Horizons Morningstar Hedge Fund Index ETF (HHF:TSX)

Transcription

1 Annual Report December 31, 2017 Horizons Morningstar Hedge Fund Index ETF (HHF:TSX) ACTIVE BENCHMARK BETAPRO Innovation is our capital. Make it yours.

2 Contents MANAGEMENT REPORT OF FUND PERFORMANCE Management Discussion of Fund Performance...1 Financial Highlights...9 Past Performance...14 Summary of Investment Portfolio of Horizons Morningstar Hedge Fund Index ETF...16 Summary of Investment Portfolio of HAP Nexus Hedge Fund Replication Trust...17 MANAGER S RESPONSIBILITY FOR FINANCIAL REPORTING...19 INDEPENDENT AUDITORS REPORT...20 FINANCIAL STATEMENTS Statements of Financial Position...21 Statements of Comprehensive Income...22 Statements of Changes in Financial Position...23 Statements of Cash Flows...24 Schedule of Investments of Horizons Morningstar Hedge Fund Index ETF...25 Schedule of Investments of HAP Nexus Hedge Fund Replication Trust...26 Notes to Financial Statements...28

3 Letter from the President and Co-CEO For both Horizons ETFs Management (Canada) Inc. ( Horizons ETFs ) and the Canadian ETF industry, 2017 was an extraordinary year. The industry surpassed $146 billion in assets under management ( AUM ) and now has over 650 ETF listings. Meanwhile, Horizons ETFs launched seven new ETFs and our AUM surpassed $9 billion, giving us a total of 81 different investment tools available for our clients. This was an especially remarkable year for Horizons ETFs for two key reasons. Firstly, we continued to create innovative, firstof-their-kind solutions for investors; and secondly, we became an official partner of the Toronto Raptors. In April, we brought to market the world s first marijuana-focused ETF the Horizons Marijuana Life Sciences Index ETF ( HMMJ ). HMMJ took investors to a new frontier by giving them diversified exposure to the rapidly growing cannabis industry. The launch of HMMJ was a tremendous success, as it captured worldwide media attention and is arguably the biggest new ETF launch in Canada in 2017, when you look at AUM growth and daily trading activity. We have continued our tradition of being a disruptive force in the industry, with the autumn launches of the Horizons Active A.I. Global Equity ETF ( MIND ) and the Horizons Robotics and Automation Index ETF ( ROBO ). MIND is the world s first global equity ETF driven by artificial intelligence, while ROBO is Canada s first ETF to give investors exposure to a basket of robotics, automation and artificial intelligence companies from across the globe. Like HMMJ, these ETFs also created significant media and investor interest. In addition to our new offerings, several of our established ETFs also distinguished themselves in Our lineup of Total Return Index ETFs ( TRI ETFs ), which use an innovative structure to deliver index returns in a low-cost and tax-efficient manner, experienced significant AUM growth this year. For the first time in decades, we may be looking at a period of prolonged rising interest rates. We believe that our low-cost family of actively managed fixed income ETFs have the flexibility to reduce duration and take advantage of these potentially seismic changes in the fixed income market. One of the primary beneficiaries of rising rates, for example, was in the Canadian preferred share asset class. The Horizons Active Preferred Share ETF ( HPR ) has been among the top asset-gatherers in the preferred share space in Canada this year and was our top-selling actively managed ETF. Regardless of the direction of markets or interest rates, we have ETF solutions that allow investors of all types to customize their portfolio exposure. Markets do change and our family of ETFs gives investors the tools they need to help meet their objectives. For more information on all our strategies, please visit where we offer a range of resources designed to inform and educate ETF investors. Thank you for your continued support and here s wishing you strong returns in Sincerely, Steven J. Hawkins, President & Co-CEO Horizons ETFs Management (Canada) Inc. P.S. LET S GO RAPTORS!

