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Have Canadian Bond Fund Managers Earned Their Keep?Hints of manager skill, but fees take heavy toll.

Q1 2016

Manager Research

1 Have Canadian Bond Fund Managers Earned Their Keep?

14 Are Bonds for Income Anymore?

17 Remaking the House That Peter Cundill Built

20 How to Measure a Fund's Level of Active Management

24 Why Funds With High Active Share Don't Always Outperform

28 Manager Research Canada Rating Update

29 Fund Report—Sionna Small Cap

33 Stewardship Report—Manulife

35 10 Questions—David Barr

Market Data38 Market Performance Periodic Table Correlation Matrix41 Category Performance42 Fund Performance by Size43 ETF Performance by Size44 Pooled Fund Performance by Sizes

Summary Using Morningstar risk-adjusted return as our performance measure, we ranked active funds in three CIFSC fixed-income categories—Canadian Fixed Income, Canadian Short-Term Fixed Income, and High-Yield Fixed Income—over three-, five-, and 10-year periods through Dec. 31, 2015, gross and net of fees. We measured the frequency of outperformance using the success ratio—the percentage of surviving funds outperforming the index (gross of fees) and an exchange-traded fund tracking the index (net of fees).

We used returns-based style analysis (RBSA) to account for differences in exposure to credit, sector, and currency risk. We calculated style-adjusted alpha on a gross-of-fees basis (versus indexes) and a net-of-fees basis (versus passive alternatives).

A large number of active managers beat their benchmarks before fees over the long term. While the three-year success ratio was just 35% for active Canadian fixed-income funds, it climbed to 43% over five years and 56% over 10. Active Canadian short-term fixed-income funds turned in more-consistent results, with just more than half surviving and outperforming their benchmark over all periods. High-yield fixed income performed best, with success ratios of around 70% versus the benchmark over all periods.

Nearly all active short-term funds generated positive alphas over all trailing periods versus their returns-based benchmarks, and an overwhelming majority of high-yield funds did so. Active Canadian fixed-income funds weren’t as consistent, but a clear majority still outperformed. High-yield funds generated far more alpha relative to their returns-based benchmarks than either category.

Most funds in our study lagged the passively managed competition. Net success ratios in the investment-grade categories landed in the low single digits (or worse) over all periods. The results were less grim in the high-yield group, with success ratios in the low-20% to low-30% range, depending on the time period.

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Manager Research Observer Q1 2016 of 45

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While the number of Canadian fixed-income and short-term funds with positive net alphas crept into low double digits over the three-year period, outperformance over longer stretches was rare. High-yield funds fared better net of fees relative to their returns-based benchmarks. The percentage of funds with positive net alphas landed in the high-30% to low-50% range over all trailing periods.

Higher management expense ratios were closely associated with lower net alphas. Correlations between MER and net alpha were sharply negative in the investment-grade categories. The relationship wasn’t as strong in the high-yield category, though correlations still fell well into negative territory.

IntroductionWhile there’s no escaping what legendary Vanguard founder John C. Bogle calls the relentless rule of humble arithmetic, bond investors face an especially tough time evading its grasp. Originally conceived by Nobel laureate William Sharpe, this rule—that investors in aggregate earn the market return before fees and therefore underperform in aggregate after fees—is as true in bonds as in stocks. He rightly argues that holding low-expense index funds virtually assures you’ll capture a larger share of market returns than most investors, who will incur higher costs on average. With lower return potential than stocks, overcoming the impact of management fees and trading costs in bonds is more difficult, especially in the lower-yielding investment-grade arena. This cruel math seemingly makes a compelling case for investing passively in bonds.

The bond market in aggregate may be doomed to underperformance after fees, but the same isn’t necessarily true for bond funds. Bigger bond market participants include insurers, pension funds, and other institutional investors. Unlike most mutual fund managers, these players aren’t necessarily in business to maximize risk-adjusted returns. Pension funds, for example, hold bonds in order to match their cash flows to future liabilities; a long-term bond creates expected cash flows that can be used to meet obligations in the distant future.

Active bond fund managers, by contrast, have more flexibility to adjust their duration, maturity, and credit profiles in response to market conditions. They can shorten their portfolios’ duration to minimize interest-rate risk, for example. Or they can capture a larger share of the credit risk premium by holding more corporate bonds than government-bond-heavy benchmarks like the FTSE Canada TMX Universe Index. High-yield managers arguably play in a less-efficient sandbox, giving them more opportunities to outperform. Because many bond investors can’t hold below-investment-grade debt, there’s more room for skilled managers to add value with research on less-widely followed issuers. This limitation also forces managers to sell bonds demoted to junk status by ratings agencies, which often pushes the downgraded issuer to prices lower than the fundamentals justify—a potential opportunity for high-yield managers.

This paper examines active bond fund managers’ ability to translate these potential advantages into market-beating risk-adjusted returns. We consider two questions: One, have active Canadian bond fund managers been able to add value over their benchmarks before fees? Two, have these managers added enough value to overcome their funds’ fee hurdles?

Manager Research

Christopher DavisDirector, Manager Research, Canada+1 416 [email protected]

Rudy LuukkoEditor, Investment and Personal FinanceMorningstar Canada+1 416 484-7825 [email protected]

Jeffrey Schumacher Fund Analyst, Fund Research, Benelux+1 31 20 [email protected]

Achilleas TaxildarisAnalyst, Manager Research+1 416 [email protected]


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Our StudyMany active/passive comparisons pit cost-free benchmarks against active funds, which charge fees. Instead, we use gross returns (that is, returns before fees) in benchmark comparisons and ETF proxies for those benchmarks (which charge fees) in net-of-fee comparisons. The former measures raw manager skill, while the latter tests whether such skill is sufficient to outperform a low-cost alternative.

Using Morningstar risk-adjusted return (MRAR) as our performance measure, we ranked active funds in three of the most widely owned CIFSC fixed-income categories—Canadian Fixed Income, Canadian Short-Term Fixed Income, and High-Yield Fixed Income—over three-, five-, and 10-year periods through December 2015 on both a gross-of-fees and net-of-fees basis. We matched up active funds’ gross MRARs against those of our designated category benchmarks and net MRARs against those of the ETF proxy over the trailing periods. That each of the indexes is tracked by at least one ETF suggests the benchmarks represent a realistic depiction of active investors’ opportunity set. Appendix 1 names the benchmark and ETF proxy for each of the categories.

We use the success ratio to measure the percentage of funds in the category that survived the period and beat the category benchmark to depict how many active funds outperformed over the periods. We calculate success ratios using gross and net return data and define success as generating better MRARs than the benchmarks and ETF proxies. Importantly, because our dataset includes all active share classes in existence at the start of each trailing period, we control for survivorship bias.

Category-based comparisons are useful but imprecise. All three categories in the study vary in their exposure to credit, sector, and currency risk. High-yield funds can have as little as 30% invested in below-investment-grade bonds, while Canadian fixed income can hold as much as 30%. The short-term category includes a raft of mortgage-heavy offerings, while high yield includes funds with substantial floating-rate and emerging-markets debt. Similarly, active funds compare imperfectly with their benchmarks. Few high-yield bond funds are as purely exposed to below-investment-grade fare as the Barclays VLI High Yield Index, while a handful of Canadian fixed-income and short-term funds hold as much in government bonds as their FTSE TMX benchmarks.

To account for these differences, we used returns-based style analysis (RBSA) to deconstruct sources of return for the active funds in our study. RBSA uses a constrained regression technique to create a custom benchmark based on which asset classes, sectors, styles, or other factors drove historical performance.1 RBSA tells how much of a fund’s performance isn’t explained (alpha) by the exposures identified in the custom benchmark (beta).

In our RBSA, we regressed funds’ gross returns against a set of indexes (listed in Appendix 1) representing each category’s probable opportunity set and net returns (using the lowest-cost available share class) against ETF proxy returns to estimate their historical exposure to relevant market segments, resulting in custom benchmarks for every fund over trailing periods. We then

1. Sharpe, W.F. 1988. “Determining a Fund’s Effective Asset Mix.” Investment Management Review, December and Sharpe, W.F. 1992. “Asset Allocation: Management Style and Performance Measurement.” Journal of Portfolio Management, Winter.


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calculated each funds’ gross-of-fee and net-of-fee alphas against these custom benchmarks. A positive alpha indicates management added value after taking these exposures into account.

To justify higher fees, active managers must demonstrate they can add value in excess of what passive alternatives could provide at lower cost.

Notes on MethodologyTo avoid counting multiple share classes of the same fund, we calculated success ratio data using a fractional weighting methodology. In cases where one of two fund share classes outperformed, the fractionally weighted success ratio would be 0.5. To account for differences in distribution costs between mutual funds and ETFs, we put commission-based mutual fund share classes on equal footing by adjusting the ETF proxy returns downward by 0.5% annually—the typical trailer fee for bond funds. We lumped the fee-based and do-it-yourself funds together because the trailer-free ETF competes directly with both distribution channels. The number of do-it-yourself funds would also be too few to make meaningful comparisons.

Our methodology has limitations, to be sure. The 10-year period in our study was a challenging one—it includes the waning days of the late-2000s credit bubble, the financial crisis and subsequent recovery, and waves of aggressive central bank action—but it nonetheless covers a single market cycle. A study of several market cycles would likely be more telling, but the universe of active funds with records long enough is small. What’s more, active managers faced a hospitable interest-rate environment over virtually the entire period. As rates fell to ultralow levels, bond funds got a boost. (Bond prices and interest rates move in opposite directions.) There’s no telling where rates will head during the next decade, but there’s more room for them to rise than to fall further. How well managers fared during the past decade may not tell us how they’ll fare in the next one.

It is possible our study understates the extent of manager skill. Our RBSA won’t address whether managers have exhibited skill in timing. Take, for instance, a fund whose alpha is zero after accounting for its historical 50/50 split between Canadian corporate and government bonds. Its manager may have successfully picked the right times to move in and out of the sectors even if he didn’t add value through investment selection.

Before Fees, Most Active Funds Survived and Many Thrived Our study requires survival and outperformance to be considered a success. After all, if a fund doesn’t survive, it can’t outperform. It is likely funds that perished had served investors poorly. It may well be that some worthwhile funds close up shop, but investment managers rarely give strong performers the hook. Typically they do so because of poor performance, to merge with another better-performing fund, or after a once-hot niche asset class goes cold. Overall, survival rates for funds in our study were relatively high: Around 90% survived the three-year period, and around 80% did so over the five- and 10-year spans. (Appendix 2 breaks down survival rates by category and time period.)


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Not only were survival rates high, a respectable-to-impressive number of active funds outpaced their category benchmarks over longer periods. In the shorter term, active Canadian fixed-income funds hardly impressed, with 35% surviving and outperforming the FTSE TMX Canada Universe Index in risk-adjusted terms during the three-year period. A healthy plurality (43%) did so over five years, though, and a majority (56%) over 10.

Active Canadian short-term fixed-income funds turned in more-consistent results, with just more than half surviving and outperforming the FTSE TMX Canada Short Term Index over the three-, five-, and 10-year periods. High-yield fixed-income funds performed best, with success ratios of around 70% versus the Barclays VLI High Yield (CAD Hedged) Index over all trailing periods.

Exhibit 1 lists the success ratios for the three fixed-income categories on a gross-of-fees basis.

Exhibit 1 Success Ratios, Gross of Fees

Index 3-Year % 5-Year % 10-Year %

Canadian Fixed Income 34.6 43.1 55.9Canadian Short Term 51.1 51.7 51.9High-Yield Fixed Income 68.6 72.4 74.0

Source: Morningstar. Data as of 12/31/2015.

Active managers also made a good case for themselves when measured against their RBSA-generated custom benchmarks before fees. Exhibit 2 breaks down the median style-adjusted alphas for the three fixed-income categories across trailing periods gross of fees. Nearly all active short-term funds generated positive alpha over all trailing periods, and an overwhelming majority of high-yield funds did so. Active Canadian fixed-income funds weren’t as consistent, but a clear majority still outperformed.

