Canadian Small Cap Class

Canadian Small Cap Class Commentary

Portfolio Advisor: QV Investors Inc.

Fund Commentary - December 31, 2011

Over the past 12 months, equity markets have been volatile with a downward bias as the global economic recovery that was set in motion several years ago faced a plethora of headwinds. An intensifying European sovereign credit crisis, softer global economic data, the U.S. debt-ceiling debacle, the "Arab Spring" and a growing Occupy movement provided abundant ammunition to alarm investors. Correlation among stocks reached near record levels, with daily stock price fluctuations increasingly driven by changes in macro sentiment rather than underlying company fundamentals.

The Portfolio Sub-Advisor kept the Fund well-diversified throughout the year. This benefitted relative performance. The benchmark, BMO Nesbitt Burns Small Cap Index, is highly concentrated in the resource sectors, with Materials and Energy making up in excess of 50% of the index. Weakness in the benchmark over the past 12 months was driven by declines in the Materials and Energy sectors with returns of -28.8% and -20.3% respectively. The Fund maintained a combined weight of roughly 26.1% in these two sectors, holding a bias towards investments in more defensive business models such as energy infrastructure, packagers and wood pole manufacturing. As a result, the Fund was able to generate gains in both of these sectors. The Fund's recent outperformance in the resource sectors explains the majority of total outperformance during the past year when compared to the benchmark. An overweight position in Consumer Staples was also a large contributor to Fund outperformance.

The largest individual contributors to performance during the past 12 months were AltaGas Ltd., The Jean Coutu Group (PJC) Inc., and Argonaut Gold Inc. AltaGas Ltd. benefited from increased investor demand for yield, continued success in the execution of its growth strategy and improving Alberta power prices. The Jean Coutu Group (PJC) Inc. benefited from increased investor demand after demonstrating stable cash flow generation and dividend growth despite recently enacted provincial drug reforms. Argonaut Gold Inc. benefited from continued success from mine operations and exploration, as well as a higher gold price.

The largest detractor to Fund performance from a sector perspective was in the Financials space, where the biggest negative contributors were E-L Financial Corp. Ltd., GMP Capital Inc. and Transcontinental Inc. The current low interest rate environment negatively impacted E-L Financial Corp. Ltd.'s life insurance division. Despite this headwind, the company remains well capitalized and the current share price does not appear to recognize the value associated with E-L Financial Corp. Ltd.'s other businesses and corporate investments. GMP Capital Inc. is one of Canada's largest independent brokerage firms. Recent weakness in capital markets has taken a toll on the company's profitability and share price performance. Transcontinental Inc. is Canada's largest, most profitable printing company. Despite challenging end-markets, the company has maintained strong margins and cash flow. The manager believes that E-L Financial Corp. Ltd., GMP Capital Inc. and Transcontinental Inc. have proven records of navigating through difficult environments and remains committed to these investments.

Additions to the Fund over the past year include: The Jean Coutu Group (PJC) Inc. and MacDonald, Dettwiler and Associates Ltd. (MDA). The Jean Coutu Group (PJC) Inc. is one of Canada's largest and most profitable drugstore operators. The company's Canadian operations have experienced significant and consistent growth over the past 10 years, with revenues more than doubling and operating profits compounding at a double-digit annual rate. MDA is a leader in providing space based information systems and geospatial services. The company has accumulated a high degree of engineering expertise in this very technical industry and has a long track record of generating returns on capital investment at above market rates. The Portfolio Sub-Advisor believes these companies have sustainable business models and expects them to provide reasonable returns over the business cycle. During the past year, the Portfolio Sub-Advisor eliminated positions in Glacier Media Inc., Le Château Inc., Savanna Energy Services Corp. and Vermilion Energy Inc.