Advantaged Canadian High Yield Bond Fund

Transcription

1 Management Report of Fund Performance Advantaged Canadian High Yield Bond Fund The following is a report on Advantaged Canadian High Yield Bond Fund s (the Fund ) performance and contains financial highlights but does not contain the audited financial statements of the Fund. This report should be read in conjunction with the financial statements and notes thereto for the year ended December 31, You can get a copy of the interim financial statements at your request, and at no cost, by calling (416) , by writing us at 40 King St. West, Scotia Plaza, 26th Floor, Box 4085, Station A, Toronto, Ontario M5W 2X6 Attention: Advantaged Canadian High Yield Bond Fund Investor Relations or by visiting our website located at or SEDAR at Unitholders 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 and quarterly portfolio disclosure. The Fund s proxy voting disclosure record for the annual period ending June 30, 2016 is available on our website. Any references to net assets or net assets per Unit in this report are references to net assets attributable to Unitholders determined in accordance with IFRS as presented in the financial statements of the Fund. Additionally, any references to net asset value or net asset value per Unit are references to values determined for valuation and transactional purposes. There are no differences between net assets per Unit and net asset value per Unit. Investment Objectives and Strategies The Fund is a closed-end investment fund established as a trust to provide holders (the Unitholders ) of Class A Units and Class F Units (collectively, the Units and each, a Unit ) with investment exposure to a diversified portfolio (the Portfolio ) of Canadian high yield fixed income securities ( Canadian HY Corporate Bonds ) actively managed by High Rock Capital Management Inc. (the Portfolio Manager ). The Fund s investment objectives are to: (i) preserve and enhance the net asset value (the Net Asset Value or NAV ) of the Fund; and (ii) provide Unitholders with quarterly distributions through investments in Canadian HY Corporate Bonds. The Fund does not have fixed distribution but intends to pay targeted quarterly distributions based on the estimated annual cash available to the Fund from the income on the Portfolio reduced by the expenses of the Fund for the period. Quarterly distributions are currently targeted to be $0.115 per Class A Unit and $0.13 per Class F Unit. In order to meet its investment objectives and obtain economic exposure to the Portfolio, the Fund had entered into a forward purchase agreement (the Forward Agreement ) with The Bank of Nova Scotia (the Counterparty ). The Portfolio was held by CHY Fund, the reference fund of the Fund. As a result of the Forward Agreement, the distributions paid by the Fund and its Net Asset Value were based on net interest income received by CHY Fund and the value of its underlying Portfolio. The Fund partially pre settled the Forward Agreement in order to fund: (i) quarterly distributions on the Units; (ii) redemptions of Units from time to time; and (iii) operating expenses and other liabilities of the Fund. As a result of changes to the Income Tax Act (Canada), the Forward Agreement was settled on its scheduled termination date of March 31, 2016 (the Forward Date ). Following this, the Fund invests directly in the Portfolio held by CHY Fund. After the Forward Date, distributions made by the Fund no longer have the same tax-advantaged nature. The declaration of trust of the Fund was amended to remove the words tax-advantaged and references to the Forward Agreement from its investment objectives. The Manager receives the same aggregate fees from the Fund or 0.60% per annum of the net assets of the Fund as had been paid by the Fund and CHY Fund prior to the Forward Date. The Fund has leveraged exposure to the Portfolio through a prime brokerage facility with Scotia Capital Inc. ( SCI ) to borrow up to 15% of the total assets of the Fund. As at December 31, 2016, the Fund had no borrowing (December 31, 2015 $9.96 million or 19.1% of the total assets of CHY Fund). The Class A Units of the Fund are listed for trading on the Toronto Stock Exchange ( TSX ) under the symbol AHY.UN. The Class F Units are not listed on a stock exchange but may be converted into Class A Units on a weekly basis for liquidity purposes. Risk Changes in the risk exposure of the Fund occurred in the following areas: Use of leverage As a result of the prime brokerage facility, Unitholders receive leveraged exposure to any change in the value of and interest earned on the Portfolio. For full disclosure of the risks associated with an investment in the Fund s Units, please refer to the Annual Information Form as filed on SEDAR. Results of Operations The net assets attributable to Unitholders were $7.66 per Class A Unit and $7.82 per Class F Unit as at December 31, 2016 as compared to $7.09 per Class A Unit and $7.27 per Class F Unit as at December 31, 2015, reflecting appreciation and interest earned on the Canadian HY Corporate Bonds offset by operating expenses and distributions paid on the Units. Advantaged Canadian High Yield Bond Fund 1 Management Report of Fund Performance