Exhibit 2 Alphas by Category, Gross of Fees

Canadian Fixed Income Canadian Short Term High-Yield Fixed Income

Alpha (Median) % Outperform Alpha (Median) % Outperform Alpha (Median) % Outperform

3-Years 6.9 13.3 6.9 13.3 6.9 13.35-Years 4.5 10.4 4.5 10.4 4.5 10.410-Years 18.5 6.1 18.5 6.1 18.5 6.1



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Hints of Manager Skill, High-Yield Offers Largest Opportunity SetIn both the category-based and returns-based analyses, the odds of success remained fairly stable across periods, and in the case of the Canadian fixed-income category, they improved the longer the time frame considered. Such persistence could mean more than luck was at play. After all, a single right call or simple luck can fuel strong performance over shorter spurts, but they’re less likely to do so over the longer term.

Of course, the frequency of outperformance doesn’t tell you anything about its magnitude. There’s a difference between winning a game by a single point or by many. A big win signifies one team played a lot better than the other, while a narrower one suggests it was harder for one team to get an edge over the other. Just as the score says something about the relative skill of the teams, the range of investment outcomes within an asset class tells us something about how easily active managers can add value. In asset classes where it’s harder to stand out, as in investment-grade bonds, the potential for extreme investment outcomes is relatively low. We’d expect a narrower dispersion of returns there than in asset classes like high yield, where the opportunity to add value—and destroy it—increases the possibility of wide-ranging results.

Exhibit 3 Alpha Range by Category, 10th to 90th Percentiles

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Short Term Fixed Income High Yield

3-Year 5-Year 10-Year 3-Year 5-Year 10-Year 3-Year 5-Year 10-Year

Source: Morningstar Direct. Data as of 12/31/15.

With more occasions to exploit opportunities than their investment-grade counterparts, skilled managers stand a better chance of delivering alpha. No wonder the median high-yield fund generated far more gross-of-fee alpha relative to its returns-based benchmarks than either investment-grade category. Over the 10-year period, it was 9 times higher than the Canadian fixed-income median and 3 times higher than the Canadian short-term fixed-income median. The variation in outcomes was far higher as well. Indeed, the standard deviation of alphas in the high-yield category was about 5 times higher than in the investment-grade categories over the 10-year period. Exhibit 3 illustrates the range of gross-of-fee alphas for all three categories over trailing periods.


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The Case of the Vanishing AlphaFrom the investor perspective, it’s the net-of-fee experience that matters most. Managers with only gross-of-fee success have captured their added value for themselves, leaving fundholders with subpar returns after fees. Unfortunately, that’s exactly what happened across most funds in our study. Exhibit 4 lists before- and after-fee success ratios for the three categories, while Exhibit 5 lists each category’s gross and net style-adjusted alphas.

Exhibit 4 Success Ratios by Category, Gross and Net of Fees

Canadian Fixed Income % Canadian Short Term % High-Yield Fixed Income %

3-year Gross 87 51 69 Net (commission-based) 5 5 31 Net (non-commission-based) 6 4 24




Exhibit 5 Alphas by Category, Gross and Net of Fees

Canadian Fixed Income Canadian Short Term High-Yield Fixed Income

Alpha (Median) % Outperform Alpha (Median) % Outperform Alpha (Median) % Outperform

3 years Gross 0.1 63 0.2 97 0.7 75 Net -0.6 19 -0.6 12 -0.7 30

5 years Gross 0.1 68 0.3 94 0.5 70 Net -1.0 1 -0.7 5 0.5 47

10 years Gross 0.1 55 0.3 94 0.9 68 Net -1.0 1 -0.6 0 0.1 50


In the investment-grade categories, where there’s not that much alpha to be found before fees, active managers had little to nothing left over after fees. Over all trailing periods, net-of-fee success ratios in the Canadian fixed-income and Canadian short-term fixed-income categories landed in the low single digits over all trailing periods regardless of distribution channel. No short-term fund outperformed in the 10-year period.

Active investment-grade managers struggled just as mightily against their custom benchmarks. The number of Canadian fixed-income and short-term fixed-income funds with positive net alphas crept into the low double digits over the three-year period, but outperformance over five- and 10-year stretches was vanishingly rare. Again, no short-term fund generated positive net alpha over the 10-year period.


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While the chances of net-of-fee outperformance were grim in the investment-grade arena, investors enjoyed better, if less-than-enticing, odds in the more opportunity-rich high-yield category, where net success ratios ranged from the low 20s to low 30s depending on time period. These numbers are best taken with a grain of salt. On one hand, they could understate manager skill. Most high-yield managers hold a slug of investment-grade corporate bonds, making for an imperfect comparison to a pure high-yield benchmark, which should earn higher returns. On the other hand, our passive comparison with a Canadian-dollar-hedged benchmark gave unhedged funds a big advantage. With high-yield funds heavily exposed to U.S. issuers, these offerings could have done well thanks to the falling loonie, not manager skill.

Our returns-based analysis accounted for these differences, improving after-fee results in the high-yield category. Although only 30% of active funds delivered positive net alphas over three years, about half did so in the five- and 10-year periods. This isn’t an unqualified victory for high-yield managers, though. The indexes we used in our RSBA didn’t capture the return drivers for high yield as well as they did in the other categories. While correlations (as measured by R-squared) with their returns-based benchmarks clocked in above 90% for most Canadian fixed-income and Canadian short-term fixed-income funds, the median for the high-yield category ranged from high 70% to low 80%, depending on the time frame. It may well be that active managers took risks that we didn’t identify, and if we were to account for them, the outcome would be less flattering.

It is worth noting that the distribution channel didn’t affect our results except in the high-yield category. High-yield funds sold through the commission-based advisors had better net success ratios than those in non-commission-based distribution channels in two of three time periods. It’s not that one distribution channel promises better results than another, though. The prevalence of do-it-yourself share classes in the high-yield category explains the disparity. These share classes add an additional 0.25% to their management fees to pay for shelf space on discount brokerage platforms, presenting a cost hurdle that fee-based share classes didn’t have to overcome.

Alpha Met Its Enemy, and It Is CostsIf a large number of funds add value gross of fees but fail to do so net of fees, costs should at least partly explain the difference. They inherently play a larger role in lower-returning, lower-dispersion asset classes. Holding all else equal, fund expenses eat a bigger share of a low return than a higher one. Fewer opportunities to add value means it’s harder to overcome one’s cost hurdle.

You’d expect cost to play a more decisive role in the less alpha-rich investment-grade categories, and that was the case. Correlations between management expense ratio and net alpha were sharply negative in the investment-grade categories and became increasingly negative the longer the time period considered. Over 10 years, the MER/net alpha correlation was negative 0.83 in the Canadian fixed-income category and negative 0.77 in the Canadian short-term fixed-income category (negative 1.0 would indicate perfectly negative correlation). The cost/performance relationship was by no means weak over shorter time periods—correlations landed in the negative mid-60s for both categories over the three-year period—but the data suggests other factors have a slightly larger influence. Exhibits 6 and 7 depict the investment-grade categories’ MER/net alpha relationships over trailing periods.


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Exhibit 6 Relationship Between MER and Net Alpha, Canadian Fixed-Income Category

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Exhibit 7 Relationship Between MER and Net Alpha, Canadian Short-Term Fixed-Income Category

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Exhibit 8 Relationship Between MER and Net Alpha, High-Yield Fixed-Income Category

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The relationship between costs and performance wasn’t as strong in the high-yield category, though correlations still fell well into negative territory, as Exhibit 8 demonstrates. The five-year period exhibited the most sharply negative correlation between MER and net alpha, at negative 0.43, while falling in the negative mid-30s over three and 10 years. Costs may have played a less decisive role in the high-yield category because the spread between the best- and worst-performing funds is wider, creating more room for skill or luck to drive performance.

The table in Exhibit 9 summarizes the negative relationship between MER and alpha across the three categories.

Exhibit 9 Summary Correlation Between MER/Alpha Across Categories

Canadian Fixed Income %

Canadian Short Term %

High-Yield Fixed Income %

3-Year –66 –62 –36

5-Year –73 –69 –47

10-Year –82 –77 –38


ConclusionThere’s no rule saying the next decade has to match the last one. The case for active management may be stronger if interest rates were to climb from today’s ultralow levels. After all, active managers can shield investors from ill effects by shortening their portfolios’ duration or by holding cash. That they would be able to do so is hardly a fait accompli, though. Predicting the timing, pace, and magnitude of interest-rate movements is difficult. Indeed, Canadian investors began 2015 expecting the Bank of Canada to hike rates, but it went in the opposite direction. Rates will rise someday, but not for a while if the central bank gets its way.

It’s likely the future will be at least as tough for active management as the recent past. Because bonds get most of their return from yield, skimpy yields foretell weak bond returns. Low returns mean fund expenses eat up a proportionately larger share of its returns—a 1% MER chews up half of a 2% yield but a quarter of a 4% yield. Unless costs fall, active managers will have a tougher time outperforming after fees.

Our argument isn’t so much against active management but against paying too much for it. If a large cohort of managers outperform before fees, there must be some price where these managers would outperform after fees. At the right price, skilled management can add value. And in less-efficient markets, such as high-yield, the odds of doing so are higher. The question isn’t so much whether manager skill exists, it’s more whether fundholders reap any of the benefit. K


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Appendix

Appendix 1 Index and ETF Proxies Used to Calculate Gross and Net Success Ratios

Category Benchmark ETF

Canadian Fixed Income FTSE TMX Universe iShares Canadian Universe BondCanadian Short-Term Fixed Income FTSE TMX Short Term iShares Canadian Short-Term BondHigh-Yield Fixed Income Barclays VLI High Yield (CAD Hedged) iShares High Yield Fixed Income


Appendix 2 Survival Rates Over Trailing Periods

Survivorship Rate %

Category 3-Year 5-Year 10-Year

Canadian Fixed Income* 87.3 83.2 78.1 Canadian Short-Term Fixed Income 94.1 82.2 83.3 High-Yield Fixed Income 87.7 81.1 86.0

Source: Morningstar Direct. Data as of 12/31/2015.*Survival rates in the Canadian fixed-income category would have been considerably worse had we not excluded “capital yield” funds from our dataset. Most fund companies shut these offerings down after tax law changes in 2014 rendered them obsolete. Including them would have said more about the impact of tax policy on survival rates than the likelihood of identifying future winners.

Appendix 3 Index and ETF Proxies, Returns-Based Analysis

Index ETFCanadian

Fixed Income %Canadian

Short Term %High-Yield

Fixed Income %

FTSE TMX Canada All Corp Bond iShares Canadian Corporate BondFTSE TMX Canada All Government Bond iShares Canadian Government BondBofAML Canada High yield TR USD None*Barclays VLI High Yield TR Hdg CAD iShares US High Yield Fixed Income

(CAD-Hedged)Barclays VLI High Yield TR USD iShares High Yield Fixed IncomeS&P/LSTA Leveraged Loan TR CAD H Power Shares Senior LoanS&P/LSTA Leveraged Loan TR CAD Power Shares Senior LoanFTSE TMX Canada Residential Mortgage None**FTSE TMX Canada ST Bond iShares Canadian Short Term

Bond IndexFTSE TMX Canada Cdn Trsy Bill 91 Day None***

Source: Morningstar Direct. Data as of 12/31/2015.* We simulated hypothetical ETF performance by applying a 0.51% MER—the same MER as iShares High Yield Fixed Income

Index—to the index's returns.** We simulated hypothetical ETF performance by applying a 0.28% MER—the same as iShares Canadian Short Term Bond

Index—to the index returns.*** We simulated hypothetical ETF performance by applying a 0.10% MER—the cost of an institutional money market—to the

index's returns.


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If they ever won a million dollars, my grandparents said they would stash their newfound wealth in a safe investment and live off the interest. When they first crafted this plan more than three decades ago, it wasn't implausible. But a million dollars isn't what it used to be, and neither is the interest you can earn off it.

Indeed, long-term Canadian government bond yields stand at just 2%, far from their 18% peak in September 1981. These yields look even skimpier in inflation-adjusted terms. The 1.5% expected inflation rate implied by long-term real return government bonds leaves investors with a 0.5% real yield.

