1. Low volatility equity strategies have "outperformed" up to now and should be expected to underperform moving forward.

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1 TD Asset Management A NEWSLETTER FOR CONSULTANTS Winter 2017 In this issue Muting the noise around low volatility equity strategies... 1 TDAM updates... 5 Events Sharing of Knowledge Learning Series 2017 Coming to a city near you! See page 4 for more details. Muting the noise around low volatility equity strategies Empirical evidence from historical equity performance suggests that risk is not properly rewarded. Research1 shows that if an equity portfolio is constructed with as little risk as possible, it would be reasonable to expect to earn approximately the same return as with the traditional capitalization-weighted stock market index (over full market cycles) while taking on only 2/3 of the risk. This was the foundation of the idea behind low volatility strategies. Since the first low volatility portfolios were created in 2006, there has been tremendous buy-in from the investment community. under management have accumulated at a staggering pace, with institutional assets exceeding $300 billion2. Once retail assets are factored in, some industry experts claim that low volatility equity equities could be as much as US$900 billion. Today's noise The popularity of low volatility equities, however, has alarmed some investors who have begun to voice criticisms over the low volatility strategies, stating that they may now constitute an over-crowded area of the stock market. These criticisms can be bucketed into three main areas: 1. Low volatility equity strategies have "outperformed" up to now and should be expected to underperform moving forward. 2. The popularity of low volatility equities has inflated their prices and they are now "expensive." 3. Low volatility equities will perform poorly as interest rates eventually rise. This article will take a deeper dive into these concerns and will illustrate that there is little evidence to back these claims.... cont d on page 2 1

2 ... cont d from page 1 Critisism #1: Low volatility equities are due to underperform The fundamental assumption with low volatility equities is that they are expected to perform better during crises and underperform during strong recoveries. So, should it really be a surprise that they have been outperforming over the past decade? Moreover, does this mean we should now expect underperformance? The past decade has witnessed a series of major market events, including the: 2008/2009 global financial crisis 2011 European debt crisis 2015/2016 commodity crisis Financial Crisis Aug'08-Mar'09 Performance review Euro Debt Crisis Oct'11 Taper Tantrum Jun'13 China, Greece, Oil EM weakness Jun'15-Dec'15 Market environment favorable to low volatility strategies Source: MSCI Inc. As of September 30, All returns on the MSCI All Country World Indices are gross of fees and in US dollars. During this time, equity performance was dramatically impacted by long periods of high volatility. The graph above shows the cumulative value of C$100 invested at the end of The dark line indicates that $100 invested in the capitalization-weighted MSCI All Country World Index would have provided a modest return of 3.2% per year. The same initial amount invested in the MSCI ACWI Minimum Volatility Index would have had a return of 7%. A market where there are wild swings in performance should bode well for low volatility equity strategies by the nature of the strategy, and the significant out-performance of low volatility equities over the past decade actually meets expectations formed from analyses of prior market cycles. The only difference, which is where the misconception of "over performance" is born, is that we have simply not witnessed a fully balanced market cycle, yet. Criticism #2: Low volatility stocks are currently overvalued Critics of the low volatility equity strategy have stated that the demand for low volatility equities has inflated stock values and now deem them "expensive." At a basic level, it seems like a legitimate argument. However, is it fair to say that a stock is overvalued only by looking at a key ratio in isolation? Or to judge it by the ratio irrespective of a comparative benchmark? Analysts utilize numerous ratios, including the price-to-book, the price-to-historical earnings, and the price-to-consensus of forward earnings in order to properly assess the expensiveness of a stock. Naturally, higher ratios would indicate they could be overvalued. Using these popular ratios, let's see if low volatility equities are, in fact, expensive. At the end of September, the MSCI All Country World Index was selling at 2.1 times book value. The MSCI ACWI Minimum Volatility Index and the TD Emerald Low Volatility All World Equity PFT were both selling at 2.7 and 2.2 times book values, respectively. On the basis of market price to accounting book value, there are no significant differences between the traditional benchmark, the minimum volatility benchmark, and the TD Emerald Fund. Moreover, the MSCI All Country World Index was selling at 21.3 times trailing earnings, only slightly lower than the multiple for the MSCI ACWI Minimum Volatility Index (21.9) and actually higher than for the TD Emerald Low Volatility All World Equity PFT (20.4). Thus, low volatility equities can actually be considered cheaper than the traditional index in terms of trailing earnings. The market price-to-consensus of forward earnings multiple also places the traditional index somewhere between the Minimum Volatility Index and the TD Fund in terms of valuations. These three popular multiples provide no significant evidence to conclude that low volatility stocks are currently overvalued. Index Price to Book Value Price to Trailing Earnings Price to Forward Earnings MSCI AC World Index MSCI ACWI Minimum Volatility Index TD Emerald Low Volatility All World Equity PFT Multiples comparison Sources: Bloomberg Finance L.P., TDAM. As of September 30, cont d on page 3 2

