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Schwab®
ETFs
| | Schwab® 1-5 Year Corporate Bond ETF | | |
SCHJ |
|
| | Schwab® 5-10 Year Corporate Bond ETF | | |
SCHI |
|
| | Schwab® U.S. Aggregate Bond ETF | | |
SCHZ |
|
| | Schwab® U.S. TIPS ETF | | |
SCHP |
|
| | Schwab® Short-Term U.S. Treasury ETF | | |
SCHO |
|
| |
Schwab®
Intermediate-Term U.S. Treasury ETF |
| |
SCHR |
|
| | Schwab® Long-Term U.S. Treasury ETF | | |
SCHQ |
|
Principal U.S. Listing Exchange: NYSE Arca, Inc.
STATEMENT OF ADDITIONAL INFORMATION
April 26, 2024
The Statement of Additional Information (SAI) is
not a prospectus. It should be read in conjunction with each fund’s prospectus
dated April 26, 2024 (as amended from time to time).
The funds’ audited financial statements and the
report of the independent registered public accounting firm thereon from the
funds’ annual
report for the fiscal year ended December 31, 2023, are incorporated by
reference into this SAI.
For a free copy of these documents or to request
other information or ask questions about the funds, call Schwab ETFs at
1-877-824-5615. For TDD service, call 1-800-345-2550. In addition, you may visit
the Schwab ETFs’ website at www.schwabassetmanagement.com/schwabetfs_prospectus for a free copy of a prospectus, SAI or an
annual or semiannual report.
Each fund is a series of Schwab Strategic Trust
(the Trust). The funds are part of the Schwab complex of funds (Schwab Funds).
Charles Schwab Investment Management, Inc., dba Schwab Asset
Management®, is the investment adviser to the funds
(investment adviser).
REG56975-15
TABLE OF CONTENTS
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| APPENDIX – RATINGS OF INVESTMENT SECURITIES | | | | | | | |
| APPENDIX – PROXY VOTING POLICY | | | | | | | |
INVESTMENT OBJECTIVES, STRATEGIES, RISKS AND
LIMITATIONS
Investment Objectives
Each fund’s investment objective is not
fundamental and therefore may be changed by the funds’ Board of Trustees (the
Board) without shareholder approval.
The Schwab 1-5 Year Corporate
Bond ETF’s goal is to track as
closely as possible, before fees and expenses, the total return of an index that
measures the performance of the short-term U.S. corporate bond market.
The Schwab 5-10 Year Corporate
Bond ETF’s goal is to track as
closely as possible, before fees and expenses, the total return of an index that
measures the performance of the intermediate-term U.S. corporate bond
market.
The Schwab U.S. Aggregate Bond
ETF’s goal is to track as closely
as possible, before fees and expenses, the total return of an index that
measures the performance of the broad U.S. investment-grade bond market.
The Schwab U.S. TIPS
ETF’s goal is to track as closely
as possible, before fees and expenses, the total return of an index composed of
inflation-protected U.S. Treasury securities.
The Schwab Short-Term U.S.
Treasury ETF’s goal is to track as
closely as possible, before fees and expenses, the total return of an index that
measures the performance of the short-term U.S. Treasury bond market.
The Schwab Intermediate-Term U.S.
Treasury ETF’s goal is to track as
closely as possible, before fees and expenses, the total return of an index that
measures the performance of the intermediate-term U.S. Treasury bond
market.
The Schwab Long-Term U.S.
Treasury ETF’s goal is to track as
closely as possible, before fees and expenses, the total return of an index that
measures the performance of the long-term U.S. Treasury bond market.
There is no guarantee the funds will achieve
their investment objectives.
Description of Indices
The Schwab 1-5 Year Corporate
Bond ETF’s index, the Bloomberg US
1-5 Year Corporate Bond Index measures the performance of U.S. investment grade,
taxable securities with maturities greater than or equal to one year and less
than five years that have $300 million or more of outstanding face
value. The securities in the index must be denominated in U.S. dollars and must
be fixed-rate. The index is market capitalization weighted and the securities in
the index are updated on the last business day of each month. As of
December 31, 2023, there were 2,741 securities in the index.
The Schwab 5-10 Year Corporate
Bond ETF’s index, the Bloomberg US
5-10 Year Corporate Bond Index measures the performance of U.S. investment
grade, taxable securities with maturities greater than or equal to
five years and less than ten years that have $300 million or more
of outstanding face value. The securities in the index must be denominated in
U.S. dollars and must be fixed-rate. The index is market capitalization weighted
and the securities in the index are updated on the last business day of each
month. As of December 31, 2023, there were 2,103 securities in the
index.
The Schwab U.S. Aggregate Bond
ETF’s index, the Bloomberg US
Aggregate Bond Index, is comprised of U.S. investment grade, taxable
fixed-income securities, including U.S. Treasuries, government-related and
corporate bonds, mortgage pass-through securities, commercial mortgage-backed
securities, and asset-backed securities that are publicly available for sale in
the United States. To be eligible for inclusion in the index, securities must be
fixed rate, non-convertible, U.S. dollar-denominated and have one or more years
remaining to maturity. U.S. Treasury, government-related and corporate
securities must have $300 million minimum par amount outstanding. For
mortgage-backed securities pass-throughs, the pool aggregates must have $1
billion par amount outstanding. Asset-backed securities must have a minimum deal
size of $500 million and a minimum tranche size of $25 million. For commercial
mortgage-backed securities, the original aggregate transaction must have a
minimum deal size of $500 million and a minimum tranche size of $25 million; the
aggregate outstanding transaction sizes must be at least $300 million to remain
in the index. The index excludes certain types of securities, including state
and local government series bonds, structured notes embedded with swaps or other
special features, private placements, floating-rate securities, inflation-linked
bonds and Eurobonds. The index is market capitalization weighted and the
securities in the index are updated on the last business day of each month. As
of December 31, 2023, there were approximately 13,380 securities in the
index.
The Schwab U.S. TIPS
ETF’s index, the Bloomberg US
Treasury Inflation-Linked Bond Index (Series-L)SM, includes all publicly-issued U.S. Treasury
Inflation-Protected Securities (TIPS) that have at least one year remaining to
maturity, are rated investment grade and have $500 million or more of
outstanding face value. TIPS are U.S. government securities issued by the U.S.
Treasury that generate principal and interest payments designed to adjust for
and protect against inflation. The TIPS in the index must be denominated in U.S.
dollars and must be fixed-rate and non-convertible. The index is market
capitalization weighted and the securities in the index are updated on the last
business day of each month. As of December 31, 2023, there were 48 TIPS in
the index.
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The Schwab Short-Term U.S.
Treasury ETF’s index, the Bloomberg
US Treasury 1-3 Year Index, includes all publicly-issued U.S. Treasury
securities that have a remaining maturity of greater than or equal to one year
and less than three years, are rated investment grade, and have
$300 million or more of outstanding face value. The securities in the index
must be denominated in U.S. dollars and must be fixed-rate and non-convertible.
The index excludes state and local government series bonds and coupon issues
that have been stripped from bonds. The index is market capitalization weighted
and the securities in the index are updated on the last business day of each
month. As of December 31, 2023, there were 97 securities in the
index.
The Schwab Intermediate-Term U.S.
Treasury ETF’s index, the Bloomberg
US Treasury 3-10 Year Index, includes all publicly-issued U.S. Treasury
securities that have a remaining maturity of greater than or equal to
three years and less than ten years, are rated investment grade, and
have $300 million or more of outstanding face value. The securities in the
index must be denominated in U.S. dollars and must be fixed-rate and
non-convertible. The index excludes state and local government series bonds and
coupon issues that have been stripped from bonds. The index is market
capitalization weighted and the securities in the index are updated on the last
business day of each month. As of December 31, 2023, there were 108
securities in the index.
The Schwab Long-Term U.S.
Treasury ETF’s index, the Bloomberg
US Long Treasury Index includes all publicly issued, U.S. Treasury securities
that have a remaining maturity of ten or more years, are rated investment
grade, and have $300 million or more of outstanding face value. The
securities in the index must be denominated in U.S. dollars and must be
fixed-rate and non-convertible. The index is market capitalization weighted and
the securities in the index are updated on the last business day of each month.
As of December 31, 2023, there were 80 securities in the index.
Index Provider
Charles Schwab Investment Management, Inc., dba
Schwab Asset Management (the investment adviser), has entered into a license
agreement with Bloomberg Finance L.P. to use the Bloomberg Indices. Fees payable
under the license agreement are paid by the investment adviser. Bloomberg
Finance L.P. has no obligation to continue to provide the Bloomberg Indices to
Schwab Asset Management beyond the term of the license agreement.
Disclaimers
BLOOMBERG® and Bloomberg US 1-5 Year Corporate Bond Index,
Bloomberg US 5-10 Year Corporate Bond Index, Bloomberg US Aggregate Bond Index,
Bloomberg US Treasury Inflation-Linked Bond Index (Series-L), Bloomberg US
Treasury 1-3 Year Index, Bloomberg US Treasury 3-10 Year Index, and Bloomberg US
Long Treasury Index (Bloomberg Indices) are service marks of Bloomberg Finance
L.P. and its affiliates, including Bloomberg Index Services Limited (BISL), the
administrator of the index (collectively, Bloomberg) and have been licensed for
use for certain purposes by Schwab Asset Management.
The Schwab ETFs are not sponsored, endorsed,
sold or promoted by Bloomberg. Bloomberg does not make any representation or
warranty, express or implied, to the owners of or counterparties to the Schwab
ETFs or any member of the public regarding the advisability of investing in
securities generally or in the Schwab ETFs particularly. The only relationship
of Bloomberg to Schwab Asset Management is the licensing of certain trademarks,
trade names and service marks and of the Bloomberg Indices, which are determined
composed and calculated by BISL without regard to Schwab Asset Management or the
owners of the Schwab ETFs. Bloomberg has no obligation to take the needs of
Schwab Asset Management or the owners of the Schwab ETFs into consideration in
determining, composing or calculating the Bloomberg Indices. Bloomberg is not
responsible for and has not participated in the determination of the timing of,
prices at, or quantities of the Schwab ETFs to be issued. Bloomberg shall not
have any obligation or liability, including, without limitation, to the Schwab
ETFs’ customers, in connection with the administration, marketing or trading of
the Schwab ETFs.
BLOOMBERG DOES NOT GUARANTEE THE ACCURACY AND/OR
THE COMPLETENESS OF THE BLOOMBERG INDICES OR ANY DATA RELATED THERETO AND SHALL
HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS OR INTERRUPTIONS THEREIN. BLOOMBERG
DOES NOT MAKE ANY WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY
SCHWAB ASSET MANAGEMENT, OWNERS OF THE SCHWAB ETFS OR ANY OTHER PERSON OR ENTITY
FROM THE USE OF THE BLOOMBERG INDICES OR ANY DATA RELATED THERETO. BLOOMBERG
DOES NOT MAKE ANY EXPRESS OR IMPLIED WARRANTIES AND EXPRESSLY DISCLAIMS ALL
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH
RESPECT TO THE BLOOMBERG INDICES OR ANY DATA RELATED THERETO. WITHOUT LIMITING
ANY OF THE FOREGOING, TO THE MAXIMUM EXTENT ALLOWED BY LAW, BLOOMBERG, ITS
LICENSORS, AND ITS AND THEIR RESPECTIVE EMPLOYEES, CONTRACTORS, AGENTS,
SUPPLIERS, AND VENDORS SHALL HAVE NO LIABILITY OR RESPONSIBILITY WHATSOEVER FOR
ANY INJURY OR DAMAGES—WHETHER DIRECT, INDIRECT, CONSEQUENTIAL, INCIDENTAL,
PUNITIVE OR OTHERWISE—ARISING IN CONNECTION WITH THE SCHWAB ETFS OR BLOOMBERG
INDICES OR ANY DATA OR VALUES RELATING THERETO—WHETHER ARISING FROM THEIR
NEGLIGENCE OR OTHERWISE, EVEN IF NOTIFIED OF THE POSSIBILITY THEREOF.
Shares of the funds are not sponsored, endorsed
or promoted by NYSE Arca, Inc. NYSE Arca makes no representation or warranty,
express or implied, to the owners of the shares of the funds or any member of
the public regarding the ability of the funds to track the total return
performance of any underlying index or the ability of the underlying index to
track stock or bond market performance. NYSE Arca is not responsible for, nor
has it participated in, the determination of the compilation or the calculation
of an underlying index, nor in the determination of the timing of, prices of, or
quantities of shares of the funds to be issued, nor in the determination or
calculation of the equation by which the shares are redeemable. NYSE Arca has no
obligation or liability to owners of the shares of the funds in connection with
the administration, marketing or trading of the shares of the funds.
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NYSE Arca shall have no liability for damages,
claims, losses or expenses caused by any errors, omissions, or delays in
calculating or disseminating any current index or portfolio value the current
value of the portfolio of securities required to be deposited to the funds; the
amount of any dividend equivalent payment or cash distribution to holders of
shares of the funds; net asset value; or other information relating to the
creation, redemption or trading of shares of the funds, resulting from any
negligent act or omission by NYSE Arca, or any act, condition or cause beyond
the reasonable control of NYSE Arca, including, but not limited to, an act of
God; fire; flood; extraordinary weather conditions; war; insurrection; riot;
strike; accident; action of government; communications or power failure;
equipment or software malfunction; or any error, omission or delay in the
reporting of transactions in one or more underlying securities. NYSE Arca makes
no warranty, express or implied, as to results to be obtained by any person or
entity from the use of any underlying index or data included therein and NYSE
Arca makes no express or implied warranties, and disclaims all warranties of
merchantability or fitness for a particular purpose with respect to shares of
the funds or any underlying index or data included therein.
Fund Investment Policies
The following investment policies may be changed
by the funds’ Board without shareholder approval.
The Schwab 1-5 Year Corporate Bond ETF will,
under normal circumstances, invest at least 90% of its net assets in the
securities of its index. The fund will notify its shareholders at least
60 days before changing this policy. For purposes of this policy, net
assets mean net assets plus the amount of any borrowings for investment
purposes.
The Schwab 5-10 Year Corporate Bond ETF will,
under normal circumstances, invest at least 90% of its net assets in the
securities of its index. The fund will notify its shareholders at least
60 days before changing this policy. For purposes of this policy, net
assets mean net assets plus the amount of any borrowings for investment
purposes.
The Schwab U.S. Aggregate Bond ETF will, under
normal circumstances, invest at least 90% of its net assets in the securities of
its index. TBA transactions (defined below in the “Mortgage Pass-Through
Securities” section) are included within the above noted investment policy. The
fund will notify its shareholders at least 60 days before changing this
policy. For purposes of this policy, net assets mean net assets plus the amount
of any borrowings for investment purposes. A substantial portion of the bonds
represented in the index are U.S. fixed-rate mortgage pass-through securities.
These securities include those issued by entities such as the Government
National Mortgage Association (Ginnie Mae), the Federal National Mortgage
Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation
(Freddie Mac) that are backed by pools of mortgages. Most transactions in
fixed-rate mortgage pass-through securities occur through standardized contracts
for future delivery in which the exact mortgage pools to be delivered are not
specified until a few days prior to settlement. The fund anticipates that it may
enter into such contracts on a regular basis. The fund, pending settlement of
such contracts, will invest its assets in high-quality, liquid short-term
instruments, including U.S. Treasury securities and shares of money market
funds. The fund will assume its pro rata share of the fees and expenses of
any money market fund in which it may invest, in addition to the fund’s own fees
and expenses.
The Schwab U.S. TIPS ETF will, under normal
circumstances, invest at least 90% of its net assets in the securities of its
index. The fund will notify its shareholders at least 60 days before
changing this policy. For purposes of this policy, net assets mean net assets
plus the amount of any borrowings for investment purposes.
The Schwab Short-Term U.S. Treasury ETF will,
under normal circumstances, invest at least 90% of its net assets in the
securities of its index. The fund will notify its shareholders at least
60 days before changing this policy. For purposes of this policy, net
assets mean net assets plus the amount of any borrowings for investment
purposes.
The Schwab Intermediate-Term U.S. Treasury ETF
will, under normal circumstances, invest at least 90% of its net assets in the
securities of its index. The fund will notify its shareholders at least
60 days before changing this policy. For purposes of this policy, net
assets mean net assets plus the amount of any borrowings for investment
purposes.
The Schwab Long-Term U.S. Treasury ETF will,
under normal circumstances, invest at least 90% of its net assets in the
securities of its index. The fund will notify its shareholders at least
60 days before changing this policy. For purposes of this policy, net
assets mean net assets plus the amount of any borrowings for investment
purposes.
Investments, Risks and Limitations
The following investment strategies, risks and
limitations supplement those set forth in the prospectus and may be changed
without shareholder approval unless otherwise noted. Also, policies and
limitations that state a maximum percentage of assets that may be invested
in a security or other asset, or that set forth a quality standard, shall be
measured immediately after and as a result of a fund’s acquisition of such
security or asset unless otherwise noted. Thus, except with respect to
limitations on borrowing and futures and option contracts, any subsequent change
in values, net assets or other circumstances does not require a fund to sell an
investment if it could not then make the same investment.
From time to time a fund may hold certain
securities not otherwise discussed in this SAI as a permissible investment for
the fund. For example, a fund may invest in certain types of securities to the
extent its index does even if the types of securities have not been identified
as part of the fund’s principal or non-principal investment strategy. To the
extent an investment becomes part of a fund’s principal or non-principal
investment
3
strategy, the fund will take the necessary steps
to identify them as permissible investments. In addition, a fund may receive
(i.e., not actively invest) such securities as a result of a corporate action,
such as securities dividends, spin-offs or rights issues. In such cases, the
fund will not actively add to its position and generally will dispose of the
securities as soon as reasonably practicable.
Principal Investment Strategies
Unless otherwise indicated, the following
investments may be used as part of each fund’s principal investment
strategy.
Concentration means that substantial amounts of assets are
invested in a particular industry or group of industries. Concentration
increases investment exposure to industry risk. For example, the automobile
industry may have a greater exposure to a single factor, such as an increase in
the price of oil, which may adversely affect the sale of automobiles and, as a
result, the value of the industry’s securities. As part of the Schwab 1-5 Year
Corporate Bond ETF’s, the Schwab 5-10 Year Corporate Bond ETF’s and the Schwab
U.S. Aggregate Bond ETF’s principal investment strategies, a fund will
concentrate its investments in a particular industry or group of industries to
approximately the same extent that its index concentrates in the securities of
such particular industry or group of industries. For purposes of this
limitation, securities of the U.S. government (including its agencies and
instrumentalities), and repurchase agreements collateralized by U.S. government
securities are not considered to be issued by members of any industry.
Cyber Security
Risk. As the use of technology,
including cloud-based technology, and the frequency of cyber attacks in the
market has become more prevalent, the funds are potentially more susceptible
to operational and information security risks resulting from breaches in
cybersecurity that may lead to financial losses. A breach in cybersecurity
refers to both intentional and unintentional events that may, among other
things, cause a fund to lose proprietary information, suffer data corruption
and/or destruction or lose operational capacity, or otherwise disrupt normal
business operations. This in turn could adversely affect a fund and its
shareholders by, among other things, interfering with the processing of
shareholder transactions; impeding a fund’s ability to calculate its net asset
value (NAV); causing the release or misuse of confidential fund information or
private shareholder information (which may violate privacy and other laws,
including those related to identity theft). A cyber attack may cause financial
losses by impeding trading, causing reputational damage, and subjecting a fund
to regulatory penalties, fines, reimbursement or other compensation costs.
Additional compliance costs could be associated with corrective measures and/or
cybersecurity risk management. Cybersecurity breaches may involve unauthorized
access to a fund’s digital information systems (e.g., through “hacking” or
malicious software coding), and may come from multiple sources, including from
outside attacks such as denial-of-service attacks (i.e., efforts to make network
services unavailable to intended users) or cyber extortion, including
exfiltration of data held for ransom and/or “ransomware” attacks that render
systems inoperable until ransom is paid, or insider actions (e.g., intentionally
or unintentionally harmful acts of adviser personnel). In addition,
cybersecurity breaches involving a fund’s third-party service providers (e.g.,
the funds’ custodian and transfer agent), trading counterparties or issuers in
which a fund invests can also subject a fund to many of the same risks
associated with direct cybersecurity breaches or extortion of data. Recently,
geopolitical tensions may have increased the scale and sophistication of
deliberate cybersecurity attacks, particularly those from nation-states or from
entities with nation-state backing.
Cybersecurity failures or breaches may result in
financial losses to a fund and its shareholders. For example, cybersecurity
failures or breaches involving trading counterparties or issuers in which a Fund
invests could adversely impact such counterparties or issuers and cause a Fund’s
investment to lose value.
Although the investment adviser
has business continuity plans and risk management systems designed to
reduce the risks associated with cybersecurity, there are inherent limitations
in these plans and systems, including the possibility that certain risks have
not been identified, in large part because different or unknown threats may
emerge in the future. As such, there is no guarantee that such efforts will
succeed, especially because the funds do not directly control the cybersecurity
systems of issuers in which a fund may invest, trading counterparties or
third-party service providers to the funds. Such entities have experienced cyber
attacks and other attempts to gain unauthorized access to systems from time to
time, and there is no guarantee that efforts to prevent or mitigate the effects
of such attacks or other attempts to gain unauthorized access will be
successful. There is also a risk that cybersecurity breaches may not be
detected. There can be no assurance that the funds will not suffer losses
relating to cyber attacks on the funds, their service providers, trading
counterparties or the issuers in which a fund invests.
Debt Securities (Principal investments for the Schwab 1-5 Year
Corporate Bond ETF, the Schwab 5-10 Year Corporate Bond ETF and the Schwab U.S.
Aggregate Bond ETF. For all other funds, principal investments with respect to
only U.S. Treasury Securities, and permissible non-principal investments with
respect to all other debt securities) are obligations issued by domestic
and foreign entities, including governments and corporations, in order to raise
money. They are basically “IOUs,” but are commonly referred to as bonds or money
market securities. These securities normally require the issuer to pay a fixed-,
variable- or floating-rate of interest on the amount of money borrowed (the
principal) until it is paid back upon maturity.
Debt securities experience price changes when
interest rates change. For example, when interest rates fall, the prices of debt
securities generally rise. Conversely, when interest rates rise, the prices of
debt securities generally fall. Certain debt securities have call features that
allow issuers to redeem or “call” their outstanding debts prior to final
maturity. Depending on the call feature, an issuer may pre-pay its outstanding
debts and issue new ones paying lower interest rates. This is more likely to
occur in a falling interest rate environment. When this happens, a fund may have
to replace these securities with lower yielding securities, which could result
in a lower return. In a rising interest rate environment, prepayment on
outstanding debt securities is less likely to occur. This is known as extension
risk and may cause the value of debt securities
4
to depreciate as a result of the higher market
interest rates. Typically, longer-maturity debt securities react to interest
rate changes more severely than shorter-term debt securities (all things being
equal), but generally offer greater rates of interest. If an issuer redeems its
debt securities prior to final maturity, a fund may have to replace those
securities with lower yielding securities, which could result in a lower
return.
A change in a central bank’s monetary policy or
economic conditions may lead to a change in interest rates, which could have
sudden and unpredictable effects on the markets and significantly impact the
value of debt securities in which a fund invests. Some debt securities, such as
bonds with longer durations, are more sensitive to interest rate changes than
others and may experience an immediate and considerable reduction in value if
interest rates rise. Longer duration securities tend to be more volatile than
shorter duration securities. As the values of debt securities in a fund’s
portfolio adjust to a rise in interest rates, the fund’s share price may fall.
In the event that a fund holds a large portion of its portfolio in longer
duration securities when interest rates increase, the share price of the fund
may fall significantly.
Debt securities also are subject to the risk
that the issuers will not make timely interest and/or principal payments or fail
to make them at all. This is called credit risk. Corporate debt securities
(bonds) tend to have higher credit risk generally than U.S. government debt
securities. Debt securities also may be subject to price volatility due to
market perception of future interest rates, the creditworthiness of the issuer
and general market liquidity (market risk). Investment-grade debt securities are
considered medium- and/or high-quality securities, although some still possess
varying degrees of speculative characteristics and risks. Debt securities rated
below investment-grade are riskier, but may offer higher yields. These
securities are sometimes referred to as high-yield securities or “junk bonds.”
The market for these securities has historically been less liquid and more
volatile than for investment-grade securities.
Corporate
bonds are debt securities issued by
corporations. Although a higher return is expected from corporate bonds, these
securities, while subject to the same general risks as U.S. government
securities, are subject to greater credit risk than U.S. government securities.
Their prices may be affected by the perceived credit quality of their
issuer.
Investment-grade
bonds. A fund will generally limit
its investments in debt securities to those that are rated investment-grade. A
fund considers investment-grade securities those that have a Bloomberg Index
Rating in one of the four highest rating categories (within which there may be
sub-categories or gradations indicating relative standing). The Bloomberg Index
Rating is based on the middle rating of Moody’s Investors Service, Standard
& Poor’s Financial Services LLC (S&P) and Fitch Ratings, Inc. (each of
which is a Nationally Recognized Statistical Rating Organization (NRSRO)). When
a rating from only two agencies is available, the lower rating is used and when
only one agency rates a bond, that rating is used. In cases where explicit bond
level ratings may not be available, Bloomberg Index Ratings may use other
sources to classify securities by credit quality. See the appendix titled
“Ratings of Investment Securities” for more information. The ratings of NRSROs
represent their opinions as to the quality of the securities. It should be
emphasized, however, that these ratings are general and are not absolute
standards of quality. Consequently, obligations with the same rating, maturity
and interest rate may have different market prices. Further, NRSROs may have
conflicts of interest relating to the issuance of a credit rating and such
conflicts may affect the integrity of the credit rating process or the
methodologies used to develop credit ratings for securities. Such conflicts may
include, but are not limited to; NRSROs being paid by issuers or underwriters to
determine the credit ratings with respect to the securities they issue or
underwrite, NRSROs being paid by issuers and underwriters for services in
addition to the NRSROs determination of credit ratings; allowing persons with
the NRSRO to directly own securities or money market instruments of, or having
other direct ownership interests in, issuers or obligors subject to a credit
rating determined by the NRSRO; and allowing persons within the NRSRO to have a
business relationship that is more than an arms-length ordinary course of
business relationship with issuers or obligors subject to a credit rating
determined by the NRSRO.
In addition, credit ratings are generally given
to securities at the time of issuance. While the rating agencies may from time
to time revise such ratings, they undertake no obligation to do so, and the
ratings given to securities at issuance do not necessarily represent ratings
that would be given to these securities on a particular subsequent date.
Accordingly, investors should note that the assignment of a rating to a security
by a rating service may not reflect the effect of recent developments on the
issuer’s ability to make interest and principal payments.
Delayed-Delivery and Forward
Commitment Transactions (Principal
investments for the Schwab U.S. Aggregate Bond ETF. Permissible non-principal
investments for each other fund) involve purchasing and selling securities on a
delayed-delivery or forward basis. A delayed-delivery agreement is a contract
for the purchase or sale of one or more securities to be delivered on an agreed
future settlement date. A forward commitment agreement is a contract for the
purchase or sale of one or more securities at a specified price, with delivery
and cash settlement on an agreed specified future date. When purchasing
securities on a delayed-delivery or forward basis, a fund assumes the rights and
risks of ownership, including the risk of price and yield fluctuations.
Typically, no interest will accrue to a fund until the security is delivered.
When a fund sells a security on a delayed-delivery or forward basis, the fund
does not participate in further gains or losses with respect to that security.
If the other party to a delayed-delivery transaction fails to deliver or pay for
the securities, a fund could miss a favorable price or yield opportunity or
suffer a loss. A fund may renegotiate a forward commitment transaction and may
sell the underlying security before delivery, which may result in capital gains
or losses for the fund.
Derivative
Instruments (Principal investments
for the Schwab 1-5 Year Corporate Bond ETF, the Schwab 5-10 Year Corporate Bond
ETF and the Schwab U.S. Aggregate Bond ETF. Permissible non-principal
investments for each other fund) are commonly defined to include instruments or
contracts whose values depend on (or “derive” from) the value of one or more
other assets such as securities, currencies, or commodities. These “other
assets” are commonly referred to as “underlying assets.” The funds may use
derivatives, principally futures contracts, primarily to seek returns on a
fund’s otherwise uninvested cash assets.
5
A derivative instrument generally consists of,
is based upon, or exhibits characteristics similar to options or forward
contracts. Options and forward contracts are considered to be the basic
“building blocks” of derivatives. For example, forward-based derivatives include
forward contracts, as well as exchange-traded futures. Option-based derivatives
include privately negotiated, over-the-counter (OTC) options (including caps,
floors, collars, and options on forward and swap contracts) and exchange-traded
options on futures. Diverse types of derivatives may be created by combining
options or forward contracts in different ways, and applying these structures to
a wide range of underlying assets. Risk management strategies include investment
techniques designed to facilitate the sale of portfolio securities, manage the
average duration of the portfolio or create or alter exposure to certain asset
classes, such as equity, other debt or foreign securities.
In addition to the derivative instruments and
strategies described in this SAI, the investment adviser expects to discover
additional derivative instruments and other investment, hedging or risk
management techniques. The investment adviser may utilize these new derivative
instruments and techniques to the extent that they are consistent with a fund’s
investment objective and permitted by a fund’s investment limitations, operating
policies and applicable regulatory authorities.
A fund’s derivative instruments can create (i)
leverage risk, which generally refers to the risk that derivatives transactions
can magnify a fund’s gains and losses, (ii) market risk, which generally refers
to the risk from potential adverse market movements in relation to a fund’s
derivatives positions, or the risk that markets could experience a change in
volatility that adversely impacts fund returns and a fund’s obligations and
exposures, (iii) counterparty risk, which generally refers to the risk that a
counterparty on a derivatives transaction may not be willing or able to perform
its obligations under the derivatives contract, and the related risks of having
concentrated exposure to such a counterparty, (iv) liquidity risk, which
generally refers to the risk involving the liquidity demands that derivatives
transactions can create to make payments of margin, collateral, or settlement
payments to counterparties, (v) operational risk, which generally refers to the
risk related to potential operational issues, including documentation issues,
settlement issues, systems failures, inadequate controls, and human error and
(vi) legal risk, which generally refers to insufficient documentation,
insufficient capacity or authority of the counterparty, or legality or
enforceability of a contract. Certain of these risks are described in more
detail as they apply to specific derivative instruments in the following
sub-sections of this SAI.
Futures
Contracts are instruments that
represent an agreement between two parties that obligates one party to buy, and
the other party to sell, specific instruments at an agreed-upon price on a
stipulated future date. In the case of futures contracts relating to an index or
otherwise not calling for physical delivery at the close of the transaction, the
parties usually agree to deliver the final cash settlement price of the
contract. A fund may purchase and sell futures contracts based on securities,
securities indices, interest rates, or any other futures contracts traded on
U.S. exchanges or boards of trade that the Commodity Futures Trading Commission
(CFTC) licenses and regulates on foreign exchanges. Although positions are
usually marked-to-market on a daily basis with an intermediary (executing
broker), there remains a credit risk with the futures exchange.
