Management Report of Fund Performance

Transcription

1 Management Report of Fund Performance 10AUG The following is a 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 financial statements and notes thereto from its commencement of operations on October 15, 2012 to December 31, You can get a copy of the 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 and quarterly portfolio disclosure. The Trust s voting disclosure record for the annual period ended June 30, 2013 will be available on our website in August Any reference to net assets in this report means that the value was determined in accordance with Canadian generally accepted accounting principles for financial statement purposes. Additionally, any reference to net asset value means that the value was determined for valuation and transactional purposes. An explanation of the difference between both values can be found in the notes to the financial statements. Commencement of Operations 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 covered call options on a portion of the Portfolio Securities. The Trust commenced operations on October 15, 2012 and issued 9,400,000 Class A units at a price of $10.00 (the Class A Units ) and 2,048,087 Class U units at a price of US$10.00 (the Class U Units, and together with the Class A Units, the Units ) raising proceeds of $94.0 million from the sale of Class A Units and US$20.5 million from the sale of the U.S. dollar denominated Class U units. Substantially all of the U.S. dollar value of the Portfolio attributable to the Class A Units is hedged back to the Canadian dollar. To pursue its investment objectives, the Trust used the net proceeds from the offering of $107.5 million for payment of its purchase obligation under 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, a newly created investment fund established for holding the Portfolio. 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 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. Report from Portfolio Manager and Options Advisor Overview Highstreet manages the option overlay strategy which involves selling covered call options on up to, but not more than, 33% of the Trust. The percentage of write for each holding and the strike prices chosen are primarily a function of the Trust s income requirements. Top 20 U.S. Dividend Trust 1 Management Report of Fund Performance

2 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 Trust 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 Since inception of the Trust, the Dow Jones Industrial average delivered a total return 1.0% in US dollars, and 0.18% in Canadian dollars from inception on October 15, 2012 to December 31, Results during this period were mixed as the outcome of the US presidential election resulted in markets selling off on fears of the so-called fiscal cliff. However, improvements in underlying US economic fundamentals, car sales, and housing prices, plus green shoots in China that appeared to confirm a soft landing, helped improve investor confidence later in the period. With the world watching a protracted political negotiation, US fiscal cliff concerns continued to dominate headlines and impact markets. Late in December, markets rallied on a combination of positive industrial activity reports from China and, more importantly, the expectation that US lawmakers would be able to come to some sort of agreement to address the pending tax increases and spending cuts. Macroeconomic events continue to be the driving force behind market performance and we may continue to see political maneuvering in the US as lawmakers wrestle with the inevitable debt ceiling posturing, among other issues, and 11th hour settlements Performance The Portfolio delivered an approximate total return of 2.3% comprised of: 3.9% from price change, 0.6% from dividends and 1.0% from premiums earned. The Dow returned 1.0% over the same period. Across stocks in the portfolio, performance was primarily negative with 14 of the 20 holdings posting a negative return. The following table lists individual performance for the Trust s holdings. Due to index rebalancing heading into year-end, Caterpillar was sold from the portfolio and replaced by Exxon Mobil Corp. The portfolio weights account for the length of time the stock was in the portfolio over the period. Average Weight Performance* % Johnson & Johnson (JNJ) United Technologies Corporation (UTX) The Coca-Cola Company (KO) The Travelers Companies Inc. (TRV) M Company (MMM) Hewlett-Packard Company (HPQ) JP Morgan Chase & Co. (JPM) Pfizer Inc. (PFE) The Procter & Gamble Company (PG) Verizon Communications Inc. (VZ) AT&T Inc. (T) Chevron Corporation (CVX) Intel Corporation (INTC) McDonald s Corporation (MCD) Merck & Company Inc. (MRK) Microsoft Corporation (MSFT) E. I. du Pont de Nemours and Company (DD) General Electric Company (GE) Cisco Systems Inc (CSCO) Caterpillar Inc. (CAT) Exxon Mobil Corporation (XOM) * Total return includes dividends and effected for covered call writing. Management Report of Fund Performance 2 Top 20 U.S. Dividend Trust

