Annual Management Report of Fund Performance

Transcription

1 (the Fund ) For the period ended September 30, 2010 Manager: BMO Investments Inc. Portfolio manager: BMO Asset Management Inc., Toronto, Ontario (formerly Jones Heward Investment Counsel Inc.) Annual Management Report of Fund Performance This annual management report of fund performance contains financial highlights but does not contain the complete annual financial statements of the Fund. If the annual financial statements of the Fund do not accompany the mailing of this report, you may obtain a copy of the annual financial statements at your request, and at no cost, by calling , by writing to us at BMO Investments Inc., 77 King Street West, 42nd Floor, Toronto, Ontario, M5K 1J5 or by visiting our website at or SEDAR at You may also contact us using one of these methods to request a copy of the Fund s proxy voting policies and procedures, proxy voting disclosure record and/or quarterly portfolio disclosure. MANAGEMENT DISCUSSION OF FUND PERFORMANCE Investment Objective and Strategies The Fund s objective is to provide above-average growth in the value of your investment over the long term by investing in small- and mid-sized Canadian companies. The portfolio manager uses a bottom-up fundamental investment process to identify attractively priced securities from small- and mid-sized Canadian companies. This process includes analyzing company financial statements, management and valuations. Risk No changes affecting the overall level of risk associated with investing in the Fund were made during the period. The risks of this Fund remain as discussed in the Fund s most recent simplified prospectus or its amendments. Results of Operations Over the period, financial market sentiment can best be described in three phases. The period began with optimism for a continued global economic recovery with equity markets responding favourably. By mid-2010, as U.S. economic data began to show evidence of a slowdown in growth, concern of a second dip into economic recession emerged. As the summer progressed and key jobs and housing data began to be released, the market started to notice a flattening in the economic deterioration and became optimistic that the current state of the economy would only be a mid-cycle slowdown, and not a full blown recession. This roller coaster of events caused the market to fluctuate in a similar pattern, where the year started-off strong, experienced a significant correction and then ended on strength in most equity markets. Canadian small capitalization ( small cap ) stocks mirrored this pattern in their performance, as these stocks are typically highly sensitive to changes in economic growth outlooks, due to their higher weightings in the commodity sector. Small cap stocks outperformed large capitalization ( large cap ) stocks in three of the previous four quarters, which resulted in significant outperformance for the period. Most of this outperformance can be explained by the strength in the Materials sector, which was driven by the strength in the underlying commodity prices. Base metals such as lead and nickel, and precious metals such as gold, silver and platinum, staged strong rallies over the past year. Small caps generally benefited from the low interest rate environment and optimism for economic growth in emerging markets. Furthermore, the consolidation activity that witnessed several large cap companies purchasing smaller companies over the year, in order to ensure their growth platform for the future, also contributed to market returns. The Fund outperformed the BMO Small Cap Index (the benchmark) primarily due to strength in stock selection in several sectors. Outperformance in small cap stocks was broad-based, with outperformance in eight of the 10 sectors. While the Fund was underweight in Materials (which is approximately 40% of the benchmark weight), detracting from the Fund s relative performance, stock selection (particularly in the gold sub-sector) more than offset any negative impact of this positioning. The Fund also benefited from stock selection in the Energy sector, where several of the Fund s holdings had positive exploration and development news, that allowed the stocks to perform much better than the underlying strength in the oil price would have implied. Health Care and Consumer Staples were two more notable sectors where stock selection added additional value. Over the past year, consolidation has been a significant trend occurring in the Canadian materials

