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2016 Annual Management Report of Fund Performance

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(the Fund ) For the 12-month period ended September 30, (the Period ) Manager: BMO Investments Inc. (the Manager or BMOII ) Portfolio manager: BMO Asset Management Inc., Toronto, Ontario (the portfolio
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(the Fund ) For the 12-month period ended September 30, (the Period ) Manager: BMO Investments Inc. (the Manager or BMOII ) Portfolio manager: BMO Asset Management Inc., Toronto, Ontario (the portfolio manager ) Annual Management Report of Fund Performance This annual management report of fund performance contains financial highlights but does not contain the complete annual financial statements of the Fund. If the annual financial statements of the Fund do not accompany the mailing of this report, you may obtain a copy of the annual financial statements at your request, and at no cost, by calling and , by writing to us at BMO Investments Inc., First Canadian Place, 100 King Street West, 43rd Floor, Toronto, Ontario, M5X 1A1 or by visiting our website at and or SEDAR at You may also contact us using one of these methods to request a copy of the Fund s proxy voting policies and procedures, proxy voting disclosure record and/or quarterly portfolio disclosure. MANAGEMENT DISCUSSION OF FUND PERFORMANCE Investment Objective and Strategies The Fund s objectives are to provide a fixed monthly distribution while preserving the value of your investment. The Fund invests primarily in Canadian fixed income securities with higher-than-average yields, issued by the federal government, provincial governments, government agencies and corporations, as well as preferred and common shares, real estate investment trusts, royalty trusts and other high-yielding investments. To enhance the yield, the Fund may also invest in Canadian or foreign lowerrated or unrated securities, derivative instruments like options, futures and forward contracts. For fixed income investments, a disciplined investment approach is used based on the portfolio manager s interest rate outlook. Overall maturity structure and sector positioning of the Fund s portfolio are based on anticipated changes in the direction of interest rates, while the selection of individual securities is determined by fundamental analysis and relative valuations. For the equity portion of the portfolio, the portfolio manager applies a bottom-up fundamental investment process to identify attractively priced securities. This process includes analyzing financial statements, company management and valuations, with an emphasis on companies that generate stable and predictable cash flows. Risk No changes affecting the overall level of risk associated with investing in the Fund were made during the Period. The risks of the Fund remain as discussed in the Fund s most recent simplified prospectus or any amendments and fund facts. Results of Operations During the Period, the Fund s total net asset value changed from approximately $3,693 million to approximately $3,935 million. Series A units of the Fund returned 9.11% versus the Fund s blended benchmark, composed of 5 FTSE TMX Canada Universe Bond Index and 5 S&P/TSX Composite Total Return Index, return of 10.29%. Please see the Past Performance section for information on the performance returns of the Fund s other series. During the Period, while the S&P/TSX Composite Total Return Index ( S&P/TSX ) had negative returns in the last quarter of, it rose 15.8% in. The Materials sector was the primary driver of the S&P/TSX performance. After a multi-year decline, gold prices were up sharply, rising 18. as longer-term interest rates declined amid lower expectations for an interest rate increase by the U.S. Federal Reserve Board ( Fed ) in. The Energy sector was the second-best performer in the S&P/TSX. While crude oil prices fell in the fourth quarter of and continued to decline early in the first quarter of, they rebounded later, driven primarily by production outages. In the third quarter of, crude production increased, particularly in the Middle East. However, the potential for an agreement to a production freeze by the Organization of the Petroleum Exporting Countries supported oil prices. The Financials sector gained 13.1% as key earnings drivers showed Canadian banks resilience. In addition, Canadian banks management continued to stress that credit losses related to the Energy sector remained manageable. However, the Health Care sector posted high double-digit losses. Nevertheless, given the relatively small size of this sector in the S&P/TSX, its performance made a modest impact on the broader equity market s performance. The Canadian bond market, as measured by the FTSE TMX Canada Universe Bond Index ( Index ), remained on an upward trajectory. The Index added 6.3% as the 10-year Canadian government bond yield fell 44 basis points to 1., while its U.S. equivalent also fell 44 basis points. Meanwhile, the Canadian yield curve flattened as some short-term interest rates rose, while mid- and long-term interest rates declined. As a result, longer-term bonds were the beneficiaries of these changes in interest rates. At the beginning of the Period, investors anticipated a low probability of an interest rate increase by the Fed during the remainder of the, but did expect an interest rate increase in. The Fed, however, increased the target range of the federal funds rate in December, but did not withdraw monetary stimulus during the remainder of the Period as it was looking for confirmation of a strengthening economy. As a result, longer-term interest rates declined in both the U.S. and Canada, supporting bond prices. Meanwhile, the Bank of Canada ( BoC ) kept its overnight interest rate unchanged as low oil prices continued to be a challenge for economic expansion. Another supporting factor for the Index was a narrowing of corporate credit spreads (i.e., a difference in yields) which lifted corporate credit. Income-oriented equities, particularly in Canada and the U.S., contributed to the Fund s performance. Top individual equity contributors to performance included Franco-Nevada Corporation on the strength of gold prices, and Brookfield Infrastructure Partners L.P. as defensive, income-oriented securities in Canada were strong. From a fixed income perspective, an