The epic fall in interest rates led to smaller yields, but because bond prices and yields move in opposite directions, it powered outsized gains for bond holders: From its 1980 launch through February 2016, the FTSE TMX Universe Index—Canada's bellwether investment-grade bond benchmark—returned 9.1%, earning it a 3% premium over risk-free Treasury bills and a 0.6% lead over the S&P/TSX Composite Index.

That's out of whack with historical norms: According to Credit Suisse, investment-grade Canadian bonds earned just 0.7% over risk-free T-bills from 1900 to 2014, and 1.8% from 1965 to 2014, as stocks beat bonds by about 3% over both periods. Because asset class returns tend to revert to historical averages, bonds will likely deliver subpar long-term results both in absolute terms and relative to stocks. Ultra-low yields also portend weak performance, as yields comprise the largest part of fixed-income returns.

Investors have long expected interest rates to rise from generational lows. The market, helped by central bankers, continues to defy these expectations, but there probably will be a day when they don't. Given the inverse relationship between yields and bond prices, higher rates could mean negative returns, even before inflation.

It's true that active managers can adjust to the threat of higher rates by making their portfolios less rate-sensitive than their benchmarks. Forecasting the timing, magnitude, and duration of higher rates is no easy feat, though. Just ask Canadian bond managers who began 2015 expecting rates to rise only for the Bank of Canada to go in the other direction.

Are Bonds for Income Anymore?Maybe not, but they haven't outlived their usefulness.



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Uninspiring Returns and Scant Yields? Sign Me Up!Given their less-than-enticing prospects, it's tempting to forgo bonds altogether. Stocks sound like a more attractive source of income. There may be a case for holding a higher-than-normal allocation to stocks, but bonds play an important role as a portfolio diversifier. From January 1980 to January 2016, the TMX Universe's correlation with domestic stocks, as measured by the S&P/TSX Composite Index, clocked in at 20%. These diversification benefits have been strongest when investors need them most: In equity bear markets since January 1980, the correlation between domestic stocks and investment-grade bond returns has been just 1%.

Indeed, investment-grade bonds have been dutiful protectors against stock market volatility. When the S&P/TSX Composite Index dropped 33% in 2008, for example, the TMX Universe climbed 6.4%. And as the Euro crisis and U.S. credit rating downgrade unnerved stock markets in 2011, the investment-grade bond universe rose 9.7% while domestic equities fell by nearly 9%. Lastly, as falling oil prices helped drag the TSX Composite to an 8% loss in 2015, the TMX Universe turned in a healthy 3.5% gain.

What investment-grade bonds lack in return potential, they make up for in safety and stability.

You Get What You Don't Pay ForIn a low-return world, costs should play a more decisive role in bond fund performance. After all, a fund's management-expense ratio will eat a bigger share of a fund's yield, leaving fund holders with a smaller one; a 1% MER chews up half of a 2% yield but a quarter of a 4% yield. A sure-fire means for investors to maximize their take is to minimize their costs.

Low-cost ETFs dependably leave investors with a larger slice of the pie than active alternatives. Active bond managers have hardly bathed themselves in glory versus their passive competitors. Just 5% of actively managed funds in the Canadian Fixed Income category survived and outperformed iShares Canadian Aggregate Bond ETF XBB—which tracks the TMX Universe index—on a risk-adjusted basis over the 10-year period ended December 2015. The future is likely to be at least as tough for active managers in the category as the past.

Our favourite Canadian fixed-income ETF, Vanguard Aggregate Bond ETF VAB, is likely to capture a bigger chunk of bond market returns than XBB, whose 0.33% MER is more than double VAB's 0.13% price tag. VAB ties iShares Core High Quality Canadian Bond ETF XQB for cheapest option in the category. Neither dazzle on the yield front; their yields-to-maturity clock in at 2.78% and 2.74, respectively. But because they rely on high-grade government and corporate bonds, they should insulate portfolios from stock market volatility. We like the Vanguard fund because it represents a broader swath of the investable Canadian bond market, but the iShares offering is appealing because it takes less interest-rate risk, if at the cost of heavy concentration in financials.

This isn't to rule out active management altogether. In fact, just over 50% of Canadian fixed-income managers outperformed the TMX Universe before fees. If large numbers outperform before fees, there must be some price where active managers stand a fighting chance. Our Gold-rated funds in


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the category—PH&N Bond and PH&N Total Return Bond—place in the cheapest 10% of the category (including passive funds), with MERs of 0.60% and 0.61%, respectively. The funds have modestly outperformed XBB over three- and 10-year periods and matched it over five years. It says something about how difficult it is to outperform in the category if its actively managed elite finish only slightly ahead of the passive alternative over most time periods.

Can't We All Get Along?The active/passive debate is often polarizing. Proponents of both sides insist investors choose one camp over the other. The fact is both approaches can coexist within a portfolio. While plain-vanilla active managers face long odds, those focused on less-efficient areas of the bond market stand a better chance of success. These funds deliver richer income streams, which could dovetail nicely with a stability-providing core passive holding.

Gold-rated Canso Corporate Value, for instance, has built one of the best track records of any Canadian bond fund with a go-anywhere approach meshing investment-grade domestic corporate bonds and global high-yield issuers. (For investors who can't meet its $25,000 minimum investment, Lysander-Canso Corporate Value Bond has a $5,000 minimum, albeit at a higher MER.)

Our high-yield favourites, including Silver-rated Fidelity American High Yield and PH&N High Yield Bond (currently closed to new investments), have excelled thanks to seasoned management and deep research. Silver-rated Manulife Strategic Income lands in the High Yield Fixed Income category, though its eclectic approach includes investment-grade and high-yield bonds in Canada, the United States, and internationally, including in developed markets. Managers Daniel Janis, Thomas Googins, and Kisoo Park won Morningstar's 2015 Fixed-Income Manager of the Year award for their efforts. K


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Rudy LuukkoEditor, Investment and Personal FinanceMorningstar Canada+1 416 484-7825 [email protected]

Remaking the House That Peter Cundill BuiltNew lead managers are in, and the unwavering commitment to deep-value investing is out.

The investment house that the late Peter Cundill built—acquired by Mackenzie Investments 10 years ago—is undergoing major renovations.

Once the transition is completed under new leadership, the deep-value discipline associated with the Cundill brand name will be superseded by a broader value-style approach. As well, significant risk constraints are being put in place in an effort to achieve more consistent and less volatile performance.

The shake-up is in response to complaints about below-average to dismal results. Without exception, Mackenzie's Cundill-branded funds deliver third- or fourth-quartile returns in their peer groups over the one-, three-, five-, and 10-year periods ended Feb. 29.

Morningstar's manager-research team has placed under review the two Mackenzie Cundill funds currently under coverage: the flagship Mackenzie Cundill Value, which competes in the Global Equity category, and Mackenzie Cundill Canadian Security, which is in the Canadian Focused Equity category.

This follows a March 24 conference call during which Mackenzie officials told Morningstar analysts that the changes go far beyond hiring new team leaders. Under new management, the Mackenzie Cundill team will implement extensive risk-management and portfolio-construction processes. Expertise in these areas was lacking at the Cundill team, Mackenzie officials say.

As a result, Mackenzie Cundill portfolios will soon start to look very different from how they've been managed historically. The managers will invest in a full range of value stocks, including core and relative-value names, depending on where they believe they have the best prospects for risk-adjusted returns.

Also relegated to history is the Mackenzie Cundill team's strictly bottom-up stock selection based on deep-value criteria, which resulted in big bets on countries, industry sectors, or individual companies.

The revamped Mackenzie Cundill funds are to hold roughly 40 to 60 stocks, as distinct from the previously more concentrated portfolios that consisted typically of 25 to 30 stocks. Company officials say investors will no longer see 9%-10% of a Cundill portfolio held in a


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single name. As well, country or sector weightings will be reined in so that they will vary by no more than 20 percentage points from their market benchmarks.

The remaking of Mackenzie Cundill will be the responsibility of recently hired Jonathan Norwood and Richard Wong, whom Mackenzie confirmed publicly on March 24 as the team's new co-leaders. Both men, who have not previously worked together, are value-style managers whom Mackenzie recruited from institutional money-management firms.

"The Cundill boutique will benefit from the added portfolio construction skill-sets of these portfolio managers who have proven expertise in global value investing with institutional asset managers," Tony Elavia, chief investment officer of Mackenzie Investments, said in a press release announcing the changes.

Norwood, whose expertise is mainly in the U.S. market, was previously a U.S. equity manager with Halifax-based Louisbourg Investments. Wong was previously a senior equity manager with Lincluden Investment Management of Mississauga, Ont., where he served as a lead manager for international equity and U.S. equity mandates.

The duo replaces longtime Cundill team members Andrew Massie, who joined the former Cundill Investment Management Research Ltd. as an analyst in 1993, and Lawrence Chin, who joined as an analyst in 1999. Mackenzie said Massie will be retiring, effective Aug. 31, and Chin is resigning effective April 30 to pursue a career opportunity outside the mutual-fund industry.

Both Massie and Chin were protégés of founder Peter Cundill, who because of failing health stepped down from the firm three years after the sale to Mackenzie. Cundill died in January 2011, leaving a legacy of benchmark-beating returns that the next generation of managers was unable to sustain.

Along with bringing a more risk-averse discipline to bear, the appointments of Norwood and Wong change the home base for the Cundill operation. Unlike their Vancouver-based prede-cessors, the new co-leaders will work at Mackenzie's head office in Toronto.

Their Toronto location will facilitate close interaction with CIO Elavia and with William Aldridge of Mackenzie's all-cap value team, who will contribute domestic stock-selection ideas to the Cundill funds. But for now, it will leave Cundill's other portfolio managers and analysts working four provinces and three time zones away.

The Mackenzie Cundill team is currently responsible for five distinct investment mandates, of which three have both mutual-fund trust and corporate-class versions. Norwood and Wong will co-manage Mackenzie Cundill Value, while Norwood will manage Mackenzie Cundill U.S. Class. Both will join the team managing Mackenzie Cundill Canadian Security and Mackenzie Canadian Balanced.


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A fifth Cundill mandate—Mackenzie Cundill Recovery, which is in the Global Small/Mid Cap Equity category—continues to be managed under a subadvisory arrangement by London-based James Morton, who is chief investment officer of Santa Lucia Asset Management Ltd.

Also affected by the remaking of Mackenzie Cundill are the Symmetry Portfolios of funds of funds, of which Mackenzie Cundill funds are components, and several multimanager funds, including Mackenzie Canadian Concentrated Equity and Mackenzie Global Concentrated Equity. K


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Active funds justify their existence by the promise of beating their benchmark on a risk-adjusted basis after fees. In order to beat the benchmark, an actively managed fund must deviate from it. This common-sense truth laid the foundation to the concept of active share.

Developed in 2006 by Martijn Cremers, of the University of Notre Dame, and Antti Petajisto, formerly of New York and Yale universities and now a vice president at BlackRock, active share has become increasingly popular with the investment community as it provides a clear and intuitive method for measuring a fund's level of active management.

Apart from investors, regulators in Canada and elsewhere have started using this metric in their hunt for funds labelled as active but which in fact closely resemble their benchmark while charging active management fees. It is not an exaggeration to say that the concept has shaken up the investment industry.

A Straightforward MetricThe active share score quantifies how much an equity portfolio's holdings differ from those of its benchmark. It is simply calculated as the sum of absolute differences between the weights of securities in a given portfolio and the weights of securities in the benchmark, divided by two. Defined differently, one can divide an actively managed equity portfolio into two components: The part that consists of overlapping holdings with the benchmark is passive, while the remaining part is the active component and is measured by active share.

At the extremes, a portfolio with an active share score of 100% would have no common holdings with the index, while a portfolio with an active share of 0% would be identical to the benchmark. The higher the score, the more actively the fund is managed.

How to Measure a Fund's Level of Active ManagementIn order to beat the benchmark, an actively managed fund must deviate from it. This common-sense truth laid the foundation to the concept of active share.