A fund must maintain a small portion of its
assets in cash to process certain shareholder transactions in and out of it and
to pay its expenses. To help manage interest rate exposure or reduce the effect
uninvested cash would have on performance, a fund may purchase futures
contracts. Such transactions also allow a fund’s cash balance to produce a
return similar to that of the underlying security or index on which the futures
contract is based. A fund may enter into futures contracts for other reasons as
well.
When buying or selling futures contracts, a fund
must place a deposit with its broker equal to a fraction of the contract amount.
This amount is known as “initial margin” and must be in the form of liquid
assets, including cash, cash-equivalents and U.S. government securities.
Subsequent payments to and from the broker, known as “variation margin” may be
made daily, if necessary, as the value of the futures contracts fluctuate. This
process is known as “marking-to-market.” The initial margin amount will be
returned to a fund upon termination of the futures contracts assuming all
contractual obligations are satisfied. Because margin requirements are normally
only a fraction of the amount of the futures contracts in a given transaction,
futures trading can involve a great deal of leverage.
While a fund intends to purchase and sell
futures contracts to simulate full investment, there are risks associated with
these transactions. Adverse market movements could cause a fund to experience
substantial losses when buying and selling futures contracts. Of course, barring
significant market distortions, similar results would have been expected if the
fund had instead transacted in the underlying securities directly. There also is
the risk of losing any margin payments held by a broker in the event of its
bankruptcy. Additionally, a fund incurs transaction costs (e.g., brokerage fees)
when engaging in futures trading. To the extent a fund also invests in futures
to simulate full investment, these same risks apply.
When interest rates are rising or securities
prices are falling, a fund may seek, through the sale of futures contracts, to
offset a decline in the value of its current portfolio securities. When interest
rates are falling or prices are rising, a fund, through the purchase of futures
contracts, may attempt to secure better rates or prices than might later be
available in the market when it effects anticipated purchases. Similarly, a fund
may sell futures contracts on a specified currency to protect against a decline
in the value of that currency and its portfolio securities that are denominated
in that currency. A fund may purchase futures contracts on a foreign currency to
fix the price in U.S. dollars of a security denominated in that currency that a
fund has acquired or expects to acquire.
Futures contracts may require actual delivery or
acquisition of an underlying security or cash value of an index on the
expiration date of the contract. In most cases, however, the contractual
obligation is fulfilled before the date of the contract by buying or selling, as
the case may be, identical futures contracts. Such offsetting transactions
terminate the original contracts and cancel the obligation to take or make
delivery of the underlying securities or cash. There may not always be a liquid
secondary market at the time a fund seeks to close out a futures position. If a
fund is unable to close out its position and prices move adversely, the fund
would have to continue to make daily cash payments to
6
maintain its margin requirements. If a fund had
insufficient cash to meet these requirements it may have to sell portfolio
securities at a disadvantageous time or incur extra costs by borrowing the cash.
Also, a fund may be required to make or take delivery and incur extra
transaction costs buying or selling the underlying securities. A fund seeks to
reduce the risks associated with futures transactions by buying and selling
futures contracts that are traded on national exchanges or for which there
appears to be a liquid secondary market.
Derivatives
Regulatory Matters. In October
2020, the U.S. Securities and Exchange Commission (SEC) adopted a rule related
to the use of derivatives, reverse repurchase agreements and certain other
transactions by registered investment companies that rescinded and withdrew the
guidance of the SEC and its staff regarding asset segregation and cover
transactions previously applicable to a fund’s use of such transactions. The
rule requires a fund to trade derivatives and other transactions that create
future payment or delivery obligations (except reverse repurchase agreements and
similar financing transactions) subject to value-at-risk (VaR) leverage limits
and derivatives risk management program and reporting requirements. Generally,
these requirements apply unless a fund satisfies a “limited derivatives users”
exception that is included in the rule. Under the rule, when a fund trades
reverse repurchase agreements or similar financing transactions, including
certain tender option bonds, it needs to aggregate the amount of indebtedness
associated with the reverse repurchase agreements or similar financing
transactions with the aggregate amount of any other senior securities
representing indebtedness when calculating a fund’s asset coverage ratio or
treat all such transactions as derivatives transactions. Reverse repurchase
agreements or similar financing transactions aggregated with other indebtedness
do not need to be included in the calculation of whether a fund satisfies the
limited derivatives users exception, but for funds subject to the VaR testing
requirement, reverse repurchase agreements and similar financing transactions
must be included for purposes of such testing whether treated as derivatives
transactions or not. The SEC also provided guidance in connection with the rule
regarding the use of securities lending collateral that may limit a fund’s
securities lending activities. In addition, under the rule, a fund will be
permitted to invest in a security on a when-issued or forward-settling basis, or
with a non-standard settlement cycle, and the transaction will be deemed not to
involve a senior security (as defined under Section 18(g) of the Investment
Company Act of 1940, as amended (the 1940 Act)), provided that, (i) the fund
intends to physically settle the transaction and (ii) the transaction will
settle within 35 days of its trade date (the Delayed-Settlement Securities
Provision). A fund may otherwise engage in when-issued, forward-settling and
non-standard settlement cycle securities transactions that do not meet the
conditions of the Delayed-Settlement Securities Provision so long as the fund
treats any such transaction as a “derivatives transaction” for purposes of
compliance with the rule. Furthermore, under the rule, a fund will be permitted
to enter into an unfunded commitment agreement, and such unfunded commitment
agreement will not be subject to the asset coverage requirements under the 1940
Act, if the fund reasonably believes, at the time it enters into such agreement,
that it will have sufficient cash and cash equivalents to meet its obligations
with respect to all such agreements as they come due. These requirements may
limit the ability of a fund to use derivatives, and reverse repurchase
agreements and similar financing transactions, when-issued, delayed delivery and
forward commitment transactions, and unfunded commitment agreements as part of
its investment strategies. These requirements may increase the cost of a fund’s
investments and cost of doing business, which could adversely affect investors.
The investment adviser cannot predict the effects of these regulations on a
fund. The investment adviser intends to monitor developments and seeks to manage
the funds in a manner consistent with achieving the funds’ investment
objectives, but there can be no assurance that it will be successful in doing
so.
The CFTC regulates the trading of commodity
interests, including certain futures contracts, options, and swaps in which a
fund may invest. A fund that invests in commodity interests will generally be
subject to certain CFTC regulatory requirements if it is considered a “commodity
pool.” A notice of eligibility for exclusion from the definition of the term
“commodity pool operator” (CPO) under the Commodity Exchange Act, as amended
(CEA) has been filed, by the funds’ investment adviser, with respect to each
fund’s operation. Therefore, each fund and its investment adviser are not
subject to registration or regulation as a CPO under the CEA. If a fund’s
investment adviser were no longer able to claim the exclusion, the fund’s
investment adviser may be required to register as a CPO and the fund and its
investment adviser would be subject to regulation as a CPO under the CEA. If a
fund or its investment adviser is subject to CFTC regulation, it may incur
additional expenses and/or may choose to make changes to its investment
strategies.
Diversification involves investing in a wide range of
securities and thereby spreading and reducing the risks of investment. Each fund
is a series of an open-end investment management company with limited
redeemability. The funds are diversified exchange-traded funds. Diversification
does not eliminate the risk of market loss.
Exchange-Traded
Funds (ETFs) such as the funds, are
investment companies that typically are registered under the 1940 Act as
open-end funds (as is the funds’ case) or unit investment trusts (UITs). ETFs
are actively traded on national securities exchanges and are generally based on
specific domestic and foreign market indices. Shares of an ETF may be bought and
sold throughout the day at market prices, which may be higher or lower than the
shares’ NAV. Market prices of ETF shares will fluctuate, sometimes rapidly and
materially, in response to various factors including changes in the ETF’s NAV,
the value of ETF holdings, and supply of and demand for ETF shares. Although the
creation/redemption feature of ETFs generally makes it more likely that ETF
shares will trade close to their NAV, market volatility, lack of an active
trading market for ETF shares, disruptions at market participants (such as
Authorized Participants or market makers) and any disruptions in the ordinary
functioning of the creation/redemption process may result in ETF shares trading
significantly above (at a “premium”) or below (at a “discount”) their NAV. An
ETF’s investment results are based on the ETF’s daily NAV. Investors transacting
in ETF shares in the secondary market, where market prices may differ from NAV,
may experience investment results that differ from results based on the ETF’s
daily NAV. An “index-based ETF” seeks to track the performance of an index by
holding in its portfolio either the contents of the index or a representative
sample of the securities in the index. Because ETFs are based on an underlying
basket of securities, they are subject to the same market fluctuations as these
types of securities in volatile market swings. ETFs, like mutual funds, have
expenses associated with their operation, including advisory fees. When a fund
invests in an ETF, in addition to directly bearing expenses associated with its
own operations, it will bear a pro rata portion of the ETF’s expenses. As with
any exchange listed security, ETF shares purchased in the secondary market are
subject to customary brokerage charges.
7
Indexing
Strategies involve tracking the
securities represented in, and therefore the performance of, an index. Each fund
normally will invest primarily in the securities of its index. Moreover, each
fund seeks to invest so that its portfolio performs similarly to that of its
index. Each fund will seek to achieve, over time, a correlation between its
performance and that of its index, before fees and expenses, of 0.95 or better.
Correlation for each fund is calculated using daily returns, according to a
mathematical formula which measures correlation between a fund’s portfolio and
index returns. Each fund may rebalance its holdings in order to track its index
more closely. A perfect correlation of 1.0 is unlikely as the funds incur
operating and trading expenses unlike their indices. In the event its intended
correlation is not achieved, the Board will consider alternative arrangements
for each fund.
There can be no guarantee that the performance
of a fund will achieve a high degree of correlation with that of its index. A
number of factors may affect a fund’s ability to achieve a high correlation with
its index, including the degree to which the fund utilizes a sampling technique.
The correlation between the performance of a fund and its index may also diverge
due to transaction costs, asset valuations, corporate actions (such as mergers
and spin-offs), timing variances, and differences between the fund’s portfolio
and the index resulting from legal restrictions (such as diversification
requirements) that apply to the fund but not to the index.
Inflation/Deflation
Risk. The funds may be subject to
inflation and deflation risk. Inflation risk is the risk that the present value
of assets or income from a fund’s investments will be less in the future as
inflation decreases the value of money. As inflation increases, the present
value of a fund’s assets can decline. Deflation risk is the risk that prices
throughout the economy decline over time. Deflation may have an adverse effect
on the creditworthiness of issuers and may make issuer default more likely,
which may result in a decline in the value of a fund’s assets.
Inflation-Protected
Securities (Principal investments
for the Schwab U.S. TIPS ETF. Permissible non-principal investments for Schwab
U.S. Aggregate Bond ETF) are fixed-income securities whose value is periodically
adjusted according to the rate of inflation. Two structures are common. The U.S.
Treasury and some other issuers utilize a structure that accrues inflation into
the principal value of the bond. Other issuers pay out the Consumer Price Index
(CPI) accruals as part of a semiannual coupon. Inflation-protected securities
issued by the U.S. Treasury have maturities of approximately five, ten or
thirty years, although it is possible that securities with other maturities
will be issued in the future. The U.S. Treasury securities pay interest on a
semiannual basis equal to a fixed percentage of the inflation adjusted
principal amount.
If the periodic adjustment rate measuring
inflation falls, the principal value of inflation-protected bonds will be
adjusted downward, and consequently the interest payable on these securities
(calculated with respect to a smaller principal amount) will be reduced.
Repayment of the original bond principal upon maturity (as adjusted for
inflation) is guaranteed by the U.S. Treasury in the case of U.S. Treasury
inflation-protected bonds, even during a period of deflation. However, the
current market value of the bonds is not guaranteed and will fluctuate. A fund
may also invest in other inflation-protected bonds which may or may not provide
a similar guarantee. If a guarantee of principal is not provided, the adjusted
principal value of the bond to be repaid at maturity may be less than the
original principal amount and, therefore, is subject to credit risk.
The value of inflation-protected bonds is
expected to change in response to changes in real interest rates. Real interest
rates in turn are tied to the relationship between nominal interest rates and
the expected rate of inflation. Therefore, if the rate of inflation rises at a
faster rate than nominal interest rates, real interest rates might decline,
leading to an increase in value of inflation-protected bonds. In contrast, if
nominal interest rates increase at a faster rate than inflation, real interest
rates might rise, leading to a decrease in value of inflation-protected
bonds.
While these securities are expected to be
protected from long-term inflationary trends, short-term increases in inflation
may lead to a decline in value. If interest rates rise due to reasons other than
inflation (for example, due to changes in currency exchange rates), investors in
these securities may not be protected to the extent that the increase is not
reflected in the bond’s inflation measure.
The periodic adjustment of U.S.
inflation-protected bonds is tied to the non-seasonally adjusted U.S. City
Average All Items Consumer Price Index for All Urban Consumers (CPI-U),
published monthly by the U.S. Bureau of Labor Statistics. The CPI-U is a
measurement of changes in the cost of living, made up of components such as
housing, food, transportation and energy. Inflation-protected bonds issued by a
foreign government are generally adjusted to reflect a comparable inflation
index, calculated by that government. There can be no assurance that the CPI-U
or any foreign inflation index will accurately measure the real rate of
inflation in the prices of goods and services. Moreover, there can be no
assurance that the rate of inflation in a foreign country will be correlated to
the rate of inflation in the United States.
Any increase in principal for an
inflation-protected security resulting from inflation adjustments is considered
by the U.S. Internal Revenue Service (IRS) to be taxable income in the year it
occurs. A fund’s distributions to shareholders include interest income and the
income attributable to principal adjustments, both of which will be taxable to
shareholders. The tax treatment of the income attributable to principal
adjustments may result in the situation where a fund needs to make its required
annual distributions to shareholders in amounts that exceed the cash received.
As a result, the fund may need to liquidate certain investments when it is not
advantageous to do so. Also, if the principal value of an inflation-protected
security is adjusted downward due to deflation, amounts previously distributed
in the taxable year may be characterized in some circumstances as a return of
capital.
The securities in the Schwab U.S. TIPS ETF’s
index include all publicly-issued U.S. Treasury inflation-protected securities
that have at least one year remaining to maturity, are rated investment grade
and have $500 million or more of outstanding face value. The securities
must be denominated in U.S. dollars and must be fixed-rate and non-convertible.
TIPS are publicly issued, dollar-denominated U.S. government securities issued
by the U.S. Treasury that have principal and interest payments linked to
official inflation measure (as measured by the Consumer Price Index, or CPI) and
their payments are supported by the full faith and credit of the United States
government.
8
Interest Rates may rise and fall over time, and debt
securities will experience price changes when interest rates change. A change in
interest rates may have sudden and unpredictable effects on the markets and a
fund’s investments. For example, when interest rates fall, the prices of debt
securities generally rise. If interest rates rise, the value of the fund’s debt
securities could be adversely impacted and the fund could lose money. The value
of debt securities in a fund can be expected to vary inversely with changes in
prevailing interest rates. In general, debt securities with longer maturities
will tend to react to interest rate changes more severely than shorter-term debt
securities, but will generally offer greater rates of interest.
During periods of rising interest rates, the
average life of certain debt securities is extended because of slower than
expected principal payments. This may lock in below-market interest rates and
extend the duration of these debt securities, making them more sensitive to
changes in interest rates. This is known as extension risk and may cause the
value of debt securities to depreciate as a result of the higher market interest
rates.
When interest rates decline, borrowers may pay
off their fixed-income securities sooner than expected. This is known as
prepayment risk and may reduce the returns of a fund because a fund will have to
reinvest that money at the lower prevailing interest rates.
Market Disruptions
Risk. The funds are subject to
investment and operational risks associated with financial, economic and other
global market developments and disruptions, including those arising from war,
terrorism, market manipulation, government interventions, defaults and
shutdowns, political changes or diplomatic developments, public health
emergencies (such as the spread of infectious diseases, epidemics and pandemics)
and natural/environmental disasters, which can all negatively impact the
securities markets and cause a fund to lose value. These events can also impair
the technology and other operational systems upon which the funds’ service
providers, including Schwab Asset Management as the funds’ investment adviser,
rely, and could otherwise disrupt the funds’ service providers’ ability to
fulfill their obligations to the funds.
A widespread health crisis, such as an
infectious disease outbreak, epidemic or pandemic, could cause substantial
market volatility, securities exchange suspensions, restrictions or closures,
and other deleterious effects, any of which could disrupt fund operations and
adversely affect fund performance. For example, the outbreak of COVID-19, a
novel coronavirus disease, caused volatility, severe market dislocations and
liquidity constraints in many markets, including those in which the funds
invest. Efforts to contain the spread of infectious disease could result in
travel restrictions and disruptions, closed international borders, enhanced
health screenings at ports of entry and elsewhere, disruption of and delays in
healthcare service preparation and delivery, quarantines, event and service
cancellations or interruptions, disruptions to business operations (including
staff reductions), supply chains and consumer activity, as well as general
concern and uncertainty that could have negative economic effects. Such
disruptions could lead to instability in the market place, including losses and
overall volatility. Future health crises could adversely affect economies, the
financial performance of individual issuers, borrowers and sectors and the
health of the markets generally in potentially significant and unforeseen
ways.
War, terrorism and related responses and events
could cause substantial market volatility, disrupt fund operations and adversely
affect fund performance. For example, Russia’s military invasion of Ukraine in
February 2022, responses by the United States and other countries to the
invasion and the potential for wider conflict have increased and may continue to
increase volatility and uncertainty in financial markets worldwide. The United
States and other countries have imposed broad-ranging economic sanctions on
Russia and Russian entities and individuals that, among other restrictions,
prohibit companies from doing business with Russia and Russian issuers, and may
adversely affect companies with economic or financial exposure to Russia and
Russian issuers. The United States and other countries have also imposed
economic sanctions on Belarus and may impose sanctions on other countries that
support Russia’s military invasion. Additionally, armed conflict between Israel
and Hamas and other militant groups in the Middle East and related events could
cause significant market disruptions and volatility. These events and other
similar events could negatively affect a fund’s performance.
U.S. and global markets have experienced
increased volatility in past years, including as a result of the failures of
certain U.S. and non-U.S. banks, which could be harmful to the funds and issuers
in which they invest. For example, if a bank in which a fund or an issuer has an
account fails, any cash or other assets in bank accounts may be temporarily
inaccessible or permanently lost by the fund or issuer. If a bank that provides
a subscription line credit facility, asset-based facility, other credit facility
and/or other services to an issuer fails, the issuer could be unable to draw
funds under its credit facilities or obtain replacement credit facilities or
other services from other lending institutions with similar terms. Even if banks
used by issuers in which the funds invest remain solvent, continued volatility
in the banking sector could cause or intensify an economic recession, increase
the costs of banking services or result in the issuers being unable to obtain or
refinance indebtedness at all or on as favorable terms as could otherwise have
been obtained. Conditions in the banking sector are evolving, and the scope of
any potential impacts to the funds and issuers, both from market conditions and
also potential legislative or regulatory responses, are uncertain. Continued
market volatility and uncertainty and/or a downturn in market and economic and
financial conditions, as a result of developments in the banking industry or
otherwise (including as a result of delayed access to cash or credit
facilities), could have an adverse impact on the funds and issuers in which they
invest.
The foregoing could lead to a significant
economic downturn or recession, increased market volatility, market closures,
changes in interest rates, higher default rates and adverse effects on the
values and liquidity of securities or other assets. Such impacts, which may vary
across asset classes, may adversely affect the performance of the funds. In
certain cases, an exchange or market may close or issue trading halts on
specific securities or even the entire market, which may result in the funds
being, among other things, unable to buy or sell certain securities or financial
instruments or to accurately price their investments.
9
Mortgage-Backed Securities
(MBS) and other Asset-Backed Securities (ABS) (Principal investments for the Schwab U.S.
Aggregate Bond ETF only) may be purchased by the fund. MBS represent
participations in mortgage loans, and include pass-through securities,
adjustable rate mortgages, collateralized mortgage obligations and stripped MBS.
MBS may be issued or guaranteed by U.S. government agencies or
instrumentalities, such as Ginnie Mae, Fannie Mae or Freddie Mac. MBS may also
be issued by private issuers, generally originators and investors in mortgage
loans, including savings associations, mortgage banks, commercial banks, and
special purpose entities (collectively, “private lenders”). MBS are based on
different types of mortgages including those on commercial real estate and
residential property. MBS issued by private lenders may be supported by pools of
mortgage loans or other MBS that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any governmental guarantee of the underlying mortgage assets but
with some form of credit enhancement. To the extent that a fund invests in MBS
issued by private lenders, such securities may be issued in the form of several
tranches. Depending on their respective seniority, individual tranches are
subject to increased (and sometimes different) credit, prepayment and liquidity
and valuation risks as compared to other tranches. These securities are often
subject to greater credit, prepayment and liquidity and valuation risks than an
MBS issued by a U.S. government agency or instrumentality. The investment
adviser will consider the creditworthiness of the guarantee providers and/or
credit enhancement providers in determining whether a MBS issued by a private
lender meets the fund’s investment quality standards. There can be no guarantee
that the enhancement provider or guarantor of a MBS can meet their obligations
under the enhancement or guarantee arrangements.
The average life of a MBS is likely to be
substantially shorter than the original maturity of the mortgages underlying the
securities. Scheduled payments and prepayments of principal by mortgagors and
mortgage foreclosures will usually result in the return of the greater part of
principal investment long before the maturity of the mortgages in the
pool.
The National Housing Act authorized Ginnie Mae
to guarantee the timely payment of principal and interest on securities backed
by a pool of mortgages insured by the Federal Housing Administration (FHA) or
guaranteed by the U.S. Department of Veterans Affairs. The Ginnie Mae guarantee
is backed by the full faith and credit of the U.S. government. Ginnie Mae is
also empowered to borrow without limitation from the U.S. Treasury if necessary
to make any payments required under its guarantee.
Freddie Mac was created in 1970 to promote
development of a nationwide secondary market in conventional residential
mortgages. Fannie Mae was established in 1938 to create a secondary market in
mortgages the FHA insures. Securities issued by Freddie Mac and Fannie Mae are
not backed by the full faith and credit of the U.S. government.
For more information on securities issued by
Fannie Mae and Freddie Mac, see “U.S. Government Securities.” On June 3,
2019, under the “Single Security Initiative” undertaken by the Federal Housing
Finance Agency (FHFA) seeking to maximize the liquidity of both Fannie Mae and
Freddie Mac MBS in the “to-be-announced” (TBA) market, Fannie Mae and Freddie
Mac started issuing uniform MBS (UMBS) in place of their previous offerings of
TBA-eligible MBS. While the initial effects of the issuance of UMBS on the
market for MBS and on a fund’s ability to invest in UMBS have been minimal, the
long-term effects of the Single Security Initiative are uncertain.
Asset-backed
Securities (ABS) have structural
characteristics similar to MBS. ABS represent direct or indirect participation
in assets such as automobile loans, credit card receivables, trade receivables,
home equity loans (which sometimes are categorized as MBS) or other financial
assets. Therefore, repayment depends largely on the cash flows generated by the
assets backing the securities. The credit quality of most ABS depends primarily
on the credit quality of the assets underlying such securities, how well the
entity issuing the security is insulated from the credit risk of the originator
or any other affiliated entities, and the amount and quality of any credit
enhancement of the securities. Payments or distributions of principal and
interest on ABS may be supported by credit enhancements including letters of
credit, an insurance guarantee, reserve funds and overcollateralization.
Asset-backed securities also may be debt instruments, which are also known as
collateralized obligations and are generally issued as the debt of a special
purpose entity, such as a trust, organized solely for the purpose of owning such
assets and issuing debt obligations.
Commercial
Mortgage-Backed Securities (CMBS)
include securities that reflect an interest in, and are secured by, mortgage
loans on commercial real property. The market for CMBS developed more recently
and in terms of total outstanding principal amount of issues is relatively small
compared to the market for residential single-family MBS. Many of the risks of
investing in CMBS reflect the risks of investing in the real estate securing the
underlying mortgage loans. These risks reflect the effects of local and other
economic conditions on real estate markets, the ability of tenants to make loan
payments, and the ability of a property to attract and retain tenants. CMBS may
be less liquid and exhibit greater price volatility than other types of
mortgage- or asset-backed securities.
Mortgage Dollar
Rolls. (Principal investments for
the Schwab U.S. Aggregate Bond ETF only) The fund may enter into mortgage dollar
rolls, in which the fund would sell MBS for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the fund would forego principal and interest paid
on the MBS during the roll period, the fund would be compensated by the
difference between the current sales price and the lower price for the future
purchase as well as by any interest earned on the proceeds of the initial sale.
The fund also could be compensated through the receipt of fee income equivalent
to a lower forward price. Mortgage dollar roll transactions may be considered a
borrowing by the fund.
The mortgage dollar rolls entered into by the
fund may be used as transactions in which the fund will maintain an offsetting
position in high-quality liquid short-term investments. Since the fund will
receive interest on the securities in which it invests the transaction proceeds,
such transactions may involve a form of leverage. However, since such securities
will be high quality and short duration, the investment adviser believes that
such transactions present lower risks to the fund than those associated with
other types of leverage. There can be no assurance that the fund’s use of the
cash it receives from a mortgage dollar roll will provide a positive
return.
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Mortgage Pass-Through
Securities. (Principal investments
for the Schwab U.S. Aggregate Bond ETF only) The term “U.S. agency mortgage
pass-through security” refers to a category of pass-through securities backed by
pools of mortgages and issued by one of several U.S. government-sponsored
entities, such as Ginnie Mae, Fannie Mae, or Freddie Mac. In the basic mortgage
pass-through structure, mortgages with similar issuer, term and coupon
characteristics are collected and aggregated into a “pool” consisting of
multiple mortgage loans. The pool is assigned a CUSIP number and undivided
interests in the pool are traded and sold as pass-through securities. The holder
of the security is entitles to a pro rata share of principal and interest
payments (including unscheduled prepayments) from the pool of mortgage
loans.
An investment in a specific pool of pass-through
securities requires an analysis of the specific prepayment risk of mortgages
within the covered pool (since mortgagors typically have the option to prepay
their loans). The level of prepayments on a pool of mortgage securities is
difficult to predict and can impact the subsequent cash flows, value and yield
of the mortgage pool. In addition, when trading specific mortgage pools, precise
execution, delivery and settlement arrangements must be negotiated for each
transaction. These factors combine to make trading in mortgage pools somewhat
cumbersome relative to other fund investments.
For these reasons, the fund may seek to obtain
exposure to U.S. agency mortgage pass-through securities, in part or in full,
through the use of “to-be-announced” or “TBA” transactions. “TBA” refers to a
commonly used mechanism for the forward settlement of U.S. agency mortgage
pass-through securities, and not to a separate type of mortgage-backed security.
Most transactions in the fixed-rate mortgage pass-through securities occur
through the use of TBA transactions. TBA transactions are generally conducted in
accordance with widely-accepted guidelines that establish commonly observed
terms and conditions for execution, settlement and delivery. In a TBA
transaction, the buyer and seller decided on general trade parameters, such as
agency, settlement date, par amount and price. The actual pools delivered
generally are determined two days prior to settlement date. The fund may use TBA
transactions in several ways. For example, the fund anticipates that it will
regularly enter into TBA agreements and “roll over” such agreements prior to the
settlement date stipulated in such agreements. This type of TBA transaction is
sometimes knows as a “TBA roll”. In a TBA roll, the fund generally will sell the
obligation to purchase the pools stipulated in the TBA agreement prior to the
stipulated settlement date and will enter into a new TBA agreement for future
delivery of pools of mortgage pass-through securities. In addition, the fund may
enter into TBA agreements and settle such transactions on the stipulated
settlement date by accepting actual receipt or delivery of the pools of mortgage
pass-through securities stipulated in the TBA agreement.
Default by or bankruptcy of a counterparty to a
TBA transaction would expose the fund to possible loss because of adverse market
action, expenses or delays in connection with the purchase or sale of the pools
of mortgage pass-through securities specified in the TBA transaction. To help
minimize this risk, the fund will enter into TBA transactions only with
established counterparties (such as major broker-dealers) and the fund’s
investment adviser will monitor the creditworthiness of such counterparties. The
fund may also acquire interests in mortgage pools through means other than TBA
transactions.
The fund’s use of “TBA rolls” may cause the fund
to experience higher portfolio turnover, higher transaction costs and to pay
higher capital gains distributions to shareholders, which may be taxable, than
if it acquired exposure to mortgage pools through means other than TBA
transactions.
The fund intends to invest cash pending
settlement of any TBA transactions in U.S. Treasury securities, money market
instruments, repurchase agreements, or other high-quality, liquid short-term
instruments, including money market funds.
Non-U.S. Issuer
Risk. (Principal investments for
the Schwab 1-5 Year Corporate Bond ETF, the Schwab 5-10 Year Corporate Bond ETF
and the Schwab U.S. Aggregate Bond ETF only) Each fund may invest in U.S.
registered, dollar-denominated debt securities of non-U.S. corporations. The
Schwab U.S. Aggregate Bond ETF also may invest in U.S. registered,
dollar-denominated debt securities of governments, agencies and supra-national
entities. Investments in securities of non-U.S. issuers involve additional risks
because they are issued by foreign entities, including foreign governments,
banks, and corporations. Foreign entities issuing these securities may not be
subject to uniform accounting, auditing and financial reporting standards,
practices and requirements comparable to those applicable to U.S. corporations.
In addition, there may be less publicly available information about foreign
entities. Foreign economic, political and legal developments, as well as a
compromise in public health and safety, could have more dramatic effects on the
value of foreign securities. For example, conditions within and around foreign
countries, such as the possibility of expropriation or confiscatory taxation,
political or social instability, diplomatic developments, currency blockage, the
imposition of sanctions and other similar measures, change of government or war
could affect the value of foreign investments. Additionally, a country could
experience a public health threat, such as an infectious illness which could
reduce consumer demand or economic output and/or result in market closures,
travel restrictions or quarantines, all of which could affect the value of that
country’s securities and impact global markets. Moreover, 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.
Securities of non-U.S. issuers typically have
less volume and are generally less liquid and more volatile than securities of
U.S. companies. There may be difficulties in obtaining or enforcing judgments
against foreign issuers as well. Bankruptcy laws in some foreign countries are
sometimes biased to the borrowers and against the creditors. These factors and
others may increase the risks with respect to the liquidity of a fund, and its
ability to meet a large number of shareholder redemption requests.
