ck0000918942-20231231
LKCM
FUNDS
LKCM
SMALL CAP EQUITY FUND
(LKSCX)
LKCM
SMALL-MID CAP EQUITY FUND
(LKSMX)
LKCM
EQUITY FUND
(LKEQX)
LKCM
BALANCED FUND
(LKBAX)
LKCM
FIXED INCOME FUND
(LKFIX)
LKCM
INTERNATIONAL EQUITY FUND
(LKINX)
301
COMMERCE STREET, SUITE 1600
FORT
WORTH, TEXAS 76102
STATEMENT
OF ADDITIONAL INFORMATION
May 1,
2024
This
Statement of Additional Information (“SAI”) is not a prospectus and should be
read in conjunction with the Prospectus of each of the above series of LKCM
Funds (each a “Fund” and collectively the “Funds”) dated May 1, 2024, as
such Prospectus may be supplemented or revised from time to time. A copy of the
Prospectus may be obtained without charge by calling the Funds at
(800) 688-LKCM or by visiting www.lkcmfunds.com.
The
Funds’ audited financial statements for the year ended December 31, 2023
are incorporated
herein by reference to
the Funds’ 2023 Annual Report. A copy of the Annual Report may be obtained
without charge by calling the Funds at (800) 688-LKCM or by visiting
www.lkcmfunds.com.
TABLE
OF CONTENTS
In deciding whether to invest in one or more Funds, you
should rely on information in this SAI and the Prospectus. The Funds have not
authorized others to provide additional information in any state or jurisdiction
in which such offering may not legally be made.
Luther
King Capital Management Corporation (the “Adviser”) serves as the investment
adviser for the Funds.
FUND
ORGANIZATION
DESCRIPTION
OF SHARES AND VOTING RIGHTS
The
LKCM Funds (the “Trust”) is an open-end, diversified, management investment
company. Each Fund is a diversified and separate series of the Trust, a Delaware
statutory trust that was established by a Declaration of Trust dated
February 10, 1994 (as amended, the “Declaration of Trust”). The Declaration
of Trust permits the Trustees of the Trust to issue an unlimited number of
shares of beneficial interest, without par value, from an unlimited number of
series. Currently, the Trust offers seven series, six of which are the LKCM
Small Cap Equity Fund (“Small Cap Equity Fund”), LKCM Small-Mid Cap Equity Fund
(“Small-Mid Cap Equity Fund”), LKCM Equity Fund (“Equity Fund”), LKCM Balanced
Fund (“Balanced Fund”), LKCM Fixed Income Fund (“Fixed Income Fund”) and LKCM
International Equity Fund (“International Equity Fund”) (the “Funds”) and
described more fully herein.
Pursuant
to the Declaration of Trust, the Trustees may also authorize the creation of
additional series (the proceeds of which would be invested in separate,
independently managed funds with distinct investment objectives and policies and
share purchase, redemption and net asset valuation procedures) with such
preferences, privileges, limitations and voting and dividend rights as the
Trustees may determine. All consideration received by the Trust for shares of
any additional series, and all assets in which such consideration is invested,
would belong to that series only and would be subject to the liabilities related
thereto.
When
issued, the shares of the Funds are fully paid and non-assessable, have no
preemptive or subscription rights and are fully transferable. There are no
conversion rights. Each share of a Fund is entitled to participate equally in
dividends and capital gain distributions and in the assets of the Fund in the
event of liquidation. The shares of the Funds have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Trustees can elect 100% of the Trustees if they choose to do so. A
shareholder is entitled to one vote for each full share held (and a fractional
vote for each fractional share held), then standing in the shareholder’s name on
the books of a Fund.
The
Funds are not required, and do not intend, to hold regular annual shareholder
meetings. The Funds may hold special meetings for consideration of proposals
requiring shareholder approval, such as changing fundamental policies. The Trust
will assist in shareholder communication in such matters to the extent required
by law.
Shares
of the Funds do not currently charge a Rule 12b-1 fee. More information
regarding the Rule 12b-1 Plans can be found under the sub-heading
“Distribution Plan.”
SHAREHOLDER
AND TRUSTEE LIABILITY
The
Declaration of Trust contains an express disclaimer of shareholder liability for
acts or obligations of the Trust and requires that notice of such disclaimer be
given in each agreement, obligation, or instrument entered into or executed by
the Trust or the Trustees, but this disclaimer may not be effective in some
jurisdictions or as to certain types of claims. The Declaration of Trust further
provides for indemnification out of the Trust’s property of any shareholder held
personally liable for the obligations of the Trust. The Declaration of Trust
also provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of the Trust and
satisfy any judgment thereon. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which the Trust itself would be unable to meet its obligations.
The
Declaration of Trust further provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties involved in the conduct of the office.
INVESTMENT
LIMITATIONS
ALL
FUNDS
The
Funds are subject to the following restrictions, which are fundamental policies
and may not be changed without the approval of a majority of a Fund’s
outstanding voting securities. As used herein, a “majority of a Fund’s
outstanding voting securities” means the lesser of: (1) at least 67% of the
voting securities of a Fund present at a meeting if the holders of more than 50%
of the outstanding voting securities of the Fund are present or represented by
proxy, or (2) more than 50% of the outstanding voting securities of a Fund.
As
a matter of fundamental policy, each Fund will not:
(1) invest
in physical commodities or contracts on physical commodities;
(2) purchase
or sell real estate, although it may purchase and sell securities of companies
that deal in real estate, other than real estate limited partnerships, and may
purchase and sell marketable securities that are secured by interests in real
estate;
(3) make
loans except: (i) by purchasing debt securities in accordance with its
investment objective and policies or entering into repurchase agreements; or
(ii) with respect to the Small Cap Equity, Small-Mid Cap Equity, Balanced,
Fixed Income, and International Equity Funds, by lending their portfolio
securities to banks, brokers, dealers and other financial institutions, so long
as such loans are not inconsistent with the Investment Company Act of 1940, as
amended (the “1940 Act”), or the rules and regulations or interpretations of the
Securities and Exchange Commission (“SEC”) thereunder;
(4) with
respect to 75% of its assets, purchase more than 10% of any class of the
outstanding voting securities of any issuer;
(5) with
respect to 75% of its assets, invest more than 5% of its total assets in the
securities of any single issuer (other than obligations issued or guaranteed by
the U.S. Government or any of its agencies or instrumentalities);
(6) borrow
money, except (i) from banks and as a temporary measure for extraordinary
or emergency purposes (not for leveraging or investment) or (ii) with
respect to the Small Cap Equity, Small-Mid Cap Equity, Balanced, Fixed Income,
and International Equity Funds in connection with reverse repurchase agreements
provided that (i) and (ii) in combination do not exceed 33 1/3% of the
Fund’s total assets (including the amount borrowed) less liabilities (exclusive
of borrowings); and the Small Cap Equity, Small-Mid Cap Equity, Equity, and
International Equity Funds cannot buy additional securities if they borrow more
than 5% of their total assets; provided, however, with respect to the
International Equity Fund, that the purchase or sale of options, futures
contracts, options on futures contracts, forward contracts, swaps, caps, floors,
collars and other similar financial instruments and margin deposits, security
interests, liens and collateral arrangements with respect to such instruments
shall not constitute borrowing;
(7) underwrite
the securities of other issuers (except to the extent that the Fund may be
deemed to be an underwriter within the meaning of the Securities Act of 1933, as
amended (the “Securities Act”) in the disposition of restricted securities);
(8) acquire
any securities of companies within one industry if, as a result of such
acquisition, more than 25% of the Fund’s total assets would be invested in
securities of companies within such industry; provided, however, that there
shall be no limitation on the purchase of obligations issued or guaranteed by
the U.S. Government, its agencies or instrumentalities; and
(9) issue
senior securities, except that this limitation shall not apply to:
(i) evidence of indebtedness which the Fund is permitted to incur;
(ii) shares of the separate classes or series of the Trust; or
(iii) collateral arrangements with respect to currency-related contracts,
futures contracts, options or other permitted investments, including deposits of
initial and variation margin.
With
the exception of fundamental investment limitation (6) above if a
percentage limitation on the investment or utilization of assets as set forth
above is adhered to at the time an investment is made, a later change in
percentage resulting from changes in the value of the investment or a Fund’s
assets will not require the sale of securities.
The
Funds are also subject to the following restrictions, which are non-fundamental
policies and may be changed by the Board of Trustees of the Trust (the “Board of
Trustees”) without shareholder approval. As a matter of non-fundamental policy,
each Fund will not:
(1) purchase
securities on margin, except for use of short-term credit as may be necessary
for the clearance of purchases and sales of securities, but it may make margin
deposits in connection with transactions in options, futures, and options on
futures; or sell securities short unless, by virtue of its ownership of other
securities, it has the right to obtain securities equivalent in kind and amount
to the securities sold and, if the right is conditional, the sale is made upon
the same conditions. Transactions in futures contracts, options and options on
futures are not deemed to constitute selling securities short;
(2) pledge,
mortgage, or hypothecate any of its assets to an extent greater than 33 1/3% of
its total assets at fair market value;
(3) invest
more than an aggregate of 15% of the net assets of a Fund in securities deemed
to be illiquid, including securities which are not readily marketable, the
disposition of which is restricted (excluding securities that are not registered
under the Securities Act but which can be sold to qualified institutional
investors in accordance with Rule 144A under the Securities Act and commercial
paper sold in reliance on Section 4(2) of the Securities Act), repurchase
agreements having maturities of more than seven days and certain
over-the-counter options;
(4) invest
its assets in securities of any investment company, except by purchase in the
open market involving only customary brokers’ commissions or in connection with
mergers, acquisitions of assets or consolidations, or except as may otherwise be
permitted by the 1940 Act;
(5) write
or acquire options or interests in oil, gas or other mineral exploration or
development programs or leases; and
(6) with
respect to each of the Small Cap Equity Fund, Small-Mid Cap Equity Fund, Equity
Fund, Fixed Income Fund and International Equity Fund, make any change in its
investment policy of investing at least 80% of its net assets in the investments
suggested by the Fund’s name without first providing the Fund’s shareholders
with at least 60 days’ prior notice.
INVESTMENT
OBJECTIVES AND POLICIES
The
investment objectives and policies of the Funds are described in detail in the
summary prospectuses under the caption “Principal Investment Strategies” and in
the statutory prospectus under the caption “Additional Information Regarding the
Investment Objectives and Principal Investment Strategies of the Funds.” These
sections provide a description of the securities in which a Fund principally may
invest to achieve its investment objective, the principal strategies it may
employ and the corresponding risks of such securities and strategies. Unless
otherwise indicated, each Fund may invest in the securities and other
instruments described below. The greatest risk of investing in a Fund is that
its returns will fluctuate and you could lose money. Past events in the
financial sector have resulted, and may continue to result, in an unusually high
degree of volatility in the financial markets. Both domestic and foreign equity
markets could experience volatility and turmoil.
DERIVATIVES
(International Equity Fund Only)
Generally,
a derivative is a financial instrument, the value of which is based on, or
“derived” from, a traditional security, asset, currency, or market index
(collectively referred to as “reference assets”). Some “derivatives” such as
mortgage-related and other asset-
backed
securities are in many respects like any other investment, although they may be
more volatile or less liquid than more traditional debt securities. There are,
in fact, many different types of derivatives and many different ways to use
them. The value of certain derivative securities is linked to other equity
securities (such as depositary receipts), currencies, interest rates, indices or
other financial indicators (reference assets).
LKCM
relies on an exclusion from regulation as a commodity pool operator (“CPO”)
under Commodity Futures Trading Commission (“CFTC”) Regulation 4.5 on behalf of
the International Equity Fund. In order for LKCM to rely on the exclusion,
the International Equity Fund’s commodity interests other than those used for
bona fide hedging purposes (as defined by the CFTC) must be limited such that
the aggregate initial margin and premiums required to establish the positions
(after taking into account unrealized profits and unrealized losses on any such
positions and excluding the amount by which options that are “in-the-money” at
the time of purchase) do not exceed 5% of the Fund’s NAV, or alternatively, the
aggregate net notional value of the positions, determined at the time the most
recent position was established, does not exceed 100% of the Fund’s NAV (after
taking into account unrealized profits and unrealized losses on any such
positions). Further, to qualify for the exclusion, the Fund must satisfy the
marketing test, which requires, among other things, that a fund not hold itself
out as a vehicle for trading commodity interests. The International Equity
Fund’s ability to use derivatives also may be limited by federal income tax
considerations. See the section entitled “Taxation.”
Derivatives
may involve significant risk. Some derivatives have the potential for unlimited
loss, regardless of the size of the International Equity Fund’s initial
investment. Not all derivative transactions require a counterparty to post
collateral, which may expose the International Equity Fund to greater losses in
the event of a default by a counterparty.
Derivatives
may be illiquid and may be more volatile than other types of investments. The
International Equity Fund may buy and sell derivatives that are neither
centrally cleared nor traded on an exchange. Such derivatives may be subject to
heightened counterparty, liquidity and valuation risk.
The
regulation of the U.S. and non-U.S. derivatives markets has undergone
substantial change in recent years and such change may continue. In particular,
effective August 19, 2022 (the “Compliance Date”), Rule 18f-4 under the
1940 Act (the “Derivatives Rule”) replaced the asset segregation regime of
Investment Company Act Release No. 10666 (“Release 10666”) with a new
framework for the use of derivatives by registered funds. As of the Compliance
Date, the SEC rescinded Release 10666 and withdrew no-action letters and similar
guidance addressing a Fund’s use of derivatives and began requiring a Fund to
satisfy the requirements of the Derivatives Rule. As a result, a Fund generally
is no longer required to engage in “segregation” or “coverage” techniques with
respect to derivatives transactions and will instead comply with the applicable
requirements of the Derivatives Rule.
The
enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(“Dodd-Frank Act”) resulted in historic and comprehensive reform relating to
derivatives, including the manner in which they are entered into, reported,
recorded, executed, and settled or cleared. Pursuant to the Dodd-Frank Act, the
SEC and CFTC have promulgated a broad range of regulations and guidance based on
the use of derivatives by registered investment companies. In addition,
regulations adopted by the banking regulators require certain banks to include
in a range of financial contracts, including many derivatives contracts, terms
delaying or restricting default, termination and other rights in the event that
the bank and/or its affiliates become subject to certain types of resolution or
insolvency proceedings. The regulations could limit a Fund’s ability to exercise
a range of cross-default rights if its counterparty, or an affiliate of the
counterparty, is subject to bankruptcy or similar proceeding. Such regulations
could further negatively impact a Fund’s use of derivatives.
Forward
Foreign Currency Contracts.
The International Equity Fund may enter into forward foreign currency contracts
(“forward currency contracts”). A forward currency contract involves an
obligation to purchase or sell a specified currency at a fixed price at a future
date, which may be any fixed number of days from the date of the contract agreed
upon by the parties at a price set at the time of the contract. Because these
forward currency contracts normally are settled through an exchange of
currencies, they are traded in the interbank market directly between currency
traders (usually large commercial banks) and their customers.
Forward
currency contracts may serve as long hedges. For example, the International
Equity Fund may purchase a forward currency contract to lock in the U.S. dollar
price of a security denominated in a foreign currency that it intends to
acquire. Forward currency contract transactions also may serve as short hedges.
For example, the International Equity Fund may sell a forward currency contract
to lock in the U.S. dollar equivalent of the proceeds from the anticipated sale
of a security or from a dividend or interest payment on a security denominated
in a foreign currency. The International Equity Fund may enter into forward
currency contracts to sell a foreign currency for a fixed U.S. dollar amount
approximating the value of some or all of its respective portfolio securities
denominated in such foreign currency. In addition, the International Equity Fund
may use forward currency contracts when the Adviser wishes to “lock in” the U.S.
dollar price of a security when the International Equity Fund is purchasing or
selling a security denominated in a foreign currency or anticipates receiving a
dividend or interest payment denominated in a foreign currency. The
International Equity Fund may enter into forward currency contracts for the
purchase or sale of a specified currency at a specified future date either with
respect to specific transactions or with respect to portfolio positions in order
to minimize the risk to the International Equity Fund from adverse changes in
the relationship between the U.S. dollar and foreign currencies. The
International Equity Fund may use forward currency contracts to seek to hedge
against changes in the value of a particular currency by using forward currency
contracts on another foreign currency or a basket of currencies, the value of
which the Adviser believes will have a positive correlation to the values of the
currency being hedged. Use of a different foreign currency magnifies the risk
that movements in the price of the forward contract will not correlate or will
correlate unfavorably with the foreign currency being hedged. In addition, the
International Equity Fund may use forward currency contracts to shift exposure
to foreign currency fluctuations from one country to another. For example, if
the International Equity Fund owned securities denominated in a foreign currency
that the Adviser believed would decline relative to another currency, it might
enter into a forward currency contract to sell an appropriate amount of the
first foreign currency, with payment to be made in the second currency.
Transactions that involve two foreign currencies are sometimes referred to as
“cross hedging.” Use of a different foreign currency magnifies the International
Equity Fund’s exposure to foreign currency exchange rate fluctuations.
The
cost to the International Equity Fund of engaging in forward currency contracts
varies with factors such as the currency involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts usually are entered into on a principal basis, no fees or commissions
are involved. When the International Equity Fund enters into a forward currency
contract, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract. Failure by the counterparty
to do so would result in the loss of any expected benefit of the transaction.
Sellers
or purchasers of forward currency contracts can enter into offsetting closing
transactions, similar to closing transactions on futures, by purchasing or
selling, respectively, an instrument identical to the instrument sold or bought,
respectively. Secondary markets generally do not exist for forward currency
contracts, however, with the result that closing transactions generally can be
made for forward currency contracts only by negotiating directly with the
counterparty. Thus, there can be no assurance that the International Equity Fund
will in fact be able to close out a forward currency contract at a favorable
price prior to maturity. In addition, in the event of insolvency of the
counterparty, the International Equity Fund might be unable to close out a
forward currency contract at any time prior to maturity. In either event, the
International Equity Fund would continue to be subject to market risk with
respect to the position and would continue to be required to maintain a position
in the securities or currencies that are the subject of the hedge or to maintain
cash or securities.
The
precise matching of forward currency contract amounts and the value of
securities whose U.S. dollar value is being hedged by those contracts involved
generally will not be possible because the value of such securities, measured in
the foreign currency, will change after the forward currency contract has been
established.
Thus,
the International Equity Fund might need to purchase or sell foreign currencies
in the spot (cash) market to the extent such foreign currencies are not covered
by forward contracts. The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain.
The
International Equity Fund bears the risk of loss of the amount expected to be
received under a forward currency contract in the event of the default or
bankruptcy of a counterparty. If such a default occurs, the International Equity
Fund may have contractual remedies pursuant to the forward currency contract,
but such remedies may be subject to bankruptcy and insolvency laws which could
affect the International Equity Fund’s rights as a creditor.
Non-Deliverable
Currency Forwards.
The International Equity Fund also may enter into non-deliverable currency
forwards (“NDFs”). NDFs are cash-settled, short-term forward contracts on
foreign currencies (each a “Reference Currency”), generally on currencies that
are non-convertible, and may be thinly traded or illiquid. NDFs involve an
obligation to pay a U. S. dollar amount (the “Settlement Amount”) equal to the
difference between the prevailing market exchange rate for the Reference
Currency and the agreed upon exchange rate (the “NDF Rate”), with respect to an
agreed notional amount. NDFs have a fixing date and a settlement (delivery)
date. The fixing date is the date and time at which the difference between the
prevailing market exchange rate and the agreed upon exchange rate is calculated.
The settlement (delivery) date is the date by which the payment of the
Settlement Amount is due to the party receiving payment.
Although
NDFs are similar to other forward currency contracts, NDFs do not require
physical delivery of each Reference Currency on the settlement date. Rather, on
the settlement date, one counterparty pays the Settlement Amount. NDFs typically
may have terms from one month up to two years and are settled in U.S. dollars.
The International Equity Fund will typically use NDFs for hedging purposes or
for direct investment in a foreign country for income or gain. The use of NDFs
for hedging or to increase income or gain may not be successful, resulting in
losses to the International Equity Fund, and the cost of such strategies may
reduce the Fund’s returns.
NDFs
are subject to many of the risks associated with derivatives in general and
forward currency transactions including risks associated with fluctuations in
foreign currency and the risk that the counterparty will fail to fulfill its
obligations. In addition, pursuant to the Dodd-Frank Act and regulations adopted
by the CFTC in connection with implementing the Dodd-Frank Act, NDFs are deemed
to be swaps, and consequently commodity interests for purposes of amended
Regulation 4.5.
Although
NDFs have historically been traded OTC, in the future pursuant to the Dodd-Frank
Act, they may be exchange-traded. Under such circumstances, they will be
centrally cleared and a secondary market for them will exist. All NDFs are
subject to counterparty risk, which is the risk that the counterparty will not
perform as contractually required under the NDF. With respect to NDFs that are
centrally-cleared, the International Equity Fund could lose margin payments it
has deposited with the clearing organization as well as the net amount of gains
not yet paid by the clearing organization if it breaches its obligations under
the NDF, becomes insolvent or goes into bankruptcy. In the event of bankruptcy
of the clearing organization, the investor may be entitled to the net amount of
gains the investor is entitled to receive plus the return of margin owed to it
only in proportion to the amount received by the clearing organization’s other
customers, potentially resulting in losses to the investor.
Futures
Contracts.
The International Equity Fund may enter into futures contracts. Futures
contracts obligate a purchaser to take delivery of, or cash settle, a specific
amount of a commodity, security or obligation underlying the futures contract at
a specified time in the future for a specified price. Likewise, the seller
incurs an obligation to deliver the specified amount of the underlying
obligation against receipt of the specified price. Futures are traded on both
U.S. and foreign commodities exchanges. The purchase of futures can serve as a
long hedge, and the sale of futures can serve as a short hedge.
No
price is paid upon entering into a futures contract. Instead, at the inception
of a futures contract the International Equity Fund is required to deposit
“initial margin” consisting of cash or U.S. Government Securities in an amount
set by the exchange on which the contract is traded and varying based on the
volatility of the underlying asset. Margin must also be deposited when writing a
call or put option on a futures contract, in accordance with applicable exchange
rules. Unlike margin in securities transactions, initial margin on futures
contracts does not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to the International
Equity Fund at the termination of the transaction if all contractual obligations
have been satisfied. Under certain
circumstances,
such as periods of high volatility, the International Equity Fund may be
required by a futures exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent
“variation margin” payments (sometimes referred to as “maintenance margin”
payments) are made to and from the futures broker daily as the value of the
futures position varies, a process known as “marking-to-market.” Variation
margin does not involve borrowing, but rather represents a daily settlement of
the International Equity Fund’s obligations to or from a futures broker. When
the International Equity Fund purchases or sells a futures contract, it is
subject to daily or even intraday variation margin calls that could be
substantial in the event of adverse price movements. If the International Equity
Fund has insufficient cash to meet daily or intraday variation margin
requirements, it might need to sell securities at a time when such sales are
disadvantageous.
Purchasers
and sellers of futures contracts can enter into offsetting closing transactions,
by selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in futures contracts may be closed only
on a futures exchange or board of trade that trades that contract. There can be
no assurance that such a market will exist for a particular contract at a
particular time. In such event, it may not be possible to close a futures
contract.
Although
many futures contracts by their terms call for the actual delivery or
acquisition of the underlying asset, in most cases the contractual obligation is
fulfilled before the date of the contract without having to make or take
delivery of the securities or currency. The offsetting of a contractual
obligation is accomplished by buying (or selling, as appropriate) on a
commodities exchange an identical futures contract calling for delivery in the
same month. Such a transaction, which is effected through a member of an
exchange, cancels the obligation to make or take delivery of the securities or
currency. Since all transactions in the futures market are made, offset or
fulfilled through a clearinghouse associated with the exchange on which the
contracts are traded, the International Equity Fund will incur brokerage fees
when it purchases or sells futures contracts.
Under
certain circumstances, futures exchanges may establish daily limits on the
amount that the price of a futures contract can vary from the previous day’s
settlement price; once that limit is reached, no trades may be made that day at
a price beyond the limit. Daily price limits do not limit potential losses
because prices could move to the daily limit for several consecutive days with
little or no trading, thereby preventing liquidation of unfavorable positions.
If
the International Equity Fund were unable to liquidate a futures contract due to
the absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The International Equity Fund would continue to
be subject to market risk with respect to the position. In addition, the
International Equity Fund would continue to be required to make daily variation
margin payments and might be required to maintain the position being hedged by
the futures contract or option thereon or to maintain cash or securities in a
segregated account.
The
ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
deposit requirements, investors may close futures contracts through offsetting
transactions that could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus producing distortion. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of securities price or currency exchange rate trends by the
Adviser may still not result in a successful transaction.
Futures
contracts also entail other risks. Although the use of such contracts may
benefit the International Equity Fund, if investment judgment about the general
direction of, for example, an index is incorrect, the International Equity
Fund’s overall performance would be worse than if it had not entered into any
such contract. There are differences between the securities and futures markets
that could result in an imperfect correlation between the markets, causing a
given transaction not to achieve its objectives.
Options. The
use of options involves investment strategies and risks different from those
associated with ordinary portfolio securities transactions. If a strategy is
applied at an inappropriate time or market conditions or trends are judged
incorrectly, the use of options may lower the International Equity Fund’s
return. There can be no guarantee that the use of options will increase the
International Equity Fund’s return or income. In addition, there may be an
imperfect correlation between the movement in prices of options and the
securities underlying them and there may at times not be a liquid secondary
market for various options.
By
writing put options, the International Equity Fund takes on the risk of declines
in the value of the underlying instrument, including the possibility of a loss
up to the entire strike price of each option it sells, but without the
corresponding opportunity to benefit from potential increases in the value of
the underlying instrument. When the International Equity Fund writes a put
option, it assumes the risk that it must purchase the underlying instrument at a
strike price that may be higher than the market price of the instrument. If
there is a broad market decline and the International Equity Fund is not able to
close out its written put options, it may result in substantial losses to the
Fund. By writing a call option, the International Equity Fund may be obligated
to deliver instruments underlying an option at less than the market price. When
the International Equity Fund writes a covered call option, it gives up the
opportunity to profit from a price increase in the underlying instrument above
the strike price. If a covered call option that the International Equity Fund
has written is exercised, the International Equity Fund will experience a gain
or loss from the sale of the underlying instrument, depending on the price at
which the Fund purchased the instrument and the strike price of the option. The
International Equity Fund will receive a premium from writing options, but the
premium received may not be sufficient to offset any losses sustained from
exercised options. In the case of a covered call, the premium received may be
offset by a decline in the market value of the underlying instrument during the
option period. If an option that the International Equity Fund has purchased is
never
exercised
or closed out, the International Equity Fund will lose the amount of the premium
it paid and the use of those funds. Options on futures contracts may be subject
to additional risks, including risks associated with the underlying futures
contract.
EQUITY
RELATED SECURITIES
The
equity securities in which the Funds may invest include American Depositary
Receipts (“ADRs”), common stocks, securities convertible into common stock
(“convertible securities”), preferred stocks, shares of real estate investment
trusts (“REITs”), rights and warrants.
ADRs.
ADRs are depositary receipts for foreign issuers in registered form traded in
U.S. securities markets. ADRs are not considered to be foreign securities when
calculating a Fund’s foreign securities limitations, but such securities may be
subject to many of the same risks as foreign securities. ADRs may be listed on a
national securities exchange or may trade in the over-the-counter market. ADR
prices are denominated in U.S. dollars; the underlying security is denominated
in a foreign currency. ADRs may not be denominated in the same currency as the
securities into which they may be converted. Investing in depositary receipts
entails substantially the same risks as direct investment in foreign securities.
There is generally less publicly available information about foreign companies
and there may be less governmental regulation and supervision of foreign stock
exchanges, brokers and listed companies. In addition, such companies may use
different accounting and financial standards (and certain currencies may become
unavailable for transfer from a foreign currency), resulting in a Fund’s
possible inability to convert immediately into U.S. currency proceeds realized
upon the sale of portfolio securities of the affected foreign companies. The
issuers of unsponsored depositary receipts generally are not obligated to
disclose material information about the underlying securities to investors in
the United States. Ownership of unsponsored depositary receipts may not entitle
a Fund to the same benefits and rights as ownership of a sponsored depositary
receipt or the underlying security. Please see “Foreign and Emerging Market
Securities” below for a description of the risks associated with investments in
foreign securities.
