Real Return Bond Fund

Real Return Bond Fund Commentary

Portfolio Advisor: Industrial Alliance Investment Management Inc.

Fund Commentary - December 31, 2011

The 2011 economic year ended on a fragile note due to the European sovereign debt crisis, which continues to have repercussions on financial markets worldwide, overshadowing any positive economic news. In the second half of 2011, the financial markets witnessed a significant resurgence in equity market volatility as concerns of a Greek debt default reached their peak. Additionally, the market began to focus its attention on Italy as it also experienced a significant increase in their government bond yields.

With the dramatic spike in equity market volatility in the second half of 2011, investors sought to place assets in what they considered safe havens, U.S. and Canadian bonds. Bond yields dropped during the year, while prices climbed, pushing up bond returns. Provincial bonds offered the best performance in 2011, with a 13.2% return, followed by federal government bonds at 8.4% and corporate bonds at 8.2%. Given the decline in the yield curve, long-term bonds (10 years or more) offered spectacular performance of 18.1%, followed by medium-term bonds and short-terms bonds, which posted returns of 10.9% and 4.7% respectively. During the year, the Bank of Canada kept its target rate at 1.0% as conditions in global financial markets have deteriorated due to the deepening sovereign debt crisis in Europe. Inflation data remains within the 3% upper limit of the Bank of Canada's target range. The Bank of Canada has indicated the next interest rate increase may not come until later in 2012. The U.S Federal Reserve has also maintained its low interest rates policy throughout 2011, indicating that it will keep rates low until they see sustained economic improvement. Interest rates still remain low by historical standards. The Fund underperformed its benchmark index in 2011. The economic context, more specifically, higher inflation expectations, was generally favourable to this asset class until the month of June.

Throughout the summer global markets experienced a significant increase in market volatility in response to the intensifying European debt crisis. The Fund initiated a position in nominal bonds at various times in the second half of the year in order to protect against a potential decline in real return bond prices. The Fund's duration remains shorter than the benchmark as the Portfolio Advisor believes the outlook for future inflation may decline in response to the continued uncertainty in global markets. The Funds weighting in provincial bonds has been raised in the last two quarters of 2011 to close to 30% of the Fund.