4 MANAGEMENT REPORT OF FUND PERFORMANCE This annual management report of fund performance for Horizons Morningstar Hedge Fund Index ETF ( HHF or the ETF ) contains financial highlights and is included with the audited annual financial statements for the investment fund. You may request a copy of the ETF s unaudited interim or audited annual financial statements, interim or annual management report of fund performance, current proxy voting policies and procedures, proxy voting disclosure record, or quarterly portfolio disclosures, at no cost, from the ETF s manager, Horizons ETFs Management (Canada) Inc. ( Horizons Management or the Manager ), by calling toll free , or locally (416) , by writing to us at: 55 University Avenue, Suite 800, Toronto, Ontario, M5J 2H7, or by visiting our website at or SEDAR at This document may contain forward-looking statements relating to anticipated future events, results, circumstances, performance, or expectations that are not historical facts but instead represent our beliefs regarding future events. By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties. There is significant risk that predictions and other forward-looking statements will not prove to be accurate. We caution readers of this document not to place undue reliance on our forward-looking statements as a number of factors could cause actual future results, conditions, actions or events to differ materially from the targets, expectations, estimates or intentions expressed or implied in the forward-looking statements. Actual results may differ materially from management expectations as projected in such forward-looking statements for a variety of reasons, including but not limited to market and general economic conditions, interest rates, regulatory and statutory developments, and the effects of competition in the geographic and business areas in which the ETF may invest and the risks detailed from time to time in the ETF s prospectus. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors. We caution that the foregoing list of factors is not exhaustive, and that when relying on forward-looking statements to make decisions with respect to investing in the ETF, investors and others should carefully consider these factors, as well as other uncertainties and potential events, and the inherent uncertainty of forward-looking statements. Due to the potential impact of these factors, the Manager does not undertake, and specifically disclaims, any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by applicable law. Management Discussion of Fund Performance Investment Objective and Strategies HHF seeks investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that replicate the performance of the Morningstar Broad Hedge Fund Index (the Hedge Fund Index ), hedged to the Canadian dollar. The ETF uses an index replication strategy that provides exposure to futures contracts, exchange traded funds, money market instruments and cash. The ETF does not invest, directly or indirectly, in the constituent hedge funds comprising the Hedge Fund Index. In order to achieve its investment objectives, HHF has entered into multiple forward purchase and sale agreements (see the Forward Agreements below) with an acceptable counterparty, pursuant to which the ETF has gained exposure to the investment portfolio of the HAP Nexus Hedge Fund Replication Trust (the Fund ). Since neither HHF, nor the Fund, invest directly or indirectly, in the constituent hedge funds comprising the Hedge Fund Index, the Fund seeks to track the performance of the Hedge Fund Index by using the Nexus Hedge Fund Index Replication Strategy (the Replication Strategy ). The Replication Strategy is a factor-based index replication method which uses statistical models to estimate the net exposure of the Hedge Fund Index s components to its main return-generating factors, which usually correspond to the main asset classes available on financial markets. National Bank of Canada ( NBC or the Replication Strategy Weightings Provider ) owns rights to use the Replication Strategy which will be implemented by the Fund s investment manager. Use of the Replication Strategy is licensed from NBC. The Fund uses derivatives, including futures contracts and forwards, for hedging purposes. The Fund is primarily invested in a basket of liquid futures contracts, money market instruments, cash, and, from time to time, exchange traded funds ( ETFs ). 1

5 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF 2 The Morningstar Broad Hedge Fund Index The Hedge Fund Index is a rules-based, asset-weighted index based on the largest and broadest hedge fund database in the hedge fund industry. The Hedge Fund Index is designed to capture the performance and behaviour of the most liquid hedge funds offering exposure to a wide spectrum of core and category hedge fund strategies. The Hedge Fund Index is comprised of between 600 and 800 U.S. based hedge funds from a universe of more than 7,000 single strategy and fundof-fund hedge funds. Many hedge funds have high initial investment requirements and long hold periods, both of which make it difficult for any investor to purchase and maintain a portfolio that holds all of the hedge funds listed in the Hedge Fund Index. As a result, the Hedge Fund Index is considered to be an un-investible index. Please refer to the ETF s most recent prospectus for a complete description of HHF s and the Fund s investment restrictions. The Forward Agreements In order to achieve its investment objective, the ETF has entered into multiple forward agreements (each a Forward Agreement ) each with a bank counterparty ( Forward Counterparty ). The Forward Agreements provide both positive exposure to the Fund and negative exposure to the Fund. The ETF seeks to achieve its investment objective through the net exposure of these Forward Agreements ( Net Notional Exposure ).The ETF generally invests its assets in interest bearing accounts and short-term Canadian federal or provincial treasury bills ( T-bills ) to earn prevailing short-term market interest rates to serve as collateral for the Forward Agreements. The one or more Forward Counterparties to any Forward Agreements entered into by the ETF must be a chartered Canadian bank or an affiliate of a chartered Canadian bank whose obligations are guaranteed by a chartered Canadian bank, and has a designated rating. In respect of short-term securities or instruments (where the maturity date of the security or instrument is less than one year), Forward Counterparties must have a designated rating for Commercial Paper/Short-Term Debt no lower than (a) Dominion Bond Rating Service Limited ( DBRS ) - R-1(low) ; (b) Fitch Ratings ( Fitch ) - F1 ; (c) Moody s Investors Service ( Moody s ) - P-1 ; and (d) Standard & Poor s ( S&P ) - A-1(Low). In respect of long-term securities or instruments (where the maturity date of the security or instrument is equal to or greater than one year), Forward Counterparties must have a designated rating for Long-Term Debt no lower than (a) DBRS - A ; (b) Fitch - A ; (c) Moody s - A2 ; and (d) S&P - A. Forward Counterparties are subject to the applicable short-term or long-term designated rating restrictions listed above. The Forward Counterparty to the Forward Agreements, National Bank of Canada ( NBC ), meets those designated rating requirements. Each Forward Agreement has a remaining term to maturity at any point in time of less than five years which, with the consent of the ETF and the applicable Forward Counterparty, will be extended annually for a fixed number of years and, provided no default or event of default and no unresolved hedging event or disruption event has occurred and is continuing, the ETF has the ability to request the termination of its exposure under a Forward Agreement, in whole or in part, at any time. Since the Forward Agreements, like most forward agreements, may settle the obligations of each party on a net basis, the exposure of the ETF to the credit risk of any one Forward Counterparty is limited to the positive mark-to-market of the Forward Agreements in aggregate entered into with that Forward Counterparty, which is calculated and accrued on a daily basis.