Common
Stocks. Common
stocks represent the residual ownership interest in the issuer and are generally
subordinate to all of its other obligations, including preferred stock. Common
stocks generally have voting rights. Common stocks fluctuate in price in
response to many factors including historical and prospective earnings of the
issuer, the value of its assets, factors affecting companies in the same
industry or sector, general economic conditions, interest rates, currency
exchange rates, investor perceptions and market liquidity. The price of a
company’s stock may also be affected by changes in financial markets that are
relatively unrelated to the particular company, such as currency exchange rates
or industry regulation. Companies that elect to pay dividends on their common
stock generally only do so after they invest in their own business and make
required payments to bondholders and on other debt and preferred stock.
Therefore, the value of a company’s common stock will usually be more volatile
than its bonds, other debt and preferred stock. Common stock may be
exchange-traded or traded over-the-counter (“OTC”). OTC stock may be less liquid
than exchange-traded stock. In the event of an issuer’s bankruptcy, there is a
substantial risk that there will be nothing left to pay common stockholders
after payments, if any, to bondholders and preferred stockholders have been
made.
Convertible
Securities.
A convertible security is a bond, debenture, note or other security that
entitles the holder to acquire common stock or other equity securities of the
same or a different issuer within a particular period of time at a specified
price or formula. A convertible security generally entitles the holder to
receive interest paid or accrued until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible securities have
characteristics similar to nonconvertible debt securities. Convertible
securities rank senior to common stock in a corporation’s capital structure and,
therefore, may entail less risk than the corporation’s common stock, although
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed income
security. The market value of convertible securities tends to decline as
interest rates increase and, conversely, to increase as interest rates decline.
While convertible securities generally offer lower interest or dividend yields
than non-convertible debt securities of similar quality, they do enable the
investor to benefit from increases in the market price of the underlying common
stock. Holders of convertible securities have a claim on the assets of the
issuer prior to the common stockholders but may be subordinated to holders of
similar non-convertible securities of the same issuer. A convertible security
may be subject to redemption at the option of the issuer at a predetermined
price. If a convertible security held by a Fund is called for redemption, the
Fund would be required to permit the issuer to redeem the security and convert
it to underlying common stock, or would sell the convertible security to a third
party.
Preferred
Stocks.
Preferred stock generally offers a stated dividend rate payable from the
corporation’s earnings. These preferred stock dividends may be cumulative or
non-cumulative, participating, or auction rate. If interest rates rise, the
fixed dividend on preferred stocks may be less attractive, causing the price of
preferred stocks to decline. Preferred stock may have mandatory sinking fund
provisions, as well as call/redemption provisions prior to maturity, a negative
feature when interest rates decline. The rights of preferred stocks are
generally subordinate to rights associated with a corporation’s debt securities.
Dividends on some preferred stock may be “cumulative” if stated dividends from
prior periods have not been paid. Preferred stock also generally has a
preference over common stock on the distribution of a corporation’s assets in
the event of liquidation of the corporation, and may be “participating,” which
means that it may be entitled to a dividend exceeding the stated dividend in
certain cases.
Real
Estate Investment Trusts. The
Funds may invest in shares of REITs. Equity REITs invest in income-producing
real estate. They produce income from rental and lease payments as well as
occasional sales of property. Mortgage REITs make construction, development, and
long-term mortgage loans. They produce income from repayment of the loans and
sales of the loan obligations. Hybrid REITs may invest in both real estate and
real estate loans.
Unlike
most corporations (and trusts and associations otherwise taxable as such for
federal tax purposes), REITs do not have to pay federal income tax on net income
and net realized gains they distribute to their shareholders if they meet
certain requirements of the Internal Revenue Code of 1986, as amended. To
qualify for that treatment, a REIT must, among other things, (1) distribute
to its shareholders for each taxable year at least 90% of the sum of its “real
estate investment trust taxable income” (which includes all net realized capital
gains) and certain other income and (2) derive at least 75% of its gross
income each taxable year from rents from real property, interest on mortgages
secured by real property, gains from the disposition of real property or such
mortgages, and certain
other
real estate related income. The failure of a company in which a Fund invests to
qualify for treatment as a REIT under federal tax law may have an adverse impact
on the Fund. REITs generally offer investors greater liquidity and
diversification than direct ownership of real estate, as well as greater income
potential than an investment in common stocks.
REITs
are subject to real estate industry risk. These risks may include the following:
declines in the value of real estate; risks related to general and local
economic conditions; possible lack of availability of mortgage funds; lack of
ability to access the credit or capital markets; overbuilding; extended
vacancies of properties; defaults by borrowers or tenants, particularly during
an economic downturn; increasing competition; increases in property taxes and
operating expenses; changes in zoning laws; losses due to costs resulting from
the clean-up of environmental problems; liability to third parties for damages
resulting from environmental problems; casualty or condemnation losses;
regulatory limitations on rents and operating expenses; changes in market and
sub-market values and the appeal of properties to tenants; and changes in
interest rates. In general, real estate values can be affected by a variety of
factors, including supply and demand for properties, the economic health of the
country as well as different regions, and the strength of specific industries
that rent properties. Ultimately, an individual REIT’s performance depends on
the types and locations for the properties it owns and on how well the REIT
manages its properties. For instance, rental income could decline because of
extended vacancies, increased competition from nearby properties, tenants’
failures to pay rent, or incompetent management. Property values could decrease
because of overbuilding in the area, environmental liabilities, uninsured
damages caused by natural disasters, a general decline in the neighborhood,
losses due to casualty or condemnation, increases in property taxes, or changes
in zoning laws. Any domestic REIT could be adversely affect by the failure of a
REIT to qualify for federal income-tax-free “pass-through” of net income and net
realized gains that are distributed to shareholders and exemption from
registration as an investment company. The failure of a company to qualify for
treatment as a REIT under the federal tax law likely would have an adverse
impact on a Fund’s after-tax performance.
REITs
are also subject to interest rate risk. REIT stock prices overall will decline
over short or even long periods in an environment of rising interest rates. In
general, during periods of high interest rates, REITs may lose some of their
appeal for investors who may be able to obtain higher yields from other
income-producing investments. Higher interest rates also mean that financing for
real estate purchases and improvements may be more costly and difficult to
obtain.
REITs
tend to be small or medium-size companies. Because small and mid-cap stocks are
typically less liquid than large-cap stocks, REIT stocks may sometimes
experience greater share-price fluctuation than the stocks of larger companies.
REITs are pooled investment vehicles with their own fees and expenses and a Fund
will indirectly bear its proportionate share of those fees and expenses, which
can be significant.
Rights
and Warrants.
Rights and warrants are options to purchase equity securities at specific prices
valid for a specific period of time. Their prices do not necessarily move
parallel to the prices of the underlying securities. Rights are similar to
warrants but normally have a short duration and are distributed by the issuer to
its shareholders. Warrants and rights have no voting rights, receive no
dividends and have no rights with respect to the assets of the issuer. The
percentage increase or decrease in the value of a warrant may be greater than
the percentage increase or decrease in the value of the underlying equity
security. The market for warrants or rights may be very limited and it may be
difficult to sell them promptly at an acceptable price.
Securities
Subject to Special Situations.
The Funds may invest in equity securities for which a tender or exchange offer
has been made or announced and in securities of companies for which a merger,
consolidation, bankruptcy, liquidation, restructuring or reorganization proposal
or other unusual event has been announced or is anticipated. The primary risk of
such investments is that if the contemplated transaction is abandoned, revised,
delayed or becomes subject to uncertainty, the market price of the securities
may decline below the purchase price paid by a Fund. Generally, securities which
are the subject of such an offer or proposal sell at a premium to their historic
market price immediately prior to the announcement of the offer or may also
discount what the stated or appraised value of the security would be if the
contemplated transaction were approved or consummated. Such investments may be
advantageous when the discount significantly overstates the risk of the
contingencies involved, significantly undervalues the securities, assets or cash
to be received by shareholders of the target company as a result of the
contemplated transaction, or fails adequately to recognize the possibility that
the offer or proposal may be replaced or superseded by an offer or proposal of
greater value.
The
evaluation of such contingencies requires broad knowledge and experience on the
part of the Adviser which must appraise not only the value of the issuer and its
component businesses as well as the assets or securities to be received as a
result of the contemplated transaction but also the financial resources and
business motivation of the offeror and the dynamics and business and regulatory
climate when the offer or proposal is in process. It may be difficult to obtain
complete financial or other information about companies involved in certain
special situations and management of such companies may be addressing a
situation with which it has little experience. Since such investments are
ordinarily short-term in nature, they will tend to increase the turnover ratio
of a Fund, thereby increasing its brokerage and other transaction expenses, and
be more speculative. Conversely, the terms of certain special situation
investments may be subject to restrictions that prevent a Fund from selling the
position until the special situation is largely resolved, which may limit a
Fund’s ability to pursue other opportunities as they arise.
FOREIGN
AND EMERGING MARKET SECURITIES
Foreign
Securities.
The Funds may invest in securities of foreign issuers. The Balanced Fund may
invest up to 10% of its total assets in foreign securities. Investing in foreign
issuers involves certain special considerations that are not typically
associated with investing in securities of U.S. issuers. Since the securities of
foreign issuers are frequently denominated in foreign currencies, the Funds may
purchase or sell non-U.S. currency futures contracts and options on non-U.S.
currency futures, and the Funds may temporarily hold invested reserves in bank
deposits in foreign currencies, the Funds will be affected favorably or
unfavorably by changes in currency rates and in exchange control regulations,
and may incur costs in connection with conversions between various currencies.
Foreign currencies will fluctuate, and may decline, in value relative to the
U.S. dollar and affect a Fund’s investments in foreign currencies or in
securities that trade in, and receive revenues in, or in derivatives that
provide exposure to, foreign currencies.
As
foreign companies are not generally subject to uniform accounting, auditing and
financial reporting standards and practices comparable to those applicable to
domestic companies, there may be less publicly available information about
certain foreign companies than about domestic companies. Securities of some
foreign companies are generally less liquid and more volatile than securities of
comparable domestic companies. There is generally less government supervision
and regulation of stock exchanges, brokers and listed companies than in the U.S.
In addition, with respect to certain foreign countries, there is the possibility
of expropriation or confiscatory taxation, political or social instability, or
diplomatic developments that could affect U.S. investments in those countries.
Although each Fund will endeavor to achieve most favorable execution costs in
its portfolio transactions, fixed commissions on many foreign stock exchanges
are generally higher than negotiated commissions on U.S. exchanges. In addition,
it is expected that the expenses for custodian arrangements of the Funds’
foreign securities will be somewhat greater than the expenses for the custodian
arrangements for handling U.S. securities of equal value, especially for
emerging market securities. Foreign markets have different clearance and
settlement procedures. In certain markets, there have been times when
settlements have been unable to keep pace with the volume of securities
transactions, making it difficult to conduct such transactions. Delays in
settlement could result in temporary periods when a portion of the assets of the
Funds are not invested and no return is earned thereon. The inability of the
Funds to make intended security purchases due to settlement problems could cause
the Funds to miss attractive investment opportunities. The inability of the
Funds to dispose of portfolio securities due to settlement problems could result
in losses to the Funds due to subsequent declines in value of the securities or,
if the Funds have entered into a contract to sell the securities, could result
in possible liability to the purchaser.
Interest
rates prevailing in other countries may affect the prices of foreign securities
and exchange rates for foreign currencies. Local factors, including the strength
of the local economy, the demand for borrowing, the government’s fiscal and
monetary policies, and the international balance of payments, often affect
interest rates in other countries. Individual foreign economies may differ
favorably or unfavorably from the U.S. economy in such respects as growth of
gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency, and balance of payments position.
Certain
foreign governments levy withholding or other taxes against dividend and
interest income paid by citizens or corporations operating therein to investors
from other countries. Although in some countries a portion of these taxes are
recoverable, the non-recovered portion of those taxes will reduce a Fund’s
income received from an issuer subject thereto.
Investing
in foreign securities may involve a greater risk for excessive trading due to
“time-zone arbitrage.” If an event occurring after the close of a foreign
market, but before the time a Fund computes its current NAV, causes a change in
the price of the foreign securities and such price is not reflected in the
Funds’ current NAV, investors may attempt to take advantage of anticipated price
movements in securities held by the Funds based on such pricing discrepancies.
Securities
of European Issuers.
A Fund’s performance may be affected by political, social and economic
conditions in Europe, such as the growth of the economic output (the gross
national product of the countries in the region), the rate of inflation, the
rate at which capital is reinvested into European economies, the success of
governmental actions to reduce budget deficits, the resource self-sufficiency of
European countries, interest rates in European countries, monetary exchange
rates between European countries,
and
conflict between European countries.
The
Economic and Monetary Union (“EMU”) of the European Union (“EU”) is comprised of
EU members that have adopted the euro currency. By adopting the euro as its
currency, a member state relinquishes control of its own monetary policies and
is subject to fiscal and monetary controls. The EMU requires Eurozone countries
to comply with restrictions on interest rates, deficits, debt levels, and
inflation rates, fiscal and monetary controls, and other factors. Although the
EMU has adopted a common currency and central bank, there is no fiscal union;
therefore, money does not automatically flow from countries with surpluses to
those with deficits. These restrictions and characteristics may limit the
ability of EMU member countries to implement monetary policy to address regional
economic conditions and significantly impact every European country and their
economic partners, including those countries that are not members of the EMU. In
addition, those EU member states that are not currently in the Eurozone
(Bulgaria, the Czech Republic, Denmark, Hungary, Poland, Romania, and Sweden),
excluding Denmark, are required to seek to comply with convergence criteria to
permit entry to the Eurozone. The economies and markets of European countries
are often closely connected and interdependent, and events in one country in
Europe can have an adverse impact on other European countries. Decreasing
imports or exports, changes in governmental or other regulations on trade,
changes in the exchange rate of the euro or other European currency, the threat
of default or actual default by one or more EU member countries, or other
European countries, on its sovereign debt, and/or an economic recession in one
or more European countries may have a significant adverse effect on the
economies of other European countries and major trading partners outside Europe.
The
European financial markets have experienced and may continue to experience
volatility and adverse trends due to concerns relating to economic downturns;
rising government debt levels and national unemployment; the possible default of
government debt in several European countries; public health crises; political
unrest; economic sanctions; inflation; energy crises; the future of the euro as
a common currency; and war and military conflict, such as the Russian invasion
of Ukraine. These events have adversely affected the exchange rate of the euro
and may continue to significantly affect European countries. Responses to
financial problems by European governments, central banks, and others, including
austerity measures and other reforms, may not produce the desired results, may
result in social unrest and may limit future growth and economic recovery or may
have unintended consequences. In order to prevent further economic
deterioration, certain countries, without prior warning, can institute “capital
controls.” Countries may use these controls to restrict volatile movements of
capital entering and exiting their country. Such controls may negatively affect
a Fund’s investments. In addition, one or more countries may abandon the euro
and/or withdraw from the EU. The impact of these actions, especially if they
occur in a disorderly fashion, could be significant and far-reaching. Many
European nations are susceptible to economic risks associated with high levels
of debt. Non-governmental issuers, and even certain governments, have defaulted
on, or been forced to restructure, their debts, and other issuers have faced
difficulties obtaining credit or refinancing existing obligations. A default or
debt restructuring by any European country could adversely impact holders of
that country’s debt and sellers of credit default swaps linked to that country’s
creditworthiness, which may be located in other countries. Such a default or
debt restructuring
could
affect exposures to other European countries and their financial companies as
well. Further defaults on, or restructurings of, the debt of governments or
other entities could have additional adverse effects on economies, financial
markets and asset valuations around the world. In addition, issuers may face
difficulties obtaining credit or refinancing existing obligations; financial
institutions may require government or central bank support, or need to raise
capital, and/or be impaired in their ability to extend credit. Furthermore,
certain European countries have had to accept assistance from supranational
agencies such as the International Monetary Fund, the European Stability
Mechanism or others. The European Central Bank has also intervened to purchase
Eurozone debt in an attempt to stabilize markets and reduce borrowing costs.
There can be no assurance that any creditors or supranational agencies will
continue to intervene or provide further assistance, and markets may react
adversely to any expected reduction in the financial support provided by these
creditors. Certain European countries have also developed increasingly strained
relationships with the U.S., and if these relationships were to worsen, they
could adversely affect European issuers that rely on the U.S. for trade.
In
addition, the national politics of European countries have been unpredictable
and subject to influence by disruptive political groups, ideologies, and
polarizing political events such as the conflict between Israel and Hamas.
Secessionist movements, as well as government or other responses to such
movements, may create instability and uncertainty in a country or region.
European governments may be subject to change and such countries may experience
social and political unrest. Unanticipated or sudden political or social
developments may result in sudden and significant investment losses. The
occurrence of terrorist incidents throughout Europe and in the Middle East also
could impact financial markets, as could military conflicts. For example, Houthi
attacks on commercial shipping in the Red Sea and Gulf of Aden, and retaliatory
action, may disrupt supply chains and cause difficulties for impacted
businesses, including those that wish to ship goods through that route. The
impact of these kinds of events could be significant and far-reaching and
materially impact the value and liquidity of a Fund’s investments. Russia’s war
with Ukraine has negatively impacted European economic activity. The
Russia/Ukraine war and Russia’s response to sanctions imposed by the U.S. and
other countries are impossible to predict, but have severely impacted the
performance of the economies of European and other countries, including through
adverse effects to global financial and energy markets, global supply chains and
global growth, and consequential inflation.
Certain
countries have applied to become new member countries of the EU, and these
candidate countries’ accessions may become more controversial to the existing EU
members. Some member states may repudiate certain candidate countries joining
the EU due to concerns about the possible economic, immigration and cultural
implications. Certain other countries have applied to join or, in the case of
Finland and Sweden, have recently joined, the North Atlantic Treaty Organization
(“NATO”). Russia is understood to oppose certain expansions, or potential
expansions, of NATO and the EU, and its reaction to such developments could
negatively impact European economic activity. The United Kingdom withdrew from
the European Union on January 31, 2020 and entered into a transition period,
which ended on December 31, 2020. The longer-term economic, legal, and political
framework between the United Kingdom and the EU is still developing and may lead
to ongoing political and economic uncertainty in the United Kingdom, Europe, and
the global market. Investments in companies with significant operations and/or
assets in the United Kingdom could be adversely impacted by the new legal,
political, and regulatory environment, whether by increased costs or impediments
to the implementation of business plans. The uncertainty resulting from any
further exits from the EU, or the possibility of such exits, would also be
likely to cause market disruption in the EU and more broadly across the global
economy, as well as introduce further legal, political, and regulatory
uncertainty in Europe.
Emerging
Market Investments. Investing
in emerging markets can have more risk than investing in developed foreign
markets, such as (i) low or non-existent trading volume, resulting in a
lack of liquidity and increased volatility in prices for such securities, as
compared to securities from more developed markets, (ii) uncertain national
policies and social, political and economic instability, increasing the
potential for expropriation of assets, confiscatory taxation, high rates of
inflation or unfavorable diplomatic or geopolitical developments,
(iii) possible fluctuations in exchange rates, differing legal systems and
the existence or possible imposition of exchange controls, custodial
restrictions or other non-U.S. or U.S. governmental laws or restrictions
applicable to such investments, (iv) national policies that may limit a
Fund’s investment opportunities such as restrictions on investment in issuers or
industries deemed sensitive to national interests, (v) the lack or
relatively early development of legal structures governing private and foreign
investments and private property, and (vi) less diverse or immature
economic structures. The risks of investing in these markets may be exacerbated
relative to investments in developed markets and investments in these countries
may be subject to erratic and abrupt price movements. In addition, emerging
markets may impose capital restrictions and thus, may adversely affect the
operations of a Fund and certain emerging markets impose constraints on currency
exchange and some currencies in emerging markets may have been devalued
significantly against the U.S. dollar. In addition to withholding taxes on
investment income, some countries in emerging markets may impose differential
capital gain taxes on foreign investors. For these and other reasons, the prices
of securities in emerging markets can fluctuate more significantly than the
prices of securities of companies in developed markets. The less developed the
country, the greater effect these risks may have on your investment in a Fund.
Emerging
markets have evolved in a dynamic political and economic environment brought
about by events over recent years that have reshaped political boundaries and
traditional ideologies. In such a dynamic environment, there can be no assurance
that these emerging markets will continue to present viable investment
opportunities for a Fund. In the past, governments of countries in emerging
markets have expropriated substantial amounts of private property, and most
claims of the property owners have never been fully settled. There is no
assurance that such expropriations will not reoccur. In such event, it is
possible that a Fund could lose the entire value of its investments in the
affected markets.
Some
economies are less well developed and less diverse and more vulnerable to the
ebb and flow of international trade, trade barriers and other protectionist or
retaliatory measures. The economies of emerging market countries may be based
predominately on only a few industries or may be dependent on revenues from
participating commodities or on international aid or developmental assistance,
may be highly vulnerable to changes in local or global trade conditions, and may
suffer from extreme and volatile debt burdens or inflation rates. Many of these
countries are grappling with severe inflation or recession, high levels of
national debt, currency exchange problems and government instability.
Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer or governmental
authority that controls the repayment of an emerging market country’s debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A debtor’s willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, and, in the case of a government debtor,
the extent of its foreign reserves, the availability of sufficient foreign
exchange on the date a payment is due, the relative size of the debt service
burden to the economy as a whole and the political constraints to which a
government debtor may be subject. Government debtors may default on their debt
and may also be dependent on expected disbursements from foreign governments,
multilateral agencies and others abroad to reduce principal and interest
arrearages on their debt. Holders of government debt may be requested to
participate in the rescheduling of such debt and to extend further loans to
government debtors. If such an event occurs, a Fund may have limited legal
recourse against the issuer and/or guarantor. Remedies must, in some cases, be
pursued in the courts of the defaulting party itself, and the ability of the
holder of foreign government fixed income securities to obtain recourse may be
subject to the political climate in the relevant country. In addition, no
assurance can be given that the holders of commercial bank debt will not contest
payments to the holders of other foreign government debt obligations in the
event of default under their commercial bank loan agreements.
A
Fund may encounter substantial difficulties in obtaining and enforcing judgments
against individuals and companies located in certain emerging market countries,
either individually or in combination with other shareholders. It may be
difficult or impossible to obtain or enforce legislation or remedies against
governments, their agencies and sponsored entities. Additionally, in certain
emerging market countries, fraud, corruption and attempts at market manipulation
may be more prevalent than in developed market countries. Shareholder claims
that are common in the U.S. and are generally viewed as determining misconduct,
including class action securities law and fraud claims, generally are difficult
or impossible to pursue as a matter of law or practicality in many emerging
markets.
Also,
there may be less publicly available information about issuers in emerging
markets than would be available for issuers in more developed markets, and such
issuers may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those to which U.S. companies or
issuers in more developed markets are subject. In certain countries with
emerging markets, reporting standards vary widely. As a result, traditional
investment measurements used in the U.S. may not be applicable. Emerging market
investments may be substantially less liquid and more volatile than those of
more developed markets, and securities may be held by a limited number of
investors. This may adversely affect the timing and pricing of a Fund’s
acquisition or disposal of emerging market investments.
The
laws in certain emerging market countries may be based upon or be highly
influenced by religious codes or rules. The interpretation of how these laws
apply to certain investments may change over time, which could have a negative
impact on those investments and a Fund.
Practices
in relation to settlement of securities transactions in emerging markets involve
higher risks than those in developed markets, in part because a Fund may use
brokers and counterparties that are less well capitalized, and custody and
registration of assets in some countries may be unreliable.
Many
emerging market countries have little experience with the corporate form of
business organization and may not have well-developed corporation and business
laws or concepts of fiduciary duty in the business context. The organizational
structures of certain issuers in emerging markets may limit investor rights and
recourse.
Regulatory
authorities in some emerging markets currently do not provide the Public Company
Accounting Oversight Board with the ability to inspect public accounting firms
as required by U.S. law, including sufficient access to inspect audit work
papers and practices, or otherwise do not cooperate with U.S. regulators, which
potentially could expose investors to significant risks.
FIXED
INCOME SECURITIES
The
fixed income securities in which the Funds may invest include securities issued
or guaranteed by the U.S. Government, its agencies or instrumentalities, and
securities issued by domestic or foreign corporations and other entities. The
Fixed Income Fund invests under normal circumstances at least 80% of its net
assets in a portfolio of investment grade corporate fixed income securities and
fixed income securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities.
Recent
Fixed Income Market Events. Although
interest rates were unusually low in recent years in the U.S. and abroad, in
2022, the Federal Reserve and certain foreign central banks began to raise
interest rates as part of their efforts to address rising inflation. It is
difficult to accurately predict the pace at which interest rates might increase
or start decreasing, the timing, frequency or magnitude of any such changes in
interest rates, or when such changes might stop or reverse course. Additionally,
various economic and political factors could cause the Federal Reserve or
another foreign central bank to change their approach in the future and such
actions may result in an economic slowdown in the U.S. and abroad. Unexpected
changes in interest rates could lead to significant market volatility or reduce
liquidity in certain sectors of the market. Deteriorating economic fundamentals
may, in turn, increase the risk of default or insolvency of particular issuers,
negatively impact market value, cause credit spreads to widen, and reduce bank
balance sheets. Any of these could cause an increase in market volatility or
reduce liquidity across various markets. Additionally, high public debt in the
U.S. and other countries creates ongoing systemic and market risks and
policymaking uncertainty. There is a potential for materially increased
regulation in the future, as well as higher taxes or taxes restructured to
incentivize different activities. These changes, should they occur, may impose
added costs on a Fund and its service providers, and affect the businesses of
various portfolio companies, in ways that cannot necessarily be foreseen at the
present time. Markets may react strongly to expectations about the changes in
these policies, which could increase volatility, especially if the markets’
expectations for changes in government policies are not borne out. Policy
changes by the U.S. Government, the Federal Reserve or the central banks may
expose a Fund’s investments in debt securities and the fixed income markets to
heightened volatility and may reduce liquidity for certain Fund investments,
which could cause the value of a Fund’s investments and share price to decline.
To the extent that a Fund experiences
high
redemptions because of these policy changes, the Fund may experience increased
portfolio turnover, which will increase the costs that the Fund incurs and may
lower the Fund’s performance, and have trouble selling investments to meet
shareholder redemptions.
Ratings.
As noted above, all of the Funds may invest in various fixed income securities,
including fixed income securities that are rated at the time of purchase as
investment grade by a nationally recognized statistical rating organization
(“NRSRO”), such as S&P Global Ratings (“S&P”), Moody’s Investors
Service, Inc. (“Moody’s”), or Fitch Ratings, Inc. (“Fitch”), or of equivalent
quality as determined by the Adviser. Investment grade fixed income securities
include:
• Securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities;
• Bonds
or bank obligations rated in one of the four highest categories (such as BBB- or
higher by S&P);
• Short-term
notes rated in one of the two highest categories (such as SP-2 or higher by
S&P); and
• Commercial
paper or short-term bank obligations rated in one of the three highest
categories (such as A-3 or higher by S&P).
Investment
grade fixed income securities are generally perceived to have a lower degree of
credit risk. However, certain investment grade securities with lower ratings are
considered medium quality and may be subject to greater credit risk than the
highest rated securities. If a security’s rating falls below that required at
the time of purchase, the Adviser will consider what action, if any, should be
taken consistent with a Fund’s investment objective. Additional information
concerning securities ratings is contained in Appendix A to this SAI.
U.S.
Government Agency Securities.
U.S. Government agency securities are issued or guaranteed by the U.S.
Government or its agencies or instrumentalities or government sponsored
enterprises. Some obligations issued by U.S. Government agencies and
instrumentalities are supported by the full faith and credit of the U.S.
Treasury; others by the right of the issuer to borrow from the U.S. Treasury;
others by the discretionary authority of the U.S. Government to purchase certain
obligations of the agency or instrumentality; and others only by the credit of
the agency or instrumentality. U.S. Government securities bear fixed, floating
or variable rates of interest. While the U.S. Government may provide financial
support to certain U.S. Government-sponsored agencies or instrumentalities, no
assurance can be given that it will do so, since it is not so obligated by law.