In addition, a fund’s investments in securities
of foreign issuers may be subject to economic sanctions or other government
restrictions.The type and severity of sanctions and other similar measures,
including counter sanctions and other retaliatory actions, that may be imposed
could vary broadly in scope, and their impact is difficult to ascertain. These
types of measures may include, but are not limited to, banning a sanctioned
country or certain persons or entities associated with such country from global
payment systems that facilitate cross-border payments,
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restricting the settlement of securities
transactions by certain investors, and freezing the assets of particular
countries, entities or persons. The imposition of sanctions and other similar
measures could, among other things, result in a decline in the value and/or
liquidity of securities issued by the sanctioned country or companies located in
or economically tied to the sanctioned country, downgrades in the credit ratings
of the sanctioned country’s securities or those of companies located in or
economically tied to the sanctioned country, currency devaluation or volatility,
and increased market volatility and disruption in the sanctioned country and
throughout the world. Sanctions and other similar measures could directly or
indirectly limit or prevent a fund from buying and selling securities (in the
sanctioned country and other markets), significantly delay or prevent the
settlement of securities transactions, and adversely impact a fund’s liquidity
and performance. As a result, such restrictions may limit a fund’s ability to
meet a large number of shareholder redemption requests.
International trade tensions may arise from time
to time which could result in trade tariffs, embargos or other restrictions or
limitations on trade. The imposition of any actions on trade could trigger a
significant reduction in international trade, an oversupply of certain
manufactured goods, substantial price reductions of goods and possible failure
of individual companies or industries which could have a negative impact on a
fund’s performance. Events such as these are difficult to predict and may or may
not occur in the future.
During the 2008-2009 global financial crisis,
financial markets in Europe experienced significant volatility due, in part, to
concerns about rising levels of government debt and the prevalence of increased
budget deficits. As a result, many economies in the region suffered through
prolonged economic downturns. Due to the economic integration of the region,
another economic downturn in one European country may have a negative impact on
the economies of other European countries. As a fund may hold investments in
issuers that are located in Europe or that depend on revenues generated from
operations in Europe, any material negative developments in Europe could have a
negative impact on the value and liquidity of these investments, which could
harm the fund’s performance.
The risk of investing in Europe may be
heightened due to steps taken by the United Kingdom (UK) to exit the European
Union (EU). On January 31, 2020, the UK officially withdrew from the EU. On May
1, 2021, the EU-UK Trade and Cooperation Agreement (TCA) took effect and now
governs certain aspects of the EU’s and the UK’s relationship, many of which are
still to be determined, including those related to financial services.
Notwithstanding the TCA, significant uncertainty remains in the market regarding
the ramifications of the UK’s withdrawal from the EU. The impact on the UK and
European economies and the broader global economy could be significant,
resulting in increased volatility and illiquidity, and companies that conduct a
significant amount of business in the UK or Europe may experience lower revenue
and/or profit growth, all of which may adversely affect the value of a fund’s
investments. Brexit also may cause additional member states to contemplate
departing the EU, which would likely perpetuate political and economic
instability in the region and cause additional market disruption in global
financial markets.
A fund’s investments in securities of issuers in
emerging markets can be considered speculative, and therefore may offer higher
potential for gains and losses than investments in developed markets of the
world. With respect to an emerging country, there may be a greater potential for
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) which could affect adversely the economies of such countries or investments
in such countries. The economies of developing countries generally are heavily
dependent upon international trade and, accordingly, have been and may continue
to be adversely affected by trade barriers, exchange or currency controls,
managed adjustments in relative currency values and other protectionist measures
imposed or negotiated by the countries with which they trade.
In addition to the risks of investing in
emerging market country debt securities, a fund’s investment in government or
government-related securities of emerging market countries and restructured debt
instruments in emerging markets are subject to special risks, including the
inability or unwillingness to repay principal and interest, requests to
reschedule or restructure outstanding debt, and requests to extend additional
loan amounts. A fund may have limited recourse in the event of default on such
debt instruments.
Certain funds may invest a portion of their
assets in bonds issued by variable interest entities (VIEs). In China, ownership
of companies in certain sectors by non-Chinese individuals and entities
(including U.S. persons and entities, such as the funds) is prohibited. To
facilitate indirect foreign investment in these businesses, many Chinese
companies have created VIE structures. In such an arrangement, a China-based
operating company typically establishes a shell entity in another jurisdiction,
such as the Cayman Islands. Non-Chinese investors hold bonds in the shell entity
rather than directly in the China-based operating company. This arrangement
allows U.S. investors to obtain economic exposure to the China-based operating
company through contractual means. The contractual arrangements also permit the
VIE to consolidate the China-based operating company into its financial
statements.
Although VIE structures are a longstanding
industry practice and well known to officials and regulators in China, VIE
structures are not formally recognized under Chinese law. As a result, investors
face the risk that future actions by the Chinese government could significantly
affect the China-based operating company’s financial performance and the
enforceability of the VIE structure’s contractual arrangements. It is uncertain
whether Chinese officials or regulators will withdraw their implicit acceptance
of the VIE structure, or whether any new laws, rules or regulations relating to
this structure will be adopted (in each case either generally or with respect to
specific industries, sectors or companies) and, if adopted, what impact they
would have on the interests of investors in the VIE structure. Under extreme
circumstances, China could prohibit the existence of VIE structures or limit a
VIE structure’s ability to pass through economic and governance rights to
non-Chinese individuals and entities. If the Chinese government takes action
affecting VIE structures, the market value of a fund’s associated portfolio
holdings in VIE structures would likely suffer significant, detrimental, and
possibly permanent negative effects, which could result in substantial
investment losses to the fund.
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In addition, Chinese companies, including
China-based operating companies listed on U.S. exchanges through a VIE
structure, are not subject to the same degree of regulatory requirements,
accounting standards or auditor oversight as companies based in more developed
countries. As a result, information about the Chinese securities and securities
in the VIE structure in which a fund invests may be less reliable or complete
than investments in other securities. Investments involving a VIE structure may
also pose additional risks because such investments are made through a company
whose interests in the underlying China-based operating company are established
through contract rather than through equity ownership. For example, in the event
of a dispute, the contractual claims with respect to the China-based operating
company may be deemed unenforceable in the PRC, thus limiting (or eliminating)
the remedies and rights available to the VIE and its investors. Such legal
uncertainty may also be exploited against the interests of the investors in the
VIE structure. Further, the interests of the direct equity owners of the
China-based operating company may conflict with the interests of the investors
in the VIE structure, and the fiduciary duties of the officers and directors of
the China-based operating company may differ from, or conflict with, the
fiduciary duties of the officers and directors of the shell entity in which a
fund invests.
Quality of Fixed-Income
Investments refers to the quality
of the securities purchased by a fund. A fund considers investment-grade
securities those that have a Bloomberg Index Rating in one of the four highest
rating categories (within which there may be sub-categories or gradations
indicating relative standing) or have been determined to be of equivalent
quality by the investment adviser pursuant to procedures adopted by the
Board.
Securities
Lending of portfolio securities is
a common practice in the securities industry. A fund may engage in security
lending arrangements. When a fund is lending portfolio securities, the fund may
receive cash collateral and may invest it in short-term, interest-bearing
obligations, including cash collateral funds, but will do so only to the extent
that it will not lose the tax treatment available to regulated investment
companies. Lending portfolio securities involves risks that the borrower may
fail to return the securities or provide additional collateral. Also, voting
rights with respect to the loaned securities may pass with the lending of the
securities and efforts to recall such securities promptly may be unsuccessful,
especially for foreign securities. Securities lending involves the risk of loss
of rights in, or delay in recovery of, the loaned securities, if the borrower
fails to return the security loaned or becomes insolvent. A fund will also bear
the risk of any decline in value of securities acquired with cash
collateral.
A fund may loan portfolio securities to
qualified broker-dealers or other institutional investors provided: (1) the
loan is secured continuously by collateral consisting of U.S. government
securities, letters of credit, cash or cash equivalents or other permitted
instruments maintained on a daily marked-to-market basis in an amount at least
equal to the current market value of the securities loaned; (2) a fund may
at any time call the loan and obtain the return of the securities loaned;
(3) a fund will receive payments in lieu of any interest or dividends paid
on the loaned securities; and (4) the aggregate market value of securities
loaned will not at any time exceed one-third of the total assets of a fund,
including collateral received from the loan (at market value computed at the
time of the loan).
Although voting rights with respect to loaned
securities pass to the borrower, the lender retains the right to recall a
security (or terminate a loan) for the purpose of exercising the security’s
voting rights. Efforts to recall such securities promptly may be unsuccessful,
especially for foreign securities or thinly traded securities such as small-cap
stocks. In addition, because recalling a security may involve expenses to a
fund, it is expected that a fund will do so only where the items being voted
upon are, in the judgment of the investment adviser, either material to the
economic value of the security or threaten to materially impact the issuer’s
corporate governance policies or structure.
To the extent a fund participates in securities
lending under the current securities lending agreements with unaffiliated
lending agents, costs and expenses, including agent fees, associated with
securities lending activities under the securities lending program paid to the
unaffiliated lending agents start at 9% of gross lending revenue, with
subsequent breakpoints to a low of 5%. In this context, the gross lending
revenue equals the income received from the investment of cash collateral and
fees paid by borrowers less any rebates paid to borrowers. Any expenses charged
by the cash collateral fund are in addition to these fees. All remaining revenue
is retained by a fund, as applicable. No portion of the lending revenue is paid
to or retained by Schwab Asset Management or any affiliate of Schwab Asset
Management.
Securities of Other
Investment Companies. Investment
companies generally offer investors the advantages of diversification and
professional investment management, by combining shareholders’ money and
investing it in securities such as stocks, bonds and money market instruments.
Investment companies include: (1) open-end funds (for example mutual funds
or ETFs) that issue and redeem their shares on a continuous basis;
(2) closed-end funds that offer a fixed number of shares, and are usually
listed on an exchange; (3) UITs that generally offer a fixed number of
redeemable shares; and (4) money market funds that typically seek current
income by investing in money market securities (see the section titled “Money
Market Securities” for more information). Certain open-end funds, closed-end
funds and UITs are traded on exchanges.
To the extent a fund invests, or has invested,
in shares of other investment companies during its prior fiscal year, the fund,
pursuant to SEC rules, must disclose any material fees and expenses indirectly
incurred by the fund as a result of such investments. These indirect fees and
expenses, to the extent incurred, will appear in the fee table of a fund’s
prospectus as a separate line item captioned “Acquired fund fees and
expenses.”
Investment companies may make investments and
use techniques designed to enhance their performance. These may include
delayed-delivery and when-issued securities transactions; swap agreements;
buying and selling futures contracts, illiquid, and/or restricted securities and
repurchase agreements; and borrowing or lending money and/or portfolio
securities. The risks of investing in a particular investment company will
generally reflect the risks of the securities in which it invests and the
investment techniques it employs. Also, investment companies charge fees and
incur expenses.
13
The funds may buy securities of other investment
companies, including those of foreign issuers and money market funds, in
compliance with the requirements of federal law or any SEC exemptive order. A
fund may invest in investment companies that are not registered with the SEC or
privately placed securities of investment companies (which may or may not be
registered), such as unregistered money market funds. Unregistered funds are
largely exempt from the regulatory requirements that apply to registered
investment companies. As a result, unregistered funds may have a greater ability
to make investments, or use investment techniques, that offer a higher potential
investment return (for example, leveraging), but which may carry high risk.
Unregistered funds, while not regulated by the SEC like registered funds, may be
indirectly supervised by the financial institutions (e.g., commercial and
investment banks) that may provide them with loans or other sources of capital.
Investments in unregistered funds may be difficult to sell, which could cause a
fund selling an interest in an unregistered fund to lose money. For example,
many hedge funds require their investors to hold their investments for at least
one year.
Federal law restricts the ability of one
registered investment company to invest in another. As a result, the extent to
which a fund may invest in another investment company may be limited. Except as
described below, the 1940 Act currently requires that, as determined immediately
after a purchase is made, (i) not more than 5% of the value of a fund’s total
assets will be invested in the securities of any one acquired investment company
(acquired fund), (ii) not more than 10% of the value of its total assets will be
invested in the aggregate in securities of acquired funds as a group and (iii)
not more than 3% of the outstanding voting stock of any one acquired fund will
be owned by a fund.
The limitations described above do not apply to
investments in money market funds subject to certain conditions. The funds may
invest in affiliated and unaffiliated money market funds without limit under
Rule 12d1-1 under the 1940 Act subject to the fund’s investment policies and
restrictions and the conditions of the Rule.
Rule 12d1-4 allows a fund to acquire shares of
an acquired fund in excess of the limitations currently imposed by the 1940 Act.
Fund of funds arrangements relying on Rule 12d1-4 will be subject to several
conditions, certain of which are specific to a fund’s position in the
arrangement (i.e., as an acquiring or acquired fund). Notable conditions include
those relating to: (i) control and voting that prohibit an acquiring fund, its
investment adviser (or a subadviser) and their respective affiliates from
beneficially owning more than 25% of the outstanding voting securities of an
unaffiliated acquired fund; (ii) certain required findings relating to
complexity, fees and undue influence (among other things); (iii) fund of funds
investment agreements; and (iv) general limitations on an acquired fund’s
investments in other investment companies and private funds to no more than 10%
of the acquired fund’s assets, except in certain circumstances. To the extent a
fund is an acquired fund, the limitations placed on acquired funds under Rule
12d1-4 may impact the investments made by a fund.
U.S. Government
Securities are issued by the U.S.
Treasury or issued or guaranteed by the U.S. government or any of its agencies
or instrumentalities. Not all U.S. government securities are backed by the full
faith and credit of the U.S. government. Some U.S. government securities, such
as those issued by Fannie Mae, Freddie Mac, the Student Loan Marketing
Association (Sallie Mae) and the Federal Home Loan Banks (FHLB), are supported
by a line of credit the issuing entity has with the U.S. Treasury. Securities
issued by other issuers are supported solely by the credit of the issuing agency
or instrumentality such as obligations issued by the Federal Farm Credit Banks
Funding Corporation. There can be no assurance that the U.S. government will
provide financial support to U.S. government securities of its agencies and
instrumentalities if it is not obligated to do so under law. U.S. government
securities, including U.S. Treasury securities, are among the safest securities;
however, not unlike other debt securities, they are still sensitive to interest
rate changes, which will cause their yields and prices to fluctuate.
In September 2008, the Federal Housing
Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. As
the conservator, FHFA succeeded to all rights, titles, powers and privileges of
Fannie Mae and Freddie Mac and of any stockholder, officer or director of Fannie
Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of
Fannie Mae and Freddie Mac. In connection with the conservatorship, the U.S.
Treasury entered into a Senior Preferred Stock Purchase Agreement (SPA) with
each of Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury agreed to
purchase up to 1,000,000 shares of senior preferred stock with an aggregate
initial liquidation preference of $1 billion and obtained warrants and
options for the purchase of common stock of each of Fannie Mae and Freddie Mac.
Under the SPAs as currently amended, the U.S. Treasury has pledged to provide
financial support to a government-sponsored enterprise (GSE) in any quarter in
which the GSE has a net worth deficit as defined in the respective SPA. Under
the current arrangement, the GSEs have a maximum amount of funding available to
them which will be reduced by any future draws. There is a risk that if a GSE
experiences a loss in any fiscal quarter that results in the GSE having a
negative net worth that is greater than the amount available under the U.S.
Treasury’s funding commitment that the FHFA could place the GSE in receivership.
In addition, each GSE may only retain a certain amount of its profits at the end
of each fiscal quarter and the U.S. Treasury’s liquidation preference will
increase in an amount equal to any increase in a GSE’s net worth up to a certain
amount. The SPAs contain various covenants that severely limit each enterprise’s
operations.
Fannie Mae and Freddie Mac are continuing to
operate as going concerns while in conservatorship and each remain liable for
all of its obligations, including its guaranty obligations, associated with its
mortgage-backed securities. The SPAs are intended to enhance each of Fannie
Mae’s and Freddie Mac’s ability to meet its obligations. The FHFA has indicated
that the conservatorship of each enterprise will end when the director of the
FHFA determines that the FHFA’s plan to restore the enterprise to a safe and
solvent condition has been completed. Should Fannie Mae and Freddie Mac be taken
out of conservatorship, it is unclear whether the U.S. Treasury would continue
to enforce its rights or perform its obligations under the SPAs. It also is
unclear how the capital structure of Fannie Mae and Freddie Mac would be
constructed post-conservatorship, and what effects, if any, the privatization of
Fannie Mae and Freddie Mac will have on their creditworthiness and guarantees of
certain mortgage-backed securities. Accordingly, should the FHFA take Fannie Mae
and Freddie Mac out of conservatorship, there could be an adverse impact on the
value of their securities which could cause a fund’s investments to lose
value.
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A default by the U.S. government on a portfolio
investment could cause a fund’s share price or yield to fall. The risk of
default on U.S. government securities may be heightened when there is
uncertainty relating to negotiations in the U.S. Congress over increasing the
statutory debt ceiling. If the U.S. Congress is unable to negotiate an increase
to the statutory debt ceiling, the U.S. government may default on certain U.S.
government securities including those held by a fund, which could have an
adverse impact on a fund. In August 2011, the long-term credit rating of the
U.S. government was downgraded by a major rating agency as a result of concern
about the U.S. government’s budget deficit and rising debt burden. More
recently, in August 2023, another major rating agency downgraded the long-term
credit rating of the U.S. government due to a combination of expected fiscal
deterioration, a high and growing government debt burden and an erosion of
governance relative to peers. Similar downgrades in the future could increase
volatility in domestic and foreign financial markets, result in higher interest
rates, lower prices of U.S. Treasury securities and increase the costs of
different kinds of debt. It is possible that under certain scenarios the U.S.
government could default on its debt, including U.S. Treasury securities.
In accordance with recommendations made by the
Treasury Market Practices Group, to the extent a fund enters into transactions
involving U.S. Treasury securities, agency debt instruments issued by Fannie
Mae, Freddie Mac and the FHLB, and agency-pass-through MBS issued or guaranteed
by Fannie Mae, Freddie Mac and Ginnie Mae, the fund may pay “fails charges” to
or be owed “fails charges” from a counterparty, in connection with certain trade
settlement charges.
Non-Principal Investment Strategies
The following investments may be used as part of
each fund’s non-principal investment strategy:
Borrowing. A fund may borrow money from banks or through
the Schwab Funds interfund borrowing and lending facility (as described below)
for any purpose in an amount up to ⅓ of the fund’s total assets (not including
temporary borrowings). A fund may also borrow for temporary or emergency
purposes; for example, a fund may borrow at times to meet redemption requests
rather than sell portfolio securities to raise the necessary cash. A borrowing
is presumed to be for temporary or emergency purposes if it is (a) not in
excess of 5% of a fund’s total assets; (b) repaid by a fund within
60 days; and (c) not extended or renewed. Provisions of the 1940 Act,
require the funds to maintain continuous asset coverage (that is, total assets
including borrowings, less liabilities exclusive of borrowings) of 300% of the
amount borrowed, with an exception for temporary borrowings. If the 300% asset
coverage should decline as a result of market fluctuations or other reasons, the
funds may be required to sell some of its portfolio holdings within three days
(not including Sundays and holidays) to reduce the debt and restore the 300%
asset coverage, even though it may be disadvantageous from an investment
standpoint to sell securities at that time.
A fund’s borrowings will be subject to interest
costs. Borrowing can also involve leveraging when securities are purchased with
the borrowed money. Leveraging creates interest expenses that can exceed the
income from the assets purchased with the borrowed money. In addition,
leveraging may magnify changes in the NAV of a fund’s shares and in its
portfolio yield. A fund is required to comply with the asset coverage
requirements of the 1940 Act when it engages in borrowing activities. If assets
used to secure a borrowing decrease in value, a fund may be required to pledge
additional collateral to avoid liquidation of those assets.
A fund may also establish lines-of-credit
(lines) with certain banks by which it may borrow funds for temporary or
emergency purposes. A borrowing is presumed to be for temporary or emergency
purposes if it is repaid by a fund within 60 days and is not extended or
renewed. A fund may use the lines to meet large or unexpected redemptions that
would otherwise force the fund to liquidate securities under circumstances which
are unfavorable to the fund’s remaining shareholders. A fund will pay a fee to
the bank for using the lines.
Credit and Liquidity
Supports or enhancements may be
employed by issuers to reduce the credit risk of their securities. Credit
supports include letters of credit, insurance and guarantees provided by
domestic entities. Liquidity supports include puts, demand features, and lines
of credit. Most of these arrangements move the credit risk of an investment from
the issuer of the security to the support provider. Changes in the credit
quality of a support provider could cause losses to a fund.
Demand Features, which may include guarantees, are used to
shorten a security’s effective maturity and/or enhance its creditworthiness. If
a demand feature provider were to refuse to permit the feature’s exercise or
otherwise terminate its obligations with respect to such feature, however, the
security’s effective maturity may be lengthened substantially, and/or its credit
quality may be adversely impacted. In either event, a fund may experience an
increase in share price volatility. This also could lengthen a fund’s overall
average effective maturity.
Capital and Trust Preferred
Securities (Non-principal
investments of the Schwab 1-5 Year Corporate Bond ETF, the Schwab 5-10 Year
Corporate Bond ETF and the Schwab U.S. Aggregate Bond ETF only) Capital
securities are certain subordinated securities. Capital securities generally
rank senior to common stock and preferred stock in an issuer’s capital
structure, but have a lower security claim than the issuer’s corporate
bonds.
These securities often have characteristics of
both equity and debt securities. Capital securities are typically issued by
utilities, industrial companies, insurance companies, banking organizations and
other financial institutions and may be rated by NRSROs.
An issuer’s capital securities generally offer
higher yields than an issuer’s senior debt securities because they carry more
risks. The characteristics of capital securities vary. Some capital securities
declare dividends monthly or quarterly instead of making regularly scheduled
interest payments. Capital securities that make interest payments may have fixed
or variable interest rates. When a capital security provides for periodic
adjustments to its interest rate, fluctuations in principal value may be
minimized. However, changes in the coupon rate can lag behind changes in market
rates, which may adversely affect a fund’s performance. In addition, capital
securities have terms to maturity
15
that vary. For example, the term to maturity on
a capital security can be in excess of 30 years, or may have no specified
maturity date at all. In certain instances, a maturity date may be extended
and/or the final payment of principal may be deferred at the issuer’s option
(without declaring default) if the issuer experiences financial difficulties.
For example, insurance companies issue securities known as surplus notes that
permit the insurance company to defer any payment that would reduce its capital
below regulatory requirements. Also, payments may be suspended for some
stipulated period, usually up to five years. If the issuer defers payments,
the deferred income continues to accrue for tax purposes, even though the
investor does not receive cash payments. Many capital securities include a
“special event” redemption option, allowing the issuer to redeem the securities
at the liquidation value if a tax law change disallows the deductibility of
payments by the issuer’s parent company, or subjects the issue to taxation
separate from the parent company. Capital securities trade on the OTC markets,
although they may be listed on major exchanges as well. There are various types
of capital securities offered in the marketplace that include, but are not
limited to, direct subordinate fixed rate capital securities, and trust
preferred securities.
Some capital securities may include loss
absorption provisions that make the securities more like equity securities. This
is particularly true of securities issued by financial companies. Events in
global financial markets in recent periods have caused regulators to review the
function and structure of capital securities more closely. This may cause loss
absorption provisions to become much more prevalent.
In one version of a capital security with loss
absorption characteristics, the liquidation value of the security may be
adjusted downward to below the original par value under certain circumstances.
This may occur, for instance, in the event that business losses have eroded
capital to a substantial extent. The write down of the par value would occur
automatically and would not entitle the holders to seek bankruptcy of the
issuer. Such securities may provide for circumstances under which the
liquidation value may be adjusted back up to par value, such as an improvement
in capitalization and/or earnings.
Bank capital securities are issued by banking
organizations to help fulfill their regulatory capital requirements. Bank
capital is generally, but not always, of investment grade quality. A bank
capital security has to adhere to supervisory guidelines concerning its
characteristics such as amount, maturity, subordination and deferral language in
order to count as capital. Recent regulatory changes may impact the demand for
certain bank capital securities, including, in particular, bank capital
securities that are trust preferred securities. Capital securities may be
subject to additional changes in regulations and there can be no assurance that
the current regulatory treatment of capital securities will continue.
Trust preferred securities are issued by a
special purpose trust subsidiary backed by subordinated debt of the corporate
parent. Holders of the trust preferred securities have limited voting rights to
control the activities of the trust and no voting rights with respect to the
parent company. Trust preferred securities have characteristics similar to other
capital securities, such as maturity dates, at times in excess of 30 years,
or no specified maturity date. Dividend payments of the trust preferred
securities generally coincide with interest payments on the underlying
subordinated debt. Trust preferred securities may have a yield advantage over
traditional preferred stocks, but unlike preferred stocks, distributions are
treated as interest rather than dividends for federal income tax
purposes.
Trust preferred securities are subject to unique
risks, which include the fact that dividend payments will only be paid if
interest payments on the underlying obligations are made. In turn, interest
payments on the underlying obligations are dependent on the financial condition
of the parent corporation and may be deferred as noted above for up to
five years. There is also the risk that the underlying obligations, and
thus the trust preferred securities, may be prepaid after a stated call date or
as a result of certain tax or regulatory events, resulting in a lower yield to
maturity. The price of trust preferred securities may fluctuate for several
reasons including changes in investors’ perception of the financial condition of
an issuer, the general condition of the market for trust preferred securities,
and when political, regulatory or economic events affecting the issuers occur.
Trust preferred securities are also (a) sensitive to interest rate
fluctuations, as the cost of capital rises and borrowing costs increase in a
rising interest rate environment, and (b) subject to the risk that they may
be called for redemption in a falling interest rate environment. Recent
regulations require banking organizations to phase out trust preferred
securities under certain circumstances. As a result, a fund’s ability to invest
in trust preferred securities may be limited in the future.
Capital or trust preferred securities in which a
fund may invest will be denominated in U.S. dollars.
High-Yield Bonds (Non-principal investments of the Schwab 1-5
Year Corporate Bond ETF, the Schwab 5-10 Year Corporate Bond ETF and the Schwab
U.S. Aggregate Bond ETF only) The funds generally will not invest in debt
securities rated below investment-grade, which are sometimes referred to as
high-yield bonds or “junk bonds.” However, a fund may purchase and hold
high-yield bonds to the extent that the securities are included in the fund’s
benchmark index and may continue to hold high-yield bonds that were investment
grade bonds and included in the index at the time of acquisition, but which were
subsequently downgraded and removed from the index, if the adviser determines
that holding such securities is in the best interests of the fund.
High-yield bonds are frequently issued by
companies without long track records of sales and earnings, or by those of
questionable credit strength, and are more speculative and volatile (though
typically higher yielding) than investment grade bonds. Adverse economic
developments could disrupt the market for high-yield securities, and severely
affect the ability of issuers, especially highly-leveraged issuers, to service
their debt obligations or to repay their obligations upon maturity.
Also, the secondary market for high-yield
securities at times may not be as liquid as the secondary market for
higher-quality debt securities. As a result, the investment adviser could find
it difficult to sell these securities or experience difficulty in valuing
certain high-yield securities at certain times. Prices realized upon the sale of
such lower rated securities, under these circumstances, may be less than the
prices at which a fund purchased them.
16
High-yield securities are more likely to react
to developments affecting interest rates and market and credit risk than are
more highly rated securities, which primarily react to movements in the general
level of interest rates. When economic conditions appear to be deteriorating,
medium- to lower-quality debt securities may decline in value more than
higher-quality debt securities due to heightened concern over credit quality,
regardless of prevailing interest rates. Prices for high-yield securities also
could be affected by legislative and regulatory developments. These laws could
adversely affect a fund’s net asset value and investment practices, the
secondary market value for high-yield securities, the financial condition of
issuers of these securities and the value of outstanding high-yield
securities.
Illiquid Securities or
Investments means any investment
that a fund reasonably expects cannot be sold or disposed of in current market
conditions in seven calendar days or less without the sale or disposition
significantly changing the market value of the investment. The liquidity of a
fund’s investments is monitored under the supervision and direction of the Board
and is governed by the 1940 Act and rules promulgated thereunder, which provide
that a fund may not acquire any illiquid investments if, immediately after the
acquisition, the fund would have invested more than 15% of the fund’s net assets
in illiquid investments. Investments currently not considered liquid include,
among others, repurchase agreements not maturing within seven days that are not
subject to a demand feature of seven days or less and certain restricted
securities. Any investment may become illiquid at times of market
dislocation.
Interfund Borrowing and
Lending. A fund may borrow money
from and/or lend money to other funds in the Fund Complex as defined under
“Management of the Funds,” including traditional mutual funds not discussed in
this SAI or in the corresponding prospectus. All loans are for temporary or
emergency purposes and the interest rates to be charged will be the average of
the overnight repurchase agreement rate and the short-term bank loan rate. All
loans are subject to numerous conditions designed to ensure fair and equitable
treatment of all participating funds. These conditions include, for example,
that a fund’s participation in the credit facility must be consistent with its
investment policies and limitations and organizational documents; no fund may
lend to another fund through the interfund lending facility if the loan would
cause the aggregate outstanding loans through the credit facility to exceed 15%
of the lending fund’s current net assets at the time of the loan; and that a
fund’s interfund loans to any one fund shall not exceed 5% of the lending fund’s
net assets. With respect to the funds discussed in this SAI, a fund lending to
another fund may forego gains which could have been made had those assets been
invested in securities of its applicable underlying index. The interfund lending
facility is subject to the oversight and periodic review of the Board.
Money Market
Securities. The funds generally
keep a portion of their assets in cash for business operations. To reduce the
effect this otherwise uninvested cash would have on performance, a fund may
invest in money market securities. A fund may also invest in money market
securities to the extent it is consistent with its investment strategy. Money
market securities are high-quality, short term debt securities that may be
issued by entities such as the U.S. government, corporations and financial
institutions (like banks). Money market securities include commercial paper,
certificates of deposit, banker’s acceptances, notes and time deposits.
Certificates of deposit and time deposits are issued against funds deposited in
a banking institution for a specified period of time at a specified interest
rate. Banker’s acceptances are credit instruments evidencing a bank’s obligation
to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. Commercial paper consists of short term, unsecured
promissory notes issued to finance short term credit needs.
Money market securities pay fixed-, variable- or
floating-rates of interest and are generally subject to credit and interest rate
risks. The maturity date or price of and financial assets collateralizing a
security may be structured in order to make it qualify as or act like a money
market security. These securities may be subject to greater credit and interest
rate risks than other money market securities because of their structure. Money
market securities may be issued with puts or sold separately; these puts, which
are sometimes called demand features or guarantees, are agreements that allow
the buyer to sell a security at a specified price and time to the seller or “put
provider.” When a fund buys a put, losses could occur as a result of the costs
of the put or if it exercises its rights under the put and the put provider does
not perform as agreed. Standby commitments are types of puts.