2 MANAGEMENT DISCUSSION OF FUND PERFORMANCE (cont d) universe. The Fund benefited from significant takeover activity in several of its holdings, most of which occurred at a significant premium to recent trading prices. Overall impact from sector positioning was minimal in comparison to the strength in stock selection. The Fund was positioned well to be underweight in Financials and Health Care which despite posting positive, double-digit returns, were still the two worst performing sectors in the small cap universe. The Fund s overweight in Information Technology had a negative impact, as several holdings in this sector posted weak results as their business recovery was plagued by the strength in the Canadian dollar, as well as a lag in end-market demand for their respective products or services. Throughout the period, the Fund increased its weighting in the Materials group. This was as a result of both capital appreciation in several holdings and the addition of new holdings. For information on the Fund s performance and composition, please refer to the Past Performance section and Summary of Investment Portfolio section of this report. Recent Developments The Fund is well positioned to participate in the economic recovery that is expected to occur in 2011, as a result of continued monetary stimulus by central governments globally. While most corporate balance sheets remain strong and commodity prices are trading at high levels, the continuation of this trend is unlikely to occur if the economic outlook deteriorates or commodity prices fall substantially. Companies would become more risk averse and less likely to move aggressively to take out other entities under these conditions. In the portfolio manager s opinion, if the economic recovery falters and moves towards a definitive economic contraction, several holdings could experience a significant correction. While the earnings outlook would deteriorate for the more economically sensitive holdings in the Fund, this correction could be exacerbated by a move by market participants to more liquid and defensive large cap stocks. Adoption of New Accounting Policy The Accounting Standards Board of the Canadian Institute of Chartered Accountants ( CICA ) recently issued an amendment to CICA Handbook Section 3862, Financial Instruments Disclosures. The Fund adopted this amendment for the fiscal 2010 financial statements in line with the require - ment of the standard. The amendments to the existing standard require classification of the Fund s financial instruments into three levels based on the inputs used to value the financial instruments. Level 1 securities are based on quoted prices in active markets for identical securities. Level 2 securities are based on significant observable market inputs, such as quoted prices from similar securities and quoted prices in inactive markets. Level 3 securities are based on significant unobservable inputs that reflect the Fund s determination of assumptions that market participants might reasonably use in valuing the securities. Transition to International Financial Reporting Standards In September 2010, the Canadian Accounting Standards Board ( AcSB ) amended their mandatory requirement for all Canadian publicly accountable enterprises to prepare their financial statements in accordance with International Financial Reporting Standards ( IFRS ) as issued by the International Accounting Standards Board ( IASB ), permitting investment companies, which includes mutual funds, to defer the adoption of IFRS to fiscal years beginning on or after January 1, The AcSB has deferred the mandatory IFRS adoption date to coincide with a new consolidation standard for investment companies that the IASB is scheduled to publish in the second quarter of calendar Under the current IFRS guidance, investment companies are required to consolidate their controlled investments. The IASB has announced that they will propose that investment companies be exempted from consolidating their controlled investments and account for them at fair value. Canadian GAAP permits investment companies to fair value their investments regardless of whether those investments are controlled. The Fund has elected to defer the adoption of IFRS to October 1, The Fund expects to report its financial results for the six month period ended March 31, 2013 prepared on an IFRS basis. The Fund will also provide comparative data on an IFRS basis, including an opening balance sheet as at October 1, Further revisions by the AcSB to the IFRS adoption date for investment companies are possible. In order to meet the requirement to transition to IFRS, the Manager established a committee for the development and implementation of a transition plan and to provide oversight of the transition to IFRS. The transition plan is comprised of three phases: a diagnostic assessment to identify potential IFRS differences relative to current policies; implementation and education, which includes confirming actual IFRS differences relative to current policies; and completion of all integration requirements for any actual differences identified. The Fund s transition to IFRS remains on track: its diagnostic assessment