2 For the year ended December 31, 2016, the Fund declared distributions of $2.38 million (2015 $6.41 million) comprised of $2.05 million or $0.514 per Class A Unit (2015 $5.22 million or $0.675 per Class A Unit) and $0.33 million or $0.575 per Class F Unit (2015 $1.19 million or $0.74 per Class F Unit). Income earned on the Portfolio funded the distributions and operating expenses of the Fund. For the year ended December 31, 2016, $2.2 million (2015 $5.6 million) was available for distribution comprised of income earned on the Portfolio of $2.7 million (2015 $6.9 million) offset by total expenses of $0.5 million (2015 $1.3 million). As a result of the termination of the Forward Agreement, distributions declared by the Fund will no longer be characterized primarily as capital gains or returns of capital and instead all or a portion of the distributions will be characterized as ordinary income, although the Fund may still distribute capital gains or returns of capital. The distributions for 2016 were characterized as 23.7% other income and 76.3% capital gains ( % return of capital). The following is a report from the Portfolio Manager for the fiscal year 2016: Portfolio Attributes: As at December 31, 2016 Current yield 7.35% Duration 3.7 years Yield to maturity (1) 7.85% 3 yr Gov of Cda Bonds 1.13% (Dec. 31, %) Yield to worst (2) 5.46% Credit rating (3) B+/B Defaults during period 3 Leverage Nil % (1) Assumes interest paid until maturity date at which time the principal is repaid. (2) Lowest yield generated given the potential stated calls prior to maturity. (3) Based on lowest available rating. N/R Bonds are rated according to the Portfolio Manager s own rating according to credit analysis in deriving the weighted average credit ratings of bonds in the Portfolio. General Market Overview After the tough start to 2016, the Canadian high yield corporate debt market ( C$HY ) started to strengthen in March 2016 and continued right through to the end of the year. The impetus for the rally was a commodity reflation trade, including oil, with the markets forecasting growth and inflation. The rally grew stronger following the US election. Even as interest rates went up markedly and government bond prices down sharply, high yield bonds continued to see prices rise, spreads tighten and yields fall. This holds true to our view that high yield corporate bonds are credit risk, not interest rate risk and correlation tables show that high yield bonds have a very low correlation to interest rate risk. This was certainly true in November through December of Accordingly, the C$HY market as measured by the Bank of America Merrill Lynch C$HY Composite Total Return Index posted a strong return increasing 16.1% on a total return basis for the year. The Fund followed this performance posting a total return of 16.0% and 16.1% for the Class A and Class F Units, respectively, after deduction of administrative and operating expenses. One negative to this strong market was that many issuers called their bonds and refinanced in other markets (Term Loan B market) or other jurisdictions (USA) thereby stripping out several of our favourite bonds from the Portfolio. On a positive note, we are currently seeing several C$HY issuers coming back to the market with new issues. The Fund benefited from our positioning earlier in the year from a higher weighting in energy bonds from 13% at December 31, 2015 to 21% at year-end. We also began the year with maximum leverage which we eventually pared down by the end of the year to a small net cash position. The Fund s performance was aided by the sale of our entire Government of Canada 10 and 30-year bonds in early September, and then adding back some 30-year Canada bonds right at the end of the year. This trade worked well, given that interest rates rose dramatically after the US election. The credit quality of the Portfolio decreased over the year from BB/B+ to B+/B. Three of