ETF Strategies for Rising Interest Rates

Transcription

1 ETF solutions for every investor TM ETF Strategies for Rising Interest Rates October 2013 Nicolas Normandeau, CFA, M.Sc. Vice President and Portfolio Manager, Fixed Income

2 Disclaimer The views expressed herein may not necessarily be the views of AlphaPro Management Inc. (the Manager ), or Horizons Investment Management (Canada) Inc. (the Investment Manager ), although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by the Investment Manager including the Horizons Active Floating Rate Bond ETF, and the Horizons Active Preferred Share ETF (the ETFs ). All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. The Investment Manager and Manager have a direct interest in the management and performance fees of the ETFs, and may, at any given time, have a direct or indirect interest in the ETFs or their holdings. Horizons ETFs is a member of Mirae Asset Global Investments 2

3 US Treasury/10 Year 1950-Present Where will interest rates go in the next few years? Many experts think we may be in a low interest rate environment for years to come, but even if rates go up to 3.5% that is 100 bps more versus where we are today 18.00% 10-Year U.S. Treasury Yield: 1962 to % 14.00% 12.00% Yield 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 1/02/62 1/02/66 1/02/70 1/02/74 1/02/78 1/02/82 1/02/86 1/02/90 1/02/94 1/02/98 1/02/02 1/02/06 1/02/10 Source: Bloomberg, For the period of January 1,1950 September 30, 2013 Horizons ETFs is a member of Mirae Asset Global Investments 3

4 Risk/Reward Profile of the Recognized Canadian Bond Universe Attractive Risk/Reward Risking 8-month of yield on a 1% interest rate increase Unattractive Risk/Reward Risking 2.5 years yield on a 1% interest rate increase 10.00% 9.00% 8.00% % % Duration % 4.00% Yield 3.00% 2.00 Duration Yield 2.00% % /01/94 12/01/95 6/01/97 12/01/98 6/01/00 12/01/01 6/01/03 12/01/04 6/01/06 12/01/07 6/01/09 12/01/10 6/01/ % Source: Bloomberg, as at September 30, 2013 Horizons ETFs is a member of Mirae Asset Global Investments 4

5 Why Duration Matters Horizons ETFs is a member of Mirae Asset Global Investments 5

6 Horizons Active Floating Rate Bond ETF General Investment Objective: Generate income consistent with prevailing short-term corporate bond yields while stabilizing market value from the effects of interest rate fluctuations. General Portfolio Strategy: Invest primarily in a portfolio of corporate bonds, while using fixed to floating interest rate swap to maintain a portfolio duration below 2 years. Details: TSX-listed as HFR; Advisor Class listed as HFR.A Sub-advised by Fiera Capital Corporation 0.40% Management Fee; Advisor Class Management Fee of 0.90%* Monthly distribution of income Annual distribution of net capital gains, if any The HFR portfolio holdings have, as of Oct 2, 2013: a weighted average yield of 2.80% an average duration of 0.6 year, with a target of below 1 year and a maximum of 2 years an average Standard & Poor s credit quality of A Seeks to hedge non-canadian dollar currency exposure to the Canadian dollar at all times *Includes Service Fee Horizons ETFs is a member of Mirae Asset Global Investments 6

7 Investment Process 4 STEP MANAGEMENT PROCESS 1) Analysis of macro factors, economic backdrop, outlook for yields and credit Analysis of global and local economies Thorough assessment of North American and global markets (credit, equity, exchange rates, interest rates) Analysis of fundamental indicators 2) Invest to take advantage of relative value opportunities In-depth credit analysis (fundamental credit analysis, company meetings, review of rating agency reports and independent credit research, discussions with Fiera s equity teams and credit/equity analysts) Extensive relative value analysis (corporate bonds, CDS, international levels, rating, capital structure, equity valuation, preferred share structure) Analysis of technical indicators 3) Hedge interest rate risks (where applicable) Enter swap agreement to deliver fixed rate and receive CDOR (Canadian Deposit Overnight Rate) 4) Continuously manage risks and deviations Daily performance tracking & reporting Rigorous risk budgeting and monitoring of holdings Horizons ETFs is a member of Mirae Asset Global Investments 7

8 HFR Yield Explained The following example uses these assumptions: 3-year swap fixed rate is 1.7%, CDOR 3 month is 1.3% Portfolio holds corporate bonds with an average yield of 3.2% and average duration of 3 years For illustration purposes only Horizons ETFs is a member of Mirae Asset Global Investments 8

9 Why Invest In A Floating Rate Corporate Bond ETF? Higher current income than Canadian money market securities Variable distribution that fluctuates or floats with prevailing Canadian short-term interest rates Lower interest rate sensitivity than typical fixed income securities Capital preservation Attractive credit risk premiums Portfolio diversification Horizons ETFs is a member of Mirae Asset Global Investments 9

10 HFP: Interest Rate Protection for Preferred Shares Name: Horizons Active Floating Rate Preferred ETF Ticker Symbol: HFP/HFP.A Management Fee: 0.55% (1.05% for Advisor Class units, which includes Service Fee) Sub-Advisor: Fiera Capital Inc. ETF Investment Structure: Holds a portfolio consisting primarily of preferred shares and uses an interest rate swap to hedge interest rate risk, of fixed rate preferreds, when deemed appropriate Taxation: Distributions are expected to consist primarily of eligible Canadian dividends. Capital gains/losses if ETF units sold Portfolio Duration: 0.8 Years, as at October 2, 2013 Distribution Frequency: Monthly Eligibility: All registered and non-registered investment accounts * Plus applicable sales taxes Horizons ETFs is a member of Mirae Asset Global Investments 10

