First Trust Senior Loan ETF (CAD-Hedged)

Transcription

1 Interim June 30, 2015

2 INTERIM MANAGEMENT REPORT OF FUND PERFORMANCE June 30, 2015 First Trust Senior Loan ETF (CAD-Hedged) (the First Trust ETF ) This interim management report of fund performance contains financial highlights, but does not contain the complete unaudited interim financial report of the First Trust ETF. All references to dollars contained herein are to Canadian dollars. Securityholders may also contact us to request a copy of the First Trust ETF s proxy voting policies and procedures, proxy voting disclosure record, or quarterly portfolio disclosures relating to the First Trust ETF by calling , by writing to us at FT Portfolios Canada Co., 330 Bay Street, Suite 1300, Toronto, Ontario M5H 2S8 or by visiting our web site at or SEDAR at Forward Looking Statements 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 beliefs regarding future events. By their nature, forward-looking statements are based on assumptions and are subject to inherent risks and uncertainties. There is significant risk that forward-looking statements will not prove to be accurate. Readers of this document should not place undue reliance on forward-looking statements as a number of factors could cause actual future results, conditions, actions or events to differ materially from the expectations, estimates or intentions expressed or implied in the forward-looking statements. These factors include but are not limited to market and general economic conditions, interest rates, foreign currency exchange rates, the extent of industry sector exposure, the performance of the securities of the issuers held in the portfolio and regulatory developments and the risks detailed in the First Trust ETF s prospectus. 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. i

3 Investment Objective and Strategy The fundamental investment objective of First Trust Senior Loan ETF (CAD-Hedged) (the First Trust ETF ) is to provide Unitholders with a high level of current income by investing primarily in a diversified portfolio of senior floating rate loans and debt securities, with capital appreciation as a secondary objective. The First Trust ETF will primarily invest in a portfolio of senior floating rate loans which are generally rated at or below BB+ by Standard & Poors, or Ba1 or less by Moody s Investor Services, Inc., or a similar rating by an approved credit rating organization (as defined in National Instrument ) and debt securities. Under normal market conditions, the fund will invest at least 80% of its net assets in senior loans, which may include loans that are not secured by any specific collateral of the borrower, loans that have a lower than first lien priority on collateral of the borrower, loans to foreign borrowers, loans in foreign currencies and other loans with characteristics that the First Trust Advisors L.P., the portfolio advisor (the Portfolio Advisor ) believes qualify as senior loans. The senior loans included in portfolio often maintain an interest rate duration of less than 90 days; however, the inclusion of LIBOR floors on certain senior loans or other factors may cause interest rate duration to exceed 90 days. The First Trust ETF will pursue its objectives by seeking senior loans that the Portfolio Advisor believes exhibit the best combination of attractive fundamental credit characteristics and relative value within the senior loan market. The Portfolio Advisor seeks to assemble a well-diversified portfolio that includes loans of issuers with strong credit metrics, including strong cash flows and effective management teams. The First Trust ETF may invest in floating rate loans of companies whose financial condition is troubled or uncertain and that may be involved in bankruptcy proceedings, reorganizations or financial restructurings. The First Trust ETF may invest up to 20% of its net assets in other floating rate debt instruments, other fixed-rate income producing securities, securities of other investments funds, warrants and equity securities and derivatives. There are two classes of units offered by the First Trust ETF: Common Class (TSX symbol: FSL) Advisor Class (TSX symbol: FSL.A) The inception date of the First Trust ETF was August 28, Risk The overall risk for the First Trust ETF during the period remains as discussed in the prospectus for the First Trust ETF. The ability of a company/issuer to pay interest and repay principal are not factors controlled by First Trust ETF management. A company may default on their obligation to repay interest and principal which could impact the value of the holdings in the First Trust ETF or the ability to pay a dividend at or above the current level. Companies may also refinance their existing debt (the First Trust ETF s holdings) which would also impact the level of income available to pay to shareholders. The First Trust ETF is suitable for investors seeking a high level of current income and potential for capital gains through exposure to a diversified portfolio of below investment grade debt securities. Results of Operations The First Trust ETF s total net asset value as of June 30, 2015 was $101,997,420 or $20.00 per Common Class unit and $19.99 per Advisor Class units. The First Trust ETF s total net asset value as of December 31, 2014 was $76,576,770 or $19.89 per Common Class unit and $19.88 per Advisor Class units. 1