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Exhibit 1 Stock Active Share Contribution Example

Allocation %

Stock Portfolio Benchmark Active Share Contribution %

A 20 15 2.50

B 0 15 7.50

C 20 10 5.00

D 15 10 2.50

E 10 10 0.00

F 5 10 2.50

G 10 10 0.00

H 5 10 2.50

I 10 10 0.00

J 5 0 2.50

Score: 25.00


The hypothetical portfolio at Exhibit 1 shows that there are three potential sources of active share: The first and purest form of generating active share is by assigning different portfolio weights to benchmark stocks. Secondly, a manager can exclude benchmark stocks from a portfolio. Thirdly, selecting off-benchmark names further adds to the level of active share.

Active shares vary a lot from fund to fund, but also from one category to another. A recent Morningstar research paper studying active share in European equity funds reveals that among European large-cap equity funds, the three-year median active share is around 72%. However, differences are very large: Some funds have active shares as low as 20% while other fund portfolios have almost nothing in common with their index and an active share above 90%.

Why Active Share MattersHistorically, the asset management industry described a portfolio's deviation from the benchmark index in statistical terms derived from financial theory such as R-squared and tracking error. R-squared, or coefficient of determination, is shown also on Morningstar's websites for each fund that has more than three years of history, while active share numbers are only available in Morningstar's professional tools.

R-squared is calculated through a regression analysis comparing a fund's returns to its benchmark's returns. It indicates the percentage of variation in returns of a fund that can be explained by the benchmark returns. Tracking error, which is also available on Morningstar's websites, is calculated as the annualised standard deviation of monthly excess returns of a fund versus its benchmark.

Before active share, these returns-based metrics were the best tools available to investors for measuring the level of active risk in a portfolio. The difficulty is that these tools are also capturing active management in terms of "factor bets," that is, deviations in sector and


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regional allocation or by market capitalization. However, a stock-picking fund manager may not want to let factor bets make a fund deviate from its benchmark. Rather, he or she may want to apply active management primarily by selecting different stocks than those in the benchmark. While such a strategy may show only a low or moderate tracking error, active share may turn out to be very high.

Distinguishing Funds on Active ShareA major novelty in active share was its ability to reveal which funds were "closet-indexers." These are funds with such small proportions of active holdings that they have little chance of beating their benchmarks after fees. Cremers and Petajisto drew the line between active and closet-indexing funds at an active share of 60%. Morningstar's study shows that approximately 20% of funds investing in European large-cap equities fall below that limit.

However, active share should not be used in isolation. Cremers and Petajisto showed that a clever fund selector combines it with tracking error to determine the type of activeness in a fund.1 This is also logical from a theoretical standpoint, as the two metrics are complementary given that they capture different dimensions of active management. In a follow-up 2013 paper, Petajisto distinguished five types of management styles based on funds' active shares and tracking errors.2 By sorting the funds into quintiles on both active share and tracking error, he was able to create the active management style grid as shown at Exhibit 2.

Exhibit 2 Active Management Style Grid Based on Active Shares and Tracking Errors

Active Share

Highest 1 Stock Pickers Concentrated

2 Moderately Active Factor Bets

3

4

Lowest 5 Closet Indexers

5 4 3 2 1

Low

Tracking Error

High

Source: Cremers and Petajisto (2009). Data as of 03/31/16.

1. Cremers, M., & Petajisto, A. 2009. "How Active is Your Fund Manager? A New Measure That Predicts Performance." AFA 2007 Chicago Meetings Paper; EFA 2007 Ljubljana Meetings Paper; Yale ICF Working Paper No. 06-14. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=891719

2. Petajisto, A. 2013. "Active Share and Mutual Fund Performance." Financial Analysts Journal, Vol. 16, No. 4, P. 73.


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The lowest active share quintile can be labelled "closet indexers," which reflects their mean active share of less than 60%. However, not all funds with low active shares are similar. Funds generating significant volatility relative to their very small active positions tend to invest by seeking exposure to so-called systematic risk factors, and their management style can be labelled "factor bets." But again, not all high-tracking-error funds are alike. Funds with high tracking error and high active share use typically very concentrated portfolios. Petajisto labelled them "Concentrated Stock Pickers."

Still two groups remain, and according to findings from Morningstar's study, both of them include many funds worth looking at. Non-concentrated funds that have a high active share but a moderate tracking error are "Stock Pickers." The rest of the funds can be called "Moderately Active," as they fall in the middle in terms of both active share and tracking error.

Morningstar's study finds that in the five-year period ending in June 2015, the highly active "Concentrated Stock Pickers" on average performed poorly, followed by funds labelled as "Factor Bets" and "Closet Indexers." Funds characterized as "Stock Pickers" and "Moderately Active" on average have done relatively well in European equities but have not excelled. This again shows that using only active share as a criterion to select funds is not sensible. Rather it should be combined with other data points, and preferably investors should take a look at some qualitative measures as well, such as the fund's team resources and stability, its investment process, as well as fees in the fund. K


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Investing differently from the benchmark is a prerequisite in order to beat the benchmark. However, as our study on active share in European equity funds indicates, funds that differed drastically from the benchmark did not necessarily achieve better returns than funds managed with a benchmark-aware approach.

Furthermore, we found strong evidence of increasing risk as active share rose. Especially for funds with very high active shares, we observed higher volatility (standard deviation) and much larger drawdowns. As a result, while high active share funds can yield fantastic results for investors, they can also turn out to be a nightmare.

Our analysis focuses on long-only non-index funds sold in Europe and competing in the three European large-cap Morningstar categories: Europe Large-Cap Value Equity, Europe Large-Cap Blend Equity, and Europe Large-Cap Growth Equity. To analyse the relation between active share and risk-return measures, we selected funds from these categories that had a track record going back to at least Jan. 1, 2010.

Active Share: Positive and Negative ReturnsThe scatter plot graph at Exhibit 1 combines funds' five-year average active shares with their five-year annualised excess returns against each fund's Morningstar Category benchmark over the five-year period ended June 2015. As active share rises, the dispersion in results grows almost in an exponential fashion. The best and the worst performers are among the most active funds.


Why Funds With High Active Share Don't Always OutperformActively managed funds that differ drastically from their benchmark do not necessarily achieve better returns than funds managed with a benchmark-aware approach.


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Exhibit 1 5-Year Active Share Annualized Excess Return Versus Category Benchmark

5-Year Active Share Annualized Excess ReturnVersus Category Benchmark

8

–8

4

0

–4

Active Share0 10 20 30 40 50 60 70 80 90

BlendEurope Large-Cap: Growth Value

80


For funds with an active share below 60%, the dispersion in annualised excess return ranged from 4% to negative 5% versus their respective benchmarks. Still, the large majority of funds were plotted relatively tightly together. In stark contrast, among funds with an active share above 60%, excess returns ranged from 6.7% to negative 11%. The results remind us that it is not the degree of deviation that determines the level of outperformance, but the quality of active positions in the portfolio.

No Return Without RiskAs all investors should know, returns go hand-in-hand with risk. How do these large return differences then affect funds' risk levels?

The most typically used risk metric is standard deviation, which we measure from monthly return data over the five-year period ending June 2015. The scatter plot at Exhibit 2 indicates that no clear relationship exists between active share and standard deviation. Only the most active funds in the 90% to 100% active share bucket posted a markedly higher standard deviation on average. Investors should be aware of the possible higher risk involved when investing in funds that strongly deviate from the benchmark.


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Exhibit 2 5-Year Active Share Versus Standard Deviation

5-Year Standard Deviation

25

5

20

15

10

Active Share0 10 20 30 40 50 60 70 80 90



Standard deviation is one definition of risk, but it does not differentiate between positive and negative deviations. Looking at maximum drawdowns can also shed light on the risk taken by investors as they invest in high active share funds. The funds in the sample on average reported a maximum drawdown of negative 20.8% over the five-year period.

As was the case for excess returns, the span of outcomes in terms of drawdowns was very wide. The lowest maximum drawdown was negative 5.1%, while the fund with the biggest decline suffered negative 38.5% from peak to trough. The scatterplot at Exhibit 3 indicates a pattern of increasing maximum drawdowns as active share rises. For investors, this means that by selecting a fund with a higher active share increases the possibility of experiencing larger losses.


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Exhibit 3 5-Year Active Share Versus Maximum Drawdown

5-Year Maximum Drawdown

0

–10

–20

–30

Active Share0 10 20 30 40 50 60 70 80 90



Be Aware of Style ExposuresOur research demonstrates that funds with a higher active share exhibit different style factor exposures than their respective category benchmark. This can be in terms of sector, style, or market cap exposure. For example, we found that funds with high active shares use small caps to a much larger extent than funds with lower active share. This could partly explain the elevated risk levels we observed previously for very active funds. Although this is not inherently wrong, investors have to be aware of such deviations and they need to make sure that no unintended style bets are taken.

Because of their strong deviation from the benchmark, investors selecting highly active funds can end up with funds that invest differently than they would expect. It is therefore crucial that investors investigate what factors drive the active share of a fund, and what kind of implications that might have for the expected performance and the level of risk involved. K


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3Manager Research Canada Ratings Update

Exhibit 1 Recent Analyst Rating Changes

Morningstar Analyst Rating

Current Old Notes

UpgradesTempleton Global Bond „ ´ World-class management and much lower, if still average, costs heightens this fund's appeal.

Manulife Strategic Income „ ´ Improved stewardship and increased conviction in management boosts our confidence in this fund.

Fidelity Canadian Disciplined Equity ´ ˇ A more-concentrated portfolio should let management's strengths shine through.

RBC Bond ´ ˇ Improved risk-management, along with a seasoned team, improves this fund's prospects.

Downgrades

Sionna Canadian Equity ´ „ Capable management and sound strategy remain, but a high price tag undermines our conviction level.

BMO Enterprise „ Œ Exit of a longtime manager reduces our conviction in this fund.

Mawer New Canada „ Œ Exit of a longtime manager reduces our conviction in this fund.

NEI Ethical Global Equity ˇ ´ Significant mangement changes, along with lacklustre performance, diminish our conviction.

Under Review

CI Harbour * Ø ˇ Significant manager departures at Harbour, including longtime manager Stephen Jenkins, puts our rating under review.

CI Harbour Growth & Income * Ø ˇ Significant manager departures at Harbour, including longtime manager Stephen Jenkins, puts our rating under review.

CI Harbour Global Equity * Ø ˇ Significant manager departures at Harbour, including longtime manager Stephen Jenkins, puts our rating under review.

New Ratings

Beutel Goodman Short Term Bond * „ — Veteran management and a cautious approach should play well in the short-term arena.

TD Short-Term Bond - D & F* ´ — One of the deepest fixed income teams in Canada and a robust process give this fund an edge.

TD Short-Term Bond - A & I * ˇ — A high price tag takes the shine off an otherwise worthy fund.

CI Cambridge Global Equity ´ — Management's ability to sniff out growing businesses gives this offering an advantage.

CI Cambridge Asset Allocation ˇ — Quality management on the equity side can't overcome fixed income weakness.

PH&N Canadian Equity ´ — Seasoned management and a disciplined process give this fund a modest advantage.

Mawer US Equity ´ — A disciplined process and decent performance sets this fund apart from its lacklustre peers.

Sionna Canadian Small Cap „ — This undiscovered gem's peformance thus far has matched the strength of its pedigree.

CI Blackcreek Global Equity „ — Experienced management and a disciplined, contrarian process make for a likely outperformer.

CI Blackcreek International Equity „ — Experienced management and a disciplined, contrarian process make for a likely outperformer.

CI Cambridge Canadian Equity ´ — Management has successfully combined top-down and bottom-up insights to deliver fine risk-adjusted returns.

CI Signature Select Global ´ — Uninspiring performance thus far, but a high-calibre team makes success likely.

Fidelity Canadian Large Cap ´ — Disciplined approach to value investing and superior downside protection give this fund an edge.

Franklin Bissett Small Cap ˇ — Dedicated small-cap approach appealing, though liquidity concerns and middling returns diminish our enthusiasm.