6 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF Risk The Manager performs a review of the ETF s risk rating at least annually, as well as when there is a material change in the ETF s investment objective or investment strategies. The current risk rating for the ETF is: low to medium. Risk ratings are determined based on the historical volatility of the ETF as measured by the standard deviation of its performance against its mean. The risk categorization of the ETF may change over time and historical volatility is not indicative of future volatility. Generally, a risk rating is assigned to the ETF based on a blend of the historical rolling 3-year and 5-year standard deviations of its return (or, generally, commencing with prospectus renewals after September 1, 2017, a rolling 10-year standard deviation), the return of an underlying index, or of an applicable proxy index. In cases where the Manager believes that this methodology produces a result that is not indicative of the ETF s future volatility, the risk rating may be determined by the ETF s category. Risk ratings are not intended for use as a substitute for undertaking a proper and complete suitability or financial assessment by an investment advisor. Investments in the units of the ETF are speculative, involve a degree of risk and are suitable only for persons who are able to assume the risk of losing their entire investment. The Manager, as a summary for existing investors, is providing the list below of the risks to which an investment in the ETF may be subject. Prospective investors should read the ETF s prospectus and consider the full description of the risks contained therein before purchasing units. The risks to which an investment in the ETF is subject are listed below and have not changed from the list of risks found in the ETF s prospectus. A full description of each risk listed below may also be found in the prospectus. The prospectus is available at or from or by contacting AlphaPro Management Inc. directly via the contact information on the back page of this document. Inability to achieve investment objective Risks relating to the Replication Strategy Leverage risk General risks of investing in the HAP Nexus Hedge Fund Replication Trust Risks relating to use of derivatives Calculation, or termination, of the Hedge Fund Index Counterparty risk Forward Agreement counterparty risk Reliance on key personnel Market price and net asset value deviation risk Purpose of the Replication Index and Replication Strategy Tax-related risks Foreign security risk Foreign currency risk Interest rate risk Political, economic and social risk Hedging risk Significant redemptions Exchange risk Conflicts of interest Loss of limited liability Business and regulatory risks of alternative investment strategies Change in legislation No ownership interest Market for units Securities lending risk Limited history of the Hedge Fund Index Results of Operations For the year ended December 31, 2017, the Class E units of the ETF returned 5.96%. The ETF seeks to provide a similar risk/return profile to its benchmark, the Hedge Fund Index, which returned 6.91% for the same period. The difference between the Hedge Fund Index and the ETF s performance can be explained by the fact that the asset class and sector 3

7 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF weights of hedge fund companies and invested securities are unknown to the ETF s Investment Manager. The Replication Strategy is a factor-based index replication method which uses statistical models to estimate the net exposure of the Hedge Fund Index s components to its main return-generating factors, which usually correspond to the main asset classes available on financial markets. For the period from January 1 to their termination on April 28, 2017, Advisor Class units of the ETF returned 0.09%. For the same period, the Hedge Fund Index returned 1.73%. Market and Portfolio Review The following discussion examines how the ETF s returns were affected by its exposure to the Fund via the Forward Agreement. Exposure to the following asset classes: equity, fixed income, foreign exchange, and commodities, allowed the ETF to offer a similar risk/return profile to the Hedge Fund Index. Equity This past year has been one of bull markets for equities. Through the warnings of asset bubbles, car loan bubbles, tech bubbles, etc., the S&P 500 reached several notable milestones on its way to returning 21.83% on a total return basis in Eleven of the twelve months ended higher, with March being the only negative month. The nine-month winning streak from April to December also registers as the longest consecutive monthly winning streak since On a singleday time scale, the index achieved more than 60 record-high closes. In addition, the index also displayed extremely low volatility. Only eight days during the entire year had a more than 1% percent movement. While multiple factors have been needed in order to provide this type of momentum, the one topic that traders focused on throughout the year was the progress of President Trump s proposed tax plan. Each time the tax bill made advancements through the various stages of becoming law, the S&P 500 would advance with it, hoping that the lower tax rate in the bill would help corporations to increase their profitability. In terms of sector performance within the Hedge Fund Index, technology stocks were the leading performer in earnings and valuations. On the other hand, the short emerging markets position was counter to the general trend of equity markets globally. Therefore the exposure of this position remained insignificant. Fixed Income increased short positions from the previous year have proven to be beneficial. The short Canadian bond futures contracts were the best performing fixed-income asset in the strategy. They fared well with the downward bond price pressure triggered by the Bank of Canada s first rate hike in 7 years in July. On the long side, German bunds and Japanese 10-year bonds, classic safe-haven assets, both provided contributed positively to performance as investors sought safer assets amid the nuclear war sabre-rattling by North Korea and the U.S. Moreover, the prices of these assets were further supported by their respective central banks who confirmed the continuation of their asset purchasing programs. Foreign Exchange 4 The foreign exchange component of the strategy was negatively impacted by the interest rate hike events around the world. Since the currency contracts are valued against U.S. dollars, and with the U.S. Federal Reserve leading the trend with three rate increases in 2017, the strategy s long currency positions were not able to generate favorable returns.

