ck0001650149-20230630
STATEMENT
OF ADDITIONAL INFORMATION
HW
Opportunities MP Fund
A
series of Series Portfolios Trust
Ticker:
HOMPX
October 31,
2023
c/o
U.S. Bank Global Fund Services
P.O.
Box 701
Milwaukee,
Wisconsin 53201-0701
888-458-1963
HW
Opportunities MP Fund (the “Fund”) is a series of Series Portfolios Trust (the
“Trust”).
This
Statement of Additional Information (“SAI”) is not a prospectus, but should be
read in conjunction with the Prospectus of the Fund dated October 31,
2023,
as may be supplemented from time to time, which is incorporated by reference
into this SAI.
The
Fund’s audited financial statements and notes thereto for the fiscal year ended
June 30, 2023, and the unqualified opinion of Cohen & Company, Ltd., the
Fund’s independent registered public accounting firm, on such financial
statements are included in the Fund’s annual report to shareholders for the
fiscal year ended June 30, 2023, and are incorporated by reference into this
SAI. Copies of the Fund’s Annual
and Semi-Annual Report to shareholders may be obtained, without charge, upon
request by contacting U.S. Bank Global Fund Services at the address or telephone
number listed above, or by visiting the Fund’s website at https://hwcm.onlineprospectus.net/HWCM/HOMPX.
Hotchkis
& Wiley Capital Management, LLC — (“Advisor”)
TABLE
OF CONTENTS
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APPENDIX
A - PROXY VOTING POLICIES AND PROCEDURES |
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APPENDIX
B - DESCRIPTION OF RATINGS |
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TRUST
HISTORY
The
Trust is a Delaware statutory trust organized on July 27, 2015, and is
registered with the SEC as an open-end management investment company. The
Trust’s Declaration of Trust, as amended and/or restated to date (the
“Declaration of Trust”) permits the Trust’s Board of Trustees (the “Board”) to
issue an unlimited number of full and fractional shares of beneficial interest,
without par value, which may be issued in any number of series. The Board may
from time to time issue other series, the assets and liabilities of which will
be separate and distinct from any other series. This SAI relates only to the
Fund.
The
Declaration of Trust also provides for indemnification and reimbursement of
expenses out of the Fund’s assets for any Trustee or Trust officer held
personally liable for obligations of the Fund or the Trust. All such rights are
limited to the assets of the Fund. The Declaration of Trust further provides
that the Trust may maintain appropriate insurance (for example, fidelity bonding
and errors and omissions insurance) for the protection of the Trust, its
shareholders, trustees, officers, employees and agents to cover possible claims
and other liabilities. However, the activities of the Trust as an investment
company would not likely give rise to liabilities in excess of the Trust’s total
assets. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which both inadequate
insurance exists and the Fund itself is unable to meet its
obligations.
The
Declaration of Trust provides that the Trust shall not in any way be bound or
limited by present or future laws or customs in regard to trust investments. The
Declaration of Trust provides that a Trustee or officer shall be liable for his
or her own willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of the office of Trustee or
officer, and for nothing else, and shall not be liable for errors of judgment or
mistakes of fact or law. The Trustees, as trustees of a registered investment
company, may have a number of duties ascribed to them under the Investment
Company Act of 1940, as amended (the “1940 Act”) and the foregoing provisions
are not intended to eliminate or alter those duties.
The
Declaration of Trust provides that by virtue of becoming a shareholder of the
Trust, each shareholder is bound by the provisions of the Declaration of Trust.
The Declaration of Trust provides a detailed process for the bringing of
derivative actions by shareholders. Prior to bringing a derivative action, a
written demand by the complaining shareholder must first be made on the
Trustees. The Declaration of Trust details conditions that must be met with
respect to the demand, including the requirement that 10% of the outstanding
Shares of the Fund who are eligible to bring such derivative action under the
Delaware Statutory Trust Act join in the demand for the Trustees to commence
such derivative action. There may be questions regarding the enforceability of
this provision based on certain interpretations of the Securities Act of 1933
Act, as amended (the “1933 Act”), the Securities Exchange Act of 1934, as
amended (the “1934 Act”) and the 1940 Act.