Banker’s
Acceptances or Notes are credit
instruments evidencing a bank’s obligation to pay a draft drawn on it by a
customer. These instruments reflect the obligation both of the bank and of the
drawer to pay the full amount of the instrument upon maturity. A fund will
invest only in banker’s acceptances of banks that have capital, surplus and
undivided profits in the aggregate in excess of $100 million.
Certificates
of Deposit or Time Deposits are
issued against funds deposited in a banking institution for a specified period
of time at a specified interest rate. A fund will invest only in certificates of
deposit of banks that have capital, surplus and undivided profits, in the
aggregate, in excess of $100 million.
Commercial
Paper consists of short term,
promissory notes issued by banks, corporations and other institutions to finance
short-term credit needs. These securities generally are discounted but sometimes
may be interest bearing. Commercial paper, which also may be unsecured, is
subject to credit risk.
Fixed
Time Deposits are bank obligations
payable at a stated maturity date and bearing interest at a fixed rate. Fixed
time deposits may be withdrawn on demand by the investor, but may be subject to
early withdrawal penalties, which vary depending upon market conditions and the
remaining maturity of the obligation. There are no contractual restrictions on
the right to transfer a beneficial interest in a fixed time deposit to a third
party, although there is no market for such deposits. A fund will not invest in
fixed time deposits, that (1) are not subject to prepayment or (2) provide
for withdrawal penalties upon prepayment (other than overnight deposits) if, in
the aggregate, more than 15% of its net assets would be invested in such
deposits, repurchase agreements maturing in more than seven days and other
illiquid assets.
17
Promissory
Notes are written agreements
committing the maker or issuer to pay the payee a specified amount either on
demand or at a fixed date in the future, with or without interest. These are
sometimes called negotiable notes or instruments and are subject to credit risk.
Bank notes are notes used to represent obligations issued by banks in large
denominations.
Municipal
Securities (Non-principal
investments of the Schwab U.S. Aggregate Bond ETF only) are debt securities
issued by municipal issuers. Municipal issuers include states, counties,
municipalities, or other political subdivisions, and their agencies,
authorities, instrumentalities and public corporations. Municipal issuers may
also include issuers located in U.S. territories, commonwealths and possessions
and the District of Columbia, including their political subdivisions, agencies,
instrumentalities and public corporations. The Bloomberg US Aggregate Bond Index
includes taxable municipal securities including Build America Bonds.
Build
America Bonds offer an alternative
form of financing to state and local governments whose primary means for
accessing the capital markets has historically been through the issuance of
tax-free municipal bonds. The Build America Bond program allows state and local
governments to issue taxable bonds for capital projects and to receive direct
federal subsidy payment from the Treasury Department for a portion of their
borrowing costs. There are two types of Build America Bonds. The first type of
Build America Bond provides a federal subsidy through federal tax credits to
investors in the bonds in an amount equal to 35% of the total coupon interest
payable by the issuer on taxable governmental bonds (net of the tax credit),
which represents a federal subsidy of the state or local governmental issuer
equal to approximately 25% of the total return to the investor. The second type
provides a federal subsidy through a refundable tax credit paid to state or
local governmental issuers by the Treasury Department and the IRS in an amount
equal to 35% (or 45% in the case of Recovery Zone Economic Development Bonds) of
the total coupon interest payable to investors in these taxable bonds.
Issuance of Build America Bonds ceased on
December 31, 2010. Outstanding Build America Bonds will continue to be
eligible for the federal interest rate subsidy, which continues for the life of
the bonds. The fund may purchase and hold Build America Bonds and other taxable
municipal securities to the extent that such bonds are included in the fund’s
index.
Puts are agreements that allow the buyer to sell a
security at a specified price and time to the seller or “put provider.” When a
fund buys a security with a put feature, losses could occur if the put provider
does not perform as agreed. If a put provider fails to honor its commitment upon
a fund’s attempt to exercise the put, the fund may have to treat the security’s
final maturity as its effective maturity. If that occurs, the security’s price
may be negatively impacted, and its sensitivity to interest rate changes may be
increased, possibly contributing to increased share price volatility for a fund.
This also could lengthen a fund’s overall average effective maturity.
Repurchase
Agreements are instruments under
which a buyer acquires ownership of certain securities (usually U.S. government
securities) from a seller who agrees to repurchase the securities at a mutually
agreed-upon time and price, thereby determining the yield during the buyer’s
holding period. Any repurchase agreements a fund enters into will involve the
fund as the buyer and banks or broker-dealers as sellers. The period of
repurchase agreements is usually short, from overnight to one week, although the
securities collateralizing a repurchase agreement may have longer maturity
dates. Default by the seller might cause a fund to experience a loss or delay in
the liquidation of the collateral securing the repurchase agreement. A fund also
may incur disposition costs in liquidating the collateral. In the event of a
bankruptcy or other default of a repurchase agreement’s seller, a fund might
incur expenses in enforcing its rights, and could experience losses, including a
decline in the value of the underlying securities and loss of income. Certain
repurchase agreements a fund may enter into may or may not be subject to an
automatic stay in bankruptcy proceedings. A fund will make payment under a
repurchase agreement only upon physical delivery or evidence of book entry
transfer of the collateral to the account of its custodian bank. Repurchase
agreements are the economic equivalents of loans.
Restricted
Securities (Non-principal
investments of the Schwab 1-5 Year Corporate Bond ETF, the Schwab 5-10 Year
Corporate Bond ETF and the Schwab U.S. Aggregate Bond ETF only) are securities
that are subject to legal restrictions on their sale. Difficulty in selling
restricted securities may result in a loss or be costly to a fund. Restricted
securities generally can be sold in privately negotiated transactions, pursuant
to an exemption from registration under the Securities Act of 1933, as amended
(the 1933 Act), or in a registered public offering. Where registration is
required, the holder of a registered security may be obligated to pay all or
part of the registration expense and a considerable period may elapse between
the time it decides to seek registration and the time it may be permitted to
sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the holder might obtain a
less favorable price than prevailed when it decided to seek registration of the
security. Certain restricted securities, such as Section 4(a)(2) commercial
paper and Rule 144A securities, may be considered to be liquid if they meet
the criteria for liquidity established by the Board. To the extent a fund
invests in restricted securities that are deemed liquid, the general level of
illiquidity in the fund’s portfolio may be increased if such securities become
illiquid.
Sinking Funds (Non-principal investments of the Schwab 1-5
Year Corporate Bond ETF, the Schwab 5-10 Year Corporate Bond ETF and the Schwab
U.S. Aggregate Bond ETF only) may be established by bond issuers to set aside a
certain amount of money to cover timely repayment of bondholders’ principal
raised through a bond issuance. By creating a sinking fund, the issuer is able
to spread repayment of principal to numerous bondholders while reducing reliance
on its then current cash flows. A sinking fund also may allow the issuer to
annually repurchase certain of its outstanding bonds from the open market or
repurchase certain of its bonds at a call price named in a bond’s sinking fund
provision. This call provision will allow bonds to be prepaid or called prior to
a bond’s maturity.
Variable- and Floating-Rate
Debt Securities pay an interest
rate, which is adjusted either periodically or at specific intervals or which
floats continuously according to a formula or benchmark. Although these
structures generally are intended to minimize the fluctuations in value that
occur when interest rates rise and fall, some structures may be linked to a
benchmark in such a way as to cause greater volatility to the security’s
value.
18
Some variable-rate securities may be combined
with a put or demand feature (variable-rate demand securities) that entitles the
holder to the right to demand repayment in full or to resell at a specific price
and/or time. While the demand feature is intended to reduce credit risks, it is
not always unconditional and may be subject to termination if the issuer’s
credit rating falls below investment grade or if the issuer fails to make
payments on other debt. While most variable-rate demand securities allow a fund
to exercise its demand rights at any time, some such securities may only allow a
fund to exercise its demand rights at certain times, which reduces the liquidity
usually associated with this type of security. A fund could suffer losses in the
event that the demand feature provider, usually a bank, fails to meet its
obligation to pay the demand.
Variable- and floating-rate debt securities
generally are less sensitive to interest rate changes but may decline in value
if their interest rates do not rise as much, or as quickly, as interest rates in
general. Conversely, floating-rate debt securities will not generally increase
in value if interest rates decline. When a fund holds variable- or floating-rate
debt securities, a decrease in market interest rates will adversely affect the
income received from such securities, which may also impact the NAV of the
fund’s shares.
Certain variable- and floating-rate debt
securities are subject to rates that are tied to an interest rate. Some
instruments in which the funds have invested are or were tied to forms of the
London Interbank Offered Rate (LIBOR). LIBOR was the basic rate of interest used
in lending transactions between banks on the London interbank market and has
been widely used as a reference for setting the interest rate on loans globally.
As a result of benchmark reforms, publication of most LIBOR settings has ceased.
Some LIBOR settings continue to be published but only on a temporary, synthetic
and non-representative basis. All such synthetic LIBOR settings are expected to
be discontinued by September 30, 2024. When publication of applicable synthetic
LIBOR settings ceases, any still outstanding instruments or investments using
synthetic LIBOR settings are expected to transition to alternative floating rate
benchmarks. Regulated entities have generally ceased entering into new LIBOR
contracts in connection with regulatory requirements. As a result of legislative
mechanisms and industry-wide efforts to replace LIBOR with alternative
floating-rate benchmarks, LIBOR has been replaced with an alternative already in
many instruments. There is no assurance that any such alternative reference rate
will be similar to or produce the same value or economic equivalence as LIBOR or
that it will have the same volume or liquidity as did LIBOR prior to its
discontinuance, unavailability or replacement, all of which may affect the
value, volatility, liquidity or return on certain of the funds’ investments and
result in costs incurred in connection with changing reference rates used for
positions, closing out positions and entering into new trades. The transition
from LIBOR to alternative reference rates may result in operational issues for a
fund or its investments. No assurances can be given as to the impact of the
LIBOR transition (and the timing of any such impact) on a fund and its
investments. These risks may also apply with respect to changes in connection
with other interbank offering rates (e.g., Euribor) and a wide range of other
index levels, rates and values that are treated as “benchmarks” and are the
subject of recent regulatory reform.
Zero-Coupon, Step-Coupon, and
Pay-in-Kind Securities
(Non-principal investments of the Schwab 1-5 Year Corporate Bond ETF, the Schwab
5-10 Year Corporate Bond ETF and the Schwab U.S. Aggregate Bond ETF only) are
debt securities that do not make cash interest payments throughout the period
prior to maturity. Zero-coupon and step-coupon securities are sold at a deep
discount to their face value. A zero-coupon security pays no interest to its
holders during its life. Step-coupon securities are debt securities that,
instead of having a fixed coupon for the life of the security, have coupon or
interest payments that may increase or decrease to predetermined rates at future
dates. Some step-coupon securities are issued with no coupon payments at all
during an initial period, and only become interest-bearing at a future date;
these securities are sold at a deep discount to their face value. Pay-in-kind
securities pay interest through the issuance of additional securities. Because
such securities do not pay current cash income, the price of these securities
can be volatile when interest rates fluctuate. High-yield securities structured
as zero-coupon bonds or pay-in-kind securities tend to be especially volatile as
they are especially sensitive to downward pricing pressures from rising interest
rates and may require a fund to pay out imputed income without receiving the
actual cash delivery. Thus, these types of high yield investments increase the
chance that a fund may lose money. While these securities do not pay current
cash income, federal income tax law requires the holders of zero-coupon,
step-coupon, and pay-in-kind securities to include in income each year the
portion of the original issue discount (or deemed discount) and other non-cash
income on such securities accruing that year. In order to continue to qualify as
a “regulated investment company” or “RIC” under the Internal Revenue Code of
1986, as amended (the Internal Revenue Code) and avoid a certain excise tax, a
fund may be required to distribute a portion of such discount and income and may
be required to dispose of other portfolio securities, which may occur in periods
of adverse market prices, in order to generate cash to meet these distribution
requirements.
Additional Investment Information
Duration was developed as a more precise alternative to
the concept of “maturity.” Traditionally, a debt obligation’s maturity has been
used as a proxy for the sensitivity of the security’s price to changes in
interest rates (which is the “interest rate risk” or “volatility” of the
security). However, maturity measures only the time until a debt obligation
provides its final payment, taking no account of the pattern of the security’s
payments prior to maturity. In contrast, duration incorporates a bond’s yield,
coupon interest payments, final maturity, call and put features and prepayment
exposure into one measure. Duration is the magnitude of the change in the price
of a bond relative to a given change in market interest rates. Duration
management is one of the fundamental tools used by the investment
adviser.
Duration is a measure of the expected life of a
debt obligation on a present value basis. Duration takes the length of the time
intervals between the present time and the time that the interest and principal
payments are scheduled or, in the case of a callable bond, the time the
principal payments are expected to be received, and weights them by the present
values of the cash to be received at each future point in time. For debt
obligations with interest payments occurring prior to the payment of principal,
duration will usually be less than maturity. In general, all else being equal,
the lower the stated or coupon rate of the interest of a fixed-income security,
the higher the duration of the security; conversely, the higher the stated or
coupon rate of a fixed-income security, the lower the duration of the
security.
19
Holding long futures or call option positions
will increase the duration of a fund’s portfolio. Holding short futures or put
options will lower the duration of a fund’s portfolio.
A swap agreement on an asset or group of assets
may affect the duration of the portfolio depending on the attributes of the
swap. For example, if the swap agreement provides a fund with a floating rate of
return in exchange for a fixed rate of return, the duration of the fund would be
modified to reflect the duration attributes of a similar security that the fund
is permitted to buy.
The above discussion provides a general overview
of the concept of duration. Application and calculation of duration may be
slightly different or become more complex when applied to other types of debt
obligations, which may require different assessments to determine and/or
calculate duration. For example, for floating- and variable-rate securities the
interest rate exposure and duration correspond to the frequency of the coupon
reset. For mortgage-backed securities and certain asset-backed securities,
calculating duration requires projecting future interest rates and the
associated pace of repayment of the underlying instruments. Finally, the
duration of the debt obligation may vary over time in response to changes in
interest rates and other market factors.
Maturity of
Investments will generally be
determined using a portfolio security’s final maturity date (date on which the
final principal payment of a bond is scheduled to be paid); however, for
securitized products, such as mortgage-backed securities and certain other
asset-backed securities, maturity will be determined on an average life basis
(weighted average time to receipt of all principal payments) by the investment
adviser. Because pre-payment rates of individual mortgage pools vary widely, the
average life of a particular pool cannot be predicted precisely. For securities
with embedded demand features, such as puts or calls, either the demand date or
the final maturity date will be used depending on interest rates, yields and
other market conditions. The average portfolio maturity of a fund is
dollar-weighted based upon the market value of a fund’s securities at the time
of the calculation.
Investment Limitations
The investment limitations
below may be changed only by vote of a majority of the outstanding voting
securities of the applicable fund.
Under the 1940 Act, a “vote of a majority of the outstanding voting securities”
of a fund means the affirmative vote of the lesser of (1) more than 50% of
the outstanding shares of a fund or (2) 67% or more of the shares present
at a shareholders meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
Each fund may not:
(1)
Purchase securities of an issuer, except as
consistent with the maintenance of its status as an open-end diversified company
under the 1940 Act, the rules or regulations thereunder or any exemption
therefrom, as such statute, rules or regulations may be amended or interpreted
from time to time.
(2)
Concentrate investments in a particular industry
or group of industries, as concentration is defined under the 1940 Act, the
rules or regulations thereunder or any exemption therefrom, as such statute,
rules or regulations may be amended or interpreted from time to time, except
that each fund may concentrate its investments to approximately the same extent
that the index the fund is designed to track concentrates in the securities of a
particular industry or group of industries and each fund may invest without
limitation in (a) securities issued or guaranteed by the U.S. government,
its agencies or instrumentalities, and (b) tax-exempt obligations of state
or municipal governments and their political subdivisions.
(3)
Purchase or sell commodities, commodities
contracts or real estate, lend or borrow money, issue senior securities,
underwrite securities issued by others, or pledge, mortgage or hypothecate any
of its assets, except as permitted or not prohibited by the 1940 Act or the
rules or regulations thereunder or any exemption therefrom, as such statute,
rules or regulations may be amended or interpreted from time to time.
With respect to Schwab 1-5 Year Corporate Bond
ETF, Schwab 5-10 Year Corporate Bond ETF and Schwab Long-Term U.S. Treasury ETF
only:
Each fund may become “non-diversified,” as
defined in the 1940 Act, with respect to investments in an issuer or several
issuers to the extent necessary to approximate the composition of the index the
fund seeks to track to the extent permitted by law or regulatory relief.
The following descriptions of the 1940 Act may
assist investors in understanding the above policies and restrictions.
Borrowing. The 1940 Act restricts an investment company
from borrowing (including pledging, mortgaging or hypothecating assets) in
excess of 33 ⅓% of its total assets (not including temporary borrowings not
in excess of 5% of its total assets). Transactions that are entered into in
accordance with the conditions to applicable SEC requirements shall not be
regarded as borrowings for the purposes of a fund’s investment
restriction.
Concentration. The SEC has defined concentration as investing
more than 25% of an investment company’s total assets in an industry or group of
industries, with certain exceptions such as with respect to investments in
obligations issued or guaranteed by the U.S. government or its agencies and
instrumentalities, or tax-exempt obligations of state or municipal governments
and their political subdivisions.
Diversification. Under the 1940 Act and the rules, regulations
and interpretations thereunder, a “diversified company,” as to 75% of its total
assets, may not purchase securities of any issuer (other than obligations of, or
guaranteed by, the U.S. government or its agencies, or instrumentalities or
securities of other investment companies) if, as a result, more than 5% of its
total assets would be invested in the securities of such issuer, or more than
10% of the issuer’s voting securities would be held by a fund.
20
Lending. Under the 1940 Act, an investment company may
only make loans if expressly permitted by its investment policies.
Real
Estate. The 1940 Act does not
directly restrict an investment company’s ability to invest in real estate, but
does require that every investment company have a fundamental investment policy
governing such investments. Each fund has adopted a fundamental policy that
would permit direct investment in real estate. However, each fund has a
non-fundamental investment limitation that prohibits it from investing directly
in real estate. This non-fundamental policy may be changed only by vote of a
fund’s Board.
Senior
Securities. Senior securities may
include any obligation or instrument issued by an investment company evidencing
indebtedness. The 1940 Act generally prohibits a fund from issuing senior
securities, although it provides allowances for certain borrowings and certain
other investments, such as short sales, reverse repurchase agreements, and firm
commitment agreements, when such investments are entered into in accordance with
the conditions to applicable SEC requirements.
Underwriting. Under the 1940 Act, underwriting securities
involves an investment company purchasing securities directly from an issuer for
the purpose of selling (distributing) them or participating in any such activity
either directly or indirectly. Under the 1940 Act, a diversified fund may not
make any commitment as underwriter, if immediately thereafter the amount of its
outstanding underwriting commitments, plus the value of its investments in
securities of issuers (other than investment companies) of which it owns more
than 10% of the outstanding voting securities, exceeds 25% of the value of its
total assets.
The following are non-fundamental investment
policies and restrictions, and may be changed by the Board.
Each fund may not:
(1)
Sell securities short except as in accordance
with current SEC rules and interpretations.
(2)
Purchase securities on margin, except such short
term credits as may be necessary for the clearance of purchases and sales of
securities and provided that margin deposits in connection with futures
contracts, options on futures or other derivative instruments shall not
constitute purchasing securities on margin.
(3)
Borrow money, except that each fund (a) may
borrow money from banks or through an interfund lending facility, if any, and
engage in reverse repurchase agreements with any party provided that such
borrowings and reverse repurchase agreements in combination do not exceed
33 ⅓% of its total assets, including the amount borrowed (not including
temporary or emergency borrowings not exceeding 5% of the fund’s total assets);
and (b) may borrow an additional amount up to 5% of its assets for
temporary or emergency purposes.
(4)
Lend any security or make any other loan if, as
a result, more than 33 ⅓% of its total assets would be lent to other
parties (this restriction does not apply to purchases of debt securities or
repurchase agreements).
(5)
Purchase securities (other than securities
issued or guaranteed by the U.S. government, its agencies or instrumentalities
or tax-exempt obligations of state or municipal governments and their political
subdivisions) if, as a result of such purchase, 25% or more of the value of its
total assets would be invested in any industry or group of industries except
that each fund may concentrate its investments to approximately the same extent
that the index the fund is designed to track concentrates in the securities of a
particular industry or group of industries).
(6)
Purchase or sell physical commodities or
commodity contracts based on physical commodities or invest in unmarketable
interests in real estate limited partnerships or invest directly in real estate.
For the avoidance of doubt, the foregoing policy does not prevent a fund from,
among other things, (i) purchasing marketable securities of companies that
deal in real estate or interests therein (including REITs); (ii) purchasing
marketable securities of companies that deal in physical commodities or
interests therein; and (iii) purchasing, selling and entering into futures
contracts (including futures contracts on indices of securities, interest rates
and currencies), options on futures contracts (including futures contracts on
indices of securities, interest rates and currencies), warrants, swaps, forward
contracts, foreign currency spot and forward contracts or other derivative
instruments.
Policies and investment limitations that state a
maximum percentage of assets that may be invested in a security or other
asset, or that set forth a quality standard shall be measured immediately after
and as a result of a fund’s acquisition of such security or asset, unless
otherwise noted. Except with respect to limitations on borrowing and futures and
option contracts, any subsequent change in total assets or net assets, as
applicable, or other circumstances does not require a fund to sell an investment
if it could not then make the same investment.
CONTINUOUS OFFERING
The funds offer and issue shares at their NAV
only in aggregations of a specified number of shares (Creation Units). The
method by which Creation Units are created and trade may raise certain issues
under applicable securities laws. Because new Creation Units are issued and sold
by the funds on an ongoing basis, at any point a “distribution,” as such term is
used in the 1933 Act, may occur. Broker-dealers and other persons are cautioned
that some activities on their part may, depending on the circumstances, result
in their being deemed participants in a distribution in a manner that could
render them statutory underwriters and subject them to the prospectus delivery
requirement and liability provisions of the 1933 Act.
For example, a broker-dealer firm or its client
may be deemed a statutory underwriter if it takes Creation Units after placing
an order with the funds’ transfer agent, breaks them down into constituent
shares, and sells such shares directly to customers, or if it chooses to couple
the creation of a supply of new shares with an active selling effort involving
solicitation of secondary market demand for shares. A determination of
21
whether one is an underwriter for purposes of
the 1933 Act must take into account all the facts and circumstances pertaining
to the activities of the broker-dealer or its client in the particular case, and
the examples mentioned above should not be considered a complete description of
all the activities that could lead to categorization as an underwriter.
Broker-dealer firms should also note that
dealers who are not “underwriters” but are effecting transactions in shares,
whether or not participating in the distribution of shares, generally are
required to deliver a prospectus. This is because the prospectus delivery
exemption in Section 4(a)(3) of the 1933 Act is not available in respect of
such transactions as a result of Section 24(d) of the 1940 Act. Firms that
incur a prospectus delivery obligation with respect to shares of a fund are
reminded that, pursuant to Rule 153 under the 1933 Act, a prospectus
delivery obligation under Section 5(b)(2) of the 1933 Act owed to an
exchange member in connection with the sale on an exchange is satisfied by the
fact that the prospectus is available at the exchange upon request. The
prospectus delivery mechanism provided in Rule 153 is only available with
respect to transactions on an exchange.
MANAGEMENT OF THE FUNDS
The funds are overseen by a Board. The trustees
are responsible for protecting shareholder interests. The trustees regularly
meet to review the investment activities, contractual arrangements and the
investment performance of each fund. The trustees met five times during the most
recent fiscal year.
Certain trustees are “interested persons.” A
trustee is considered an interested person (Interested Trustee) of the Trust
under the 1940 Act if he or she is an officer, director, or an employee of
Schwab Asset Management. A trustee also may be considered an interested person
of the Trust under the 1940 Act if he or she owns stock of The Charles Schwab
Corporation (CSC), a publicly traded company and the parent company of Schwab
Asset Management.
As used herein, the terms “Fund Complex”
and “Family of Investment Companies” each refer collectively to The Charles
Schwab Family of Funds, Schwab Investments, Schwab Annuity Portfolios, Schwab
Capital Trust, Schwab Strategic Trust and Laudus Trust which, as of April 26,
2024, included 106 funds. As used herein, the term “Schwab Funds” refers
collectively to The Charles Schwab Family of Funds, Schwab Investments, Schwab
Annuity Portfolios and Schwab Capital Trust; and the term “Schwab ETFs” refers
to Schwab Strategic Trust.
Each of the officers and/or trustees serves in
the same capacity, unless otherwise noted, for The Charles Schwab Family of
Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios,
Schwab Strategic Trust and Laudus Trust. The tables below provide information
about the trustees and officers for the Trust, which includes the funds in this
SAI. The address of each individual listed below is 211 Main Street, San
Francisco, CA 94105.
| |
Name, Year of Birth, and Position(s) with
the Trust (Term of Office and Length of Time Served(1)) |
| |
Principal Occupations During the Past Five Years |
| |
Number of Portfolios in Fund Complex Overseen by the Trustee |
| |
Other Directorships During the Past Five Years |
|
| |
INDEPENDENT TRUSTEES |
| |||||||||
| | Michael J. Beer 1961 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2022) |
| | Retired. Director, President and Chief Executive Officer (Dec. 2016-Sept. 2019), Principal Funds (investment management). | | |
106 |
| | Director (2016‑2019), Principal Funds, Inc. |
|
| | Robert W. Burns 1959 Trustee (Trustee of Schwab Strategic Trust since 2009; The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios and Laudus Trust since 2016) |
| | Retired/Private Investor. | | |
106 |
| | None | |
| | Nancy F. Heller 1956 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2018) |
| | Retired. | | |
106 |
| | None | |
| | David L. Mahoney 1954 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios and Laudus Trust since 2011; Schwab Strategic Trust since 2016) |
| | Private Investor. | | |
106 |
| |
Director (2004‑present),
Corcept Therapeutics Incorporated Director (2009‑2021),
Adamas Pharmaceuticals, Inc. Director (2003‑2019), Symantec Corporation |
|
22
| |
Name, Year of Birth, and Position(s) with
the Trust (Term of Office and Length of Time Served(1)) |
| |
Principal Occupations During the Past Five Years |
| |
Number of Portfolios in Fund Complex Overseen by the Trustee |
| |
Other Directorships During the Past Five Years |
|
| |
INDEPENDENT TRUSTEES |
| |||||||||
| | Jane P. Moncreiff 1961 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2019) |
| | Consultant (2018-present), Fulham Advisers LLC (management consulting); Chief Investment Officer (2009-2017), CareGroup Healthcare System, Inc. (healthcare). | | |
106 |
| | None | |
| | Kimberly S. Patmore 1956 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2016) |
| | Consultant (2008-present), Patmore Management Consulting (management consulting). | | |
106 |
| | None | |
| | J. Derek Penn 1957 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2021) |
| | Head of Equity Sales and Trading (2006-2018), BNY Mellon (financial services). | | |
106 |
| | None | |
| |
INTERESTED TRUSTEES |
| |||||||||
| | Walter W. Bettinger II(2)
1960 Chairman and Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios since 2008; Schwab Strategic Trust since 2009; Laudus Trust since 2010) |
| | Co-Chairman of the Board (July 2022-present), Director and Chief Executive Officer (Oct. 2008-present) and President (Feb. 2007-Oct. 2021), The Charles Schwab Corporation; President and Chief Executive Officer (Oct. 2008-Oct. 2021) and Director (May 2008-Oct. 2021), Charles Schwab & Co., Inc.; Co-Chairman of the Board (July 2022-present) and Director (Apr. 2006-present), Charles Schwab Bank, SSB; Co-Chairman of the Board (July 2022-present) and Director (Nov. 2017-present), Charles Schwab Premier Bank, SSB; Co-Chairman of the Board (July 2022-present) and Director (July 2019-present), Charles Schwab Trust Bank; Director (May 2008-present), Chief Executive Officer (Aug. 2017-present) and President (Aug. 2017-Nov. 2021), Schwab Holdings, Inc.; Manager (Sept. 2023-present), TD Ameritrade Holding LLC; Director (Oct. 2020-Aug. 2023), TD Ameritrade Holding Corporation; Director (July 2016-Oct. 2021), Charles Schwab Investment Management, Inc. | | |
106 |
| | Director (2008‑present), The Charles Schwab Corporation |
|
| | Richard A. Wurster(2)
1973 Trustee (Trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2022) |
| | President (Oct. 2021-present) and Executive Vice President – Schwab Asset Management Solutions (Apr. 2019-Oct. 2021), The Charles Schwab Corporation; President, Director (Oct. 2021-present), Executive Vice President – Schwab Asset Management Solutions (July 2019-Oct. 2021) and Senior Vice President – Advisory (May 2016-July 2019), Charles Schwab & Co., Inc.; President (Nov. 2021-present), Schwab Holdings, Inc.; Director (Oct. 2021-present) and Chief Executive Officer (Nov. 2019-Jan. 2022), Charles Schwab Investment Management, Inc.; Director, Chief Executive Officer and President (Mar. 2018-Oct. 2022), Charles Schwab Investment Advisory, Inc.; Chief Executive Officer (July 2016-Apr. 2018) and President (Mar. 2017-Apr. 2018), ThomasPartners, Inc.; Chief Executive Officer (July 2016-Apr. 2018), Windhaven Investment Management, Inc. | | |
106 |
| | None | |
23
| |
Name, Year of Birth, and Position(s) with
the Trust (Term of Office and Length of Time Served(3)) |
| |
Principal Occupations During the Past
Five Years |
|
| |
OFFICERS |
| |||
| | Omar Aguilar 1970 Chief Executive Officer, President and Chief Investment Officer (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2011) |
| | Chief Executive Officer (Jan. 2022-present), President (Oct. 2023-present), Chief Investment Officer (Apr. 2011-present) and Senior Vice President (Apr. 2011-Jan. 2022), Charles Schwab Investment Management, Inc.; Director, Chief Executive Officer and President (Oct. 2022-present), Charles Schwab Investment Advisory, Inc.; Chief Executive Officer (Sept. 2023-present), President (Oct. 2023-present), Chief Investment Officer (June 2011-present) and Vice President (June 2011-Sept. 2023), Schwab Funds, Laudus Trust and Schwab ETFs. | |
| | Mark Fischer 1970 Chief Operating Officer (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2013) |
| | Chief Operating Officer (Dec. 2020-present) and Treasurer and Chief Financial Officer (Jan. 2016-Dec. 2022), Schwab Funds, Laudus Trust and Schwab ETFs; Chief Financial Officer (Mar. 2020-present), Chief Operating Officer (Oct. 2023-present), Managing Director (Mar. 2023-present) and Vice President (Oct. 2013-Mar. 2023), Charles Schwab Investment Management, Inc. | |
| | Dana Smith 1965 Treasurer and Chief Financial Officer (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2023) |
| | Treasurer and Chief Financial Officer (Jan. 2023-present) and Assistant Treasurer (Dec. 2015-Dec. 2022), Schwab Funds, Laudus Trust and Schwab ETFs; Managing Director (Mar. 2023-present), Vice President (Mar. 2022-Mar. 2023) and Director (Oct. 2015-Mar. 2022), Charles Schwab Investment Management, Inc.; Managing Director (May 2022-present) and Vice President (Apr. 2022-May 2022), Charles Schwab & Co., Inc. | |
| | Patrick Cassidy 1964 Vice President and Chief Investment Officer (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2018) |
| | Chief Investment Officer (Oct. 2023-present) and Vice President (Feb. 2018-present), Schwab Funds, Laudus Trust and Schwab ETFs; Managing Director (Mar. 2023-present), Chief Investment Officer (Oct. 2023-present), and Senior Vice President (Oct. 2012-Mar. 2023), Charles Schwab Investment Management, Inc. | |
| | William P. McMahon, Jr. 1972 Vice President and Chief Investment Officer (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios, Schwab Strategic Trust and Laudus Trust since 2021) |
| | Managing Director (Mar. 2023-present), Senior Vice President (Jan. 2020-Mar. 2023) and Chief Investment Officer (Jan. 2020-present), Charles Schwab Investment Management, Inc.; Vice President and Chief Investment Officer (June 2021-present), Schwab Funds, Laudus Trust and Schwab ETFs; Senior Vice President and Chief Investment Officer – ThomasPartners Strategies (Apr. 2018-Dec. 2019), Charles Schwab Investment Advisory, Inc.; Senior Vice President and Chief Investment Officer (May 2001-Apr. 2018), ThomasPartners, Inc. | |
| | Catherine MacGregor 1964 Chief Legal Officer and Secretary, Schwab Funds and Schwab ETFs Chief Legal Officer, Vice President and Clerk, Laudus Trust (Officer of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios and Laudus Trust since 2005; Schwab Strategic Trust since 2009) |
| | Chief Legal Officer (Mar. 2022-present), Managing Director (Mar. 2023-present) and Vice President (Sept. 2005-Mar. 2023), Charles Schwab Investment Management, Inc.; Managing Director (May 2022-present) and Vice President (Aug. 2005-May 2022), Charles Schwab & Co., Inc.; Vice President (Dec. 2005-present) and Chief Legal Officer and Clerk (Mar. 2007-present), Laudus Trust; Chief Legal Officer and Secretary (Oct. 2021-present), Vice President (Nov. 2005-Oct. 2021) and Assistant Secretary (June 2007-Oct. 2021), Schwab Funds; Chief Legal Officer and Secretary (Oct. 2021-present), Vice President and Assistant Secretary (Oct. 2009-Oct. 2021), Schwab ETFs. | |
(1)
Each Trustee shall hold office until the
election and qualification of his or her successor, or until he or she dies,
resigns or is removed. The retirement policy requires that each independent
trustee retire by December 31 of the year in which the Trustee turns 74 or
the Trustee’s twentieth year of service as an independent trustee on any trust
in the Fund Complex, whichever occurs first.