3 MANAGEMENT DISCUSSION OF FUND PERFORMANCE (cont d) to identify potential IFRS differences is completed, and the Committee is currently working through the second phase of the transition plan. The diagnostic assessment of the Fund revealed the following: The criteria contained within the IFRS Financial Instruments: Presentation standard (IAS 32) may require unitholders equity to be classified as a liability within the Fund s Statement of Net Assets, unless certain conditions are met. The Manager is currently assessing the Fund s unitholder structure to confirm classification. Presentation changes to unitholders equity will not have an impact on the Fund s results of operations or financial position. Subject to the IASB publishing a new consolidation standard for investment companies that is effective prior to the Fund s adoption of IFRS, and subject to the Fund being in scope of this new standard, the Fund would be permitted to continue to fair value all its investments, including any investments in other funds that it may have a controlling interest in, when it transitions to IFRS. The diagnostic assessment did not reveal any other potential material differences between the Fund s current accounting policies and the requirements under IFRS. The Manager does not foresee any impact or change to the Fund s business arrangements that the Fund will need to make as a result of the changeover to IFRS. The Manager has not identified any changes that will impact NAV per unit as a result of the changeover to IFRS. However, this determination is subject to change as we finalize our assessment of IFRS differences and as new standards are issued by the IASB prior to the Fund s adoption of IFRS. RELATED PARTY TRANSACTIONS BMO Investments Inc. ( BMOII ), an indirect, wholly-owned subsidiary of Bank of Montreal, is the Manager of the Fund. From time to time, the Manager may, on behalf of the Fund, enter into transactions or arrangements with or involving other members of BMO Financial Group, or certain other persons or companies that are related or connected to the Manager (each a Related Party ). The purpose of this section is to provide a brief description of any transaction involving the Fund and a Related Party. Portfolio Manager The Fund s portfolio manager is BMO Asset Management Inc. ( BMO AM ), an affiliate of the Manager. BMO AM was formerly known as Jones Heward Investment Counsel Inc. having changed its name as of May 7, BMO AM provides portfolio management services to the Fund. BMO AM receives an investment advisory fee based on assets under management, calculated daily and payable monthly. Administration Fees The Fund pays a fixed administration fee to the Manager. The Manager in return pays the operating expenses of the Fund, other than certain specified expenses that are paid directly by the Fund ( Fund Expenses ). Fund Expenses include interest or other borrowing expenses, costs and expenses related to the operation of the Fund s Independent Review Committee ( IRC ), including fees and expenses of IRC members, taxes to which the Fund is or might be subject, and costs associated with compliance with any new governmental or regulatory requirement introduced after December 1, Fund Expenses are allocated proportionately among the series. If the Fund Expenses are specific to a series, the Fund Expenses are allocated to that series. The fixed administration fee is calculated as a fixed annual percentage of the average net assets of each relevant series of the Fund and, for the most part, replaces the previous cost recovery method under which operating expenses were charged or allocated to the Fund. Further details about the fixed administration fee and/or Fund Expenses can be found in the Fund s most recent simplified prospectus at or Buying and Selling Securities Related Party Underwritings During the period, the Manager relied on an approval and standing instruction provided by the Fund s IRC to enable the Fund to make an investment in a class of equity and/or non-government debt securities of an issuer during the period of distribution of those securities to the public and/or the 60-day period following the distribution period where BMO Nesbitt Burns Inc. ( NBI ), an affiliate of the Manager, acted as an underwriter in the distribution (each investment, a Related Party Transaction ). In accordance with the IRC s approval and standing instruction, in making a decision to cause the Fund to make a Related Party Transaction, the Manager and portfolio manager of the Fund are required to comply with the Manager s written policy and procedure governing the Related Party Transaction and report periodically to the IRC, describing each instance that the Manager and/or portfolio manager relied on the approval and standing instruction and their compliance or non-compliance with the governing policy and procedure. The governing policy and procedure is designed to ensure the Related Party Transaction (i) is made free from any influence of NBI or an associate or affiliate of NBI and without taking into account any considerations

4 RELATED PARTY TRANSACTIONS (cont d) relevant to NBI or an associate or affiliate of NBI, (ii) represents the business judgment of the portfolio manager, uninfluenced by considerations other than the best interests of the Fund, and (iii) achieves a fair and reasonable result for the Fund. Brokerage Commissions The Fund pays standard brokerage commissions at market rates to BMO Nesbitt Burns Inc., an affiliate of the Manager, for executing a portion of its trades. The brokerage commissions charged to the Fund during the period were as follows: $000s $000s Total brokerage commissions 1,870 1,823 Brokerage commissions paid to BMO Nesbitt Burns Inc Distribution Services The Manager markets and distributes the Fund directly through Bank of Montreal branches and through registered dealers and brokers, including BMO InvestorLine Inc. and BMO Nesbitt Burns Inc., both affiliates of the Manager. The Manager pays to these affiliates on an ongoing basis annual service or trailing commissions based on the average daily value of the units that are held in investor accounts. Management Fees The Manager monitors and evaluates the Fund s performance, pays for the investment advice provided by the Fund s portfolio managers and provides certain administrative services required by the Fund. As compensation for its services the Manager is entitled to receive a management fee payable monthly, calculated based on the daily net asset value of each series of the Fund at the maximum annual rate set out in the table below. As a Percentage of Management Fees General Maximum Annual Administration, Management Dealer Investment Fee Rate* Compensation Advice and Profit % % % Series A Units Series I Units Series F Units (1) Advisor Series Units * For series I units, separate series I fees are negotiated and paid by each series I investor. Because the Manager pays no distribution, service or trailing fees on series I units, series I units will have lower series I fees than the management fees for series A units. (1) Series F Units refers to BMO Guardian Special Equity Fund Series F Units ( Series F or Series F Units ). Advisor Series Units refers to BMO Guardian Special Equity Fund Advisor Series Units ( Advisor Series or Advisor Series Units ). OTHER MATERIAL INFORMATION Harmonized Sales Tax Effective July 1, 2010, goods and services tax ( GST ) was replaced by the harmonized sales tax ( HST ) in certain provinces and is imposed at higher rates than the GST. Since the applicable HST is being paid by the Fund, it has resulted in an overall increase in expenses incurred by the Fund since the effective date of implementation. FINANCIAL HIGHLIGHTS The following tables show selected key financial information about the Fund and are intended to help you understand the Fund s financial performance for the periods indicated. The Fund s Net Assets per Unit (1) Series A Net assets, beginning of period $ Increase (decrease) from operations: Total revenue $ Total expenses $ Realized gains (losses) for the period $ Unrealized gains (losses) for the period $ Total increase (decrease) from operations (3) $ Distributions: From income (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Series I (5) 2008) Net assets, beginning of period $ )* Increase (decrease) from operations: Total revenue $ Total expenses $ Realized gains (losses) for the period $ Unrealized gains (losses) for the period $ Total increase (decrease) from operations (3) $ Distributions: From income (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $

