ETF Strategies for Rising Interest Rates Nicolas Normandeau, CFA, M.Sc. Vice President and Portfolio Manager, Fixed Income ETF solutions for every investor May 2013
Disclaimer The views expressed herein may not necessarily be the views of AlphaPro Management Inc. (the Manager ), or Horizons Investment Management (Canada) Inc. (the Investment Manager ), although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by the Investment Manager including the Horizons Active Floating Rate Bond ETF, and the Horizons Active Preferred Share ETF (the ETFs ). All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. The Investment Manager and Manager have a direct interest in the management and performance fees of the ETFs, and may, at any given time, have a direct or indirect interest in the ETFs or their holdings. 2
US Treasury/10 Year 1950-Present Where will interest rates go in the next few years? Many experts think we may be in a low interest rate environment for years to come, but even if rates go up to 3.5% that is double where we are today Yield 16 U.S. Treasury 10 year (US$) Yields 1950-Present 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 50 55 60 65 70 75 80 85 90 95 00 05 10 15 Source: Bloomberg, For the period of January 1,1950 March 18, 2013 3
Risk/Reward Profile of the Recognized Canadian Bond Universe Yield 10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 Attractive Risk/Reward Risking 6-month of yield on a 1% interest rate increase Unattractive Risk/Reward Risking 3 years yield on a 1% interest rate increase 1.00 0.00 Duration Yield Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Source: Bloomberg Jan 1995 Jan 2013 4
Why Duration Matters 5
Horizons Active Floating Rate Bond ETF General Investment Objective: Generate income consistent with prevailing short-term corporate bond yields while stabilizing market value from the effects of interest rate fluctuations. General Portfolio Strategy: Invest primarily in a portfolio of corporate bonds, while using fixed to floating interest rate swap to maintain a portfolio duration below 2 years. Details: TSX-listed as HFR; Advisor Class listed as HFR.A Sub-advised by Fiera Capital Corporation 0.40% Management Fee; Advisor Class Management Fee of 0.90%* Monthly distribution of income Annual distribution of net capital gains, if any The HFR portfolio holdings have, as of March 31 st, 2013: a weighted average yield to maturity of 1.95% and an annualized current yield of 2.70% an average duration of 0.532 years, with a target of below 1 year and a maximum of 2 years an average Standard & Poor s credit quality of A Seeks to hedge non-canadian dollar currency exposure to the Canadian dollar at all times *Includes Service Fee 6
Investment Process 4 STEP MANAGEMENT PROCESS 1) Analysis of macro factors, economic backdrop, outlook for yields and credit Analysis of global and local economies Thorough assessment of North American and global markets (credit, equity, exchange rates, interest rates) Analysis of fundamental indicators 2) Invest to take advantage of relative value opportunities In-depth credit analysis (fundamental credit analysis, company meetings, review of rating agency reports and independent credit research, discussions with Fiera s equity teams and credit/equity analysts) Extensive relative value analysis (corporate bonds, CDS, international levels, rating, capital structure, equity valuation, preferred share structure) Analysis of technical indicators 3) Hedge interest rate risks (where applicable) Enter swap agreement to deliver fixed rate and receive CDOR (Canadian Deposit Overnight Rate) 4) Continuously manage risks and deviations Daily performance tracking & reporting Rigorous risk budgeting and monitoring of holdings 7
HFR Yield Explained The following example uses these assumptions: 3-year swap fixed rate is 1.4%, CDOR 3 month is 1.3% Portfolio holds corporate bonds with an average yield-to-maturity of 2.1% and average duration of 3 years For illustration purposes only 8
Why Invest In A Floating Rate Corporate Bond ETF? Higher current income than Canadian money market securities Variable distribution that fluctuates or floats with prevailing Canadian short-term interest rates Lower interest rate sensitivity than typical fixed income securities Capital preservation Attractive credit risk premiums Portfolio diversification 9
Horizons Active Preferred Share ETF General Investment Objective: To provide dividend income while preserving capital. General Portfolio strategy: Invest primarily in a portfolio of preferred shares of Canadian companies directly, or through investments in securities of other investment funds, including exchange traded funds. Details: TSX-listed (HPR); Advisor Class listed (HPR.A) Sub-advised by Fiera Capital Corporation 0.55% Management Fee; Advisor Class Management Fee of 1.05%* Monthly distribution of income, taxed as earned Annual distribution of net realized gains, if any, taxed as earned The HPR portfolio holdings contain: A minimum 80% preferred shares A maximum 10% positions in each of common equity, government bonds and corporate bonds. A maximum 15% in foreign currency An estimated weighted average current yield of 4.81% as at March 31 st, 2012 *Includes Service Fee 10
Why Invest in Preferred Shares? Structural Reasons High, tax-advantaged current income Attractive risk/return profile, particularly in low economic growth environments Portfolio diversification given lower volatility than, and low correlation with, equity markets Market Reasons Attractive pricing levels Substantial improvement in capitalization of issuers over past three years Additional Catalysts Increasing number of retirees 11
Why an Actively Managed Preferred Share Strategy? Active management presents significant opportunities to enhance returns without increasing risk through: Solid credit analysis (not just relying on credit rating agencies to determine the credit worthiness of an issuer, as the index does) Valuation assessment based on credit risk and market risk (passive management has no valuation mandate) Analysis of the various preferred share structures to take advantage of relative mispricings. Bullish/bearish portfolio positioning depending on outlook for preferred shares Ability to interact with Canadian and International equity/corporate bond investment professionals gives additional insight into credit and market risk. 12
Why an Actively Managed Preferred Share Strategy? Source: Bloomberg, between February 2, 2013 and April 24, 2013 13
Why an Actively Managed Preferred Share Strategy? Source: Bloomberg, between December 31, 2012 and April 24, 2013 14
Disclaimer Commissions, trailing commissions, management fees and expenses all may be associated with an investment in the Horizons Active Floating Rate Bond ETF, and the Horizons Active Preferred Share ETF managed by AlphaPro Management Inc. (the ETFs ). The ETFs are not guaranteed, their value changes frequently and past performance may not be repeated. Indicated rates of return are the historical annual compounded total returns including changes in per unit values and reinvestment of all dividends and distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. The prospectus contains important detailed information about these ETFs. Please read the prospectus before investing. 15
Thank You May 2013 ETF solutions for every investor HorizonsETFs.com