TWG. Toronto Wealth Group. My Conversations with: Peter J. Frost & Tristan Sones. Investments, Retirement Planning, Insurance.

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1 I attended the AGF Think Income, Think Equities, Investment Insights from Peter Frost event on January 22 nd, 2013 and the AGF Open House & Investment Forum on March 7 th, 2013 featuring Tristan Sones. Below are my brief notes. Peter J. Frost, CFA, Tristan Sones, CFA, Peter Frost manages the AGF Traditional Income Fund. Peter Frost and Tristan Sones manage the AGF Monthly High Income Fund together. Peter Frost joined AGF in the fall of 2009 and is Vice-President Portfolio Manager of the AGF Investment Management Team. He has over 20 years of experience in both the retail and institutional markets, has a strong understanding of the Canadian equities, US equities and fixed income markets, as well as a deep philosophical belief in traditional fundamental investing. He has earned an MBA from the University of Dallas and is a CFA charter holder. The AGF Traditional Income Fund was launched in May 7th, 2010 and the targeted annual distribution yield is 5%, paid monthly. He started managing AGF's Monthly High Income Fund in 2010 and it is designed for investors seeking a high level of income with a targeted annual distribution yield of 7%, paid annual distribution yield of 7%, paid monthly. Both these two mandates use an actively managed asset allocation mix to achieve a steady level of income, to mitigate the volatility in the market to produce solid returns. Looking at a chart of the North American equity markets dating back to 1956, as that happens to be the date of inception for the TSX; an investor from 1956 to 2012 would have got a 9.1% compounded return per annum for that period, and upon analysis of the Total Return Series the contribution from the dividend component was 3.2% per annum, about one third of the 9.1% per annum return. The standard deviation of the index from 1956 to 2012 averaged a normal 15%, but in year 2008 and 2009 we were reminded of the downsides of the equity market when we saw negative 25% or more. Dividends contribute a lot to return and they reduce volatility because they are very secure. Left: Peter J. Frost, CFA volatility because they are very secure. Had you invested $10,000 in the index from December 1986 to July 2012, by reinvesting the proceeds, that portfolio would have grown to around $47,928. Had you taken that same $10,000 and invested it in a growing dividends strategy and reinvested the proceeds, that portfolio could be worth $179,856. So it shows you the power of the strategy of not only nice dividend growth, but also capital accumulation. Companies with rising dividends are great for clients looking for income, and capital accumulation. He screens about five thousand companies every month on their dividend growth and scores them on a consistency ranking. He looks over the last 15 years and counts how many individual (Continued on Page 2)

2 (Continued from Page 1) counts how many individual calendar years the company has raised their dividend for those that have a culture of raising their own dividend. This is a great strategy for retirees, and Peter Frost said his mother who is age 76 has half of her money in the AGF Traditional Income Fund; yet it is also suitable for a young investor who has a long investment horizon because the fund accumulates capital wealth over time. AGF Traditional Income Fund The AGF Traditional Income Fund provides investors with the opportunity to grow their capital by investing in those companies that have a culture of rewarding their shareholders with above average dividend growth, like companies that are growing their cash flows and dividend through their fundamental business at a regular pace of at least 10% dividend growth. These companies retain a large portion of their earnings and re-invests back into their business. The payout ratios of the companies in the AGF Traditional Income Fund range from 30% to 35% on the low end, and up to 55% to 60% on the high end. The asset mix of the AGF Traditional Income Fund is normally 50% stocks 50% stocks and 50% bonds, but can go as low as 30% or up to 70% in either category. Right now he is overweight equities at 65% stocks, and underweight fixed income at 26% bonds, with the remaining 9% in cash. By country allocation, he is 70% invested in Canada, 23% invested in the US, and 7% invested outside of North America. He tactically hedges currency risk, and currently has 86% of the funds exposed to the Canadian Dollar, with about half of his exposure in US Dollars hedged back to the Canadian Dollar. Most of his non-north American holdings are in Sterling, in UK-based companies. Right now, it is very advantageous to hedge most foreign currencies back to the Canadian Dollar because Canadian interest rates are higher than most countries, especially the US and United Kingdom. The dividend growth over the last five years of the companies in the portfolio has been about 15% per annual over that period versus only 4% for the market. The volatility is around 11% which is about a third less with the market s 15% and that is great risk control. AGF Monthly High Income Fund The AGF Monthly High Income Fund is for clients looking for income as their primary source of return, because they need to supplement their day-to-day Right: Tristan Sones, CFA supplement their day-to-day living using their investment portfolio. Peter looks for companies that are typically more mature in profile, generates significant cash flow, and do not have a lot of requirements to re-invest back into the business so they pay out most of their cash flow to their shareholder base. Typically, payout ratios range from 65% to 70% at the low end, and up to 80% to 85% on the high end. His current asset mix is underweight fixed income with 68% in equity stocks and a little bit of cash, for he believes equity is safer to be in now than bonds. Credit spreads have narrowed so much, and yields are so low now that what you got in 2008 from a Triple A, you have to go out to Single B area now to get the (Continued on Page 3)