Manulife Monthly Income „ — Long-ternured management, a sound process, and a reasonble price make for an appealing choice.

Sources: Morningstar. Data as of December 31, 2015. * Indicates change in 2016's 1st quarter.


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As is sometimes the case in the small-cap realm, promising companies with strong management teams that are focused on executing over the long term can go unnoticed and unloved for extended periods of time. The stocks of these companies likely offer compelling risk/reward opportunities. Similarly, this appears to be the case with Sionna Canadian Small Cap Equity. A consistent and repeatable investment process executed by an experienced team has resulted in solid performance since the fund's inception at the end of 2006. What's puzzling is the fund's relatively small asset base, especially considering the capacity-constrained nature of the asset class and the closed status of many of the fund's top peers. While the fund has gone mostly unnoticed, a sound process executed by a strong team earns it a Morningstar Analyst Rating of Silver.

The fund is run by Sionna Investment Managers using a value investing philosophy. The firm targets underpriced companies with the expectation that stock prices will return to their intrinsic fair value over the long term. The team, led by industry veteran Kim Shannon, narrows its focus by first quantitatively screening the Canadian market for potentially mispriced stocks and then delving into the fundamentals of names that appear attractive and possess defensive traits. The team uses a standard questionnaire to evaluate a company's competitive position and its ability to generate steady earnings and cash flows, providing for consistency and repeatability in the research. At the portfolio level, they build a benchmark-agnostic portfolio with an emphasis on quality metrics, believing that stable companies will lead to compounding growth over time. The team is disciplined, though, and captures value by actively trimming or adding to names as they move closer to or further from intrinsic value.

The fund can lag its more aggressive peers in up markets but should protect value in falling markets. Its 31.2% loss in 2008 was less severe than what the majority of its peers suffered, stacking up nicely against the median manager's 42.1% decline. Similarly, the portfolio performed well when the benchmark experienced negative returns in 2011 and 2014 and has only experienced 45.7% of the benchmark's downside since the fund's inception. Further, the strategy has been a consistent performer. Over rolling 36 month periods, the fund has outperformed the benchmark 73% of the time and finished in the first or second quartile in the Canadian Small/Mid-Cap Equity category 78% of the time. It has achieved these results with a low standard deviation that ranks in the bottom quartile.

Process Pillar: ∞ PositiveWhile there isn't one part of the process that sticks out as having a competitive advantage, Sionna gets its edge from the consistency with which it plies its trade, earning it a Positive for Process. The team employs an intrinsic value model which screens and ranks the

Jeffrey Bunce, CFAAnalyst, Manager Research+1 416 [email protected]

Morningstar's Take 09/23/2015

Morningstar Analyst Rating „

Morningstar PillarsProcess ∞PositivePerformance ∞PositivePeople ∞PositiveParent ∞PositivePrice ¶Neutral

Morningstar Analyst RatingMorningstar evaluates mutual funds based on five key pillars, which its analysts believe lead to funds that are more likely to outperform over the long term on a riskadjusted basis.

Analyst Rating Spectrum

Œ„´‰Á

Fund Performance

Total Return % +/– Category

YTD 4.77 –0.072015 –15.27 –9.552014 11.95 7.022013 26.27 4.982012 19.13 13.60

Fund Report—Sionna Canadian Small Cap Equity BIP191A hidden gem in the small-cap category.


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Canadian universe on the basis of book value, historical return on equity, and relative price/earnings ratios. The team then focuses its attention on those stocks trading 30% below their intrinsic value. Despite the model being fairly basic, it is effective at focusing the team's attention on the most attractive opportunities. Sionna typically embraces companies experiencing cyclical or operational troubles as they claim these firms are often misunder-stood by the broader market. The team eschews high levels of financial risk and will avoid companies with too much debt, resulting in a portfolio with a quality bent.

Stocks that screen well are examined under a fundamental lens to develop a full understanding of a company's prospects and risks. Importantly, the team leverages a singular research questionnaire and seeks to answer the same questions about each company providing consistency and comparability. The whole team then debates potential buys in a group setting and strives for consensus before making a decision. Notable in this process is Sionna's desire to avoid common behavioural biases that can undermine group decision-making.

In a category mixed with mid- and small-cap funds, Sionna builds a true small-cap portfolio of 30 to 55 names. The weighted average market cap of the fund as of June 30, 2015, was $768 million, which was less than the BMO Small Cap Index and among the lowest in the category. The large majority of positions have a market cap less than $2 billion—solidly in the small-cap arena. Even though Sionna generates and researches ideas in the same manner as its large-cap names, the smallcap portfolio looks slightly different. While the fund will have value characteristics because of its process, the team emphasizes quality over value in the small-cap space. This results in the portfolio easily exhibiting higher returns on equity, returns on invested capital, and lower debt/capital than the benchmark and category average. For example, the fund's return on invested capital is 10.1%, which compares favourably to the index at 3.0% and the category average at 7.1%. Meanwhile, value characteristics are less prominent. The price/earnings ratio of 16.5 is less than the benchmark's 18.6 but price/book and price/sales ratios are higher than the benchmark.

In another departure from its large-cap sibling, the team constructs the portfolio in a benchmark-agnostic manner; avoiding exposure to junior oil and gold companies with little to no revenue and instead concentrating on companies with morestable, long-term track records. This corresponds to a greater than 20% overweighting in the financials sector and close to a 6% overweighting in the industrials sector while underweight positions in the materials and energy sectors amount to approximately 12% and 4%, respectively. The portfolio is also absent holdings in health care and utilities.

Further, Sionna prizes owner-operators where management has a significant ownership stake in the business and has a history of growing shareholder wealth. These management teams are also more likely to be conservative and have a long-term orientation, aligned with investors. Examples of owner-operator stocks in the portfolio include Home Capital Group and FirstService Corp, both of which are in the top 10 holdings.


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Performance Pillar: ∞ PositiveThe appeal of the small-cap strategy comes from its low volatility, which ranks in the lowest quartile of the category. Further, the fund has consistently outperformed the category and benchmark in down markets such as 2008, 2011, and 2014. The defensive, quality-oriented approach has worked well in the small-cap space during the last number of years.

Since inception in late December 2006, the fund has an annualized return of 7.2%, outperforming the BMO Small Cap Index by 5.9% and the category average by 2.7%. During this period, Morningstar's attribution shows that stock selection in the materials, energy, and financials sectors has been a strong contributor of outperformance, a credit to the team's bottom-up, fundamental process.

Investors should keep in mind that this performance record was achieved in an environment that has generally been conducive to Sionna's strategy, so expectations going forward should be tempered. Indeed, the fund's upside-capture ratio of 67% ranks in the bottom quartile, so expect the fund to lag the benchmark and peers if low-quality stocks or commodities rally. Despite this, returns on an absolute basis should remain attractive.

People Pillar: ∞ PositivePresident and CIO Kim Shannon oversees the investment team. She is the face of Sionna and is highly engaged in the portfolio management process. Shannon's 30-plus years in the industry and experience managing portfolios through numerous market cycles is invaluable. Prior to founding Sionna in 2002, she built a solid track record as CIO at Merrill Lynch Canada. Shannon's wealth of experience provides her with a long-term perspective that not many in the industry can match. Because of this, she has a good appreciation of market mispricing and how it tends to revert to historical averages over time.

Teresa Lee is the lead portfolio manager for the fund, having managed it since inception. Prior to joining Sionna in 2003, Lee ran a small-cap value strategy for seven years at Royal & Sun Alliance. Shannon and Lee are also supported by portfolio managers Marian Hoffmann, Mel Mariampillai, and David Britton. Further, Sionna adds to its depth by hiring analysts fresh out of school or with only a few years of experience to be groomed in the Sionna discipline. With the exception of Shannon, all investment team members conduct research. Analysts start off as generalists before settling on specific sector coverage that spans the entire market-cap spectrum. Shannon remains the gatekeeper of the firm’s culture, philosophy, and process, so we would be concerned with any change in her role. However, a strong cast of talent is emerging to eventually take the reins of the firm.

Shannon's experience and her deep and growing team, all of whom share in the same value discipline, result in a Positive for People.


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Parent Pillar: ∞ PositiveBridgehouse Asset Managers is fully owned by San Diego-based Brandes Investment Partners—an independent advisory firm founded by Charles Brandes in 1974. The firm first launched a suite of mutual funds in Canada in 2003. Bridgehouse distributes funds run by Brandes, Sionna Investment Managers, Lazard Asset Management, and Greystone Managed Investments.

Brandes' Graham-and-Dodd value approach has had some bumps along the way. While the execution of this strategy historically has been consistent, the firm's large-cap committee appeared reluctant to make the aggressive moves that we would have expected given the opportunities that abounded through the market downturn in 2008–09. The firm has experienced a dramatic slide in its asset base since then, primarily because of market performance, but client outflows have also been hefty.

The Canadian fund lineup was strengthened following an alliance in December 2006 with Sionna, an employee-owned boutique manager focused on Canadian equity. Sionna's investment style is also value-oriented, although its products could be characterized as more mainstream. Bridgehouse further expanded its lineup in 2013 and 2014, adding alliances with Lazard and Greystone.

Overall, Bridgehouse and its strategic partners seem to put a greater focus on performance than product creation or marketing. The firm has also shown discipline by closing funds to new investment in periods where their asset bases have grown.

Price Pillar: ¶ NeutralThe fund falls in the middle of the pack in the Canadian small/mid-cap equity category, resulting in a Neutral rating for Price. The A share class, with a 2.56% management expense ratio, is 0.08% cheaper than the median. The F share class though, with an MER of 1.51%, is slightly more expensive relative to its distribution channel. Portfolio turnover has ranged between 30% and 60%. This modest level of turnover gives the fund one of the lowest trading expense ratios in the category, averaging 0.12% during the last five years. Ranking MER and TER together, the fund looks more attractive, placing in the secondcheapest quintile.

Bridgehouse has absorbed fees and expenses during the past few years, making the MER more competitive. As the fund has grown, the amount the manager has absorbed has declined but still amounted to 0.22% in 2014. K


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Corporate Culture: BManulife Mutual Funds offers funds run in-house and by external management teams. The internally managed funds are managed by Manulife Asset Management, an indirect wholly owned subsidiary of Manulife Financial Corp.

Overall, a long-term, bottom-up, research-driven approach to asset management seems to permeate at Manulife, leading to shared values and collaboration among investment teams. MAM is structured as a collection of independent investment teams that currently hosts more than 330 investment professionals globally, with significant exposure in several countries in Asia. This gives the advantage of small teams, such as flexibility and quick decision-making, while providing the resources of a large organization, such as effective risk-management processes.

Risk management is an area on which MAM is keenly focused. The independent assessment of portfolios and manager behaviour helps guard against risks such as asset bloat, liquidity, and unintended exposures to macroeconomic themes. The firm’s scale and resources help risk management access tools as well as develop internal models to monitor and stress-test exposures and correlations of risk factors.

In 2015 Manulife completed the acquisition of Standard Life’s Canadian operations. The MAM structure of independent teams was helpful in a seamless transition for the equity team based in Montreal. The fixed-income investment personnel that were retained joined MAM’s team in Toronto. Manulife pursued several fund mergers to rationalize the expanded product shelf that included significant overlap in strategies. The majority of the decisions were made with investors’ interests in mind including the nonaction in funds that would have unfavourable tax consequences.

About 15% of the firm's assets are managed by capable external subadvisors. Mawer Investment Management, for example, has excelled thanks to thoughtful management and a disciplined process. Mawer has also a history of proactively capping funds to avoid the negative impact of asset bloat. Manulife has maintained these mandates and strengthened its relationship with the manager, unlike other firms that would drop closed strategies as they won’t contribute to revenue growth. Manulife itself also showed unitholder-friendly behaviour by capping proactively in 2015 one of its most popular funds, Manulife Monthly High Income.



Stewardship Grade Scorecard Corporate Culture: BFund Manager Incentives: BFees: CRegulatory History: NeutralOverall Stewardship Grade: B

11 December 2015

Morningstar Stewardship Grade for Manulife Mutual Funds BReaping the benefits of a global organization.