8 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF The long Australian dollar position in particular was more heavily impacted by the trend because the Reserve Bank of Australia refused to follow its peers on increasing its benchmark rate. On the other hand, the Bank of Canada decided to keep pace with its neighbour, announcing a second rate increase in September. The stronger Canadian dollar was not inline with the strategy s short position. Furthermore, the value of the British pound also moved higher, and against the strategy s short exposure, as investors recovered from the Brexit shock. However, the short British pound position still has the potential to be profitable. Even though phase 1 of the Brexit negotiations was successful, the full impact of the end result remains unclear. Prime Minister Theresa May s plan to consolidate her majority government by calling for a snap-election after the phase 1 talks was not successful. The continuous delays of phase 2 negotiations, and the multiple foreseeable difficulties also cast a negative outlook on the pound. Commodities The best performer in the commodity component of the strategy in 2017 was copper. First, at the beginning of 2017, a miners strike disrupted the supply of copper. This was exacerbated by China s winter anti-pollution policy which reduced its domestic production. So, the largest consumer of copper (China) had to increase imports to meet the demand. The price of the metal surged to the highest level in 3 years, which was beneficial to the strategy s long copper position. Unfortunately, the agricultural commodities did not perform as well. Ongoing political crises in Brazil caused frustrated farmers, tired of dealing with enduring uncertainties and the declining Brazilian real, to increase their soy supply. The strategy s long soy bean position was hampered by this excess supply. Moreover, the strategy s short wheat position realized losses as the price of wheat continued to rise in the face of severe drought forecasts in the U.S. On the energy side, WTI crude oil prices remained under U.S.$55 per barrel for the first half of 2017, despite the production cut efforts by the Organization of the Petroleum Exporting Countries (OPEC). The missing supply was filled by shale oil production in the U.S. However, in the latter half of the year, the worsening crisis in Venezuela, which brought that crude oil producing nation s output to a 28-year low, combined with the improved outlook from the International Energy Agency and OPEC, sent the per barrel price of oil close to $60. This price surge is counter to the strategy s short crude oil position. Contrary to the production curbs of crude oil, Qatar announced a plan to increase natural gas output by 30%, which equates to 8% of the current world s supply. The extra supply on the market is advantageous to the strategy s short natural gas position. Lastly, the long heating oil position in the strategy benefitted from higher demand due to the winter storms generated by the polar vortex which hit North American recently. Other Operating Items and Changes in Net Assets Attributable to Holders of Redeemable Units For the year ended December 31, 2017, the ETF generated gross comprehensive income (loss) from investments and derivatives of $3,031,561. This compares to $1,679,556 for the year ended December 31, The ETF incurred management, operating and transaction expenses of $808,284 (2016 $966,057). Of these expenses, the Manager either paid or absorbed $59,220 (2016 $98,082) on behalf of the ETF. The waiving and/or absorption of such fees and/or expenses by the Manager may be terminated at any time, or continued indefinitely, at its discretion. The ETF did not make any distributions to unitholders during the years ended December 31, 2017 and

9 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF Leverage The aggregate market exposure of all instruments held directly or indirectly by HHF to gain exposure to the Hedge Fund Index, calculated daily on a mark-to-market basis, can exceed HHF s net asset value, and can exceed the amount of cash and securities held as margin on deposit to support the derivatives trading activities of the Fund. Under normal market conditions, the maximum amount of leverage used, directly or indirectly, by the ETF and the Replication Strategy, expressed as a ratio of total underlying notional value of the securities and/or financial derivative positions of HHF divided by the net assets of HHF (the Leverage Ratio ), will generally not exceed 3:1. For periods of extreme volatility of the Hedge Fund Index, the Leverage Ratio used by HHF and the Replication Strategy may exceed 3:1. The following table discloses the minimum and maximum leverage levels for the ETF for the year ended December 31, 2017; the ETF s leverage at the end of the reporting year; and, approximately what that leverage represents as a percentage of the ETF s net assets. Presentation Leverage at end of Reporting Year Approximate Percentage of Net Assets Minimum Maximum Year Ended Leverage Leverage December 31, :1 3.01:1 2.52:1 252% The attached financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ). Any mention of total net assets, net assets, net asset value or increase (decrease) in net assets in the financial statements and/or management report of fund performance is referring to net assets or increase (decrease) in net assets attributable to holders of redeemable units as reported under IFRS. Recent Developments Other than indicated below, there are no recent industry, management or ETF related developments that are pertinent to the present and future of the ETF. Changes to the Manager and Investment Management Structure Horizons ETFs Management (Canada) Inc. is the manager, trustee and investment manager of the ETF and of the Fund (the Manager or the Investment Manager ). Prior to September 30, 2017, AlphaPro Management Inc. ( AlphaPro ), a wholly-owned subsidiary of Horizons Management, acted as the manager and trustee of the ETF and the Fund and had engaged Horizons Management to act as the investment manager of the ETF and the Fund. Effective September 30, 2017, AlphaPro amalgamated with Horizons Management (the Amalgamation ). Post-Amalgamation, the duties of manager and trustee for the ETF and the Fund previously performed by AlphaPro were assumed by Horizons Management, in addition to its existing role as investment manager for both entities. Horizons Management, as investment manager, is responsible for implementing the investment strategies of the ETF and the Fund. As well, on May 12, 2016, Horizons Management assumed the duties previously performed by Fiera Capital Corporation as the investment sub-advisor to the ETF and the Fund. 6