U.S. Government agency obligations and repurchase agreements secured thereby are
primarily subject to market risk, credit risk and interest rate risk.
U.S.
Treasury Obligations.
U.S. Treasury obligations may differ in their interest rates, maturities, times
of issuance and other characteristics, and include bills (initial maturities of
one year or less), notes (initial maturities between two and ten years), and
bonds (initial maturities over ten years) issued by the U.S. Treasury,
Separately Traded Registered Interest and Principal component parts of such
obligations known as STRIPS, which are traded independently, and Treasury
inflation protected securities, whose principal value is periodically adjusted
according to the rate of inflation. The prices of these securities (like all
debt securities) change between issuance and maturity in response to fluctuating
market interest rates. U.S. Treasury obligations are subject to credit risk and
interest rate risk. The total amount of debt the Treasury is authorized to incur
is subject to a statutory limit. Once the Treasury reaches the debt limit,
Congress must raise, extend or otherwise modify the limit to enable the Treasury
to incur additional debt to pay the obligations of the U.S. government,
including principal and interest payments on certain U.S. Treasury obligations
(such as Treasury bills, notes and bonds). The failure, or potential failure, to
increase the statutory debt limit could: increase the risk that the U.S.
government defaults on payments on certain U.S. Treasury obligations; cause the
credit rating of the U.S. government to be downgraded or increase volatility in
both stock and bond markets; result in higher debt servicing payments by the
U.S. government; reduce prices of Treasury securities; and/or increase the costs
of certain kinds of debt.
The
Funds may invest in component parts of U.S. Treasury notes or bonds, namely
either the principal of such Treasury obligations or one of the interest
payments scheduled to be paid on such obligations. These obligations may take
the form of: (1) Treasury obligations from which the interest coupons have
been stripped; (2) the interest coupons that are stripped;
(3) book-entries at a Federal Reserve member bank representing ownership of
Treasury obligation components; or (4) receipts evidencing the component
parts (principal or coupons) of Treasury obligations that have not actually been
stripped. Such receipts evidence ownership of component parts of Treasury
obligations (principal or coupons) purchased by a third party (typically an
investment banking firm) and held on behalf of the third party in physical or
book-entry form by a major commercial bank or trust company pursuant to a
custody agreement with the third party. These custodial receipts are known by
various names, including “Treasury Receipts,” “Treasury Investment Growth
Receipts” (“TIGRs”) and “Certificates of Accrual on Treasury Securities”
(“CATs”), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
Investment
Grade Fixed Income Securities.
The Funds may invest in fixed income securities of domestic or foreign issuers
(corporate bonds, debentures, notes and other similar corporate debt
instruments) rated as investment grade at the time of purchase by a NRSRO.
Even
fixed income securities rated investment grade by a NRSRO possess some
speculative characteristics. There are risks involved in applying credit ratings
as a method for evaluating fixed income securities in that credit ratings
evaluate the safety of principal and interest payments, not market value risk.
In addition, credit ratings may not be correct and credit rating agencies may
not change credit ratings on a timely basis to reflect changes in economic or
company conditions that affect a security’s market value. Changes in economic
conditions or other circumstances may lead to a weakened capacity of the issuer
to make principal and interest payments on such securities.
The
Funds will rely on the judgment, analysis and experience of the Adviser in
evaluating the creditworthiness of an issuer. In this evaluation, the Adviser
may take into consideration, among other things, the issuer’s financial
resources and ability to cover its interest and fixed charges, factors relating
to the issuer’s industry and its sensitivity to economic conditions and trends,
its operating
history,
the quality of the issuer’s management and regulatory matters. The rate of
return or return of principal on some debt obligations may be linked or indexed
to the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
The
risk of loss due to default by the issuer is significantly greater for the
holders of lower quality fixed income securities because such securities are
generally unsecured and are often subordinated to other obligations of the
issuer. During an economic downturn or a sustained period of rising interest
rates, highly leveraged issuers of lower quality fixed income securities may
experience financial stress and may not have sufficient revenues to meet their
interest payment obligations. An issuer’s ability to service its debt
obligations may also be adversely affected by specific corporate developments,
its inability to meet specific projected business forecasts, or the
unavailability of additional financing.
Factors
adversely affecting the market value of fixed income securities may adversely
affect the net asset value of a Fund if it invests in such securities. At this
time, interest rates are at or near historic lows. In the future, interest rates
may increase, perhaps significantly and/or rapidly, thereby heightening a Fund’s
exposure to the risks associated with rising interest rates. In addition, a Fund
may incur additional expenses to the extent it is required to seek recovery upon
a default in the payment of principal of or interest on its portfolio holdings.
The
secondary trading market for lower-quality fixed income securities is generally
not as liquid as the secondary market for higher-quality fixed income securities
and is very thin for some fixed income securities. The relative lack of an
active secondary market may have an adverse impact on market price and a Fund’s
ability to dispose of particular issues when necessary to meet the Fund’s
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. The relative lack of an
active secondary market for certain securities may also make it more difficult
for a Fund to obtain information for purposes of valuing the Fund’s portfolio.
Pricing data is generally available on many high yield issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales. During such times, the ability to value the
securities becomes more difficult and judgment plays a greater role in valuation
because there is less reliable, objective data available.
Variable
and Floating Rate Obligations. The
interest rates payable on certain fixed income securities in which a Fund may
invest are not fixed and may fluctuate based upon changes in market rates. A
variable rate obligation has an interest rate which is adjusted at predesignated
periods in response to changes in the market rate of interest on which the
interest rate is based. Variable and floating rate obligations are generally
less effective than fixed rate instruments at locking in a particular yield.
Nevertheless, such obligations may fluctuate in value in response to interest
rate changes if there is a delay between changes in market interest rates and
the interest reset date for the obligation, or for other reasons.
The
Funds may invest in floating rate debt instruments (“floaters”) and engage in
credit spread trades. The interest rate on a floater is a variable rate which is
tied to another interest rate, such as a money-market index or Treasury bill
rate. The interest rate on a floater resets periodically, typically every six
months. While, because of the interest rate reset feature, floaters provide a
Fund with a certain degree of protection against rises in interest rates, a Fund
will participate in any declines in interest rates as well. A credit spread
trade is an investment position relating to a difference in the prices or
interest rates of two securities or currencies, where the value of the
investment position is determined by movements in the difference between the
prices or interest rates, as the case may be, of the respective securities or
currencies.
The
floating rate obligations in which a Fund invests typically have multiple reset
periods during the year with each reset period applicable to a designated
portion of the obligations. If a Fund does so, it will consider the shortened
period to be the adjustment period of the obligations. As short-term interest
rates rise, interest payable to a Fund should increase. As short-term interest
rates decline, interest payable to the Fund should decrease. The amount of time
that will pass before a Fund experiences the effects of changing short-term
interest rates will depend on the dollar-weighted average time until the next
interest rate adjustment on the Fund’s portfolio of obligations.
Obligations
usually have mandatory and optional prepayment provisions. Because of
prepayments, the actual remaining maturity of an obligation may be considerably
less than its stated maturity. If an obligation is prepaid, a Fund will have to
reinvest the proceeds in other obligations or securities, which may have a lower
fixed spread over its base rate. In such a case, the amount of interest paid to
a Fund would likely decrease.
In
the event of a change in the benchmark interest rate on an obligation, the rate
payable to lenders under the obligation will, in turn, change at the next
scheduled reset date. If the benchmark rate goes up, a Fund as lender would earn
interest at a higher rate, but only on and after the reset date. If the
benchmark rate goes down, a Fund as lender would earn interest at a lower rate,
but only on and after the reset date.
Market
interest rate changes may also cause a Fund’s NAV to experience volatility. This
is because the value of an obligation asset in a Fund is partially a function of
whether it is paying what the market perceives to be a market rate of interest
for the particular obligation given its individual credit and other
characteristics. If market interest rates change, an obligation’s value could be
affected to the extent the interest rate paid on that obligation does not reset
at the same time. The rates of interest paid on the obligation in which a Fund
invests have a weighted average reset period that typically is less than 90
days. Therefore, the impact of the lag between a change in market interest rates
and the change in the overall rate on the portfolio is expected to be minimal.
Finally,
to the extent that changes in market rates of interest are reflected, not in a
change to a base rate, but in a change in the spread over the base rate which is
payable on obligations of the type and quality in which a Fund invests, the
Fund’s NAV could be adversely affected. Again, this is because the value of an
obligation asset in a Fund is partially a function of whether it is paying what
the market perceives to be a market rate of interest for the particular
obligation given its individual credit and other characteristics. However,
unlike changes in market rates of interest for which there is only a temporary
lag before the portfolio reflects those changes, changes in an obligation’s
value based on changes in the market spread on obligations in a Fund’s portfolio
may be of longer duration.
Interest
Rates and Portfolio Maturity. Interest
rates on securities in which a Fund invests may adjust periodically based on a
base rate plus a premium or spread over the base rate. The base rate usually is
the federal funds rate, the prime rate, or other base lending rates or Reference
Rates (as defined below) used by commercial lenders. The prime rate quoted by a
major U.S. bank is generally the interest rate at which that bank is willing to
lend U.S. dollars to its most creditworthy borrowers, although it may not be the
bank’s lowest available rate.
Certain
variable or floating securities have coupon rates that were based on the London
Interbank Offered Rate (“ICE LIBOR” or “LIBOR”), or are based on the Secured
Overnight Financing Rate (“SOFR”), Euro Interbank Offered Rate and other similar
types of reference rates (each, a “Reference Rate”). These Reference Rates are
generally intended to represent the rate at which contributing banks may obtain
short-term borrowings within certain financial markets. LIBOR was produced daily
by averaging the rates reported by a number of banks and may have been a
significant factor in determining a Fund’s payment obligations under a
derivative instrument, the cost of financing to a Fund, or an investment’s value
or return to a Fund, and may have been used in other ways that affected a Fund’s
performance.
LIBOR
was phased out at the end of June 2023. SOFR was selected by a committee
established by the Board of Governors of the Federal Reserve System and the
Federal Reserve Bank of New York to replace LIBOR as a Reference Rate in the
United States and U.S. law requires that contracts without a practicable LIBOR
alternative default to SOFR plus a set spread beginning in mid-2023. SOFR is a
secured, nearly risk-free rate, while LIBOR was an unsecured rate that included
an element of bank credit risk. In addition, SOFR is strictly an overnight rate,
while LIBOR historically was published for various maturities, ranging from
overnight to one year. Certain contracts provided for a spread adjustment when
transitioning to SOFR from LIBOR, but there is no assurance that it provided
adequate compensation. Other countries have undertaken similar initiatives to
identify replacement Reference Rates for LIBOR in their respective markets.
However, certain issuers may have encountered obstacles to converting their
investments and transactions to a new Reference Rate, as well as risks
associated with using a new Reference Rate with respect to new investments and
transactions. Market participants may have transitioned Reference Rates through
contractual amendments, legislation, market wide protocols, fallback contractual
provisions, bespoke negotiations or otherwise.
The
termination of certain Reference Rates presents risks to a Fund. The failure of
issuers to transition could lead to increased volatility and illiquidity in
markets for instruments that have yet to rely on a substitute to determine their
next coupon rates and a reduction in the values of those investments, all of
which would impact a Fund. Various complexities brought about by significant
changes to operational processes and IT systems may not be complete, and
coordination with other market participants may be severely impacted, which may
negatively impact a Fund.
In
addition, the alternative reference or benchmark rate may be an ineffective
substitute, potentially resulting in prolonged adverse market conditions for a
Fund. The elimination of a Reference Rate or any other changes or reforms to the
determination or supervision of Reference Rates could have an adverse impact on
the market for or value of any securities or payments linked to those Reference
Rates and other financial obligations held by a Fund or on its overall financial
condition or results of operations. Any substitute Reference Rate and any
pricing adjustments imposed by a regulator or by counterparties or otherwise may
adversely affect a Fund’s performance and/or NAV. At this time, it is not
possible to completely identify or predict the effect of any such changes, any
establishment of alternative Reference Rates or any other reforms to Reference
Rates that may be enacted in the UK or elsewhere.
Non-Investment
Grade Fixed Income Securities.
The Funds may invest in non-investment grade fixed income securities (commonly
known as “junk bonds”). The Small Cap Equity, Small-Mid Cap Equity, Equity,
Balanced and International Equity Funds may only invest up to 5% of their
respective total assets in non-investment grade fixed income securities.
Investments in such securities are inherently speculative. The lower ratings
reflect a greater possibility that adverse changes in the financial condition of
the issuer or in general economic conditions, or both, or an unanticipated rise
in interest rates, may impair the ability of the issuer to make payments of
interest and principal. The inability (or perceived inability) of issuers to
make timely payment of interest and principal would likely make the values of
such securities held by a Fund more volatile and could limit the Fund’s ability
to sell its securities at prices approximating the values the Fund had placed on
such securities. In the absence of a liquid trading market for securities held
by a Fund, it may be difficult to establish a fair value of such securities. If
the issuer defaults on its obligation, the value of the security would fall and
a Fund’s income also would decline.
Securities
ratings are based largely on the issuer’s historical financial condition and the
rating agencies’ analysis at the time of rating. Consequently, the rating
assigned to any particular security is not necessarily a reflection of the
issuer’s current financial condition, which may be better or worse than the
rating would indicate. In addition, the rating assigned to a security by an
NRSRO does not reflect an assessment of the volatility of the security’s market
value or the liquidity of an investment in the security.
Like
those of other fixed income securities, the values of non-investment grade
securities generally go up and down in response to changes in interest rates. A
decrease in interest rates generally will result in an increase in the value of
fixed income securities. Conversely, during periods of rising interest rates,
the value of a Fund’s fixed income securities generally will decline. The values
of non-investment grade fixed income securities often may be affected to a
greater extent by changes in general economic conditions and business conditions
affecting the issuers of such securities and their industries. Negative
publicity or investor perceptions also may adversely affect the values of
non-investment grade fixed income securities. Changes by NRSROs in their ratings
of any fixed income security and changes in the ability of an issuer to make
payments of interest and principal also may affect the value of these
investments. Changes in the value of portfolio securities generally will not
affect income derived from these securities, but will affect a Fund’s net asset
value.
Issuers
of lower rated securities often are highly leveraged, so that their ability to
service their debt obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. Such issuers may not have more
traditional methods of financing available to them and may be unable to repay
outstanding obligations at maturity by refinancing. The risk of loss
due
to default in payment of interest or repayment of principal by such issuers is
significantly greater because such securities frequently are unsecured and
subordinated to the prior payment of senior indebtedness.
Mortgage
Pass-Through Securities.
The Balanced and Fixed Income Funds may invest in residential and commercial
mortgage pass-through securities. Mortgage pass-through securities represent
interests in pools of mortgages in which payments of both principal and interest
on the securities are generally made monthly, in effect “passing through”
monthly payments made by borrowers in the residential or commercial mortgage
loans which underlie the securities (net of any fees paid to the issuer or
guarantor of the securities). Mortgage pass-through securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose a Fund to a lower rate of return upon reinvestment of principal. Also, if
a security subject to repayment has been purchased at a premium, in the event of
prepayment, the value of the premium would be lost.
There
are generally three types of mortgage pass-through securities: (1) those
issued by the U.S. Government, one of its agencies or instrumentalities or a
government sponsored enterprise, such as Government National Mortgage
Association (“GNMA”), Fannie Mae (“FNMA”), and Federal Home Loan Mortgage
Corporation (“FHLMC”); (2) those issued by private issuers that represent an
interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or
are collateralized by whole mortgage loans or pass-through securities without a
government guarantee but may have some form of private credit enhancement.
GNMA
is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such as savings and loan institutions, commercial
banks and mortgage banks), and backed by pools of FHA-insured or VA-guaranteed
mortgages. Obligations of FNMA and FHLMC are not backed by the full faith and
credit of the U.S. Government. In the case of obligations not backed by the full
faith and credit of the U.S. Government, a Fund must look principally to the
agency issuing or guaranteeing the obligation for ultimate repayment. FNMA and
FHLMC may attempt to borrow from the U.S. Treasury to meet their obligations,
but the U.S. Treasury is under no obligation to lend to FNMA or FHLMC.
The
FHFA and the U.S. Treasury have imposed strict limits on the size of FNMA and
FHLMC’s mortgage portfolios. Discussions among policymakers continue, however,
as to whether FNMA and FHLMC should be nationalized, privatized, restructured,
or eliminated altogether. FNMA and FHLMC also are the subject of several
continuing legal actions and investigations over certain accounting, disclosure
or corporate governance matters, which (along with any resulting financial
restatements) may continue to have an adverse effect on the guaranteeing
entities. Importantly, the future of FNMA and FHLMC remains in question as the
U.S. Government considers multiple options.
Under
the direction of the FHFA, FNMA and FHLMC jointly developed a common
securitization platform for the issuance of a uniform mortgage-backed security
(“UMBS”) (the “Single Security Initiative”) that aligns the characteristics of
FNMA and FHLMC certificates. In June 2019, under the Single Security Initiative,
FNMA and FHLMC started issuing UMBS in place of their prior offerings of
to-be-announced mortgage-backed securities (“TBA”). The Single Security
Initiative seeks to support the overall liquidity of the TBA market by aligning
the characteristics of FNMA and FHLMC certificates. The effects that the Single
Security Initiative may have on the market for TBA and other mortgage-backed
securities are uncertain.
Private
mortgage pass-through securities are structured similarly to GNMA, FNMA, and
FHLMC mortgage pass-through securities and are issued by originators of and
investors in mortgage loans, including depository institutions, mortgage banks,
investment banks and special purpose subsidiaries of the foregoing.
Pools
created by private mortgage pass-through issuers generally offer a higher rate
of interest than government and government-related pools to compensate for the
fact that there are no direct or indirect government or agency guarantees of
payments in the private pools. The timely payment of interest and principal on
mortgage loans in these pools may be supported by various other forms of
insurance or guarantees, including individual loan, pool and hazard insurance,
subordination and letters of credit. Such insurance and guarantees may be issued
by private insurers, banks and mortgage poolers. There is no assurance that
private guarantors or insurers, if any, will meet their obligations. Timely
payment of interest and principal of these pools also may be partially supported
by various enhancements such as over-collateralization and senior/subordination
structures and by various forms of insurance or insured by governmental
entities, private insurers and the mortgage poolers. Some mortgage pass-through
securities issued by private organizations may not be readily marketable, may be
more difficult to value accurately and may be more volatile than similar
securities issued by a government entity.
WHEN-ISSUED
SECURITIES
The
Small Cap Equity, Small-Mid Cap Equity, Balanced, Fixed Income, and
International Equity Funds may purchase securities on a “when-issued” basis. In
buying “when-issued” securities, a Fund commits to buy securities at a certain
price even though the securities may not be delivered for up to 120 days. No
payment or delivery is made by a Fund in a “when-issued” transaction until the
Fund receives payment or delivery from the other party to the transaction.
Although a Fund receives no income from the above-described securities prior to
delivery, the market value of such securities is still subject to change. As a
consequence, it is possible that the market price of the securities at the time
of delivery may be higher or lower than the purchase price. When a Fund
purchases securities on a when-issued basis, it will maintain with its custodian
cash or liquid securities having an aggregate value equal to the amount of its
purchase commitment until payment is made. The purpose and effect of such
maintenance is to prevent a Fund from gaining investment leverage from
when-issued transactions. When-issued securities may decline or increase in
value during the period from a Fund’s investment commitment to the settlement of
the purchase.
INITIAL
PUBLIC OFFERINGS
The
Small Cap Equity, Small-Mid Cap Equity, Equity, Balanced, and International
Equity Funds may invest in initial public offerings (“IPOs”). By definition,
IPOs have not traded publicly until the time of their offerings. Special risks
associated with IPOs may include a limited number of shares available for
trading, unseasoned trading, lack of investor knowledge of the company, and
limited operating history, all of which may contribute to price volatility. Many
IPOs are issued by undercapitalized companies of small or microcap size. Some of
the companies involved in new industries may be regarded as developmental state
companies, without revenues or operating income, or the near-term prospects of
them. Investments in IPOs may have a magnified performance impact relative to
other investments.
Pursuant
to the Adviser’s allocation policies and procedures, the Small Cap Equity,
Small-Mid Cap Equity, Equity, Balanced and International Equity Funds generally
will be eligible to participate on a rotating basis in any applicable IPOs that
may come available to eligible clients of the Adviser.
ILLIQUID
INVESTMENTS, RESTRICTED SECURITIES AND PRIVATE PLACEMENT OFFERINGS
Illiquid
Investments.
The SEC’s liquidity risk management rule, Rule 22e-4 (the “Liquidity Rule”),
defines the term “illiquid investments” to mean any investments that the Funds
reasonably expect cannot be sold or disposed of in current market conditions in
seven calendar days or less in the ordinary course of business without the sale
or disposition significantly changing the market value of the investment. Under
the supervision of the Board of Trustees, the Adviser determines the liquidity
of a Fund’s investments and, through reports from the Adviser and the Funds’
administrator, the Board monitors investments in illiquid investments. Illiquid
investments may include securities and other financial instruments that do not
have a readily available market, repurchase agreements which have a maturity of
longer than seven calendar days, restricted securities, other than certain
foreign securities, restricted securities pursuant to Rule 144A under the
Securities Act and commercial paper sold in reliance on Section 4(2) of the
Securities Act, unless, based upon a review of the relevant market, trading and
investment-specific considerations, those investments are determined not to be
illiquid. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. When no market quotations are available,
illiquid investments are priced at fair value as determined in good faith by the
Adviser using guidelines approved by the Board of Trustees. The Funds may not
acquire any illiquid investment if, immediately after the acquisition, a Fund
would have invested more than 15% of its net assets in illiquid investments. If
through a change in values, net assets, or other circumstances, a Fund was in a
position where more than 15% of its net assets were invested in illiquid
investments, the Fund would take appropriate steps to protect liquidity. If the
limitation on illiquid investments is exceeded, other than by a change in market
values, the condition will be reported to the Board of Trustees and, when
required by the Liquidity Rule, to the SEC. Disposing of these investments may
involve time-consuming negotiation and legal expenses, and it may be difficult
or impossible for a Fund to sell them promptly at an acceptable price and may
have to dispose of such investments over extended periods of time.
Restricted
Securities.
Restricted securities can generally be sold in privately negotiated
transactions, pursuant to an exemption from registration under the Securities
Act or in a registered public offering. Where registration is required, a Fund
may be obligated to pay all or part of the registration expense and a
considerable period may elapse between the time the Fund decides to seek
registration and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, a Fund might obtain a less favorable price than
prevailed at the time it decided to seek registration of the security.
Private
Placement Offerings.
The Small Cap Equity, Small-Mid Cap Equity, Balanced, Fixed Income and
International Equity Funds may invest in private placement offerings.
Investments in private placement offerings are made in reliance on the “private
placement” exemption from registration afforded by Section 4(2) or
Regulation D of the Securities Act (“Section 4(2) securities”).
Section 4(2) securities are restricted as to disposition under the federal
securities law and generally are sold to institutional investors such as the
Funds that agree they are purchasing the securities for investment and not with
an intention to distribute to the public.
OTHER
INVESTMENT COMPANIES
The
Funds may invest in shares of other investment companies, including open-end
funds, closed-end funds, business development companies, exchange-traded funds
(“ETFs”), exchange-traded notes (“ETNs”), and interests in unit investment
trusts. Investments in the securities of other investment companies may involve
duplication of advisory fees and certain other expenses. By investing in another
investment company, a Fund becomes a shareholder of that investment company. As
a result, Fund shareholders indirectly will bear a Fund’s proportionate share of
the fees and expenses paid by shareholders of the other investment company, in
addition to the fees and expenses Fund shareholders directly bear in connection
with the Fund’s own operations, and are indirectly exposed to the risks of the
investments held by the other investment company. These other fees and expenses
would be reflected as Acquired Fund Fees and Expenses and would be included in
the Fees and Expenses Table in the Prospectus, if applicable. Investment in
other investment companies may involve the payment of substantial premiums above
the value of such issuer’s portfolio securities or a Fund may have to sell such
investments at a discount to the issuer’s portfolio securities. Exchange-traded
and closed-end funds may trade at premiums or discounts to their net asset
values and be subject to trading halts.
Although
a money market fund is designed to be a relatively low risk investment, it is
not free of risk. Despite the short maturities and high credit quality of a
money market fund’s investments, increases in interest rates and deteriorations
in the credit quality of the instruments the money market fund has purchased may
reduce the money market fund’s yield and can cause the price of a money market
security to decrease. In addition, a money market fund is subject to the risk
that the value of an investment may be eroded over time by inflation.
ETFs
trade like a common stock and passive ETFs usually represent a fixed portfolio
of securities designed to track the performance and dividend yield of a
particular domestic or foreign market index. If a Fund invests in ETFs, a Fund
would typically purchase passive ETF shares to obtain exposure to all or a
portion of the stock or bond market. As a shareholder of an ETF, a Fund would be
subject to its ratable share of the ETF’s expenses, including its advisory and
administration expenses.
An
investment in an ETF generally presents the same primary risks as an investment
in a conventional mutual fund (i.e., one that is not exchange-traded) that has
the same investment objective, strategies, and policies. The price of an ETF can
fluctuate within a wide range, and a Fund could lose money investing in an ETF
if the prices of the securities owned by the ETF go down. In addition, ETFs are
subject to the following risks that do not apply to conventional funds:
(1) the market price of the ETF’s shares may trade at a discount or premium
to their NAV; (2) an active trading market for an ETF’s shares may not
develop or be maintained; or (3) trading of an ETF’s shares may be halted
if the listing exchange’s officials deem such action appropriate, the shares are
de-listed from the exchange, or the activation of market-wide “circuit breakers”
(which are tied to large decreases in stock prices) halts stock trading
generally. A Fund may also invest in ETNs, which are structured debt securities.
Whereas ETFs’ liabilities are secured by their portfolio securities, ETNs’
liabilities are unsecured general obligations of the issuer. ETFs and ETNs have
expenses associated with their operation, typically including, with respect to
ETFs, advisory fees.
Each
Fund’s investment in securities of other investment companies is generally
limited to (i) 3% of the total voting stock of any one investment company, (ii)
5% of the Fund’s total assets with respect to any one investment company and
(iii) 10% of the Fund’s total assets in all investment companies in the
aggregate. However, a Fund may exceed these limits when investing in shares of
an ETF or other investment company, subject to the terms and conditions of an
exemptive order from the SEC obtained by the ETF or other investment company
that permits an investing fund, such as the Fund, to invest in the ETF or other
investment company in excess of the limits described above. A Fund may also
exceed these limits when investing in shares of money market funds to the extent
permitted by the 1940 Act and applicable rules and regulations adopted by the
SEC thereunder.
Additionally,
Rule 12d1-4 under the 1940 Act permits certain types of fund of fund
arrangements without an exemptive order, subject to certain conditions,
including limits on control and voting of acquired funds’ shares, evaluations
and findings by investment advisers, fund investment agreements, and limits on
most three-tier fund structures.
SECURITIES
LENDING
The
Small Cap Equity, Small-Mid Cap Equity, Balanced, Fixed Income and,
International Equity Funds may lend securities to qualified brokers, dealers,
banks and other financial institutions. Securities lending would allow a Fund to
retain ownership of the securities loaned and, at the same time, to earn
additional income. Since there may be delays in the recovery of loaned
securities, or even a loss of rights in collateral supplied should the borrower
fail financially, loans would be made only to parties deemed by the Adviser to
be of good standing. In addition, they would only be made if, in the Adviser’s
judgment, the consideration to be earned from such loans would justify the risk.
Such loans would not be made if, as a result, the aggregate of all outstanding
loans of a Fund exceed one-third of the value of its total assets (including the
value of all assets received as collateral for the loan). The Funds do not
currently engage in securities lending activities.
