, US and many global markets suffered from a global growth scare as investors reacted to concerns about the US economy which were heightened by the impact of an exceptionally cold winter. Developments in Ukraine caused much angst around the globe in March when Russian troops annexed Crimea in scenes reminiscent of Cold War aggression. However, as tensions abated and a relatively quick stalemate emerged this alleviated most investor anxiety about the region. As the quarter progressed the weather-induced slowdown receded and investors started to receive strong data notably in housing, trucking and auto sales. Through April and May strong markets continued and the second quarter of 2014 delivered the sixth consecutive quarter of positive returns; only the sixth time this has occurred since The market mood is currently ebullient however we have concerns with respect to breadth, volume, and which sectors are currently leading the market higher. All-time highs can be viewed bullishly but as investors it is our job to remain focused on fundamentals and not get caught up in sentiment. Valuations are high in many parts of the developed world and external risks such as multi-year highs in oil prices and related turmoil in the Middle East pose real risks to economic growth. As we approach the latter part of 2014 we will see how markets, particularly the bond market, respond to the removal of the purchase of US fixed income assets, and we anticipate a higher level of volatility throughout this period. Performance was reasonably wide-spread with nine of ten sectors delivering positive performance. The top performing sectors over the period were Utilities and Energy. Stocks that delivered the best performance were Newfield Exploration and Nabors Industries, while the bottom performers were Coach and Whole Foods Market. The Fund benchmark, the Dow Jones Industrial Average, delivered a return over the period of 2.7%. Portfolio Performance The Portfolio delivered a total return of 6.1% for the six month period comprised of: 2.9% from price change, 1.2% from dividends received and 2.0% from premium earned. Interim Management Report of Fund Performance 2 Top 20 U.S. Dividend Trust

3 Performance for each of the individual Portfolio Securities was as follows: Performance 1 Securities (%) Consumer Discretionary McDonald s Corp. (MCD) 5.5% Consumer Staples Procter & Gamble Co. (PG) 2.0% The Coca-Cola Company (KO) 4.1% Wal-Mart Stores Inc. (WMT) 3.4% Energy Chevron Corp. (CVX) 6.4% Exxon Mobil Corp. (XOM) 0.9% Financial Services JPMorgan Chase & Co. (JPM) 0.2% The Travelers Companies, Inc. (TRV) 5.1% Health Care Johnson & Johnson (JNJ) 15.9% Merck & Co Inc. (MRK) 17.4% Pfizer Inc. (PFE) 1.4% Industrials 3M Company (MMM) 3.4% Caterpillar Inc. (CAT) 21.2% General Electric Company (GE) 4.7% Information Technology Cisco Systems Inc. (CSCO) 12.6% Intel Corp. (INTC) 21.2% Microsoft Corp. (MSFT) 13.1% Materials EI du Pont de Nemours & Co. (DD) 2.1% Telecommunications AT&T Inc. (T) 3.3% Verizon Communications Inc. (VZ) 1.8% 1 Performance comprised of price change and dividends. Option Activity For the six months, call options were written on the Trust s Portfolio Securities raising $2.0 million in premium or approximately 2.0% on the Portfolio. The average percentage written on the Portfolio was approximately 28.9% with an average strike percentage of 101.3%. Highstreet s proprietary option overlay model examines a number of factors, including short-term price change and momentum metrics, to determine a target level of call writing and level of strike for each holding in the underlying Portfolio. Targeted strike levels are preferably out-of-the-money to allow the opportunity to capture potential positive performance of the underlying stocks in addition to option premiums. Volatility The application of a covered call writing strategy endeavors to reduce the overall level of portfolio volatility. The following chart and table compares the annualized, realized volatility over the six month period for the Trust relative to: 1. The same underlying portfolio (with no covered call overlay); and Top 20 U.S. Dividend Trust 3 Interim Management Report of Fund Performance

