PREFERRED SHARE INVESTMENT TRUST. Annual Management Report of Fund Performance for the year ended December 31, 2015

Transcription

1 PREFERRED SHARE INVESTMENT TRUST Annual Management Report of Fund Performance for the year ended December 31, 2015

2 Fund: Preferred Share Investment Trust Securities: Trust Units - Listed TSX: PSF.UN Period: January 1, 2015 to December 31, 2015 Manager & Trustee: First Asset Investment Management Inc. ("First Asset") 95 Wellington Street West, Suite 1400 Toronto, Ontario M5J 2N7 (416) or (877) info@firstasset.com Portfolio Manager: Aston Hill Asset Management Inc. 220 Bay Street, Suite 1500 Toronto, Ontario M5J 2W4 Notes: 1. This annual management report of fund performance contains financial highlights but does not contain the complete annual financial statements of the Fund. You can get a copy of the annual financial statements at your request, and at no cost, by contacting us (contact information above) or on SEDAR at Holders may also contact us to request a free copy of the Fund s proxy voting policies and procedures, proxy voting disclosure record, or quarterly portfolio disclosure. 2. This report may contain forward looking statements. Forward looking statements involve risks and uncertainties and are predictive in nature and actual results could differ materially from those contemplated by the forward looking statements. 3. Unless otherwise indicated all information is as at December 31, None of the websites that are referred to in this report, nor any of the information on any such websites, are incorporated by reference in this report.

3 Investment Objectives and Strategies The Fund s investment objectives are to provide holders with: (i) quarterly distributions and (ii) the opportunity for capital appreciation from the performance of the Fund s portfolio. The Fund invests in an actively managed portfolio comprised primarily of investment grade preferred shares and, to a lesser extent, investment grade corporate debt and convertible bonds. Risks There were no changes to the Fund over the period of this report that materially affected the overall level of risk associated with an investment in the Fund. Securityholders should still refer to the annual information form ( AIF ) for the Fund for the year ended December 31, 2015 as it contains a detailed discussion of risk and other considerations relating to an investment in the Fund. The AIF is available free of charge from us (contact information above), on our website at and on SEDAR at Readers are also directed to note 5 and the Fund Specific Notes of the Fund s 2015 annual financial statements, which discusses management of financial risks. Results of Operations For the year ended December 31, 2015, the net assets per security of the Fund was $6.97 after payment of distributions to securityholders compared to $9.77 on December 31, The Fund paid cash distributions of $0.60 per security during the year. The Fund s total return for the year was -23.0%, compared to the S&P/TSX Preferred Share Total Return Index, which returned -15.0%. The Fund s net assets as at December 31, 2015 were $36.7 million, a decrease from $72.8 million as at December 31, The largest factors contributing to this decrease were redemptions of $15.9 million, net losses on investments of $14.0 million and distributions of $3.8 million. The consistent erosion of crude oil prices had a significant impact on markets in West Texas Intermediate ( WTI ) oil came under constant pressure as U.S. and global oil inventories continued to build. As oil and natural gas prices worsened, so did the prospects for an economic recovery in western Canada, leading the Bank of Canada ( BoC ) to reassess its interest rate forecasts. The BoC lowered interest rates twice in 2015, and appear ready to lower rates again in Unfortunately, much of the preferred share market is priced off short-term interest rates. As preferred shares get reset in such an environment, average dividends for preferred shares also decline, which has been the main source of weakness in the Canadian preferred share market. The Fund s holdings in AltaGas Ltd Series I and the Great-West Lifeco Inc. Series S were two of the better performing preferred shares in Both contributed to the Fund s performance as a result of their large dividends (at 5.3% annually), and they will not reset until 2019 and 2020, respectively. The most significant impact on the Fund s performance in 2015 was the consistent erosion of crude oil prices. Additionally, the Fund s leverage detracted from its performance. The leverage was put into place so the Fund can generate enough income to pay monthly distributions, but as preferred share prices declined, that decline was amplified by the leverage. Holdings in shorter-dated rate reset preferred shares with low reset spreads were the worst performers, as they were at the greatest risk of being reset at low dividend rates. Individual detractors from the Fund s performance included Aimia Inc. Series 3 preferred shares, which performed poorly as prospects for the company deteriorated. The Portfolio Manager does not believe the company s credit is impaired, but its profitability will be weak as travel and loyalty point accumulation has slowed. Another detractor was Power Financial Corporation Series A preferred shares, as the company performed poorly shares and its shares were reset at a low rate. The Portfolio Manager purchased new holdings in Bank of Nova Scotia Series 34 preferred shares and Royal Bank of Canada Series BK preferred shares, while eliminating bond positions in Westcoast Energy Inc., 8.5% of 2018 and Greater Toronto Airports Authority, 5.3% of BORROWING The Fund may borrow up to a maximum of 33% of the Fund s total assets. The Fund has obtained such leverage by way of a prime brokerage arrangement. This arrangement provides the Fund with margin to execute trades and for working capital purposes. The prime broker is also the custodian of the Fund s portfolio, a portion of which is required to be deposited as collateral for amounts borrowed under this arrangement. Interest on amounts borrowed is based on a floating rate. The amount of borrowings ranged between nil and $25.3 million during the year and represented 31.1% of the Fund s net assets (or 23.3% of total assets) as at December 31, ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE PREFERRED SHARE INVESTMENT TRUST 1