10 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF There were no changes to the investment objectives and strategies of the ETF or the Fund as result of these two transactions, or to the day-to-day management of the ETF and the Fund. Conversion and Termination of Advisor Class units The previously announced conversion (the Conversion ) of the ETF s advisor class units ( Advisor Class units ) into the ETF s common class units ( Class E units ) was completed at the close of business on April 28, 2017 (the Conversion Date ). The remaining unitholders of record of the Advisor Class units as at the Conversion Date received a number of whole Class E units of the ETF with an aggregate net asset value ( NAV ) equal to the aggregate NAV of the Advisor Class units converted, based on the respective NAVs of the two classes as at the Conversion Date (the Conversion Ratio ). The ETF s Conversion Ratio was , meaning, that for each Advisor Class unit of the ETF subject to the Conversion, the unitholder received Class E units of the ETF. The conversion of Advisor Class units into whole Class E units of the ETF did not give rise to a disposition by unitholders of converting Advisor Class units for tax purposes on any whole units converted. Any remaining fractional Advisor Class units were redeemed for cash and such redemption is considered a disposition for tax purposes. Immediately following the completion of the Conversion, the Advisor Class units were terminated. Related Party Transactions Certain services have been provided to the ETF by related parties and those relationships are described below. Manager, Trustee and Investment Manager As a result of the Amalgamation transaction described above, the manager, trustee and investment manager of the ETF is Horizons ETFs Management (Canada) Inc., 55 University Avenue, Suite 800, Toronto, Ontario, M5J 2H7, a corporation incorporated under the laws of Ontario. Horizons Management is a member of the Mirae Asset Financial Group based in Seoul, South Korea. If the ETF invests in other Horizons Management ETFs, Horizons Management may receive management fees in respect of the ETF s assets invested in such Horizons Management ETFs. Other Related Parties During the year, an affiliate of National Bank of Canada ( NBC ) and National Bank Financial Inc. ( NBF ) previously held an indirect minority interest in AlphaPro. These relationships may have created an actual or perceived conflict of interest which investors may have considered in relation to an investment in the ETF. In particular, by virtue of these relationships, NBF or NBC may have profited from the sale and trading of the ETF s units. Fiera, the former sub-advisor of the ETF and the Fund, is an affiliate of NBF and, as stated above, an affiliate of NBF held an indirect minority interest in AlphaPro. As a result, up until the change to the investment management structure on May 12, 2016, Fiera was considered to be an associate of AlphaPro. NBF s potential roles as a designated broker and a dealer of the ETF was not as an underwriter of the ETF in connection with the primary distribution of units under the ETF s prospectus. NBF was not involved in the preparation of, nor did it 7

11 Management Discussion of Fund Performance (continued) Horizons Morningstar Hedge Fund Index ETF perform any review of, the contents of the ETF s prospectus. NBF and its affiliates may, at present or in the future, engage in business with the ETF, the issuers of securities making up the investment portfolio of the ETF, or with the Manager or any funds sponsored by the Manager or its affiliates, including by making loans, executing brokerage transactions, entering into derivative transactions or providing advisory or agency services. In addition, the relationship between NBF and its affiliates, and the Manager and its affiliates may have extended to other activities, such as being part of a distribution syndicate for other funds sponsored by the Manager or its affiliates. The ETF, in its normal course of business in seeking to achieve its investment objective, may enter into portfolio transactions that involve an investment in securities of an issuer that was a related party to the Manager during the year. The Manager was permitted to execute these transactions without seeking advance approval from the ETF s Independent Review Committee ( IRC ), provided the Manager complied with the predetermined list of requirements agreed upon with the IRC. Effective June 30, 2017, Horizons Management acquired the minority interest of AlphaPro owned by an affiliate of NBC and as a result, became the sole shareholder of AlphaPro. Accordingly, NBC and NBF are no longer considered affiliates or related parties of Horizons Management and, prior to the Amalgamation, AlphaPro. For the years ended December 31, 2017 and 2016, the ETF did not make any payments to NBF and/or its affiliates in broker commissions on portfolio transactions. As discussed in the Recent Developments section above, effective September 30, 2017, AlphaPro amalgamated with its parent company, Horizons Management, and now the amalgamated companies carry on business as Horizons ETFs Management (Canada) Inc. 8

12 Financial Highlights The following tables show selected key financial information about the ETF and are intended to help you understand the ETF s financial performance for the past five fiscal years. This information is derived from the ETF s audited annual financial statements. Please see the front page for information on how you may obtain the annual or interim financial statements. The ETF s Net Assets per Unit Class E Year (1) Net assets, beginning of year $ Increase from operations: Total revenue Total expenses (0.28) (0.24) (0.24) (0.23) (0.12) Realized gains (losses) for the year (0.03) 3.34 (1.10) Unrealized gains (losses) for the year 0.53 (0.17) 0.35 (1.53) 2.95 Total increase from operations (2) Distributions: From net realized capital gains (0.56) Total annual distributions (3) (0.56) Net assets, end of year (4) $