TEMPORARY
INVESTMENTS
The
temporary investments that the Funds may make include:
(1)
Cash, time deposits, certificates of deposit (including marketable variable rate
certificates of deposit) and bankers’ acceptances issued by a commercial bank or
savings and loan association. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of time at a stated
interest rate. Time deposits maturing in more than seven days will not be
purchased by the Funds. Certificates of deposit are negotiable short-term
obligations issued by commercial banks or savings and loan associations against
funds deposited in the issuing institution. Variable rate certificates of
deposit are certificates of deposit on which the interest rate is periodically
adjusted prior to their stated maturity based upon a specified market rate. A
bankers’ acceptance is a time draft drawn on a commercial bank by a borrower
usually in connection with an international commercial transaction (to finance
the import, export, transfer or storage of goods).
The
Funds may invest in obligations of U.S. banks, foreign branches of U.S. banks
(Eurodollars), and U.S. branches of foreign banks (Yankee dollars). Euro and
Yankee dollar investments will involve the same risks of investing in foreign
securities discussed previously. Although the Adviser carefully considers these
factors when making investments, the Funds do not limit the amount of its assets
which can be invested in any one type of instrument or in any foreign country in
which a branch of a U.S. bank or the parent of a U.S. branch is located.
The
Funds will not invest in any security issued by a commercial bank unless
(i) the bank has total assets of at least $1 billion, or the
equivalent in other currencies, or, in the case of a domestic bank that does not
have total assets of at least $1 billion, the aggregate investment made in
any one such bank is limited to $250,000 and the principal amount of such
investment is insured in full by the Federal Deposit Insurance Corporation and
(ii) in the case of U.S. banks, it is a member of the Federal Deposit
Insurance Corporation.
(2)
Commercial paper that at the time of purchase is rated in the highest rating
category by a NRSRO or, if not rated, issued by a corporation having an
outstanding unsecured debt issue that meets such rating requirement at time of
purchase;
(3)
Short-term corporate obligations rated in the highest rating category by a NRSRO
at time of purchase;
(4)
U.S. Government obligations, including bills, notes, bonds and other debt
securities issued by the U.S. Treasury. These are direct obligations of the U.S.
Government and differ mainly in interest rates, maturities and dates of issue;
(5)
U.S. Government agency securities issued or guaranteed by U.S. Government
sponsored instrumentalities and federal agencies. These include securities
issued by the Federal Home Loan Banks, Federal Land Bank, Farmers Home
Administration, Farm Credit Banks, Federal Intermediate Credit Bank, Fannie Mae,
Federal Financing Bank, the Tennessee Valley Authority, and others; and
(6)
Repurchase agreements.
REGULATORY
AND RECENT MARKET EVENTS
Policy
changes by the U.S. government and/or Federal Reserve and political events
within the U.S. and abroad, such as changes in the U.S. presidential
administration and Congress, the U.S. government’s inability at times to agree
on a long-term budget and deficit reduction plan, the threat or occurrence of a
federal government shutdown or the occurrence of a failure to increase the
federal government’s debt limit, which could result in a default on the
government’s obligations, may affect investor and consumer confidence and may
adversely impact financial markets and the broader economy, perhaps suddenly and
to a significant degree. The severity or duration of adverse economic conditions
may also be affected by policy changes made by governments or quasi-governmental
organizations. Global economies and financial markets are becoming increasingly
interconnected, which increases the possibility of many markets being affected
by events in a single country or events affecting a single or small number of
issuers. Both U.S. and international markets have experienced significant
volatility in recent years. As a result of such volatility, investment returns
may fluctuate significantly, and the risks discussed herein associated with an
investment in a Fund may be increased. Deteriorating economic fundamentals may
increase the risk of default or insolvency of particular issuers, negatively
impact market value, increase market volatility, cause credit spreads to widen,
reduce bank balance sheets and cause unexpected changes in interest rates. Any
of these could cause an increase in market volatility, reduce liquidity across
various sectors or markets or decrease confidence in the markets. Historical
patterns of correlation among asset classes may break down in unanticipated ways
during times of high volatility, disrupting investment programs and potentially
causing losses.
Although
interest rates were unusually low in recent years in the U.S. and abroad, in
2022, the U.S. Federal Reserve and certain foreign central banks began to raise
interest rates as part of their efforts to address rising inflation. It is
difficult to accurately predict the pace at which interest rates might increase
or start decreasing, the timing, frequency or magnitude of any such changes in
interest rates, or when such changes might stop or reverse course. Unexpected
changes in interest rates could lead to significant market volatility or reduce
liquidity in certain sectors of the market. Over the longer term, rising
interest rates may present a greater risk than has historically been the case
due to the prior period of relatively low rates and the effect of government
fiscal and monetary policy initiatives and potential market reaction to those
initiatives, or their alteration or cessation. It is difficult to predict the
impact on various markets of significant rate changes or other significant
policy changes.
Markets
and market participants are increasingly reliant upon both publicly available
and proprietary information data systems. Data imprecision, software or other
technology malfunctions, programming inaccuracies, unauthorized use or access,
the execution of ransomware and other cyberattacks, and similar circumstances
may impair the performance of these systems and may have an adverse impact upon
a single issuer, a group of issuers, or the market at large. In certain cases,
an exchange or market may close or issue trading halts on either specific
securities or even the entire market, which may result in a Fund being, among
other things, unable to buy or sell certain securities or financial instruments
or accurately price its investments. These fluctuations in securities prices
could be a sustained trend or a drastic movement. The financial markets
generally move in cycles, with periods of rising prices followed by periods of
declining prices. The value of your investment may reflect these fluctuations.
Some
countries, including the U.S., have in recent years adopted more protectionist
trade policies. Slowing global economic growth, the rise in protectionist trade
policies, changes to international trade agreements, risks associated with the
aftermath of the United Kingdom’s departure from the European Union and the
trade agreement between the United Kingdom and the European Union, the risks
associated with ongoing trade negotiations with China, the possibility of
changes to some international trade agreements, tensions, war, or open conflict
between nations, such as between Russia and Ukraine or in eastern Asia,
political or economic dysfunction within some nations, including major producers
of oil, and dramatic changes in commodity and currency prices could have adverse
effects that cannot be foreseen at the present time. Tensions, war or open
conflict between nations, such as between Russia and Ukraine, in the Middle East
or in eastern Asia could affect the economies of many nations, including the
United States. The duration of ongoing hostilities and any sanctions and related
events cannot be predicted. Those events present material uncertainty and risk
with respect to markets globally and the performance of a Fund and its
investments or operations could be negatively impacted.
Regulators
in the U.S. have proposed and recently adopted a number of changes to
regulations involving the markets and issuers, some of which apply to a Fund.
The full effect of various newly-adopted regulations is not currently known.
Additionally, it is not clear whether the proposed regulations will be adopted.
However, due to the broad scope of the new and proposed regulations, certain
changes could limit a Fund’s ability to pursue its investment strategies or make
certain investments, or may make it more costly for a Fund to operate, which may
impact performance. Further, advancements in technology may also adversely
impact market movements and liquidity and may affect the overall performance of
a Fund. For example, the advanced development and increased regulation of
artificial intelligence may impact the economy and the performance of a Fund. As
artificial intelligence is used more widely, the value of a Fund’s holdings may
be impacted, which could impact the overall performance of a Fund.
High
public debt in the U.S. and other countries creates ongoing systemic and market
risks and policymaking uncertainty. There is no assurance that the U.S. Congress
will act to raise the nation’s debt ceiling; a failure to do so could cause
market turmoil and substantial investment risks that cannot now be fully
predicted. Unexpected political, regulatory and diplomatic events within the
U.S. and abroad may affect investor and consumer confidence and may adversely
impact financial markets and the broader economy.
Certain
illnesses spread rapidly and have the potential to significantly and adversely
affect the global economy. The impact of epidemics and/or pandemics that may
arise in the future could negatively affect the economies of many nations,
individual companies and the global securities and commodities markets,
including their liquidity, in ways that cannot necessarily be foreseen at the
present time
and
could last for an extended period of time. China’s economy, which has been
sustained through debt-financed spending on housing and infrastructure, appears
to be experiencing a significant slowdown and growing at a lower rate than prior
years. Due to the size of China’s economy, such a slowdown could impact
financial markets and the broader economy.
In
March 2023, the shutdown of certain financial institutions in the U.S. and
questions regarding the viability of other financial institutions raised
economic concerns over disruption in the U.S. and global banking systems. There
can be no certainty that the actions taken by the U.S. or foreign governments to
strengthen public confidence in the U.S. and global banking systems will be
effective
in mitigating the effects of financial institution failures on the economy and
restoring public confidence in the U.S. and global banking system.
Economists
and others have expressed increasing concern about the potential effects of
global climate change on property and security values. Impacts from climate
change may include significant risks to global financial assets and economic
growth. A rise in sea levels, an increase in powerful windstorms and/or a
climate-driven increase in sea levels or flooding could cause coastal properties
to lose value or become unmarketable altogether. Certain issuers, industries and
regions may be adversely affected by the impacts of climate change, including on
the demand for and the development of goods and services and related production
costs, and the impacts of legislation, regulation and international accords
related to climate change, as well as any indirect consequences of regulation or
business trends driven by climate change. Regulatory changes and divestment
movements tied to concerns about climate change could adversely affect the value
of certain land and the viability of industries whose activities or products are
seen as accelerating climate change. These losses could adversely affect, among
others, corporate issuers and mortgage lenders, the value of mortgage-backed
securities, the bonds of municipalities that depend on tax or other revenues and
tourist dollars generated by affected properties, and insurers of the property
and/or of corporate, municipal or mortgage-backed securities.
CYBERSECURITY
With
the increased use of technologies such as the internet and the dependence on
computer systems to perform necessary business functions, the Funds and their
service providers and third-party fund distribution platforms may have become
more susceptible to operational and related risks through breaches in
cybersecurity. A cybersecurity incident may refer to intentional or
unintentional events that allow an unauthorized party to gain access to Fund
assets, shareholder data, or proprietary information, or cause a Fund or Fund
service providers (including, but not limited to, the Adviser, distributor, fund
accountants, custodian, transfer agent, sub-advisers (if applicable), and
financial intermediaries), as well as securities trading venues and their
service providers, to suffer data corruption, lose operational functionality, or
be the target of ransomware. A cybersecurity incident could, among other things,
result in the loss or theft of shareholder data or funds, impact a Fund’s
ability to calculate NAV per share, cause the release of private shareholder
information or confidential business information, impede trading, subject the
Funds to regulatory fines or financial losses and/or cause reputational damage.
A cyber attack may also result in shareholders or service providers being unable
to access electronic systems (“denial of services”), loss or theft of
proprietary information or corporate data, physical damage to a computer or
network system, or remediation costs associated with system repairs. The Funds
may also incur additional costs for cybersecurity risk management purposes.
Similar types of cybersecurity risks are also present for issuers or securities
in which the Funds may invest, which could result in material adverse
consequences for such issuers and may cause a Fund’s investment in such
companies to lose value. A Fund’s service providers also may be negatively
impacted due to operational risks arising from non-cybersecurity related factors
such as processing errors and human errors, inadequate or failed internal or
external processes, failures in systems and technology errors or malfunctions,
changes in personnel, and errors caused by Fund service providers or
counterparties.
In
addition, other events or circumstances — whether foreseeable, unforeseeable, or
beyond the Funds’ control, such as acts of war, other conflicts, terrorism,
natural disaster, widespread disease, pandemic or other public health crises may
result in, among other things, quarantines and travel restrictions, workforce
displacement and loss or reduction in personnel and other resources. In the
above circumstances, the Funds and the Funds’ service providers’ operations may
be significantly impacted, or even temporarily halted. The Funds’ securities
market counterparties or vendors may face the same or similar systems failure,
cybersecurity breaches and other business disruptions risks.
Any
of these results could have a substantial adverse impact on a Fund and its
shareholders. For example, if a cybersecurity incident results in a denial of
service, Fund shareholders could lose access to their electronic accounts and be
unable to buy or sell Fund shares for an unknown period of time, and service
providers could be unable to access electronic systems to perform critical
duties for the Fund, such as trading, NAV calculation, shareholder accounting or
fulfilment of Fund share purchases and redemptions. Cybersecurity incidents
could cause a Fund or Fund service provider to incur regulatory penalties or
scrutiny, reputational damage, additional compliance costs associated with
corrective measures, or financial loss of a significant magnitude and could
result in allegations that a Fund or Fund service provider violated privacy and
other laws. Similar adverse consequences could result from cybersecurity
incidents affecting issuers of securities in which a Fund invests,
counterparties with which a Fund engages in transactions, governmental and other
regulatory authorities, exchange and other financial market operators, banks,
brokers, dealers, insurance companies, and other financial institutions and
other parties. Risk management systems and business continuity plans seek to
reduce the risks associated with cybersecurity in the event there is a
cybersecurity breach, but there are inherent limitations in these systems and
plans, including the possibility that certain risks may not have been adequately
identified or prepared for, in large part because different or unknown threats
may emerge in the future. Furthermore, the Funds do not control the
cybersecurity systems and plans of the issuers of securities in which the Funds
invest or the Funds’ third party service providers or trading counterparties or
any other service providers whose operations may affect the Funds or their
shareholders. The widespread use of work from home arrangements, such as during
the COVID-19 pandemic, may increase operational and information security risks.
Most issuers in which the Funds invest are heavily dependent on computers and
other technological platforms and resources for data storage and operations,
which require ready access to the internet to conduct their business. Thus,
cybersecurity incidents could also affect issuers of securities in which a Fund
invests, leading to significant loss of value in the securities of issuers
impacted by any such cybersecurity incidents
TRUSTEES
AND OFFICERS OF THE LKCM FUNDS
The
Board of Trustees
The
Trust is governed by its Board of Trustees. The Board is responsible for and
oversees the overall management and operations of the Trust and the Funds, which
includes the general oversight and review of the Funds’ investment activities,
in accordance with federal law and the law of the State of Delaware, as well as
the stated policies of the Funds. The Board oversees the Trust’s officers and
service providers, including the Adviser, which is responsible for the
management of the day-to-day operations of the Funds based on policies and
agreements reviewed and approved by the Board. In carrying out these
responsibilities, the Board regularly interacts with and receives reports from
senior personnel of service providers, including the Adviser’s personnel and the
Trust’s
Chief Compliance Officer (“CCO”). The Board also is assisted by the Trust’s
independent registered public accounting firm (who reports directly to the
Trust’s Audit and Compliance Committee), independent counsel and other experts
as appropriate, all of whom are selected by the Board. The Board met four times
during the fiscal year ended December 31, 2023.
Risk
Oversight
Consistent
with its responsibility for oversight of the Trust and the Funds, the Board
oversees the management of risks relating to the administration and operation of
the Trust and the Funds. The Adviser, as part of its responsibilities for
the day-to-day operations of the Funds, is responsible for day-to-day risk
management for the Funds. The Board, in the exercise of its reasonable business
judgment, also separately considers potential risks that may impact the Funds.
The Board performs this risk management oversight directly and, as to certain
matters, through its committees and through the Independent Trustees. The
following provides an overview of the principal, but not all, aspects of the
Board’s oversight of risk management for the Trust and the Funds.
In
general, a Fund’s risks include, among others, investment risk, credit risk,
liquidity risk, valuation risk and operational risk. The Board has adopted, and
periodically reviews, policies and procedures designed to address risks to the
Trust and the Funds. In addition, under the general oversight of the Board, the
Adviser and other service providers to the Funds have adopted a variety of
policies, procedures and controls designed to address particular risks to the
Funds. Different processes, procedures and controls are employed with
respect to different types of risks.
The
Board also oversees risk management for the Trust and the Funds through review
of regular reports, presentations and other information from officers of the
Trust and other persons. The Funds’ CCO and senior officers of the Adviser
regularly report to the Board on a range of matters, including those relating to
risk management. The Board also regularly receives reports from the Adviser with
respect to the Funds’ investments. In addition to regular reports from the
Adviser, the Board also receives reports regarding other service providers to
the Trust, either directly or through the Adviser or the Funds’ CCO, on a
periodic or regular basis. At least annually, the Board receives a report from
the Funds’ CCO regarding the effectiveness of the Funds’ compliance program.
Also, on an annual basis, the Board receives reports, presentations and other
information from the Adviser in connection with the Board’s consideration of the
renewal of the Trust’s advisory agreement with the Adviser and the Trust’s
distribution plans under Rule 12b-1 under the 1940 Act.
The
CCO also reports regularly to the Board on Fund valuation matters. In
addition, the Audit and Compliance Committee receives regular reports from the
Trust’s independent registered public accounting firm on internal control and
financial reporting matters. On at least a quarterly basis, the Independent
Trustees meet with the Funds’ CCO to discuss matters relating to the Funds’
compliance program.
Board
Structure and Related Matters
Board
members who are not “interested persons” of the Funds as defined in
Section 2(a)(19) of the 1940 Act (“Independent Trustees”) constitute a
majority of the Board. Larry J. Lockwood, an Independent Trustee, serves as
Chairman of the Board. As Chairman, Mr. Lockwood’s responsibilities
include: setting an agenda for each meeting of the Board; presiding at all
meetings of the Board and Independent Trustees; and serving as a liaison with
other Trustees, the Trust’s officers and other management personnel, and counsel
to the Funds. As Chairman, Mr. Lockwood also performs such other
duties as the Board may from time to time determine.
The
Trustees discharge their responsibilities collectively as a Board, as well as
through Board committees, each of which operates pursuant to a charter approved
by the Board that delineates the specific responsibilities of that
committee. The Board has established three standing committees: the Audit
and Compliance Committee, the Nominating Committee and the Qualified Legal
Compliance Committee. The members and responsibilities of each Board
committee are summarized below.
The
Board periodically evaluates its structure and composition as well as various
aspects of its operations. The Board believes that its leadership structure,
including its independent Chairman and Board committees, is appropriate for the
Trust in light of, among other factors, the asset size and nature of the Funds,
the number of Funds overseen by the Board, the arrangements for the conduct of
the Funds’ operations, the number of Trustees, and the Board’s
responsibilities. On an annual basis, the Board conducts a self-evaluation
that considers, among other matters, whether the Board and its committees are
functioning effectively and whether, given the size and composition of the Board
and each of its committees, the Trustees are able to oversee effectively the
number of Funds in the complex.
The
Board holds four regularly scheduled meetings each year. The Board may hold
special meetings, as needed, either in person or by telephone, to address
matters arising between regular meetings. During a portion of each regular
meeting, the Independent Trustees meet outside of management’s presence. The
Independent Trustees may hold special meetings, as needed, either in person or
by telephone.
The
Trustees of the Trust are identified in the tables below, which provide
information as to their year of birth and positions with the Trust, term of
office with the Trust and length of time served, their principal occupations for
the past five years and other directorships held in public companies during the
past five years.
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Independent
Trustees |
Name,
Address and Age |
Position(s) Held
with the Trust |
Term
of Office and
Length
of Time Served(1) |
Principal Occupation During
Past Five Years |
Number
of Portfolios in
Fund Complex Overseen by Trustee |
Other Directorships Held by
Trustee During the Past Five Years |
Richard
J. Howell
301
Commerce Street
Suite
1600
Fort
Worth, Texas 76102
Year
of Birth: 1942 |
Trustee
Chairman of
the Audit and Compliance Committee |
Since 2005
Since
2008 |
CPA;
Adjunct Faculty at SMU Cox School of Business from 2004 to 2009;
Consulting Services, since 2002; Audit Partner, Arthur Andersen LLP from
1974 to 2002. |
7 |
None |
Larry
J. Lockwood
301
Commerce Street
Suite
1600
Fort
Worth, Texas 76102
Year
of Birth: 1953 |
Chairman
of the Board of Trustees |
Since
2021 |
C.
R. Williams Professor of Finance, Stan Block Endowed Chair in Finance,
Department of Finance, Neeley School of Business, Texas Christian
University since 1994. |
7 |
None |
Trustee |
Since
2013 |
Steven
R. Purvis
301
Commerce Street
Suite
1600
Fort Worth, Texas 76102
Year
of Birth: 1964 |
Trustee |
Since
2013 |
Principal,
Luther King Capital Management Corporation from 2004 to 2021, Vice
President and Portfolio Manager, Luther King Capital Management
Corporation from 1996 to 2021. |
7 |
AZZ Incorporated |
Mauricio
Rodriguez
301
Commerce Street
Suite
1600
Fort
Worth, Texas 76102
Year
of Birth: 1966 |
Trustee |
Since
2021 |
Chair,
Department of Finance, Neeley School of Business; Texas Christian
University since
2002. |
7 |
None |
Interested
Trustees |
J.
Luther King, Jr.(2)
301
Commerce Street
Suite
1600
Fort
Worth, Texas 76102
Year
of Birth: 1940 |
Trustee,
President and Chief Executive Officer |
Since
1994 |
Chairman,
President and Director, Luther King Capital Management Corporation since
1979. |
7 |
TXO
Partners, L.P. |
(1) Each
Trustee holds office during the lifetime of the Trust until that individual
resigns, retires or is otherwise removed or replaced.
(2) Mr. King
is considered to be an “interested person” of the Trust (as defined in the 1940
Act) because of his affiliation with the Adviser.
In
addition to the information set forth in the tables above and other relevant
qualifications, experience, attributes or skills applicable to a particular
Trustee, the following provides further information about the qualifications and
experience of each Trustee.
Richard
J. Howell:
Mr. Howell has extensive audit and business experience as a certified
public accountant, service as a partner in a global accounting firm, service as
a faculty member at a private university’s business school, service as a
director of a publicly held corporation and multiple years of service as a
Trustee.
J.
Luther King, Jr.:
Mr. King has extensive experience in the investment management industry as
chairman, president and director of an investment management firm, service on
the board of numerous public and private corporations and foundations, and
multiple years of service as a Trustee.
Larry
J. Lockwood:
Mr. Lockwood has extensive experience in finance as professor of finance at
the business school of a private university and service as a chartered financial
analyst, business consultant and lecturer, and multiple years of service as a
Trustee.
Steven
R. Purvis:
Mr. Purvis has extensive experience as principal of an investment
management firm and service as a portfolio manager, director of research and
senior analyst, and multiple years of service as a Trustee.
Mauricio
Rodriguez:
Mr. Rodriguez has extensive experience in finance as professor of finance
at the business school of a private university and service as a business
consultant, expert witness in securities and commercial litigation, and
lecturer, and multiple years of service as a Trustee.
The
table below sets forth the compensation paid by the Trust to each Trustee of the
Trust during the fiscal year ended December 31, 2023:
COMPENSATION
TABLE
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Name
of Trustee |
Aggregate Compensation from the Funds |
Pension or Retirement Benefits Accrued
As Part of Fund Expenses |
Estimated Annual Benefits Upon Retirement |
Total Compensation from all Funds in the Trust
Complex(1) |
|
|
|
|
|
Interested
Trustees |
|
|
|
|
J.
Luther King, Jr. |
$0 |
$0 |
$0 |
$0 |
|
|
|
|
|
Independent
Trustees |
|
|
|
|
Richard
J. Howell |
$71,761 |
$0 |
$0 |
$76,000 |
Larry
J. Lockwood |
$75,578 |
$0 |
$0 |
$80,000 |
Steven
R. Purvis |
$66,036 |
$0 |
$0 |
$70,000 |
Mauricio
Rodriguez |
$66,036 |
$0 |
$0 |
$70,000 |
(1) There
are currently seven series comprising the Trust, one of which is offered in a
separate prospectus and SAI.
Effective
January 1, 2024, the Independent Trustees receive an annual retainer of $54,000,
with the Chairman of the Board receiving an additional $14,000 retainer and the
Chairman of the Audit and Compliance Committee receiving an additional $8,000
retainer. Each Independent Trustee also receives a meeting fee of $4,500 for
each Board meeting attended in person and a meeting fee of $2,000 for each
telephonic meeting, and is reimbursed for their reasonable out of pocket
expenses incurred in attending Board meetings. For this purpose, the Board
considers attendance at regular meetings held by videoconference to constitute
in-person attendance at a Board meeting. Independent Trustees may also receive a
meeting fee for each Board committee meeting attended in person or by telephone
if so determined by the chairman of the applicable Board committee.
Board
Ownership in the Funds
The
table below sets forth the dollar range of the value of the shares of each Fund,
and the dollar range of the aggregate value of the shares of all Funds overseen
by a Trustee, owned beneficially by each Trustee as of December 31, 2023.
For purposes of this table, beneficial ownership is defined to mean a direct or
indirect pecuniary interest. Exact dollar amounts of securities held are not
listed in the table. Rather, the ranges are identified according to the
following key:
Key
A. None
B. $1
- $10,000
C. $10,001
- $50,000
D. $50,001
- $100,000
E. over
$100,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Name
of Trustee |
Small Cap Equity Fund |
Small-Mid Cap Equity Fund |
Equity Fund |
Balanced Fund |
Fixed Income Fund |
International Equity Fund |
Aggregate Dollar Range of Equity
Securities in Trust Complex(1) |
|
|
|
|
|
|
|
|
Richard
J. Howell
Independent
Trustee |
E |
D |
E |
B |
C |
A |
E |
|
|
|
|
|
|
|
|
Larry
J. Lockwood
Independent
Trustee |
A |
A |
C |
A |
A |
A |
C |
|
|
|
|
|
|
|
|
Steven
R. Purvis
Independent
Trustee |
E |
A |
A |
A |
A |
A |
E |
|
|
|
|
|
|
|
|
Mauricio
Rodriguez
Independent
Trustee |
A |
A |
A |
A |
A |
A |
A |
|
|
|
|
|
|
|
|
J.
Luther King, Jr.(2)
Interested
Trustee, President and Chief Executive Officer |
E |
E |
E |
E |
E |
E |
E |
(1) There
are currently seven series comprising the Trust, one of which is offered in a
separate prospectus and SAI.
(2) Mr. King
is a Principal of the Adviser and a participant in the Adviser’s profit sharing
plan, which owns shares of the Funds as indicated under “Portfolio Managers –
Ownership of Securities.”
Board
Committees
Audit
and Compliance Committee. The
Trust has an Audit and Compliance Committee, consisting of Messrs. Howell,
Lockwood, Purvis and Rodriguez. The members of the Audit and Compliance
Committee are Independent Trustees. The primary responsibilities of the Audit
and Compliance Committee are to make recommendations to the Board as to: the
engagement or discharge of the Trust’s independent registered public accounting
firm (including the audit fees charged by the accounting firm); the supervision
of investigations into matters relating to audits; the review with the
independent registered public accounting firm of the results of audits;
oversight of the Trust’s compliance with legal and regulatory requirements,
internal control over financial reporting and independent audits; and addressing
any other matters regarding audits and compliance. The Audit and Compliance
Committee met two times during the fiscal year ended December 31, 2023.
Nominating
Committee. The
Trust has a Nominating Committee, consisting of Messrs. Howell, Lockwood, Purvis
and Rodriguez. The Nominating Committee is responsible for the selection and
nomination for appointment of candidates to serve as Trustees of the Trust. The
Nominating Committee will review shareholders’ nominations to fill vacancies on
the Board. Shareholders can submit recommendations in writing addressed to the
attention of the chair of the Nominating Committee, 301 Commerce Street, Suite
1600, Fort Worth, Texas 76102. A shareholder’s recommendation must include the
following information about the nominee: (1) name; (2) date of birth;
(3) education; (4) business, professional or other relevant experience
and areas of expertise; (5) current business, professional or other
relevant experience and areas of expertise; (6) current business and home
addresses and contact information; (7) other board positions or prior
experience; and (8) any knowledge and experience relating to investment
companies and investment company governance. The Nominating Committee met once
during the fiscal year ended December 31, 2023.
With
respect to the criteria the Nominating Committee uses for selecting nominees, a
successful candidate should have certain uniform characteristics, such as a very
high level of integrity, appropriate experience, and a commitment to fulfill the
fiduciary duties inherent in Board membership. The Nominating Committee also
will consider the extent to which potential candidates possess sufficiently
diverse skill sets and diversity characteristics that would contribute to the
Board’s overall effectiveness.
Qualified
Legal Compliance Committee. The
Trust has a Qualified Legal Compliance Committee, consisting of Messrs. Howell,
Lockwood, Purvis and Rodriguez. The members of the Qualified Legal Compliance
Committee are Independent Trustees. The primary responsibility of the Trust’s
Qualified Legal Compliance Committee is to receive, review and take appropriate
action with respect to any report made or referred to the Qualified Legal
Compliance Committee by an attorney of evidence of a material violation of
applicable U.S. federal or state securities law, material breach of a fiduciary
duty under U.S. federal or state law or a similar material violation by the
Trust or by any officer, director, employee, or agent of the Trust. The
Qualified Legal Compliance Committee did not meet during the fiscal year ended
December 31, 2023.
