Impressions from our trip to Calgary. Short term

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1 December 3 rd, 2014 INVESTMENT STRATEGY NOTES Nick Majendie, CA Director, Wealth Management ScotiaMcLeod Senior Portfolio Manager, with responsibility for advising the Anchor Impressions from our trip to Calgary Stock market outlook In our last Anchor Note, we discussed three potential market scenarios. The first involved no U.S. recession until at least 2017 or later. The second, we called a melt up and then melt down and third a free fall. Our concluding remarks were as follows: Judging the odds of each of the above scenarios materializing is hazardous at best. However, at this stage we would put odds of 45% on scenario one, of 35% on scenario two and of 20% on scenario three. We continue to have a lot of sympathy with Jeremy Grantham s view which we have quoted before: namely that the most likely ultimate peak of the cyclical bull market would come around the time of the next Presidential election: around November At that point, the S & P 500 would be 100% overvalued and would likely experience another 50% drop. In essence, this is a melt up and then melt down scenario but more gradual in coming to fruition. Our last Anchor Note was delayed as a result of our visit to Calgary to interview the management of companies in our equity universe located there. This Anchor Note summarizes some of the key takeaways from that trip. The initial market reaction was a swift markdown of stocks related to the Alberta economy whether justified by the fundamentals or not. Thus, aside from oil and gas and energy service stocks, bids for CP and CNR dropped sharply as they did for Canadian Western Bank, many of the pipelines particularly the midstream players utilities and even Boardwalk REIT where rental demand would actually improve in a weakening housing environment. Calgary impressions A) Outlook for oil prices Short term There had been much speculation about the potential impact on energy prices of the November 24 deadline for negotiations with Iran on its nuclear programme and of the November 27 OPEC meeting. The first resulted in an extension of the deadline for those negotiations to July 1 and hence no noticeable short term impact on energy prices while the OPEC meeting resulted in no production cut. As a direct consequence, the WTI oil price dropped sharply again, hitting at least a short term low on December 1 of $63.72 before rallying to around $68.50 at the close that day. We saw 11 energy companies during our visit. While our company visits predated the OPEC meeting, there was a general belief that oil prices would stay depressed for the next six to 12 months barring an unexpected move to cut production by OPEC (Canadian Natural Resources was more bearish believing that the oil price could stay low for months). In terms of U.S. shale oil producers, it was felt that, if the WTI oil price was around $75 per barrel or even $65 or $70 per barrel, it would be

2 six to nine months before there would be much in the way of a production fall off. This was partially because many of the companies, being significantly debt financed, had hedged a good portion of their next six months production at decent prices and partially because increasing efficiencies in the drilling process in fields such as the Bakken and Eagleford have dropped the breakeven level for many producers to $70 and below. Longer term Among the majors we interviewed, the consensus for the long term WTI price was $90 a barrel. The widest gap that we encountered was between CNQ and Suncor. The former s best guess was that the long term price would range between $80 and $90 while the latter is using $90 to $100 a barrel. In our 2017 cash flow per share estimates for all the companies we have assumed $90 a barrel. B) Natural gas price outlook short and long term Short term Early winter conditions have sent natural gas prices higher than expected a couple of months ago. However, injections to storage have been running close to record levels to catch up with the drawdowns from the polar vortex last winter. The forward AECO strip has moved up about 25 cents over the same time period but we think using a lower AECO price of $3.50 is prudent for 2015 estimates since supply particularly from new infrastructure for Marcellus gas will likely offset any demand improvement barring another very cold winter which is virtually impossible to forecast. Longer term Again, the consensus among the majors in the companies we visited was that the AECO natural gas price would stay in the $3.50 to 4.00 range. CNQ the second largest gas producer is putting its money where its mouth is: they noted that in 2007, they drilled 1,000 gas wells while in 2015, they plan to drill 68 gas wells of which one third are to keep the Septimus gas plant full and for land retention. In our 2017, CFPS forecasts we have generally used a $3.50 AECO price. C) Our defensive/balance sheet oriented strategy In our October 31 Anchor Note, we explained how we had stress tested each of the companies in our universe under the following constraints: maintaining a debt to cash flow ratio of 2.0 times or better at $75 a barrel prices and around 2.0 times at $70 a barrel WTI. For companies with natural gas production, we also assumed an AECO gas price of $3.50/mcf at both oil prices. We also screened for a simple dividend payout ratio of 50% or better at $70 a barrel oil prices and 133% or better if Capex was added to current dividends in order to calculate a total dividend payout ratio. We also screened to ensure that companies would not have drawn down their entire credit lines if they maintained their 2014 Capex programmes in 2015 and the WTI oil price fell to $70 a barrel. This exercise resulted in us selling companies that did not meet those tests and switching into or adding to three that did. Thus, for example, we sold out of Baytex at about $37.50 after it had dropped from $42 at the end of September. However, it has since dropped to the low $20 s. Our purchases/additions were concentrated in Arc Energy, Peyto Energy and Vermillion. Arc and Peyto are around the levels at which we purchased or added while unfortunately Vermillion is about 20 percent lower. We highlight below the results of our meetings with those three companies. D) Short and long term outlook for Arc Energy, Peyto and Vermillion Energy Inc.