?
(2)
Mr. Bettinger and Mr. Wurster are Interested
Trustees. Mr. Bettinger and Mr. Wurster are Interested Trustees because each
owns stock of CSC, the parent company of Schwab Asset Management, the investment
adviser for the trusts in the Fund Complex, and is an employee of Charles Schwab
& Co., Inc., the principal underwriter for The Charles Schwab Family of
Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity Portfolios and
Laudus Trust.
?
(3)
The President, Treasurer and Secretary/Clerk
hold office until their respective successors are chosen and qualified or until
he or she sooner dies, resigns, is removed or becomes disqualified. Each of the
other officers serves at the pleasure of the Board.
Board Leadership Structure
The Chairman of the Board, Walter W. Bettinger
II, is Chief Executive Officer and a member of the Board of Directors of CSC and
an interested person of the Trust as that term is defined in the 1940 Act. The
Board is comprised of a super-majority (78 percent) of trustees who are not
interested persons of the Trust (i.e., independent trustees). There are three
primary committees of the Board: the Audit, Compliance and Valuation Committee;
the Governance Committee; and the Investment Oversight Committee. Each of the
Committees is chaired by an independent trustee, and each Committee is currently
comprised solely of independent trustees. The Committee chairs preside at
Committee meetings, participate in formulating agendas for those meetings, and
coordinate with management to serve as a liaison between the independent
trustees and management on matters within the scope of the responsibilities of
each Committee as set forth in its Board-approved charter. The independent
trustees meet regularly in executive session without management. While the Board
does not have single lead independent trustee, the chair of the Governance
Committee leads executive sessions held by the independent trustees and
coordinates responses from the independent trustees to management. The Board has
determined that this leadership structure is appropriate given the specific
characteristics and circumstances of the Trust. The Board made this
determination in consideration of, among other things, the fact that the
independent
24
trustees of the Trust constitute a
super-majority of the Board, the fact that Committee chairs are independent
trustees, the number of funds (and classes) overseen by the Board, and the total
number of trustees on the Board.
Board Oversight of Risk Management
Like most investment companies, fund management
and its other service providers have responsibility for day-to-day risk
management for the funds. The Board’s duties, as part of its risk oversight of
the Trust, consist of monitoring risks identified during regular and special
reports to the Committees of the Board, as well as regular and special reports
to the full Board. In addition to monitoring such risks, the Committees and the
Board oversee efforts of fund management and service providers to manage risks
to which the funds of the Trust may be exposed. For example, the Investment
Oversight Committee meets with portfolio managers and receives regular reports
regarding investment risk and credit risk of a fund’s portfolio. The Audit,
Compliance and Valuation Committee meets with the funds’ Chief Compliance
Officer and Chief Financial Officer and receives regular reports regarding
compliance risks, operational risks and risks related to the valuation and
liquidity of portfolio securities. From its review of these reports and
discussions with management, each Committee receives information about the
material risks of the funds of the Trust and about how management and service
providers mitigate those risks, enabling the independent Committee chairs and
other independent members of the Committees to discuss these risks with the full
Board.
The Board recognizes that not all risks that may
affect the funds can be identified nor can processes and controls be developed
to eliminate or mitigate the occurrence or effects of certain risks; some risks
are simply beyond the reasonable control of the funds, their management, and
service providers. Although the risk oversight functions of the Board, and the
risk management policies of fund management and fund service providers, are
designed to be effective, there is no guarantee that they will eliminate or
mitigate all risks. In addition, it may be necessary to bear certain risks (such
as investment-related risks) to achieve each fund’s investment objective. As a
result of the foregoing and other factors, the funds’ ability to manage risk is
subject to significant limitations.
Individual Trustee Qualifications
The Board has concluded that each of the
trustees should initially and continue to serve on the Board because of
(i) his or her ability to review and understand information about the Trust
provided to them by management, to identify and request other information they
may deem relevant to the performance of their duties, to question management
regarding material factors bearing on the management of the Trust, and to
exercise their business judgment in a manner that serves the best interests of
the Trust’s shareholders and (ii) the trustee’s experience, qualifications,
attributes or skills as described below.
The Board has concluded that Mr. Beer should
serve as trustee of the Trust because of the experience he gained serving as
director, president and chief executive officer of Principal Funds and his
knowledge and experience in the investment management industry.
The Board has concluded that Mr. Bettinger
should serve as trustee of the Trust because of the experience he gained as
president and chief executive officer of The Charles Schwab Corporation, his
knowledge of and experience in the financial services industry, and the
experience he has gained serving as trustee of the Schwab Funds since 2008, the
Schwab ETFs since 2009, and the Laudus Trust since 2010.
The Board has concluded that Mr. Burns
should serve as trustee of the Trust because of the experience he gained as
managing director of Pacific Investment Management Company, LLC (PIMCO) and
president of PIMCO Funds as well as the experience he has gained serving as
trustee of the Schwab ETFs since 2009, and the Schwab Funds and Laudus Trust
since 2016.
The Board has concluded that Ms. Heller
should serve as trustee of the Trust because of the experience she gained as
president of TIAA Charitable and as senior managing director at TIAA, the
experience she has gained serving on other non-public company boards, her
knowledge of and experience in the financial services industry, as well as the
experience she has gained serving as trustee of the Schwab Funds and Schwab ETFs
since 2018.
The Board has concluded that Mr. Mahoney
should serve as trustee of the Trust because of the experience he gained serving
as trustee of the Schwab Funds and Laudus Trust since 2011 and Schwab ETFs since
2016, as co-chief executive officer of McKesson Corporation, and his service on
other public company boards.
The Board has concluded that Ms. Moncreiff
should serve as trustee of the Trust because of the experience she gained as
chief investment officer of CareGroup Healthcare System, the experience she has
gained serving on other non-public company boards, her knowledge of and
experience in the financial services industry, as well as the experience she has
gained serving as trustee of the Schwab Funds and Schwab ETFs since 2019.
The Board has concluded that Ms. Patmore should
serve as trustee of the Trust because of the experience she gained serving as
chief financial officer and executive vice president of First Data Corporation,
her knowledge of and experience in management consulting, as well as the
experience she has gained serving as trustee of the Schwab Funds and Schwab ETFs
since 2016.
The Board has concluded that Mr. Penn should
serve as trustee of the Trust because of the experience he gained as head of
equity sales and trading of BNY Mellon and his knowledge of and experience in
the financial services industry, as well as the experience he has gained serving
as trustee of the Schwab Funds and Schwab ETFs since 2021.
25
The Board has concluded that Mr. Wurster should
serve as trustee of the Trust because of the experience he gained leading
investment advisory firms and organizations, including Schwab Asset Management,
and his knowledge of and experience in the investment management
industry.
Trustee Committees
The Board has established certain committees and
adopted Committee charters with respect to those committees, each as described
below:
●
The Audit, Compliance and Valuation Committee
reviews the integrity of the Trust’s financial reporting processes and
compliance policies, procedures and processes, and the Trust’s overall system of
internal controls. The Audit, Compliance and Valuation Committee also reviews
and evaluates the qualifications, independence and performance of the Trust’s
independent auditors, and the implementation and operation of the Trust’s
valuation policy and procedures. This Committee is comprised of at least three
independent trustees and currently has the following members: Kimberly S.
Patmore (Chair), Michael J. Beer and J. Derek Penn. The Committee met four times
during the most recent fiscal year.
●
The Governance Committee reviews and makes
recommendations to the Board regarding Trust governance-related matters,
including but not limited to Board compensation practices, retirement policies
and term limits, Board self-evaluations, the effectiveness and allocation of
assignments and functions by the Board, the composition of Committees of the
Board, and the training of trustees. The Governance Committee is responsible for
selecting and nominating candidates to serve as trustees. The Governance
Committee does not have a written policy with respect to consideration of
candidates for trustee submitted by shareholders. However, if the Governance
Committee determined that it would be in the best interests of the Trust to fill
a vacancy on the Board, and a shareholder submitted a candidate for
consideration by the Board to fill the vacancy, the Governance Committee would
evaluate that candidate in the same manner as it evaluates nominees identified
by the Governance Committee. Nominee recommendations may be submitted to the
Secretary of the Trust at the Trust’s principal business address. This Committee
is comprised of at least three independent trustees and currently has the
following members: David L. Mahoney (Chair), Robert W. Burns and Kimberly S.
Patmore. The Committee met four times during the most recent fiscal year.
●
The Investment Oversight Committee reviews the
investment activities of the Trust and the performance of the funds’ investment
adviser. This Committee is comprised of at least three trustees (at least
two-thirds of whom shall be independent trustees) and currently has the
following members: Jane P. Moncreiff (Chair), Robert W. Burns, Nancy F. Heller
and David L. Mahoney. The Committee met four times during the most recent fiscal
year.
Trustee Compensation
The following table provides trustee
compensation for the fiscal year ended December 31, 2023 earned with
respect to the funds in this SAI and the Fund Complex. Trustee compensation
for the funds is paid by Schwab Asset Management.
|
Name of Trustee |
| |
Aggregate Compensation from the Funds in this SAI |
| |
Pension or Retirement Benefits
Accrued as Part of Fund Expenses |
| |
Total Compensation from the Funds and Fund Complex Paid to Trustees |
| ||||||
|
INTERESTED TRUSTEES |
| |||||||||||||||
| Walter W. Bettinger II | | | | | None | | | |
N/A |
| | | | None | | |
| Richard A. Wurster | | | | | None | | | |
N/A |
| | | | None | | |
|
INDEPENDENT TRUSTEES |
| |||||||||||||||
| Michael J. Beer | | | | $ | 21,118 | | | |
N/A |
| | | $ | 345,000 | | |
| Robert W. Burns | | | | $ | 21,118 | | | |
N/A |
| | | $ | 345,000 | | |
| Nancy F. Heller | | | | $ | 21,118 | | | |
N/A |
| | | $ | 345,000 | | |
| David L. Mahoney | | | | $ | 22,648 | | | |
N/A |
| | | $ | 370,000 | | |
| Jane P. Moncreiff | | | | $ | 22,648 | | | |
N/A |
| | | $ | 370,000 | | |
| Kimberly S. Patmore | | | | $ | 22,648 | | | |
N/A |
| | | $ | 370,000 | | |
| J. Derek Penn | | | | $ | 21,118 | | | |
N/A |
| | | $ | 345,000 | | |
26
Securities Beneficially Owned by Each
Trustee
The following table provides each trustee’s
equity ownership of the funds and ownership of all registered investment
companies overseen by each trustee in the Family of Investment Companies as of
December 31, 2023.
|
Name of Trustee |
| |
Dollar Range of Trustee Ownership of the
Funds Included in the SAI |
| |
Aggregate Dollar Range of Trustee Ownership in the Family of Investment Companies |
| |||
|
INTERESTED TRUSTEES |
| |||||||||
| Walter W. Bettinger II | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
$10,001-$50,000 |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
$1-$10,000 |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| Richard A. Wurster | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
Over
$100,000 |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
|
INDEPENDENT TRUSTEES |
| |||||||||
| Michael J. Beer | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| Robert W. Burns | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
Over
$100,000 |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
Over
$100,000 |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
Over
$100,000 |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| Nancy F. Heller | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
$1-$10,000 |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
$1-$10,000 |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
27
|
Name of Trustee |
| |
Dollar Range of Trustee Ownership of the
Funds Included in the SAI |
| |
Aggregate Dollar Range of Trustee Ownership in the Family of Investment Companies |
| |||
|
INDEPENDENT TRUSTEES |
| |||||||||
| David L. Mahoney | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| Jane P. Moncreiff | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
$10,001-$50,000 |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
$10,001-$50,000 |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| Kimberly S. Patmore | | | | | | | | |
Over $100,000 |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
| J. Derek Penn | | | | | | | | |
None |
|
| | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
| | | |
| | | | Schwab U.S. TIPS ETF | | |
None |
| | | |
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
| | | |
| | | | Schwab Long-Term U.S. Treasury ETF | | |
None |
| | | |
As of December 31, 2023 none of the
independent trustees or their immediate family members owned beneficially or of
record any securities of Schwab Asset Management or Schwab or any subadvisers or
the distributor of the funds, or in a person (other than a registered investment
company) directly or indirectly controlling, controlled by or under common
control with Schwab Asset Management or Schwab or any subadvisers or the
distributor of the funds.
Code of Ethics
The funds, the investment adviser and the
distributor have adopted Codes of Ethics as required under the 1940 Act. Subject
to certain conditions or restrictions, the Codes of Ethics permit the trustees,
directors, officers or advisory representatives of the funds or the investment
adviser or the directors or officers of the distributor to buy or sell directly
or indirectly securities for their own accounts. This includes securities that
may be purchased or held by the funds. Securities transactions by some of these
individuals may be subject to prior approval of the investment adviser’s Chief
Compliance Officer or alternate. Most securities transactions are subject to
quarterly reporting and review requirements.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF
SECURITIES
As of March 28, 2024, the officers and
trustees of the Trust, as a group owned, of record or beneficially, less than 1%
of the outstanding voting securities of the funds.
28
Although the Trust does not have information
concerning the beneficial ownership of shares held in the names of DTC
participants, as of March 28, 2024, the name and percentage of
ownership of each DTC participant that owned of record 5% or more of the
outstanding voting securities of a fund were as follows (a shareholder’s or an
entity’s address will be listed once at the first mention and not repeated for
future entries):
|
Fund |
| |
Name and Address |
| |
Percentage of Ownership |
| ||||
|
Schwab 1-5 Year Corporate Bond ETF
|
| |
Charles Schwab & Co., Inc. 3000 Schwab Way Westlake, TX 76262 |
| | | | 76.25 | % | | |
| | National Financial Services LLC 200 Liberty Street One World Financial Centre 5th Floor New York, NY 10281‑1003 |
| | | | 5.60 | % | | | ||
| Schwab 5-10 Year Corporate Bond ETF | | | Charles Schwab & Co., Inc. | | | | | 89.29 | % | | |
|
Schwab U.S. Aggregate Bond ETF
|
| |
Charles Schwab & Co., Inc.
|
| | | | 63.70 | % | | |
| | Citibank N.A. 388 Greenwich Street 14th Floor New York, NY 10013 |
| | | | 19.90 | % | | | ||
|
Schwab U.S. TIPS ETF |
| |
Charles Schwab & Co., Inc.
|
| | | | 39.51 | % | | |
| | Pershing LLC 1 Pershing Plaza Jersey City, NJ 07399 |
| | | | 10.96 | % | | | ||
| | National Financial Services LLC | | | | | 10.17 | % | | | ||
| | The Bank of New York Mellon 111 Sanders Creek Parkway 2nd Floor East Syracuse, NY 13057 |
| | | | 6.80 | % | | | ||
| | Brown Brothers Harriman & Co./ETF
50 Post Office Sq. Boston, MA 02110 |
| | | | 5.73 | % | | | ||
|
Schwab Short-Term U.S. Treasury
ETF |
| |
Merrill Lynch, Pierce, Fenner & Smith
Incorporated/8862 MLPF&S 200 N College Street Charlotte, NC 28255 |
| | | | 34.87 | % | | |
| | Charles Schwab & Co., Inc. | | | | | 28.68 | % | | | ||
| | American Enterprise Investment Services
Inc. 5414 Ameriprise Financial Center Minneapolis, MN 55474 |
| | | | 8.57 | % | | | ||
| | National Financial Services LLC | | | | | 5.13 | % | | | ||
|
Schwab Intermediate-Term U.S. Treasury
ETF |
| |
Charles Schwab & Co., Inc.
|
| | | | 73.50 | % | | |
| | RBC Capital Markets, LLC 200 Vesey Street 5th Floor Three World Financial Center New York, NY 10281 |
| | | | 6.83 | % | | | ||
|
Schwab Long-Term U.S. Treasury ETF
|
| |
Charles Schwab & Co., Inc.
|
| | | | 50.25 | % | | |
| | National Financial Services LLC | | | | | 21.78 | % | | | ||
| | Merrill Lynch, Pierce, Fenner & Smith
Incorporated/8862 MLPF&S Boston, MA 02111 |
| | | | 13.26 | % | | | ||
Persons who beneficially own more than 25% of a
fund may be deemed to control the fund. As a result, it may not be possible for
matters subject to a vote of a majority of the outstanding voting securities of
such fund to be approved without the affirmative vote of such shareholder, and
it may be possible for such matters to be approved by such shareholder without
the affirmative vote of any other shareholder.
29
INVESTMENT ADVISORY AND OTHER SERVICES
Investment Adviser
Charles Schwab Investment Management, Inc., dba
Schwab Asset Management, a wholly owned subsidiary of CSC, 211 Main Street, San
Francisco, CA 94105, serves as the funds’ investment adviser pursuant to an
Amended and Restated Advisory Agreement (Advisory Agreement) between it and the
Trust. Charles R. Schwab is the founder, Chairman and Director of CSC. As a
result of his ownership of and interests in CSC, Mr. Schwab may be deemed to be
a controlling person of Schwab Asset Management.
Advisory Agreement
The continuation of a fund’s Advisory Agreement
must be specifically approved at least annually (1) by the vote of the
trustees or by a vote of the shareholders of the fund, and (2) by the vote
of a majority of the trustees who are not parties to the investment advisory
agreement or “interested persons” of any party (independent trustees), cast in
person, except to the extent permitted under the 1940 Act, the rules or
regulations thereunder or any exemption therefrom, at a meeting called for the
purpose of voting on such approval.
Each year, the Board calls and holds a meeting
to decide whether to renew the Advisory Agreement between the Trust and Schwab
Asset Management with respect to existing funds in the Trust. In preparation for
the meeting, the Board requests and reviews a wide variety of materials provided
by Schwab Asset Management, as well as extensive data provided by third parties,
and the independent trustees receive advice from counsel to the independent
trustees.
As described below, Schwab Asset Management is
entitled to receive a fee from each fund, payable monthly, for its advisory and
administrative services to each fund. As compensation for these services, Schwab
Asset Management receives a management fee from each fund, expressed as
a percentage of each fund’s average daily net assets.
|
Fund |
| |
Fee |
| |||
| Schwab 1-5 Year Corporate Bond ETF | | | | | 0.03%(1) | | |
| Schwab 5-10 Year Corporate Bond ETF | | | | | 0.03%(1) | | |
| Schwab U.S. Aggregate Bond ETF | | | | | 0.03%(1) | | |
| Schwab U.S. TIPS ETF | | | | | 0.03%(2) | | |
| Schwab Short-Term U.S. Treasury ETF | | | | | 0.03%(1) | | |
| Schwab Intermediate-Term U.S. Treasury ETF | | | | | 0.03%(1) | | |
| Schwab Long-Term U.S. Treasury ETF | | | | | 0.03%(1) | | |
(1)
Effective July 1, 2022, the management fee of
the fund was reduced from 0.04% to 0.03%. Prior to December 20, 2021, the
management fee of the Schwab 1-5 Year Corporate Bond ETF, Schwab 5-10 Year
Corporate Bond ETF, Schwab Short-Term U.S. Treasury ETF, Schwab
Intermediate-Term U. S. Treasury ETF and Schwab Long-Term U.S. Treasury ETF was
0.05%.
?
(2)
Effective July 1, 2022, the management fee of
the fund was reduced from 0.05% to 0.04% and effective September 25, 2023, the
management fee of the fund was reduced from 0.04% to 0.03%.
The following table shows the net investment
advisory fees paid by each fund for the past three fiscal years.
|
Fund |
| |
2023 |
| |
2022 |
| |
2021 |
|
| Schwab 1-5 Year Corporate Bond ETF | | |
$112,381 |
| |
$139,110 |
| |
$257,649 |
|
| Schwab 5-10 Year Corporate Bond ETF | | |
$1,193,990 |
| |
$135,688 |
| |
$173,695 |
|
| Schwab U.S. Aggregate Bond ETF | | |
$2,115,296 |
| |
$2,679,264 |
| |
$3,585,705 |
|
| Schwab U.S. TIPS ETF | | |
$4,604,229 |
| |
$7,706,240 |
| |
$9,122,496 |
|
| Schwab Short-Term U.S. Treasury ETF | | |
$3,852,335 |
| |
$3,146,855 |
| |
$4,267,836 |
|
| Schwab Intermediate-Term U.S. Treasury ETF | | |
$2,237,471 |
| |
$2,183,806 |
| |
$1,863,825 |
|
| Schwab Long-Term U.S. Treasury ETF | | |
$101,381 |
| |
$34,566 |
| |
$43,674 |
|
Pursuant to the Advisory Agreement, Schwab Asset
Management pays the operating expenses of the funds, including the cost of
transfer agency, custody, fund administration, legal, audit and other services,
but excluding taxes, brokerage expenses and extraordinary or non-routine
expenses.
Distributor
SEI Investments Distribution Co. (the
Distributor), 1 Freedom Valley Drive, Oaks, PA 19456, is the principal
underwriter and distributor of shares of the funds. The Distributor has entered
into an agreement with the Trust pursuant to which it distributes shares of the
funds (the Distribution Agreement). The Distributor continually distributes
shares of the funds on a best effort basis. The Distributor has no obligation to
sell any specific quantity of fund shares. The Distribution Agreement will
continue for two years from its effective date and is renewable annually
30
thereafter in accordance with the 1940 Act.
Shares are continuously offered for sale by the funds through the Distributor
only in Creation Units, as described in the funds’ prospectus. Shares in less
than Creation Units are not distributed by the Distributor. The Distributor is a
broker-dealer registered under the Securities Exchange Act of 1934, as amended
(the 1934 Act) and a member of the Financial Industry Regulatory Authority. The
Distributor is not affiliated with the Trust, Schwab Asset Management, or any
stock exchange.
The Distribution Agreement provides that it may
be terminated at any time, without the payment of any penalty, on at least sixty
(60) days prior written notice to the other party. The Distribution Agreement
will terminate automatically in the event of its “assignment” (as defined in
the 1940 Act).
Payments to Financial Intermediaries
Schwab Asset Management and its affiliates make
payments to certain broker-dealers, banks, trust companies, insurance companies,
retirement plan service providers, consultants and other financial
intermediaries (Intermediaries) for services and expenses incurred in connection
with certain activities or services which may educate financial advisors or
facilitate, directly or indirectly, investment in the funds and other investment
companies advised by Schwab Asset Management, including the Schwab ETFs. These
payments are made by Schwab Asset Management or its affiliates at their own
expense, and not from the assets of the funds. Although a portion of Schwab
Asset Management’s and its affiliates’ revenue comes directly or indirectly in
part from fees paid by the funds, these payments do not increase the expenses
paid by investors for the purchase of fund shares, or the cost of owning a
fund.
These payments may relate to educational efforts
regarding the funds, or for other activities, such as marketing and/or fund
promotion activities and presentations, educational training programs,
conferences, data analytics and support, or the development and support of
technology platforms and/or reporting systems. In addition, Schwab Asset
Management or its affiliates make payments to certain Intermediaries that make
shares of the funds available to their customers or otherwise promote the funds,
which may include Intermediaries that allow customers to buy and sell fund
shares without paying a commission or other transaction charge. Payments of this
type are sometimes referred to as revenue-sharing or marketing support.
Payments made to Intermediaries may be
significant and may cause an Intermediary to make decisions about which
investment options it will recommend or make available to its clients or what
services to provide for various products based on payments it receives or is
eligible to receive. As a result, these payments could create conflicts of
interest between an Intermediary and its clients and these financial incentives
may cause the Intermediary to recommend the funds over other investments.
As of April 26, 2024, Schwab Asset Management
anticipates that Ascensus, LLC, Envestnet Asset Management, Inc., Fidelity
Brokerage Services LLC/National Financial Services LLC, Empower Annuity
Insurance Company of America, Minnesota Life Insurance Company, Morgan Stanley
Smith Barney LLC, Principal Life Insurance Company and Teachers Insurance
and Annuity Association of America will receive these payments. Schwab Asset
Management may enter into similar agreements with other FINRA member firms (or
their affiliates) in the future. In addition to member firms of FINRA, Schwab
Asset Management and its affiliates may also make these payments to certain
other financial intermediaries, such as banks, trust companies, insurance
companies, and plan administrators and consultants that sell fund shares or
provide services to the funds and their shareholders. These firms may not be
included in this list. You should ask your financial intermediary if it receives
such payments.
Schwab Asset Management also makes payments to
Charles Schwab & Co., Inc. (Schwab) for certain administrative, professional
and support services provided by Schwab, in its capacity as an affiliated
financial intermediary of the funds. These payments reimburse Schwab for its
charges, costs and expenses of providing Schwab personnel to perform marketing
and sales activities under the direction of Schwab Asset Management, such as
sales lead generation and sales support, assistance with public relations,
marketing and/or advertising activities and presentations, educational training
programs, conferences, and data analytics and support. Payments also are made by
Schwab Asset Management to Schwab for Schwab Asset Management’s allocated costs
of general corporate services provided by Schwab, such as human resources,
facilities, project management support and technology.
Transfer Agent
State Street Bank and Trust Company (State
Street), One Congress Street, Suite 1, Boston, MA 02114, serves as the funds’
transfer agent. As part of these services, the firm maintains records pertaining
to the sale, redemption and transfer of the funds’ shares.
The transfer agent is also responsible for the
order-taking function for the funds’ shares.
Custodian and Fund Accountant
State Street, One Congress Street, Suite 1,
Boston, MA 02114, serves as custodian and accountant for the funds.
The custodian is responsible for the daily
safekeeping of securities and cash held by the funds. The funds’ accountant
maintains all books and records related to the funds’ transactions.
31
Independent Registered Public Accounting
Firm
The funds’ independent registered public
accounting firm, Deloitte & Touche LLP (Deloitte), 1601 Wewatta Street,
Suite 400, Denver, CO 80202, audits and reports on the annual financial
statements of the funds and reviews certain regulatory reports. Deloitte or one
of its affiliates also reviews each fund’s federal income tax returns and
performs other professional, accounting, auditing, tax and advisory services
when engaged to do so by the Trust.
Securities Lending Activities
The funds’ securities lending agent is Goldman
Sachs Bank USA (d/b/a Goldman Sachs Agency Lending). The securities lending
agent provides services to the funds which include the following: locating
borrowers, negotiating the loan terms, monitoring the value of loans and
collateral on a daily basis, marking each loan to market on a daily basis,
coordinating collateral movements, collecting income, monitoring and processing
corporate actions, managing recalls of loaned securities and termination of
loans, and recordkeeping.
The table below summarizes key information
regarding the funds’ securities lending activities to the extent each fund
engaged in securities lending during the most recent fiscal year.
| | | |
Schwab 1-5 Year Corporate Bond ETF |
| |
Schwab 5-10 Year Corporate Bond ETF |
| |
Schwab U.S. Aggregate Bond ETF |
| |||||||||
| Gross income from securities lending activities | | | | $ | 7,476 | | | | | $ | 912,772 | | | | | $ | 217,638 | | |
| Fees and/or compensation paid for securities lending activities and related services: | | | | | | | | | | | | | | | | | | | |
|
Fees
paid to securities lending agent from a revenue split |
| | | $ | 182 | | | | | $ | 27,063 | | | | | $ | 5,745 | | |
|
Fees paid for any cash collateral
management service (including fees deducted from a pooled cash
collateral reinvestment vehicle) that are not included in a revenue split |
| | | $ | 155 | | | | | $ | 19,604 | | | | | $ | 4,919 | | |
|
Administrative fees not included in
revenue split |
| | | | — | | | | | | — | | | | | | — | | |
|
Indemnification fees not included in
revenue split |
| | | | — | | | | | | — | | | | | | — | | |
|
Rebates (paid to borrower) |
| | | $ | 3,925 | | | | | $ | 408,628 | | | | | $ | 115,621 | | |
|
Other fees not included in revenue
split |
| | | | — | | | | | | — | | | | | | — | | |
| Aggregate fees/compensation paid for securities lending activities | | | | $ | 4,262 | | | | | $ | 455,295 | | | | | $ | 126,285 | | |
|
Net income from
securities lending activities(1)
|
| | | $ | 3,214 | | | | | $ | 457,477 | | | | | $ | 91,353 | | |
(1)
“Net income from securities
lending activities” may not match the fund’s current financial statements, which
may reflect certain accrual adjustments.