4 The First Trust ETF paid cash distributions per unit as follows: Jan 12 th Feb 6 th Payment Dates Mar Apr 6 th 8 th May 7 th Jun 5 th FSL FSL.A The First Trust ETF s Common Class units returned 2.69% and the Advisor Class Units returned 2.41% for the six months ending June 30, 2015, versus a return of 1.98% for the First Trust ETF s benchmark, the S&P/LSTA Leveraged Loan 100 Index (CAD-Hedged) ( Benchmark ). Unlike the Benchmark, the First Trust ETF s return is net of fees and expenses. The First Trust ETF held 165 positions diversified across 35 industries at the end of the reporting period. The top 10 holdings accounted for 23.61% of the portfolio. Health Care Providers & Services, Hotels, Restaurants & Leisure and Media were the top three industries. The portfolio management team uses fundamental credit analysis to select securities for the First Trust ETF. By comparison, the First Trust ETF held 162 positions across 37 industries with the top 10 holdings comprising 23.06% at December 31, Senior loans and high-yield bonds posted a strong first half to 2015, outperforming both rate sensitive fixed income instruments as well as US equities. Much of this strong performance can be attributed to these asset classes beginning the year at very attractive valuations after a healthy bout of volatility in the back half of In addition, the strong relative performance has come as the rhetoric continues to build around the US Federal Reserve ( The Fed ) increasing interest rates later this year, which has served to pressure the returns of the more rate sensitive areas of fixed income (investment grade corporate bonds, US Treasuries, etc.). While senior loans and high yield bonds performed better than traditional interest rate sensitive fixed-income in the period, returns cooled in the latter half. A number of factors are responsible for the moderation in credit market returns. One is the volatility created by Greece s potential exit from the Euro which, while driving volatility in the market, is unlikely to have any lasting implications for US senior loan and high-yield bond investors. Another factor is weak commodity prices, notably in oil, coal, iron ore, and natural gas. While these commodity industries represent only modest exposure within the senior loan market (oil & gas is 4.2%, while metals/mining is 1.4%), they are far more significant within the high yield market (oil and gas represents some 14.5%, while metals/mining comprises another 3.4%). Oil appeared relatively stable for most of the second quarter, but despite the stability in the underlying commodity, fear surrounding fundamentals (excess supply relative to demand) began driving energy related asset prices (bonds and equities) lower late in the period. In fact, energy exploration and production high-yield bonds were off 3.5% in June, after having strengthened earlier in the quarter. The market is not only concerned with the existing excess supply of crude oil in the market, but the implications of even greater supply entering the crude oil market if sanctions are lifted on Iran and continued soft worldwide demand. Away from oil, natural gas related bonds have declined in price on greater supply concerns (from the US shale) and weaker demand (cooler weather across the US). The weak natural gas price environment has resulted in softer demand for coal, due to the fact that electric utilities can substitute coal fired power plants with natural gas fired power plants to a greater extent when natural gas prices are low. Iron ore, heavily utilized in the production of steel, has also come under pressure as fears of softening demand from China weigh heavily on the price. This weak commodity price environment within the coal and iron ore segments of the market has resulted in high-yield bonds in this segment trading off over 5% in the quarter. With low yields in many countries around the world and central banks weakening currencies to stimulate demand for their countries goods and service, the US finds itself standing alone, with the potential for interest rate increases on the horizon and a strong currency. We believe that credit sensitive senior loans and high-yield bonds are positioned well within the fixed income market. The combination of a healthy, albeit slow growing US economy and sound fundamentals (conservative balance sheets and improving profitability) within corporate America should lead to a continued modest default environment and further support the performance of senior loans and high-yield bonds. As 2