Additionally,
the Declaration of Trust provides that the Court of Chancery of the State of
Delaware, to the extent there is subject matter jurisdiction in such court for
the claims asserted or, if not, then in the Superior Court of the State of
Delaware shall be the exclusive forum in which certain types of litigation may
be brought, which may require shareholders to have to bring an action in an
inconvenient or less favorable forum. The demand requirements set out in
Delaware law and the Declaration of Trust do not generally apply to shareholder
actions alleging violations of the Federal securities laws. There may be
questions regarding the enforceability of this provision because the 1933 Act,
the 1934 Act and the 1940 Act allow claims to be brought in state and federal
courts. The Declaration of Trust provides that shareholders waive any and all
right to trial by jury in any claim, suit, action or proceeding.
Pursuant
to the Declaration of Trust, to the extent that, at law or in equity, a Trustee
or officer of the Trust has duties (including fiduciary duties) and liabilities
relating thereto to the Trust, the shareholders or to any other person, such
Trustee or officer acting under the Declaration of Trust shall not be liable to
the Trust, the shareholders or to any other person for his or her good faith
reliance on the provisions of the Declaration of Trust. Notwithstanding the
foregoing, nothing in the Declaration of Trust modifying, restricting, or
eliminating the duties or liabilities of the Trustees shall apply to or in any
way limit the duties (including state law fiduciary duties of loyalty and care)
or liabilities of such persons of matters arising under the federal securities
laws.
INVESTMENT
POLICIES, STRATEGIES AND ASSOCIATED RISKS
The
investment objective, principal investment strategies and related principal
risks of the Fund are set forth in the Prospectus. This SAI includes additional
information about those investment strategies and risks as well as information
about other investment strategies in which the Fund may engage and the risks
associated with such strategies.
Investment
Restrictions
The
investment restrictions applicable to the Fund are set forth below and are
either fundamental or non-fundamental. Fundamental restrictions may not be
changed without a majority vote of shareholders as required by the Investment
Company Act of 1940, as amended (the “1940 Act”). Non-fundamental policies or
restrictions may be changed by the Board without shareholder
approval.
Fundamental
Investment Restrictions
The
Trust (on behalf of the Fund) has adopted the following restrictions as
fundamental policies, which may not be changed without the affirmative vote of
the holders of a “majority” of the outstanding voting securities of the Fund.
Under the 1940 Act, the “vote of the holders of a majority of the outstanding
voting securities” means the vote of the holders of the lesser of (i) 67% or
more of the shares of the Fund present at a meeting at which the holders of more
than 50% of the Fund’s outstanding shares are present or represented by proxy or
(ii) more than 50% of the outstanding shares of the Fund.
As
a matter of fundamental policy:
1.The
Fund may not lend money or other assets except to the extent permitted by (i)
the 1940 Act, or interpretations or modifications by the SEC, SEC staff or other
authority with appropriate jurisdiction, or (ii) exemptive or other relief or
permission from the SEC, SEC staff or other authority.
2.The
Fund may not borrow money, except as permitted by (i) the 1940 Act, or
interpretations or modifications by the SEC, SEC staff or other authority with
appropriate jurisdiction, or (ii) exemptive or other relief or permission from
the SEC, SEC staff or other authority.
3.The
Fund may not issue senior securities except as permitted by (i) the 1940 Act, or
interpretations or modifications by the SEC, SEC staff or other authority with
appropriate jurisdiction, or (ii) exemptive or other relief or permission from
the SEC, SEC staff or other authority.
4.The
Fund may not concentrate its investments in a particular industry, 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 the Fund may invest without
limitation in: (i) securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities; (ii) tax-exempt obligations of state or municipal
governments and their political subdivisions; (iii) securities of other
investment companies; and (iv) repurchase agreements.
5.The
Fund may not purchase or sell real estate, except as permitted by (i) the 1940
Act, or interpretations or modifications by the SEC, SEC staff or other
authority with appropriate jurisdiction, or (ii) exemptive or other relief or
permission from the SEC, SEC staff or other authority.
6.The
Fund may not buy or sell commodities or commodity (futures) contracts, except as
permitted by (i) the 1940 Act, or interpretations or modifications by the SEC,
SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or
other relief or permission from the SEC, SEC staff or other
authority.
7.The
Fund may not engage in the business of underwriting the securities of other
issuers except as permitted by (i) the 1940 Act, or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate
jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC
staff or other authority, and except to the extent that the Fund may be deemed
to be an underwriter within the meaning of the Securities Act of 1933, as
amended (the “Securities Act”) in connection with the purchase and sale of
portfolio securities.