13 Financial Highlights (continued) Advisor Class Year (1) Net assets, beginning of year $ Increase from operations: Total revenue Total expenses (0.12) (0.35) (0.35) (0.32) (0.21) Realized gains (losses) for the year (0.02) 3.23 (1.09) Unrealized gains (losses) for the year (0.31) (0.08) 0.42 (1.55) 2.92 Total increase from operations (2) Distributions: From net realized capital gains (0.44) Total annual distributions (3) (0.44) Net assets, end of year (4) $ This information is derived from the ETF s audited annual financial statements as at December 31 of the years shown. Advisor Class information for 2017 is presented as at the termination date of those units on April 28, Class E units and Advisor Class units effectively began operations on April 26, Information is presented in accordance with IFRS. 2. Net assets per unit and distributions are based on the actual number of units outstanding at the relevant time. The increase (decrease) from operations is based on the weighted average number of units outstanding over the financial period. 3. Income, dividend and/or return of capital distributions, if any, are paid in cash, reinvested in additional units of the ETF, or both. Capital gains distributions, if any, may or may not be paid in cash. Noncash capital gains distributions are reinvested in additional units of the ETF and subsequently consolidated. They are reported as taxable distributions and increase each unitholder s adjusted cost base for their units. Neither the number of units held by the unitholder, nor the net asset per unit of the ETF change as a result of any non-cash capital gains distributions. Distributions classified as return of capital, if any, decrease each unitholder s adjusted cost base for their units. The characteristics of distributions, if any, are determined subsequent to the end of the ETF s tax year. Until such time, distributions are classified as from net investment income (excluding dividends) for reporting purposes. 4. The Financial Highlights are not intended to act as a continuity of the opening and closing net assets per unit. 10

14 Financial Highlights (continued) Ratios and Supplemental Data Class E Year (1) Total net asset value (000 s) $ 44,710 36,660 48,822 30,752 21,302 Number of units outstanding (000 s) 3,078 2,674 3,643 2,320 1,844 Management expense ratio (2)(5) 1.22% 1.25% 1.23% 1.20% 1.20% Management expense ratio excluding proportion of expenses from underlying investment funds 0.54% 0.54% 0.54% 0.52% 0.52% Management expense ratio before waivers and absorptions (3) 1.58% 1.59% 1.57% 1.95% 2.34% Trading expense ratio (4)(5) 1.74% 1.46% 1.41% 1.42% 0.80% Trading expense ratio excluding proportion of costs from underlying investment funds 1.47% 1.27% 1.31% 1.36% 0.63% Portfolio turnover rate (6) 0.00% 0.00% 0.00% 0.26% 55.66% Net asset value per unit, end of year $ Closing market price $ Advisor Class Year (1) Total net asset value (000 s) $ ,277 Number of units outstanding (000 s) Management expense ratio (2)(5) 2.08% 2.10% 2.08% 2.07% 2.06% Management expense ratio excluding proportion of expenses from underlying investment funds 1.39% 1.39% 1.39% 1.38% 1.37% Management expense ratio before waivers and absorptions (3) 2.83% 2.41% 2.42% 2.83% 3.21% Trading expense ratio (4)(5) 1.74% 1.46% 1.41% 1.42% 0.80% Trading expense ratio excluding proportion of costs from underlying investment funds 1.47% 1.27% 1.31% 1.36% 0.63% Portfolio turnover rate (6) 0.00% 0.00% 0.00% 0.26% 55.66% Net asset value per unit, end of year $ Closing market price $ The information for Class E units is provided as at December 31 of the years shown. Advisor Class information is presented as at April 28, 2017 and December 31 of the other years shown. Information is presented in accordance with IFRS. 2. Management expense ratio is based on total expenses, including sales tax, (excluding commissions and other portfolio transaction costs) for the stated period and is expressed as an annualized percentage of daily average net asset value during the year. Out of their management fees, the Manager pays for such services to the ETF as portfolio manager compensation, service fees and marketing. 3. The Manager, at its discretion, may waive and/or absorb a portion of the fees and/or expenses otherwise payable by the ETF. The waiving and/or absorption of such fees and/or expenses by the Manager may be terminated at any time, or continued indefinitely, at its discretion. 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 year. 5. The ETF s management expense ratio (MER) and trading expense ratio (TER) include an estimated proportion of the MER and TER for any underlying investment funds held in the ETF s portfolio during the period. 6. The ETF s portfolio turnover rate indicates how actively its portfolio investments are traded. A portfolio turnover rate of 100% is equivalent to the ETF buying and selling all of the securities in its portfolio once in the course of the year. Generally, the higher the portfolio turnover rate in a year, the greater the trading costs payable by the ETF in the year, and the greater the chance of an investor receiving taxable capital gains in the year. There is not necessarily a relationship between a high turnover rate and the performance of the ETF. 11