11 Why Interest Rates Matter Preferred shares are generally as interest rate sensitive as bonds and their prices will generally fluctuate in response to changes in interest rates In June 2013, when the U.S. Federal Reserve Chairman hinted that the U.S. might taper its program of quantitative easing, preferred shares generally saw a significant decline in prices as, it is believed, investors anticipated higher interest rates and sold preferred shares Fears of Rising Interest Rates Source: Bloomberg, from June 1, 2013 to September 17, Horizons ETFs is a member of Mirae Asset Global Investments 11

12 Why Interest Rates Matter Even the S&P/TSX Preferred Share Ladder Index, which is less interest rate sensitive than the broader index due to the fact it limits duration exposure by staggering rate resets, also saw significant price declines Fears of Rising Interest Rates Source: Bloomberg, from April 1, 2013 to September 17, Horizons ETFs is a member of Mirae Asset Global Investments 12

13 Portfolio Snapshot The majority of the portfolio is expected to consist of fixed-tofloating rate preferreds that have an option to reset as floating rate exposure in the future Over time the weight of floating rate issues should grow in the Canadian preferred market Estimated Yield is CDOR (1.30%) + Projected Portfolio Yield (4.45%) Fixed Swap Payment (1.95%) = Gross Yield (3.8%)** The yield will increase as short-term interest rates rise Target HFP portfolio duration = 0.5 years* * As at October 2, 2013 **These numbers are hypothetical, the yield of HFP will fluctuate with market conditions. These numbers should be used for illustrative purposes only. Horizons ETFs is a member of Mirae Asset Global Investments 13

14 HFP Hedge Mechanics Swap Counterparty (Cdn Bank) CDOR Above 1.3% Deliver 1.95% HFP Net receive CDOR + 2.5% Unitholder* 3.8% Receive 4.45% High Quality Preferred Shares This example uses the following assumptions: Assumes 100% fixed-to-floating portfolio 3-year swap fixed rate is 1.95%, CDOR is 1.3% Portfolio holds high-quality preferred shares with a duration (time to reset date) of around 3 years * Before fees and expenses. For illustration purposes only. Horizons ETFs is a member of Mirae Asset Global Investments 14

15 Why Own HFP? Attractive yield while lowering interest rate risk of traditional preferreds Distributions to rise with any rise in short term rates Portfolio diversification Sub-advised by an experienced portfolio management team with an excellent track record Tax Efficient Low Cost Listed on the TSX Horizons ETFs is a member of Mirae Asset Global Investments 15

16 The Performance of the Horizons Active Preferred Share ETF (HPR) HPR has outperformed index-tracking strategies since its inception in November of 2010 using a combination of credit analysis, security analysis and maintaining a lower exposure to securities that have higher duration than the benchmark 18% 16% 14% 12% HPR and S&P/TSX Preferred Share Index Total Return Performance Comparison Since HPR Inception: November 22, 2010 Horizons Active Preferred Share ETF S&P/TSX Preferred Share Index Cumulative Return 10% 8% 6% 4% 2% 0% -2% -4% 11/22/2010 3/22/2011 7/22/ /22/2011 3/22/2012 7/22/ /22/2012 3/22/2013 7/22/2013 Source: Bloomberg as of August 31, The rates of return shown in the chart are used only to illustrate the effects of the compound growth rate and are not intended to reflect future values of the Horizons Active Preferred Share ETF or returns on investment in the Horizons Active Preferred Share ETF, or future performance of the index. Horizons ETFs is a member of Mirae Asset Global Investments 16

17 HPR Performance Product Ticker Type 1 Month 3 Month 6 Month YTD 1 Year 3 Year Since Inception Distribution Yield Mgmt Fees Horizons Active Preferred Share ETF HPR Total Return -0.88% -3.19% -2.69% -1.65% 0.30% N/A 4.06%* 4.35% 0.55% ishares S&P/TSX Canadian Preferred Share Index Fund CPD Total Return -1.06% -4.23% -4.10% -2.98% -1.37% 3.59% 2.41% 4.51% 0.45% BMO S&P/TSX Laddered Preferred Share Index ETF ZPR Total Return -0.84% -4.25% -4.27% -2.50% N/A N/A N/A 4.48% 0.45% The indicated rates of returns in the table are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends and distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Past performance is not a guarantee of future results. Performance greater than one year is the average annual return. *Since Inception performance is as of November 22, Beta is to the S&P/TSX Preferred Share Index Source: Bloomberg, as at August 31, 2013 Investment Objectives: CPD: ishares S&P/TSX Canadian Preferred Share Index Fund seeks to track, less fees and expenses,the S&P/TSX Preferred Share Index. ZPR: BMO S&P/TSX Laddered Preferred Share Index ETF has been designed to replicate, to the extent possible, the performance of the S&P/TSX Preferred Share Laddered Index, net of expenses. Horizons ETFs is a member of Mirae Asset Global Investments 17

18 Disclaimer Commissions, trailing commissions, management fees and expenses all may be associated with an investment in the Horizons Active Floating Rate Bond ETF, and the Horizons Active Preferred Share ETF managed by AlphaPro Management Inc. (the ETFs ). The ETFs are not guaranteed, their value changes frequently and past performance may not be repeated. Indicated rates of return are the historical annual compounded total returns including changes in per unit values and reinvestment of all dividends and distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. The prospectus contains important detailed information about these ETFs. Please read the prospectus before investing. Horizons ETFs is a member of Mirae Asset Global Investments 18

19 ETF solutions for every investor TM May 2013 HorizonsETFs.com Thank You