The
Trust does not hold annual shareholder meetings and, therefore, does not have a
policy with respect to Trustees’ attendance at such meetings.
Principal
Officers of the Trust
The
officers of the Trust conduct and supervise its daily business. As of the date
of this SAI, the officers of the Trust are identified in the following table,
which provides information as to their year of birth and positions with the
Trust, term of office with the Trust and length of time served, their principal
occupations for the past five years and, for officers who also serve as
Trustees, other directorships held in public companies during the past five
years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Name,
Address and Age |
Position(s) Held
with the Trust |
Term
of Office and Length of Time Served(1) |
Principal
Occupation During Past Five Years |
Number
of Portfolios in Fund Complex Overseen by
Trustee/ Officer |
Other Directorships Held
by Trustee/Officer During the Past Five Years |
J.
Luther King, Jr.(2)
301
Commerce Street
Suite
1600
Fort
Worth, Texas 76102
Year
of Birth: 1940 |
Trustee,
President and Chief Executive Officer |
Since 1994 |
Chairman,
President and Director, Luther King Capital Management Corporation since
1979. |
7 |
TXO
Partners, L.P. |
Paul
W. Greenwell
301
Commerce Street
Suite
1600
Fort Worth, Texas 76102
Year
of Birth: 1950 |
Vice President |
Since 1996 |
Principal,
Luther King Capital Management Corporation since 1986, Vice President and
Portfolio Manager, Luther King Capital Management Corporation since
1983. |
Not
Applicable |
Not
Applicable |
Richard
Lenart
301
Commerce Street
Suite
1600
Fort Worth, Texas 76102
Year
of Birth: 1966 |
Secretary
and Treasurer |
Since
2006 |
Luther
King Capital Management Corporation since 2005. |
Not
Applicable |
Not
Applicable |
Jacob
D. Smith
301
Commerce Street
Suite
1600
Fort Worth, Texas 76102
Year
of Birth: 1974 |
Chief
Financial Officer
Chief
Compliance Officer |
Since
2010
Since
2006 |
General
Counsel, Luther King Capital Management Corporation since 2006; Chief
Compliance Officer, Luther King Capital Management Corporation from
2006-2022; Principal, Luther King Capital Management Corporation since
2013. |
Not
Applicable |
Not
Applicable |
(1) Each
officer holds office during the lifetime of the Trust until that individual
resigns, retires or is otherwise removed or replaced.
(2) Mr. King
is considered to be an “interested person” of the Trust (as defined in the 1940
Act) because of his affiliation with the Adviser.
CONTROL
PERSONS AND PRINCIPAL SHAREHOLDERS
A
principal shareholder is any person who owns of record or beneficially 5% or
more of the outstanding shares of any of the Funds. A control person is one who
owns beneficially or through controlled companies more than 25% of the voting
securities of a company or acknowledges the existence of control. A person who
controls a Fund may be able to determine the outcome of any matter submitted to
a vote of shareholders. As of April 2, 2024, the following persons owned of
record or are known by the Funds to own beneficially 5% or more of the
outstanding shares of the Funds.
PRINCIPAL
SHAREHOLDERS
SMALL
CAP EQUITY FUND
|
|
|
|
|
|
|
| |
Name
and Address |
Percent of Fund |
Record
or Beneficial |
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1905 |
38.58% |
Record |
Capinco
c/o U.S. Bank, NA
1555
North RiverCenter Dr., Suite 302
Milwaukee,
WI 53212-3958 |
11.12% |
Record |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
11.04% |
Beneficial |
National
Financial Services LLC
For
the Exclusive Benefit of its Customers
Attn:
Mutual Funds Department, 4th
Fl
499
Washington Blvd.
Jersey
City, NJ 07310-1995 |
10.06% |
Record |
Muir &
Co 0
c/o
Frost Bank Trust Dept.
P.O.
Box 2950
San
Antonio, TX 78299-2950 |
7.81% |
Record |
J.P.
Morgan Securities LLC
1111
Polaris Pkwy., FL 2J
Columbus,
OH 43240-2031 |
5.50% |
Record |
PRINCIPAL
SHAREHOLDERS
SMALL-MID
CAP EQUITY FUND
|
|
|
|
|
|
|
| |
|
|
|
Name
and Address |
Percent of Fund |
Record
or Beneficial |
|
|
|
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1901 |
44.88% |
Record |
Muir &
Co 0
c/o
Frost Bank Trust Dept.
P.O.
Box 2950
San
Antonio, TX 78299-2950 |
33.64% |
Record |
National
Financial Services LLC
For
the Exclusive Benefit of its Customers
Attn:
Mutual Funds Department, 4th
Fl
499
Washington Blvd.
Jersey
City, NJ 07310-1995 |
11.03% |
Record |
Luther
King Capital Management Corporation
Profit
Sharing Plan
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
17.55% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
8.08% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
6.06% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
5.48% |
Beneficial |
Luther
King Capital Management Corporation
For
the Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
5.42% |
Beneficial |
PRINCIPAL
SHAREHOLDERS
EQUITY
FUND
|
|
|
|
|
|
|
| |
|
|
|
Name
and Address |
Percent of Fund |
Record
or Beneficial |
|
|
|
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1901 |
64.18% |
Record |
Luther
King Capital Management Corporation
Profit
Sharing Plan
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
10.70% |
Beneficial |
Muir &
Co 1
c/o
Frost Bank Trust Dept.
P.O.
Box 2950
San
Antonio, TX 78299-2950 |
8.11% |
Record |
PRINCIPAL
SHAREHOLDERS
BALANCED
FUND
|
|
|
|
|
|
|
| |
|
|
|
Name
and Address |
Percent of Fund |
Record
or Beneficial |
|
|
|
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1901 |
79.76% |
Record |
Luther
King Capital Management Corporation
Profit
Sharing Plan
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
10.69% |
Beneficial |
PRINCIPAL
SHAREHOLDERS
FIXED
INCOME FUND
|
|
|
|
|
|
|
| |
|
|
|
Name
and Address |
Percent of Fund |
Record
or Beneficial |
|
|
|
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1901 |
52.71% |
Record |
J.P.
Morgan Securities LLC
1111
Polaris Pkwy., FL 2J
Columbus,
OH 43240-2031 |
17.20% |
Record |
Muir &
Co 1
c/o
Frost Bank Trust Dept.
P.O.
Box 2950
San
Antonio, TX 78299-2950 |
14.93% |
Record |
Luther
King Capital Management Corporation
For
the Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
6.02% |
Beneficial |
PRINCIPAL
SHAREHOLDERS
INTERNATIONAL
EQUITY FUND
|
|
|
|
|
|
|
| |
|
|
|
Name
and Address |
Percent of Fund |
Record
or Beneficial |
|
|
|
Charles
Schwab & Co., Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
211
Main St.
San
Francisco, CA 94105-1901 |
62.28% |
Record |
Muir &
Co 0
c/o
Frost Bank Trust Dept.
P.O.
Box 2950
San
Antonio, TX 78299-2950 |
28.89% |
Record |
Luther
King Capital Management Corporation
Profit
Sharing Plan
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
10.87% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
9.58% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
8.99% |
Beneficial |
Luther
King Capital Management Corporation
For
the Exclusive Benefit of its Client
301
Commerce Street, Suite 1600
Fort
Worth, Texas 76102 |
7.99% |
Beneficial |
Shareholders
with a controlling interest could affect the outcome of proxy voting or the
direction of management of the Funds.
PROXY
VOTING PROCEDURES
The
Funds have delegated their authority to vote proxies to the Adviser, subject to
the supervision of the Board of Trustees. The Adviser’s proxy voting policies
are summarized below.
GENERAL
The
Adviser’s Chief Compliance Officer (“Adviser CCO”) is responsible for monitoring
the proxy voting process, including engaging and overseeing any third-party
vendor retained to review, monitor, or vote proxies.
The
Adviser has engaged Institutional Shareholder Services, Inc. (“ISS”) as its
voting delegate to:
(1) research
and make voting determinations in accordance with the policies and procedures
described herein;
(2) vote
and submit proxies in a timely manner;
(3) handle
other administrative functions of proxy voting;
(4) maintain
records of proxy statements received in connection with proxy votes and provide
copies of such proxy statements promptly upon request;
(5) maintain
records of votes cast; and
(6) provide
recommendations with respect to proxy voting matters in general.
The
Adviser has determined that, except as set forth below, proxies will be voted in
accordance with the voting recommendations contained in the applicable domestic
or global ISS Voting Guidelines in effect at the time of voting (as applicable,
the “ISS Voting Guidelines”). The Adviser will periodically review the ISS
Voting Guidelines, including any significant changes or updates thereto. In
connection with such reviews, the Adviser may determine that it is not in the
best interest of the Funds to vote proxies in accordance with the ISS Voting
Guidelines on certain matters. In such event, the Adviser will follow the
procedures below in connection with voting any such proxies contrary to the ISS
Voting Guidelines.
In
the event the ISS Voting Guidelines do not address how a proxy should be voted,
the Adviser will vote the proxy in accordance with ISS recommendations. If ISS
refrains from making any such recommendations, the Adviser will vote the proxy
consistent with what it believes to be a Fund’s best interest. Prior to voting
any proxies in the absence of ISS recommendations, however, the Adviser CCO will
determine whether any material conflict of interest may exist between the
Adviser and a Fund with
respect
thereto. If the Adviser CCO determines that any such material conflict of
interest may exist, the Adviser will follow the procedures below in connection
with the voting of such proxies.
There
may be circumstances under which the Adviser believes that it is in the best
interest of a Fund to vote proxies in a manner inconsistent with the ISS Voting
Guidelines or ISS recommendations. Prior to voting any proxies inconsistent with
the ISS Voting Guidelines or ISS recommendations, however, the Adviser CCO will
determine whether any material conflict of interest may exist between the
Adviser and a Fund with respect thereto. If the Adviser CCO determines that any
such material conflict of interest may exist, the Adviser will follow the
procedures below in connection with the voting of such proxies.
The
Adviser maintains records relating to the implementation of its proxy voting
policies and procedures, including, but not limited to, (i) records of each
vote cast, which ISS maintains on the Adviser’s behalf, and (ii) documents
considered or prepared by the Adviser that are material in making a decision to
vote proxies on behalf of a Fund or that memorialize the basis for that
decision.
CONFLICTS
OF INTEREST
The
Adviser periodically reviews ISS’ conflicts of interest policy and code of
ethics, which address conflicts of interest that could arise in connection with
proxy advisory services provided by ISS or its affiliates. The Adviser believes
that ISS’ conflicts of interest policy and code of ethics contain policies and
procedures that are reasonably designed to minimize any such potential conflicts
of interest.
In
the event that the Adviser or the Adviser CCO determines that voting a proxy may
present a material conflict of interest between the Adviser and a Fund, the
Adviser will (1) in cases where ISS had made a recommendation, take no
further action, in which case ISS shall vote such proxy in accordance with the
ISS Voting Guidelines or ISS recommendations, as applicable, (2) disclose
such conflict of interest to the Board of Trustees and obtain written direction
from the Board as to how to vote the proxy, (3) suggest that the Board
engage another party to determine how to vote the proxy, or (4) engage
another independent third party to determine how to vote the proxy.
Notwithstanding
the foregoing, the Adviser must vote proxies in what it believes to be in the
best interest of the Funds when material conflicts of interest may exist with
respect thereto. The Adviser believes that these policies and procedures are
reasonably designed to address material conflicts of interest that may arise as
to the manner in which proxies are voted.
MORE
INFORMATION
The
actual voting records relating to portfolio securities during the most recent
12-month period ended June 30 are available without charge, upon request by
calling toll-free, (800) 688-LKCM or by accessing the SEC’s website at
www.sec.gov. In addition, a copy of the Funds’ proxy voting policies and
procedures are currently available by calling (800) 688-LKCM and will be
sent within three business days of receipt of a request.
INVESTMENT
ADVISER
The
investment adviser of the Funds is Luther King Capital Management Corporation a
Delaware corporation controlled by J. Luther King, Jr. (the “Adviser”). The
Adviser’s parent company is Southwest JLK Corporation, a Texas corporation of
which Mr. King is the majority owner and controlling shareholder.
Mr. King is a member of the Board of Trustees and President, Chief
Executive Officer and Portfolio Manager of the Trust. Under an Investment
Advisory Agreement (the “Agreement”) with the Funds, the Adviser manages the
investment and reinvestment of the Funds’ assets, subject to the control and
supervision of the Board of Trustees. The Adviser is responsible for making
investment decisions for the Funds and for placing the Funds’ purchase and sale
orders. Under the Agreement, the Funds pay the Adviser an advisory fee,
calculated daily and payable quarterly, equal to the annual rate set forth under
“Contractual Advisory Fee” in the table below based on the Fund’s average daily
net assets for the quarter. However, the Adviser has contractually agreed to
waive all or a portion of its advisory fees and/or reimburse the Funds through
May 1, 2025 to limit the total annual operating expenses of the Funds from
exceeding the respective caps as shown in the following table. This expense
limitation excludes interest, taxes, brokerage commissions, indirect fees and
expenses relating to investments in other investment companies, including money
market funds (“Acquired Fund Fees and Expenses”), and extraordinary expenses.
The fee waiver and expense reimbursement agreement may be terminated or changed
only with the consent of the Board of Trustees.
The
advisory fees and expense caps for the current fiscal year are as follows:
|
|
|
|
|
|
|
| |
|
|
|
|
Contractual Advisory Fee |
Cap on Total Annual Operating
Expenses |
|
|
|
Small
Cap Equity Fund |
0.75% |
1.00% |
Small-Mid
Cap Equity Fund |
0.75% |
1.00% |
Equity
Fund |
0.70% |
0.80% |
Balanced
Fund |
0.65% |
0.80% |
Fixed
Income Fund |
0.50% |
0.50% |
International
Equity Fund |
0.90% |
1.00% |
As
compensation for the services rendered by the Adviser under the Agreement, for
the fiscal years ended December 31, 2023, 2022 and 2021, the Adviser earned
and waived and/or reimbursed the amounts listed below.
|
|
|
|
|
|
|
|
|
|
| |
|
|
| |
|
Contractual Advisory Fees Incurred |
Waived Fees and/or Expenses Reimbursed by the Adviser |
Net Advisory Fees paid to the Adviser |
|
|
|
|
Small
Cap Equity Fund |
|
|
|
Year
Ended December 31, 2021 |
$1,718,396 |
$(74,254) |
$1,644,142 |
Year
Ended December 31, 2022 |
$1,395,312 |
$(125,665) |
$1,269,647 |
Year
Ended December 31, 2023 |
$1,488,393 |
$(140,774) |
$1,347,619 |
|
|
|
|
Small-Mid
Cap Equity Fund |
|
|
|
Year
Ended December 31, 2021 |
$119,726 |
$(118,194) |
$1,532 |
Year
Ended December 31, 2022 |
$124,143 |
$(131,696) |
$(7,553)(1) |
Year
Ended December 31, 2023 |
$144,536 |
$(142,893) |
$1,643 |
|
|
|
|
Equity
Fund |
|
|
|
Year
Ended December 31, 2021 |
$3,547,029 |
$(804,807) |
$2,742,222 |
Year
Ended December 31, 2022 |
$3,343,687 |
$(830,646) |
$2,513,041 |
Year
Ended December 31, 2023 |
$3,301,184 |
$(941,230) |
$2,359,954 |
|
|
|
|
Balanced
Fund |
|
|
|
Year
Ended December 31, 2021 |
$883,371 |
$(217,130) |
$666,241 |
Year
Ended December 31, 2022 |
$778,799 |
$(233,447) |
$545,352 |
Year
Ended December 31, 2023 |
$713,831 |
$(269,008) |
$444,823 |
|
|
|
|
Fixed
Income Fund |
|
|
|
Year
Ended December 31, 2021 |
$1,461,765 |
$(818,913) |
$642,852 |
Year
Ended December 31, 2022 |
$1,410,331 |
$(805,761) |
$604,570 |
Year
Ended December 31, 2023 |
$1,392,057 |
$(868,939) |
$523,118 |
|
|
|
|
International
Equity Fund |
|
|
|
Year
Ended December 31, 2021 |
$431,451 |
$(189,401) |
$242,050 |
Year
Ended December 31, 2022 |
$415,306 |
$(206,382) |
$208,924 |
Year
Ended December 31, 2023 |
$507,186 |
$(233,343) |
$273,843 |
(1) A
negative amount indicates advisory fees waived and expenses reimbursed in excess
of the advisory fees accrued.
PORTFOLIO
MANAGERS
The
portfolio managers listed below have responsibility for the day-to-day
management of accounts other than the Funds. The information listed below for
such other accounts is as of December 31, 2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Number of Other Accounts Managed and Assets by Account Type |
Number of Accounts and Assets for which Advisory Fee is Performance Based |
|
|
|
|
|
|
|
|
Registered Investment Companies |
Other
Pooled Investment Vehicles |
Other Accounts |
Registered Investment Companies |
Other Pooled Investment Vehicles |
Other Accounts |
|
|
|
|
|
|
|
J.
Luther King, Jr. |
0 |
12 |
254 |
0 |
8 |
0 |
0 |
$4.0
billion |
$5.7
billion |
$0 |
$2.6
billion |
$0 |
Scot
C. Hollmann |
1 |
$0 |
344 |
0 |
0 |
0 |
$58.3
million |
$0 |
$2.2
billion |
$0 |
$0 |
$0 |
Joan
M. Maynard |
0 |
0 |
15 |
0 |
0 |
0 |
$0 |
$0 |
$193
million |
$0 |
$0 |
$0 |
Mark
L. Johnson |
0 |
0 |
152 |
0 |
0 |
0 |
$0 |
$0 |
$504.7
million |
$0 |
$0 |
$0 |
Mason
D. King |
0 |
1 |
81 |
0 |
0 |
0 |
$0 |
$14.9
million |
$285.8
million |
$0 |
$0 |
$0 |
Brittny
G. Allred |
0 |
0 |
55 |
0 |
0 |
0 |
$0 |
$0 |
$158.7
million |
$0 |
$0 |
$0 |
Daniel
C. Downes |
0 |
0 |
20 |
0 |
0 |
0 |
$0 |
$0 |
$45.4
million |
$0 |
$0 |
$0 |
Conflicts
of Interest
The
portfolio managers are responsible for managing the Funds and other separately
managed accounts, including accounts for investment companies, employee benefit
plans, pension plans, endowments, foundations, trusts, high net worth
individuals, and pooled investment vehicles. When a portfolio manager is
responsible for the management of more than one account, the potential arises
for the portfolio manager to favor one account over another. The principal types
of conflicts of interest that may arise are discussed below. The Adviser
believes that it has established policies and procedures that are reasonably
designed to mitigate these potential conflicts of interest.
• The
portfolio managers are responsible for managing other accounts that may have
investment objectives, guidelines, strategies, risk profiles or other
considerations that may differ from those of the Funds. The portfolio managers
make investment decisions for each account based on its investment objectives
and guidelines, policies, and other relevant considerations. Consequently, the
portfolio managers may purchase or sell securities at the same or different
times for one account and not another account or the Funds. The portfolio
managers may also make investment decisions on behalf of other accounts that are
directly or indirectly contrary to investment decisions made on behalf of the
Funds, or make investment decisions that are similar to those made for the
Funds, any of which has the potential to adversely impact the Funds depending on
market conditions.
• The
portfolio managers may purchase or sell for their own account securities that
are purchased or sold on behalf of the Funds. The portfolio managers also have a
beneficial interest in pooled investment vehicles or other accounts managed by
the Adviser, other than the Funds. The Adviser has implemented a code of ethics
and other policies and procedures in an effort to mitigate these potential
conflicts of interest.
• The
portfolio managers could favor one account over another in allocating new
investment opportunities of a limited nature, such as initial public offerings
and private placements. The Adviser has implemented policies and procedures,
including a rotational system for allocating initial public offerings, in an
effort to ensure that investment opportunities of a limited nature are allocated
fairly and equitably among eligible accounts.
• The
portfolio managers could favor one account over another in the order in which
trades for accounts are placed. If the portfolio managers determine to purchase
a security for more than one account in an aggregate amount that may influence
the market price of the security, accounts that purchased or sold the security
first may receive a more favorable price than accounts that made subsequent
transactions. In addition, the Funds and other accounts, including pooled
investment vehicles, managed by the portfolio managers may participate in
aggregated purchase or sale transactions. To the extent that accounts
participating in aggregated trades do not receive their full allocation, a
potential conflict of interest exists because the Adviser and portfolio managers
have an incentive to allocate trades to accounts in which the Adviser and
portfolio managers have a financial interest. The Adviser has implemented trade
allocation and aggregation policies and procedures in an effort to mitigate this
potential conflict of interest.
• The
portfolio managers are responsible for managing other accounts and pooled
investment vehicles, some of which entitle the Adviser to incentive fees and/or
management fees exceeding those paid by the Funds. This compensation structure
presents a potential conflict of interest because the Adviser and the portfolio
managers may be incentivized to favor such accounts over the Funds.
• The
Adviser and the portfolio managers have significant personal investments in some
of the private investment funds managed by the Adviser. As a result of such
investments, the Adviser and the portfolio managers may be motivated to favor
these funds over the Funds.
• Under
Section 28(e) of the Securities Exchange Act of 1934, as amended, the
Adviser may pay commissions to brokers for the Funds’ transactions that exceed
the amount of commissions that would be charged by another broker for the same
transactions, provided that the Adviser determines in good faith that the amount
of commissions paid are reasonable in relation to the value of the brokerage and
research services provided by such broker, either in terms of a particular
transaction or the Adviser’s overall responsibilities with respect to accounts
for which it exercises investment discretion. Pursuant to Section 28(e),
the Adviser has entered into soft dollar and commission sharing arrangements
with third parties and brokers for eligible brokerage and research products and
services. A potential conflict of interest may exist because the Adviser
receives these brokerage and research products and services from brokers in
exchange for directing commissions from the Funds’ transactions, rather than
paying for these products and services with its own assets. The Adviser has
implemented policies and procedures governing its use of such soft dollar and
commission sharing arrangements.
Compensation
As
an independent firm, the Adviser has full control over its compensation
structure. The Adviser seeks to maintain a compensation program that is
competitively positioned to attract and retain high-caliber investment
professionals. Each member of the professional staff is provided a salary. They
also are eligible to participate in the Adviser’s profit sharing plan. The
majority of compensation is derived from bonuses, which are discretionary and
based on individual merit as well as success of the Adviser in any given year.
Criteria for individual bonuses include, among other factors, stock selection,
relationship building, investment performance, client service, and portfolio
management. There is no standard formula or method for determining bonuses and
the factors considered for bonuses vary by individual. Compensation is not based
directly on the performance of the Funds or the net asset levels of the Funds.
Ownership
of Securities
As
of March 31, 2024, the officers and Trustees of the Trust as a group owned
approximately 4.24% of the Equity Fund, approximately 1.82% of the Small-Mid Cap
Equity Fund, approximately 1.98% of the Small Cap Equity Fund, approximately
2.43% of the International Equity Fund, and less than one percent of the
Balanced Fund and Fixed Income Fund.
The
Adviser’s employees, including officers of the Trust and portfolio managers of
the Funds, are participants in the Luther King Capital Management Corporation
Profit Sharing Plan (“LKCM Profit Sharing Plan”). As of March 31, 2024, the
LKCM Profit Sharing Plan owned approximately 10.70% of the Equity Fund,
approximately 10.69% of the Balanced Fund, approximately 3.32% of the Fixed
Income Fund, approximately 17.55% of the Small-Mid Cap Equity Fund,
approximately 4.84% of the Small Cap Equity Fund, and approximately 10.87% of
the International Equity Fund. J. Luther King, Jr. serves as trustee of the LKCM
Profit Sharing Plan.
As
of March 31, 2024, the Adviser owned approximately 4.32% of the Balanced Fund,
approximately 2.82% of the Small Cap Equity Fund, approximately 3.44% of the
International Equity Fund, approximately 1.11% of the Equity Fund, approximately
1.12% of the Small-Mid Cap Equity Fund, and less than one percent of the Fixed
Income Fund. J. Luther King, Jr. controls the Adviser and is the majority
shareholder of the Adviser’s parent company.
Each
portfolio manager of the Funds also owned the following amounts of shares of
each of the Funds as of December 31, 2023:
Key
A.
None
B.
$1 - $10,000
C.
$10,001 - $50,000
D.
$50,001 - $100,000
E.
$100,001 - $500,000
F.
$500,001 - $1,000,000
G.
Over $1,000,000
|
|
|
|
|
|
|
| |
|
| |
Fund
Name |
Name
of Portfolio Manager |
Dollar
Range of Shares Owned |
|
|
|
Small
Cap Equity Fund |
Mason
D. King
J.
Luther King, Jr.
Mark
L. Johnson |
E
G
A |
|
|
|
Small-Mid
Cap Equity Fund |
Daniel
C. Downes
J.
Luther King, Jr.
Mason
D. King |
F
F
C |
|
|
|
Equity
Fund |
J.
Luther King, Jr.
Scot
C. Hollmann
Mason
D. King |
G
A
G |
|
|
|
Balanced
Fund |
Scot
C. Hollmann
J.
Luther King, Jr.
Mark
L. Johnson |
F
E
A |
|
|
|
Fixed
Income Fund |
Joan
M. Maynard
Scot
C. Hollmann
Mark
L. Johnson |
C
D
A |
|
|
|
International
Equity Fund |
Mason
D. King
J.
Luther King, Jr.
Brittny
G. Allred |
E
G
C |
PORTFOLIO
TRANSACTIONS AND BROKERAGE
The
Agreement authorizes the Adviser to select the brokers or dealers that will
execute the purchases and sales of investment securities for the Funds and
directs the Adviser to use its best efforts in seeking best execution with
respect to all securities transactions for the Funds. In selecting brokers or
dealers for securities transactions for the Funds, the Adviser may consider,
among other things: the quality of executions and liquidity provided by the
broker; the ability of the broker to maintain confidentiality of client orders
and order flow; the ability of the broker to minimize market impact for client
transactions; the commission rates charged by the broker in comparison to the
rates of other brokers for similar transactions; the broker’s provision of
eligible brokerage and research services; the broker’s ability to obtain timely,
accurate, and cost-effective executions; the ability of the broker to accurately
communicate the nature of the market for a particular security; the broker’s
execution policies and commitment to providing best execution; the size and
volume of the broker’s order flow; and the efficiency and accuracy of the
broker’s operations area with regard to settlement procedures.
As
permitted by Section 28(e) of the Securities Exchange Act of 1934, as
amended, the Adviser may cause the Funds to pay higher commission rates than the
lowest available when the Adviser believes in good faith that the commissions
paid are reasonable in light of the value of the brokerage or research services
provided by the broker, either in terms of a particular transaction or the
Adviser’s overall responsibilities with respect to accounts for which it has
investment discretion. These services generally include third-party and
proprietary analyses and reports concerning issuers, industries, securities,
general economic and market conditions and trends, portfolio strategy;
third-party and proprietary analyses and reports regarding the value of
securities, the advisability of purchasing or selling securities, and the
availability of sellers and purchasers of securities; and services related to
effecting securities transactions and performing functions incidental thereto.
The Adviser may use some of these services in providing investment advisory
services to all of its clients, and not all of these services may be used by the
Adviser in providing investment advisory services to the Funds. During the
fiscal year ended December 31, 2023, the Small Cap Equity Fund, Small-Mid
Cap Equity Fund, Equity Fund and Balanced Fund directed transactions to brokers
pursuant to which the brokers provided third-party or proprietary research or
brokerage services to the Adviser. Pursuant to these arrangements to receive
research and brokerage services, during the fiscal year ended December 31,
2023 it is estimated that the Small Cap Equity Fund paid total commissions of
approximately $70,400 on transactions with a principal value of approximately
$57.3 million, the Small-Mid Cap Equity Fund paid total commissions of
approximately $9,200 on transactions with a principal value of approximately
$13.7 million, the Equity Fund paid total commissions of approximately
$7,700 on transactions with a principal value of approximately $16.6 million,
and the Balanced Fund paid total commissions of approximately $3,700 on
transactions with a principal value of approximately $11.1 million.