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Fund Manager Incentives: BMAM has increased levels of coinvestment to above-industry-average levels in recent years, as it forces its portfolio managers to invest a minimum of 40% of their long-term compensation to the funds they manage.

Fees: CManulife has not been very competitive on the fee front. The recent effort to improve pricing of the F series, which targets fee-based advisors, just lands it in the middle of the pack.

Regulatory History: Neutral

Because investors should expect fund companies to comply with laws and regulations, the highest Regulatory History rating a firm can receive is Neutral.

Because Manulife Mutual Funds has not had material regulatory infractions in the recent past, it gets full credit for Regulatory History. K


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David Barr is CEO and co-CIO of Pender, a value-based investment manager in Vancouver, Canada. Barr also manages Pender Small Cap Opportunities fund, which sports one of the best long-term records of any Canadian small-cap fund.

Achilleas Taxildaris, an analyst with Morningstar Canada, interviewed Barr in March. His answers have been edited for length and clarity.

What or who were the biggest influences for your education as an investor?During my first week of business school, Tony Arrell of Burgundy Asset Management gave a speech to our class. He mentioned Warren Buffett. I went straight out and read a book on Buffett. I was immediately hooked on value Investing. I proceeded to read everything I could find about Buffett and value investing. After I graduated, I moved into private equity and a couple of years later read the book, Common Stocks and Uncommon Profits by Phil Fisher. His “scuttlebutt” research process was analogous to the private equity due-diligence process I was using. Combining the two really helped solidify how I invest—a private equity approach with a value-based strategy.

Which book would you recommend to any young aspiring investor?The Intelligent Investor by Benjamin Graham and Common Stocks and Uncommon Profits are an absolute must. I think it’s more important to read as many books as you can on the subject to find role models with an investment process that makes sense to you, so you can learn from people who look at investing the same way you do. We read and reread all of Buffett's shareholder letters to absorb his timeless lessons. And rather than just reading investment books, you should also read biographies and books about businesses that chart both big successes (Made in America by Sam Walton) and tragic failures (Billion Dollar Lessons by Paul B. Carroll and Chunka Mui). Aspiring investors should strive to become better investment and business analysts.

What is the biggest market inefficiency that you try to exploit in investing?We think that the small-cap sector provides the greatest opportunity to exploit market inefficiencies for two main reasons:3The lack of participants on both the buy side and the sell side.3The fact that smaller companies tend to have more-pronounced up swings and down swings, giving you the opportunity to buy low and sell high.

David Barr of PenderFund Capital Management on Small-Cap Stocks, Value Investing, and His Favourite Apps



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What looks attractive in Canada right now? What about large caps versus small caps?We find Canada challenging right now. We are not comfortable with the majority of resources stocks right now, given current industry conditions with respect to commodity prices, inventory, and supply/demand. Also as a result of capital leaving resources, it has found a home in larger, more liquid companies, increasing demand for these high-quality businesses and raising valuations to levels that we are not comfortable with. That leaves small-cap non-resources-based companies as a place where we continue to find opportunities and deploy capital.

What should investors pay attention to when investing in the small-cap space?The best opportunities for long-term capital appreciation tend to be found in small caps. When looking at companies that have tremendous upside, investors can get carried away thinking about what could be. We have found that it is more important to look at the downside so as to minimize permanent impairments of capital. During the past 100 years, small-cap companies that have done poorly had characteristics such as highly leveraged balance sheets, a history of losses, bad management, and they were concept stocks with no revenue. There are plenty of high-quality, well-managed businesses with well-engineered products, high margins, and established customer bases that have fantastic runways ahead of them. You just have to find them.

How do you keep up with technology innovations that may affect investments, and is it that important?I have over 20 years of experience in the technology sector, initially as an operator, but mainly as an investor. As a value investor, investing in technology can be quite tricky due to the threat of disruption. However, our experience has taught us that there are two general types of opportunities: consumer technology or business technology. 3Consumer technology is very ripe for disruption, as product life cycles tend to be shorter and are

more “fashion” driven. In Canada, you don’t have to look any further than Blackberry to see how quickly a top technology company can be disrupted by the newest, coolest device.

3On the business side, technology decisions take longer, and when you have software integrated into the day-to-day operations of a business, switching technologies can be very costly. That being said, you need to keep an eye on what’s coming.

Which behavioural biases did you identify in yourself and how do you control them?As humans, our ability to make rational decisions when we are highly emotional is compromised. Never more so than when stocks we are holding or following experience rapid declines or appreciation. Staying rational and making a good decision on whether to buy or sell a stock is challenging at these times. So we try to take the emotion out of the decision. We do our work on a company and figure out the price we want to own it at and sell it at, so we can make a fast and rational decision if the stock moves suddenly.


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In a world that has a constant flow of information, how do you filter out the noise?This is interesting. During the last couple of decades, the investment industry has changed quite a bit. In the past, a diligent investor could get an analytical advantage over other investors by tracking down material documents that others hadn’t read yet or had limited access to. Now the problem we face is having too much information. Today, you can gain the advantage by using your time to focus on what is important to your investment thesis, and the key to knowing what information this is, is understanding what the key drivers to your investment thesis are and only processing relevant information.

In addition, Pender is based in Vancouver, so there is a lot of distance between us and some of the noise of both Wall Street and Bay Street and the herdlike behaviour. The advantage of being on the West Coast means that we can do our own research, form our own opinions, and invest independently.

What have been some really useful apps for you on your smartphone?3My S&P Capital IQ app is great. I have access to almost all the information I need, anywhere I go,

and I am looking forward to the version that includes real-time price feeds. 3Instapaper allows me to read all my saved articles on the go.3The Kindle app allows me to pick up whatever book I’m currently reading whenever I have some

spare time. 3Slack is a new internal communications platform we are using, which lets me turn off email to

block out the noise but still communicate with my team.

What’s the biggest misperception domestic investors have about investing in Canada?Most investors believe they have a diversified portfolio if they hold the index. They don’t realize our index [the S&P/TSX Composite] is highly weighted to financial services, energy, and materials compared with larger, more representative indexes, like the S&P 500. K

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Exhibit 1 Trailing Total Returns

Index 3-Month YTD 1-Year 3-Year 5-Year 10-Year 15-Year

Canadian Equity Market

S&P/TSX 60 TR CAD 4.24 4.24 -6.12 5.79 2.57 4.30 6.54S&P/TSX Capped Composite TR CAD 4.54 4.54 -6.57 5.03 2.10 4.05 6.57BMO Small Cap Blended (Weighted) CAD 7.66 7.66 -7.16 -0.41 -3.25 1.79 6.99S&P/TSX Completion TR 8.52 8.52 -5.69 -0.59 -4.97 0.02 3.87S&P/TSX Small Cap TR 5.52 5.52 -7.89 2.84 0.73 3.68 6.97

U.S. Equity MarketS&P 500 TR CAD -5.63 -5.63 3.95 21.19 18.12 8.12Russell 2000 TR CAD -8.30 -8.30 -7.84 15.80 13.49 6.35

Global Equity MarketMSCI ACWI NR CAD -6.66 -6.66 -2.30 14.38 11.39 5.16 3.73MSCI World NR CAD -7.21 -7.21 -1.40 15.77 12.76 5.36 3.60MSCI EAFE-Enhanced NR CAD -9.68 -9.68 -6.32 10.80 8.29 2.85 2.97MSCI EM NR CAD -1.57 -1.57 -10.15 3.50 1.49 4.08 7.93

Canadian Fixed Income MarketFTSE TMX Canada Universe Bond 1.39 1.39 0.78 3.87 5.15 5.22 5.79FTSE TMX Canada All Government Bond 1.35 1.35 0.81 3.94 5.08 5.07 5.65FTSE TMX Canada All Corp Bond 1.51 1.51 0.69 3.67 5.33 5.65 6.21FTSE TMX Canada ST Bond 0.41 0.41 1.12 2.31 2.84 3.86 4.31FTSE TMX Canada MT Bond 1.53 1.53 2.07 4.44 6.07 6.04 6.41

FTSE TMX Canada LT Bond 2.63 2.63 -0.56 5.59 8.15 6.90 7.78FTSE TMX Canada Real Return Bond 2.09 2.09 -2.23 1.70 4.57 4.89 7.17S&P/TSX Preferred Share TR -5.62 -5.62 -15.63 -6.57 -1.87 0.28 —

Source: Morningstar Direct. Data as of March 31, 2016.


Market Data


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Exhibit 2 Historical Asset Class Returns

2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD

MSCI EM GR CAD 18.5

FTSE TMX Canada Universe Bond 6.4

S&P/TSX Small Cap TR 62.4



S&P 500 TR USD 16.0

Russell 2000 TR CAD 48.1

S&P 500 TR CAD 23.9

S&P 500 TR CAD 21.6


S&P/TSX Composite TR 9.8

Russell 2000 TR CAD -17.2

MSCI EM GR CAD 52.0

S&P/TSX Completion TR 30.3

S&P 500 TR CAD 4.6

MSCI EM GR CAD 16.0

S&P 500 TR CAD 41.3

MSCI World GR CAD 15.0




S&P 500 TR CAD -21.2



S&P 500 TR USD 2.1

MSCI EAFE GR CAD 15.3





S&P 500 TR USD 5.5

MSCI World GR CAD -25.4





S&P 500 TR USD 32.4

S&P 500 TR USD 13.7

MSCI ACWI NR CAD 17.1

S&P 500 TR USD 1.7


MSCI ACWI NR CAD -27.7

S&P 500 TR USD 26.5

S&P 500 TR USD 15.1








MSCI EAFE GR CAD-28.8


MSCI EM GR CAD 13.0






MSCI EM GR CAD -4.1


S&P/TSX Composite TR -33.0


S&P 500 TR CAD 9.1

S&P/TSX Completion TR -7.9

S&P 500 TR CAD 13.4



MSCI EM GR CAD 2.4

S&P 500 TR CAD -8.3

MSCI EAFE GR CAD -5.3

S&P 500 TR USD -37.0






MSCI EM GR CAD 7.0

S&P 500 TR USD 1.4












S&P 500 TR CAD -10.5

MSCI EM GR CAD -41.4

S&P 500 TR CAD 7.4


MSCI EM GR CAD -16.1


MSCI EM GR CAD 4.3





S&P/TSX Small Cap TR -45.5





FTSE TMX Canada Universe Bond -1.2




Asset Class

S&P/TSX Composite TR S&P 500 TR USD S&P 500 TR CAD S&P/TSX Completion TR S&P/TSX Small Cap TR

Asset Class

MSCI EM GR CAD MSCI EAFE GR CAD MSCI ACWI NR CAD MSCI World GR CAD

Asset Class

Russell 2000 TR CAD FTSE TMX Canada Universe Bond

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Exhibit 3 5-Year Correlation Matrix

Indicies 1 2 3 4 5 6 7 8 9 10 11 12 13 14

1 S&P/TSX Composite TR

2 S&P/TSX Completion TR 0.93

3 S&P/TSX Composite Dividend TR 0.98 0.91

4 S&P/TSX Small Cap TR 0.88 0.95 0.86

5 S&P 500 TR CAD 0.44 0.32 0.41 0.26

6 Russell 2000 TR CAD 0.48 0.43 0.44 0.38 0.82

7 MSCI ACWI NR CAD 0.61 0.52 0.58 0.45 0.91 0.77

8 MSCI EAFE GR CAD 0.55 0.48 0.51 0.41 0.76 0.63 0.95

9 MSCI EM NR CAD 0.72 0.68 0.71 0.63 0.51 0.5 0.76 0.73

10 FTSE TMX Canada Universe Bond –0.13 –0.11 –0.17 –0.14 0.1 –0.04 0.11 0.12 0.1

11 FTSE TMX Canada All Gov't Bond –0.17 –0.15 –0.21 –0.17 0.09 –0.06 0.08 0.09 0.06 1

12 FTSE TMX Canada ST Bond –0.13 –0.12 –0.18 –0.14 0.13 0.02 0.15 0.18 0.12 0.93 0.92

13 FTSE TMX Canada LT Bond –0.15 –0.13 –0.19 –0.16 0.08 –0.07 0.06 0.06 0.05 0.99 0.99 0.86

14 FTSE TMX Canada All Corp Bond 0.01 0.04 –0.03 –0.01 0.16 0.05 0.2 0.21 0.23 0.95 0.92 0.89 0.94

15 FTSE TMX Canada Cdn Trsy Bill 91 Day –0.07 –0.14 –0.11 –0.19 0.24 0.22 0.23 0.25 0.06 0.44 0.44 0.53 0.4 0.4

1 to .76 .75 to .51 .50 to .26 .25 to 0 0 to –.24 –.25 to –.49 –.50 to –.74 –.75 to –.100

Source: Morningstar Direct. Data as of March 31, 2016.


