Annual Management Report of Fund Performance 19FEB201310182961 The following is a report on the performance of Top 20 Dividend Trust (the Trust ) and contains financial highlights but does not contain the complete financial statements of the Trust. This report should be read in conjunction with the audited financial statements and notes thereto for the years ended December 31, 2014 and December 31, 2013. You can get a copy of the annual financial statements at no cost by calling (416) 863-7007, by writing us at 40 King St. West, Scotia Plaza, 26th Floor, Box 4085, Station A, Toronto, Ontario M5W 2X6, Attention: Top 20 Dividend Trust Investor Relations or by visiting our website located at www.scotiamanagedcompanies.com or SEDAR at www.sedar.com. You may also contact us using one of these methods to request a copy of the Trust s proxy voting policies and procedures, proxy voting disclosure and quarterly portfolio disclosure. The Trust s voting disclosure record for the annual period ended June 30, 2014 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 Trust. 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 at December 31, 2014 and 2013. Prior to 2013, any differences between the two values was a result of net assets per Unit being calculated for financial statement purposes using closing bid prices versus net asset value per Unit being calculated for transactional purposes using closing sale prices. Investment Objective and Strategies The Trust is a closed-end investment fund established as a trust to provide holders (the Unitholders ) of units (the Units ) of the Trust with investment exposure to an equally-weighted portfolio (the Portfolio ) comprised of the 20 highest yielding securities ( Portfolio Securities ) included in the S&P/TSX 60 Index. The S&P/TSX 60 Index consists of the 60 largest and most liquid issuers on the Toronto Stock Exchange ( TSX ) and is generally maintained to have sector weights in line with the S&P/TSX Composite Index. The Trust s investment objectives are to provide holders of Units with: (i) stable monthly distributions; and (ii) the opportunity for capital appreciation. The distributions are funded from dividends generated by the Portfolio and supplemented by premiums received on writing covered call options on a portion of the Portfolio. Highstreet Asset Management Inc. (the Portfolio Manager and Options Advisor or Highstreet ) provides investment advisory and portfolio management services to the Trust and maintains the Portfolio in accordance with the investment objectives, strategy and restrictions of the Trust. The Portfolio is reconstituted annually to include the top 20 highest yielding constituents of the S&P/TSX 60 Index and is rebalanced to an equal weight basis prior to the end of each calendar quarter. Highstreet writes covered call options from time to time in respect of not more than 25% of the Portfolio in order to earn income from option premiums to supplement dividends generated by the Portfolio. Highstreet will generally only write covered calls to the extent needed to increase the yield on the Portfolio to a targeted yield. This targeted yield will enable the Trust to pay the targeted distribution. The Trust will purchase Units under the mandatory market purchase program to the extent premiums generated from writing covered call options are in excess of amounts needed to fund the distribution. Risk There have been no material changes in the risk exposure of the Trust during the year. The value of the Units varies according to the value of the Portfolio. The value of the Portfolio is influenced by factors which are not within the control of the Trust including the financial performance of the 20 companies included in the Portfolio, interest rates and other financial market conditions. Accordingly, the value of the Units varies from time to time. For full disclosure of the risks associated with an investment in the Trust s Units, please refer to the Investment Considerations and Risk Factors section in the Annual Information Form as filed on SEDAR. Top 20 Dividend Trust 1 Annual Management Report of Fund Performance