our bonds were downgraded to D (for Defaulted) during the year. Although downgraded by the rating agency to D, two of the bonds were not technically in default and were some of our best performers during the year including Perpetual Energy (8.75% July 2019) and Tervita Corp (9.0% Nov 2018). Perpetual Energy redeemed a majority of the July 2019 bonds, using funding from the sale of its holding of Tourmaline Oil stock which was extremely positive for the capital structure of Perpetual, including the July 2019 bonds which we hold. The Perpetual 8.75% bonds are currently rated at CC+. Tervita Corp. s 1st lien bonds were downgraded to D following a missed coupon on some of the company s subordinate debt which we did not hold. The Tervita 9% bonds were subsequently upgraded from D however we exited the position in September. Duration in the portfolio increased slightly over the year from 3.0 years to 3.7 years. Our outlook is for continued strength but at a much more moderate pace. Our view on energy credits is that E&P companies have cut costs by about 30% in C$ terms and given their expenses are in C$ and revenues in US$, the cost savings are closer to 50% from two years ago thereby improving their overall competitiveness. We believe OPEC will continue to do what they need to do to drive WTI to U$60/bbl and this will support our energy credits. Away from energy, we are less bullish on other parts of the commodity sector as well as the consumer discretionary sector. Overall, we continue to believe in the merits of C$HY as a separate asset class. Related Party Transactions For its services to the Fund, SMCAI is entitled to receive (i) a management fee plus (ii) an amount equal to the service fee with respect to the Class A Units to be paid by SMCAI to the dealers whose clients hold Class A Units, plus applicable taxes. The management fee is equal to 0.60% per annum of the net assets of the Fund (prior to the Forward Date 0.30%). The total management fee paid to SMCAI for the year ended December 31, 2016 was Management Report of Fund Performance 2 Advantaged Canadian High Yield Bond Fund

3 $198,112 (2015 $256,077). The service fee rate is equal to 0.40% per annum of the net asset value of Class A Units. No service fee is paid in respect of the Class F Units. The total service fee paid for the year ended December 31, 2016 was $122,169 (2015 $279,094).The ongoing management fee and service fee are calculated and accrued weekly and are payable quarterly in arrears. Up to the Forward Date, the Fund paid to the Counterparty an additional amount, calculated weekly and payable monthly in arrears, of up to 0.30% per annum of the notional amount of the Forward Agreement being the net asset value of the Fund. The total fees paid or payable to The Bank of Nova Scotia relating to the Forward Agreement for the year ended December 31, 2016 were $26,486 (2015 $240,443). The Fund has a Loan Facility with Scotia Capital Inc. The total interest expense on the margin account for the year ended December 31, 2016 was $24,006 (2015 nil). The Portfolio Manager is responsible for managing the purchase and sale of Canadian HY Corporate Bonds as required to meet investment objectives and operating policies of the Fund. Such transactions may be carried out using the services of SCI on an agency basis for which trading commissions are not explicitly charged. For the year ended December 31, 2016, $500,000 purchases and $2,120,938 in sales were transacted with SCI (2015 $nil purchases and $8,857,419 in sales). At December 31, 2016, the Fund had accrued liabilities of $13,907 (December 31, 2015 $60,639) payable to SMCAI and The Bank of Nova Scotia, and had cash on deposit with The Bank of Nova Scotia of $34,333 (December 31, 2015 $101,494). Advantaged Canadian High Yield Bond Fund 3 Management Report of Fund Performance

4 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 since inception. The information is derived from the Fund s audited financial statements. For the Year Ended December 31, December 31, December 31, December 31, December 31, (1) 2012 CLASS A Units Net assets per Unit, beginning of year $ 7.09 $ 8.42 $ 8.82 $ 8.94 $ 8.57 Increase (decrease) from operations: Total income 0.41 Total expenses (2) (0.14) (0.10) (0.13) (0.08) (0.17) Realized gains (losses) for the year (0.03) (0.02) Unrealized gains (losses) for the year (3) (0.63) (1.04) Total increase (decrease) from operations 1.08 (0.65) Distributions: From interest (0.20) From capital gains From return of capital (0.31) (0.68) (0.68) (0.68) (0.68) Total Distributions (4) (0.51) (0.68) (0.68) (0.68) (0.68) Net