4 2. The benchmark index (no covered call overlay) Portfolio Portfolio (No Call Writing) DJIA Index Top 20 US Dividend Trust 8.7% 9.8% 11.1% 12.00% 10.00% Volatility 8.00% 6.00% 4.00% 2.00% Data Source: Bloomberg 0.00% Top 20 US Portfolio Portfolio (No Call Writing) DJIA Index 11AUG On an individual basis, stock volatilities were quite variable. The following chart shows the 30 day, 90 day, and average 30 day annualized, realized return volatility for each of the names held during the quarter. Intel Corporation (21.9%) had the highest volatility of any name, followed by Caterpillar Inc. (19.2%), while 3M Company (8.0%) and The Coca-Cola Company (8.3%) had the lowest. On average, on an individual security basis, realized volatilities fell during the quarter, with Intel and Caterpillar being the notable exceptions. Individual Volatility 25.00% 20.00% Volatility 15.00% 10.00% 5.00% 0.00% CAT US CSCO US CVX US DD US GE US INTC US JNJ US JPM US KO US MCD US MMM US MRK US MSFT US 30 Day 90 Day Average 30 Day PFE US PG US T US TRV US VZ US WMT US XOM US 11AUG Data Source: Bloomberg Interim Management Report of Fund Performance 4 Top 20 U.S. Dividend Trust

5 Results of Operations Financial Performance The net assets attributable to Unitholders were $11.31 per Class A Unit and US$11.30 per Class U Unit at June 30, 2014 as compared to $10.96 per Class A Unit and US$10.95 per Class U Unit at December 31, 2013, reflecting the appreciation in the fair value of the Portfolio Securities offset by the Trust s operating expenses including Forward Agreement fees and distributions paid on the Units. Pursuant to the mandatory market purchase program the Trust may purchase any Units offered in the market at a price less than 98% of the latest net asset value per Unit. For the six month period ended June 30, 2014, 17,813 Class A Units (2013 7,467) were purchased under this program at an average price of $10.63 (2013 $10.16) per Class A Unit for a total purchase amount of $189,330 (2013 $75,836). Distributions The Trust does not have a fixed distribution but intends to pay equal monthly distributions through pre-settlements of the Forward Agreement based on, among other things, the actual and expected returns on the Portfolio and the actual and expected expenses of the Trust and TTU Trust. Monthly distributions are targeted to be $ per Class A Unit and US$ per Class U Unit ($0.50 and US$0.50 per annum, respectively) representing an annual yield of 5.0% on the issue price, consisting primarily of returns of capital which are not immediately taxable but which reduce the adjusted cost base of the Units. For the six month period ended June 30, 2014, the Trust declared total distributions of $2.3 million (2013 $2.9 million) comprised of $2.0 million or $ per Class A Unit (2013 $2.4 million of $ per Class A Unit) and US$0.3 million or US$ per Class U Unit (2013 US$0.5 million or US$ per Class U Unit). Dividends earned on the Portfolio Securities and premiums received on writing covered call options on a portion of the Portfolio Securities funded the distributions and operating expenses of the Trust. For the six month period ended June 30, 2014, $2.5 million (2013 $2.8 million) was available for distribution comprised of dividends earned on the Portfolio Securities (including interest) of $1.2 million (2013 $1.4 million) and option premiums received of $2.0 million (2013 $2.1 million) offset by total operating expenses and purchases under the mandatory market purchase program of $0.7 million (2013 $0.7 million). Recent Developments Tax Changes Affecting Forward Agreement Structures In the budget announced March 21, 2013, the government proposed and enacted to eliminate the tax benefits associated with forward agreements used by some investment funds to achieve capital gains treatment on income that would otherwise be treated as ordinary income. The government refers to these as character conversion transactions. Distributions from investment funds which enter into a forward agreement will now generally be taxed as income at the time of distribution as opposed to returns of capital which are not generally taxable at time of receipt and capital gains. This measure will apply to forward agreements entered into on or after March 21, The less favorable tax treatment will also apply to forward agreements entered into before March 21st, if the terms of the agreement are extended or modified. This measure does not immediately affect the Trust as it entered into its Forward Agreement before March 21, 2013 and as such, the distributions will continue to be characterized primarily as returns of capital and capital gains until the Forward Agreement matures on October 31, Adoption of International Financial Reporting Standards ( IFRS ) The Fund s financial statements have been prepared in accordance with IFRS commencing January 1, 2014 as required by Canadian securities legislation and the Canadian Accounting Standards