Portfolio PerspectivesTHIRD QUARTER 2013 Bui ld Prese r ve Trans fe r

Global equity markets rallied during the quarter, as investors rejoiced in the news that the U.S. Federal Reserve Board (the Fed) would delay the tapering of its long-term asset-buying program. Canadian equities rallied 6.25%, while U.S. equities increased 2.94%. Emerging markets rose 3.61% and the DEX Universe Bond Index had a modest return of 0.11%.

• The Fed surprised markets when it opted not to taper its bond-buying program. They stated the need for “more evidence that economic progress will be sustained.” Equity markets responded enthusiastically, with both the S&P 500 and Dow Jones indices hitting record highs. Meanwhile, bond yields fell considerably, as did the U.S. dollar. More recently, capital markets have shifted focus to the partial shutdown of the U.S. government and debt ceiling debate.

• Canadian equities outperform on materials rebound. Gold prices rebounded approximately 14% in July from their June low due to stronger Asian demand, which lifted Canadian equities. Meanwhile, oil prices were buffeted by the potential for a Western-led military strike on Syria. Home sales continued their cross-Canada rebound in September according to Canadian Real Estate Association data, while all of Canada’s big banks attained record quarterly profits as reported in August.

• Eurozone turns the corner on improved business activity. The eurozone pulled out of its one-and-a-half-year recession in August, thanks to faster-than-expected growth in Germany and France. Meanwhile, the International Monetary Fund advised that urgent economic action was still needed to help turn some of the more embattled economies around. As such, the European Central Bank (ECB) left its key interest rate at 0.5% in September, as widely expected. However, the ECB said it would cut rates or provide economic stimulus, if needed, to help the eurozone’s recovery.

• China softens policy controls, boosting manufacturing. Business activity in the region improved during the quarter due in part to the People’s Bank of China softening its control over interest rates, coupled with government-imposed tax breaks for small businesses. Moreover, steadily improving Chinese manufacturing boosted demand for copper, pushing prices to record highs in August.

IN THIS ISSUE:

• Fed surprises markets with no taper decision; supports bond and equity markets.

• Asset mix: neutral positioning in cash, fixed income and equities.

• Canadian economy moves along sluggishly.

• U.S. political issues overhang markets.

Quarter in Review

Change (%) Index LevelINDEX (C$) 1 Mth 3 Mth 1 Yr

DEX 91 Day T-Bill 0.09 0.29 1.05 394

DEX Bond Universe 0.52 0.11 -1.28 880

S&P/TSX Composite 1.40 6.25 7.12 12787

S&P 500 0.86 2.94 24.91 1731

MSCI World 2.73 5.92 26.54 1589

MSCI Emerging Markets

4.19 3.57 6.05 1017

Change (%)PriceCOMMODITIES (US$) 1 Mth 3 Mth 1 Yr

Gold Spot ($/oz) -4.75 7.64 -25.01 1328.94

Oil WTI ($/barrel) -4.94 5.98 11.00 102.33

Natural Gas ($/MMBtu) -0.59 -0.14 7.23 3.56

Change (%) Exchange RateCURRENCIES 1 Mth 3 Mth 1 Yr

US$/C$ 2.16 1.99 -4.62 0.97

C$/Euro -0.05 1.74 10.09 1.39

C$/Pound 2.01 4.12 4.77 1.67

Yen/C$ 1.75 0.58 19.65 94.80

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A message from Wes Mills, Chief Investment Officer, Scotia Private Client Group

The U.S. debt ceiling has been raised until February 7th, 2014, which enables the government to re-open and allow time to negotiate among other things, its future spending levels. While the political brinksmanship did not help with the perception of politicians (approval ratings hit new lows), we do not think that it will have a material impact on overall corporate earnings and investor confidence. We continue to find quality companies offering an attractive risk/reward profile in this environment. The deal averted an immediate debt-limit crisis, but may set the stage for more fiscal battles in the weeks and months ahead. Therefore, we are advising our clients to continue focusing on the underlying fundamentals, which include improving economic growth and corporate profitability in most regions in the context of reasonable valuations.