Report from Portfolio Manager and Options Advisor Overview Highstreet manages the option overlay strategy which involves selling call options on up to, but not more than, 25% of the Portfolio. The percentage of write for each holding and the strike prices chosen are primarily a function of the Trust s income requirements. Highstreet may choose to close out option positions prior to their expiry, for options that are both out-of-the-money, and/or in-the-money, when prudent. Highstreet endeavors to avoid assignment, when possible, on any in-the-money positions. The overall investment objectives of the Trust are to provide targeted monthly cash distributions, to provide the opportunity for capital appreciation, and to provide lower overall volatility of portfolio returns than would otherwise be experienced from owning the equity securities on a stand-alone basis. Market Performance 2014 was an interesting year for Canadian equities. Starting the year on volatile note, the broad S&P/TSX Composite rose steadily toward the end of the second quarter, delivering a return of 12.9% over the first six months. The year began with a negative outlook, as Canadian, US and global markets were adversely impacted by concerns about the health of indebted Emerging Market (EM) economies, as well as lingering concerns about the impact of an exceptionally cold winter on the US economy. Gold, long seen as a traditional safe haven asset, was a significant beneficiary of these concerns. Developments in Ukraine caused significant concern around the globe in March when Russian troops annexed Crimea in scenes reminiscent of Cold War aggression. As a relatively quick stalemate emerged, tensions lifted, and most investor anxiety was alleviated. This allowed investors to conclude that the global economy remained on the path to recovery and investors confirmed this by moving out of gold late in the first quarter. Throughout the second quarter, there was a continuation of the theme that investors appeared to be willing to take on more risk in their investments. Temporary setbacks mid-year included concerns around tensions in the Middle East due to incursions by the self-titled Islamic State into Iraq, Syria and neighbouring countries. Once again, gold rallied on the back of these concerns. The second half of 2014 was a much different picture in the Canadian equity market. The broad index delivered a return of (2.05)% in the second half of the year, bringing the twelve month return for 2014 down slightly to 10.5%. Commodity sectors dragged the index lower and energy stocks plummeted as oil fell more than forty-one percent due to mounting over-supply concerns following OPEC s decision not to cut its production quota. Investors became increasingly concerned toward the end of 2014 that deflationary pressures would ultimately weigh on economic growth. The Fund benchmark, the S&P/TSX 60 Total Return Index, posted an annual return of 12.3% for the year, confirming that larger cap stocks outperformed the broad market index, while the Portfolio delivered a return of (0.2)% driven by a steep decline in energy names over the second half of the year. Annual Management Report of Fund Performance 2 Top 20 Dividend Trust
Portfolio Performance The Portfolio delivered a total return of (0.2)% for the year comprised of: (8.0)% from price change, 4.5% from dividends and 3.3% from option premiums earned. Performance for each of the individual Portfolio Securities held during the year was as follows: Performance (1) Securities (%) Energy ARC Resources Ltd. (ARX) (11.4) Canadian Oil Sands Limited (COS) (44.2) Crescent Point Energy Corp. (CPG) (30.0) Enerplus Corporation (ERF) (38.5) Husky Energy Inc. (HSE) (15.3) Penn West Petroleum Ltd. (PWT) (69.7) TransCanada Corporation (TA) 21.9 Financials Bank of Montreal (BMO) 20.8 Bank of Nova Scotia (The) (BNS) 3.7 Canadian Imperial Bank Of Commerce (CM) 14.6 National Bank of Canada (NA) 16.4 Power Corporation of Canada (POW) 3.2 Royal Bank of Canada (RY) 16.6 Sun Life Financial Inc. (SLF) 15.9 Consumer Discretionary Shaw Communications Inc. (SJR.B) 26.2 Materials Potash Corporation of Saskatchewan Inc. (POT) 22.1 Telecommunication Services BCE Inc. (BCE) 21.7 Rogers Communications Inc. (RCI.B) 10.4 TELUS Corporation (T) 19.0 Utilities Fortis Inc. (FTS) 33.0 TransAlta Corp. (TA) 0.4 (1) Performance comprised of price change and dividends. Option Activity For the year, call options expiring in all months from January to December were sold on the Trust s Portolio