Board. Previously, the Fund prepared its financial statements in accordance with Canadian generally accepted accounting principles as defined in Part V of the CPA Canada Handbook ( Canadian GAAP ). The comparative information has been restated from Canadian GAAP to comply with IFRS. The Fund has consistently applied the accounting policies used in the preparation of its opening IFRS statement of financial position at January 1, 2013 and throughout all periods presented, as if these policies had always been in effect. There was no impact to net assets presented under Canadian GAAP from the changeover to IFRS other than additional disclosures in the financial statements and a change in the presentation of Unitholders equity to a financial liability. Related Party Information For its services to the Trust Scotia Managed Companies Administration Inc. ( SMCAI ), a wholly-owned subsidiary of Scotia Capital Inc. ( SCI ) which in turn is a wholly-owned subsidiary of The Bank of Nova Scotia, is entitled to receive a management fee equal to 0.25% per annum of the net asset value. SMCAI is responsible for paying fees to Highstreet. The total management fee paid or payable to SMCAI for the period ended June 30, 2014 was $139,500 (2013 $166,200). The ongoing management fee is calculated and accrued weekly and is payable quarterly in arrears. Under the Forward Agreement, the Trust pays to the Counterparty an additional purchase amount, calculated weekly and payable quarterly in arrears, of 0.45% per annum of the notional amount of the Forward Agreement being the net asset value of TTU Trust. The Top 20 U.S. Dividend Trust 5 Interim Management Report of Fund Performance

6 total fees paid or payable to The Bank of Nova Scotia relating to the Forward Agreement for the period ended June 30, 2014 were $221,200 (2013 $247,900). At June 30, 2014, the Trust had accrued liabilities of $53,885 (December 31, 2013 $141,076) payable to SMCAI and had cash on deposit with SCI and The Bank of Nova Scotia of $135,511 (December 31, 2013 $239,059). For the six month period ended June 30, 2014, commissions of $346 (December 31, 2013 $923) were paid to SCI under the mandatory market purchase program. Highstreet is responsible for managing the purchase and sale of Portfolio Securities and writing covered call options. Such transactions may be carried out using the services of Scotia Capital Inc. on an agency basis for which commissions of $17,764 were paid. For the six months ended June 30, 2014, the Trust purchased 17,813 Class A Units under the mandatory market purchase program at an average price of $10.63 per Unit for a total repurchase amount of $189,330. Commissions of $149 were paid to SCI under the mandatory market purchase program. Financial Highlights The following tables show selected key financial information about the Trust and are intended to help you understand the Trust s financial performance since inception. The information for the six months ended June 30, 2014 is derived from the Trust s unaudited interim financial statements while the December 31, 2013 information is derived from the Trust s audited annual financial statements. For the Year For the Period For the Six Ended Ended Months Ended December 31, December 31, June 30, (1) Class A Class U Class A Class U Class A Class U CAD USD CAD USD CAD USD Net assets per Unit, beginning of period (1)... $10.96 $10.95 $ 9.10 $ 9.07 $10.00 $10.00 Increase (decrease) from operations: Total income... Total expenses (2)... (0.05) (0.05) (0.09) (0.09) (0.60) (0.61) Realized gains (losses) on Forward Agreement for the period (0.01) (0.02) Unrealized gains (losses) on Forward Agreement for the period (3) 0.04 (0.37) (0.19) (0.20) Total increase (decrease) from operations (0.80) (0.83) Distributions: From return of capital... (0.25) (0.27) (0.50) (0.50) (0.10) (0.10) Total Distributions (4)... (0.25) (0.27) (0.50) (0.50) (0.10) (0.10) Net assets per Unit, end of period... $11.31 $11.30 $10.96 $10.95 $ 9.10 $ 9.07 Based on the weighted average number of Units during the period except for the net assets and distributions wherein the actual number of Units outstanding at the relevant time are used. (1) Results for the period October 15, 2012 (inception date) to December 31, (2) Total expenses include forward fees of $221,200 (2013 $247,900, 2012 issue costs of $6,590,031 and forward fees of $99,690). (3) In 2014 adjustments of nil per Class A Unit and $0.01 per Class U Units (2013 $0.01 per Class A Unit and USD$0.02 per Class U Unit, 2012 $0.01 per Class A Unit and US$0.02 per Class U Units) were made to reconcile the basis of calculation of per Unit amounts between the weighted average and the end of period number of Units. (4) All distributions were paid in cash. Interim Management Report of Fund Performance 6 Top 20 U.S. Dividend Trust