Except
with respect to borrowing and liquidity, all percentage or rating restrictions
on an investment or use of assets set forth herein or in the Prospectus are
adhered to at the time of investment. Later changes in the percentage or rating
resulting from any cause other than actions by the Fund will not be considered a
violation of the Fund’s investment restrictions. If the value of the Fund’s
holdings of illiquid securities at any time exceeds the percentage limitation
applicable due to subsequent fluctuations in value or other reasons, the Board
will consider what actions are appropriate to maintain adequate
liquidity.
Additional
Information Regarding Fundamental Investment Restrictions
The
following descriptions of the 1940 Act may assist investors in understanding the
above policies and restrictions.
Lending.
The 1940 Act does not prohibit a fund from making loans (including lending its
securities); however, SEC staff interpretations currently prohibit funds from
lending more than one-third of their total assets (including lending its
securities), except through the purchase of debt obligations or the use of
repurchase agreements. In addition, collateral arrangements with respect to
options, forward currency and futures transactions and other derivative
instruments (as applicable), as well as delays in the settlement of securities
transactions, will not be considered loans.
For
purposes of the Fund’s fundamental investment restriction with respect to
lending, the entry into repurchase agreements, lending securities and acquiring
of debt securities shall not constitute loans by the Fund.
Senior
Securities and Borrowing.
The
1940 Act prohibits the Fund from issuing any class of senior securities or
selling any senior securities of which it is the issuer, except that the Fund is
permitted to borrow from a bank so long as, immediately after such borrowings,
there is an asset coverage of at least 300% for all borrowings of the Fund (not
including borrowings for temporary purposes in an amount not exceeding 5% of the
value of the Fund’s total assets). In the event that such asset coverage falls
below this percentage, the Fund is required to reduce the amount of its
borrowings within three days (not including Sundays and holidays) so that the
asset coverage is restored to at least 300%. Asset coverage means the ratio that
the value of a fund’s total assets (including amounts borrowed), minus
liabilities other than borrowings, bears to the aggregate amount of all
borrowings. Borrowing money to increase portfolio holdings is known as
“leveraging.” In addition, “the Derivatives Rule” under the 1940 Act permits a
fund to enter into derivatives transactions, notwithstanding the prohibitions
and restrictions on the issuance of senior securities under the 1940 Act,
provided that the fund complies with the conditions of “the Derivatives
Rule”.
Derivative
instruments are not considered to be borrowings for purposes of the Fund’s
Fundamental Investment Restrictions because they will be “covered,” as described
above.
Concentration.
The SEC staff has defined concentration as investing 25% or more of a fund’s
total assets in any particular 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. The SEC staff has further maintained that a fund should consider
the underlying investments, where easily determined, of investment companies in
which the fund is invested when determining concentration of the fund. For
purposes of the Fund’s concentration policy, the Fund may classify and
re-classify companies in a particular industry and define and re-define
industries in any reasonable manner, consistent with SEC and SEC staff guidance.
In this regard, the Advisor may analyze the characteristics of a particular
issuer and instrument and may assign an industry classification consistent with
those characteristics. The Advisor may, but need not, consider industry
classifications provided by third parties.
Non-Diversification.
Under the 1940 Act and the rules, regulations and interpretations thereunder, an
investment company is a “diversified company” if, as to 75% of its total assets,
it does 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 the investment company.
For purposes of the Fund’s diversification policy, the identification of the
issuer of a security may be determined in any reasonable manner, consistent with
SEC guidance. The Fund is non-diversified, which means that there is no
restriction under the 1940 Act on how much the Fund may invest in the securities
of one issuer. As a non-diversified investment company, the Fund may be subject
to greater risks than diversified companies because of the larger impact of
fluctuation in the values of securities of fewer issues.
However,
since the Fund intends to qualify as a “regulated investment company” under
Subchapter M of the Internal Revenue Code of 1986, as amended, (the “Code”), the
Fund will limit its investment, excluding cash, cash items (including
receivables), U.S. government securities and securities of other regulated
investment companies, so that at the close of each quarter of the taxable year,
(1) not more than 25% of the Fund’s total assets will be invested in the
securities of a single issuer, and (2) with respect to 50% of its total assets,
not more than 5% of the Fund’s total assets will be invested in the securities
of a single issuer nor represent more than 10% of the issuer’s outstanding
voting securities.
Underwriting.