Securities raising $2.3 million in option premiums or approximately 3.3% on the Portfolio. The average percentage written on the Portfolio was approximately 22.8% with an average strike percentage of 100.5%. Highstreet s proprietary option overlay model examines a number of factors, including short-term price change and momentum metrics, to determine a target level of call writing and level of strike for each holding in the underlying Portfolio. Targeted strike levels are preferably out-of-the-money to allow the opportunity to capture potential positive performance of the underlying stocks in addition to option premiums. Top 20 Dividend Trust 3 Annual Management Report of Fund Performance
Volatility The application of a covered call writing strategy endeavors to reduce the overall level of portfolio volatility. The following table and chart compares the annualized, realized volatility over the full calendar year of 2014 for the Trust relative to: 1. The same underlying portfolio (with no covered call overlay); and 2. The benchmark index (no covered call overlay) Portfolio S&P/TSX 60 Total Portfolio (No Call Writing) Return Index Top 20 Dividend Trust 11.1% 11.9% 10.3% 12.50% 12.00% Realized Volatility 11.50% 11.00% 10.50% 10.00% 9.50% Data Source: Bloomberg 9.00% Top 20 Canada 12MAR201517141410 Portfolio Portfolio (No Call Writing) S&P/TSX 60 Total Return Index Annual Management Report of Fund Performance 4 Top 20 Dividend Trust
On an individual basis, stock volatilities were quite variable. Penn West Trust had the highest volatility of any name held in the portfolio followed by Enerplus, while Bank of Montreal and Royal Bank had the lowest. On average, on an individual basis, volatility levels rose through the year, with the energy companies experiencing substantial increases during the fourth quarter, ending the year 200% 300% higher than where they started. Realized Volatility 60.0% Q1 Q2 Q3 Q4 Volatility 40.0% 20.0% 0.0% ARX CN BCE CN Data Source: Bloomberg BMO CN BNS CN CM CN COS CN CPG CN ERF CN FTS CN HSE CN NA CN POT CN POW CN PWT CN RCI/B CN RY CN SRJ/B CN SLF CN T CN TA CN 12MAR201517141558 TRP CN Results of Operations Financial Performance The net assets attributable to Unitholders as at December 31, 2014 were $10.14 per Unit as compared to $10.93 per Unit at December 31, 2013, representing a decrease of 7.2%, primarily reflecting depreciation in the fair value of the Portfolio coupled with the Trust s operating expenses, including distributions paid on the Units. During the year, 586,874 (2013 1,371,292) Units were retracted for cash in the amount of $5.8 million (2013 $15.0 million). Pursuant to the mandatory market purchase program, the Trust may purchase any Units offered in the market at a price less than 98% of the latest net asset value per Unit. For the year ended December 31, 2014 14,465 (2013 34,127) Units were purchased under this program at an average price of $10.89 (2013 $10.41) per Unit for a total purchase amount of $157,593 (2013 $355,151). Distributions The Trust does not have a fixed distribution but intends to pay equal monthly distributions based on, among other things, the actual and expected returns on the Portfolio and the actual and expected expenses of the Trust. Monthly distributions are targeted to be $0.0583 per Unit ($0.70 annually) representing an annual yield of 7.0% on the issue price of the Units. For the year ended December 31, 2014, the Trust declared total distributions of $4.58 million or $0.6996 per Unit (2013 $5.48 million or $0.6996 per Unit). Distributions consisted of 76.6% return of capital (2013 53.5%) and 23.4% dividend income (2013 46.5%). Dividends earned on the Portfolio Securities and premiums received on writing covered call options on a portion of the Portfolio Securities funded the distributions and operating expenses of the Trust. For the year ended December 31, 2014, $4.97 million (2013 $5.54 million) was available for distribution comprised of dividends earned on the Portfolio Securities (including interest) of $3.22 million (2013 $4.01 million) and option premiums received of $2.35 million (2013 $2.19 million) offset by total operating expenses (excluding transaction costs) of $0.60 million (2013 $0.66 million). Recent Developments Adoption of International Financial Reporting Standards ( IFRS ) The Trust s financial statements have been prepared in compliance with IFRS commencing January 1, 2014 as required by Canadian securities legislation and the Canadian Accounting Standards Board. Previously, the Trust prepared its financial statements in accordance with Part V of the CPA Canada Handbook. The Trust has consistently applied the accounting policies used in the preparation of its opening IFRS statement of financial position at January 1, 2013 and throughout all periods presented, as if these policies had always been in effect. As a result, upon adoption of IFRS, an adjustment was recognized to increase the carrying amount of Top 20 Dividend Trust 5 Annual Management Report of Fund Performance
the Trust s investments and net assets by $162,124 at January 1, 2013 and $53,304 as at December 31, 2013 as reflected in the Financial Highlights section. As well, there are additional disclosures in the financial statements and a change in the presentation of Unitholders equity to a financial liability. Related Party Information For its services to the Trust, Scotia Managed Companies Administration Inc. ( SMCAI ), a wholly-owned subsidiary of Scotia Capital Inc. ( SCI ) which in turn is a wholly-owned subsidiary of The Bank of Nova Scotia, is entitled to receive a quarterly fee (the Management Fee ) equal to 0.50% per annum of the net asset value of the Trust. SMCAI pays Highstreet out of the Management Fee. The total management fees paid for the year ended December 31, 2014 were $410,915 (2013 $472,611). At December 31, 2014, the Trust had accrued liabilities of $637 (2013 $420) payable to SMCAI and had cash on deposit with SCI and The Bank of Nova Scotia of $2,989 (2013 $5,291). The Portfolio Manager and Options Advisor is responsible for managing the purchase and sale of Portfolio Securities as required to meet investment objectives and operating policies of the Trust. Such transactions may be carried out using the services of SCI or other brokerage houses on an agency basis for a fixed cost. During the year ended December 31, 2014, all portfolio transactions were conducted on an agency basis with SCI receiving transaction costs of $14,839 (2013 $64,914). For the year ended December 31, 2014, the Trust purchased 14,465 (2013 34,127) Units under the mandatory market purchase program at an average price of $10.89 (2013 $10.41) per Unit for a total purchase amount of $157,593 (2013 $355,151). Transaction costs of $280 (2013 $644) were paid to SCI under the mandatory market purchase program. Financial Highlights The following tables show selected key financial information about the Trust and are intended to help you understand the Trust s financial performance since inception. This information is derived from the Trust s audited financial statements. For the Years Ended December 31 2014 2013 (2) 2012 (1) Net assets per Unit, beginning of year... $10.93 $ 9.87 $10.00 Increase (decrease) from operations: Total revenue... 0.49 0.50 0.28 Total expenses (3)... (0.10) (0.10) (0.65) Realized gains (losses) for the year... (0.03) 0.63 0.11 Unrealized appreciation (depreciation) for the year (4)... (0.45) 0.73 0.48 Total increase (decrease) from operations... (0.09) 1.76 0.22 Distributions: From dividends... (0.70) (0.70) (0.37) Total Distributions (5)... (0.70) (0.70) (0.37) Net assets per Unit, end of year... $10.14 $10.93 $ 9.85 Based on the weighted average number of Units during the year except for the net assets and distributions wherein the actual number of Units outstanding at the relevant time are used. (1) Results for the period June 20, 2012 (inception date) to December 31, 2012. (2) Upon adoption of IFRS, net assets, beginning of year, increased $162,124 or $0.02 per Unit, unrealized appreciation decreased $108,820 or $0.01 per Unit and net assets, end of year, increased $53,304 or $0.01 per Unit following revaluation of investments to closing prices. (3) Total expenses for 2012 include issue costs of $4,677,375. (4) Includes adjustment to reconcile the basis of calculation of per Unit amounts between the weighted average and the end of year number of Units as follows: 2014 $0.04, 2013 $0.01, 2012 $0.02. (5) All distributions were paid in cash. Annual Management Report of Fund Performance 6 Top 20 Dividend Trust