3 i) Arc Energy Arc is one of the most conservatively financed of the energy companies in our universe. Assuming that the WTI oil price averages $75 in 2015 and the AECO gas price is $3.50, on reduced 2015 capital expenditures of $875 million, ARC s debt to cash flow ratio would be at about 1.2 times well within the Company s times targeted range. Also, Arc would have almost $1 billion of undrawn credit lines. At $65 a barrel and (with hedges) gas at $3.75, the debt to cash flow ratio would be between 2.1 and 2.2 times. However, we would expect some reduction in Capex to be announced in the first quarter or half of 2015, if oil settled at $65 a barrel to bring the ratio down to 2.0 times or below. It should be noted that Arc has managed to reduce operating costs for three years in a row. On a longer term basis, we project that, with the AECO gas price at $3.50 and the WTI oil price at $90, 2017 cash flow per share would be in the region of $4.20, rising to $4.70 in 2018 when the new Dawson gas plant is fully on stream production would be around 130,000 BOE s a day. Those levels of CFPS, if achieved, should lead to a modest increase in the dividend to about $1.30 and $1.40 in the respective years compared to today s level of $1.20. However, the annual total shareholder return over the three and four year periods should handily exceed 10%, in our opinion. ii) Peyto Peyto continues to impress. Most significantly, it remains the gas producer with the lowest operating costs. In fact, operating costs per MCF have been flat for the last eight years and other cash costs have been low too. The only other producer that can boast costs anywhere close to Peyto s level would be Trilogy. In addition, PEY has already hedged about a third of its 2015 production at $3.73 which is not far off the current strip. Assuming that next year s production is sold at close to that price, production in BOE terms should be around 92,000 barrels a day and cash flow per share by our estimate at about $5.10. At their current price, PEY shares sell at their average low P/CF multiple of the last three years. Longer term, assuming a $3.75 AECO price and WTI at $90 per barrel, we believe that production could reach in excess of 135,000 BOE s a day by 2017, providing CFPS of about $7.80. Importantly, we believe that could lead to dividend growth each year to a level of better than $2.00 a share in On that basis, over the three years, we think the total shareholder return could exceed 20% per year. iii) Vermillion Because 50% of Vermillion s production sells at Brent or European gas prices (around $10/MCF currently), Vermillion s netbacks are high and either number one or number two among its Canadian peers. Thus, assuming a Brent price of $80 per barrel (equivalent to $75 per barrel WTI), we estimate 2015 CFPS at about $6.60 per share. Even at a Brent price of $70, 2015 CFPS would still be around $6.30 with an estimated rise on similar prices to $7.30 in This is under the assumption that Corrib comes on stream mid-year and takes two months to ramp up. Corrib will supply approximately 65% of Ireland s gas needs with peak production expected to be maintained through to early That might be prolonged with drilling of one to two more wells which would not take place until Because of the significant capital expenditures on Corrib, Capex will fall off sharply from the middle of next year onwards and free cash flow will increase commensurately. We anticipate a dividend increase at some point next year. In addition, the Company s debt to cash flow ratio should fall from a likely peak of close to 2.0 times (on $70 Brent) at least half way towards its normal comfort zone of 1.0 to 1.3 times.