The 1940 Act does not prohibit a fund from engaging in the underwriting business
or from underwriting the securities of other issuers; in fact, in the case of
diversified funds, the 1940 Act permits a fund to have underwriting commitments
of up to 25% of its assets under certain circumstances. Those circumstances
currently are that the amount of the fund’s underwriting commitments, when added
to the value of the fund’s investments in issuers where the fund owns more than
10% of the outstanding voting securities of those issuers, cannot exceed the 25%
cap.
Investment
Strategies and Related Risks
The
Fund’s principal investment strategies utilized by the Advisor and the principal
risks associated with the same are set forth in the Fund’s Prospectus. The
following discussion provides additional information about those principal
investment strategies and related risks, as well as information about investment
strategies (and related risks) that the Fund may utilize, even though they are
not considered to be “principal” investment strategies. Accordingly, an
investment strategy (and related risk) that is described below, but which is not
described in the Prospectus, should not be considered to be a non‑principal
strategy (or related risk) applicable to the Fund. The following strategies and
risks apply to the Fund directly or indirectly through its investments in
exchange-traded funds and derivatives.
Bank
Capital Securities
The
Fund may invest in bank capital securities. Bank capital securities are issued
by banks to help fulfill their regulatory capital requirements. There are two
common types of bank capital: Tier I and Tier II. Bank capital is generally, but
not always, of investment grade quality. Tier I securities often take the form
of common and non-cumulative preferred stock. Tier II securities are commonly
thought of as hybrids of debt and preferred stock, are often perpetual (with no
maturity date), callable and, under certain conditions, allow for the issuer
bank to withhold payment of interest until a later date. Subject to certain
regulatory requirements, both Tier I and Tier II securities may include trust
preferred securities. As a general matter, trust preferred securities are being
phased out as Tier I and Tier II capital of banking organizations unless they
qualify for grandfather treatment.
Bonds
The
term “bond” or “bonds” as used in the Prospectus and this SAI is intended to
include all manner of fixed income securities, debt securities and other debt
obligations unless specifically defined or the context requires
otherwise.
Borrowing
The
Fund may borrow money for investment purposes, which is a form of leveraging.
Leveraging investments, by purchasing securities with borrowed money, is a
speculative technique that increases investment risk while increasing investment
opportunity. Such borrowing may make the Fund’s NAV more volatile than funds
that do not borrow for investment purposes because leverage magnifies changes in
the Fund’s NAV and on the Fund’s investments. Although the principal of
borrowings will be fixed, the Fund’s assets may change in value during the time
the borrowing is outstanding. Leverage also creates interest expenses for the
Fund. To the extent the income derived from securities purchased with borrowed
funds exceeds the interest the Fund will have to pay, the Fund’s net income will
be greater than it would be if leverage were not used. Conversely, if the income
from the assets obtained with borrowed funds is not sufficient to cover the cost
of leveraging, the net income of the Fund will be less than it would be if
leverage were not used, and therefore the amount available for distribution to
shareholders as dividends will be reduced. The use of derivatives in connection
with leverage creates the potential for significant loss. Any leveraging will
comply with the applicable requirements of the 1940 Act and the applicable
guidance of no-action letters issued by the SEC, including Investment Company
Act Release No. 10666 (Apr. 18, 1979), intended to minimize the use of leverage
and the possibility that the Fund’s liabilities will exceed the value of its
assets.
The
Fund may also borrow money to meet redemptions or for other emergency purposes.
Such borrowings may be on a secured or unsecured basis at fixed or variable
rates of interest. The 1940 Act requires the Fund to maintain continuous asset
coverage of not less than 300% with respect to all borrowings. If such asset
coverage should decline to less than 300% due to market fluctuations or other
reasons, the Fund will be required to reduce the amount of its borrowings within
three days (not including Sundays and holidays), and may be required to dispose
of some portfolio holdings in order to reduce the Fund’s debt and restore the
300% asset coverage, even though it may be disadvantageous from an investment
standpoint to dispose of assets at that time. The Fund also may be required to
maintain minimum average balances in connection with such borrowing or to pay a
commitment or other fee to maintain a line of credit. Either of these
requirements would increase the cost of borrowing over the stated interest rate.
Convertible
Securities
The
Fund may invest in convertible securities of domestic or foreign issuers.