3 ... cont d from page 2 Criticism #3: Low volatility stocks are negatively correlated to interest rate movements The third criticism is that low volatility equities will perform poorly in a rising interest rate environment. Low volatility equities typically have higher dividend yields, and as such, have become a substitute for bonds. Their popularity over the past decade is due in part to falling interest rates. However, today the perception is that as interest rates eventually rise, investors will leave higher dividend payers and return to bonds, leading to poor performance of low volatility equities. But is this negative correlation actually true? Our research has shown that based on the behavior of low volatility and high volatility equities, this negative correlation is not true over the long term. The graph below illustrates the excess return of the quintile of large-cap U.S. equities with the lowest volatility vs. the quintile of large-cap U.S. equities with the highest volatility and charts it next to the 10-year U.S. Treasury yield. The positive shaded areas correspond to periods during which low volatility equities outperformed high volatility equities. The negative shaded areas correspond to periods during which volatile stocks outperformed less volatile stocks. From late 1953 through mid-1981, less volatile equities outperformed 68% of the time. From mid-1981 through late 2016, low volatility equities outperformed 79% of the time. 3 Correlation analysis is a high correlation between the strength and direction of equity markets; namely, low volatility equities tend to outperform in bear markets and to underperform in strong market recoveries. Changing with the times The sources of risk and volatility change over time. What's important to keep in mind is that different sources of risk will be associated with changing volatility patterns. Moving forward, the successful low volatility portfolios will be the ones that can anticipate and adapt to the changing sources of risk, adjusting their portfolios accordingly. 1 A Review of the Historical Return-Volatility Relationship, Yuriy Bodjov and Isaac Lemprière, May All Low Volatility Equity Universe from evest Alliance. As of September 30, This includes the excess return of the 100 least volatile stocks minus the 100 most volatile stocks (chosen on the basis of a trailing 60 month return volatility basis from among the 500 largest U.S stocks. These portfolios are equally-weighted. A low volatility portfolio would also use correlations to select stocks and would not be equally weighted. There does not appear to be a correlation to interest rates Source: Isaac Lempriere and Yuriy Bodjov, "Low Volatility Strategies: The Historical Performance", Canadian Investment Review, May 19, While some equities are more sensitive to changes in interest rates than others, historical evidence suggests that there has not been a strong correlation between the direction of interest rates and the relative performance of low volatility vs. high volatility equites. However, there 3