Source: Bloomberg, as of September 30, 2013.

• Asset mix: neutral positioning in cash, fixed income and equities. Over the quarter, we made several tactical changes to our asset mix in response to a number of market-driven events, and in part due to market drift. Most notably, we have adjusted our bond allocation to neutral and, given the rally in equities over the summer, we have trimmed our equity exposure and moved the proceeds into cash.

• Cash: increased cash amidst market volatility. While returns on cash are at extremely low levels, we made the tactical decision to increase our cash weighting in light of the recent market volatility. This will provide us with the flexibility to redeploy cash to other asset classes and take advantage of short-term opportunities during market pullbacks.

• Bonds: yields retreat after recent advance. Bond yields have slowly, albeit steadily, retreated since the Fed’s no-taper announcement in September. Even with the recent pullback in yields, we believe there may be considerable room for yields to decline as they are still handily above longer-term moving averages. We have adjusted our bond exposure to a neutral position to account for market drift.

• Equities: reduced U.S. equities, increased REITs and international equities. Given the strong, persistent performance of U.S. equities, we took the opportunity to lock in profits and reduce our exposure to neutral. We have taken the proceeds from U.S. equities and re-allocated to real estate investment trusts (REITs). With interest rates at more stablized levels, we believe REITs provide defensive characteristics and reasonable yield. Lastly, we have slightly increased our allocation to international equities, but remain underweight the benchmark. This adjustment is based on the view that the economic outlook is improving for Japan and Europe, and both have the potential to sustain this positive momentum. Overall, we have a positive long-term view on equities, and expect the Fed’s delay in reducing its bond-purchasing program to be supportive for equity markets going into year-end.

Investment Strategy Summary

PORTFOLIO PERSPECTIVES – THIRD QUARTER 2013

ASSET ALLOCATION VIEWS Underweight Neutral OverweightChange from Last Quarter

Cash Increased cash amid market volatility Bonds Yields retreat after recent advance Equities Reduced U.S. equities, locked in profits No change

Canadian Equity U.S. Equity International Equity No change

The following represents our asset allocation views (as of September 30, 2013):

Note: The term neutral refers to a weighting that is equivalent or close to a portfolio’s benchmark.

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PORTFOLIO PERSPECTIVES – THIRD QUARTER 2013

Fixed Income and Currencies

• No taper decision provides support for bond markets. The bond market was volatile throughout the quarter, but reversed course after the Fed’s surprise move to postpone the reduction of its bond-purchasing program. After a fairly sharp rise in bond yields at the beginning of the quarter, bonds yields in Canada and the U.S. retreated and moderated the upward pressure on yields that had dominated in the past few months. With Janet Yellen nominated to succeed Ben Bernanke as Chair of the Fed, monetary policy is expected to remain stimulative and even tilt in a more “dovish” direction, as the first interest rate hike is expected to be pushed out to late 2014 or early 2015. The absence of tapering will provide a better environment for bond investors going into year-end, and should mute the interest rate rise that occurred over the last few months.

• Defensive positioning: overweight federal, neutral corporate bonds. The portfolio’s average maturity ended the quarter slightly above benchmark, as average maturity was opportunistically increased before interest rates declined late in the quarter. The portfolio’s underweight positioning to the long end of the yield curve and strong security selection within the corporate sector was additive to performance. We are currently defensively positioned with an overweight exposure to federal bonds relative to provincial bonds, and a neutral weight to corporate

bonds, with a bias towards quality. While the near-term outlook for bonds remains challenged, we continue to look for opportunities to add value through the use of floating rate notes to capture short-term rising rates, as well as reducing average maturity, adjusting credit exposure (corporate and high yield bonds) and using derivatives (i.e., bond futures) where appropriate. Despite concerns about when the Fed will decide to unwind its current policies, we believe fixed income will continue to be an important component in an overall portfolio. In a nominal growth world, we think bonds still offer good value, offering steady income, relatively lower volatility, and diversification benefits.