15 Financial Highlights (continued) Management Fees The Manager appoints the Investment Manager and provides, or oversees the provision of, administrative services required by the ETF and the Fund (together, the Funds ) including, but not limited to: negotiating contracts with certain third-party service providers, such as portfolio managers, custodians, registrars, transfer agents, auditors and printers; authorizing the payment of operating expenses incurred on behalf of the Funds; arranging for the maintenance of accounting records for the Funds; preparing reports to unitholders and to the applicable securities regulatory authorities; calculating the amount and determining the frequency of distributions by the Funds; preparing financial statements, income tax returns and financial and accounting information as required by the Funds; ensuring that unitholders are provided with financial statements and other reports as are required from time to time by applicable law; ensuring that the Funds comply with all other regulatory requirements, including the continuous disclosure obligations of the Funds under applicable securities laws; administering purchases, redemptions and other transactions in units of the Funds; and dealing and communicating with unitholders of the Funds. The Manager provides office facilities and personnel to carry out these services, if not otherwise furnished by any other service provider to the Funds. The Manager also monitors the investment strategies of the Funds to ensure that the ETF and the Fund each complies with its investment objectives, investment strategies and investment restrictions and practices. In consideration for the provision of these services, the Manager receives a monthly management fee at the annual rate of 0.45%, plus applicable sales taxes, of the net asset value of the ETF s Class E units, calculated and accrued daily and payable monthly in arrears. Up until the termination of the ETF s Advisor Class units on April 28, 2017, as described in the section on Recent Developments, the ETF also received a monthly management fee at the annual rate of 1.20%, plus applicable sales taxes, of the net asset value of the ETF s Advisor Class units, calculated and accrued daily and payable monthly in arrears. In addition, up until the termination of the Advisor Class units, the Manager, and not the ETF, paid to registered dealers a service fee equal to 0.75% per year of the net asset value of Advisor Class units held by clients of the registered dealer. No service fees are paid to registered dealers in respect of Class E units. The Manager also receives a monthly fee at the annual rate of 0.50%, plus applicable sales taxes, of the net asset value of the HAP Nexus Hedge Fund Replication Trust, calculated and accrued daily and payable monthly in arrears for services similar to those provided to the ETF. The aggregate annual management fee is approximately 0.95% of the net asset value of the Class E units of the ETF. The aggregate annual management for the Advisor Class units prior to termination was approximately 1.70% of the net asset value of the Advisor Class units. The Investment Manager and Replication Strategy Weightings Provider are compensated for their services by the Manager without any further cost to the ETF or to the Fund. The table below details, in percentage terms, the services received by the ETF from the Manager in consideration of the management fees paid during the year. Portfolio management fees, Waived/absorbed general administrative costs expenses of the ETF Marketing and profit 5% 63% 32% 12

16 Financial Highlights (continued) Fees related to the operation of the Forward Agreements are not included in the management fees or other operating expenses of the ETF. Forward fees related to the Forward Agreements, as described in the Fees and Expenses section of the ETF s prospectus, are payable to the Forward Counterparty based on the net assets of the HAP Nexus Hedge Fund Replication Trust. For the purposes of financial reporting, these expenses have been disclosed in transaction costs in the statement of comprehensive income and are included in the trading expense ratio in the management report of fund performance. 13

17 Past Performance Commissions, trailing commissions, management fees and expenses all may be associated with an investment in the ETF. Please read the prospectus before investing. The indicated rates of return are the historical total returns including changes in unit value and reinvestment of all distributions, if any, and do not take into account sales, redemptions, distributions or optional charges or income taxes payable by any investor that would have reduced returns. An investment in the ETF is not guaranteed. Its value changes frequently and past performance may not be repeated. The ETF s performance numbers assume that all distributions are reinvested in additional units of the ETF. If you hold this ETF outside of a registered plan, income and capital gains distributions that are paid to you increase your income for tax purposes whether paid to you in cash or reinvested in additional units. The amount of the reinvested taxable distributions is added to the adjusted cost base of the units that you own. This would decrease your capital gain or increase your capital loss when you later redeem from the ETF, thereby ensuring that you are not taxed on this amount again. Please consult your tax advisor regarding your personal tax situation. Year-by-Year Returns The following chart presents the performance of the ETF for its Class E units for the periods shown. In percentage terms, the chart shows how much an investment made on the first day of the financial period would have grown or decreased by the last day of the financial period % 15.00% Rate of Return 10.00% 5.00% 0.00% -5.00% HHF -1.81% 17.64% 14.74% 1.12% 2.29% 5.96% The ETF effectively began operations on April 26,

18 Past Performance (continued) Annual Compound Returns The following table presents the ETF s annual compound total return since inception and for the periods shown ended December 31, 2017 along with a comparable market index. The table is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of the ETF or future returns on investments in the ETF. Period HHF Return % Morningstar Broad Hedge Fund Index Return % 1 Year 5.96% 6.91% 3 Year 3.10% 3.74% 5 Year 8.15% 5.16% Since Inception 6.79% 4.82% The ETF effectively began operations on April 26, Former Advisor Class unitholders had their units converted to Class E units of the ETF based on the Conversion Ratio disclosed in the Recent Developments section as at the close of business on April 28, Assuming the former Advisor Class unitholders held the Class E units they received as part of the Conversion until December 31, 2017, the returns those unitholders would have experienced for 2017 and for the other periods disclosed in the table above would have been substantially similar to those of the Class E unitholders, when adjusted for the differences in the expenses of the ETF paid by each class. 15