overweight exposure to corporate bonds contributed to the Fund s performance as they outperformed Government of Canada bonds. Allocation to long-term provincial bonds, those with terms to maturity of greater than 10 years, contributed to performance. The Fund s yield curve positioning also contributed to performance as long-term interest rates outperformed short-term interest rates by nearly 0.5. An underweight allocation to the metals sub-sector detracted from the Fund s performance, particularly in gold, silver and base metals. An underweight exposure to the Energy sector, specifically in exploration and production, also detracted from performance. Individual detractors from performance included underweight holdings in precious metals firms Barrick Gold Corporation, Agnico Eagle Mines Limited and Silver Wheaton Corp. In addition, an underweight allocation to the cyclicals detracted from performance due to holdings in Canadian National Railway Company. During the Period, the portfolio manager added a new position in The Bank of Nova Scotia as the company s fundamentals improved. A new position in Inter Pipeline Ltd. (4.97%, February 2, 2021) was added for its largely feebased contracted portfolio and investment-grade clients. The bond provides exposure to the company at an attractive spread to government securities with a maturity that reduces volatility. In addition, the portfolio manager increased the Fund s existing exposure to cyclicals through increases to banks and other Financials sector stocks. An equity position in Ritchie Bros. Auctioneers Incorporated was eliminated as a result of deteriorating fundamentals. A position in NAV Canada (3.53%, February 23, 2046) was also eliminated to reallocate to securities that offered a more compelling relative value. The Fund s exposure to consumer-related sectors was trimmed amid weakening data out of Canada. The Manager confirms that the Fund did not borrow money during the period. For information on the Fund s performance and composition, please refer to the Past Performance section and Summary of Investment Portfolio section of this report. Recent Developments The portfolio manager is cautious regarding global equities in the short term, but positive in the longer term. Changes in global interest rates may impact equity market performance in the coming period. The portfolio manager believes that a low but modest growth environment may limit the ability of wages to be pushed materially higher, and that commodities such as oil are not likely to rise significantly. Limited wage growth, contained commodity prices and productive capacity should keep inflation within its target of less than 2.. With inflation within target, the portfolio manager does not anticipate that the BoC will increase interest rates in the coming months. With respect to fixed income securities, the overweight exposure to corporate bonds will be maintained, which should drive performance, but the portfolio manager may reduce the overweight position to better adjust the Fund to current valuations. Multi-Series Structure Change Effective October 19,, in addition to the types of units currently available for sale to investors, the Manager began offering Series F6 units. Series F6 units are suitable for investors holding securities outside of a registered plan and wishing to receive monthly distributions. Series F6 units may only be purchased through dealers who have entered into an F Series Agreement with the Manager. RELATED PARTY TRANSACTIONS BMO Investments Inc., an indirect, wholly-owned subsidiary of Bank of Montreal ( BMO ), is the Manager of the Fund. From time to time, the Manager may, on behalf of the Fund, enter into transactions or arrangements with or involving other members of BMO Financial Group, or certain other persons or companies that are related or connected to the Manager (each a Related Party ). The purpose of this section is to provide a brief description of any transaction involving the Fund and a Related Party. Portfolio Manager The Fund s portfolio manager is BMO Asset Management Inc. ( BMOAM ), an affiliate of the Manager. BMOAM provides portfolio management services to the Fund. BMOAM receives from the Fund a management fee based on assets under management, calculated daily and payable monthly. Administration Fees and Operating Expenses The Fund pays a fixed administration fee to the Manager in respect of each series other than Series I. The Manager in return pays the operating expenses of these series of the Fund, other than certain specified expenses that are paid directly by the Fund ( Fund Expenses ). Fund Expenses include interest or other borrowing expenses, costs and expenses related to the operation of the Fund s Independent Review Committee ( IRC ), including fees and expenses of IRC members, taxes to which the Fund is or might be subject, and costs associated with compliance with any new governmental or regulatory requirement introduced after December 1, 2007 (e.g., cost associated with the production of fund facts, filed in compliance with the relevant amendments to NI ). Fund Expenses are allocated proportionately among the relevant series. If the Fund Expenses are specific to a series, the Fund Expenses are allocated to that series. The fixed administration fee is calculated as a fixed annual percentage of the average net asset value of each relevant series of the Fund. Separate fees and expenses are negotiated and paid by each Series I investor. Further details about the fixed administration fee and/or Fund Expenses can be found in the Fund s most recent simplified prospectus at and or Buying and Selling Securities Investments in Bank of Montreal Common Shares or Preferred Shares, Investments in Bank of Montreal Debt Securities in the Secondary Market, Investing in Bank of Montreal Debt Securities in a Primary Offering, Related-Party Underwritings, and Trades in Debt Securities with a Related Entity, Trading as Principal During the Period, the Manager relied on an approval and standing instruction provided by the Fund s IRC with respect to the following related party transactions: (a) investments in common shares or preferred shares of BMO, an affiliate of the Manager; (b) investments in debt securities of BMO, an affiliate of the Manager, in the secondary market; (c) investments in debt securities of BMO, an affiliate of the Manager, in a primary offering; (d) investments