Ratios and Supplemental Data (based on Net Asset Value) 2014 2013 2012 Net asset value (000 s) (1)(2)... $ 60,343 $ 71,635 $ 78,553 Number of Units outstanding (1)... 5,953,242 6,554,581 7,960,000 Management expense ratio (3)... 0.83% 0.81% 6.93% Trading expense ratio (4)... 0.04% 0.12% 0.29% Portfolio turnover rate (5)... 12.98% 25.21% 19.47% Net asset value per Unit (1)... $ 10.14 $ 10.93 $ 9.87 Market value per Unit... $ 10.00 $ 10.64 $ 9.70 (1) This information is provided as at December 31st of the years shown. (2) Net asset value is equal to net asset value per Unit multiplied by the number of Units outstanding. (3) Management expense ratio ( MER ) is based on total expenses of the Trust for the stated years, excluding transaction costs. The Trust realized costs of $4,677,375 in connection with the issue of 7,960,000 Units. Without these costs the MER would have been 0.83% in 2012. The ratio is expressed as an annualized percentage of the weekly average net asset value during the year. (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 year. (5) The portfolio turnover rate indicates how actively the Portfolio Manager manages the portfolio investments. A portfolio turnover rate of 100% is equivalent to the Trust buying and selling all of the securities in its Portfolio once in the course of the year. Past Performance Year by Year Returns The following chart shows the performance of the Trust s Units based on net asset value since the Trust s inception indicating, in percentage terms, how much an investment made on the first day of each financial year would have increased or decreased by the last day of each financial year and assumes that distributions are reinvested in additional Units at net asset value. Past performance is not an indication of how the Units will perform in the future. The calculation of the returns based on net asset value follows the requirements of NI 81-106. 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 in narrative form below as an indication of returns actually available to Unitholders. 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% 1.9% 18.4% -1.3% 2012 2013 2014 For the years ended December 31, 2013 and 2014 and for the period from June 20, 2012 to December 31, 2012 26FEB201519350941 The market value return for the Units from inception to December 31, 2012 was 1.3% and was 17.5% and 0.3% for the years 2013 and 2014, respectively. This performance from inception reflects the payment of upfront costs related to the establishment of the Trust 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. Top 20 Dividend Trust 7 Annual Management Report of Fund Performance
Annual Compound Returns The calculation of the annual compound returns based on net asset value follows the requirements of NI 81-106. 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 in narrative form below as an indication of returns actually available to Unitholders. Returns are based on the net asset value of the Units. One Year From inception (1) Top 20 Dividend Trust Unit... 1.3% 7.2% S&P/TSX 60 Total Return Index (2)... 12.3% 13.3% (1) The return is for the period from June 20, 2012, the date of inception, to December 31, 2014 based on the Unit issue price of $10.00. (2) The S&P/TSX 60 Total Return Index is a modified capitalization-weighted index which consists of the 60 largest and most liquid issuers on the TSX. The annual compound returns based on market value for the Units for the one-year period and from inception to December 31, 2014 are respectively as follows: 0.3% and 7.2%. Summary of Investment Portfolio Below is a summary of the Trust s Portfolio by industry sector based on closing sale prices as at December 31, 2014. This summary may change due to ongoing portfolio transactions. Weekly updates are available on the internet at www.scotiamanagedcompanies.com or by contacting investor relations at 416-863-7007. Investment portfolio, at market value... PORTFOLIO SECTOR WEIGHTINGS $ 66.1 million Utilities and Infrastructure 6.3% Telecommunication Services 17.8% Energy 26.1% Basic Materials 5.8% Consumer Discrectionary 6.3% Financials 27FEB201502534457 37.7% NI 81-106 requires that the Trust disclose the top 25 positions held. The Trust has not done so as it holds an approximately equally weighted portfolio. Annual Management Report of Fund Performance 8 Top 20 Dividend Trust