19 Summary of Investment Portfolio As at December 31, 2017 % of ETF s Asset Mix Net Asset Value Net Asset Value Investments* $ 5,562, % Cash and Cash Equivalents held for Collateral 39,197, % Cash and Cash Equivalents Other % Other Assets less Liabilities (50,214) -0.11% $ 44,709, % Top Holdings % of ETF s Net Asset Value Cash and Cash Equivalents held for Collateral 87.67% Forward Agreements (net notional value $44,693,839)* 12.44% * The ETF has exposure to the investments of the HAP Nexus Hedge Fund Replication Trust through the Forward Agreements. Please see the supplementary Summary of Investment Portfolio of the HAP Nexus Hedge Fund Replication Trust on the following page for more detail on that fund s investments. The summary of investment portfolio may change due to the ongoing portfolio transactions of the ETF. The most recent financial statements are available at no cost by calling , by writing to us at 55 University Avenue, Suite 800, Toronto, Ontario, M5J 2H7, by visiting our website at or through SEDAR at 16

20 Summary of Investment Portfolio (supplementary - HAP Nexus Hedge Fund Replication Trust) As at December 31, 2017 Horizons Morningstar Hedge Fund Index ETF % of Fund s Asset & Sector Mix Net Asset Value Net Asset Value Long Positions Futures Contracts Index Speculative* $ 320, % Futures Contracts Commodity Speculative* 231, % Futures Contracts Currency Speculative* 60, % Currency Forward Hedge* 16, % Futures Contracts Treasury Bond Speculative* (91,877) -0.21% Cash and Cash Equivalents 39,519, % Margin Deposits 4,660, % Other Assets less Liabilities (14,408) -0.03% Short Positions Futures Contracts Treasury Bond Speculative* 280, % Futures Contracts Index Speculative* (20,439) -0.05% Futures Contracts Currency Speculative* (22,417) -0.05% Futures Contracts Commodity Speculative* (245,884) -0.55% $ 44,693, % *Positions in futures and/or forward contracts are disclosed as the gain/(loss) that would be realized if the contracts were closed out on the date of this report. 17

21 Summary of Investment Portfolio (supplementary - HAP Nexus Hedge Fund Replication Trust) (continued) As at December 31, 2017 Top Holdings** % of Fund s Net Asset Value Long Positions S&P 500 E-Mini Index Futures 57.20% Japanese 10-Year Mini Bond Futures 52.34% Euro-Bund Futures 35.46% Australian Dollar Currency Futures 7.91% Copper Futures 6.03% NY Harbor ULSD Futures 3.66% Soybean Futures 3.25% Japanese Yen Currency Futures 1.25% U.S. 2-Year Treasury Bond Futures 1.20% Short Positions Gold 100oz. Futures -0.74% Canadian Dollar Currency Futures -1.12% Mini MSCI Emerging Markets Index Futures -1.47% Silver Futures -1.93% Crude Oil Futures -2.04% U.S. 10-Year Treasury Bond Futures -3.14% Natural Gas Futures -3.90% Australian 10-Year Treasury Bond Futures -5.67% Wheat Futures -6.55% British Pound Currency Futures -7.39% Australian 3-Year Treasury Bond Futures % Canadian 10-Year Treasury Bond Futures % ** All futures positions are speculative in nature. Positions in futures contracts are disclosed in terms of their notional exposure. Aggregate notional exposure of futures contracts equals % of the Fund s NAV. The summaries of investment portfolio may change due to the ongoing portfolio transactions of the ETF and of the Fund. The most recent financial statements are available at no cost by calling , by writing to us at 55 University Avenue, Suite 800, Toronto, Ontario, M5J 2H7, by visiting our website at or through SEDAR at 18

22 MANAGER S RESPONSIBILITY FOR FINANCIAL REPORTING The accompanying audited annual financial statements of Horizons Morningstar Hedge Fund Index ETF (the ETF ) are the responsibility of the manager and trustee to the ETF, Horizons ETFs Management (Canada) Inc. (the Manager ). They have been prepared in accordance with International Financial Reporting Standards using information available and include certain amounts that are based on the Manager s best estimates and judgments. The Manager has developed and maintains a system of internal controls to provide reasonable assurance that all assets are safeguarded and to produce relevant, reliable and timely financial information, including the accompanying financial statements. These financial statements have been approved by the Board of Directors of the Manager and have been audited by KPMG LLP, Chartered Professional Accountants, Licensed Public Accountants, on behalf of unitholders. The independent auditors report outlines the scope of their audit and their opinion on the financial statements. Steven J. Hawkins Director Horizons ETFs Management (Canada) Inc. Taeyong Lee Director Horizons ETFs Management (Canada) Inc. 19