5 FINANCIAL HIGHLIGHTS (cont d) Series F Net assets, beginning of period $ )* Increase (decrease) from operations: Total revenue $ Total expenses $ Realized gains (losses) for the period $ Unrealized gains (losses) for the period $ 6.16 Total increase (decrease) from operations (3) $ Distributions: From income (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Advisor Series ) ) Net assets, beginning of period $ )* Increase (decrease) from operations: Total revenue $ Total expenses $ Realized gains (losses) for the period $ Unrealized gains (losses) for the period $ Total increase (decrease) from operations (3) $ Distributions: From income (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ * Initial net assets. (1) This information is derived from the Fund s audited financial statements. The net assets per unit presented in the financial statements differs from the net asset value calculated for fund pricing purposes. An explanation of these differences can be found in the notes to the Fund s financial statements. Prior to 2007, commissions and other portfolio transaction costs were not included in expenses as they were included in realized and unrealized gains (losses). (3) Net assets 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. This table is not intended to be a reconciliation of beginning to ending net assets per unit. (4) Distributions were either paid in cash or reinvested in additional units of the Fund, or both. (5) The information shown in this column is for the period beginning March 5, 2008 (the series launch date) and ending September 30, The information shown in this column is for the period beginning November 3, 2008 (the series launch date) and ending September 30, Ratios and Supplemental Data Series A Total net asset value (000 s) (1) $ 339, , , , ,684 Number of units outstanding (000 s) (1) 10,892 11,698 11,342 10,108 10,342 Management expense ratio % Management expense ratio before waivers or absorptions % Portfolio turnover rate (3) % Trading expense ratio (4) % Net asset value per unit $ Series I (5) 2008) Total net asset value (000 s) (1) $ 8, Number of units outstanding (000 s) (1) Management expense ratio + % Management expense ratio before waivers or absorptions + % Portfolio turnover rate (3) % Trading expense ratio (4) % Net asset value per unit $ Series F Total net asset value (000 s) (1) $ Number of units outstanding (000 s) (1) 18 3 Management expense ratio % Management expense ratio before waivers or absorptions % Portfolio turnover rate (3) % Trading expense ratio (4) % Net asset value per unit $ Advisor Series Total net asset value (000 s) (1) $ 9, Number of units outstanding (000 s) (1) Management expense ratio % Management expense ratio before waivers or absorptions % Portfolio turnover rate (3) % Trading expense ratio (4) % Net asset value per unit $ ) ) + Operating expenses are paid by BMOII and management fees are paid directly to BMOII as negotiated with the investor. (1) This information is provided as at September 30 of the period shown, as applicable. Management expense ratio is based on total expenses (excluding commissions and other portfolio transactions costs) for the stated period and is expressed as an annualized percentage of daily average net asset value during the period. (3) The Fund s portfolio turnover rate indicates how actively the Fund s portfolio manager manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the Fund buying and selling all of the securities in its portfolio once in the course of the year. The higher a fund s portfolio turnover rate in a year, the greater the trading costs payable by the Fund 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 a fund. (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 period. (5) The information shown in this column is for the period beginning March 5, 2008 (the series launch date) and ending September 30, The information shown in this column is for the period beginning November 3, 2008 (the series launch date) and ending September 30, 2009.