4 Recent Developments Uncertainty over China will continue to impact markets until there is some definitive statement from the People s Bank of China. Added to this uncertainty, the Portfolio Manager believes that the U.S. economy is not immune to the trouble outside its borders, which will be a main source of volatility. It is highly unlikely that the U.S. Federal Reserve Board ( Fed ) will raise interest rates four times this year, as some economists have predicted. At this pace, it would be a surprise if the Fed raises rates more than once. Sentiment for Canadian interest rates will continue to be negative in If the BoC follows through on a rate cut in 2016, rate reset preferred shares will very likely sell off again. The Fund will continue to add to the latest round of non-viability contingent capital ( NVCC ) preferred shares, as they are the most shielded from BoC moves, and will most likely outperform the market. On October 23, 2015, CI Financial Corp. announced that it had agreed to acquire First Asset Capital Corp. The transaction, which closed on November 30, 2015, resulted in a change of control of First Asset. Related Party Transactions First Asset and the Portfolio Manager are deemed to be related parties to the Fund. Please refer to the "Management Fee" section below which outlines fees paid to these parties. F.A. Administration Services Inc., an affiliate of First Asset, administers the Fund's relationship with the Fund's Independent Review Committee ( IRC ) on behalf of First Asset, however, it receives no compensation for doing so. The Fund has received standing instructions from its IRC with respect to the certain related party transactions: (a) since November 30, 2015, trades in securities of CI Financial Corp. (referred to as Related Issuer Trades ), which indirectly owns and controls First Asset; (b) purchases or sales of securities of an issuer from or to another investment fund managed by First Asset (referred to as Inter-Fund Trades ); (c) purchases or sales by the Fund of securities of another investment fund managed by First Asset (referred to as Related Fund Trades ); and (d) mergers of funds with another fund that is subject to National Instrument ( Fund Mergers ). The applicable standing instructions require that related party transactions be conducted in accordance with First Asset s policies and procedures. First Asset is required to advise the IRC of any material breach of a condition of the standing instructions. The standing instructions require, among other things, that the investment decision in respect to related party transactions (a) are made by First Asset free from any influence by any entities related to First Asset and without taking into account any consideration to any affiliate of First Asset; (b) represent the business judgment of First Asset uninfluenced by considerations other than the best interests of the Fund; and (c) are made in compliance with First Asset s policies and procedures. Transactions made by First Asset in respect of the Fund under the standing instructions are subsequently reviewed by the IRC on a semi-annual basis to monitor compliance. Except as otherwise noted below, First Asset, the Portfolio Manager and the Fund were not party to any related party transactions during the year ended December 31, First Asset and an affiliate of First Asset have agreed to reimburse the Fund for the expenses of the initial public offering which amounted to $3,963,455 as well as a portion of the expenses of subsequent follow-on offerings which amounted to $2,383,530 and $1,838,000 and consisted of agents fees and other offering expenses. The obligations are evidenced by promissory notes dated July 8, 2009, December 5, 2011 and August 24, 2012 (collectively, the Notes ). The Notes are repayable in quarterly installments equal to one quarter of 1.00% of the Fund s net asset value until December 31, 2017 (the Due Date ). Each Note bears interest from the date of issue at the prime rate of interest and is reduced proportionately if securities of the Fund are purchased for cancellation by the Fund, redeemed or retracted. If any securities remain outstanding on the Due Date, then the balance of the principal amount remaining outstanding on the Due Date, if any, shall be repaid on the Due Date. The aggregate balance outstanding on the Notes at December 31, 2015 totaled $0.1 million. 2 PREFERRED SHARE INVESTMENT TRUST 2015 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE

5 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 past five years. THE FUND'S NET ASSETS PER SECURITY (1) Net Assets, beginning of period $9.77 $9.94 $10.95 $11.23 $11.88 Increase (decrease) from operations Total revenue Total expenses (0.31) (0.34) (0.36) (0.37) (0.40) Realized gains (losses) for the period (0.97) (0.23) (0.04) Unrealized gains (losses) for the period (1.65) 0.39 (0.57) 0.02 (0.95) Total increase (decrease) from operations (2) (2.36) 0.44 (0.32) Distributions From income (excluding dividends) (0.03) From dividends (0.08) (0.17) (0.21) (0.23) (0.19) From capital gains (0.35) Return of capital (0.52) (0.43) (0.49) (0.47) (0.13) Total Distributions (3) (0.60) (0.60) (0.70) (0.70) (0.70) Net Assets, end of period (4) $6.97 $9.77 $9.94 $10.92 $11.23 Notes: (1) This information is derived from the Fund's audited annual financial statements. The term "net assets" used in this report and the term "net assets attributable to holders of redeemable securities" used in the Fund's financial statements are interchangeable. The Fund adopted International Financial Reporting Standards ("IFRS") on January 1, Previously, the Fund prepared its financial statements in accordance with Canadian generally accepted accounting principles ("Canadian GAAP") as defined in Part V of the CPA Canada Handbook. Under Canadian GAAP, the Fund measured the fair values of its investments in accordance with CICA Handbook Section 3855 which required the use of bid prices for long positions and ask prices for short positions. Under IFRS, the Fund measures the fair value of its investments using the guidance in IFRS 13 which requires that if an asset or liability has a bid price and an ask price, then its fair value is to be based on a price within the bid-ask spread that is most representative of fair value. Accordingly, the opening net assets as at January 1, 2013 was restated to reflect the accounting policy adjustments made in accordance with IFRS. All figures presented for periods prior to January 1, 2013 remain in accordance with Canadian GAAP. (2) Net assets and distributions are based on the actual number of securities outstanding at the relevant time. The increase/decrease from operations is based on the weighted average number of securities outstanding over the financial period. (3) Distributions were paid in cash. (4) This is not a reconciliation of the beginning and ending net assets per security ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE PREFERRED SHARE INVESTMENT TRUST 3

6 RATIOS AND SUPPLEMENTAL DATA Total net asset value (000s) (1) $36,690 $72,843 $104,426 $160,440 $114,935 Number of securities outstanding (1) 5,261,739 7,454,548 10,503,026 14,695,074 10,197,464 Management expense ratio excluding offering expenses (2) 3.58% 3.43% 3.36% 3.35% 3.43% Management expense ratio (2) 3.58% 3.43% 3.37% 3.91% 4.13% Management expense ratio before waivers or absorptions (2) 3.58% 3.43% 3.37% 3.91% 4.13% Portfolio turnover rate (3) 27.21% 27.55% 8.62% 22.85% 57.36% Trading expense ratio (4) 0.10% 0.02% 0.04% 0.04% 0.13% Net asset value per security $6.97 $9.77 $9.94 $10.92 $11.27 Closing market price $6.65 $9.30 $9.34 $10.68 $11.41 Notes: (1) This information is provided as at December 31 of the year shown. (2) 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. The MER for the periods ending December 31, 2011, 2012 and 2013 include agents' fees and other offering expenses, which are one-time expenses and therefore are not annualized. (3) The Fund's portfolio turnover rate indicates how actively the Portfolio Manager manages the Fund's 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 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. Management Fee First Asset manages and administers the business, operations and affairs of the Fund. First Asset has retained the Portfolio Manager to provide portfolio management services required by the Fund. As compensation for the services it provides to the Fund, First Asset is entitled to receive an annual management fee from the Fund in an amount equal to 2.10% of the net asset value of the Fund, which is calculated daily and paid monthly in arrears. First Asset pays the Portfolio Manager out of its management fee. In addition, First Asset is entitled to an amount equal to the service fee (the Service Fee ) payable to registered dealers which is equal to 0.40% annually of the net asset value of the Fund held by clients of the registered dealers. This Service Fee is calculated daily and paid quarterly in arrears. The services provided by First Asset to the Fund include, without limitation, the proper oversight to ensure implementation of the Fund's investment strategies, negotiating contracts with certain third-party service providers, authorizing the payment of operating expenses incurred on behalf of the Fund, maintaining certain accounting and financial records, calculating the amount and determining the frequency of distributions by the Fund, ensuring that securityholders are provided with financial statements and other reports as are required from time to time by applicable law, ensuring that the Fund complies with all other regulatory requirements including continuous disclosure obligations under applicable securities law and administering redemptions and other transactions in securities. 4 PREFERRED SHARE INVESTMENT TRUST 2015 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE

7 Past Performance Please note that the performance information shown in this section assumes that all distributions made by the Fund in the periods shown were reinvested in additional securities of the Fund. Also note that the performance information does not take into account sales, redemption, distribution or other optional charges that would have reduced returns on performance. The performance of the Fund in the past does not necessarily indicate how it will perform in the future. YEAR-BY-YEAR RETURNS (1) The following bar chart shows the Fund s annual performance for the financial years shown and illustrates how the Fund s performance has changed from year to year. The bar chart shows, in percentage terms, how much an investment made on the first day of each financial year would have grown or decreased by the last day of each financial year. 10% 8.4% 5% 0% 0.3% 3.4% 4.4% -5% -2.9% -10% -15% -20% -25% -23.0% ANNUAL COMPOUND RETURNS The table below summarizes the Fund's annual compound total returns for the periods ended December 31 as indicated. As a basis for comparison we have provided the performance of the S&P/TSX Composite Total Return Index ( Index A ) and the S&P/TSX Preferred Share Total Return Index ("Index B"). The S&P/TSX Composite Total Return Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange. The S&P/TSX Preferred Share Total Return Index is comprised of preferred stocks trading on the Toronto Stock Exchange that meet criteria relating to size, liquidity, and issuer rating. As the criteria for determining the constituents of the Fund and the indices differ, it is not expected that the Fund's performance will mirror that of the indices. Further, the return of the indices is calculated without the deduction of management fees and fund expenses whereas the performance of the Fund is calculated after deducting such fees and expenses. Period Fund (1) Index A Index B 1 year (23.0)% (8.3)% (15.0)% 3 year (7.9)% 4.6% (4.0)% 5 year (4.1)% 2.3% (0.3)% Since inception 1.4% 8.6% 3.9% (1) Returns based on net asset value per security ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE PREFERRED SHARE INVESTMENT TRUST 5

8 Summary of Investment Portfolio The following is a summary of the Fund's investment portfolio as at December 31, This is a summary only and will change due to ongoing portfolio transactions of the Fund. A quarterly update is available on TOP 25 HOLDINGS AS AT DECEMBER 31, 2015 Description % of Net Asset Value Bank of Montreal 8.14 Power Financial Corporation 6.43 BCE Inc Royal Bank of Canada 6.12 Brookfield Asset Management Inc Enbridge Inc The Toronto-Dominion Bank 5.72 Brookfield Office Properties Inc Canadian Imperial Bank of Commerce 5.54 Great-West Lifeco Inc Northland Power Inc Pembina Pipeline Corporation 5.29 The Bank of Nova Scotia 5.24 Canadian General Investments Ltd Laurentian Bank of Canada 4.57 Veresen Inc National Bank of Canada 4.27 Manulife Financial Corporation 4.16 Birchcliff Energy Ltd Algonquin Power & Utilities Corp Canadian Western Bank 3.61 Element Financial Corp Loblaw Companies Limited 3.09 RioCan Real Estate Investment Trust 3.07 Bank of Nova Scotia 2.84 Total Net Asset Value $36,690,386 SECTOR ALLOCATIONS AS AT DECEMBER 31, 2015 Industry % of Net Asset Value Financials Energy Utilities Telecommunication Services 6.30 Consumer Staples 3.09 Consumer Discretionary Other Liabilities, Net of Assets (31.41) Total Net Asset Value PREFERRED SHARE INVESTMENT TRUST 2015 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE

9 95 Wellington Street West, Suite 1400, Toronto, Ontario M5J 2N7 (416) or (877)