Short Term Bond Fund

Short-Term 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 is continuing 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 which 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, such as U.S. and Canadian bonds. Bond yields dropped during the year while prices climbed, pushing up bond returns. The Canadian bond market, represented by the DEX Universe Bond Index ended the year up 9.7%. 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 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 Portfolio Advisor steered the duration of the Fund actively during a turbulent year, keeping it generally lower than the benchmark index during the first quarter and raising it over the index in the following quarter. In general, the duration positioning of the Fund proved beneficial as bonds yields continued to decline throughout the year. The Fund's overweight position in provincial government bonds and in corporate bonds, as well as the underweight in federal government bonds was a positive contributor to performance. At the end of the period, the Fund's duration remains higher than the benchmark index in anticipation of slower economic growth and lower short-term (1 to 5 years) interest rates. The Fund maintains an overweight position in provincial government bonds and an underweight position in federal government bonds. Municipal bonds were also purchased during the last quarter of 2011, with the anticipation the securities would benefit from tighter credit spreads.