• U.S. dollar falls on Fed’s surprise decision. Over the quarter, the Canadian dollar gained ground versus the U.S. dollar, appreciating close to 2%. This strength was underpinned by a relatively firm commodities backdrop, improving fundamentals and better-than-expected economic data releases. Also providing support, the U.S. dollar fell to a seven-month low after the Fed surprised investors with its decision to continue its massive stimulus program, citing strains in the U.S. economy. With the timing of tapering now uncertain, some support for the U.S. dollar has been removed, at least for the short term. Given the short-term uncertainty, we have a neutral outlook on the U.S. dollar until greater clarity develops.

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FIXED INCOME & CURRENCY VIEWS Neutral Positioning

Duration(Average Maturity)

Expect interest rates to move lower in the short term, as economic growth continues to weaken.

Short Long

QualityUnderweight provincial bonds (quality remains high), in favour of a defensive overweight in federal bonds.

Low High

CurrenciesThe U.S. economy appears to be strengthening vs. the Canadian economy, but still subject to headline risk.

USD CAD

The following represents our current fixed income and currency views:

Note: Duration is a commonly used measure in bond investing to help calculate a bond’s price sensitivity to changes in interest rates. A longer duration means a bond’s price will change by a greater amount in response to a change in interest rates. For example, if rates rise 1.00%, a bond with a 3-year duration is likely to lose about 3% of its value.

Canadian Equity

• Materials rebound while interest-rate-sensitive sectors decline. The Canadian equity market outperformed other major markets over the past quarter, which was a welcome reversal from the performance experienced over the past year. Strong returns were fueled by takeover activity, a small recovery in the resource sector, and strong performance from Canadian banks. Conversely, higher yielding securities and interest-rate-sensitive equities (REITs and utilities) lagged the market. From an asset allocation standpoint, we believe REITs provide defensive characteristics and reasonable yield given their recent market correction, and we have thus increased our allocation. From a Canadian equity strategy perspective, we continue to favour mature companies with strong balance sheets, strong cash flow generation capabilities, and the ability and potential to grow dividends. We continue to find compelling opportunities in the financials, consumer discretionary and consumer staples sectors.

• Canadian economy moves along sluggishly. The Canadian economy continues to grow, albeit at a slower pace than other developed countries. Canada’s year-over-year economic growth has been below 1.5% for the past four quarters, with a richly valued real estate market and over-stretched consumer debt remaining an overhang for future growth. However, this lethargic economic view should be balanced by Canada’s strong fiscal position compared to the U.S. In Canada, there is no looming debt ceiling crisis, no quantitative easing to reverse, and the central bank policy interest rate is comfortably higher than most developed market counterparts. Altogether, these factors lead us to believe that the Bank of Canada will remain accommodative, with no interest rate adjustment for some time. Looking forward, our outlook for large-capitalization Canadian equities is positive relative to other equity markets. If economic growth picks up, Canadian equities should perform well, given Canada’s large concentration in natural resources that continue to be leaders in performance.

PORTFOLIO PERSPECTIVES – THIRD QUARTER 2013

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Markets will remain volatile and subject to news headlines surrounding the debt ceiling discussions, as in past episodes. The portfolios we manage are well positioned to withstand this volatility – in fact we would use any subsequent market weakness to add to the high-quality companies we hold in our portfolios, based on our longer-term outlook for an improving world growth profile going forward.

Sue Lavigne, Vice President & Portfolio Manager, GCIC Ltd.