5 we near liftoff for interest rates, we believe that today s relatively low interest rate environment has eroded the necessary shock-absorption for traditional interest rate sensitive fixed income investors. As such, there remains a tremendous asymmetry in the potential payoff for long duration fixed income securities (those with the most rate sensitivity). Therefore, we believe that even modestly increasing interest rates can present challenges for traditional rate sensitive fixed income investors. Investment Performance The First Trust ETF outperformed the Benchmark during the period. As a reminder, the First Trust ETFs return is net of fees and expenses. The overweight position in Food Service and Retailers (excluding Food & Drug) and underweight in Utilities and Publishing were positive contributors to performance at the sector level. Portillo s, Red Lobster and BJ s Wholesale were among the individual holdings that also positively contributed. Moreover, our rigorous credit selection process helped us avoid holdings like TXU, Weight Watchers and Getty Images that performed poorly in the quarter. Another primary performance contributor over the period was the First Trust ETFs underweight in lower quality CCC and below rated issues, relative to the Index. The scenario of lower quality underperforming higher quality is fairly typical when the market s is risk averse. We continue to believe that a higher credit quality portfolio can achieve higher risk adjusted returns over time. Investments in the Lodging & Casino sector and the underweight position in the Oil & Gas sector were a headwind to performance during the period. The First Trust ETFs small cash position, a result of share creation, was also a headwind as both loans and bonds had positive performance. Finally, the First Trust ETF benefited from holdings with LIBOR floors. With three-month LIBOR at 28bps at quarter end, a LIBOR floor requires the issuers to pay a higher base rate, typically between 0.75% and 1.25% instead of the current LIBOR rate. At quarter end, the portfolio held 80.01% of its assets in loans that had LIBOR floors. During the period, appreciation in the US dollar versus the Canadian dollar over the period was not advantageous for the ETF given the currency hedge. Recent Developments Retail investors have been reducing exposure to senior loans in the wake of declining Treasury yields, while institutional investors have simultaneously embraced senior loans. We believe that with a potential increase in the Federal Funds rate on the horizon, we ll likely begin to see greater demand for senior loans in the coming months from retail investors. Based on current valuations, we believe senior loans, given their senior secured position in the capital structure and floating interest rate, are well positioned as we move through The respite in retail demand has helped to somewhat balance supply and demand within the senior loan market, given reduced new senior loan issuance that resulted from new regulatory constraints that have been placed on banks issuing senior loans. The Federal Reserve and Office of the Comptroller of the Currency (OCC) have imposed Leveraged Lending Guidelines, as they are called, to restrict a bank s ability to lend to a company whose financial metrics are outside certain acceptable thresholds. The restriction is intended to reduce the systemic risk in the banking system, whereby banks take too much risk with depositors capital. We believe today s high-yield bond yields and spreads over US Treasuries remain attractive. While weak pricing in energy (oil & gas) and metals/mining commodities (coal and iron ore) may lead to higher defaults within the high-yield market, those defaults will likely be contained within those specific sectors, and hence, not systemic to other areas of the market. We have maintained a significant underweight position in energy and metals/mining, which should prove beneficial in the wake of recent commodity price declines. Importantly, energy induced volatility is likely to weigh on the high-yield benchmark, which we believe further supports the rationale for active decision making, rather than passive, within the high-yield credit market. In summary, we believe that both the high-yield and senior loan markets offer compelling opportunities today, principally within an actively managed framework where risk can be appropriately managed. As we evaluate new investment opportunities, decisions will continue to be rooted in our rigorous bottom-up credit analysis and focus on the opportunities that we believe offer the best risk and reward balance. Despite the many distractions that ebb and flow every quarter, we remain firmly focused on finding value in the high-yield bond and senior loan markets. 3

6 International Financial Reporting Standards The financial statements of the First Trust ETF have been prepared in compliance with International Financial Reporting Standards (IFRS) as published by the International Accounting Standards Board (IASB). The First Trust ETF adopted this basis of accounting in 2014 as required by Canadian securities legislation and the Canadian Accounting Standards Board. Previously, the First Trust ETF prepared its financial statements in accordance with Canadian generally accepted accounting principles as defined in Part V of the CPA Handbook (Canadian GAAP). Related Party Transactions FT Portfolios Canada Co. is the Manager of the First Trust ETF and is a Canadian affiliate of First Trust Advisors L.P., the investment advisor (the Advisor ) of the First Trust ETF. Pursuant to terms of the declaration of trust of the First Trust ETF, the Manager provides or arranges for all management, administrative and other services required by the First Trust ETF. The Manager receives a management fee from the First Trust ETF. For further details, please see Management Fees. The Manager has retained the Advisor to provide certain services to the First Trust ETF pursuant to an investment advisory agreement. The Advisor receives advisory fees from the Manager out of the management fee. 4