It
is not the Adviser’s practice to allocate brokerage or principal business on the
basis of sales of shares of Funds that may be made through intermediary brokers
or dealers. However, the Adviser may place orders with qualified broker-dealers
who recommend the Funds or who act as agents in the purchase of shares of the
Funds for their clients, without considering these factors in selecting a
broker-dealer. The Adviser does not have an affiliated broker, therefore it has
not engaged in any affiliated brokerage transactions.
The
aggregate amount of brokerage commissions paid by each Fund during the past
three fiscal years ended December 31 is as follows:
|
|
|
|
|
|
|
|
|
|
| |
|
2021 |
2022 |
2023 |
Small
Cap Equity Fund |
$294,239 |
$259,196 |
$179,317 |
Small-Mid
Cap Equity Fund |
$17,628 |
$19,190 |
$18,512 |
Equity
Fund |
$55,546 |
$53,005 |
$78,005 |
Balanced
Fund |
$6,796 |
$14,791 |
$5,324 |
Fixed
Income Fund |
$0 |
$0 |
$0 |
International
Equity Fund |
$58,046 |
$41,213 |
$39,292 |
Some
securities considered for investment by the Funds may also be appropriate for
other clients served by the Adviser. If purchases or sales of securities
consistent with the investment policies of the Funds and one or more of these
other clients serviced by the Adviser are considered at or about the same time,
transactions in such securities may be aggregated and allocated among the Funds
and such clients in accordance with the Adviser’s allocation policies and
procedures or in any other manner deemed fair and reasonable by the Adviser.
As
of December 31, 2023, the Funds did not hold securities of their “regular
brokers or dealers” (as defined in the 1940 Act) or their parent companies.
PORTFOLIO
TURNOVER
Although
the Funds generally will not invest for short-term trading purposes, portfolio
securities may be sold without regard to the length of time they have been held
when, in the opinion of the Adviser, investment or other considerations warrant
such action. Portfolio turnover rate is calculated by dividing (1) the
lesser of purchases or sales of long-term portfolio securities for the fiscal
year by (2) the monthly average of the value of long-term portfolio
securities owned during the fiscal year. A 100% turnover rate would occur if all
the securities in a Fund’s portfolio, with the exception of securities whose
maturities at the time of acquisition were one year or less, were sold and
either repurchased or replaced within one year. A high rate of portfolio
turnover (100% or more) generally leads to higher transaction costs and may
result in a greater number of transactions on which net taxable gains are
realized. Portfolio turnover may vary significantly from year to year due to a
variety of factors, including fluctuating volume of shareholder purchase
and redemption orders, market conditions, investment strategy changes,
and/or changes in the Adviser’s investment outlook.
The
Funds had the following portfolio turnover rates for the past two fiscal years
ended December 31:
|
|
|
|
|
|
|
| |
|
2022 |
2023 |
Small
Cap Equity Fund |
42% |
28% |
Small-Mid
Cap Equity Fund |
50% |
32% |
Equity
Fund |
11% |
10% |
Balanced
Fund |
13% |
11% |
Fixed
Income Fund |
21% |
23% |
International
Equity Fund |
26% |
11% |
CUSTODIAN
As
custodian of the Funds’ assets, U.S. Bank, N.A. (the “Custodian”), 1555 N.
RiverCenter Drive, Suite 302, Milwaukee, WI 53212, has custody of all securities
and cash of the Funds, delivers and receives payment for securities sold,
receives and pays for securities purchased, collects income from investments,
and performs other duties, all as directed by the officers of the Trust. U.S.
Bank, N.A. and Fund Services (as defined below) are affiliates.
TRANSFER
AGENT
U.S.
Bancorp Fund Services, LLC, doing business as U.S. Bank Global Fund Services
(“Fund Services”), 615 East Michigan Street, Milwaukee, Wisconsin, 53202 serves
as transfer agent, dividend disbursing agent and shareholder servicing agent for
the Funds. In such capacity, Fund Services’ responsibilities include:
receiving and processing all orders for purchases, exchanges and redemptions of
Fund shares; responding to shareholder inquiries and instructions concerning
their accounts; updating of shareholder accounts to reflect declaration and
payment of dividends and other distributions; and preparing and distributing
account statements and tax documents to shareholders regarding their accounts.
U.S. Bank, N.A. and Fund Services are affiliates.
ADMINISTRATOR
Pursuant
to a Fund Administration Agreement, Fund Services provides each Fund with
administrative services. The services under this Agreement are subject to the
supervision of the Board of Trustees and officers of the Trust, and include
day-to-day administration of matters necessary to the Funds’ operations,
maintenance of their records, preparation of reports, compliance testing of the
Funds’ activities, and preparation of periodic updates of the registration
statement under federal and state laws. For administration services, Fund
Services receives from each Fund a fee, calculated daily and paid monthly. U.S.
Bank, N.A. and Fund Services are affiliates.
Administration
fees incurred during the past three fiscal years ended December 31 were as
follows:
|
|
|
|
|
|
|
|
|
|
| |
|
2021 |
2022 |
2023 |
Small
Cap Equity Fund |
$212,708 |
$174,684 |
$202,777 |
Small-Mid
Cap Equity Fund |
$43,551 |
$52,050 |
$62,321 |
Equity
Fund |
$438,476 |
$422,510 |
$443,684 |
Balanced
Fund |
$125,271 |
$117,072 |
$119,441 |
Fixed
Income Fund |
$264,709 |
$264,080 |
$278,270 |
International
Equity Fund |
$47,981 |
$52,857 |
$68,833 |
Fund
Services also acts as Transfer Agent, Dividend-Disbursing Agent, and Fund
Accountant for the Funds.
DISTRIBUTOR
Quasar
Distributors, LLC (the “Distributor”), 3 Canal Plaza, Suite 100, Portland, ME
04101, a registered broker-dealer and member of the Financial Industry
Regulatory Authority, distributes the Funds’ shares. The Distributor uses its
best efforts to distribute the Funds’ shares, which shares are offered for sale
by the Funds continuously at net asset value per share without the imposition of
a sales charge. The Funds pay that portion of the compensation owed to the
Distributor that is permitted under Rule 12b-1 of the 1940 Act (if the
Funds currently pay any fees under their Rule 12b-1 Plans), and the Adviser pays
the remaining portion of any such compensation.
DISTRIBUTION
PLAN
The
Board has adopted a Distribution Plan pursuant to Rule 12b-1 under the 1940 Act
(the “Distribution Plan”). Pursuant to the Distribution Plan, the Funds can pay
up to an aggregate maximum of 0.75% per annum of each Fund’s average daily net
assets for the distribution and promotion of the shares of the Funds and the
retention of shares by Fund shareholders. These services include, but are not
limited to, the printing of Prospectuses, Statements of Additional Information,
reports used for sales purposes, advertisements, expenses of preparation and
printing of sales literature, other distribution-related expenses and providing
services to shareholders. Although approved, the Board of Trustees has not
authorized payments under the Distribution Plan at this time. As a result, the
Funds did not pay any amounts in Rule 12b-1 expenses for the fiscal year ended
December 31, 2023.
The
Distribution Plan is regulated by Rule 12b-1 under the 1940 Act, which requires
that the Board receive and review at least quarterly reports concerning the
amount and purpose of expenses which are made, and that the Distribution Plan
may be continued from year-to-year only if the Board, including a majority of
the Independent Trustees, concludes at least annually that continuation of the
Distribution Plan is reasonably likely to benefit the Trust and its
shareholders.
PAYMENTS
TO FINANCIAL INTERMEDIARIES
A
financial intermediary through which you purchase your shares may receive all or
a portion of the Distribution Plan Rule 12b-1 fees, if applicable, discussed
above. In addition to those payments, the Adviser makes additional cash payments
to certain intermediaries in connection with the promotion and sale of shares of
the Funds. The Adviser and the Funds also make payments for certain sub-transfer
agency and administrative services. Payments made by the Adviser are from its
own resources. The categories described below are not mutually exclusive. The
same financial intermediary may receive payments under more than one or all
categories.
Revenue
Sharing Payments.
The Adviser makes revenue sharing payments as incentives to certain financial
intermediaries to promote and sell shares of the Funds. The benefits that the
Adviser receives when it makes these payments include, among other things,
placing the Funds on the financial intermediary’s funds sales system. The
Adviser compensates financial intermediaries differently depending typically on
the level and/or type of considerations provided by the financial intermediary.
Revenue
sharing payments may be calculated on sales of shares of the Funds (“Sales-Based
Payments”). Such payments also may be calculated on the average daily net assets
of the applicable Funds attributable to that particular financial intermediary
(“Asset-Based Payments”). Sales-Based Payments primarily create incentives to
make new sales of shares of the Funds and Asset-Based Payments primarily create
incentives to retain previously sold shares of the Funds in shareholder
accounts. The Adviser may pay a financial intermediary either or both
Sales-Based Payments and Asset-Based Payments.
Administrative
and Processing Support Payments.
Firms that establish omnibus accounts and provide substantially the same
services to their clients as are provided by Fund Services to direct
shareholders of the Funds may receive sub-transfer agent fees for such services
from the respective Fund. In an omnibus account, the Funds maintain a single
account in the name of a financial intermediary such as a broker, dealer,
record-keeper or other service provider and the financial intermediary maintains
all of the individual shareholder accounts.
Record-keeping
and shareholder services typically include: establishing and maintaining
shareholder accounts and records; recording shareholder account balances and
changes thereto; arranging for the wiring of funds; providing statements to
shareholders; furnishing proxy materials, periodic reports of the Funds,
prospectuses and other communications to current shareholders as required;
transmitting shareholder transaction information; and providing information in
order to assist the Funds in their compliance with federal and state securities
laws. Each Fund typically would be paying these shareholder servicing fees
directly if the financial intermediary did not hold all of its customer accounts
in a single omnibus account with the Funds. Likewise, for many retirement plans,
a third party administrator may open an omnibus account with the Funds and the
administrator will then maintain all of the participant accounts. The Adviser
and the Funds make payments to certain financial intermediaries for certain
administrative services, including record keeping and sub-accounting shareholder
accounts. The Adviser, the Distributor and the Funds also make payments to
certain financial intermediaries in connection with client account maintenance
support, statement preparation and transaction processing.
Other
Cash Payments.
From time to time, the Adviser, at its own expense, may provide additional
compensation to financial intermediaries which sell or arrange for the sale of
shares of the Funds. This additional compensation may be offered to the extent
not prohibited by state laws or any self-regulatory agency, such as Financial
Industry Regulatory Authority, Inc. Such compensation may include financial
assistance to financial intermediaries that enables the Adviser to:
(1) participate in and/or present at conferences or seminars for invited
registered representatives and other employees, (2) participate in client
entertainment, client and investor events, and other financial
intermediary-sponsored events, and (3) pay expenses incurred by registered
representatives and other employees in connection with client prospecting,
retention and due diligence trips.
The
Adviser is motivated to make the payments described above since they promote the
sale of Fund shares and the retention of those investments by clients of
financial intermediaries. To the extent financial intermediaries sell more
shares of Funds or retain shares of Funds in their clients’ accounts, the
Adviser benefits from the incremental management and other fees paid to the
Adviser by the Funds with respect to those assets.
In
certain cases these payments could be significant to the financial intermediary.
Your financial intermediary may charge you additional fees or commissions other
than those disclosed in the prospectus and this SAI. You may ask your financial
intermediary about any payments it receives from the Adviser or the Funds, as
well as about fees and/or commissions it charges.
INTERESTS
OF CERTAIN PERSONS
With
the exception of the Adviser, no “interested person” of the Funds, as defined in
the 1940 Act, and no Trustee of the Trust who is not an “interested person”, has
or had a direct or indirect financial interest in the Distribution Plan or any
related agreement.
CODE
OF ETHICS
The
Trust, Adviser and Distributor have each adopted a written Code of Ethics. These
Codes of Ethics govern the personal securities transactions of trustees,
directors, officers and employees who may have access to current trading
information of the Funds. The Codes of Ethics permit such persons to invest in
the Funds and/or other securities for their personal accounts, including
securities that may be purchased or held by the Funds, subject to certain
conditions. The Codes of Ethics include reporting and other obligations to
monitor personal transactions and confirm that such transactions do not
disadvantage the Funds.
PURCHASE
AND PRICING OF SHARES
PURCHASE
OF SHARES
The
Funds will be deemed to have received a purchase or redemption order when an
authorized broker or, if applicable, a broker’s designee receives the order.
Purchasing
Shares with Liquid Securities.
Certain clients of the Adviser may, subject to the approval of the Trust,
purchase shares of the Funds with liquid securities that are eligible for
purchase by a Fund (consistent with the Fund’s investment policies and
restrictions) and that have a value that is readily ascertainable (and not
established
only by fair valuation procedures) as evidenced by a listing on the New York
Stock Exchange (“NYSE”) or NASDAQ. These transactions will be effected only if
the Adviser intends to retain the security in the Funds as an investment. Assets
so purchased by the Funds will be valued in generally the same manner as they
would be valued for purposes of pricing a Fund’s shares, if such assets were
included in the Fund’s assets at the time of purchase.
Automatic
Investment Program.
The Automatic Investment Program (“AIP”) permits investors who own shares of a
Fund with a value of $2,000 or more to purchase shares (minimum of $100 per
transaction) at regular intervals selected by the investor. Provided the
investor’s financial institution allows automatic withdrawals, shares are
purchased by transferring funds from an investor’s checking or savings account.
The financial institution must be a member of the Automatic Clearing House
network. There is
no
charge for this service. A $25 fee will be charged if the investor’s bank
rejects the scheduled transaction. At the investor’s option, the account
designated will be debited in the specified amount, and shares will be purchased
on a specified day or days of a month.
The
AIP is one means by which an investor may use “dollar cost averaging” in making
investments. Instead of trying to time market performance, a fixed dollar amount
is invested in shares at predetermined intervals. This may help investors to
reduce their average cost per share because the agreed upon fixed investment
amount allows more shares to be purchased during periods of lower share prices
and fewer shares during periods of higher prices. In order to be effective,
dollar cost averaging should usually be followed on a sustained, consistent
basis. Investors should be aware, however, that shares bought using dollar cost
averaging are purchased without regard to their price on the day of investment
or market trends. In addition, while investors may find dollar cost averaging to
be beneficial, it will not prevent a loss if an investor ultimately redeems his
or her shares at a price that is lower than their purchase price.
To
establish the AIP, an investor must complete the appropriate sections of the New
Account Application. Please call the Trust at 800-688-LKCM if you have
questions. An investor may cancel his or her participation in this Program or
change the amount of purchase at any time by notifying the Transfer Agent by
telephone or in writing, five days prior to the effective date of the next
transaction. The Trust may modify or terminate this privilege at any time or
charge a service fee, although no such fee currently is contemplated.
PRICING
OF SHARES
Shares
of the Funds are sold and redeemed on a continual basis at the net asset value
per share next computed following acceptance of an order by a Fund. A Fund’s net
asset value per share for the purpose of pricing purchase and redemption orders
is normally determined as of the scheduled close of normal trading (generally
4:00 p.m. Eastern Time) on each day the NYSE is scheduled to be open for
trading. The NYSE is generally scheduled to be closed on the following holidays:
New Year’s Day, Martin Luther King, Jr. Day, President’s Day, Good Friday,
Memorial Day, Juneteenth National Independence Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
Equity
securities listed or traded on a U.S. securities exchange for which market
quotations are readily available are valued at the last quoted sale price on the
exchange on which the security is primarily traded. Nasdaq Global Market
securities are valued at the Nasdaq Official Closing Price. Unlisted U.S. equity
securities and listed U.S. equity securities not traded on a particular
valuation date are valued at the mean of the most recent quoted bid and ask
price on the relevant exchanges or markets.
Equity
securities listed on a foreign exchange for which market quotations are readily
available are valued at the last quoted sales price on the exchange on which the
security is primarily traded.
Debt
securities are normally valued at the mean of the closing bid and ask price
and/or by using a combination of broker quotations or evaluated prices provided
by an independent pricing service. Futures and options on futures are valued at
the settlement prices established each day on the principal exchange on which
they are traded. Forward contracts are valued based on the forward rate using
information provided by an independent pricing service. Other assets and
securities for which no market or broker quotations or evaluated prices are
readily available are valued in good faith at fair value using guidelines
approved by the Board of Trustees.
Rule
2a-5 under the Investment Company Act (the “Valuation Rule”) establishes
requirements for determining fair value in good faith for purposes of the
Investment Company Act, including related oversight and reporting requirements.
The Valuation Rule also defines when market quotations are “readily available”
for purposes of the Investment Company Act, the threshold for determining
whether a security must be fair valued.
The
Valuation Rule permits a Fund’s board to designate the Fund’s investment adviser
as “valuation designee” to perform the Fund’s fair value determinations subject
to board oversight and certain reporting and other requirements intended to
ensure that the registered investment company’s board receives the information
it needs to oversee the investment adviser’s fair value determinations. The
Board has designated the Adviser as valuation designee under the Valuation Rule
to perform fair value functions in accordance with the requirements of the
Valuation Rule. The Adviser may value securities at fair value in good faith
pursuant to the Adviser’s and the Fund’s procedures. The Adviser may use prices
provided by independent pricing services to assist in the fair valuation of the
Fund’s portfolio securities.
The
policies and procedures adopted by the Funds and the Adviser authorize the
Adviser to fair value a security in good faith if, among other things, the
Adviser determines that (i) closing prices of foreign securities do not
reflect their fair market value due to events that occur between the closing of
foreign markets and the time at which a Fund calculates its NAV,
(ii) trading in a security is halted and does not resume prior to the
closing of the exchange or other market on which such security normally trades,
or (iii) the price for such security provided by the Funds’ independent
pricing services appears invalid, is not readily available, or otherwise
provides a valuation that in the judgment of the Adviser does not represent the
fair market value of such security. Prices provided by independent pricing
services may be used to assist in the fair valuation of the Funds’ portfolio
securities. For foreign securities held by the International Equity Fund, such
fair value prices generally are based on such independent pricing services’
proprietary multi-factor models that measure movements in relevant indices,
market indicators and other factors between the time the relevant foreign
markets have closed and the time a Fund calculates its NAV, and therefore may
differ from quoted or official closing prices for such foreign securities in
such foreign markets. If fair value pricing is utilized, the fair values
assigned to such Fund’s foreign investments may not be the quoted or published
prices of the investments on their primary markets or exchanges.
An
example of how each Fund calculated its total offering price per share as of
December 31, 2023 is as follows:
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Net
Assets |
= |
Net Asset Value per share |
|
Shares Outstanding |
|
|
Small
Cap Equity Fund |
$231,550,097 |
= |
$19.53 |
|
11,856,139 |
|
|
Small-Mid
Cap Equity Fund |
$28,493,771 |
= |
$9.91 |
|
2,876,562 |
|
|
Equity
Fund |
$494,676,681 |
= |
$34.41 |
|
14,377,853 |
|
|
Balanced
Fund |
$113,667,125 |
= |
$26.00 |
|
4,372,486 |
|
|
Fixed
Income Fund |
$286,492,175 |
= |
$10.36 |
|
27,662,742 |
|
|
International
Equity Fund |
$60,245,489 |
= |
$12.68 |
|
4,752,938 |
|
|
PORTFOLIO
HOLDINGS INFORMATION
It
is the policy of LKCM Funds to protect the confidentiality of portfolio holdings
and prevent the selective disclosure of non-public information concerning the
Funds. No information concerning the portfolio holdings of the Funds may be
disclosed to any person except as provided below.
The
Adviser and the Funds maintain portfolio holdings disclosure policies that
govern the timing and circumstances of disclosure to shareholders and third
parties of information regarding the portfolio investments held by the Funds.
These portfolio holdings disclosure policies have been approved by the Board of
Trustees. Disclosure of the Funds’ complete holdings is required to be made
quarterly within 60 days of the end of each fiscal quarter in the Annual Report
and Semi-Annual Report to Fund shareholders. Monthly portfolio disclosures are
filed quarterly with the SEC on Form N-PORT, with quarter-end disclosures being
made public 60 days after the end of each fiscal quarter. These reports are
available, free of charge, on the EDGAR database on the SEC’s website at
www.sec.gov. In addition, each Fund also makes available on the Funds’ website a
complete schedule of its portfolio holdings no sooner than 30 days following the
end of each calendar quarter. Information contained within Fund Fact Sheets is
made publicly available on the website upon completion (generally within 10-15
days after the close of the calendar quarter). In an effort to prevent parties
from potentially misusing portfolio holdings information, the Funds will
generally only disclose the Fund Fact Sheets and complete schedules of portfolio
holdings as of the end of the most recent calendar quarter, no earlier than 10
days and 30 days after the end of the calendar quarter, respectively.
In
addition, the Funds’ service providers, including the administrator, custodian,
legal counsel, proxy voting administrator, independent pricing service, and
independent registered public accounting firm, receive portfolio holdings
information in connection with their services to the Funds. The Funds’ service
providers have a duty to keep nonpublic information about the Funds, some of
which is received on a daily basis with no lag time, confidential based on
existing laws and due to the nature of their roles with the Funds. An officer of
the Adviser or the Chief Compliance Officer of the Funds may distribute (or
authorize the Funds’ administrator to distribute) portfolio holdings to rating
and ranking agencies for a legitimate business purpose on a quarterly basis.
Except as noted above, this information is provided no earlier than 30 days
after the end of a calendar quarter and no compensation is received by the
Adviser or the Funds as consideration for such disclosure. The Funds’ Chief
Compliance Officer may waive certain of the requirements of this policy. The
Board of Trustees and the Adviser may, on a case-by-case basis, impose
additional restrictions on the dissemination of portfolio holdings information
beyond those required by the Funds’ policy. Notwithstanding these policies, the
Funds may disclose portfolio holdings information to the extent required by
applicable law.
The
Funds’ Chief Compliance Officer will report any violations of these policies to
the Board of Trustees on a quarterly basis. In no event shall the Adviser, its
affiliates or employees, or the Funds receive any direct or indirect
compensation in connection with the disclosure of information about the Funds’
portfolio holdings.
If
the disclosure of portfolio holdings presents a conflict of interest between the
shareholders and the Adviser, the Funds’ principal distributor or any of their
respective affiliates, then such conflict will be reported to the Board for its
consideration prior to the dissemination of portfolio holdings information.
EXCHANGES
Shareholders
of a Fund may exchange shares of the Fund for shares of another series of the
Trust.
REDEMPTIONS
IN KIND
The
Trust has made an election with the SEC to pay in cash all redemptions requested
by any shareholder of record limited in amount during any 90-day period to the
lesser of (i) $250,000 or (ii) 1% of the net assets of a Fund at the beginning
of such period. Such commitment is irrevocable without the prior approval of the
SEC. Redemptions in excess of the above limits may be paid in whole or in part
in investment securities or in cash, as the Trustees may deem advisable;
however, payment will be made wholly in cash unless the Trustees believe that
economic or market conditions exist which would make such a practice detrimental
to the best interests of the applicable Fund. If redemptions are paid in
investment securities the redeeming shareholders might incur brokerage expenses
if they converted these securities to cash. Securities used to make such
“in-kind” redemptions will be readily marketable. The method of valuing such
securities will be the same as the method of valuing Fund securities described
under “Pricing of Shares,” and such valuation will be made as of the same time
the redemption price is determined.
TAXATION
TAXATION
OF THE FUNDS
The
following discussion of certain federal tax matters concerning the Funds and the
purchase, ownership and disposition of Fund shares is not complete and may not
deal with all aspects of federal taxation that may be relevant to you in light
of your particular circumstances. This discussion is based on the Internal
Revenue Code of 1986, as amended (the “Code”), the regulations promulgated
thereunder and judicial and administrative interpretations thereof, publicly
available as of the date hereof; all these authorities are subject to change,
which may be applied retroactively. You should consult your own tax advisers
with regard to the federal tax consequences to you of the purchase, ownership
and disposition of Fund shares, as well as the tax consequences thereof to you
arising under the laws of any state, locality, foreign country or other taxing
jurisdiction.
Each
Fund, which is treated as a separate corporation for federal tax purposes,
intends to continue to qualify annually for treatment as a “regulated investment
company” under Subchapter M of Chapter 1 of Subtitle A of the Code (“RIC”). If
so qualified, a Fund (but not its shareholders) will not be liable for federal
income tax to the extent it distributes its net earnings and realized net gains
to its shareholders on a timely basis.
To
continue to qualify for treatment as a RIC for a taxable year, a Fund must
distribute to its shareholders at least the sum of 90% of its investment company
taxable income (consisting generally of net investment income, the excess, if
any, of net short-term capital gain over net long-term capital loss (“net
short-term capital gain”) and net gains and losses from certain foreign currency
transactions, if any, all determined without regard to any deduction for
dividends paid) and 90% of its net exempt interest income for that year
(“Distribution Requirement”) and must meet several additional requirements. With
respect to each Fund, these requirements include the following: (1) the
Fund must derive at least 90% of its gross income for the taxable year from
dividends, interest, payments with respect to securities loans and gains
(without regard to losses) from the sale or other disposition of securities or
foreign currencies, or other income derived with respect to its business of
investing in securities or those currencies and income from qualified publicly
traded partnerships (“Income Requirement”); and (2) at the close of each
quarter of the Fund’s taxable year, (a) at least 50% of the value of its
total assets must be represented by cash and cash items, Government securities,
securities of other RICs and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
that value and that does not represent more than 10% of the issuer’s outstanding
voting securities, and (b) not more than 25% of that value may be invested
in (i) the securities (other than Government securities or securities of
other RICs) of any one issuer, (ii) the securities (other than securities
of other RICs) of two or more issuers the Fund controls (by owning 20% or more
of their voting power) that are determined to be engaged in the same, similar or
related trades or businesses, or (iii) interests in qualified publicly
traded partnerships (“Diversification Requirements”).
If
a Fund fails to qualify for treatment as a RIC for any taxable year – either
(1) by failing to satisfy the Distribution Requirement, even if it
satisfies the Income and Diversification Requirements, or (2) by failing to
satisfy the Income Requirement and/or Diversification Requirements and is
unable, or determines not, to avail itself of Code provisions that enable a RIC
to cure a failure to satisfy any of the Income and Diversification Requirements
as long as the failure “is due to reasonable cause and not due to willful
neglect” and the RIC pays a deductible tax calculated in accordance with those
provisions and meets certain other requirements – then for federal tax purposes
it would be treated as a regular corporation. In that case, it would be subject
to federal income tax, and any distributions that it made to its shareholders
would not be deductible by it and would be taxable to them as ordinary income
(with no part treated as a capital gain distribution) to the extent of its
earnings and profits, except for the part of those dividends that is “qualified
dividend income” (described in the Prospectus), which is subject to maximum
federal income tax rates of 15% and 20% for certain shareholders. That treatment
would increase the cost of investing in that Fund for shareholders and would
make it more economical for shareholders to invest directly in securities held
by the Fund instead of investing indirectly in those securities through the
Fund.
Each
Fund will be subject to a nondeductible 4% excise tax (“Excise Tax”) to the
extent it fails to distribute by the end of any calendar year substantially all
of its ordinary income for that year and capital gain net income for the
one-year period ending on October 31 (or December 31, if it so elects)
of that year, plus certain other amounts.
Some
futures contracts, foreign currency contracts, and “non-equity” options (i.e.,
certain listed options, such as those on a “broad-based” securities index) —
except any “securities futures contract” that is not a “dealer securities
futures contract” (both as defined in the Code) and any interest rate swap,
currency swap, basis swap, interest rate cap, interest rate floor, commodity
swap, equity swap, equity index swap, credit default swap, or similar
agreement—in which the Fund invests may be subject to Code section
1256
(collectively, “Section 1256 contracts”). Any Section 1256 contract
the Fund holds at the end of its taxable year must be “marked-to-market” (that
is, treated as having been sold at that time for its fair market value) for
federal income tax purposes, with the result that unrealized gains or losses
will be treated as though they were realized. Sixty percent of any net gain or
loss realized on these deemed sales, and 60% of any net realized gain or loss
from any actual sales of Section 1256 contracts, will be treated as
long-term capital gain or loss, and the balance will be treated as short-term
capital gain or loss. Section 1256 contracts also may be marked-to-market
for purposes of the Excise Tax. These rules may operate to increase the amount
that a Fund must distribute to satisfy the Distribution Requirement (i.e., with
respect to the portion treated as short-term capital gain), which will be
taxable to its shareholders as ordinary income when distributed to them, and to
increase the net capital gain the Fund recognizes, without in either case
increasing the cash available to it.