in a class of non-government debt securities and/or equity securities of an issuer during the period of distribution of those securities to the public and/or the 60-day period following the distribution period where BMO Nesbitt Burns Inc., an affiliate of the Manager, acted as an underwriter in the distribution; and (e) trades in debt securities in the secondary market with BMO Nesbitt Burns Inc. who is trading with the Fund as principal (each, a Related Party Transaction ). In accordance with the IRC s approval and standing instruction, in making a decision to cause the Fund to make a Related Party Transaction, the Manager and portfolio manager of the Fund, are required to comply with the Manager s written policies and procedures governing the Related Party Transaction and report periodically to the IRC, describing each instance that the Manager relied on the approval and standing instruction and its compliance or non-compliance with the governing policies and procedures. The governing policies and procedures are designed to ensure the Related Party Transaction (i) is made free from any influence of BMO, BMO Nesbitt Burns Inc. or an associate or affiliate of BMO and/or BMO Nesbitt Burns Inc. and without taking into account any considerations relevant to BMO, BMO Nesbitt Burns Inc. or an associate or affiliate of BMO and/or BMO Nesbitt Burns Inc., (ii) represents the business judgment of the Manager, uninfluenced by considerations other than the best interests of the Fund, and (iii) achieves a fair and reasonable result for the Fund. Brokerage Commissions The Fund pays standard brokerage commissions at market rates to BMO Nesbitt Burns Inc., an affiliate of the Manager, for executing a portion of its trades. The brokerage commissions charged to the Fund (excluding exchange and other fees) during the periods indicated, were as follows: Period ended Period ended Sep. 30, Sep. 30, $000 $000 Total brokerage commissions $ 1,077 1,127 Brokerage commissions paid to BMO Nesbitt Burns Inc. $ Distribution Services The Manager markets and distributes the Fund through Bank of Montreal branches and/or (depending on the series) through registered dealers and brokers, including BMO InvestorLine Inc. and BMO Nesbitt Burns Inc., both affiliates of the Manager. The Manager pays to these affiliates a service fee called a trailing commission based on the average daily value of the units and/or shares that are held in investor accounts. This service fee is paid monthly or quarterly and varies by purchase option and by series. Management Fees The Manager is responsible for the day-to-day management of the business and operations of the Fund. The Manager monitors and evaluates the Fund s performance, pays for the investment advice provided by the Fund s portfolio manager and provides certain administrative services required by the Fund. As compensation for its services, the Manager is entitled to receive a management fee payable monthly, calculated based on the daily net asset value of each series of the Fund at the maximum annual rate set out in the table below. As a Percentage of Management Fees General Maximum Annual Administration, Management Dealer Investment Fee Rate* Compensation Advice and Profit % % % Series A Units Series T6 Units Series F Units Series D Units Series I Units Series R Units FINANCIAL HIGHLIGHTS The following tables show selected key financial information about the Fund and are intended to help you understand the Fund s financial performance for the periods indicated. The Fund s Net Assets per Unit (1) Series A Units Net assets, beginning of period $ Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Series T6 Units 2014 (6) 2013) Net assets, beginning of period $ )* Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ * For Series I Units, separate Series I fees are negotiated and paid by each Series I investor. Since the Manager pays no distribution, service or trailing fees on Series I Units, the combined management and administrative fees for Series I Units will not exceed the management fee charged for Series A Units. Series F Units Net assets, beginning of period $ Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Premium Series Units (8) )(9) ) Net assets, beginning of period $ )* Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ 9.76 Series D Units (7) 2014) Net assets, beginning of period $ )* Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Series I Units Net assets, beginning of period $ Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ Series R Units 2014 (5) 2013) Net assets, beginning of period $ )* Total revenue $ Total expenses (2) $ for the period $ for the period $ from operations (3) $ (excluding dividends) $ From dividends $ From capital gains $ Return of capital $ Total Annual Distributions (4) $ Net assets, end of period $ * Initial net assets. (1) This information is derived from the Fund s audited financial statements. The financial information presented for the periods ended September 30,, September 30, and September 30, 2014 is derived from the financial statements determined in accordance with IFRS. Information for periods prior to October 1, 2013 is derived from prior period financial statements prepared in accordance with Canadian GAAP. (2) Includes commissions and other portfolio transaction costs. Prior to October 1, 2013, withholding taxes were not included in expenses as they were included in revenue. (3) Net assets and distributions are based on the actual number of units outstanding at the relevant time. The increase/decrease from operations is based on the weighted average number of units outstanding over the financial period. This table is not intended to be a reconciliation of beginning to ending net assets per unit. (4) Distributions were either paid in cash or reinvested in additional units of the Fund, or both. The allocation of the distributions from each of income, dividends, capital gains and return of capital is based on the Manager s estimate as at September 30 of the period shown, which is the Fund s financial year-end. However, the actual allocation of distributions is determined as at December 15, the Fund s tax year-end. Accordingly, the actual allocation among income, dividends, capital gains and return of capital may differ from these estimates. (5) The information shown in this column is for the period beginning
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