assets per Unit, end of year $ 7.66 $ 7.09 $ 8.42 $ 8.82 $ 8.94 For the Year Ended December 31, December 31, December 31, December 31, December 31, (1) 2012 CLASS F Units Net assets per Unit, beginning of year $ 7.27 $ 8.64 $ 9.10 $ 9.21 $ 8.85 Increase (decrease) from operations: Total income 0.39 Total expenses (2) (0.10) (0.06) (0.09) (0.09) (0.14) Realized gains (losses) for the year (0.03) (0.02) Unrealized gains (losses) for the year (3) (0.54) (1.06) Total increase (decrease) from operations 1.13 (0.63) Distributions: From interest (0.23) From capital gains From return of capital (0.35) (0.74) (0.74) (0.74) (0.74) Total Distributions (4) (0.58) (0.74) (0.74) (0.74) (0.74) Net assets per Unit, end of year $ 7.82 $ 7.27 $ 8.64 $ 9.10 $ 9.21 Based on the weighted average number of Units during the year except for the net asset values and distributions wherein the actual number of Units outstanding at the relevant time are used. (1) Prepared in compliance with IFRS. All years prior to 2013 have not been restated for IFRS. (2) Total expenses include reorganization costs of $69,408 for Class A Units and $10,592 for Class F Units for the year ended December 31, Total expenses include forward fees of $0.006, $0.026, $0.043, $0.013 and $0.027 per Unit December 31, 2016, 2015, 2014, 2013 and 2012 respectively. (3) Includes adjustment to reconcile the basis of calculation of per Unit amounts between the weighted average and the end of period number of Units as follows: December 31, 2016 Class A Units $0.13/ Class F units $0.19, December 31, 2015 Class A Units $0.04/ Class F units $(0.05), 2014 Class A Units $0.01 / Class F Units $(0.04), 2013 Class A Units $0.01 / Class F Units $nil, 2012 Class A Units $0.01 / Class F Units $0.02. (4) All distributions were paid in cash. Management Report of Fund Performance 4 Advantaged Canadian High Yield Bond Fund

5 Class A Units Ratios and Supplemental Data (based on net asset value) December Net asset value (000 s) (1) $ 21,047 $ 34,087 $ 62,796 $ 65,006 $ 63,751 Number of Units outstanding 2,747,315 4,810,939 7,455,933 7,369,720 7,129,863 Management expense ratio (2) 1.89% 1.83% 2.08% 2.00% 1.91% Management expense ratio excluding interest (2) 1.79% 1.64% 1.90% 1.82% 1.72% Trading expense ratio (3) 0.00% 0.00% 0.00% 0.00% 0.00% Portfolio turnover rate (4) 55.1% 5.7% 42.3% 62.7% 69.2% Net asset value per Unit $ 7.66 $ 7.09 $ 8.42 $ 8.82 $ 8.93 Market Value per Unit $ 7.25 $ 6.50 $ 8.29 $ 9.00 $ 8.91 Class F Units Ratios and Supplemental Data (based on net asset value) December Net asset value (000 s) (1) $ 3,084 $ 6,345 $ 16,186 $ 19,391 $ 21,339 Number of Units outstanding 394, ,150 1,873,062 2,130,942 2,315,682 Management expense ratio (2) 1.36% 1.24% 1.62% 1.50% 1.41% Management expense ratio excluding interest (2) 1.29% 1.06% 1.44% 1.31% 1.23% Trading expense ratio (3) 0.00% 0.00% 0.00% 0.00% 0.00% Portfolio turnover rate (4) 55.1% 5.7% 42.3% 62.7% 69.2% (1) Net asset value is equal to net asset value per Unit multiplied by the number of Units outstanding. (2) Management expense ratio ( MER ) is based on total expenses of the Fund and CHY Fund for the stated year (including Forward Agreement fees). The ratio is expressed as an annualized percentage of the weekly average Unit net asset value during the year. The Fund realized costs in connection with its 2016 Reorganization. Without this cost, the 2016 MER s would have been 1.77% and 1.29%, and excluding interest, 1.69% and 1.22% for Class A Units and Class F Units, respectively. (3) 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 year. (4) CHY Fund s portfolio turnover rate indicates how actively the Portfolio Manager manages its Canadian HY Corporate Bonds. A portfolio turnover rate of 100% is equivalent to CHY Fund buying and selling all of the fixed income securities in its portfolio once in the course of a year. The turnover rate includes transactions in Government of Canada bonds which are used to aid in mitigating overall market risk in the Portfolio. Without these transactions the turnover rate would have been 44.5%, 4.5%, 38.1%, 49.0% and 42.8% for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively. Past Performance Year by Year Returns The following chart shows the performance of the Fund s Units based on net asset value since the Fund s inception, indicating in percentage terms, how much an investment made on the first day of each financial period/year would have increased or decreased by the last day of each financial period/year assuming reinvestment of all dividends at net asset value. Past performance is not an indication of how the shares will perform in the future. The calculation of returns based on net asset value follows the requirements of NI As an investor cannot purchase or sell the Units at net asset value, the following is an indication of the performance of the assets of the Fund rather than returns available to Unitholders. Advantaged Canadian High Yield Bond Fund 5 Management Report of Fund Performance