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Exhibit 4 Category Performance

Index 3-Month YTD 1-Year 3-Year 5-Year 10-Year 15-Year

Canada Precious Metals Equity 35.09 35.09 20.25 –7.14 –14.84 –0.66 9.64Canada Natural Resources Equity 8.98 8.98 –14.83 –10.26 –15.65 –3.21 5.92Canada Canadian Dividend & Income Equity 4.21 4.21 –3.36 5.66 4.62 4.43 6.70Canada Canadian Equity 3.69 3.69 –4.83 6.18 2.90 3.49 5.48Canada Energy Equity 3.53 3.53 –23.17 –7.36 –7.04 –2.25 5.16

Canada Canadian Long Term Fixed Income 2.31 2.31 –1.17 4.35 7.11 5.57 6.50Canada Canadian Equity Balanced 1.75 1.75 –3.34 5.40 3.81 3.74 5.19Canada Canadian Small/Mid Cap Equity 1.60 1.60 –6.95 5.53 3.03 3.44 8.27Canada Canadian Inflation-Protected Fixed Inc 1.59 1.59 –2.87 0.54 3.36 3.32 3.51Canada Canadian Neutral Balanced 1.04 1.04 –2.67 5.24 4.60 4.22 5.21

Canada Canadian Fixed Income 0.83 0.83 –0.42 2.69 3.93 4.10 4.53Canada Canadian Fixed Income Balanced 0.45 0.45 –1.55 4.00 4.27 3.66 3.80Canada 2025 Target Date Portfolio 0.38 0.38 –2.56 5.20 4.65 4.51 —Canada Canadian Focused Equity 0.10 0.10 –5.30 7.47 4.40 3.71 5.80Canada Canadian Money Market 0.06 0.06 0.27 0.40 0.43 1.10 1.43

Canada Canadian Synthetic Money Market 0.04 0.04 0.11 0.28 0.32 1.12 —Canada Canadian Short Term Fixed Income 0.03 0.03 0.25 1.59 1.93 2.61 2.83Canada Real Estate Equity –0.05 –0.05 1.20 11.79 11.76 6.34 9.11Canada High Yield Fixed Income –0.05 –0.05 –3.15 2.37 4.22 4.36 4.62Canada 2020 Target Date Portfolio –0.15 –0.15 –1.63 3.79 3.89 3.80 —

Canada Canadian Focused Small/Mid Cap Equity –0.17 –0.17 –6.39 6.00 4.57 2.43 6.39Canada Global Fixed Income –0.22 –0.22 0.58 4.03 5.08 4.75 3.16Canada 2025+ Target Date Portfolio –0.35 –0.35 –3.64 6.21 5.17 5.55 —Canada Global Fixed Income Balanced –0.38 –0.38 –1.65 4.83 5.15 4.00 4.11Canada 2015 Target Date Portfolio –0.57 –0.57 –1.45 5.24 4.75 4.57 —

Canada Floating Rate Loans –0.81 –0.81 –1.34 1.62 2.61 1.27 —Canada Tactical Balanced –0.83 –0.83 –4.00 4.68 3.51 3.97 5.03Canada Emerging Markets Equity –1.54 –1.54 –10.57 1.26 –0.65 2.19 5.48Canada Global Neutral Balanced –1.77 –1.77 –2.54 6.42 5.63 4.03 4.40Canada Global Equity Balanced –2.28 –2.28 –2.99 8.26 6.38 3.81 4.20

Canada US Small/Mid Cap Equity –4.04 –4.04 –4.17 13.18 11.36 6.23 5.56Canada Global Equity –4.60 –4.60 –2.71 11.49 9.01 4.07 3.26Canada Preferred Share Fixed Income –4.79 –4.79 –12.44 –4.62 –0.26 3.80 —Canada US Equity –4.97 –4.97 –0.92 16.09 12.96 5.51 3.10Canada North American Equity –5.45 –5.45 –5.45 10.78 7.83 4.02 3.90

Canada Asia Pacific ex-Japan Equity –5.68 –5.68 –8.29 5.28 4.24 5.45 5.34Canada Global Small/Mid Cap Equity –6.19 –6.19 –5.25 11.13 7.68 4.34 4.88Canada US Money Market –6.83 –6.83 2.29 8.51 5.97 2.05 –0.23Canada European Equity –6.90 –6.90 –1.54 10.89 8.70 3.41 2.93Canada Financial Services Equity –6.92 –6.92 –4.46 11.02 8.17 1.18 4.03

Canada International Equity –7.47 –7.47 –5.30 9.28 6.67 1.76 2.05Canada Asia Pacific Equity –7.77 –7.77 –4.79 8.00 5.31 2.39 2.80Canada Greater China Equity –10.54 –10.54 –13.72 9.67 3.81 6.18 5.40

Source: Morningstar Direct. Data as of March 31, 2016, Return ranking over 3 month period.


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Exhibit 5 Largest Mutual Fund Performance

% Category Rank

Name AUM ($Mil) Morningstar CategoryMorningstar Overall Rating 1-Year 3-Year 5-Year 10-Year 15-Year

RBC Select Conservative Portfolio Sr A 20,912 Global Neutral Balanced ÙÙÙ 23 61 59 57 29RBC Select Balanced Portfolio Sr A 20,046 Global Neutral Balanced ÙÙÙÙ 48 27 28 48 24RBC Canadian Dividend Sr A 16,922 Canadian Dividend & Income Equity ÙÙÙÙ 53 31 38 35 28RBC Bond Sr A 16,115 Canadian Fixed Income ÙÙÙÙ 35 22 21 29 50Investors Dividend C 16,043 Canadian Equity Balanced ÙÙ 54 76 49 76 54

TD Canadian Bond - I 14,463 Canadian Fixed Income ÙÙÙÙ 35 41 39 34 15TD Canadian Core Plus Bond - A 11,721 Canadian Fixed Income ÙÙÙ 58 48 37 — —Fidelity Monthly Income Series A 11,523 Canadian Neutral Balanced ÙÙÙÙ 10 34 13 9 —RBC Select Very Conservative Port Adv 10,538 Canadian Fixed Income Balanced ÙÙÙ 16 44 56 — —Fidelity Canadian Bond Sr A 10,040 Canadian Fixed Income ÙÙÙ 69 58 59 62 58

Manulife Monthly High Income Adv 9,223 Canadian Neutral Balanced ÙÙÙÙÙ 7 4 2 19 3TD Mgd Income Portfolio I 8,993 Canadian Fixed Income Balanced ÙÙÙÙ 45 21 30 59 41PH&N Bond Sr D 8,969 Canadian Fixed Income ÙÙÙÙÙ 14 9 12 7 5CI Signature High Income 8,744 Global Neutral Balanced ÙÙÙ 93 86 65 15 1RBC Monthly Income Sr A 8,024 Canadian Neutral Balanced ÙÙÙ 48 70 57 39 14

PIMCO Monthly Income A 7,975 Global Fixed Income ÙÙÙÙ 38 46 3 — —PH&N Total Return Bond Sr D 7,881 Canadian Fixed Income ÙÙÙÙÙ 14 8 9 8 3TD Monthly Income - I 7,455 Canadian Neutral Balanced ÙÙÙÙ 20 46 33 29 5CI Income Class A 7,161 Global Fixed Income Balanced ÙÙ 58 83 83 — —TD Comfort Balanced Port - I 6,824 Global Neutral Balanced ÙÙÙ 56 75 59 — —

Fidelity Canadian Balanced Sr A 6,823 Canadian Neutral Balanced ÙÙÙÙ 84 17 28 17 19Manulife Strategic Income Adv 6,815 High Yield Fixed Income ÙÙÙÙÙ 15 15 17 5

RBC Select Growth Portfolio Sr A 6,679 Global Equity Balanced ÙÙÙ 40 37 43 55 29TD Global Low Volatility A 6,370 Global Equity ÙÙÙ 28 45 — — —TD Dividend Growth - I 6,241 Canadian Dividend & Income Equity ÙÙÙ 46 39 45 52 23

TD Short Term Bond - I 6,224 Canadian Short Term Fixed Income ÙÙÙÙ 46 46 45 25 15Fidelity Canadian Asset Alloc Sr B 6,035 Canadian Equity Balanced ÙÙÙ 55 42 65 44 44RBC Balanced Sr A 5,911 Canadian Neutral Balanced ÙÙ 63 48 69 82 66Investors Income Plus Portfolio C 5,785 Canadian Fixed Income Balanced ÙÙ 38 82 89 80 38TD Mgd Inc & Mod Growth Port I 5,716 Global Neutral Balanced ÙÙÙ 36 47 46 71 64

RBC European Equity Sr A 5,615 European Equity ÙÙÙÙ 42 18 26 67 78TD Comfort Balanced Growth Portfolio - I 5,595 Global Neutral Balanced ÙÙÙ 52 56 50 — —RBC Global Corporate Bond Adv 5,563 Global Fixed Income ÙÙÙ 58 64 60 37 —Investors Real Property C 5,438 Miscellaneous - Income and Real Property — — — — — —Beutel Goodman Canadian Equity Class D 5,414 Canadian Equity ÙÙÙÙÙ 18 28 8 5 4

Sentry Canadian Income A 5,378 Canadian Focused Equity ÙÙÙÙÙ 19 21 13 6 —TD Income Advantage Portfolio - I 5,369 Canadian Fixed Income Balanced ÙÙÙ 46 77 70 28 —PH&N Short Term Bond & Mortgage Sr D 5,258 Canadian Short Term Fixed Income ÙÙÙÙ 11 14 20 10 4Investors Mortgage & S/T Inc C 5,239 Canadian Short Term Fixed Income ÙÙ 68 84 80 78 78Dynamic Strategic Yield Sr A 5,209 Global Neutral Balanced ÙÙÙ 36 79 58 — —

Scotia Canadian Dividend A 5,062 Canadian Dividend & Income Equity ÙÙÙÙ 16 9 16 31 37CI Signature Income & Growth 5,051 Global Neutral Balanced ÙÙ 96 83 86 35 10Fidelity True North Sr A 4,858 Canadian Equity ÙÙÙÙÙ 28 14 13 16 19EdgePoint Global Portfolio Series A 4,753 Global Equity ÙÙÙÙÙ 36 3 4 — —RBC Canadian Short Term Income Sr A 4,751 Canadian Short Term Fixed Income ÙÙÙ 52 51 48 46 52

Fidelity Canadian Large Cap Sr A 4,604 Canadian Focused Equity ÙÙÙÙÙ 7 8 5 3 3TD Comfort Balanced Income Portfolio - I 4,564 Canadian Fixed Income Balanced ÙÙÙ 75 56 47 — —CIBC Monthly Income 4,473 Canadian Neutral Balanced ÙÙ 68 93 97 87 30Mawer International Equity A 4,415 International Equity ÙÙÙÙÙ 8 12 8 3 2Mackenzie Ivy Foreign Equity A 4,384 Global Equity ÙÙÙÙÙ 10 28 12 10 10

Source: Morningstar Direct. Data as of March 31, 2016, Return ranking over 3 month period.