Section 988
of the Internal Revenue Code also may apply to a Fund’s forward currency
contracts and options and futures contracts on foreign currencies. Under that
section, each foreign currency gain or loss generally is computed separately and
treated as ordinary income or loss. These gains or losses will increase or
decrease the amount of the Fund’s investment company taxable income to be
distributed to its shareholders as ordinary income, rather than affecting the
amount of its net capital gain. If a Fund’s section 988 losses exceed its other
investment company taxable income during a taxable year, the Fund would not be
able to distribute any dividends, and any distributions made during that year
(including those made before the losses were realized) would be characterized as
a non-taxable “return of capital” to shareholders, rather than as a dividend,
thereby reducing each shareholder’s basis in his or her Fund shares and treating
any part of such distribution exceeding that basis as gain from the disposition
of those shares.
Offsetting
positions a Fund enters into or holds in any actively traded option, futures or
forward contract may constitute a “straddle” for federal income tax purposes.
Straddles are subject to certain rules that may affect the amount, character and
timing of recognition of the Fund’s gains and losses with respect to positions
of the straddle by requiring, among other things, that (1) losses realized
on disposition of one position of a straddle be deferred to the extent of any
unrealized gain in an offsetting position until the latter position is disposed
of, (2) the Fund’s holding period in certain straddle positions not begin
until the straddle is terminated (possibly resulting in gain being treated as
short-term rather than long-term capital gain), and (3) losses recognized
with respect to certain straddle positions, that otherwise would constitute
short-term capital losses, be treated as long-term capital losses. Applicable
regulations also provide certain “wash sale” rules, which apply to transactions
where a position is sold at a loss and a new offsetting position is acquired
within a prescribed period, and “short sale” rules applicable to straddles.
Different elections are available, which may mitigate the effects of the
straddle rules, particularly with respect to “mixed straddles” (i.e., a straddle
at least one, but not all, positions of which are Section 1256 contracts).
When
a covered call option written (sold) by a Fund expires, it will realize a
short-term capital gain equal to the amount of the premium it received for
writing the option. When the Fund terminates its obligations under such an
option by entering into a closing transaction, it will realize a short-term
capital gain (or loss), depending on whether the cost of the closing transaction
is less (or more) than the premium it received when it wrote the option. When a
covered call option written by the Fund is exercised, it will be treated as
having sold the underlying security, producing long-term or short-term capital
gain or loss, depending on the holding period of the underlying security and
whether the sum of the option price received on the exercise plus the premium
received when it wrote the option is more or less than the underlying security’s
basis.
If
a Fund has an “appreciated financial position” – generally, an interest
(including an interest through a short sale) with respect to any stock, debt
instrument (other than “straight debt”) or partnership interest the fair market
value of which exceeds its adjusted basis – and enters into a “constructive
sale” of the position, the Fund will be treated as having made an actual sale
thereof, with the result that it will recognize gain at that time. A
constructive sale generally consists of a short sale or an offsetting notional
principal contract a Fund or a related person enters into with respect to the
same or substantially identical property. In addition, if the appreciated
financial position is itself a short sale or such a contract, acquisition of the
underlying property or substantially identical property will be deemed a
constructive sale. The foregoing will not apply, however, to any transaction by
a Fund during any taxable year that would otherwise be treated as a constructive
sale if the transaction is closed within 30 days after the end of that year and
the Fund holds the appreciated financial position unhedged for 60 days after
that closing (i.e.,
at no time during that 60-day period is the Fund’s risk of loss regarding that
position reduced by reason of certain specified transactions with respect to
substantially identical or related property, such as having an option to sell,
being contractually obligated to sell, making a short sale or granting an option
to buy substantially identical stock or securities).
Certain
aspects of the tax treatment of derivative instruments are currently unclear and
may be affected by changes in legislation, regulations, administrative rules,
and/or other legally binding authority that could affect the treatment of income
from those instruments and the character, timing of recognition and amount of
the Fund’s taxable income or net realized gains and distributions. If the
Internal Revenue Service (“IRS”) were to assert successfully that income a Fund
derives from those investments does not constitute Qualifying Other Income, the
Fund might cease to qualify as a RIC (with the consequences described above) or
might be required to reduce its exposure to such investments.
Investments
in Foreign Securities.
Dividends and interest a Fund receives, and gains it realizes, on foreign
securities may be subject to income, withholding or other taxes imposed by
foreign countries and U.S. possessions that would reduce the yield and/or total
return on its securities. Tax conventions between certain countries and the
United States may reduce or eliminate those taxes, however, and many foreign
countries do not impose taxes on capital gains in respect of investments by
foreign investors.
Each
Fund may invest in the stock of “passive foreign investment companies”
(“PFICs”). A PFIC is any foreign corporation (with certain exceptions) that, in
general, meets either of the following tests for a taxable year:
(1) at
least 75% of its gross income is passive; or
(2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income.
Under
certain circumstances, a Fund will be subject to federal income tax on a portion
of any “excess distribution” it receives on the stock of a PFIC and of any gain
on disposition of the stock (collectively, “PFIC income”), plus interest
thereon, even if the Fund distributes the PFIC income as a taxable dividend to
its shareholders. The balance of the PFIC income will be included in the Fund’s
investment company taxable income and, accordingly, will not be taxable to it to
the extent it distributes that income to its shareholders. Fund distributions
attributable to PFIC income will not be eligible for the 15% and 20% maximum
federal income tax rates on “qualified dividend income” mentioned above.
If
a Fund invests in a PFIC and elects to treat the PFIC as a “qualified electing
fund” (“QEF”), then in lieu of the foregoing tax and interest obligation, the
Fund would be required to include in income each taxable year its pro
rata
share of the QEF’s annual ordinary earnings and net capital gain even if the QEF
did not distribute those earnings and gain to the Fund. In most instances it
will be very difficult, if not impossible, to make this election because of
certain requirements thereof.
Each
Fund may elect to “mark to market” its stock in any PFIC. “Marking-to-market,”
in this context, means including in gross income (and treating as ordinary
income) each taxable year the excess, if any, of the fair market value of the
stock over a Fund’s adjusted basis therein as of the end of that year. Pursuant
to the election, a Fund also may deduct (as an ordinary, not a capital, loss)
the excess, if any, of its adjusted basis in PFIC stock over the fair market
value thereof as of the taxable year-end, but only to the extent of any net
mark-to-market gains with respect to that stock the Fund included in income for
prior taxable years under the election. A Fund’s adjusted basis in each PFIC’s
stock subject to the election would be adjusted to reflect the amounts of income
included and deductions taken thereunder.
Investors
should be aware that determining whether a foreign corporation is a PFIC is a
fact-intensive determination that is based on various facts and circumstances
and thus is subject to change, and the principles and methodology used therein
are subject to interpretation. As a result, a Fund may not be able, at the time
it acquires a foreign corporation’s shares, to ascertain whether the corporation
is a PFIC, and a foreign corporation may become a PFIC after a Fund acquires
shares therein. While each Fund generally will seek to avoid investing in PFIC
shares to avoid the tax consequences detailed above, there are no guarantees
that it will be able to do so and it reserves the right to make such investments
as a matter of its investment policy.
Gains
or losses (1) from the disposition of foreign currencies, (2) on the
disposition of a debt security denominated in a foreign currency that are
attributable to fluctuations in the value of the foreign currency between the
dates of acquisition and disposition of the security and (3) that are
attributable to exchange rate fluctuations between the time a Fund accrues
interest, dividends or other receivables or expenses or other liabilities
denominated in a foreign currency and the time it actually collects the
receivables or pays the liabilities, generally are treated as ordinary income or
loss. These gains or losses will increase or decrease the amount of investment
company taxable income available to a Fund for distribution to its shareholders
as ordinary income, rather than increasing or decreasing the amount of its net
capital gain.
For
federal income tax purposes, net capital losses incurred by a Fund in a
particular taxable year can be carried forward to offset net capital gains in
any subsequent year until such loss carryforwards have been fully used, and such
capital losses carried forward will retain their character as either short-term
or long term capital losses. To the extent subsequent net capital gains are
offset by such losses, they would not result in federal income tax liability to
the Fund and would not be distributed as such to shareholders.
At
December 31, 2023, the capital loss carryforwards were as follows:
|
|
|
|
|
|
|
| |
|
Short-Term |
Long-Term |
LKCM
Small-Mid Cap Equity Fund |
$— |
$162,339 |
LKCM
Fixed Income Fund |
$396,545 |
$1,975,866 |
LKCM
International Equity Fund |
$801,583 |
$2,949,909 |
TAXATION
OF THE SHAREHOLDERS
Distributions
of net capital gain, if any, designated as capital gains dividends are taxable
to a shareholder as long-term capital gains, regardless of how long the
shareholder has held Fund shares. A distribution of an amount in excess of a
Fund’s current and accumulated earnings and profits will be treated by a
shareholder as a return of capital which is applied against and reduces the
shareholder’s basis in his or her shares. To the extent that the amount of any
such distribution exceeds the shareholder’s basis in his or her shares, the
excess will be treated by the shareholder as gain from a sale or exchange of the
shares. Distributions of gains from the sale of investments that a Fund owned
for one year or less will be taxable as ordinary income.
A
Fund may elect to retain its net capital gain or a portion thereof for
investment and be taxed at corporate rates on the amount retained. In such case,
it may designate the retained amount as undistributed capital gains in a notice
to its shareholders who will be treated as if each received a distribution of
his pro rata share of such gain, with the result that each shareholder will
(i) be required to report his pro rata share of such gain on his tax return
as long-term capital gain, (ii) receive a refundable tax credit for his pro
rata share of tax paid by the Fund on the gain and (iii) increase the tax
basis for his shares by an amount equal to the deemed distribution less the tax
credit.
If
Fund shares are sold at a loss after being held for six months or less, the loss
will be treated as a long-term, instead of a short-term, capital loss to the
extent of any capital gain distributions received on those shares.
Effective
for taxable years beginning after December 31, 2017 and before
January 1, 2026, the Code generally allows individuals and certain
non-corporate entities a deduction for 20% of qualified REIT
dividends. Regulations allow a RIC to pass the character of its qualified
REIT dividends through to its shareholders provided certain holding period
requirements are met. As a result, individuals or other shareholders eligible
for the deduction with respect to qualified REIT dividends will also be eligible
to receive the
benefit
of this deduction with respect to qualified REIT dividends received by a Fund
that are thereafter included in Fund dividends to shareholders, provided that
the eligible shareholders have held their Fund shares for at least 46 days
during the 91-day period beginning on the date that is 45 days before the date
on which the shares become ex-dividend with respect such Fund dividend.
As
noted in the Prospectus, a shareholder’s basis in Fund shares that he or she
acquired or acquires after December 31, 2011 (“Covered Shares”), will be
determined in accordance with the Funds’ default method, which is average basis,
unless the shareholder affirmatively elects in writing (which may be electronic)
to use a different acceptable basis determination method, such as a specific
identification method. The basis determination method a Fund shareholder elects
(or the default method) may not be changed with respect to a redemption
(including a redemption that is part of an exchange) of Covered Shares after the
settlement date of the redemption.
In
addition to the requirement to report the gross proceeds from redemptions of
shares, each Fund (or its administrative agent) must report to the IRS and
furnish to its shareholders the basis information for Covered Shares and
indicate whether they had a short-term (one year or less) or long-term (more
than one year) holding period. Fund shareholders should consult with their tax
advisers to determine the best IRS-accepted basis determination method for their
tax situation and to obtain more information about how the basis reporting law
applies to them.
If
more than 50% of the value of a Fund’s total assets at the close of any taxable
year consists of securities of foreign corporations, it will be eligible to file
an election for that year with the IRS that would enable its shareholders to
benefit from any foreign tax credit or deduction available with respect to any
foreign taxes it pays. Pursuant to the election, a Fund would treat those taxes
as dividends paid to its shareholders and each shareholder (1) would be
required to include in gross income, and treat as paid by the shareholder, the
shareholder’s proportionate share of those taxes, (2) would be required to
treat that share of those taxes and of any dividend the Fund paid that
represents income from foreign or U.S. possessions sources (“foreign-source
income”) as the shareholder’s own income from those sources, and (3) could
either use the foregoing information in calculating the foreign tax credit
against the shareholder’s federal income tax or, alternatively, deduct the
foreign taxes deemed paid by the shareholder in computing taxable income. If a
Fund makes this election for a taxable year, it will report to its shareholders
shortly after that year their respective shares of the foreign taxes it paid and
its foreign-source income for that year.
Individual
shareholders of a Fund who, for a taxable year, have no more than $300 ($600 for
married persons filing jointly) of creditable foreign taxes included on IRS
Forms 1099 and all of whose foreign-source income is “qualified passive income”
may elect for that year to be exempt from the extremely complicated foreign tax
credit limitation for federal income tax purposes (about which shareholders may
wish to consult their tax advisers), in which event they would be able to claim
a foreign tax credit without having to file the detailed Form 1116 that
otherwise is required. A shareholder will not be entitled to credit or deduct
its portion of foreign taxes a Fund paid that is allocable to Fund shares the
shareholder has not held for at least 16 days during the 31-day period beginning
15 days before the ex-distribution date for those shares. The minimum holding
period will be extended if the shareholder’s risk of loss with respect to those
shares is reduced by reason of holding an offsetting position. No deduction for
foreign taxes may be claimed by a shareholder who does not itemize deductions. A
foreign shareholder may not deduct or claim a credit for foreign taxes in
determining its federal income tax liability unless the Fund dividends paid to
it are effectively connected with the shareholder’s conduct of a U.S. trade or
business.
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte &
Touche LLP serves as the Funds’ independent registered public accounting firm,
whose services include an audit of the Funds’ financial statements and the
performance of other related audit and tax services.
FINANCIAL
STATEMENTS
The
audited financial statements for the Funds are incorporated herein by reference
to the Funds’ Annual
Report
to Shareholders for the year ended December 31, 2023. Financial statements
audited by the Funds’ independent registered public accounting firm will be
distributed to shareholders at least annually.
APPENDIX
A
DESCRIPTION
OF SECURITIES RATINGS
RATINGS
DEFINITIONS
S&P
Global Ratings’ Issue Credit Rating Definitions
An
S&P Global Ratings issue credit rating is a forward-looking opinion about
the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program (including ratings on medium-term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The opinion
reflects S&P Global Ratings’ view of the obligor’s capacity and willingness
to meet its financial commitments as they come due, and this opinion may assess
terms, such as collateral security and subordination, which could affect
ultimate payment in the event of default.
Issue
credit ratings can be either long-term or short-term. Short-term issue credit
ratings are generally assigned to those obligations considered short-term in the
relevant market, typically with an original maturity of no more than 365 days.
Short-term issue credit ratings are also used to indicate the creditworthiness
of an obligor with respect to put features on long-term obligations. S&P
Global would typically assign a long-term issue credit rating to an obligation
with an original maturity of greater than 365 days. However, the ratings
assigned to certain instruments may diverge from these guidelines based on
market practices.
Short-Term
Issue Credit Ratings
A-1
A
short-term obligation rated ‘A-1’ is rated in the highest category by S&P
Global Ratings. The obligor’s capacity to meet its financial commitments on the
obligation is strong. Within this category, certain obligations are designated
with a plus sign (+). This indicates that the obligor’s capacity to meet its
financial commitments on these obligations is extremely strong.
A-2
A
short-term obligation rated ‘A-2’ is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rating categories. However, the obligor’s capacity to meet its financial
commitments on the obligation is satisfactory.
A-3
A
short-term obligation rated ‘A-3’ exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to weaken an obligor’s capacity to meet its financial commitments on the
obligation.
B
A
short-term obligation rated ‘B’ is regarded as vulnerable and has significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitments; however, it faces major ongoing uncertainties that could
lead to the obligor’s inadequate capacity to meet its financial commitments.
C
A
short-term obligation rated ‘C’ is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitments on the obligation.
D
A
short-term obligation rated ‘D’ is in default or in breach of an imputed
promise. For non-hybrid capital instruments, the ‘D’ rating category is used
when payments on an obligation are not made on the date due, unless S&P
Global Ratings believes that such payments will be made within any stated grace
period. However, any stated grace period longer than five business days will be
treated as five business days. The ‘D’ rating also will be used upon the filing
of a bankruptcy petition or the taking of a similar action and where default on
an obligation is a virtual certainty, for example due to automatic stay
provisions. A rating on an obligation is lowered to ‘D’ if it is subject to a
distressed debt restructuring.
SPUR
(S&P Underlying Rating)
A
SPUR is an opinion about the stand-alone capacity of an obligor to pay debt
service on a credit-enhanced debt issue, without giving effect to the
enhancement that applies to it. These ratings are published only at the request
of the debt issuer or obligor with the designation SPUR to distinguish them from
the credit-enhanced rating that applies to the debt issue. S&P Global
Ratings maintains surveillance of an issue with a published SPUR.
Dual
Ratings
Dual
ratings may be assigned to debt issues that have a put option or demand feature.
The first component of the rating addresses the likelihood of repayment of
principal and interest as due, and the second component of the rating addresses
only the demand feature. The first component of the rating can relate to either
a short-term or long-term transaction and accordingly use either short-term or
long-term rating symbols. The second component of the rating relates to the put
option and is assigned a short-term rating symbol (for example, ‘AAA/A-1+’ or
‘A-1+/A-1’). With U.S. municipal short-term demand debt, the U.S. municipal
short-term note rating symbols are used for the first component of the rating
(for example, ‘SP-1+/A-1+’).
S&P
Global Ratings Disclaimers
The
analyses, including ratings, of S&P Global Ratings and its affiliates
(together, S&P Global Ratings) are statements of opinion as of the date they
are expressed and not statements of fact or recommendations to purchase, hold,
or sell any securities or make any investment decisions. S&P Global Ratings
assumes no obligation to update any information following publication. Users of
ratings or other analyses should not rely on them in making any investment
decision. S&P Global Ratings’ opinions and analyses do not address the
suitability of any security. S&P Global Ratings does not act as a fiduciary
or an investment advisor except where registered as such. While S&P Global
Ratings has obtained information from sources it believes to be reliable, it
does not perform an audit and undertakes no duty of due diligence or independent
verification of any information it receives. Ratings and other opinions may be
changed, suspended, or withdrawn at any time.
Qualifiers
S&P
Global Ratings assigns qualifiers to ratings when appropriate. This section
details active and inactive qualifiers.
Active
Qualifiers
S&P
Global Ratings uses the following qualifiers that limit the scope of a rating.
The structure of the transaction can require the use of a qualifier such as a
‘p’ qualifier, which indicates the rating addresses the principal portion of the
obligation only. A qualifier appears as a suffix and is part of the rating.
1.
Federal Deposit Insurance Limit: “L” qualifier
Ratings
qualified with ‘L’ apply only to amounts invested up to federal deposit
insurance limits.
2.
Principal: “p” qualifier
This
suffix is used for issues in which the credit factors, the terms, or both that
determine the likelihood of receipt of payment of principal are different from
the credit factors, terms, or both that determine the likelihood of receipt of
interest on the obligation. The ‘p’ suffix indicates that the rating addresses
the principal portion of the obligation only and that the interest is not rated.
3.
Preliminary Ratings: “prelim” qualifier
Preliminary
ratings, with the ‘prelim’ suffix, may be assigned to obligors or obligations,
including financial programs, in the circumstances described below. Assignment
of a final rating is conditional on the receipt by S&P Global Ratings of
appropriate documentation. S&P Global Ratings reserves the right not to
issue a final rating. Moreover, if a final rating is issued, it may differ from
the preliminary rating.
• Preliminary
ratings may be assigned to obligations, most commonly structured and project
finance issues, pending receipt of final documentation and legal opinions.
• Preliminary
ratings may be assigned to obligations that will likely be issued upon the
obligor’s emergence from bankruptcy or similar reorganization, based on
late-stage reorganization plans, documentation, and discussions with the
obligor. Preliminary ratings may also be assigned to the obligors. These ratings
consider the anticipated general credit quality of the reorganized or
post-bankruptcy issuer as well as attributes of the anticipated obligation(s).
• Preliminary
ratings may be assigned to entities that are being formed or that are in the
process of being independently established when, in S&P Global Ratings’
opinion, documentation is close to final. Preliminary ratings may also be
assigned to the obligations of these entities.
• Preliminary
ratings may be assigned when a previously unrated entity is undergoing a
well-formulated restructuring, recapitalization, significant financing, or other
transformative event, generally at the point that investor or lender commitments
are invited. The preliminary rating may be assigned to the entity and to its
proposed obligation(s). These preliminary ratings consider the anticipated
general credit quality of the obligor, as well as attributes of the anticipated
obligation(s), assuming successful completion of the transformative event.
Should the transformative event not occur, S&P Global Ratings would likely
withdraw these preliminary ratings.
• A
preliminary recovery rating may be assigned to an obligation that has a
preliminary issue credit rating.
4.
Termination Structures: “t” qualifier
This
symbol indicates termination structures that are designed to honor their
contracts to full maturity or, should certain events occur, to terminate and
cash settle all their contracts before their final maturity date.
5.
Counterparty Instrument Rating: “cir” qualifier
This
symbol indicates a counterparty instrument rating (CIR), which is a
forward-looking opinion about the creditworthiness of an issuer in a
securitization structure with respect to a specific financial obligation to a
counterparty (including interest rate swaps, currency swaps, and liquidity
facilities). The CIR is determined on an ultimate payment basis; these opinions
do not take into account timeliness of payment.
Inactive
Qualifiers
Inactive
qualifiers are no longer applied or outstanding.
1.
Contingent upon final documentation: “*” inactive qualifier
This
symbol indicated that the rating was contingent upon S&P Global Ratings’
receipt of an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows. Discontinued use in August 1998.
2.
Termination of obligation to tender: “c” inactive qualifier
This
qualifier was used to provide additional information to investors that the bank
may terminate its obligation to purchase tendered bonds if the long-term credit
rating of the issuer was lowered to below an investment-grade level and/or the
issuer’s bonds were deemed taxable. Discontinued use in January 2001.
3.
U.S. direct government securities: “G” inactive qualifier
The
letter ‘G’ followed the rating symbol when a fund’s portfolio consisted
primarily of direct U.S. government securities.
4.
Interest Payment: ‘i’ inactive qualifier
This
suffix was used for issues in which the credit factors, terms, or both that
determine the likelihood of receipt of payment of interest are different from
the credit factors, terms, or both that determine the likelihood of receipt of
principal on the obligation. The ‘i’ suffix indicated that the rating addressed
the interest portion of the obligation only. The ‘i’ suffix was always used in
conjunction with the ‘p’ suffix, which addresses likelihood of receipt of
principal. For example, a rated obligation could have been assigned a rating of
‘AAApNRi’ indicating that the principal portion was rated ‘AAA’ and the interest
portion of the obligation was not rated.
5.
Public Information Ratings: ‘pi’ qualifier
This
qualifier was used to indicate ratings that were based on an analysis of an
issuer’s published financial information, as well as additional information in
the public domain. Such ratings did not, however, reflect in-depth meetings with
an issuer’s management and therefore could have been based on less comprehensive
information than ratings without a ‘pi’ suffix. Discontinued use as of December
2014 and as of August 2015 for Lloyd’s Syndicate Assessments.
6.
Provisional Ratings: “pr” inactive qualifier
The
letters ‘pr’ indicate that the rating was provisional. A provisional rating
assumed the successful completion of a project financed by the debt being rated
and indicates that payment of debt service requirements was largely or entirely
dependent upon the successful, timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of the
project, made no comment on the likelihood of or the risk of default upon
failure of such completion.
7.
Quantitative Analysis of public information: “q” inactive qualifier
A
‘q’ subscript indicates that the rating is based solely on quantitative analysis
of publicly available information. Discontinued use in April 2001.
8.
Extraordinary risks: “r” inactive qualifier
The
‘r’ modifier was assigned to securities containing extraordinary risks,
particularly market risks, that are not covered in the credit rating. The
absence of an ‘r’ modifier should not be taken as an indication that an
obligation would not exhibit extraordinary noncredit-related risks. S&P
Global Ratings discontinued the use of the ‘r’ modifier for most obligations in
June 2000 and for the balance of obligations (mainly structured finance
transactions) in November 2002.
Active
Identifiers
S&P
Global Ratings currently uses seven other identifiers. These words or symbols
provide additional information but do not change the definition of a rating or
our opinion about the issue’s or issuer’s creditworthiness. The identifiers are
often required by regulation.
1.
Unsolicited: ‘unsolicited’ and ‘u’ identifier
The
‘u’ identifier and ‘unsolicited’ designation are assigned to credit ratings
initiated by parties other than the issuer or its agents, including those
initiated by S&P Global Ratings.
2.
Structured finance: “sf” identifier
The
‘sf’ identifier shall be assigned to ratings on “securitization instruments”
when required to comply with an applicable law or regulatory requirement or when
S&P Global Ratings believes it appropriate. The addition of the ‘sf’
identifier to a rating does not change that rating’s definition or our opinion
about the issue’s creditworthiness. For detailed information on the instruments
assigned the ‘sf’ identifier, please see the appendix for the types of
instruments that carry the ‘sf identifier’.
3.
Japan: ‘JR’ identifier
The
‘JR’ identifier is assigned to all issue and issuer ratings assigned by either
S&P Global Ratings Japan or S&P Global SF Japan, each of which is a
registered credit rating agency in Japan, as ratings registered under Japanese
regulation. The addition of the identifier does not change the definition of
that rating or our opinion about the issue’s or issuer’s creditworthiness.
4.
European Union: ‘EU’ identifier
S&P
Global Ratings applies the ‘EU’ identifier to global scale ratings assigned by
S&P Global Ratings Europe (SPGRE) (including through its branches), which is
registered with the European Securities and Markets Authority (ESMA) and subject
to EU regulation on credit rating agencies. The addition of the ‘EU’ identifier
to a rating does not change that rating’s definition or our opinion about the
issue’s or issuer’s creditworthiness.
5.
European Endorsed: ‘EE’ identifier
S&P
Global Ratings applies the ‘EE’ identifier to global scale ratings assigned by
S&P Global Ratings affiliates established outside the European Union and
endorsed by SPGRE. SPGRE is registered with ESMA and subject to EU regulation on
credit rating agencies. The addition of the ‘EE’ identifier to a rating does not
change that rating’s definition or our opinion about the issue’s or issuer’s
creditworthiness.
6.
United Kingdom: ‘UK’ identifier
S&P
Global Ratings applies the ‘UK’ identifier to global scale ratings assigned by
S&P Global Ratings UK (SPGRUK) which is registered with the UK Financial
Conduct Authority (FCA) and subject to UK regulation on credit rating agencies.
The addition of the ‘UK’ identifier to a rating does not change that rating’s
definition or our opinion about the issue’s or issuer’s creditworthiness.
7.
United Kingdom Endorsed: ‘UKE’ identifier
S&P
Global Ratings applies the ‘UKE’ identifier to global scale ratings assigned by
S&P Global Ratings’ affiliates established outside the U.K. and endorsed by
SPGRUK. SPGRUK is registered with the FCA and subject to UK regulation on credit
rating agencies. The addition of the ‘UKE’ identifier to a rating does not
change that rating’s definition or our opinion about the issue’s or issuer’s
creditworthiness.
8.
S&P Global SF Japan: ‘XN’ identifier
S&P
Global SF Japan assigns the ‘XN’ identifier to credit ratings assigned by
S&P Global SF Japan S&P Global SF Japan is not a Nationally Recognized
Statistical Rating Organization. The addition of the ‘XN’ identifier to a rating
does not change that rating’s definition or our opinion about the issue’s or
issuer’s creditworthiness.
9.
Under criteria observation ‘UCO’ identifier
The
‘UCO’ identifier may (or shall, if an EU regulatory requirement) be assigned to
credit ratings under review as a result of a criteria revision. The addition of
the ‘UCO’ identifier to a rating does not change that rating’s definition or our
opinion about the issue’s or issuer’s creditworthiness.