3 Options Activity Since inception, monthly covered call options written on the Trust s Portfolio Securities generated premiums of USD$1,140,461. The percentage of the Portfolio written on was approximately 23.8% on average for the three writes with an average strike price for the calls of 100.4%. A summary of the monthly write activity is below: October November December Premium received USD$361,483 USD$416,486 USD$362,492 Percent written 25% 23% 21% Average strike 101% 100% 100% Volatility Volatility levels rose steadily from inception until the end of November then descended rapidly in December as equity markets recovered. At the end of December, the average volatility of the portfolio was 15.9% % Average 30 Day Realised Volatility 20.00% 15.00% 10.00% 5.00% 0.00% Jan-12 Apr-12 Jul-12 Oct-12 13MAR The portfolio s average volatility was skewed by Hewlett-Packard, whose volatility spiked to 50% at year-end. The volatility of most of the remaining stocks was market-like: 60.0% Individual Volatilities (30 day) 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% CSCO CVX DD GE HPQ INTC JNJ JPM KO MCD MMM MRK MSFT Volatility Average PFE PG T TRV UTX VZ XOM 13MAR Top 20 U.S. Dividend Trust 3 Management Report of Fund Performance

4 Risk The value of the Units varies according to the value of the Portfolio. The value of the Portfolio is influenced by factors which are not within the control of the Trust including the financial performance of the 20 companies included in the Portfolio, interest rates and other financial market conditions. Accordingly, the value of the Units varies from time to time. For full disclosure of the risks associated with an investment in the Trust s units, please refer to the Prospectus dated September 12, Results of Operations Upon completion of the offering of the Units, the Trust commenced operations on October 15, 2012 with net assets, after deduction of issue expenses, of $9.42 per Class A Unit and US$9.42 per Class U Unit. The net assets as at December 31, 2012 decreased to $9.10 or (3.4%) per Class A Unit and US$9.07 or (3.7%) per Class U Unit and primarily reflects the net decrease in the fair value of the Portfolio. The Trust does not have a fixed distribution but intends to pay monthly distributions through pre-settlement 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 initially expected 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 a Unitholder s adjusted cost base of its Units. For the period ended December 31, 2012, the Trust declared and paid distributions of $1.20 million comprised of $0.98 million to Class A Unitholders or $ per Class A Unit and $0.21 million to Class U Unitholders or US$ per Class U Unit consistent with the initially estimated monthly distributions, prorated from October 15, 2012 to December 31, Dividends earned on the Portfolio Shares and premiums received on writing covered call options on a portion of the Portfolio Shares funded the distributions and operating expenses of the Trust. For the period ended December 31, 2012, $1.45 million was available for distribution comprised of dividends earned on the Portfolio Shares (including interest) of $0.64 million and option premiums received of $1.14 million offset by total operating expenses of $0.33 million. Recent Developments Transition to International Financial Reporting Standards ( IFRS ) The Canadian Institute of Chartered Accountants ( CICA ) Accounting Standards Board requires all Canadian publicly accountable enterprises to adopt IFRS for the years beginning on or after January 1, 2011 other than investment companies as defined in the CICA Handbook, for which transition to IFRS has been deferred to January 1, The objective of the change is to move towards the use of a single set of world wide accounting standards, thereby facilitating and improving global cash flows, as well as improving financial reporting and transparency. The Trust, which is an investment trust, will adopt IFRS commencing January 1, In order to prepare for the transition to IFRS, the Administrator performed an assessment of the impact of significant accounting differences between IFRS and Canadian GAAP, including the impact to business processes and systems. Currently, the Administrator does not expect a significant impact to net assets from the changeover to IFRS with the main impact of IFRS on the Trust s financial statements being additional disclosures in the financial statements and a potential change in the presentation of Unitholders equity. Finally, the Administrator affirms that the current business processes and information technology will not be impacted on the adoption of IFRS. Further updates on implementation progress and any changes to reporting impacts from the adoption of IFRS will be provided during the implementation period leading up to January 1, Tax Changes Affecting Forward Agreement Structures On March 21, 2013, the Federal Minister of Finance presented the majority government s budget. The budget proposes to treat the returns earned from forward agreement structures similar to the one entered into by the Trust as ordinary income rather than capital gains. The changes are expected to apply to such agreements entered into or amended after March 20, Based on the Trust s legal structure and the Forward Agreement in place, the Manager does not currently expect any impact on the Trust as a result of these changes until the maturity of its existing derivative agreement on October 31, Related Party Information The Trust retained Scotia Managed Companies Administration Inc. ( SMCAI ), a wholly owned subsidiary of Scotia Capital Inc. ( SCI ), on September 12, 2012 under a management agreement (the Management Agreement ) to administer all of the ongoing operations of the Trust. In consideration for the services provided by the manager, including cash management, accounting, and tax administration, the Trust pays SMCAI a quarterly fee (the Management Fee ) equal to 1 4 of 0.50% of the net asset value of the Trust. SMCAI pays the Highstreet out of the Management Fee. The Management Agreement has a term expiring on the redemption of all of the Units. The total management fees paid or payable to SMCAI for the period ended December 31, 2012 were $62,415. Management Report of Fund Performance 4 Top 20 U.S. Dividend Trust