7 Financial Highlights The following tables show selected key financial information about the First Trust ETF and are intended to help you understand the First Trust ETF s financial performance for the past two years. The date of inception of the First Trust ETF was August 28, The information are derived from the First Trust ETF s interim unaudited financial statements for the six-month period ending June 30 and from the annual financial statements for the years ending December 31. Net Asset Value per Unit FSL June 30, (a) Net asset value, beginning of period/year (1) $19.89 $20.12 $20.00 (b) Increase (Decrease) from operations: Total revenue Total expenses (0.09) (0.19) (0.07) Realized gains (losses) for the period/year (0.63) (1.14) (0.71) Unrealized gains (losses) for the period/year Total increase (decrease) from operations (2) $0.48 $0.45 $0.35 Distributions: From income (excluding dividends) (0.42) (0.74) (0.17) From dividends From capital gains Return of capital - (0.02) (0.02) Total annual distributions (3) $(0.42) $(0.76) $(0.19) Net asset value, end of period/year (4) $20.00 $19.89 $20.12 (a) December 31, 2013 does not relate to the full year as the date of inception of the First Trust ETF was August 28, (b) Initial offering price (1) This information is provided as at June 30 and December 31 of the period/years shown and is prepared under IFRS. (2) Net asset value 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 period/year. (3) Distributions were either paid in cash or reinvested in additional units of the First Trust ETF. (4) This table is not intended to be a reconciliation of beginning to ending net asset value per unit. Ratios and Supplemental Data FSL June 30, Net asset value (000 s) $99,999 $74,589 $37,217 Number of units outstanding 5,000,000 3,750,000 1,850,000 Management expense ratio (1) 0.94% 0.95% 0.95% Management expense ratio before waivers or absorption 0.95% 0.98% 0.95% Trading expense ratio (2) N/A N/A N/A Portfolio turnover rate (3) 90.62% % % Net asset value per unit $20.00 $19.89 $20.12 (1) Management expense ratio is based on total expenses for the stated period and is expressed as an annualized percentage of daily average net asset value during the period/year. (2) 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/ year. (3) The First Trust ETF s portfolio turnover rate indicates how actively the First Trust ETF s portfolio advisor manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the First Trust ETF buying and selling all of the securities in its portfolio once in the course of the period/year. The higher a First Trust ETF s s portfolio turnover rate in a year, the greater the trading cost payable by the First Trust 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 high turnover rate and the performance of a First Trust ETF. 5

8 Net Asset Value per Unit FSL.A June 30, (a) Net asset value, beginning of period/year (1) $19.88 $20.10 $20.00 (b) Increase (Decrease) from operations: Total revenue Total expenses (0.15) (0.30) (0.11) Realized gains (losses) for the period/year (0.63) (1.14) (0.27) Unrealized gains (losses) for the period/year Total increase (decrease) from operations (2) $0.55 $0.44 $0.27 Distributions: From income (excluding dividends) (0.37) (0.63) (0.09) From dividends From capital gains Return of capital - (0.02) (0.07) Total annual distributions (3) $(0.37) $(0.65) $(0.16) Net asset value, end of period/year (4) $19.99 $19.88 $20.10 (a) December 31, 2013 does not relate to the full year as the date of inception of the First Trust ETF was August 28, (b) Initial offering price (1) This information is provided as at June 30 and December 31 of the period/years shown and is prepared under IFRS. (2) Net asset value 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 period/year. (3) Distributions were either paid in cash or reinvested in additional units of the First Trust ETF. (4) This table is not intended to be a reconciliation of beginning to ending net asset value per unit. Ratios and Supplemental Data FSL.A June 30, Net asset value (000 s) $1,999 $1,988 $2,010 Number of units outstanding 100, , ,000 Management expense ratio (1) 1.50% 1.51% 1.55% Management expense ratio before waivers or absorption 1.51% 1.54% 1.55% Trading expense ratio (2) N/A N/A N/A Portfolio turnover rate (3) 90.62% % % Net asset value per unit $19.99 $19.88 $20.10 (1) Management expense ratio is based on total expenses for the stated period and is expressed as an annualized percentage of daily average net asset value during the period/year. (2) 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/year. (3) The First Trust ETF s portfolio turnover rate indicates how actively the First Trust ETF s portfolio advisor manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the First Trust ETF buying and selling all of the securities in its portfolio once in the course of the period/year. The higher a First Trust ETF s s portfolio turnover rate in a year, the greater the trading cost payable by the First Trust 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 high turnover rate and the performance of a First Trust ETF. 6