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Exhibit 6 Largest ETF Performance

% Category Rank


iShares S&P/TSX 60 11,788 Canadian Equity ÙÙÙÙ 67 59 58 36 22iShares Core S&P 500 (CAD-Hedged) 3,668 US Equity ÙÙ 33 86 77 53iShares Core S&P/TSX Capped Composite 2,497 Canadian Equity ÙÙÙ 71 67 65 43 24BMO S&P 500 ETF (CAD) 2,334 US Equity ÙÙÙÙÙ 10 6 — — —iShares Canadian Short Term Bond 2,247 Canadian Short Term Fixed Income ÙÙÙÙÙ 22 18 19 5 1

iShares 1-5 Year Laddered Corp Bd Adv 2,173 Canadian Short Term Fixed Income ÙÙÙÙ 61 32 18 — —iShares Canadian Universe Bond 2,113 Canadian Fixed Income ÙÙÙÙ 20 14 10 11 9iShares Canadian Corporate Bond 1,513 Canadian Fixed Income ÙÙÙÙ 26 22 11 — —iShares Canadian Select Dividend 1,403 Canadian Dividend & Income Equity ÙÙÙ 56 78 60 46 —BMO Mid-Term US IG Corp Bond ETF (CAD) 1,355 Global Fixed Income ÙÙÙÙÙ 13 1 — — —

iShares S&P/TSX Capped REIT 1,264 Real Estate Equity Ù 91 98 98 20 —BMO S&P/TSX Capped Composite ETF 1,255 Canadian Equity ÙÙÙ 71 66 71 — —iShares MSCI EAFE CAD-Hedged 1,242 International Equity ÙÙ 90 88 67 82 —BMO Laddered Preferred Share ETF 1,237 Preferred Share Fixed Income Ù 100 100 — — —BMO High Yld US Corp Bd Hdgd to CAD ETF 1,193 High Yield Fixed Income ÙÙÙ 84 82 44 — —

iShares S&P/TSX Canadian Pref Share Adv 1,154 Preferred Share Fixed Income ÙÙ 93 85 78 — —iShares 1-5 Year Laddered Govt Bd Adv 1,133 Canadian Short Term Fixed Income ÙÙÙÙ 34 36 29 — —BMO MSCI EAFE ETF 1,104 International Equity — 57 — — — —iShares S&P/TSX Capped Energy 1,087 Energy Equity ÙÙÙ 34 64 86 84 60BMO S&P 500 Hedged to CAD ETF 1,082 US Equity ÙÙ 34 87 76 — —

BMO Covered Call Canadian Banks ETF 1,082 Financial Services Equity ÙÙ 3 70 87 — —iShares S&P/TSX Capped Financials 1,001 Financial Services Equity ÙÙÙÙ 11 62 65 1 1iShares S&P/TSX Cdn Div Aristocrats Adv 980 Canadian Dividend & Income Equity ÙÙÙ 72 77 51 — —BMO Short Corporate Bond ETF 921 Canadian Short Term Fixed Income ÙÙÙÙÙ 13 9 5 — —BMO Mid Corporate Bond ETF 920 Canadian Fixed Income ÙÙÙÙÙ 8 6 2 — —

BMO Aggregate Bond ETF 899 Canadian Fixed Income ÙÙÙÙ 18 13 10 — —BMO Low Volatility Canadian Equity ETF 878 Canadian Equity ÙÙÙÙÙ 1 1 — — —Vanguard Canadian Short-Term Bond ETF 858 Canadian Short Term Fixed Income ÙÙÙÙ 18 16 — — —BMO S&P/TSX Equal Weight Banks ETF 818 Financial Services Equity ÙÙÙ 1 65 78 — —BMO MSCI EAFE Hdg to CAD ETF 792 International Equity ÙÙÙ 89 85 54 — —

BMO Low Volatility US Equity ETF (CAD) 784 US Equity ÙÙÙÙÙ 1 1 — — —Vanguard Canadian Short-Term Corp Bd ETF 778 Canadian Short Term Fixed Income ÙÙÙÙÙ 14 8 — — —Vanguard Canadian Aggregate Bond ETF 732 Canadian Fixed Income ÙÙÙÙÙ 17 11 — — —Vanguard S&P 500 ETF 701 US Equity ÙÙÙÙÙ 9 6 — — —iShares S&P/TSX Global Gold 674 Precious Metals Equity ÙÙ 69 85 28 93 100

Horizons S&P/TSX 60 ETF 672 Canadian Equity ÙÙÙ 66 57 55 — —Horizons Active Preferred Share ETF Comm 650 Preferred Share Fixed Income ÙÙÙ 52 36 45 — —iShares Diversified Monthly Income 620 Canadian Fixed Income Balanced Ù 93 94 79 49 —BMO Canadian Dividend ETF 616 Canadian Dividend & Income Equity ÙÙ 83 87 — — —PowerShares 1-5 Yr Lad InvGr CorpBd ETF 598 Canadian Short Term Fixed Income ÙÙÙÙÙ 15 7 — — —

BMO Mid Federal Bond ETF 592 Canadian Fixed Income ÙÙÙÙÙ 4 10 3 — —Vanguard US Total Market ETF 588 US Equity — 24 — — — —BMO MT US IG Corp Bd Hdg to CAD ETF 580 Canadian Fixed Income ÙÙÙÙ 3 12 — — —iShares Core MSCI EAFE IMI 546 International Equity — 41 — — — —iShares US Dividend Growers(CAD-Hdg)Adv 543 US Equity ÙÙ 5 90 — — —

iShares Core S&P 500 526 US Equity — 12 — — — —iShares US High Yield Bond CAD-Hedged 523 High Yield Fixed Income ÙÙÙ 72 66 38 — —PowerShares Ultra Liquid LT Govt Bd ETF 519 Canadian Long Term Fixed Income ÙÙÙÙ 31 9 — — —BMO Floating Rate High Yield ETF 519 Floating Rate Loans — 3 — — — —Horizons Active Corporate Bond ETF Comm 517 Canadian Fixed Income ÙÙÙÙÙ 36 29 9 — —

Source: Morningstar Direct, Data as of March 31, 2016.


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Exhibit 7 Largest Pooled Fund Performance

% Category Rank


PH&N Bond Sr O 8,942 Canadian Fixed Income ÙÙÙÙ 20 15 31 11 —PH&N Total Return Bond Sr O 7,846 Canadian Fixed Income ÙÙÙÙ 27 14 23 22 —RBC European Equity Ser O 5,615 European Equity ÙÙÙ 50 75 25 — —PH&N Short Term Bond & Mortgage Sr O 5,197 Canadian Short Term Fixed Income ÙÙÙ 11 24 53 34 —RBC Global Bond Ser O 4,114 Global Fixed Income ÙÙÙ 19 34 39 — —

PH&N High Yield Bond Sr O 3,599 High Yield Fixed Income ÙÙ 51 86 93 25 —RBC Private Canadian Equity Pool 3,391 Canadian Equity ÙÙÙ 44 64 48 35 —PH&N Mortgage Pension Trust Sr O 3,374 Canadian Short Term Fixed Income ÙÙÙÙ 8 4 11 14 —Manulife Canadian Pooled Real Estate 3,183 Miscellaneous - Income and Real Property — — — — — —Franklin Bissett Canadian Equity 2,956 Canadian Equity ÙÙÙÙ 33 39 11 9 17

Franklin Bissett Core Plus Bond 2,724 Canadian Fixed Income ÙÙ 98 72 62 69 58RBC US Dividend Series O 2,698 US Equity ÙÙÙ 30 56 66 — —RBC QUBE US Equity Series O 2,640 US Equity — 52 — — — —PH&N Canadian Equity Underlying Ser O 2,479 Canadian Equity ÙÙÙ 61 54 51 — —PH&N Monthly Income Ser O 2,449 Canadian Neutral Balanced Ù 61 98 94 — —

PH&N Dividend Income Sr O 2,336 Canadian Dividend & Income Equity ÙÙÙ 55 58 48 77 —RBC Emerging Markets Equity Sr O 2,320 Emerging Markets Equity ÙÙÙÙ 22 7 10 — —RBC Global Dividend Growth Ser O 2,229 Global Equity ÙÙÙ 66 11 34 — —RBC Private Canadian Dividend Pool 2,212 Canadian Dividend & Income Equity ÙÙÙÙ 30 36 31 27 —RBC Private Canadian Corporate Bond Pool 2,098 Canadian Fixed Income ÙÙÙÙ 55 45 12 24 —

United Canadian Fixed Income Pool 2,092 Canadian Fixed Income ÙÙ 87 82 78 87 97RBC Private Canadian Bond Pool 2,019 Canadian Fixed Income — 25 51 54 42 —Mawer Global Small Cap Series O 1,828 Global Small/Mid Cap Equity ÙÙÙÙÙ 7 1 1 — —RBC High Yield Bond Sr O 1,810 High Yield Fixed Income ÙÙÙ 22 41 34 — —RBC Global Equity Focus O 1,788 Global Equity — 31 — — — —

RBC Private US Large Cap Cr Eq Pl 1,776 US Equity ÙÙÙ 87 67 46 — —Quadrus Fixed Income (Portico) N 1,762 Canadian Fixed Income — — — — — —PH&N Canadian Underlying Equity II O 1,714 Canadian Equity — 66 — — — —Quadrus Mac Strat Income N5 1,699 Canadian Neutral Balanced — — — — — —Quadrus Mac Strat Income Ser N 1,699 Canadian Neutral Balanced — — — — — —

Fidelity ClearPath Inst 2050 Portfolio 1,657 2025+ Target Date Portfolio ÙÙÙÙ 87 32 — — —RBC O'Shaughnessy US Value Ser O 1,656 US Equity Ù 98 91 89 — —RBC QUBE Low Volatility Cdn Eq Sr O 1,569 Canadian Equity ÙÙÙÙÙ 1 4 — — —RBC Asia Pacific ex-Japan Equity O 1,540 Asia Pacific ex-Japan Equity — 1 — — — —PH&N Canadian Money Market Sr O 1,501 Canadian Money Market — 23 27 35 37 —

CI Signature Canadian Balanced Pooled 1,426 Canadian Neutral Balanced ÙÙÙÙ 98 80 89 7 7RBC Private Short-Term Income Pool 1,339 Canadian Short Term Fixed Income ÙÙÙ 40 60 58 73 —BlueBay Global Monthly Income Bond Sr O 1,310 Global Fixed Income Ù 94 92 — — —PH&N Institutional S.T.I.F. Sr O 1,303 Canadian Money Market — 21 23 28 20 21Quadrus Mackenzie US Mid Cap Growth Cl N 1,293 US Small/Mid Cap Equity — — — — — —

BlueBay Global Convert Bd (CAN) Sr O 1,265 High Yield Fixed Income ÙÙÙÙ 54 23 — — —PH&N Balanced Pension Trust Sr O 1,252 Canadian Neutral Balanced ÙÙÙ 49 18 46 68 —RBC QUBE Low Volatility US Eq Sr O 1,173 US Equity ÙÙÙÙ 2 21 — — —Quadrus Mac Cdn Large Cap Dividend N 1,165 Canadian Dividend & Income Equity — — — — — —Franklin Bissett Canadian Balanced 1,140 Canadian Neutral Balanced ÙÙÙ 85 84 44 45 35

RBC QUBE Canadian Equity Series O 1,136 Canadian Equity — 77 — — — —Pyramis Canadian Focused Equity Trust 1,069 Canadian Equity ÙÙÙÙÙ 28 4 3 — —PH&N Canadian Equity Sr O 1,055 Canadian Equity ÙÙÙ 61 53 50 66 —PH&N Canadian Equity Value Sr O 1,026 Canadian Equity ÙÙÙÙ 20 47 23 — —RBC Balanced Growth & Income O 1,008 Global Equity Balanced — 40 — — — —

Source: Morningstar, Inc. Data as of March 31, 2016.

About Morningstar Manager ResearchMorningstar Manager Research provides independent, fundamental analysis on managed investment strategies. Analyst views are expressed in the form of Analyst Ratings, which are derived through research of five key pillars—Process, Performance, Parent, People, and Price. A global research team issues detailed analyst reports on strategies that span vehicle, asset class, and geography.

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