6 PAST PERFORMANCE The Fund s performance information assumes that all distributions made by the Fund in the periods shown were used to purchase additional units or shares of the Fund and is based on the net asset value of the Fund. The performance information does not take into account sales, redemption, distribution or other optional charges that, if applicable, would have reduced returns or performance. Please remember that how the Fund has performed in the past does not indicate how it will perform in the future. Series F 50% 25% 0% -25% -50% The returns of each series may differ from one another for a number of reasons, including if the series was not issued and outstanding for the entire reporting period and because of the different levels of fees and expenses allocated and payable by each series. On November 13, 2009, BMO Guardian Small Cap Growth and Income Fund merged into the Fund. This change could have affected the performance of the Fund, had it been in effect throughout the performance measurement periods presented. Year-by-Year Returns The following bar charts show the performance for each series of the Fund for each of the financial years shown. The charts show in percentage terms how an investment made on the first day of each financial year would have increased or decreased by the last day of each financial year. Series A 50% 25% 0% -25% -50% Series I 50% 25% 0% Advisor Series 50% 25% 0% -25% % (1) For the period beginning March 5, 2008 to September 30, For the period beginning November 3, 2008 to September 30, Annual Compound Returns This table compares the historical annual compound returns of the Fund with its benchmark indices, the BMO Small Cap Index ( BMO SCI ) and the S&P/TSX Composite Total Return Index ( S&P/TSX ). The BMO SCI reflects the stock performance of small to mid-size Canadian companies. The S&P/TSX reflects the price movements of selected securities listed on the Toronto Stock Exchange and weighted by market capitalization. Series A Since year years years years Inception BMO Special Equity Fund % n/a BMO SCI % S&P/TSX % Series I Since year years years years Inception (1) BMO Special Equity Fund % BMO SCI % S&P/TSX % % -50% (1)

7 PAST PERFORMANCE (cont d) Series F Since year years years years Inception BMO Special Equity Fund % BMO SCI % S&P/TSX % Advisor Series Since year years years years Inception BMO Special Equity Fund % BMO SCI % S&P/TSX % (1) Inception Date: March 5, Inception Date: November 3, A commentary on the market and/or information regarding the relative performance of the Fund as compared to its benchmark can be found under the Results of Operations section of this report. SUMMARY OF INVESTMENT PORTFOLIO As at September 30, 2010 % of Net Portfolio Allocation Asset Value Materials Energy Information Technology Consumer Discretionary Financials Industrials Money Market Investments Other Cash/Receivables/Payables % of Net Top 25 Holdings Asset Value Issuer Semafo Inc MacDonald, Dettwiler and Associates Ltd Province of British Columbia, Promissory Notes, 0.708% Oct 27, Romarco Minerals Inc Canadian Western Bank Dollarama Inc Canadian Wheat Board, Discounted Notes, 0.898% Jan 5, Canaccord Financial Inc Dundee Wealth Management Inc Martinrea International Inc Andean Resources Limited Linamar Corporation Descartes Systems Group Inc., The Canfor Corporation Osisko Mining Corporation Rainy River Resources Ltd Keegan Resources Inc Calfrac Well Services Ltd Allied Nevada Gold Corp Colossus Minerals Inc Pacific Rubiales Energy Corp Canacol Energy Limited Churchill Corporation, The, Class A Quadra FNX Mining Ltd Bear Creek Mining Corporation Top holdings as a percentage of total net asset value 49.1 Total Net Asset Value $357,822,717 The summary of investment portfolio may change due to the Fund s ongoing portfolio transactions. Updates are available quarterly.

8 For more information please call 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, the effects of competition in the geographic and business areas in which the Fund may invest in and the risks detailed from time to time in BMO Mutual Funds simplified prospectus. 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 Fund, 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, BMO Investments Inc. 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. Registered trade-mark of Bank of Montreal, used under licence. Trade-marks of AIR MILES International Trading B.V. Used under licence by Loyalty Management Group Canada Inc., and BMO Investments Inc. All other third-party trade-marks are used under licence. BMO Mutual Funds are offered by BMO Investments Inc., a financial services firm and separate legal entity from Bank of Montreal.