PORTFOLIO MANAGERS
Other Accounts. In addition to the funds, each portfolio
manager (collectively referred to as the Portfolio Managers) is responsible for
the day-to-day management of certain other accounts, as listed below. The
accounts listed below are not subject to a performance-based advisory fee. The
information below is provided as of December 31, 2023.
| | | |
Registered Investment Companies (this amount does not include the funds in this SAI) |
| |
Other Pooled Investment Vehicles
|
| |
Other Accounts |
| |||||||||||||||||||||||||||
|
Name |
| |
Number of Accounts |
| |
Total Assets |
| |
Number of Accounts |
| |
Total Assets |
| |
Number of Accounts |
| |
Total Assets |
| ||||||||||||||||||
|
Matthew Hastings |
| | | | 5 | | | | | $ | 8,864,585,757 | | | | | | 0 | | | | | $ | 0 | | | | | | 0 | | | | | $ | 0 | | |
| Steven Hung | | | | | 3 | | | | | $ | 6,267,765,684 | | | | | | 0 | | | | | $ | 0 | | | | | | 0 | | | | | $ | 0 | | |
| Mark McKissick | | | | | 3 | | | | | $ | 8,534,724,540 | | | | | | 0 | | | | | $ | 0 | | | | | | 0 | | | | | $ | 0 | | |
|
Alfonso Portillo, Jr. |
| | | | 1 | | | | | $ | 4,450,368,097 | | | | | | 0 | | | | | $ | 0 | | | | | | 0 | | | | | $ | 0 | | |
Conflicts of
Interest. A Portfolio Manager’s
management of other accounts may give rise to potential conflicts of interest in
connection with its management of the funds’ investments, on the one hand, and
the investments of the other accounts, on the other. These other accounts may
include separate accounts and other mutual funds and ETFs advised by Schwab
Asset Management (collectively, the Other Managed Accounts). The Other Managed
Accounts might have similar investment objectives as the funds, track the same
index the funds track or otherwise hold, purchase, or sell securities that are
eligible to be held, purchased, or sold by the funds. While the Portfolio
Managers’ management of Other Managed Accounts may give rise to the potential
conflicts of interest listed below, Schwab Asset Management does not believe
that the conflicts, if any, are material or, to the extent any such conflicts
are material, Schwab Asset Management believes it has adopted policies and
procedures that are designed to manage those conflicts in an appropriate
way.
Knowledge
of the Timing and Size of Fund Trades. A potential conflict of interest may arise as a
result of the Portfolio Managers’ day-to-day management of the funds. Because of
their positions with the funds, the Portfolio Managers know the size, timing,
and possible market impact of fund trades. It is theoretically possible that the
Portfolio Managers could use this information to the advantage of the Other
Managed Accounts they manage and to the possible detriment of a fund. However,
Schwab Asset Management has adopted policies and procedures
32
reasonably designed to allocate investment
opportunities on a fair and equitable basis over time. Moreover, with respect to
an index fund, which seeks to track its index, much of this information is
publicly available. When it is determined to be in the best interest of both
accounts, the Portfolio Managers may aggregate trade orders for the Other
Managed Accounts, excluding separate accounts, with those of a fund. All
aggregated orders are subject to Schwab Asset Management’s aggregation and
allocation policy and procedures, which provide, among other things, that (i) a
Portfolio Manager will not aggregate orders unless he or she believes such
aggregation is consistent with his or her duty to seek best execution; (ii) no
account will be favored over any other account; (iii) each account that
participates in an aggregated order will participate at the average security
price with all transaction costs shared on a pro-rata basis; and (iv) if the
aggregated order cannot be executed in full, the partial execution is allocated
pro-rata among the participating accounts in accordance with the size of each
account’s order.
Investment
Opportunities. A potential conflict
of interest may arise as a result of the Portfolio Managers’ management of a
fund and Other Managed Accounts which, in theory, may allow them to allocate
investment opportunities in a way that favors the Other Managed Accounts over a
fund, which conflict of interest may be exacerbated to the extent that Schwab
Asset Management or the Portfolio Managers receive, or expect to receive,
greater compensation from their management of the Other Managed Accounts than
the fund. Notwithstanding this theoretical conflict of interest, it is Schwab
Asset Management’s policy to manage each account based on its investment
objectives and related restrictions and, as discussed above, Schwab Asset
Management has adopted policies and procedures reasonably designed to allocate
investment opportunities on a fair and equitable basis over time and in a manner
consistent with each account’s investment objectives and related restrictions.
For example, while the Portfolio Managers may buy for an Other Managed Account
securities that differ in identity or quantity from securities bought for a fund
or refrain from purchasing securities for an Other Managed Account that they are
otherwise buying for a fund in an effort to outperform its specific benchmark,
such an approach might not be suitable for a fund given its investment
objectives and related restrictions.
Compensation. During the most recent fiscal year, Portfolio
Manager compensation consisted of a fixed annual (base) salary and a
discretionary bonus. Portfolio Managers also have the potential to participate
in discretionary equity awards. The base salary is determined considering
compensation payable for a similar position across the investment management
industry and an evaluation of the individual Portfolio Manager’s overall
performance such as the Portfolio Manager’s contribution to the investment
process, good corporate citizenship, risk management and mitigation, and
functioning as an active contributor to the firm’s success. The discretionary
bonus is determined in accordance with the relevant Portfolio Manager Incentive
Plan (the Plan) as follows:
There are two independent funding components for
the Plan:
●
a portion based on weighting of Investment
Fund Performance and Other Managed Account Performance (if
applicable)
●
a portion based on corporate results
Investment Fund Performance
At the close of the year, each fund’s
performance will be determined by its 1-year, 1- and 2-year, or 1- and 3-year
percentile standing (based on pre-tax return before expenses) within its
designated benchmark, peer group, or category, depending on the strategy of the
fund (i.e., whether the fund is passively or actively managed) using standard
statistical methods approved by Schwab Asset Management senior management.
Investment Fund Performance measurements may be changed or modified at the
discretion of the Schwab Asset Management President and Schwab Asset Management
Chief Operating Officer. As each participant may be a member of a team that
manages and/or supports a number of funds, there may be several funds and/or
Other Managed Accounts considered in arriving at the incentive compensation
funding.
Portfolio Managers who are chief investment
officers of the investment adviser are covered by a Plan that specifically
includes a risk mitigation component in the funding determination.
Certain Portfolio Managers receive a
discretionary bonus that is funded based only on corporate results.
Corporate Performance
The Corporate Bonus Plan is an annual bonus plan
that provides discretionary awards based on the financial performance of CSC
during the annual performance period. Quarterly advances may be paid for the
first three quarters. Allocations are discretionary and aligned with CSC and
individual performance. Funding for the Plan is determined at the conclusion of
the calendar year. Funding will be capped at 200% of target.
Allocation of Discretionary Bonus
At year-end, funding for both components of
discretionary bonus is allocated to Plan participants by Schwab Asset Management
senior management based on their assessment of a variety of performance
factors.
Factors considered in Schwab Asset Management
senior management’s allocation process will include objective and subjective
factors that will take into consideration total performance and will include,
but are not limited to:
●
Fund performance relative to performance
measure
●
Risk management and mitigation
●
Individual performance against key
objectives
●
Contribution to overall group results
33
●
Functioning as an active contributor to the
firm’s success
●
Team work
●
Collaboration between Analysts and Portfolio
Managers
●
Regulatory/Compliance management
The Portfolio Managers’ compensation is neither
based on the value of the assets held in a fund’s portfolio or any Other Managed
Account, nor flows into a fund’s portfolio or any Other Managed Account.
Ownership of
Fund Shares. The following
table shows the dollar amount range of the Portfolio Managers’ “beneficial
ownership” of shares of the funds they managed as of December 31, 2023.
Dollar amount ranges disclosed are established by the SEC. “Beneficial
ownership” is determined in accordance with Rule 16a-1(a)(2) under the 1934
Act.
|
Portfolio Manager |
| |
Fund |
| |
Dollar Range of Fund Shares Owned |
|
| Matthew Hastings | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
|
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
|
| | | | Schwab U.S. Aggregate Bond ETF | | |
None |
|
| | | | Schwab U.S. TIPS ETF | | |
None |
|
| | | | Schwab Short-Term U.S. Treasury ETF | | |
None |
|
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
None |
|
| | | | Schwab Long-Term U.S. Treasury ETF | | |
$10,001-$50,000 |
|
| Steven Hung | | | Schwab 1-5 Year Corporate Bond ETF | | |
None |
|
| | | | Schwab 5-10 Year Corporate Bond ETF | | |
None |
|
| | | | Schwab U.S. Aggregate Bond ETF | | |
$1-$10,000 |
|
| Mark McKissick | | | Schwab U.S. Aggregate Bond ETF | | |
None |
|
| | | | Schwab U.S. TIPS ETF | | |
None |
|
| | | | Schwab Short-Term U.S. Treasury ETF | | |
$10,001-$50,000 |
|
| | | | Schwab Intermediate-Term U.S. Treasury ETF | | |
$10,001-$50,000 |
|
| | | | Schwab Long-Term U.S. Treasury ETF | | |
$1-$10,000 |
|
| Alfonso Portillo, Jr. | | | Schwab U.S. Aggregate Bond ETF | | |
$1-$10,000 |
|
BROKERAGE ALLOCATION AND OTHER PRACTICES
Portfolio Turnover
For reporting purposes, a fund’s portfolio
turnover rate is calculated by dividing the value of purchases or sales of
portfolio securities for the fiscal year, whichever is less, by the monthly
average value of portfolio securities the fund owned during the fiscal year.
When making the calculation, all securities whose maturities at the time of
acquisition were one year or less (short-term securities) are excluded.
Securities received or delivered in the processing of in-kind creation or
redemption baskets are excluded from the calculation.
A 100% portfolio turnover rate would occur, for
example, if all portfolio securities (aside from short-term securities) were
sold and either repurchased or replaced once during the fiscal year.
Typically, funds with high turnover (such as
100% or more) tend to generate higher capital gains and transaction costs, such
as brokerage commissions. The Schwab U.S. Aggregate Bond ETF participates in
rolling to-be-announced (TBA) transactions on a regular basis as it tracks the
portion of the index represented by mortgage-backed securities. This may result
in a higher portfolio turnover for the fund than a typical index fund.
The following table shows the portfolio turnover
rate for each fund for the past two fiscal years.
|
Fund |
| |
2023 |
| |
2022 |
| |||||||
| Schwab 1-5 Year Corporate Bond ETF | | | | | 28%(2) | | | | | | 14 | % | | |
| Schwab 5-10 Year Corporate Bond ETF | | | | | 24%(3) | | | | | | 10 | % | | |
| Schwab U.S. Aggregate Bond ETF(1) | | | | | 63% | | | | | | 53 | % | | |
| Schwab U.S. TIPS ETF | | | | | 26% | | | | | | 18 | % | | |
| Schwab Short-Term U.S. Treasury ETF | | | | | 81% | | | | | | 106 | % | | |
34
|
Fund |
| |
2023 |
| |
2022 |
| |||||||
| Schwab Intermediate-Term U.S. Treasury ETF | | | | | 56%(4) | | | | | | 88 | % | | |
| Schwab Long-Term U.S. Treasury ETF | | | | | 35% | | | | | | 41 | % | | |
(1)
Includes to-be-announced (TBA)
transactions.
?
(2)
The fund experienced increased portfolio
turnover as a result of higher transactions in fund shares and index turnover,
driven by index rebalances/annual reconstitution and corporate actions.
?
(3)
The fund experienced increased portfolio
turnover as a result of higher transactions in fund shares and index turnover,
driven by index rebalances/annual reconstitution, corporate actions and
increases in assets and volatility during the year.
?
(4)
The Portfolio Management team
of the fund completed a series of tax loss harvesting trades this year that
resulted in decreased portfolio turnover compared to the prior year.
Portfolio Transactions
The investment adviser makes decisions with
respect to the purchase and sale of portfolio securities on behalf of the funds.
The investment adviser is responsible for implementing these decisions,
including the negotiation of commissions and the allocation of principal
business and portfolio brokerage. The funds generally do not incur any
commissions or sales charges when they invest in underlying Schwab Funds, but
they may incur such costs if they invest directly in other types of securities
or in unaffiliated funds. Purchases and sales of securities on a stock exchange,
including ETF shares, or certain riskless principal transactions placed on
NASDAQ are typically effected through brokers who charge a commission for their
services. Exchange fees may also apply to transactions effected on an exchange.
Purchases and sales of fixed-income securities may be transacted with the
issuer, the issuer’s underwriter, or a dealer. The funds do not usually pay
brokerage commissions on purchases and sales of fixed-income securities,
although the price of the securities generally includes compensation, in the
form of a spread or a mark-up or mark-down, which is not disclosed separately.
The prices the funds pay to underwriters of newly-issued securities usually
include a commission paid by the issuer to the underwriter. Transactions placed
through dealers who are serving as primary market makers reflect the spread
between the bid and asked prices. The money market securities in which the funds
may invest are traded primarily in the over-the-counter market on a net basis
and do not normally involve either brokerage commissions or transfer taxes. It
is expected that the cost of executing portfolio securities transactions of the
funds will primarily consist of dealer spreads and brokerage commissions.
The investment adviser seeks to obtain the best
execution for the funds’ portfolio transactions. The investment adviser may take
a number of factors into account in selecting brokers or dealers to execute
these transactions. Such factors may include, without limitation, the following:
execution price; brokerage commission or dealer spread; size or type of the
transaction; nature or character of the markets; clearance or settlement
capability; reputation; financial strength and stability of the broker or
dealer; efficiency of execution and error resolution; block trading
capabilities; willingness to execute related or unrelated difficult transactions
in the future; order of call; ability to facilitate short selling; and provision
of additional brokerage or research services or products; whether a broker
guarantees that a fund will receive, on aggregate, prices at least as favorable
as the closing prices on a given day when adherence to “market-on-close” pricing
aligns with fund objectives; or whether a broker guarantees that a fund will
receive the volume weighted average price (VWAP) for a security for a given
trading day (or portion thereof) when the investment adviser believes that VWAP
execution is in the fund’s best interest. In addition, the investment adviser
may have incentive sharing arrangements with certain unaffiliated brokers who
guarantee market-on-close pricing: on a day when such a broker executes
transactions at prices better, on aggregate, than market-on-close prices, that
broker may receive, in addition to his or her standard commission, a portion of
the net difference between the actual execution prices and corresponding
market-on-close prices for that day.
The investment adviser may cause the funds to
pay a higher commission than otherwise obtainable from other brokers or dealers
in return for brokerage or research services or products if the investment
adviser believes that such commission is reasonable in relation to the services
provided. In addition to agency transactions, the investment adviser may receive
brokerage and research services or products in connection with certain riskless
principal transactions, in accordance with applicable SEC and other regulatory
guidelines. In both instances, these services or products may include: economic,
industry, or company research reports or investment recommendations;
subscriptions to financial publications or research data compilations;
compilations of securities prices, earnings, dividends, and similar data;
computerized databases; quotation equipment and services; research or analytical
computer software and services; products or services that assist in effecting
transactions, including services of third-party computer systems developers
directly related to research and brokerage activities; and effecting securities
transactions and performing functions incidental thereto (such as clearance and
settlement). The investment adviser may use research services furnished by
brokers or dealers in servicing all fund accounts, and not all services may
necessarily be used in connection with the account that paid commissions or
spreads to the broker or dealer providing such services.
The investment adviser may receive a service
from a broker or dealer that has both a “research” and a “non-research” use.
When this occurs, the investment adviser will make a good faith allocation,
under all the circumstances, between the research and non-research uses of the
service. The percentage of the service that is used for research purposes
may be paid for with fund commissions or spreads, while the investment adviser
will use its own funds to pay for the percentage of the service that is
used for non-research purposes. In making this good faith allocation, the
investment adviser faces a potential conflict of interest, but the investment
adviser believes that the costs of such services may be appropriately allocated
to their anticipated research and non-research uses.
The investment adviser may purchase new issues
of securities in a fixed price offering for the funds. In these situations, the
seller may be a member of the selling group that will, in addition to selling
securities, provide the investment adviser with research services, in accordance
with applicable rules and regulations permitting these types of arrangements.
Generally, the seller will provide research “credits” in these situations at a
rate that is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of
Section 28(e) of the 1934 Act.
35
The investment adviser may place orders directly
with electronic communications networks or other alternative trading systems.
Placing orders with electronic communications networks or other alternative
trading systems may enable the funds to trade directly with other institutional
holders. At times, this may allow the funds to trade larger blocks than would be
possible trading through a single market maker.
The investment adviser may aggregate securities
sales or purchases among two or more funds. The investment adviser will not
aggregate transactions unless it believes such aggregation is consistent with
its duty to seek best execution for each affected fund and is consistent with
the terms of the investment advisory agreement for such fund. In any single
transaction in which purchases and/or sales of securities of any issuer for the
account of a fund are aggregated with other accounts managed by the investment
adviser, the actual prices applicable to the transaction will be averaged among
the accounts for which the transaction is effected, including the account of the
fund.
In determining when and to what extent to use
Schwab or any other affiliated broker-dealer as its broker for executing orders
for the funds on securities exchanges, the investment adviser follows
procedures, adopted by the funds’ Board, that are designed to ensure that
affiliated brokerage commissions (if relevant) are reasonable and fair in
comparison to unaffiliated brokerage commissions for comparable transactions.
The Board reviews the procedures annually and approves and reviews transactions
involving affiliated brokers quarterly.
Brokerage Commissions
During the last three fiscal years, the funds
paid no brokerage commissions.
Regular Broker-Dealers
During the fiscal year, certain of the funds
held securities issued by their respective “regular broker-dealers” (as defined
in Rule 10b-1 under the 1940 Act), indicated below as of December 31,
2023.
|
Fund |
| |
Regular Broker-Dealer |
| |
Value of Holdings(1) |
| |||
|
Schwab 1‑5 Year Corporate Bond ETF |
| | BofA Securities, Inc. | | | | $ | 13,092,971 | | |
| | Morgan Stanley & Co. LLC | | | | $ | 9,435,197 | | | ||
| | Goldman Sachs & Co. LLC | | | | $ | 8,079,447 | | | ||
| | Barclays Capital Inc. | | | | $ | 3,859,506 | | | ||
| | Charles Schwab & Co., Inc. | | | | $ | 1,593,040 | | | ||
| | Jefferies LLC | | | | $ | 379,066 | | | ||
|
Schwab 5‑10 Year Corporate Bond ETF |
| | BofA Securities, Inc. | | | | $ | 167,831,731 | | |
| | Citigroup Global Markets Inc. | | | | $ | 106,439,575 | | | ||
| | Wells Fargo Securities, LLC | | | | $ | 96,090,959 | | | ||
| | Goldman Sachs & Co. LLC | | | | $ | 66,859,618 | | | ||
| | Barclays Capital Inc. | | | | $ | 43,172,474 | | | ||
| | Charles Schwab & Co., Inc. | | | | $ | 23,592,628 | | | ||
| | Deutsche Bank Securities Inc. | | | | $ | 19,758,207 | | | ||
| | RBC Capital Markets, LLC | | | | $ | 15,445,495 | | | ||
| | BMO Capital Markets Corp. | | | | $ | 3,295,479 | | | ||
|
Schwab U.S. Aggregate Bond ETF |
| | J.P. Morgan Securities LLC | | | | $ | 47,501,967 | | |
| | Citigroup Global Markets Inc. | | | | $ | 39,996,339 | | | ||
| | Morgan Stanley & Co. LLC | | | | $ | 38,701,643 | | | ||
| | Goldman Sachs & Co. LLC | | | | $ | 31,038,198 | | | ||
| | Barclays Capital Inc. | | | | $ | 12,655,087 | | | ||
| | Charles Schwab & Co., Inc. | | | | $ | 5,182,535 | | | ||
| | BMO Capital Markets Corp. | | | | $ | 4,560,428 | | | ||
| | Nomura Securities International, Inc. | | | | $ | 4,441,908 | | | ||
| Schwab U.S. TIPS ETF | | | None | | | | | N/A | | |
|
Schwab Short‑Term U.S. Treasury ETF |
| | None | | | | | N/A | | |
|
Schwab Intermediate‑Term U.S.
Treasury ETF |
| | None | | | | | N/A | | |
|
Schwab Long‑Term U.S. Treasury ETF |
| | None | | | | | N/A | | |
(1)
Includes securities issued by
regular broker-dealer’s parent and affiliates, if any.
36
PROXY VOTING
The Board has delegated the responsibility for
voting proxies to Schwab Asset Management, pursuant to the investment adviser’s
Proxy Voting Policy with respect to proxies voted on behalf of the various
Schwab Funds’ portfolios. A description of such Proxy Voting Policy is included
in Appendix – Proxy Voting Policy.
The Trust is required to disclose annually a
fund’s complete proxy voting record on Form N-PX. A fund’s proxy voting record
for the most recent 12-month period ended June 30th is available by
visiting the Schwab ETFs’ website at www.schwabassetmanagement.com/schwabetfs_prospectus. A fund’s Form N-PX will also be available on
the SEC’s website at www.sec.gov.
PORTFOLIO HOLDINGS DISCLOSURE
For this section only, the following disclosure
relates to The Charles Schwab Family of Funds, Schwab Investments, Schwab
Annuity Portfolios, Schwab Capital Trust, Schwab Strategic Trust and Laudus
Trust (collectively, the Trusts) and each series thereunder (each a fund and
collectively, the funds).
The Trusts’ Board has approved policies and
procedures that govern the timing and circumstances regarding the disclosure of
fund portfolio holdings information to shareholders and third parties. These
policies and procedures are designed to ensure that disclosure of information
regarding the funds’ portfolio securities is in the best interests of fund
shareholders, and include procedures to address conflicts between the interests
of the funds’ shareholders, on the one hand, and those of the funds’ investment
adviser, subadviser (if applicable), principal underwriter or any affiliated
person of a fund, its investment adviser, subadviser or principal underwriter,
on the other. Pursuant to such procedures, the Board has authorized one of the
Chief Executive Officer, President, Chief Operating Officer or Chief Financial
Officer of the Trusts (in consultation with a fund’s subadviser, if applicable)
to authorize the release of the funds’ portfolio holdings prior to regular
public disclosure (as outlined in the prospectus and below) or regular public
filings, as necessary, in conformity with the foregoing principles.
The Board exercises on-going oversight of the
disclosure of fund portfolio holdings by overseeing the implementation and
enforcement of the funds’ policies and procedures by the Chief Compliance
Officer and by considering reports and recommendations by the Chief Compliance
Officer concerning any material compliance matters. The Board will receive
periodic updates, at least annually, regarding entities which were authorized to
be provided “early disclosure” of the funds’ portfolio holdings information and
will periodically review any agreements that the Trusts have entered into to
selectively disclose portfolio holdings.
Portfolio holdings may be made available on a
selective basis to ratings agencies, certain industry organizations, consultants
and other qualified financial professionals when the appropriate officer of the
Trusts determines such disclosure meets the requirements noted above and serves
a legitimate business purpose. Agreements entered into with such entities will
describe the permitted use of portfolio holdings and provide that, among other
customary confidentiality provisions: (i) the portfolio holdings will be
kept confidential; (ii) the person will not trade on the basis of any
material non-public information; and (iii) the information will be used
only for the purpose described in the agreement.
The funds’ service providers including, without
limitation, the investment adviser, subadvisers (if applicable), the
distributor, the custodian, fund accountant, transfer agent, certain affiliates
of the investment adviser, counsel, auditor, proxy voting service provider,
pricing information vendors, trade execution measurement vendors, portfolio
management system providers, cloud database providers, securities lending
agents, publisher, printer and mailing agent may receive disclosure of portfolio
holdings information as frequently as daily in connection with the services they
perform for the funds. Schwab Asset Management, any subadviser to a fund as
disclosed in the most current prospectus, Glass, Lewis & Co., LLC, State
Street, Citibank, N.A. and/or Brown Brothers Harriman & Co., as service
providers to the funds, are currently receiving this information on a daily
basis. Donnelley Financial Solutions, as a service provider to the funds, is
currently receiving this information on a quarterly basis. Deloitte, the
Transfer Agent, and the Distributor, as service providers to the funds, receive
this information on an as-needed basis. Service providers are subject to a duty
of confidentiality with respect to any portfolio holdings information they
receive whether imposed by the confidentiality provisions of the service
providers’ agreements with the Trusts or by the nature of its relationship with
the Trusts. Although certain of the service providers are not under formal
confidentiality obligations in connection with disclosure of portfolio holdings,
a fund will not continue to conduct business with a service provider who the
fund believes is misusing the disclosed information.
To the extent that a fund invests in an
unaffiliated acquired fund, the Trusts will, when required by Rule 12d1-4,
promptly notify the acquired fund, upon causing a fund to acquire more than 3%
of the acquired fund’s outstanding shares.
The funds’ policies and procedures prohibit the
funds, the funds’ investment adviser or any related party from receiving any
compensation or other consideration in connection with the disclosure of
portfolio holdings information.
Generally, a complete list of a fund’s portfolio
holdings is published on the fund’s website www.schwabassetmanagement.com on the
“Prospectus & Reports” tab under “Portfolio Holdings” generally
60-80 days after a fund’s fiscal quarter-end in-line with regulatory
filings unless a different timing is outlined in the fund’s prospectus.
Specifically for the Schwab ETFs (other than the
Schwab Ariel ESG ETF), each Schwab ETF discloses its portfolio holdings each
business day on its website before the opening of regular trading on the ETF’s
primary listing exchange in accordance with the requirements of Rule 6c-11 under
the 1940 Act. Portfolio holdings information made available in connection with
the process of purchasing or redeeming Creation Units for the Schwab ETFs may be
provided to other entities that provided services to the funds in the ordinary
course of business after it has been disseminated to the NSCC.
37
The Schwab Money Funds have an ongoing
arrangement to make available information about the funds’ portfolio holdings
and information derived from the funds’ portfolio holdings to iMoneyNet, a
rating and ranking organization, which is subject to a confidentiality
agreement. Under its arrangement with the funds, iMoneyNet, among other things,
receives information concerning the funds’ net assets, yields, maturities and
portfolio compositions on a weekly basis, subject to a one business day
lag.
On the website, the funds also may provide, on a
monthly or quarterly basis, information regarding certain attributes of a fund’s
portfolio, such as a fund’s top ten holdings, sector weightings, composition,
credit quality and duration and maturity, as applicable. This information is
generally updated within 5-25 days after the end of the period. This
information on the website is publicly available to all categories of
persons.
The funds may disclose non-material information
including commentary and aggregate information about the characteristics of a
fund in connection with or relating to a fund or its portfolio securities to any
person if such disclosure is for a legitimate business purpose, such disclosure
does not effectively result in the disclosure of the complete portfolio
securities of any fund (which can only be disclosed in accordance with the above
requirements), and such information does not constitute material non-public
information. Such disclosure does not fall within the portfolio securities
disclosure requirements outlined above.
Whether the information constitutes material
non-public information will be made on a good faith determination, which
involves an assessment of the particular facts and circumstances. In most cases,
commentary or analysis would be immaterial and would not convey any advantage to
a recipient in making a decision concerning a fund. Commentary and analysis
include, but are not limited to, the allocation of a fund’s portfolio securities
and other investments among various asset classes, sectors, industries,
countries or other relevant category, the characteristics of the stock
components and other investments of a fund, the attribution of fund returns by
asset class, sector, industry, country or other relevant category, and the
volatility characteristics of a fund.
DESCRIPTION OF THE TRUST
Each fund is a series of Schwab Strategic Trust,
an open-end investment management company organized as a Delaware statutory
trust on January 27, 2009.
The Declaration of Trust provides for the
perpetual existence of the Trust. The Trust may, however, be terminated at any
time by vote of at least two-thirds of the outstanding shares of each series of
the Trust or by the vote of the trustees.
Shareholders are entitled to one vote for each
full share held (with fractional votes for fractional shares held) and will vote
(to the extent provided on the Declaration of Trust) in the election of trustees
and the termination of the Trust and on other matters submitted to the vote of
shareholders. Shareholders will vote by individual series on all matters except
(i) when required by the 1940 Act, shares shall be voted in the aggregate
and not by individual series and (ii) when the trustees have determined
that the matter affects only the interests of one or more series, then only
shareholders of such series shall be entitled to vote thereon. Shareholders of
one series shall not be entitled to vote on matters exclusively affecting
another series, such matters including, without limitation, the adoption of or
change in any fundamental policies or restrictions of the other series and the
approval of the investment advisory contracts of the other series.
There will normally be no meetings of
shareholders for the purpose of electing trustees, except that in accordance
with the 1940 Act (i) the Trust will hold a shareholders’ meeting for the
election of trustees at such time as less than a majority of the trustees
holding office have been elected by shareholders, and (ii) if, as a result
of a vacancy in the Board, less than two-thirds of the trustees holding office
have been elected by the shareholders, that vacancy may only be filled by a vote
of the shareholders. In addition, trustees may be removed from office by a
written consent signed by the holders of two-thirds of the outstanding shares
and filed with the Trust’s custodian or by a vote of the holders of two-thirds
of the outstanding shares at a meeting duly called for the purpose, which
meeting shall be held upon the written request of the holders of not less than
10% of the outstanding shares. Except as set forth above, the trustees shall
continue to hold office and may appoint successor trustees. Voting rights are
not cumulative.
The Trust may, without shareholder vote,
restate, amend or otherwise supplement the Declaration of Trust. Shareholders
shall have the right to vote on any amendment that could affect their right to
vote, any amendment to the Amendments section, any amendment for which
shareholder vote may be required by applicable law or by the Trust’s
registration statement filed with the SEC, and on any amendment submitted to
them by the trustees.
Any series of the Trust may reorganize or merge
with one or more other series of the Trust or another investment company. Any
such reorganization or merger shall be pursuant to the terms and conditions
specified in an agreement and plan of reorganization authorized and approved by
the trustees and entered into by the relevant series in connection therewith. In
addition, such reorganization or merger may be authorized by vote of a majority
of the trustees then in office and, to the extent permitted by applicable law,
without the approval of shareholders of any series.