3 (Continued from Page 2) to Single B area now to get the equivalent yield. There is more credit in the AGF Monthly High Income Fund portfolio and he has been moving more of the bond portfolio into the corporate credit space. He strategically hedges foreign currency in this fund because it is an income-based fund for Canadians looking for Canadian Dollar income. He aims to minimize the fluctuations that would come with some of the foreign investments in the fund. Currently he has at least 93% of the portfolio exposed in the Canadian Dollar with an overall yield around 5% and he expects it to go up over the next several months because of some pretty good opportunities on the equity side for high yield in both the Canadian and US markets. Volatility has been around 12% which is about 3% below the market s 15% and that is great risk control. Peter shared with us his research process of a stock in the portfolio. He likes to run a very flat structure so a stock will be between 2% and 3% in the portfolio. He may let it run to 6% and bring it back to a normal weight in the portfolio by selling some and taking some money off the table to buy other stocks that off the table to buy other stocks that have a better upside. He does not have a problem selling stocks and may trim it back to re-deploy assets elsewhere. His stock selection is based on fundamental analysis, and uses technical analysis to see how the stock trades when buying it. His turnover has historically been around 20%, but over the last three years it has been around 30%. Market Outlook will be very different from previous years because of the declining efficacy of the Federal Reserve s Quantitative Easing (QE) program. We are likely to go more into a traditional stock picker s market for The most recent iteration QE3 was announced in September 2012 and has an indefinite period. QE1 gave the markets a very powerful uplift where all equities went up at the same time and the financial sector benefited the most. QE2 gave the market a less powerful move up and the commodity sector benefited the most. QE3 so far has shown less benefit because positive sentiment had diminished considerably. We see from a chart measuring the effects of quantitative easing on sentiment and the lift that the equity market went through. QE1 was very powerful lasting 285 trading days, and the market was up 85% from its Left: Peter J. Frost and the market was up 85% from its trough to peak. When QE1 ended the markets faded. QE2 is announced and the market goes up 171 trading days with a lift of 30%. After QE2 ended the US was downgraded by Standard & Poors and the market fell again. Operation Twist was implemented and lifted the markets for 126 trading days by 29%. QE3 is what we are seeing now and the market seems to be reacting flat to it momentarily, perhaps the drug of liquidity has become less effective. If liquidity slows down or ends, Peter does not believe there will be a huge retracement, he believes the market will retrace normally because the driver will be bond money coming in back into the equity market. The sovereign debt crisis will continue to progress through time. (Continued on Page 4)

4 (Continued from Page 3) Bond yields are bottoming now and have been range-bound since July There is risk certainly going out into the next couple of years that yields will start to rise as investors sell their bond holdings putting negative pressure on bond prices. Although inflation is benign for now, interest rates will rise. Many investors may be surprised by negative returns in the end of 2013 and 2014 in their bond funds. Many investors are not expecting that to happen as they think bonds are the safe place to be, but bonds are the riskier place to be right now, and it is safer to be in selected equities. During Q3 and Q4 of 2012 most people were focused on the fiscal cliff. In November and December it was not just Tax-Loss selling, but Tax-Gain selling as US investors crystallized capital gains because of the uncertainty and sold a lot of their holdings. The debt ceiling is not going to be an issue as it is not beneficial for the US economically and politically to make too much of an issue with it. It will just get raised. The German federal election is in September Within the European Union, Germany has money and has been funding the rest of Europe. Yet if there is increasing indication that Germany will close their wallets, then we will start to see their wallets, then we will start to see Credit Spreads start to widen in Italy and the peripheral countries. Recently, Credit Spreads have pulled back and narrowed, but they will start to move out and widen again if there is anticipation of increased risk. Peter is watching for indications to see if Federal Reserve Chairman Ben Bernanke will stay on after his second term ends on January 31 st, 2014 for signs of impending monetary policy change. The US has been under-writing almost everybody around the world in supporting, providing liquidity. Any view that a new Federal Reserve Chairman that is not as accommodative, and we probably will get some volatility in the markets. In the recent January FOMC meeting minutes were comments that the Federal Reserve may try to pull back some of their stimulus at the end of 2013, and that caused equity markets to fall for a few days. So that is a possible risk in the second half of this year. Not many people are talking about that right now, but will be more of an issue in Q3 and Q4 of Security selection in equities and fixed income will be very important as not all boats will go up with the tide. We are certainly getting close to the end of the bond bull market if Right: Tristan Sones, CFA to the end of the bond bull market if not already based on the 10-Year Note yield which is at historical lows. Bond portfolio durations have increased therefore interest rate sensitivity is much higher, and a small increase in interest rates can cause bond portfolios to go down in price. Back in 2008, a Government of Canada 10-Year Triple A bond yielded 5%. Today, we have to get into the BB or B grade bonds for the same yield because they have become so tightly compressed. Investors have stretched too far out of their comfort zone to stay in bonds because they have been scared of equities, but they may have moved too far out of the risk curve and are taking risk that they do not understand. (Continued on Page 5)

5 (Continued from Page 4) The Canadian equity market has been an under-performer versus the US since the fall of It coincided with the softness in the Chinese economy. Referring to the Purchasing Manager s Index (PMI), when it is over 50 it means we are in economic expansion, below 50 is contraction. Since 2011, the Chinese economy has been weak but recently there has been a pick up in economic activity, and looks like it is starting to break out now to the upside. So those are positive environments for the Canadian commodity complex which has lagged in recent years. This is an encouraging sign moving forward. Summer months. He does not have a bias on the capitalization of small cap stocks, but rather it is liquidity he prefers because it allows him to move in and out of positions. In the US are many small cap names that are very liquid and easy to trade, but Canada is a tougher market to move around because of lesser liquidity. Please note that Peter Frost and Tristan Sones may have changed their opinions by the time you read this Special Report. The reader should consult their investment advisor before making any investment decision. Left: Peter J. Frost Peter has been tactically repositioning within sectors, he reduced duration in December 2012 as bond yields moved down, and subsequently extended duration as bond yields moved to the top of the historical range. His bond duration is shorter than the market at less than five years, and he will continue making adjustments. In the last three years he has gone from less than 5% cash to around 20% cash at some point during the year may be the same, but likely towards the end of the year when more opportunities appear, so he may likely build cash going into the summer months. He does not have a