Local
Currency and Foreign Currency Ratings
S&P
Global Ratings’ issuer credit ratings make a distinction between foreign
currency ratings and local currency ratings. A foreign currency rating on an
issuer can differ from the local currency rating on it when the obligor has a
different capacity to meet its obligations denominated in its local currency,
versus obligations denominated in a foreign currency.
Moody’s
Credit Rating Definitions
Ratings
assigned on Moody’s global long-term and short-term rating scales are
forward-looking opinions of the relative credit risks of financial obligations
issued by non-financial corporates, financial institutions, structured finance
vehicles, project finance vehicles, and public sector entities. Moody’s defines
credit risk as the risk that an entity may not meet its contractual financial
obligations as they come due and any estimated financial loss in the event of
default or impairment. The contractual financial obligations1
addressed by Moody’s ratings are those that call for, without regard to
enforceability, the payment of an ascertainable amount, which may vary based
upon standard sources of variation (e.g., floating interest rates), by an
ascertainable date. Moody’s rating addresses the issuer’s ability to obtain cash
sufficient to service the obligation, and its willingness to pay.2
Moody’s ratings do not address non-standard sources of variation in the amount
of the principal obligation (e.g., equity indexed), absent an express statement
to the contrary in a press release accompanying an initial rating.3
Long-term ratings are assigned to issuers or obligations with an original
maturity of eleven months or more and reflect both on the likelihood of a
default or impairment on contractual financial obligations and the expected
financial loss suffered in the event of default or impairment. Short-term
ratings are assigned to obligations with an original maturity of thirteen months
or less and reflect both on the likelihood of a default or impairment on
contractual financial obligations and the expected financial loss suffered in
the event of default or impairment.4,
5
Moody’s issues ratings at the issuer level and instrument level on both the
long-term scale and the short-term scale. Typically, ratings are made publicly
available although private and unpublished ratings may also be
assigned.6
Moody’s
differentiates structured finance ratings from fundamental ratings (i.e.,
ratings on nonfinancial corporate, financial institution, and public sector
entities) on the global long-term scale by adding (sf) to all structured finance
ratings.7
The addition of (sf) to structured finance ratings should eliminate any
presumption that such ratings and fundamental ratings at the same letter grade
level will behave the same. The (sf) indicator for structured finance security
ratings indicates that otherwise similarly rated structured finance and
fundamental securities may have different risk characteristics. Through its
current methodologies, however, Moody’s aspires to achieve broad expected
equivalence in structured finance and fundamental rating performance when
measured over a long period of time.
1.
In the case of impairments, there can be a financial loss even when contractual
obligations are met. See the definition of Impairment in this publication.
2.
For issuer level ratings, see the definition of Issuer Ratings in this
publication. In some cases the relevant credit risk relates to a third party, in
addition to, or instead of the issuer. Examples include credit-linked notes and
guaranteed obligations.
3.
Because
the number of possible features or structures is limited only by the creativity
of issuers, Moody’s cannot comprehensively catalogue all the types of
non-standard variation affecting financial obligations, but examples include
equity indexed principal values and cash flows, prepayment penalties, and an
obligation to pay an amount that is not ascertainable at the inception of the
transaction.
4.
For certain preferred stock and hybrid securities in which payment default
events are either not defined or do not match investors’ expectations for timely
payment, long-term and short-term ratings reflect the likelihood of impairment
(as defined below in this publication) and financial loss in the event of
impairment.
5.
Debts held on the balance sheets of official sector institutions – which include
supranational institutions, central banks and certain government-owned or
controlled banks – may not always be treated the same as debts held by private
investors and lenders. When it is known that an obligation is held by official
sector institutions as well as other investors, a rating (short-term or
long-term) assigned to that obligation reflects only the credit risks faced by
non-official sector investors.
6.
For
information on how to obtain a Moody’s credit rating, including private and
unpublished credit ratings, please see Moody’s Investors Service Products.
Please note that Moody’s always reserves the right to choose not to assign or
maintain a credit rating for its own business reasons.
7.
Like other global scale ratings, (sf) ratings reflect both the likelihood of a
default and the expected loss suffered in the event of default. Ratings are
assigned based on a rating committee’s assessment of a security’s expected loss
rate (default probability multiplied by expected loss severity), and may be
subject to the constraint that the final expected loss rating assigned would not
be more than a certain number of notches, typically three to five notches, above
the rating that would be assigned based on an assessment of default probability
alone. The magnitude of this constraint may vary with the level of the rating,
the seasoning of the transaction, and the uncertainty around the assessments of
expected loss and probability of default.
Rating
Symbols
Gradations
of creditworthiness are indicated by rating symbols, with each symbol
representing a group in which the credit characteristics are broadly the same.
There are nine symbols as shown below, from that used to designate least credit
risk to that denoting greatest credit risk:
Aaa
Obligations
rated Aaa are judged to be of the highest quality, subject to the lowest level
of credit risk.
Aa
Obligations
rated Aa are judged to be of high quality and are subject to very low credit
risk.
A
Obligations
rated A are judged to be upper-medium grade and are subject to low credit risk.
Baa
Obligations
rated Baa are judged to be medium-grade and subject to moderate credit risk and
as such may possess certain speculative characteristics.
Ba
Obligations
rated Ba are judged to be speculative and are subject to substantial credit
risk.
B
Obligations
rated B are considered speculative and are subject to high credit risk.
Caa
Obligations
rated Caa are judged to be speculative of poor standing and are subject to very
high credit risk.
Ca
Obligations
rated Ca are highly speculative and are likely in, or very near, default, with
some prospect of recovery of principal and interest.
C
Obligations
rated C are the lowest rated and are typically in default, with little prospect
for recovery of principal or interest.
Note:
Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that generic rating category. Additionally, a “(hyb)” indicator is appended to
all ratings of hybrid securities issued by banks, insurers, finance companies,
and securities firms.*
Note:
For more information on long-term ratings assigned to obligations in default,
please see the definition “Long-Term Credit Ratings for Defaulted or Impaired
Securities” in the Other Definitions section of this publication.
* By
their terms, hybrid securities allow for the omission of scheduled dividends,
interest, or principal payments, which can potentially result in impairment if
such an omission occurs. Hybrid securities may also be subject to contractually
allowable write-downs of principal that could result in impairment. Together
with the hybrid indicator, the long-term obligation rating assigned to a hybrid
security is an expression of the relative credit risk associated with that
security.
Short-Term
Obligation Ratings
Moody’s
assigns ratings to long-term and short-term financial obligations. Long-term
ratings are assigned to issuers or obligations with an original maturity of
eleven months or more and reflect both on the likelihood of a default on
contractually promised payments and the expected financial loss suffered in the
event of default. Short-term ratings are assigned to obligations with an
original maturity of thirteen months or less and reflect both on the likelihood
of a default on contractually promised payments and the expected financial loss
suffered in the event of default. Moody’s employs the following designations to
indicate the relative repayment ability of rated issuers:
P-1
Ratings
of Prime-1 reflect a superior ability to repay short-term obligations.
P-2
Ratings
of Prime-2 reflect a strong ability to repay short-term obligations.
P-3
Ratings
of Prime-3 reflect an acceptable ability to repay short-term obligations.
NP
Issuers
(or supporting institutions) rated Not Prime do not fall within any of the Prime
rating categories.
The
following table indicates the long-term ratings consistent with different
short-term ratings when such long-term ratings exist.
SHORT-TERM
VS. LONG-TERM RATINGS
Fitch’s
National Credit Ratings
National
ratings express creditworthiness across the full range of the credit rating
scale, using similar symbols to those used for international ratings. However,
to assure differentiation between the two scales, a two- or three-letter suffix
is appended to the national rating to reflect the specific nature of the
national scale to the country concerned. For ease of reference, Fitch uses the
suffix of (xxx) to indicate a national rating. Each country or monetary
union’s national rating scale is specific to that jurisdiction and is not
comparable to national scales of different countries.
A
“+” or “–” may be appended to a National Rating to denote relative status within
a major rating category. Such suffixes are not added to the ‘AAA(xxx)’ National
Rating category, to categories below ‘CCC(xxx)’, or to Short-Term National
Ratings other than ‘F1(xxx)’.
National
Relativity
National
ratings are a measure of relative credit risk among issuers in a country or
monetary union, except in circumstances when ratings are notched for support or
at the instrument level to differentiate priority/recovery prospects relative to
other local market instruments. Where national ratings are derived by notching,
they reflect creditworthiness relative to the respective supporting entity’s
(parent or government) national rating, rather than to unsupported national
ratings.
LC
and FC Issuer National Ratings
National
ratings can be assigned to the issuer or at the specific debt instrument level.
Issuer-level national ratings address the relative vulnerability to default of
LC obligations (or legal tender) for local issuers within the country concerned
when not notched for support. Therefore, national ratings exclude the risk that
cross border investors may be unable to repatriate interest and principal
repayments out of the country. Issuer-level national ratings do not incorporate
transfer and convertibility risk associated with the FC obligations of a local
issuer, and this is the reason the national scale rating analysis begins with an
international LC rating or LC credit opinion as transfer and convertibility risk
is only incorporated into FC ratings; there are some exceptions where ratings
may be notched.
Issuer
and Instrument-level National Ratings
Fitch
assigns national ratings to specific debt instruments denominated in LC and
issued where the entity or issuer is domiciled. Fitch may also assign national
instrument ratings to i) foreign issuers’ obligations issued in LC in the
country concerned, and ii) local or foreign issuers’ (legal entities or
branches) obligations where repayment is in FC and a national scale rating may
be required to comply with local regulation and/or local market practices often
found in Central America and countries with high levels of dollarization;
national ratings of FC instruments are less common.
Convergence
at ‘C’
A
’C’ level rating on both the international and national rating scales reflects
that the default of an issuer is imminent. As a result, a ‘C’ rating on one
scale is necessarily a ‘C’ rating on the other scale. Due to the greater
differentiation across national rating scales relative to the international
rating scale, there can be more rating volatility and more significant rating
transition for National Ratings compared with International Ratings.
National
Short-Term Credit Ratings
F1(xxx)
Indicates
the strongest capacity for timely payment of financial commitments relative to
other issuers or obligations in the same country. Under the agency’s National
Rating scale, this rating is assigned to the lowest default risk relative to
others in the same country or monetary union. Where the liquidity profile is
particularly strong, a “+” is added to the assigned rating.
F2(xxx)
Indicates
a good capacity for timely payment of financial commitments relative to other
issuers or obligations in the same country or monetary union. However, the
margin of safety is not as great as in the case of the higher ratings.
F3(xxx)
Indicates
an adequate capacity for timely payment of financial commitments relative to
other issuers or obligations in the same country or monetary union.
B(xxx)
Indicates
an uncertain capacity for timely payment of financial commitments relative to
other issuers or obligations in the same country or monetary union.
C(xxx)
Indicates
a highly uncertain capacity for timely payment of financial commitments relative
to other issuers or obligations in the same country or monetary union.
RD(xxx):
Restricted default
Indicates
an entity that has defaulted on one or more of its financial commitments,
although it continues to meet other financial obligations. Applicable to entity
ratings only.
D(xxx)
Indicates
a broad-based default event for an entity, or the default of a short-term
obligation.
Notes:
The
ISO country code suffix is placed in parentheses immediately following the
rating letters to indicate the identity of the National market within which the
rating applies. For illustrative purposes, (xxx) has been used.
LONG-TERM
RATINGS
S&P
Global
Ratings’
Long-Term Issue Credit Ratings
Issue
credit ratings are based, in varying degrees, on S&P Global Ratings’
analysis of the following considerations:
• The
likelihood of payment--the capacity and willingness of the obligor to meet its
financial commitments on an obligation in accordance with the terms of the
obligation;
• The
nature and provisions of the financial obligation, and the promise we impute;
and
• The
protection afforded by, and relative position of, the financial obligation in
the event of a bankruptcy, reorganization, or other arrangement under the laws
of bankruptcy and other laws affecting creditors’ rights.
An
issue rating is an assessment of default risk but may incorporate an assessment
of relative seniority or ultimate recovery in the event of default. Junior
obligations are typically rated lower than senior obligations, to reflect lower
priority in bankruptcy, as noted above. (Such differentiation may apply when an
entity has both senior and subordinated obligations, secured and unsecured
obligations, or operating company and holding company obligations.)
Long-Term
Issue Credit Ratings*
AAA
An
obligation rated ‘AAA’ has the highest rating assigned by S&P Global
Ratings. The obligor’s capacity to meet its financial commitments on the
obligation is extremely strong.
AA
An
obligation rated ‘AA’ differs from the highest-rated obligations only to a small
degree. The obligor’s capacity to meet its financial commitments on the
obligation is very strong.
A
An
obligation rated ‘A’ is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor’s capacity to meet its financial
commitments on the obligation is still strong.
BBB
An
obligation rated ‘BBB’ exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to weaken the
obligor’s capacity to meet its financial commitments on the obligation.
BB;
B; CCC; CC; and C
Obligations
rated ‘BB’, ‘B’, ‘CCC’, ‘CC’, and ‘C’ are regarded as having significant
speculative characteristics. ‘BB’ indicates the least degree of speculation and
‘C’ the highest. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposure to adverse conditions.
BB
An
obligation rated ‘BB’ is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions that could lead to the obligor’s
inadequate capacity to meet its financial commitments on the obligation.
B
An
obligation rated ‘B’ is more vulnerable to nonpayment than obligations rated
‘BB’, but the obligor currently has the capacity to meet its financial
commitments on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor’s capacity or willingness to meet its
financial commitments on the obligation.
CCC
An
obligation rated ‘CCC’ is currently vulnerable to nonpayment and is dependent
upon favorable business, financial, and economic conditions for the obligor to
meet its financial commitments on the obligation. In the event of adverse
business, financial, or economic conditions, the obligor is not likely to have
the capacity to meet its financial commitments on the obligation.
CC
An
obligation rated ‘CC’ is currently highly vulnerable to nonpayment. The ‘CC’
rating is used when a default has not yet occurred but S&P Global Ratings
expects default to be a virtual certainty, regardless of the anticipated time to
default.
C
An
obligation rated ‘C’ is currently highly vulnerable to nonpayment, and the
obligation is expected to have lower relative seniority or lower ultimate
recovery compared with obligations that are rated higher.
D
An
obligation rated ‘D’ is in default or in breach of an imputed promise. For
non-hybrid capital instruments, the ‘D’ rating category is used when payments on
an obligation are not made on the date due, unless S&P Global
Ratings
believes that such payments will be made within the next five business days in
the absence of a stated grace period or within the earlier of the stated grace
period or the next 30 calendar days. The ‘D’ rating also will be used upon the
filing of a bankruptcy petition or the taking of similar action and where
default on an obligation is a virtual certainty, for example due to automatic
stay provisions. A rating on an obligation is lowered to ‘D’ if it is subject to
a distressed debt restructuring.
* Ratings
from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-)
sign to show relative standing within the rating categories.
Moody’s
Long-Term Obligation Ratings
Long-Term
Obligation Ratings
Ratings
assigned on Moody’s global long-term and short-term rating scales are
forward-looking opinions of the relative credit risks of financial obligations
issued by non-financial corporates, financial institutions, structured finance
vehicles, project finance vehicles, and public sector entities. Moody’s defines
credit risk as the risk that an entity may not meet its contractual financial
obligations as they come due and any estimated financial loss in the event of
default or impairment. The contractual financial obligations1
addressed by Moody’s ratings are those that call for, without regard to
enforceability, the payment of an ascertainable amount, which may vary based
upon standard sources of variation (e.g., floating interest rates), by an
ascertainable date. Moody’s rating addresses the issuer’s ability to obtain cash
sufficient to service the obligation, and its willingness to pay.2
Moody’s ratings do not address non-standard sources of variation in the amount
of the principal obligation (e.g., equity indexed), absent an express statement
to the contrary in a press release accompanying an initial rating.3
Long-term ratings are assigned to issuers or obligations with an original
maturity of eleven months or more and reflect both on the likelihood of a
default or impairment on contractual financial obligations and the expected
financial loss suffered in the event of default or impairment. Short-term
ratings are assigned to obligations with an original maturity of thirteen months
or less and reflect both on the likelihood of a default or impairment on
contractual financial obligations and the expected financial loss suffered in
the event of default or impairment.4,
5
Moody’s issues ratings at the issuer level and instrument level on both the
long-term scale and the short-term scale. Typically, ratings are made publicly
available although private and unpublished ratings may also be
assigned.
6
Moody’s
differentiates structured finance ratings from fundamental ratings (i.e.,
ratings on nonfinancial corporate, financial institution, and public sector
entities) on the global long-term scale by adding (sf) to all structured finance
ratings.7
The addition of (sf) to structured finance ratings should eliminate any
presumption that such ratings and fundamental ratings at the same letter grade
level will behave the same. The (sf) indicator for structured finance security
ratings indicates that otherwise similarly rated structured finance and
fundamental securities may have different risk characteristics. Through its
current methodologies, however, Moody’s
aspires
to achieve broad expected equivalence in structured finance and fundamental
rating performance when measured over a long period of time.
1.
In the case of impairments, there can be a financial loss even when contractual
obligations are met. See the definition of Impairment in this publication.
2.
For issuer level ratings, see the definition of Issuer Ratings in this
publication. In some cases the relevant credit risk relates to a third party, in
addition to, or instead of the issuer. Examples include credit-linked notes and
guaranteed obligations.
3.
Because the number of possible features or structures is limited only by the
creativity of issuers, Moody’s cannot comprehensively catalogue all the types of
non-standard variation affecting financial obligations, but examples include
equity indexed principal values and cash flows, prepayment penalties, and an
obligation to pay an amount that is not ascertainable at the inception of the
transaction.
4.
For certain preferred stock and hybrid securities in which payment default
events are either not defined or do not match investors’ expectations for timely
payment, long-term and short-term ratings reflect the likelihood of impairment
(as defined below in this publication) and financial loss in the event of
impairment.
5.
Debts held on the balance sheets of official sector institutions – which include
supranational institutions, central banks and certain government-owned or
controlled banks – may not always be treated the same as debts held by private
investors and lenders. When it is known that an obligation is held by official
sector institutions as well as other investors, a rating (short-term or
long-term) assigned to that obligation reflects only the credit risks faced by
non-official sector investors.
6.
For information on how to obtain a Moody’s credit rating, including private and
unpublished credit ratings, please see Moody’s Investors Service Products.
Please note that Moody’s always reserves the right to choose not to assign or
maintain a credit rating for its own business reasons.
7.
Like other global scale ratings, (sf) ratings reflect both the likelihood of a
default and the expected loss suffered in the event of default. Ratings are
assigned based on a rating committee’s assessment of a security’s expected loss
rate (default probability multiplied by expected loss severity), and may be
subject to the constraint that the final expected loss rating assigned would not
be more than a certain number of notches, typically three to five notches, above
the rating that would be assigned based on an assessment of default probability
alone. The magnitude of this constraint may vary with the level of the rating,
the seasoning of the transaction, and the uncertainty around the assessments of
expected loss and probability of default.
Moody’s
Long-Term Rating Definitions:
Aaa
Obligations
rated Aaa are judged to be of the highest quality, subject to the lowest level
of credit risk.
Aa
Obligations
rated Aa are judged to be of high quality and are subject to very low credit
risk.
A
Obligations
rated A are judged to be upper-medium grade and are subject to low credit risk.
Baa
Obligations
rated Baa are judged to be medium-grade and subject to moderate credit risk and
as such may possess certain speculative characteristics.
Ba
Obligations
rated Ba are judged to be speculative and are subject to substantial credit
risk.
B
Obligations
rated B are considered speculative and are subject to high credit risk.
Caa
Obligations
rated Caa are judged to be speculative of poor standing and are subject to very
high credit risk.
Ca
Obligations
rated Ca are highly speculative and are likely in, or very near, default, with
some prospect of recovery of principal and interest.
C
Obligations
rated C are the lowest rated and are typically in default, with little prospect
for recovery of principal or interest.
Note:
Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that generic rating category. Additionally, a “(hyb)” indicator is appended to
all ratings of hybrid securities issued by banks, insurers, finance companies,
and securities firms.*
Note:
For more information on long-term ratings assigned to obligations in default,
please see the definition “Long-Term Credit Ratings for Defaulted or Impaired
Securities” in the Other Definitions section of this publication.
* By
their terms, hybrid securities allow for the omission of scheduled dividends,
interest, or principal payments, which can potentially result in impairment if
such an omission occurs. Hybrid securities may also be subject to contractually
allowable write-downs of principal that could result in impairment. Together
with the hybrid indicator, the long-term obligation rating assigned to a hybrid
security is an expression of the relative credit risk associated with that
security.
Fitch’s
National Long-Term Credit Ratings
AAA(xxx)
‘AAA’
National Ratings denote the highest rating assigned by the agency in its
National Rating scale for that country. This rating is assigned to issuers or
obligations with the lowest expectation of default risk relative to all other
issuers or obligations in the same country or monetary union.
AA(xxx)
‘AA’
National Ratings denote expectations of a very low level of default risk
relative to other issuers or obligations in the same country or monetary union.
The default risk inherent differs only slightly from that of the country’s
highest rated issuers or obligations.
A(xxx)
‘A’
National Ratings denote expectations of a low level of default risk relative to
other issuers or obligations in the same country or monetary union.
BBB(xxx)
‘BBB’
National Ratings denote a moderate level of default risk relative to other
issuers or obligations in the same country or monetary union.
BB(xxx)
‘BB’
National Ratings denote an elevated default risk relative to other issuers or
obligations in the same country or monetary union.
B(xxx)
‘B’
National Ratings denote a significantly elevated level of default risk relative
to other issuers or obligations in the same country or monetary union.
CCC(xxx)
‘CCC’
National Ratings denote a very high level of default risk relative to other
issuers or obligations in the same country or monetary union.
CC(xxx)
‘CC’
National Ratings denote the level of default risk is among the highest relative
to other issuers or obligations in the same country or monetary union.
C(xxx)
A
default or default-like process has begun, or the issuer is in standstill, or
for a closed funding vehicle, payment capacity is irrevocably impaired.
Conditions that are indicative of a ‘C’ category rating for an issuer include:
•The
issuer has entered into a grace or cure period following non-payment of a
material financial obligation;
•The
issuer has entered into a temporary negotiated waiver or standstill agreement
following a payment default on a material financial obligation;
•The
formal announcement by the issuer or their agent of a distressed debt exchange;
and
•A
closed financing vehicle where payment capacity is irrevocably impaired such
that it is not expected to pay interest and/or principal in full during the life
of the transaction, but where no payment default is imminent.
RD(xxx):
Restricted default.
‘RD’
ratings indicate an issuer that, in Fitch’s opinion, has experienced an uncured
payment default on a bond, loan or other material financial obligation but that
has not entered into bankruptcy filings, administration, receivership,
liquidation or other formal winding-up procedure and has not otherwise ceased
business. This would include:
•The
selective payment default on a specific class or currency of debt;
•The
uncured expiry of any applicable grace period, cure period or default
forbearance period following a payment default on a bank loan, capital markets
security or other material financial obligation;
•The
extension of multiple waivers or forbearance periods upon a payment default on
one or more material financial obligations, either in series or in parallel; or
•Execution
of a distressed debt exchange on one or more material financial obligations.
D(xxx)
‘D’
National Ratings denote an issuer that has entered into bankruptcy filings,
administration, receivership, liquidation or other formal winding-up procedure
or that has otherwise ceased business.
Notes:
The
ISO country code suffix is placed in parentheses immediately following the
rating letters to indicate the identity of the National market within which the
rating applies. For illustrative purposes, (xxx) has been used.
MUNICIPAL
NOTE RATINGS
S&P’s
Municipal Short-Term Note Ratings Definitions
An
S&P Global Ratings U.S. municipal note rating reflects S&P Global
Ratings’ opinion about the liquidity factors and market access risks unique to
the notes. Notes due in three years or less will likely receive a note rating.
Notes with an original maturity of more than three years will most likely
receive a long-term debt rating. In determining which type of rating, if any, to
assign, S&P Global Ratings’ analysis will review the following
considerations:
• Amortization
schedule--the larger the final maturity relative to other maturities, the more
likely it will be treated as a note; and
• Source
of payment--the more dependent the issue is on the market for its refinancing,
the more likely it will be treated as a note.
SP-1
Strong
capacity to pay principal and interest. An issue determined to possess a very
strong capacity to pay debt service is given a plus (+) designation.
SP-2
Satisfactory
capacity to pay principal and interest, with some vulnerability to adverse
financial and economic changes over the term of the notes.
SP-3
Speculative
capacity to pay principal and interest.
D
‘D’
is assigned upon failure to pay the note when due, completion of a distressed
debt restructuring, or the filing of a bankruptcy petition or the taking of
similar action and where default on an obligation is a virtual certainty, for
example due to automatic stay provisions.
Moody’s
US Municipal Short-Term Debt and Demand Obligation Ratings
Short-Term
Obligation Ratings
Moody’s
uses the global short-term ‘Prime’ rating scale for commercial paper issued by
US municipalities and nonprofits. These commercial paper programs may be backed
by external letters of credit or liquidity facilities, or by an issuer’s
self-liquidity. For other short-term municipal obligations, Moody’s uses one of
two other short-term rating scales, the Municipal Investment Grade (MIG) and
Variable Municipal Investment Grade (VMIG) scales discussed below.
Moody’s
uses the MIG scale for US municipal cash flow notes, bond anticipation notes and
certain other short-term obligations, which typically mature in three years or
less. Under certain circumstances, Moody’s uses the MIG scale for bond
anticipation notes with maturities of up to five years.
MIG
1
This
designation denotes superior credit quality. Excellent protection is afforded by
established cash flows, highly reliable liquidity support, or demonstrated
broad-based access to the market for refinancing.
MIG
2
This
designation denotes strong credit quality. Margins of protection are ample,
although not as large as in the preceding group.
MIG
3
This
designation denotes acceptable credit quality. Liquidity and cash-flow
protection may be narrow, and market access for refinancing is likely to be less
well-established.
SG
This
designation denotes speculative-grade credit quality. Debt instruments in this
category may lack sufficient margins of protection.
VMIG
Ratings
In
the case of variable rate demand obligations (VRDOs), a two-component rating is
assigned. The components are a long-term rating and a short-term payment
obligation rating. The long-term rating addresses the issuer’s ability to meet
scheduled principal and interest payments. The short-term payment obligation
rating addresses the ability of the issuer or the liquidity provider to meet any
purchase price payment obligation resulting from optional tenders (“on demand”)
and/or mandatory tenders of the VRDO. The short-term payment obligation rating
uses the VMIG scale. Transitions of VMIG ratings with conditional liquidity
support differ from transitions of Prime ratings reflecting the risk that
external liquidity support will terminate if the issuer’s long-term rating drops
below investment grade. Please see Moody’s methodology that discusses
obligations with conditional liquidity support. For VRDOs, Moody’s typically
assigns the VMIG rating if the frequency of the payment obligation is less than
every three years. If the frequency of the payment obligation is less than three
years, but the obligation is payable only with remarketing proceeds, the VMIG
short-term rating is not assigned and it is denoted as “NR.” Industrial
development bonds in the US where the obligor is a corporate may carry a VMIG
rating that reflects Moody’s view of the relative likelihood of default and
loss. In these cases, liquidity assessment is based on the liquidity of the
corporate obligor.
VMIG
1
This
designation denotes superior credit quality. Excellent protection is afforded by
the superior short-term credit strength of the liquidity provider and structural
and legal protections.
VMIG
2
This
designation denotes strong credit quality. Good protection is afforded by the
strong short-term credit strength of the liquidity provider and structural and
legal protections.
VMIG
3
This
designation denotes acceptable credit quality. Adequate protection is afforded
by the satisfactory short-term credit strength of the liquidity provider and
structural and legal protections.
SG
This
designation denotes speculative-grade credit quality. Demand features rated in
this category may be supported by a liquidity provider that does not have a
sufficiently strong short-term rating or may lack the structural or legal
protections.
The
following table indicates the municipal long-term ratings consistent with the
highest potential MIG and VMIG short-term ratings.