Shareholders wishing to submit proposals for
inclusion in a proxy statement for a future shareholder meeting should send
their written submissions to the Trust at 1 Freedom Valley Drive, Oaks, PA
19456. Proposals must be received a reasonable time in advance of a proxy
solicitation to be included. Submission of a proposal does not guarantee
inclusion in a proxy statement because proposals must comply with certain
federal securities regulations.
38
PURCHASE, REDEMPTION AND PRICING OF
SHARES
Creation and Redemption of Creation Units
The funds are open each day that the New York
Stock Exchange (NYSE) is open (Business Days). The NYSE’s trading session is
normally conducted from 9:30 a.m. Eastern Time until 4:00 p.m. Eastern Time,
Monday through Friday, although some days, such as in advance of and following
holidays, the NYSE’s trading session closes early. The NYSE typically observes
the following holidays: New Year’s Day, Martin Luther King, Jr. Day, Presidents’
Day, Good Friday, Memorial Day, Juneteenth National Independence Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Although it is
expected that the same holidays will be observed in the future, the NYSE may
modify its holiday schedule or hours of operation at any time. Only orders that
are received and deemed acceptable by the transfer agent no later than the time
specified by the Trust will be executed that day at a fund’s share price
calculated that day. On any day that the NYSE closes early, the funds reserve
the right to advance the time by which purchase and redemption orders must be
received by the transfer agent that day to be executed that day at that day’s
share price. If the NYSE is closed due to weather or other extenuating
circumstances on a day it would typically be open for business, or the NYSE has
an unscheduled early closing on a day it has opened for business, the funds
reserve the right to treat such day as a Business Day and accept purchase and
redemption orders and calculate their NAV as of the normally scheduled close of
regular trading on the NYSE for that day.
Creation. The Trust issues and sells shares of the funds
only in Creation Units on a continuous basis through the Distributor, without a
sales load, at the NAV next determined after receipt, on any Business Day, for
an order received and deemed acceptable by the transfer agent.
Fund Deposit. The consideration for purchase of Creation
Units of the funds may consist of (i) the in-kind deposit of a designated
portfolio of securities (the Deposit Securities), and (ii) an amount of
cash denominated in U.S. Dollars (the Cash Component) computed as described
below. Together, the Deposit Securities and the Cash Component constitute the
“Fund Deposit,” which represents the minimum initial and subsequent
investment amount for a Creation Unit of a fund.
The funds may accept a basket of money market
instruments or cash that differs from the composition of the published basket.
The funds may permit or require the consideration for Creation Units to consist
solely of cash. The funds may permit or require the substitution of an amount of
cash (i.e., a “cash in lieu” amount) to be added to the Cash Component to
replace any Deposit Security. For example, the Trust reserves the right to
permit or require a “cash in lieu” amount where the delivery of the Deposit
Security by the Authorized Participant (as described below) would be restricted
under the securities laws or where the delivery of the Deposit Security to the
Authorized Participant would result in the disposition of the Deposit Security
by the Authorized Participant becoming restricted under the securities laws, or
in certain other situations.
The Cash Component is sometimes also referred to
as the “Balancing Amount.” The Cash Component serves the function of
compensating for any differences between the NAV per Creation Unit and the value
of the Deposit Securities. If the Cash Component is a positive number (i.e., the
NAV per Creation Unit exceeds the value of the Deposit Securities), the creator
will deliver the Cash Component. If the Cash Component is a negative number
(i.e., the NAV per Creation Unit is less than the value of the Deposit
Securities), the creator will receive the Cash Component. Computation of the
Cash Component excludes any stamp duty tax or other similar fees and expenses
payable upon transfer of beneficial ownership of the Deposit Securities, which
shall be the sole responsibility of the Authorized Participant.
The identity and amount of Deposit Securities
and Cash Component for a fund changes as the composition of the fund’s portfolio
changes and as rebalancing adjustments and corporate action events are reflected
from time to time by Schwab Asset Management with a view to the investment
objective of the fund. The composition of the Deposit Securities may also change
in response to adjustments to the weighting or composition of the component
securities of a fund’s index. The funds also reserve the right to include or
remove Deposit Securities from the basket in contemplation of index rebalancing
changes.
A fund or its agent, through the NSCC or
otherwise, makes available on each Business Day, prior to the opening of
business on the NYSE Arca, Inc. Exchange (currently 9:30 a.m., Eastern
Time), the current Fund Deposit for the fund. Such Deposit Securities are
applicable, subject to any adjustments, in order to effect creations of Creation
Units of a fund until such time as the next-announced composition of the Deposit
Securities is made available.
Procedures for Creation of
Creation Units. To be eligible to
place orders with the transfer agent and to create a Creation Unit of a fund, an
entity must be a Depository Trust Company (DTC) participant, such as a
broker-dealer, bank, trust company, clearing corporation or certain other
organization, some of whom (and/or their representatives) own DTC (each a DTC
Participant). DTC acts as securities depositary for the shares. The DTC
Participant must have executed an agreement with the Distributor with respect to
creations and redemptions of Creation Units (Participant Agreement). A DTC
Participant that has executed a Participant Agreement is referred to as an
Authorized Participant. Investors should contact the Distributor for the names
of Authorized Participants that have signed a Participant Agreement. All shares
of a fund, however created, will be entered on the records of DTC in the name of
DTC or its nominee and deposited with, or on behalf of, DTC.
All orders to create shares must be placed for
one or more Creation Units. Orders must be transmitted by an Authorized
Participant pursuant to procedures set forth in the Participant Agreement. The
date on which an order to create Creation Units (or an order to redeem Creation
Units, as discussed below) is placed is referred to as the Transmittal Date.
Orders must be transmitted by an Authorized Participant by telephone or other
transmission method acceptable to the transfer agent pursuant to procedures set
forth in the Participant Agreement, as described below. Economic or market
disruptions or changes, or telephone or other communication failure, may impede
the ability to reach the transfer agent or an Authorized Participant.
39
On days when the New York Stock Exchange or U.S.
bond markets close earlier than normal, a fund may require purchase orders to be
placed earlier in the day. All questions as to the number of Deposit Securities
to be delivered, and the validity, form and eligibility (including time of
receipt) for the deposit of any tendered securities, will be determined by the
Trust, whose determination shall be final and binding.
If a fund does not receive both the required
Deposit Securities and the Cash Component by the specified time on the
settlement date, the Trust may cancel or revoke acceptance of such order. Upon
written notice to the transfer agent, such canceled or revoked order may be
resubmitted the following Business Day using the Fund Deposit as newly
constituted to reflect the then current NAV of a fund. The delivery of Creation
Units so created generally will occur no later than the settlement date.
Creation Units may be created in advance of
receipt by the Trust of all or a portion of the applicable Deposit Securities as
described below. In these circumstances, the initial deposit will have a value
greater than the NAV of the shares on the date the order is placed since, in
addition to available Deposit Securities, cash must be deposited in an amount
equal to the sum of (i) the Cash Component, plus (ii) at least 110%,
which the Trust may change from time to time, of the market value of the
undelivered Deposit Securities (the Additional Cash Deposit) with a fund pending
delivery of any missing Deposit Securities. The Authorized Participant must
deposit with the custodian the appropriate amount of federal funds by
10:00 a.m. New York time (or such other time as specified by the Trust) on
the settlement date. If a fund does not receive the Additional Cash Deposit in
the appropriate amount by such time, then the order may be deemed to be rejected
and the Authorized Participant shall be liable to a fund for losses, if any,
resulting therefrom. An additional amount of cash shall be required to be
deposited with a fund, pending delivery of the missing Deposit Securities to the
extent necessary to maintain the Additional Cash Deposit with the Trust in an
amount at least equal to 110% or 115% as required, which the Trust may change
from time to time, of the daily marked to market value of the missing Deposit
Securities. To the extent that missing Deposit Securities are not received by
the specified time on the settlement date, or in the event a marked-to-market
payment is not made within one Business Day following notification by a fund
that such a payment is required, the Trust may use the cash on deposit to
purchase the missing Deposit Securities. The Authorized Participant will be
liable to the Trust for the costs incurred by the Trust in connection with any
such purchases. These costs will be deemed to include the amount by which the
actual purchase price of the Deposit Securities exceeds the market value of such
Deposit Securities on the transmittal date plus the brokerage and related
transaction costs associated with such purchases. The Trust will return any
unused portion of the Additional Cash Deposit once all of the missing Deposit
Securities have been properly received by a fund or purchased by the Trust and
deposited into the Trust. In addition, a transaction fee, as listed below, will
be charged in all cases.
Acceptance of Orders for
Creation Units. The Trust reserves
the right to reject or revoke acceptance of an individual creation order
transmitted to it by the transfer agent in respect of a fund if, including, but
not limited to, the following conditions are present: (i) the order does not
conform to the procedures set forth in the Participant Agreement; (ii) the
investor(s), upon obtaining the shares ordered, would own 80% or more of the
currently outstanding shares of a fund; (iii) the Deposit Securities delivered
are not as disseminated through the facilities of the NSCC for that date by a
fund as described above; (iv) acceptance of the Deposit Securities would have
certain adverse tax consequences to a fund; (v) acceptance of the Fund Deposit
would, in the opinion of counsel, be unlawful; (vi) acceptance of the Fund
Deposit would otherwise, in the discretion of the Trust or Schwab Asset
Management, have an adverse effect on the Trust or the rights of beneficial
owners; or (vii) in the event that circumstances outside the control of the
Trust, the custodian, the transfer agent, the Distributor or Schwab Asset
Management make it for all practical purposes impossible to process creation
orders. Examples of such circumstances include natural disaster, war,
revolution; public service or utility problems such as fires, floods, extreme
weather conditions and power outages resulting in telephone, telecopy and
computer failures; market conditions or activities causing trading halts;
systems failures involving computer or other information systems affecting the
Trust, Schwab Asset Management, the transfer agent, the Distributor, DTC, NSCC,
custodian (or sub-custodian) or any other participant in the creation process,
and similar extraordinary events. The transfer agent shall notify a prospective
creator of a Creation Unit and/or the Authorized Participant acting on behalf of
the creator of a Creation Unit of its rejection of the order of such person. The
Trust, custodian (or sub-custodian), transfer agent and the Distributor are
under no duty, however, to give notification of any defects or irregularities in
the delivery of Fund Deposits nor shall any of them incur any liability for the
failure to give any such notification.
Creation/Redemption
Transaction Fee. The funds may
impose a transaction fee on investors purchasing or redeeming Creation Units.
The transaction fee will be limited to amounts that have been determined by
Schwab Asset Management to be appropriate. The purpose of the transaction fee is
to protect the existing shareholders of the funds from the dilutive costs
associated with the purchase and redemption of Creation Units. With the
exception of the Schwab 1-5 Year Corporate Bond ETF, the Schwab 5-10 Year
Corporate Bond ETF and the Schwab U.S. Aggregate Bond ETF, the funds currently
do not charge a standard creation or redemption transaction fee, but may do so
in the future. Where the funds permit cash creations (or redemptions) or cash in
lieu of depositing one or more Deposit Securities, the purchaser (or redeemer)
may be assessed an additional variable transaction fee to offset the transaction
cost to the funds of buying (or selling) those particular Deposit Securities.
Transaction fees may differ for the funds, depending on the transaction expenses
related to the funds’ portfolio securities. Every purchaser of a Creation Unit
will receive a prospectus that contains disclosure about the transaction fee,
including the maximum amount of the additional variable transaction fee charged
by each fund. In certain circumstances, the cost of any standard transaction
fees and/or variable transaction fees may be waived by a fund when doing so is
believed to be in the best interests of the funds. From time to time, the
investment adviser may cover the cost of any transaction fees.
The following table shows, as of March 28,
2024, the approximate value of one Creation Unit of the funds and sets forth the
standard and additional creation/redemption transaction fee for the
funds.
40
|
Fund |
| |
Approximate Value of One Creation Unit |
| |
Standard Creation/ Redemption Transaction Fee |
| |
Maximum Additional Creation Transaction Fee(1) |
| |
Maximum Additional Redemption Transaction Fee(1) |
| ||||||||||||
|
Schwab 1‑5 Year Corporate Bond ETF |
| | | $ | 2,415,755 | | | | | $ | 100 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab 5‑10 Year Corporate Bond ETF |
| | | $ | 2,226,085 | | | | | $ | 100 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab U.S. Aggregate Bond ETF |
| | | $ | 4,598,940 | | | | | $ | 500 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab U.S. TIPS ETF |
| | | $ | 2,607,220 | | | | | $ | 0 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab Short‑Term U.S. Treasury ETF |
| | | $ | 2,409,540 | | | | | $ | 0 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab Intermediate‑Term U.S. Treasury ETF |
| | | $ | 2,451,635 | | | | | $ | 0 | | | | | | 3.0% | | | | | | 2.0% | | |
|
Schwab Long‑Term U.S. Treasury ETF |
| | | $ | 1,686,650 | | | | | $ | 0 | | | | | | 3.0% | | | | | | 2.0% | | |
(1)
As a percentage of the
total amount invested or redeemed.
Placement of Redemption
Orders. The process to redeem
Creation Units works much like the process to purchase Creation Units, but in
reverse. Orders to redeem Creation Units of the funds must be delivered through
an Authorized Participant. Investors other than Authorized Participants are
responsible for making arrangements for a redemption request to be made through
an Authorized Participant. Orders must be accompanied or followed by the
requisite number of shares of the funds specified in such order, which delivery
must be made to the Distributor no later than 10:00 a.m. New York time on
the next Business Day following the Transmittal Date. All other procedures set
forth in the Participant Agreement must be properly followed.
Fund securities received on redemption may not
be identical to Deposit Securities that are applicable to creations of Creation
Units. Each fund reserves the right to honor a redemption request by delivering
a basket of securities or cash that differs from the basket of fund securities
generally applicable to redemption requests. An Authorized Participant
submitting a redemption request is deemed to represent to the Trust that it (or
its client) (i) owns outright or has full legal authority and legal
beneficial right to tender for redemption the requisite number of fund shares to
be redeemed and can receive the entire proceeds of the redemption, and
(ii) the fund shares to be redeemed have not been loaned or pledged to
another party nor are they the subject of a repurchase agreement, securities
lending agreement or such other arrangement that would preclude the delivery of
such fund shares to the Trust. The Trust reserves the right to verify these
representations at its discretion, but will typically require verification with
respect to a redemption request from a fund in connection with higher levels of
redemption activity and/or short interest in the fund. If the Authorized
Participant, upon receipt of a verification request, does not provide sufficient
verification of its representations as determined by the Trust, the redemption
request will not be considered to have been received in proper form and may be
rejected by the Trust.
To the extent contemplated by an Authorized
Participant’s agreement, in the event the Authorized Participant has submitted a
redemption request but is unable to transfer all or part of the Creation Units
to be redeemed to a fund, the transfer agent will nonetheless accept the
redemption request in reliance on the undertaking by the Authorized Participant
to deliver the missing shares as soon as possible. Such undertaking shall be
secured by the Authorized Participant’s delivery and maintenance of collateral
consisting of cash having a value (marked-to-market daily) at least equal to
110%, which Schwab Asset Management may change from time to time, of the value
of the missing shares.
The current procedures for collateralization of
missing shares require, among other things, that any cash collateral shall be in
the form of U.S. dollars (or, at the discretion of the Trust, non-U.S. currency
in an equivalent amount) in immediately-available funds and shall be held by the
custodian and marked-to-market daily. The fees of the custodian (and any
sub-custodians) in respect of the delivery, maintenance and redelivery of the
cash collateral shall be payable by the Authorized Participant. The Trust, on
behalf of the funds, is permitted to purchase the missing shares or acquire the
Deposit Securities and the Cash Component underlying such shares at any time and
will subject the Authorized Participant to liability for any shortfall between
the cost to the Trust of purchasing such shares, Deposit Securities or Cash
Component and the value of the collateral.
If the requisite number of shares of a fund are
not delivered on the Transmittal Date as described above, the fund may reject or
revoke acceptance of the redemption request. If it is not possible to effect
deliveries of the fund securities, the Trust may in its discretion exercise its
option to redeem such shares in U.S. cash and the redeeming Authorized
Participant will be required to receive its redemption proceeds in cash. In
addition, an investor may request a redemption in cash that a fund may, in its
sole discretion, permit. In either case, the investor will receive a cash
payment equal to the NAV of its shares based on the NAV of shares of a fund next
determined after the redemption request is received (minus a redemption
transaction fee and additional charge for requested cash redemptions specified
above, to offset the Trust’s brokerage and other transaction costs associated
with the disposition of fund securities).
Redemptions of shares for fund securities will
be subject to compliance with applicable federal and state securities laws and
the funds (whether or not it otherwise permits cash redemptions) reserve the
right to redeem Creation Units for cash to the extent that the Trust could not
lawfully deliver specific fund securities upon redemptions or could not do so
without first registering the fund securities under such laws.
41
The funds will not suspend or postpone
redemption beyond seven days, except as permitted under Section 22(e) of
the 1940 Act or pursuant to Rule 6c-11 under the 1940 Act. Section 22(e)
provides that the right of redemption may be suspended or the date of payment
postponed with respect to the funds (1) for any period during which the
NYSE is closed (other than customary weekend and holiday closings); (2) for
any period during which trading on the NYSE is suspended or restricted;
(3) for any period during which an emergency exists as a result of which
disposal of the shares of a fund’s portfolio securities or determination of its
net asset value is not reasonably practicable; or (4) in such other
circumstance as is permitted by the SEC.
Large Shareholder
Redemptions. Certain accounts or
Schwab affiliates may from time to time own (beneficially or of record) or
control a significant percentage of a fund’s shares. Redemptions by these
shareholders of their holdings in a fund or large redemptions by several
shareholders resulting from events affecting investor demand, to the extent such
redemptions are not executed in the secondary market but rather directly with
the fund through an Authorized Participant, may impact the fund’s liquidity and
NAV. These redemptions if made in cash, rather than in-kind, may also force a
fund to sell securities, which may negatively impact the fund’s brokerage costs.
To the extent a fund effects redemptions in cash, this activity could also
accelerate the realization of capital gains. Large purchases of shares, if made
in cash rather than in-kind, may adversely affect a fund’s performance to the
extent that the fund is delayed in investing new cash and is required to
maintain a larger cash position than it ordinarily would.
Pricing of Shares
Each business day, the funds calculate their
share price, NAV per share, as of the close of the NYSE (generally
4:00 p.m. Eastern Time). This means that NAVs are calculated using the
values of a fund’s portfolio securities as of the close of the NYSE. Such values
are required to be determined in one of two ways: securities for which market
quotations are readily available are required to be valued at current market
value; and securities for which market quotations are not readily available or
that the investment adviser deems to be unreliable are required to be valued at
fair value following procedures approved by the Board. If the NYSE is closed due
to weather or other extenuating circumstances on a day it would typically be
open for business, or the NYSE has an unscheduled early closing on a day it has
opened for business, the funds reserve the right to treat such day as a business
day and accept purchase and redemption orders and calculate their share prices
as of the normally scheduled close of regular trading on the NYSE for that
day.
To the extent a fund invests in foreign
securities, shareholders should be aware that because foreign markets are often
open on weekends and other days when the funds are closed, the value of some of
a fund’s securities may change on days when it is not possible to buy or sell
shares of the fund.
The funds use approved pricing sources
(including pricing services) to provide values for their portfolio securities.
Values are generally determined by the approved pricing sources as follows:
generally, securities traded on stock exchanges, excluding the NASDAQ National
Market System, are valued at the last-quoted sales price on the exchange on
which such securities are primarily traded (closing values), or, lacking any
sales, at the mean between the bid and ask prices; securities traded in the
over-the-counter market are generally valued at an evaluated price using a
mid-price supplied by an approved, independent pricing service. The mid-price is
the mean of the bid and ask prices as calculated by the pricing service.
Generally, securities listed on the NASDAQ National Market System are valued in
accordance with the NASDAQ Official Closing Price. In addition, securities that
are primarily traded on foreign exchanges are generally valued at the official
closing price or last sales price on the exchange where the securities are
primarily traded with these values then translated into U.S. dollars at the
current exchange rate. Fixed-income securities normally are valued based on
valuations provided by approved pricing services. Securities will be fair valued
pursuant to procedures approved by the funds’ Board when market quotations are
not “readily available” or the investment adviser deems them unreliable. For
example, a fund may fair value a security when a security is de-listed or its
trading is halted or suspended; when a security’s primary pricing source is
unable or unwilling to provide a price; when a security’s primary trading market
is closed during regular domestic market hours; or when a security’s value is
materially affected by events occurring after the close of the security’s
primary trading market. The Board has designated the investment adviser as the
valuation designee (Valuation Designee) for the funds to perform the fair value
determination relating to all fund investments. The Valuation Designee
periodically provides reports to the Board on items related to its fair value of
fund investments.
NOTE: Transactions in fund shares will be priced
at NAV only if you purchase or redeem shares directly from a fund in Creation
Units. Fund shares are purchased or sold on a national securities exchange at
market prices, which may be higher (premium) or lower (discount) than
NAV.
TAXATION
This discussion of federal income tax
consequences is based on the Internal Revenue Code and the regulations issued
thereunder as in effect on the date of this SAI. New legislation, as well as
administrative changes or court decisions, may significantly change the
conclusions expressed herein, and may have a retroactive effect with respect to
the transactions contemplated herein.
Federal Tax Information for the Funds
It is each fund’s policy to qualify for taxation
as a “regulated investment company” (RIC) by meeting the requirements of
Subchapter M of the Internal Revenue Code. By qualifying as a RIC, each fund
expects to eliminate or reduce to a nominal amount the federal income tax to
which it is subject. If a fund does not qualify as a RIC under the Internal
Revenue Code, it will be subject to federal income tax on its net investment
income and any net realized capital gains. In addition, each fund could be
required to recognize unrealized gains, pay substantial taxes and interest, and
make substantial distributions before requalifying as a RIC.
42
Each fund is treated as a separate entity for
federal income tax purposes and is not combined with the Trust’s other funds.
Each fund intends to qualify as a RIC so that it will be relieved of federal
income tax on that part of its income that is distributed to shareholders. In
order to qualify for treatment as a RIC, a fund must, among other requirements,
distribute annually to its shareholders at least the sum of 90% of its
investment company taxable income (generally, net investment income plus the
excess, if any, of net short-term capital gain over net long-term capital
losses) and 90% of its net tax-exempt income. Among these requirements are the
following: (i) at least 90% of a fund’s gross income each taxable year must
be derived from dividends, interest, payments with respect to securities loans,
and gains from the sale or other disposition of stock, securities or foreign
currencies, or other income derived with respect to its business of investing in
such stock or securities or currencies and net income derived from an interest
in a qualified publicly traded partnership; (ii) at the close of each
quarter of a fund’s taxable year, at least 50% of the value of its total assets
must be represented by cash and cash items, U.S. government securities,
securities of other RICs and other securities, with such other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of a fund’s assets and that does not represent more than 10% of the
outstanding voting securities of such issuer; and (iii) at the close of
each quarter of a fund’s taxable year, not more than 25% of the value of its
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer or of two or more issuers and
which are engaged in the same, similar, or related trades or businesses if the
fund owns at least 20% of the voting power of such issuers, or the securities of
one or more qualified publicly traded partnerships.
Certain master limited partnerships may qualify
as “qualified publicly traded partnerships” for purposes of the Subchapter M
diversification rules described above. To do so, the master limited partnership
must satisfy two requirements during the taxable year. First, the interests of
such partnership either must be traded on an established securities market or
must be readily tradable on a secondary market (or the substantial equivalent
thereof). Second, the partnership must meet the 90% gross income requirements
for the exception from treatment as a corporation with gross income other than
income consisting of dividends, interest, payments with respect to securities
loans, or gains from the sale or other disposition of stock or securities or
foreign currencies, or other income derived with respect to its business of
investing in such stock securities or currencies.
The Internal Revenue Code imposes a
non-deductible excise tax on RICs that do not distribute in a calendar year
(regardless of whether they otherwise have a non-calendar taxable year) an
amount equal to 98% of their “ordinary income” (as defined in the Internal
Revenue Code) for the calendar year plus 98.2% of their net capital gain for the
one-year period ending on October 31 of such calendar year, plus any
undistributed amounts from prior years. The non-deductible excise tax is
equal to 4% of the deficiency. For the foregoing purposes, a fund is treated as
having distributed any amount on which it is subject to income tax for any
taxable year ending in such calendar year. A fund may in certain circumstances
be required to liquidate fund investments to make sufficient distributions to
avoid federal excise tax liability at a time when the investment adviser might
not otherwise have chosen to do so, and liquidation of investments in such
circumstances may affect the ability of a fund to satisfy the requirements for
qualification as a RIC.
A fund’s transactions in futures contracts,
forward contracts, options and certain other investment and hedging activities
may be restricted by the Internal Revenue Code and are subject to special tax
rules. In a given case, these rules may accelerate income to a fund, defer its
losses, cause adjustments in the holding periods of a fund’s assets, convert
short-term capital losses into long-term capital losses or otherwise affect the
character of a fund’s income. These rules could therefore affect the amount,
timing and character of distributions to shareholders. Each fund will endeavor
to make any available elections pertaining to these transactions in a manner
believed to be in the best interest of a fund and its shareholders.
Each fund is required for federal income tax
purposes to mark-to-market and recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts as of the end of the
year as well as those actually realized during the year. Gain or loss from
futures and options contracts on broad-based indexes required to be
marked-to-market will be 60% long-term and 40% short-term capital gain or loss.
Application of this rule may alter the timing and character of distributions to
shareholders. Each fund may be required to defer the recognition of losses on
futures contracts, options contracts and swaps to the extent of any unrecognized
gains on offsetting positions held by the fund. It is anticipated that any net
gain realized from the closing out of futures or options contracts will be
considered gain from the sale of securities and therefore will be qualifying
income for purposes of the 90% requirement described above. Each fund
distributes to shareholders at least annually any net capital gains which have
been recognized for federal income tax purposes, including unrealized gains at
the end of the fund’s fiscal year on futures or options transactions. Such
distributions are combined with distributions of capital gains realized on a
fund’s other investments and shareholders are advised on the nature of the
distributions.
With respect to investments in zero coupon
securities or other securities which are issued with “original issue discount,”
a fund will be required to include as part of its current income the imputed
interest on such obligations even though the fund has not received any interest
payments on such obligations during that period. Because each fund distributes
all of its net investment income to its shareholders, a fund may have to sell
fund securities to distribute such imputed income which may occur at a time when
the investment adviser would not have chosen to sell such securities and which
may result in taxable gain or loss.
Special federal income tax rules apply to the
inflation-indexed bonds. Generally, all stated interest on such bonds is taken
into income by a fund under its regular method of accounting for interest
income. The amount of a positive inflation adjustment, which results in an
increase in the inflation-adjusted principal amount of the bond, is treated as
OID. The OID is included in a fund’s gross income ratably during the period
ending with the maturity of the bond, under the general OID inclusion rules. The
amount of a fund’s OID in a taxable year with respect to a bond will increase a
fund’s taxable income for such year without a corresponding receipt of cash,
until the bond matures. As a result, as noted above, a fund
43
may need to raise cash by selling portfolio
investments, which may occur at a time when the adviser would not have chosen to
sell such securities and which may result in capital gains to a fund and
additional capital gains distributions to fund shareholders. The amount of
negative inflation adjustment, which results in a decrease in the
inflation-adjusted principal amount of the bond, reduces the amount of interest
(including stated interest, OID, and market discount, if any) otherwise
includible in a fund’s income with respect to the bond for the taxable
year.
Any market discount recognized on a bond is
taxable as ordinary income. A market discount bond is a bond acquired in the
secondary market at a price below redemption value or adjusted issue price if
issued with original issue discount. Absent an election by a fund to include the
market discount in income as it accrues, gain on the fund’s disposition of such
an obligation will be treated as ordinary income rather than capital gain to the
extent of the accrued market discount.
Federal Income Tax Information for
Shareholders
The discussion of federal income taxation
presented below supplements the discussion in each fund’s prospectus and only
summarizes some of the important federal tax considerations generally affecting
shareholders of the funds. Accordingly, prospective investors (particularly
those not residing or domiciled in the United States) should consult their own
tax advisors regarding the consequences of investing in the funds.
Any dividends declared by a fund in October,
November or December and paid the following January are treated, for tax
purposes, as if they were received by shareholders on December 31 of the
year in which they were declared. In general, distributions by a fund of
investment company taxable income (including net short-term capital gains), if
any, whether received in cash or additional shares, will be taxable to you as
ordinary income. It is not expected that any portion of these distributions will
be eligible for the dividends-received deduction for corporate shareholders or
to be treated as qualified dividend income which is eligible in certain
circumstances for reduced maximum tax rates to individuals.
Distributions from net capital gain (if any)
that are reported as capital gain dividends are taxable as long-term capital
gains without regard to the length of time the shareholder has held shares of a
fund. However, if you receive a capital gain dividend with respect to fund
shares held for six months or less, any loss on the sale or exchange of
those shares shall, to the extent of the capital gain dividend, be treated as a
long-term capital loss. The maximum individual rate applicable to “qualified
dividend income” and long-term capital gains is generally either 15% or 20%,
depending on whether the individual’s income exceeds certain threshold
amounts.
An additional 3.8% Medicare tax is imposed on
certain net investment income (including ordinary dividends and capital gains
distributions received from a fund and net gains from redemptions or other
taxable dispositions of fund shares) of U.S. individuals, estates and trusts to
the extent that such person’s “modified adjusted gross income” (in the case of
an individual) or “adjusted gross income” (in the case of an estate or trust)
exceeds a threshold amount.
A fund will inform you of the amount of your
ordinary income dividends and capital gains distributions, if any, at the time
they are paid and will advise you of their tax status for federal income tax
purposes, including what portion of the distributions will be qualified dividend
income, shortly after the close of each calendar year.
If a fund makes a distribution to a shareholder
in excess of a fund’s current and accumulated earnings and profits in any
taxable year, the excess distribution will be treated as a return of capital to
the extent of the shareholder’s tax basis in its shares, and thereafter, as
capital gain. A return of capital is not taxable, but reduces a shareholder’s
tax basis in its shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of its shares. To the extent
that a return of capital distribution exceeds a shareholder’s adjusted basis,
the distribution will be treated as gain from the sale of shares.
A sale of shares in a fund may give rise to a
gain or loss. In general, any gain or loss realized upon a taxable disposition
of shares will be treated as long-term capital gain or loss if the shares have
been held for more than one year. Otherwise, the gain or loss on the taxable
disposition of shares will be treated as short-term capital gain or loss. The
maximum individual tax rate applicable to long-term capital gains is generally
either 15% or 20%, depending on whether the individual’s income exceeds certain
threshold amounts. Any loss realized upon a taxable disposition of shares held
for six months or less will be treated as long-term, rather than
short-term, to the extent of any long-term capital gains distributions received
(or deemed received) by the shareholder with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of shares will be
disallowed if other substantially identical shares of a fund are purchased
within 30 days before or after the disposition. In such a case, the basis
of the newly purchased shares will be adjusted to reflect the disallowed
loss.