4 SAVE THE DATE Sharing of Knowledge Learning Series 2017 This year will mark the 14th year of TDAM s Sharing of Knowledge Learning Series. TDAM will once again go across the country to facilitate discussions on industry issues that affect all of us in the institutional investment world. This year s event will focus on "Taking Control" and feature thought-provoking presentations by investment experts from TDAM and Epoch Investment Partners that you won t want to miss. Look for your invitation coming soon. Saskatoon March 29 Manos Restaurant Regina March 30 Hotel Saskatchewan Halifax April 5 Marriott Harbourfront Ottawa April 6 Fairmont Château Laurier Vancouver April 11 Fairmont Hotel Vancouver Calgary April 12 Saltlik Steakhouse Edmonton April 13 Fairmont Hotel MacDonald Montreal April 19 Ritz-Carlton Montreal Quebec City April 20 Le Michelangelo Toronto April 20 Shangri-La Toronto Winnipeg April 26 Fairmont Winnipeg Industry Outlook: Articles to read Click on the title below to view the article More bends in the Road Ahead, Benefits and Pension Monitor By: Bruce Cooper, CFA, CEO, CIO, TD Asset Management, December 2016 The Big Rewind, Epoch Investment Partners By: William W. Priest, CFA, CEO, Co-CIO, Portfolio Manager and Kevin Hebner, PHD, Managing Director, Global Portfolio Management, Epoch, December 2016 Equity market returns with less risk December 2016 Exposing the Low Volatility Anomaly December

5 Staff updates Additions Prior experience Date Niel Macintyre Associate, Investment Grade Credit Research Private Debt Transfer to Investment Grade Credit Research team from TDAM Risk Management team Role Change Details Date Bruce Cooper, CFA Chief Executive Officer and Chief Investment Officer Geoff Wilson, CFA Managing Director, Head of Asset Allocation and Innovative Solutions Jonathan Allen, CFA Vice President & Director, Head of Investment Grade Credit Research Promotion to Chief Executive Officer and Chief Investment Officer from Chief Investment Officer Promotion to Head of the Asset Allocation and Innovative Solutions group from Head of the Asset Allocation team Promotion to Head of the Investment Grade Credit Research team from Analyst Investment Grade Credit Research 12/ /2016 Departures Reason Date Tim Wiggan, CFA Chief Executive Officer Tim returned to TD Securities in an expanded role to lead their Equities business Geoff Watson, CFA Managing Director, Investment Grade Credit Research Deceased We invite you to learn more about how our strategies and services can help you meet your clients' specific investment needs. Please visit us at or contact Brendan O'Brien at (416) for more information or feedback. Telephone: The statements contained herein are based on material believed to be reliable. Where such statements are based in whole or in part on information provided by third parties, they are not guaranteed to be accurate or complete. The information does not provide individual financial, legal, tax or investment advice and is for information purposes only. Graphs and charts are used for illustrative purposes only and do not reflect future values or changes. Past performance is not indicative of future returns. TD Asset Management Inc., The Toronto-Dominion Bank and its affiliates and related entities are not liable for any errors or omissions in the information or for any loss or damage suffered. All products contain risk. Important information about the pooled fund trusts is contained in their offering circular, which we encourage you to read before investing. Please obtain a copy. The indicated rates of return are the historical annual compounded total returns of the funds including changes in unit value and reinvestment of all distributions. Yields, investment returns and unit values will fluctuate for all funds. All performance data represent past returns and are not necessarily indicative of future performance. Pooled Fund units are not deposits as defined by the Canada Deposit Insurance Corporation or any other government deposit insurer and are not guaranteed by The Toronto-Dominion Bank. Mutual fund strategies and current holdings are subject to change. TD Emerald Funds are managed by TD Asset Management Inc. Certain statements in this document may contain forward-looking statements ( FLS ) that are predictive in nature and may include words such as expects, anticipates, intends, believes, estimates and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS. Index returns are shown for comparative purposes only. Indexes are unmanaged and their returns do not include any sales charges or fees as such costs would lower performance. It is not possible to invest directly in an index. TD Asset Management Inc. is a wholly-owned subsidiary of The Toronto-Dominion Bank. All trademarks are the property of their respective owners. The TD logo and other trade-marks are the property of The Toronto-Dominion Bank. 5 CN1/2017