7 Ratios and Supplemental Data (based on Net Asset Value) June 30, 2014 December 31, 2013 December 31, 2012 Class A Class U Class A Class U Class A Class U CAD USD CAD USD CAD USD Net asset value (000 s) (1)(2)... $ 89,924 $ 11,331 $ 84,419 $ 13,618 $ 85,775 $ 18,303 Number of Units outstanding (1)... 7,951,454 1,002,473 7,705,712 1,243,363 9,430,030 2,017,987 Management expense ratio (3) % 1.32% 1.21% 1.19% 7.84% 7.75% Trading expense ratio (4) % 0.02% 0.05% 0.05% 0.08% 0.08% Portfolio turnover rate (5) % 19.04% 42.60% 42.60% 11.84% 11.84% Net asset value per Unit (1)... $ $ $ $ $ 9.10 $ 9.07 Market value per Unit... $ N/A $ N/A $ 8.91 N/A (1) This information is provided as at June 30, 2014, December 31, 2013 and December 31, 2012, respectively. (2) Net asset value is equal to net asset value per Unit multiplied by the number of Units outstanding. (3) Management expense ratio ( MER ) is based on total expenses of the Trust and TTU Trust for the stated period. During 2012, the Trust realized costs of $6,590,031 in connection with the issue of 9,400,000 Class A Units and 2,048,087 Class U Units. Without these costs the MER would have been 1.48% and 1.43% for the Class A Units and the Class U Units, respectively. The ratio is expressed as an annualized percentage of the weekly average net asset value during the period. (4) The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average net asset value during the period. (5) The portfolio turnover rate indicates how actively the Portfolio Manager manages the portfolio investments. A portfolio turnover rate of 100% is equivalent to the Trust buying and selling all of the securities in its portfolio once in the course of the period. Past Performance Year by Year Returns The following bar chart shows how much an investment in Units made on the first day of each financial period would have grown or decreased by the last day of the financial period. Past performance is not an indication of how the Units will perform in the future. The calculation of returns based on net asset value follows the requirements of NI As an investor cannot purchase or sell the Units at net asset value, the following is an indication of the performance of the assets of the Fund rather than returns available to Unitholders. Returns based on market value are also presented for the Class A Units in narrative form below as indication of returns actually available to Class A Unitholders. Class A Class U 26.6% 27.0% 5.5% 5.4% 32.0% 28.0% 24.0% 20.0% 16.0% 12.0% 8.0% 4.0% 0.0% -4.0% -8.0% -12.0% -8.4% 32.0% 28.0% 24.0% 20.0% 16.0% 12.0% 8.0% 4.0% 0.0% -4.0% -8.0% -12.0% -8.8% For the years ended December 31, 2012 and 2013 and for the six months ended June 30, AUG For the years ended December 31, 2012 and 2013 and for the six months ended June 30, AUG The Class A Units are listed for trading on the Toronto Stock Exchange ( TSX ) while the Class U Units are not but may be converted into Class A Units on a weekly basis. Accordingly, the market value return for the Class A Units was 10.3% and 23.8% for years 2012 and 2013, respectively, and was 10.5% for the six months period ended June 30, This performance from inception reflects payment of upfront cost related to the establishment of the Trust and assumes that distributions are reinvested in additional units at the then market price on the TSX which price may reflect a premium or discount to net asset value. Top 20 U.S. Dividend Trust 7 Interim Management Report of Fund Performance

8 Summary of Investment Portfolio Below is a summary of the Trust s investment Portfolio based on closing sale prices as at June 30, This summary may change due to ongoing portfolio transactions. Weekly updates are available on the internet at or by contacting investor relations at Investment portfolio, at market value... $100,041,476 Telecommunications, 9.6% Total written call options, -0.2% Business Services, 5.1% Oil & Gas, 10.1% Consumer Products, 29.6% Merchandising & Lodging, 5.0% Management & Diversified, 10.0% Financial Services, 10.2% Industrial Products, 20.6% 11AUG NI requires the Trust to disclose the Top 25 positions held. The Trust has not done so as TTU Trust holds an approximately equally weighted portfolio of 20 securities. Interim Management Report of Fund Performance 8 Top 20 U.S. Dividend Trust