4 On a longer term basis, with a $95 per barrel Brent oil price and flat European gas prices, we estimate 2017 CFPS in the region of $9.30. Based on historical payout ratios in the 35%- 40% range, the dividend could increase to around $3.70 per share under those circumstances. Again, achievement of those metrics should make the shares a very rewarding investment in terms of total shareholder return. E) The service company outlook The oil and gas service industry has been under fairly constant downwards pressure in the last few months. The two companies in our universe that we saw on this trip were Trinidad and Savanna. Both are currently selling at less than half their respective June and May highs. Short term, the prospects for both look reasonable. Both companies were able to pass through their labour cost increases in their rates. Activity should be reasonable this winter as many of their customers have already made their commitments. However, assuming energy prices stay low for most of 2015, the back half of next year could prove to be quite problematical. Thus, in the short term, although both stocks look statistically cheap, we do not advocate playing them for the normal seasonal up pattern. All of the producers that we interviewed expected their service costs to be flat to down next year. If, as and when the oil price outlook stabilizes or improves within the next months, both companies would be good candidates for purchase as both have good geographical exposure (Trinidad in North America and Saudi Arabia and Mexico though the Halliburton JV and Savanna in North America and Australia) and increasingly modern equipment. However, we would be careful about aggressive participation in the sector currently. In addition, there has been a fair degree of optimism about the prospects for BC LNG but our discussions with some of the key natural gas players makes us cautious that no more than a couple of LNG plants will ultimately receive a favourable investment decision from their sponsors (the most likely being Petronas and Shell/Chevron). US Gulf projects have a cost structure that is 50% to 60% of ours. F) Pipelines Of the two major pipeline companies, we favour Enbridge and of the midstream/pipeline players we currently prefer Interpipeline although we also own the Transcanada and Pembina in various percentages in our three major portfolios. Enbridge s level of commercially secured projects appears on the face of it to be smaller than Transcanada s. However, there is much more uncertainty as to the timing or ultimate approval of TRP s slate of projects. Both have had recent investor days. ENB (including Enbridge Energy Partners EEP and Encore Energy Partners ENP ) recently revealed $33 billion of commercially secured projects for 2014 to 2017 of which $10 billion will have come into service this year and a further $23 billion by 2017 while TRP revealed $46 billion of commercially secured projects. However, $8 billion of that relates to Keystone XL where it is possible that President Obama - absent a Senate veto override could delay approval during the rest of his term. In addition, Energy East accounts for $12 billion of the $46 billion with another $1.5 billion from transfer of mainline assets to tie in Marcellus gas. The two aforementioned LNG projects would require $5.0 billion for Prince Rupert Gas and $4.0 billion for the Shell Coastal gas line as well as $2 billion for the Merrick Chevron line. Thus, in TRP s case, $33 billion of the $46 billion are in yet to be approved projects. The remaining $13 billion is in smaller projects, which will generate sufficient cash flow to fund a jump in the Company s dividend growth rate to 8% from 4% with further upside if one or more of the 4 larger

5 projects ultimately gets approved. Based on that dividend growth rate and our estimate of 2017 CFPS of slightly over $7 in 2017, we project a total shareholder return annually of just shy of 10% over the next three years. In ENB s case, the much larger capital program through 2017 will not, in our opinion, require any additional equity issue. EPS are expected to grow at a 10%-12% rate while ENB disclosed that its free cash flow would grow at least 25% per year through to This will allow dividends to grow much faster than earnings over the next three years. An announcement of the new dividend growth rate is likely to come in the first week of December. However, currently we are estimating a 2017 dividend close to $2.40 in 2017 with EPS around $2.64. On that basis, we believe that the annual total shareholder return could be close to mid- double digits over the next three years. Interpipeline has considerable EBITDA growth between 2014 and 2017 from commercially secured oil sands pipeline projects with additional potential for fuller usage of pipeline capacity. Conventional pipeline EBITDA is also expected to grow by close to 15% over the next 3 years while NGL extraction and bulk liquids storage is projected to be roughly flat over the same period. The net result is that we estimate that CFPS will roughly double from 2014 to Importantly, the proportion of EBITDA that will be cost of service or fee for service versus commodity based will rise to 90%. This greater predictability should allow dividends to grow at a 10% per year pace, providing, by our estimate, a total annual shareholder return over the next three years of 12%-13%. Although we still own Pembina Pipeline in our three main portfolios, we took significant profits a couple of months ago after very substantial gains. We retain holdings, however, since we expect total annual shareholder returns of at least 10% from today s lower stock price over the next three years. In contrast to IPL, PPL in 2017 will see 20% or over of its cash flow be commodity based yet currently the shares are selling at a 10% P/CF multiple premium to IPL. Finally, its dividend is expected to grow at roughly a 4% pace annually compared to IPL s 10% growth rate. G) Utilities Transalta is a stock that currently everybody seems to love to hate. Indeed, in early November, the stock touched a low of $10.40 a level it has not seen in 25 years. It had recovered about 15% since then but with the general downdraft in the recent week in all Alberta related stocks, it is now 5% up from its low. One of the key reasons that its shares have suffered in the market place is that there is general scepticism among investors that it can increase its cash flow and possibly maintain its dividend which was reduced to $0.72 early this year. Even at current levels, its P/CF multiple is barely above the low it saw at the bottom in We believe TA shares represent great value here. The Company is targeting 3%-5% annual CFPS growth between now and 2017 of which two thirds has already been locked in through two Australian deals. Dropdowns to Transalta Renewables and modest free cash flow should allow TA to finance additional deals to make up for the other third. Thereafter, Sundance A is expected to generate cumulative incremental EBITDA between $120 and $280 million in the timeframe once the PPA expires dependent on whether Alberta power prices are $55 or $75/MWH. That gives additional annual cash flow per share over current levels of between 6% and 15%. We believe Alberta power demand growth will eat up the current excess supply within two to three years putting upwards pressure on power prices. H) Boardwalk REIT