9 Management Fees The First Trust ETF will pay the Manager a management fee equal to 0.85% and, in respect of the FSL.A, an additional amount for a service fee (see FSL.A Service Fee below) based on the average daily NAV of the First Trust ETF. The management fee, plus applicable taxes including HST, will be accrued daily and paid quarterly in arrears. The Manager may, from time to time in its discretion, waive all or a portion of the management fee charged at any given time. FSL.A Service Fee The Manager pays registered dealers a service fee equal to 0.50% per annum of the NAV of the Advisor Class Units held by clients of the registered dealer, plus any applicable taxes. The service fee will be calculated and accrued daily and paid quarterly at the end of each calendar quarter. Past Performance General The past performance information shown assumes that all distributions made by the First Trust ETF in the periods shown were reinvested in additional securities of the First Trust ETF. The performance information does not take into account sales, redemption, distribution or other optional charges that would have reduced returns or performance. How the First Trust ETF has performed in the past does not necessarily indicate how it will perform in the future. Year by Year Returns The bar charts below show the First Trust ETF s performance, per class, for the six-month period ended June 30, 2015 and for the years ended December 31 and illustrate how the investment fund s performance has changed from year to year. The charts also show, in percentage terms, how much an investment made on the first day of each financial year would have grown or decreased by the last day of each financial year. First Trust Senior Loan ETF (CAD-Hedged) - FSL 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 1.69% 2.65% 2.69% 0.00% *Aug 28/13 to Dec 31/13 Jan 1/14 to Dec 31/14 Jan 1/15 to Jun 30/15 FSL 1.69% 2.65% 2.69% *Date of Inception 7

10 First Trust Senior Loan ETF (CAD-Hedged) - FSL.A 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 1.51% 2.11% 2.41% 0.00% *Aug 28/13 to Dec 31/13 Jan 1/14 to Dec 31/14 Jan 1/15 to Jun 30/15 FSL.A 1.51% 2.11% 2.41% *Date of Inception Summary of Investment Portfolio The table sets out the percentage (based on total net asset value) of the First Trust ETF s top 25 holdings, by issuer, as at June 30, This summary of portfolio holdings may change due to ongoing portfolio transactions of the First Trust ETF. A quarterly update is available at Top 25 Issuers % of ETF Total Net Asset Value PetSmart, Inc. 2.86% Albertsons LLC 2.49% Valeant Pharmaceuticals International, Inc. 2.40% Numericable U.S. LLC 2.37% BJ's Wholesale Club, Inc. 2.37% Amaya Holdings B.V. 2.31% Tenet Healthcare Corp. 2.26% BMC Software Finance, Inc. 2.21% Portillo's Holdings LLC 2.19% Acosta, Inc. 2.15% Formula One (Delta 2 Lux S.A.R.L.) 2.13% Caesars Growth Partners LLC 1.97% Advantage Sales & Marketing, Inc. 1.85% Charter Communications Operating LLC 1.85% Truven Health Analytics, Inc. (VCPH Holding Corp.) 1.82% New HB Acquisition LLC 1.81% Dell, Inc. 1.64% CHS/Community Health Systems, Inc. 1.57% Asurion LLC 1.56% Ortho-Clinical Diagnostics, Inc. 1.46% Serta Simmons Holdings LLC 1.44% Kinetic Concepts, Inc. 1.37% 21st Century Oncology, Inc. 1.33% Healogics, Inc. (CDRH Parent, Inc.) 1.32% InVentiv Health, Inc. 1.24% 8

11 Portfolio Breakdown The table sets out the percentage (based on total net asset value) of the First Trust ETF s portfolio, by sector, as at June 30, Sector Weightings % of ETF Total Net Asset Value Health Care 30.34% Consumer Discretionary 22.74% Consumer Staples 11.66% Industrials 10.35% Information Technology 8.59% Telecommunication Services 4.68% Materials 4.46% Financials 4.37% Energy 0.93% The table sets out the percentage (based on total net asset value) of the First Trust ETF s portfolio, by credit rating, as at June 30, S&P Rating % of ETF Total Net Asset Value BBB 1.64% BBB- 0.37% BB+ 3.64% BB 5.05% BB % B % B 31.02% B % CCC+ 7.48% CCC 1.24% CCC- 0.00% 9

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