6 Returns based on market value are also presented for the Class A Units in narrative form below as an indication of returns actually available to Class A Unitholders. 20% 15% 12.6% Class A 16.0% 20% 15% 13.0% Class F 16.1% 10% 5% 6.4% 2.8% 10% 5% 6.6% 2.8% 0% 0% -5% -10% -15% -9.2% % 16MAR % -10% -15% -5.7% -7.9% 16MAR The Class A Units are listed for trading on the TSX while the Class F Units are not but may be converted into Class A Units on a weekly basis. Accordingly, the market value return for the Class A Units was (6.6%), 8.7%, 8.9%, (0.6%) and (14.3%)for the 2011, 2012, 2013, 2014 and 2015, respectively, and was 20% for the year ended December 31, This performance from inception reflects payment of upfront costs related to the establishment of the Fund and assumes that distributions are reinvested in additional units at the then market price on the TSX which price may reflect a premium or discount to net asset value. Annual Compound Returns The calculation of the annual compound returns based on net asset value follows the requirements of NI As an investor cannot purchase or sell the Units at net asset value, the following is an indication of the performance of the assets of the Trust rather than returns available to Unitholders. Returns based on market value are also presented for Class A Units in narrative form below as an indication of returns actually available to Class A Unitholders. Returns are based on the net asset value of a Unit. One Year Three Year Five Year From inception (1) Advantaged Canadian High Yield Class A Unit % 3.0% 5.5% 3.1% Advantaged Canadian High Yield Class F Unit % 3.2% 5.8% 3.9% BAML C$HY Composite Total Return Index (2) % 4.7% 7.1% 6.1% (1) The return is for the period from March 31, 2011, the date of inception, to December 31, 2016 based on the Unit issue price of $ (2) The BofA Merrill Lynch Canada High Yield Composite Index is a capitalization-weighted index designed to measure activity of bonds in the Canadian domestic market. The annual compound returns based on market value for the Class A Units for the one-year, three year, five year and from inception to December 31, 2016 are respectively as follows: 20.0%, 0.7%, 3.9% and 2.1%. Management Report of Fund Performance 6 Advantaged Canadian High Yield Bond Fund

7 Summary of Investment Portfolio Below is a summary of the Portfolio as at December 31, 2016, upon which the Unitholders return is based. This summary of the Portfolio may change due to ongoing portfolio transactions. Weekly updates of the net asset value are available on the internet at or by contacting investor relations at Investment portfolio, at market value... $23,049,011 Industrials, 11.4% Transportation, 3.8% Basic Materials, 11.6% Consumer Discretionary, 19.3% Energy, 20.8% Financial, 3.1% Consumer Staple, 11.6% Government, 4.8% Top 25 Investments Cable/Telecom, 13.6% 16MAR % of Net Asset Value 1. Perpetual Energy Inc. 8.75% 23 July % 2. DHX Media LTD Company 5.875% 2 Dec % 3. Great Canadian Gaming CO Company 6.625% 25 July % 4. Shearer s Escrow Corp, 9% 1 Nov 2019 (USD) % 5. Tembec Industrial Inc. 9% 15 Dec 2019 (USD) % 6 Canadian Government 2.75% 1 Dec % 7. YPG Financing Inc. 9.25% 30 Nov % 8. AGT Food & Ingredients 9% 14 Feb % 9. Newalta Corp. 7.75% 14 Nov % 10. Canexus Corp 7.875% 20 Sept % 11. Athabasca Oil Corp. 7.5% 19 Nov % 12. Air Canada 4.75% 6 Oct % 13 Gateway Casinos & Entertainment Ltd. 8.5% 26 Nov % 14. River Cree Ent. 11% 20 Jan % 15. Videotron Ltd 5.625% 15 June % 16. Atlantic Power L.P. 5.95% 23 June % 17 DirectCash Payments Inc % 8 Aug % 18. Canadian Energy Services & Technology Corp % 17 April % 19. Superior Plus 6.5% 9 Dec % 20. Postmedia Network Inc. 8.25% 15 July % 21 Millar Western Forest Products Ltd. 8.5% 1 Apr 2021 (USD) % 22. Quebecor Media SR Unsecured 6.625% 15 Jan % 23. Baytex Energy Corp % 19 July % 24 AGT Food & Ingredients 5.875% 21 Dec % 25. Canexous Corp. 6% 31 Dec % Total % of Net Asset Value represented by these holdings % (USD) denominated in United States Dollar (1) Total Portfolio as a percentage of Net Asset Value is 95.6% Advantaged Canadian High Yield Bond Fund 7 Management Report of Fund Performance