For taxable years beginning after 2017 and
before 2026, non-corporate taxpayers generally may deduct 20% of “qualified
business income” derived either directly or through partnerships or S
corporations. For this purpose, “qualified business income” generally includes
ordinary REIT dividends and income derived from MLP investments. A fund is
permitted to pass through to shareholders the character of ordinary REIT
dividends so as to allow non-corporate shareholders to claim this deduction.
There currently is no mechanism for a fund to pass through to non-corporate
shareholders the character of income derived from MLP investments. It is
uncertain whether future legislation or other guidance will enable the funds to
pass through to non-corporate shareholders the ability to claim this deduction
with respect to income derived from MLP investments.
An Authorized Participant who exchanges
securities for Creation Units generally will recognize a gain or a loss. The
gain or loss will be equal to the difference between the market value of the
Creation Units at the time and the sum of the exchanger’s aggregate basis in the
securities surrendered plus the amount of cash paid for such Creation Units. A
person who redeems Creation Units will generally recognize a gain or loss
44
equal to the difference between the exchanger’s
basis in the Creation Units and the sum of the aggregate market value of any
securities received plus the amount of any cash received for such Creation
Units. The IRS, however, may assert that a loss realized upon an exchange of
securities for Creation Units cannot be deducted currently under the rules
governing “wash sales,” or on the basis that there has been no significant
change in economic position.
Any capital gain or loss realized upon the
creation of Creation Units will generally be treated as long-term capital gain
or loss if the securities exchanged for such Creation Units have been held for
more than one year. Any capital gain or loss realized upon the redemption of
Creation Units will generally be treated as long-term capital gain or loss if
the shares comprising the Creation Units have been held for more than one year.
Otherwise, such capital gains or losses will be treated as short-term capital
gains or losses.
Each fund has the right to reject an order for
Creation Units if the purchaser (or group of purchasers) would, upon obtaining
the shares so ordered, own 80% or more of the outstanding shares of the fund and
if, pursuant to section 351 of the Internal Revenue Code, the respective fund
would have a basis in the deposit securities different from the market value of
such securities on the date of deposit. Each fund also has the right to require
information necessary to determine beneficial Share ownership for purposes of
the 80% determination.
Certain tax-exempt shareholders, including
qualified pension plans, individual retirement accounts, salary deferral
arrangements, 401(k)s, and other tax-exempt entities, generally are exempt from
federal income taxation except with respect to their unrelated business taxable
income (UBTI). Under current law, each fund generally serves to block UBTI from
being realized by their tax-exempt shareholders. However, notwithstanding the
foregoing, a tax-exempt shareholder could realize UBTI by virtue of its
investment in a fund where, for example, (i) a fund invests in REITs that
hold residual interests in real estate mortgage investment conduits (REMICs), or
(ii) its shares in the fund constitute debt-financed property in the hands
of the tax-exempt shareholder within the meaning of section 514(b) of the
Internal Revenue Code. Charitable remainder trusts are subject to special rules
and should consult their tax advisors. There are no restrictions preventing a
fund from holding investments in REITs that hold residual interests in REMICs,
and a fund may do so. The IRS has issued recent guidance with respect to these
issues and prospective shareholders, especially charitable remainder trusts, are
strongly encouraged to consult with their tax advisors regarding these
issues.
Backup Withholding
– Each fund will be required in
certain cases to withhold at the applicable withholding rate and remit to the
U.S. Treasury the withheld amount of taxable dividends and redemption proceeds
paid to any shareholder who (1) fails to provide a correct taxpayer
identification number certified under penalty of perjury; (2) is subject to
withholding by the IRS for failure to properly report all payments of interest
or dividends; (3) fails to provide a certified statement that he or she is not
subject to “backup withholding;” or (4) fails to provide a certified statement
that he or she is a U.S. person (including a U.S. resident alien). Backup
withholding is not an additional tax and any amounts withheld may be credited
against the shareholder’s ultimate U.S. tax liability.
Disclosure for Non-U.S.
Shareholders – Foreign shareholders
(i.e., nonresident alien individuals and foreign corporations, partnerships,
trusts and estates) are generally subject to U.S. withholding tax at the rate of
30% (or a lower tax treaty rate) on distributions derived from net investment
income and short-term capital gains; provided, however, U.S. source interest
related dividends and short-term capital gain dividends generally are not
subject to U.S. withholding tax if a fund elects to report such dividends in a
written notice. Distributions to foreign shareholders of such short-term capital
gain, of long-term capital gains, and any gains from the sale or other
disposition of shares of a fund, generally are not subject to U.S. taxation,
unless the recipient is an individual who either (1) meets the Internal
Revenue Code’s definition of “resident alien” or (2) is physically present
in the U.S. for 183 days or more per year. Foreign shareholders may also be
subject to U.S. estate taxes with respect to shares in a fund. Different tax
consequences may result if the foreign shareholder is engaged in a trade or
business within the United States. In addition, the tax consequences to a
foreign shareholder entitled to claim the benefits of a tax treaty may be
different than those described above. Notwithstanding the foregoing, a portion
of the income, if any, derived by a fund from investments in REITs that hold
residual interests in REMICs may be classified as “excess inclusion income.” In
respect of foreign shareholders, no exemption or reduction in withholding tax
will apply to such excess inclusion income.
The funds are required to withhold U.S. tax (at
a 30% rate) on payments of taxable dividends made to certain non-U.S. entities
that fail to comply (or be deemed compliant) with extensive reporting and
withholding requirements designed to inform the U.S. Department of the Treasury
of U.S.-owned foreign investment accounts. Shareholders may be requested to
provide additional information to the funds to enable the funds to determine
whether withholding is required.
Reportable Transactions
– Under U.S. Treasury regulations,
if a shareholder recognizes a loss of $2 million or more for an individual
shareholder or $10 million or more for a corporate shareholder, the
shareholder must file with the IRS a disclosure statement on Form 8886. Direct
shareholders of portfolio securities are in many cases excepted from this
reporting requirement, but under current guidance, shareholders of a RIC such as
the funds are not excepted. Future guidance may extend the current exception
from this reporting requirement to shareholders of most or all RICs. The fact
that a loss is reportable under these regulations does not affect the legal
determination of whether the taxpayer’s treatment of the loss is proper.
Shareholders should consult their tax advisors to determine the applicability of
these regulations in light of their individual circumstances.
Shareholders are urged to consult their tax
advisors as to the state and local tax rules affecting investments in the
funds.
45
APPENDIX – RATINGS OF INVESTMENT
SECURITIES
From time to time, a fund may report the
percentage of its assets that fall into the rating categories set forth below,
as defined by the ratings agencies.
MOODY’S INVESTORS SERVICE
Global Long-Term Rating Scale
?
Aaa:
Obligations rated Aaa are judged to be of the
highest quality, with minimal 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 considered upper
medium-grade and are subject to low credit risk.
?
Baa:
Obligations rated Baa are subject to moderate
credit risk. They are considered medium-grade and as such may possess
speculative characteristics.
?
Ba:
Obligations rated Ba are judged to have
speculative elements 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 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 in
principal and interest.
?
C:
Obligations rated C are the lowest-rated class
of bonds and are typically in default, with little prospect for recovery of
principal and interest.
Global Short-Term Rating Scale
?
P-1:
Issuers (or supporting institutions) rated
Prime-1 have a superior ability to repay short-term debt obligations.
?
P-2:
Issuers (or supporting institutions) rated
Prime-2 have a strong ability to repay short-term debt obligations.
?
P-3:
Issuers (or supporting institutions) rated
Prime-3 have 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.
STANDARD & POOR’S FINANCIAL SERVICES
LLC
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
commitment 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 commitment 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 commitment 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:
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
which could lead to the obligor’s inadequate capacity to meet its financial
commitment 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 commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor’s capacity or
willingness to meet its financial commitment 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 commitment
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.
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 commitment 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 commitment 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.
FITCH RATINGS, INC.
Long-Term Ratings Scales
AAA:
‘AAA’ ratings denote the lowest expectation of
default risk. They are assigned only in cases of exceptionally strong capacity
for payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA:
‘AA’ ratings denote expectations of very low
default risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A:
‘A’ ratings denote expectations of low default
risk. The capacity for payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to adverse business or
economic conditions than is the case for higher ratings.
BBB:
‘BBB’ ratings indicate that expectations of
default risk are currently low. The capacity for payment of financial
commitments is considered adequate but adverse business or economic conditions
are more likely to impair this capacity.
?
BB:
‘BB’ ratings indicate an elevated vulnerability
to default risk, particularly in the event of adverse changes in business or
economic conditions over time; however, business or financial flexibility exists
that supports the servicing of financial commitments.
B:
‘B’ ratings indicate that material default risk
is present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is vulnerable to
deterioration in the business and economic environment.
CCC:
Very low margin for safety. Default is a real
possibility.
CC:
Default of some kind appears probable.
?
C:
A default or default-like process has begun, or
for a closed funding vehicle, payment capacity is irrevocably impaired.
Conditions that are indicative of a ‘C’ category rating for an issuer
include:
i.
the issuer has entered into a grace or cure
period following non-payment of a material financial obligation;
ii.
the formal announcement by the issuer or their
agent of a distressed debt exchange; and
iii.
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:
‘RD’ ratings indicate an issuer that in Fitch’s
opinion has experienced:
i.
an uncured payment default or distressed debt
exchange on a bond, loan or other material financial obligation, but
ii.
has not entered into bankruptcy filings,
administration, receivership, liquidation, or other formal winding-up procedure,
and
iii.
has not otherwise ceased operating.
This would include:
a.
the selective payment default on a specific
class or currency of debt;
b.
the uncured expiry of any applicable original
grace period, cure period or default forbearance period following a payment
default on a bank loan, capital markets security or other material financial
obligation.
?
D:
‘D’ ratings indicate an issuer that in Fitch’s
opinion has entered into bankruptcy filings, administration, receivership,
liquidation or other formal winding-up procedure or that has otherwise ceased
business and debt is still outstanding.
Short-Term Ratings
?
F1:
Indicates the strongest intrinsic capacity for
timely payment of financial commitments; may have an added “+” to denote any
exceptionally strong credit feature.
?
F2:
Good intrinsic capacity for timely payment of
financial commitments.
?
F3:
The intrinsic capacity for timely payment of
financial commitments is adequate.
APPENDIX – PROXY VOTING POLICY
| |
The
Charles Schwab Family of Funds
Schwab Investments
Schwab Capital Trust
Schwab Annuity Portfolios
Laudus Trust
Schwab Strategic Trust |
|
PROXY VOTING POLICY
AS OF MARCH 2024
AS OF MARCH 2024
The Boards of Trustees (the “Board”) of The
Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab
Annuity Portfolios, and Laudus Trust (“Schwab Funds”) and Schwab Strategic Trust
(“Schwab ETFs”; collectively with Schwab Funds, the “Funds”) have delegated to
the Funds’ investment adviser, Charles Schwab Investment Management, Inc.
(“CSIM”), the responsibility to vote proxies relating to the Funds’ portfolio
securities pursuant to CSIM’s Proxy Voting Policy (“CSIM Proxy Policy”). On an
annual basis, CSIM will report to the Board any changes to the CSIM Proxy Policy
and on the implementation of the CSIM Proxy Policy.
| |
Charles Schwab Investment Management,
Inc. |
|
PROXY VOTING POLICY
AS OF MARCH 2024
AS OF MARCH 2024
I.
INTRODUCTION
Charles Schwab Investment Management, Inc.
(“CSIM”), as an investment adviser, is responsible for voting proxies with
respect to the securities held in accounts of investment companies and other
clients that have delegated the authority to vote proxies to CSIM. CSIM’s Proxy
Committee exercises and documents CSIM’s responsibility with regard to voting of
client proxies, including the review and approval of the Proxy Voting Policy
(the “Proxy Policy”). CSIM’s Investment Stewardship Team has the primary
responsibility for overseeing that voting is carried out consistent with the
Proxy Policy. The Investment Stewardship Team also conducts research into proxy
issues and carries out engagement activities with companies. The Proxy Committee
receives regular reports from the Investment Stewardship Team on these
activities.
II.
PHILOSOPHY
As a leading asset manager, it is CSIM’s
responsibility to use its proxy votes to encourage transparency, corporate
governance structures, and the management of environmental, social and other
governance issues that it believes protect and promote shareholder value.
Just as the investors in CSIM’s equity funds
generally have a long-term investment horizon, CSIM takes a long-term, measured
approach to investment stewardship. CSIM’s client-first philosophy drives all of
its efforts, including its approach to decision making. In the investment
stewardship context, that unfolds through CSIM’s efforts to appropriately manage
risk by encouraging transparency and focusing on corporate governance structures
that will help protect and promote shareholder value. CSIM also recognizes that
companies can conduct themselves in ways that have important environmental and
social consequences. Therefore, CSIM’s focus on maximizing long-term shareholder
value includes consideration of potential environmental and social impacts that
we believe are relevant to individual companies.
In general, CSIM believes corporate directors,
as the elected representatives of all shareholders, are best positioned to
oversee the management of their companies. Accordingly, CSIM typically supports
a board of directors’ and management’s recommendations on proxy matters.
However, CSIM will vote against management’s recommendations when it believes
doing so will protect or promote long-term shareholder value.
III.
USE OF PROXY ADVISORS
To assist CSIM in its responsibility for voting
proxies and the overall proxy voting process, CSIM has retained Glass, Lewis
& Co., LLC (“Glass Lewis”) as an expert in the proxy voting and corporate
governance area. The services provided by Glass Lewis include in-depth research,
global issuer analysis, and voting recommendations as well as vote execution,
reporting and record keeping. CSIM has also retained Institutional Shareholder
Services Inc. to conduct research and provide voting recommendations on certain
topics and may retain additional experts in the proxy voting, corporate
governance, and environmental and social areas in the future.
To support CSIM in efficiently executing its
votes, Glass Lewis, simultaneously with issuing its voting recommendations, also
automatically populates votes based on CSIM’s custom voting guidelines, except
for certain ballot items which CSIM elects to vote manually. CSIM’s votes are
executed just prior to the vote deadline, which allows CSIM the opportunity to
incorporate changes in Glass Lewis voting recommendations or the receipt of
additional information from the company or other parties.
IV.
PROXY VOTING PRINCIPLES
CSIM invests on behalf of its clients in
companies domiciled all over the world. Since corporate governance standards and
best practices differ by country and jurisdiction, the market context is taken
into account in the analysis of proposals. Furthermore, there are instances
where CSIM may determine that voting is not in the best interests of its clients
(typically due to costs or to trading restrictions) and will refrain from
submitting votes.
The Proxy Committee reviews CSIM’s proxy voting
guidelines with input from the Investment Stewardship Team at least annually and
evaluates them in light of the long-term best interests of shareholders. In
addition, for U.S. companies, contested director elections, “vote no” campaigns,
mergers and acquisitions, some executive compensation and election of director
proposals, and many shareholder proposals, including environmental, social, and
governance-related proposals, such as those requesting additional environmental,
social and political disclosures, are voted on a case-by-case basis by the
Investment Stewardship Team.
The following is a summary of CSIM’s proxy
voting principles which are grouped according to types of proposals usually
presented to shareholders in proxy statements.
1
A.
DIRECTORS AND AUDITORS
i.
Directors
As a starting point, CSIM expects boards to be
composed of at least a majority of independent directors and to be responsive to
shareholders. CSIM also expects directors that serve on a company’s nominating,
compensation or audit committee to be independent. CSIM believes that diversity
of background, experience and skills, and personal characteristics, including
gender, race, ethnicity and age, meaningfully contribute to a board’s ability to
make effective decisions on behalf of shareholders.
Factors that may result in a vote against one or
more directors:
●
The board is not majority independent
●
A Russell 3000 Index or S&P 500 Index
company board is not sufficiently diverse with respect to gender,
race/ethnicity, experience, and
skill sets, or a company outside of those indices does not have any diverse
directors, and the board has not provided a reasonable explanation for its lack
of diversity nor a plan to increase it
●
A Russell 3000 Index or S&P 500 Index
company board has not provided explicit disclosure of director diversity and
skills
●
Non-independent directors serve on the
nominating, compensation or audit committees
●
A director recently failed to attend at least
75% of meetings or serves on an excessive number of publicly traded company
boards
●
The directors approved executive compensation
schemes that appear misaligned with shareholders’ interests
●
A director recently acted in a manner
inconsistent with this Proxy Policy or failed to be responsive to shareholder
concerns
●
The company has not provided explicit disclosure
of board oversight of material risks, including environmental and social
risks
ii.
Contested Director
Elections
A proxy contest is when a dissident shareholder
(or group of shareholders) proposes outside nominees to compete against
incumbent directors. A “Vote No” campaign is when an activist shareholder
attempts to solicit votes against certain directors. CSIM evaluates proxy
contests and Vote No campaigns on a case-by-case basis and votes for the outcome
it believes will maximize long-term shareholder value. CSIM considers numerous
factors when making its voting decision, including but not limited to the merit
of the campaign, the qualifications of director nominees, long-term company
performance compared to peers, board oversight of material risks, and, in the
case of proxy contests, the dissident’s and management’s strategic plans for
driving improvements.
iii.
Auditors
CSIM typically supports the ratification of
auditors unless CSIM believes that the auditors’ independence may have been
compromised.
Factors that may result in a vote against the
ratification of auditors:
●
Audit-related fees are less than half of the
total fees paid by the company to the audit firm
●
A recent material restatement of annual
financial statements
●
A pattern of inaccurate audits or other behavior
that may call into question an auditor’s effectiveness
B.
BOARD MATTERS
i.
Classified
Boards
CSIM generally does not support classified board
proposals unless management has provided valid reasoning for the
structure.
ii.
Majority
Voting
CSIM generally supports majority voting
proposals when they call for plurality voting standards in contested
elections.
iii.
Proxy Access
CSIM typically supports proxy access proposals
when the following criteria are met:
●
Ownership threshold of at least 3% of the
company’s outstanding shares held for at least three years
●
Number of nominees is no more than 20% of
current board (rounded down to nearest whole number)
●
Group size is capped at 20 shareholders
iv.
Separation of Chair
and CEO role
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CSIM believes that boards are typically best
positioned to determine their leadership structure. Therefore, CSIM will
typically not support proposals requiring the separation of these roles unless
certain circumstances are in place.
Factors that may result in a vote supporting a
shareholder proposal requiring the separation of the Chair and CEO roles
include:
●
The board does not have a lead independent
director
●
The board is not two-thirds independent
●
The company did not implement a shareholder
proposal that was passed by shareholders at two previous shareholder
meetings
●
The company nominated directors for election
that did not receive a majority of shareholder support at the previous
shareholder meeting
●
The company had material financial statement
restatements
●
The company’s board adopted a Shareholder Rights
Plan during the past year and did not submit it to shareholders for
approval
●
Ongoing executive compensation concerns
●
Ongoing financial underperformance
●
Lack of robust lead independent director
v.
Independent
Chair
CSIM believes that boards are typically best
positioned to determine their leadership structure. Therefore, CSIM will
typically not support proposals requiring an independent chair unless CSIM has
concerns regarding a board’s accountability or responsiveness to
shareholders.
Factors that may result in a vote supporting a
shareholder proposal requiring an independent chair:
●
The board does not have a lead independent
director
●
The board is not two-thirds independent
●
The company did not implement a shareholder
proposal that was passed by shareholders at two previous shareholder
meetings
●
The company nominated directors for election
that did not receive a majority of shareholder support at the previous
shareholder meeting
●
The company had material financial statement
restatements
●
The company’s board adopted a Shareholder Rights
Plan during the past year and did not submit it to shareholders for
approval
●
Ongoing executive compensation concerns
●
Ongoing financial underperformance
C.
COMPENSATION
i.
Advisory Vote on
Executive Compensation and Frequency
CSIM generally supports advisory votes on
executive compensation (which are proposed by management and are known as
“Say-On-Pay”) when the compensation scheme appears aligned with shareholder
economic interests and lacks problematic features.
Factors that may result in a vote against a
company’s Say-On-Pay proposal:
●
Executive compensation is out of line with
industry peers considering the company’s performance over time
●
Executive compensation plan includes significant
guaranteed bonuses or has a low amount of compensation at risk
●
Executive compensation plan offers excessive
one-time payments, perquisites, tax-gross up provisions, or golden
parachutes
●
Compensation amounts are increased, or goals are
lowered without providing a valid explanation
●
Executive compensation plan lacks adequate
disclosure or rationale for decisions related to goals and amounts
CSIM typically supports annual advisory votes on
executive compensation.
ii.
Equity Compensation
Plans
CSIM generally supports stock-based compensation
plans when they do not overly dilute shareholders by providing participants with
excessive awards and lack problematic features.
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Factors that may result in a vote against Equity
Compensation Plans:
●
Plan’s total potential dilution appears
excessive
●
Plan’s burn rate appears excessive compared to
industry peers
●
Plan allows for the re-pricing of options
without shareholder approval
●
Plan has an evergreen feature
iii.
Employee Stock
Purchase Plans
CSIM supports the concept of broad employee
participation in a company’s equity. Therefore, CSIM typically supports employee
stock purchase plans when the shares can be purchased at 85% or more of the
shares’ market value.
iv.
Re-price/Exchange
Option Plans
CSIM generally only supports management
proposals to re-price options when the plan excludes senior management and
directors, does not excessively dilute shareholders, and the company has not
significantly underperformed its industry peers over time.
D.
ANTI-TAKEOVER
i.
Shareholder Rights
Plans
Shareholder Rights Plans constrain a potential
acquirer’s ability to buy shares in a company above a certain threshold without
the approval of the company’s board of directors. While such a plan may help a
company in achieving a higher bid, it may also entrench the incumbent management
and board. CSIM believes that shareholders should have the right to approve a
Shareholder Rights Plan within a year of its adoption. CSIM generally votes
against such plans if they do not have safeguards to protect shareholder
interests.
Factors that may result in a vote against a
Shareholder Rights Plan proposal:
●
Plan does not expire in a relatively short time
horizon
●
Plan does not have a well-crafted permitted bid
or qualified offer feature that mandates shareholder votes in certain
situations
●
Plan automatically renews without shareholder
approval
●
Company’s corporate governance profile is
problematic
ii.
Right to Call
Special Meeting
CSIM generally votes against shareholder
proposals asking for shareholders to be given the right to call a special
meeting unless the threshold to call a special meeting is 25% or more of shares
outstanding to avoid wasting corporate resources.
iii.
Right to Act by
Written Consent
CSIM generally votes against shareholder
proposals asking for shareholders to be given the right to act by written
consent if the company already offers shareholders the right to call special
meetings. CSIM expects appropriate mechanisms for implementation.
iv.
Supermajority
Voting
CSIM generally supports the concept of simple
majority standards to pass proposals.
E.
CAPITAL STRUCTURE, MERGERS AND
ACQUISITIONS
i.
Increase in
Authorized Common Shares
CSIM typically supports proposals to increase
the authorized shares unless the company does not sufficiently justify the need
for the use of the proposed shares.
ii.
Preferred
Shares
CSIM generally supports proposals to create a
class of preferred shares with specific voting, dividend, conversion and other
rights.
iii.
Mergers and
Acquisitions
CSIM generally supports transactions that appear
to maximize shareholder value. CSIM assesses these proposals on a case-by-case
basis and considers the proposed transaction’s strategic rationale, the offer
premium, the board’s oversight of the sales process, and other pertinent
factors.
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F.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE
PROPOSALS
Effective oversight of material environmental,
social and governance risks relevant to a company and its business is an
essential board function. In CSIM’s view, appropriate risk oversight of
environmental, social and governance issues contributes to sustainable long-term
value and companies should provide pertinent information on material risks
common to their industry and
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specific to their business. CSIM evaluates, on a
case-by-case basis, shareholder proposals regarding environmental, social and
governance issues, including those calling for additional disclosure of material
risks to a company, with emphasis placed on those risks identified within the
framework of the Sustainability Accounting Standards Board (SASB).
CSIM recognizes that financial performance can
be impacted by a company’s environmental, social and human capital management
policies. CSIM’s case-by-case evaluation of these proposals takes into
consideration a company’s current practices, level of reporting, disclosures by
its peers, and the existence of controversies or litigation related to the
issue.
CSIM believes that, in most instances, boards
are best positioned to determine their company’s strategy and manage its
operations, and generally does not support shareholder proposals seeking a
change in business practices.
i.
Climate Change
Proposals
CSIM believes that companies should provide
pertinent information on the management of potential climate change-related
risks, with the understanding that the relevance of this disclosure for any
specific company will vary depending on its industry and operations. For
companies operating in carbon-intensive industries, we believe boards should be
considering a range of energy demand scenarios. We generally support proposals
requesting additional disclosure on climate change-related impacts when the
company’s current reporting is inadequate.
ii.
Corporate Political
Activity Proposals
CSIM expects boards of directors to have a
stated oversight process for political contributions and lobbying activities.
CSIM evaluates proposals asking for disclosure of a company’s political
contributions and lobbying activities and generally supports them if there is no
evidence of board oversight or a company’s disclosure is deficient and lags that
of its peers.
V.
ADMINISTRATION
A.
CONFLICTS OF INTERESTS
CSIM maintains the following practices that seek
to prevent undue influence on its proxy voting activity. Such influence might
arise from any relationship between the company holding the proxy (or any
shareholder or board member of the company) and CSIM, CSIM’s affiliates, a
mutual fund or exchange-traded fund managed by CSIM (“Affiliated Fund”), an
affiliate of such Fund, or a CSIM employee. The Proxy Committee has directed
that Glass Lewis be instructed to vote any such proxies in the same proportion
as the votes of all other shareholders in the fund (i.e., “echo vote”).
With respect to proxies of an underlying
Affiliated Fund, the Investment Stewardship Team will ensure that such proxies
are “echo voted”, unless otherwise required by law. When required by law or
applicable exemptive order, the Investment Stewardship Team will also ensure the
“echo voting” of an unaffiliated mutual fund or exchange traded fund. For
example, certain exemptive orders issued to a fund by the Securities and
Exchange Commission and Section 12(d)(1)(F) of the Investment Company Act of
1940, as amended, require the fund, under certain circumstances, to “echo vote”
proxies of registered investment companies that serve as underlying investments
of the fund.
In addition, with respect to holdings of The
Charles Schwab Corporation (“CSC”) (ticker symbol: SCHW), the Investment
Stewardship Team will ensure such proxies are echo-voted, unless otherwise
required by law.
Where the Proxy Committee has delegated an item
to the Investment Stewardship Team, CSIM has taken certain steps to mitigate
perceived or potential conflicts of interest, including, but not limited to, the
following:
●
maintaining a reporting structure that separates
employees with voting authority from those with sales or business relationship
authority,
●
reporting of potential conflicts to the Proxy
Committee to review the conflict and provide final vote determination,
●
defaulting to the standard CSIM Proxy Voting
Policy.
In all other cases, proxy issues that present
material conflicts of interest between CSIM, and/or any of its affiliates, and
CSIM’s clients, will be delegated to Glass Lewis to be voted in accordance with
CSIM’s Proxy Voting Guidelines which are set each year based on governance
criteria and not influenced by any individual issuer or ballot item.
Where CSIM’s Investment Stewardship Team
conducts an engagement meeting with a company, CSIM has taken certain steps to
mitigate perceived or potential conflicts of interest, including, but not
limited to, the following:
●
ensuring that no members of the board of (i) CSC
or (ii) an Affiliated Fund, that are affiliated with such company, are
participants in such meetings.
B.
FOREIGN SECURITIES/SHAREBLOCKING
Voting proxies with respect to shares of foreign
securities may involve significantly greater effort and corresponding cost than
voting proxies with respect to domestic securities due to the variety of
regulatory schemes and corporate practices in foreign countries with respect to
proxy voting. Problems voting foreign proxies may include the following:
●
proxy statements and ballots written in a
foreign language,
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●
untimely and/or inadequate notice of shareholder
meetings,
●
restrictions of foreigner’s ability to exercise
votes,
●
requirements to vote proxies in person,
●
requirements to provide local agents with power
of attorney to facilitate CSIM’s voting instructions.
In consideration of the foregoing issues, CSIM,
in conjunction with Glass Lewis, uses its best efforts to vote foreign proxies.
As part of its ongoing oversight, the Proxy Committee will monitor the voting of
foreign proxies to determine whether all reasonable steps are taken to vote
foreign proxies. If the Proxy Committee determines that the cost associated with
the attempt to vote outweighs the potential benefits clients may derive from
voting, the Proxy Committee may decide not to attempt to vote. In addition,
certain foreign countries impose restrictions on the sale of securities for a
period of time before and/or after the shareholder meeting. To avoid these
trading restrictions, the Proxy Committee instructs Glass Lewis not to vote such
foreign proxies (share-blocking).
C.
SECURITIES LENDING
Certain of the funds managed by CSIM enter into
securities lending arrangements with lending agents to generate additional
revenue for their portfolios. In securities lending arrangements, any voting
rights that accompany the loaned securities generally pass to the borrower of
the securities, but the lender retains the right to recall a security and may
then exercise the security’s voting rights. In order to vote the proxies of
securities out on loan, the securities must be recalled prior to the established
record date. CSIM will use its best efforts to recall a fund’s securities on
loan when deemed appropriate and in the best interest of shareholders and
complies with all reporting requirements.
D.
SUB-ADVISORY RELATIONSHIPS
Where CSIM has delegated day-to-day investment
management responsibilities to an investment sub-adviser, CSIM may (but
generally does not) delegate proxy voting responsibility to such investment
sub-adviser. In addition, CSIM may share proxy voting with an investment
sub-adviser. Each sub-adviser to whom proxy voting responsibility has been
delegated will be required to review all proxy solicitation material and to make
voting decisions in the best interest of each investment company and its
shareholders, or other client associated with the securities it has been
allocated. Each sub-adviser to whom proxy voting has been delegated must inform
CSIM of its voting decisions to allow CSIM to implement the votes or in the case
of shared voting responsibility, potentially override the sub-adviser’s vote
recommendation. Prior to delegating the proxy voting responsibility, CSIM will
review each sub-adviser’s proxy voting policy to determine whether it believes
that each sub-adviser’s proxy voting policy is generally consistent with the
maximization of the value of CSIM’s clients’ investments by protecting the
long-term best interest of shareholders.
E.
REPORTING AND RECORD RETENTION
CSIM will maintain, or cause Glass Lewis to
maintain, records that identify the manner in which proxies have been voted (or
not voted) on behalf of CSIM clients. CSIM will comply with all applicable rules
and regulations regarding disclosure of its or its clients’ proxy voting records
and procedures.
CSIM will retain all proxy voting materials and
supporting documentation as required under the Investment Advisers Act of 1940,
as amended.
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