5 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 total fees paid or payable to The Bank of Nova Scotia relating to the Forward Purchase Agreement for the period ended December 31, 2012 were $99,690. At December 31, 2012, the Trust had accrued liabilities of $62,415 payable to SMCAI and had cash and short-term investments on deposit with SCI and its parent company, The Bank of Nova Scotia of $525,695. 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 $24,361 were paid. Commissions on the offering include amounts paid to SCI, as lead agent, aggregating $3,398,886. Financial Highlights The following table shows selected key financial information about the Trust and is intended to help you understand the Trust s financial performance since commencement of operations on October 15, 2012 to December 31, This information is derived from the Trust s audited financial statements. For the Period Ended December 31, 2012 (1) Class A Class U CAD USD Net assets per Unit, beginning of period (1)... $10.00 $10.00 Increase (decrease) from operations: Total revenue... Total expenses (2)... (0.60) (0.61) Realized losses for the period... (0.01) (0.02) Unrealized losses on forward agreement for the period (3)... (0.19) (0.20) Total increase (decrease) from operations... (0.80) (0.83) Distributions: From dividends... From other income... From capital gains... From return of capital... (0.10) (0.10) Total Distributions (4)... (0.10) (0.10) Net assets per Unit, end of period... $ 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 issue costs of $6,590,031 and forward fees of $99,690. (3) Adjustments of $0.01 per Class A Unit and (USD$0.02) per Class U Unit 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. Top 20 U.S. Dividend Trust 5 Management Report of Fund Performance

6 Ratios and Supplemental Data (based on Net Asset Value) December 31, 2012 Class A Class U CAD USD Net asset value (000 s) (1) (2)... $ 85,775 $ 18,303 Number of Units outstanding (1)... 9,430,030 2,017,987 Management expense ratio (3) % 7.75% Trading expense ratio (4) % 0.08% Portfolio turnover rate (5) % 11.84% Net asset value per Unit (1)... $ 9.10 $ 9.07 Market value per Unit... $ 8.91 N/A (1) This information is provided as at December 31, (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. 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 We have not presented the past performance data as the Trust has not completed its first financial year. Management Report of Fund Performance 6 Top 20 U.S. Dividend Trust

7 Summary of Investment Portfolio Below is a summary of the Trust s investment Portfolio by sector based on closing sale prices as at December 31, 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... $103,213,791 Telecommunications, 10.1% Total written call options, -0.2% Business Services, 5.0% Oil & Gas, 10.1% Merchandising & Lodging, 5.0% Consumer Products, 24.8% Management & Diversified, 15.2% Financial Services, 10.0% Industrial Products, 20.0% 28FEB NI requires TTU Trust to disclose the top 25 positions held. TTU Trust has not done so as it holds an approximately equally weighted portfolio of 20 securities. Top 20 U.S. Dividend Trust 7 Management Report of Fund Performance