U.S. Equity • U.S. equities maintain momentum through taper

talk. The U.S. equity market maintained its upward trajectory in the third quarter, albeit with an increased dose of volatility. U.S. stocks were supported by stable economic growth and backed by the Fed’s decision to maintain its bond-purchasing program. The U.S. equity market has been the strongest year-to-date, experiencing compound annual returns of almost 18.5% over the past three years, which is well ahead of most equity markets. Its strong performance can be attributed to the continued recovery in U.S. housing and employment, sustained growth in corporate earnings, and improving consumer finances.

From an asset allocation view, we believe that U.S. equities have become more fairly valued compared to the past few years. We have been gradually trimming our overweight allocation to U.S. equities to a neutral position, and feel this positioning is appropriate at the present time. From a U.S. equity strategy perspective, we continue to find attractive opportunities in the financials, health care, industrials, information technology and consumer discretionary sectors.

• U.S. political issues provide an overhang on markets. The U.S. economy continues to generate steady growth, shrugging off the effects of higher taxes and reduced government spending. However, this positive momentum was largely overshadowed by the recent behaviour of U.S. politicians. The U.S. political environment remained in gridlock at the end of the quarter, which led to the partial shutdown of the U.S. government for over two weeks and also put the U.S. on the brink of debt default.

While the path to reach a compromise was difficult, a deal between the House and Senate was reached hours before the U.S. Treasury was set to reach its borrowing limit. The deal extends the government borrowing limit to February 7, 2014, and stipulates that budget negotiations must be completed by December 13 of this year. Longer term, the question remains whether the deal is yet another stop gap measure that moves the uncertainty into 2014 or whether the next few months will be used productively. That said, markets have started to develop some resistance to this political brinkmanship, as demonstrated by the CBOE Volatility VIX Index (a widely used measure of volatility for the S&P 500), which peaked at just over 21% during the partial government shutdown and has since fallen considerably (see Figure 1 on the following page).

PORTFOLIO PERSPECTIVES – THIRD QUARTER 2013

International Equity

• International markets find firmer footing. The U.K., Germany, China, Japan, and other international equity markets have all taken a backseat in the headlines, as all interest has been fixated on the Fed’s tapering decision. Generally speaking, the recent economic data from Europe, China and Japan are all encouraging, but, similar to the U.S., these regions are not completely out of the woods. While sentiment can turn quickly, the MSCI EAFE Index has generated a very respectable return of roughly 25% over the past year. We acknowledge that things do seem to be improving in Japan and parts of Europe, and this helped to justify our increased allocation to those regions in August, moving closer to the benchmark weight.

Economic data from emerging markets countries in general has not been favourable, but lowered expectations have clearly been priced in as 13 of the 21 constituent countries posted negative returns over the past year. If global economic growth even modestly accelerates in the near future, we believe that emerging markets equities will benefit and generate very attractive returns.

® Registered trademark of The Bank of Nova Scotia, used under licence. © Copyright 2013 1832 Asset Management L.P. All rights reserved.

Scotia Private Client Group® consists of private client services offered by The Bank of Nova Scotia, The Bank of Nova Scotia Trust Company, 1832 Asset Management L.P., 1832 Asset Management U.S. Inc., ScotiaMcLeod Financial Services Inc., WaterStreet Family Offices®, a division of 1832 Asset Management L.P., and ScotiaMcLeod®, a division of Scotia Capital Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.

This document has been prepared for Scotia Private Client Group® clients and may not be redistributed. It is for general information purposes only and is not intended to provide personal investment advice. Information herein was obtained from various sources believed to be reliable but is not guaranteed for its accuracy. All opinions, projections and estimates herein reflect the author’s judgment as of the date of the document, may not be realized, and are subject to change without notice. Scotia Private Client Group is under no obligation to update this commentary and readers should assume the information contained herein will not be updated. Neither Scotia Private Client Group nor any director, officer or employee of any of its members accept any liability whatsoever for any damages or losses arising from any use of this document or its contents.

Figure 1: CBOE Volatility Index

Source: Bloomberg, as of September 30, 2013.

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