6 At the end of October, Boardwalk touched an alltime high although it has since pulled back by 10% with the investor kneejerk reaction to lower oil prices and the impact on the Alberta economy. Shareholders (as of December 31) will receive a special distribution of about 2%. BEI.UN owns 225 properties and 34,600 apartment units. It is one of the largest publicly traded residential landlords in Canada and North America. The Company pursues a policy of low financial leverage with a low payout ratio. The strong free cash flow and balance sheet have helped the REIT sell at a premium AFFO multiple. Q3 results saw the beginnings of upwards operating cost pressure. If interest rates go up, the common reaction would be that Boardwalk would be under pressure. However, the Company maintains that it would be a big winner in these circumstances as rents would go up and their 60% margin gives it pricing power. Our view is that there is some truth to this in terms of NOI growth but we think that there would be some offset in terms of a lower AFFO multiple. Short term, we see the potential for a 10% total shareholder return and longer term (over 3 years) a high single digit total shareholder return excluding any special dividends in either case. Our trades in the last two weeks largely emanate from our Calgary trip and the underlying fundamental rationale for those trades is to be found in the comments on the individual stocks above. Thus, in the Anchor Defensive Income fund, we added significantly to our Enbridge position and modestly to our Pembina Pipeline holding which was materially off its highs. We also bought a new position in Inter Pipeline (see reasons for purchase in our November 24 Strategy Note). These purchases were funded through sale of a portion of our IShares Shortterm Bond ETF. In the Anchor Dividend Growth fund, we bought a new position in Interpipeline and added to our Enbridge position. These additions were funded by modest profit taking in our holdings of Brookfield Property Partners and Brookfield Infrastructure Partners, both of which recently touched all-time highs, as well as in H & R REIT and Boardwalk REIT (the latter also touching an all-time high fairly recently). In the Anchor High Income fund, we added to Enbridge and funded those purchases from profit taking in Brookfield Property Partners and Brookfield Infrastructure Partners. However, after the trades, all three stocks plus Telus comprise our largest holdings in the Anchor High Income fund. Portfolio changes Nick Majendie, CA Director, Wealth Management, Senior Portfolio Manager, ScotiaMcLeod PLEASE NOTE: IMPORTANT DISCLOSURES AND DISCLAIMERS ARE CONTAINED ON THE FOLLOWING PAGE.

7 i The Bank of Nova Scotia is the parent company of Scotia Capital Inc. ( SCI ) and is therefore a related issuer of SCI. Scotia Managed Companies Administration Inc., a wholly-owned subsidiary of SCI, is the manager of the Anchor. ScotiaMcLeod, a division of SCI is the portfolio advisor to the Anchor. Nicholas L. Majendie, who is employed by ScotiaMcLeod, provides portfolio advice to the Funds. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. These Anchor are distributed under a Simplified Prospectus. The Simplified Prospectus, Fund Facts and Annual Information Form are available from ScotiaMcLeod or on Anchor hold securities of the following issuers referred to in this note: Boardwalk REIT, Brookfield Property Partners, Brookfield Infrastructure Partners, Enbridge, H & R REIT, IShares Short-term Bond ETF, Inter Pipeline, Pembina Pipeline, Peyto Exploration & Development Corp, TransAlta Corporation, TransCanada Corporation and Vermillion Energy. Nick Majendie, who provides portfolio management advice to the Anchor, personally holds securities of the following issuers referred to in this note: Boardwalk REIT, Brookfield Property Partners, Brookfield Infrastructure Partners, Enbridge, H & R REIT, IShares Short-term Bond ETF, Inter Pipeline, Pembina Pipeline, Peyto Exploration & Development Corp, TransAlta Corporation, TransCanada Corporation and Vermillion Energy. This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaMcLeod, a division SCI, but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice. The statements in this newsletter may contain statements related to future financial performance of certain securities, indices or the Anchor Managed funds that may constitute forward-looking statements. These statements may be identified by words such as expect, look forward to,

8 anticipate, believe, seek, estimate, project, potential, predict, or words of similar meaning. Such statements are based on the current expectations and certain assumptions of the author, and are, therefore, subject to certain risks and uncertainties. A variety of factors, many of which are beyond the author s control, affect the performance of the securities and capital markets indices and therefore the performance of the Anchor funds and could cause the actual results, performance or achievements of the securities, indices or the Anchor funds to be materially different.