Convertible securities are generally preferred stocks and other securities,
including fixed income securities, which may be converted at a stated price
within a specified period of time into a certain quantity of common stock or
other equity securities of the same or a different issuer. Convertible
securities rank senior to common stock in a corporation’s capital structure but
are usually subordinated to similar non-convertible securities. While providing
a fixed income stream (generally higher in yield than the income derivable from
common stock but lower than that afforded by a similar non-convertible
security), a convertible security also affords an investor the opportunity,
through its conversion feature, to participate in the capital appreciation
attendant upon a market price advance in the convertible security’s underlying
common stock.
In
general, the market value of a convertible security is at least the higher of
its “investment value” (that is, its value as a fixed income security) or its
“conversion value” (that is, its value upon conversion into its underlying
stock). As a fixed income security, a convertible security tends to increase in
market value when interest rates decline and tends to decrease in value when
interest rates rise. However, the price of a convertible security is also
influenced by the market value of the security’s underlying common stock. The
price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. In the event of a liquidation of the underlying
company, holders of convertible securities may be paid before the company's
common stockholders but after holders of any senior debt obligations of the
company. Consequently, the issuer's convertible securities generally entail less
risk than its common stock but more risk than its debt obligations.
A
convertible security may be subject to redemption at the option of the issuer at
a predetermined price. If a convertible security held by the Fund is called for
redemption, the Fund would be required to permit the issuer to redeem the
security and convert it to underlying common stock, or would sell the
convertible security to a third party, which may have an adverse effect on the
Fund’s ability to achieve its investment objective.
Contingent
Convertible Instruments
Contingent
convertible securities (“CoCos”) are a form of hybrid debt security that are
intended to either convert into equity or have their principal written down upon
the occurrence of certain “triggers.” The triggers are generally linked to
regulatory capital thresholds or regulatory actions calling into question the
issuing banking institution’s continued viability as a going-concern. CoCos’
unique equity conversion or principal write-down features are tailored to the
issuing banking institution and its regulatory requirements. Some additional
risks associated with CoCos include, but are not limited to:
•Loss
absorption risk.
CoCos have fully discretionary coupons. This means coupons can potentially be
cancelled at the banking institution’s discretion or at the request of the
relevant regulatory authority in order to help the bank absorb
losses.
•Subordinated
instruments.
CoCos will, in the majority of circumstances, be issued in the form of
subordinated debt instruments in order to provide the appropriate regulatory
capital treatment prior to a conversion. Accordingly, in the event of
liquidation, dissolution or winding-up of an issuer prior to a conversion having
occurred, the rights and claims of the holders of the CoCos, such as the Fund,
against the issuer in respect of or arising under the terms of the CoCos shall
generally rank junior to the claims of all holders of unsubordinated obligations
of the issuer. In addition, if the CoCos are converted into the issuer’s
underlying equity securities following a conversion event (i.e.,
a “trigger”), each holder will be subordinated due to their conversion from
being the holder of a debt instrument to being the holder of an equity
instrument.
•Market
value will fluctuate based on unpredictable factors.
The value of CoCos is unpredictable and will be influenced by many factors
including, without limitation: (i) the creditworthiness of the issuer and/or
fluctuations in such issuer’s applicable capital ratios; (ii) supply and demand
for the CoCos; (iii) general market conditions and available liquidity; and (iv)
economic, financial and political events that affect the issuer, its particular
market or the financial markets in general.
Corporate
Debt Securities
The
Fund may invest in corporate debt securities (corporate bonds, debentures, notes
and other similar corporate debt instruments including convertible securities)
of domestic or foreign issuers. The rate of return or return of principal on
some debt obligations may be linked or indexed to the level of exchange rates
between the U.S. dollar and a foreign currency or currencies. Corporate debt
securities are subject to the risk of the issuer’s inability to meet principal
and interest payments on the obligation and may also be subject to price
volatility due to such factors as interest rate sensitivity, market perception
of the creditworthiness of the issuer and general market liquidity. When
interest rates rise, the value of corporate debt securities can be expected to
decline. Debt securities with longer maturities tend to be more sensitive to
interest rate movements than those with shorter maturities. Security ratings are
based on at least one major rating agency, or if unrated, of comparable quality
in the Advisor’s opinion.
Securities
rated Baa and BBB are the lowest which are considered “investment grade”
obligations. Moody’s Investors Service, Inc. (“Moody’s”) describes securities
rated Baa as “judged to be medium-grade and subject to moderate credit risk and
as such may possess certain speculative characteristics.” Standard & Poor’s
Ratings Services (“S&P”) describes securities rated BBB as “exhibiting
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.” Fitch Ratings Inc. (“Fitch”) describes
securities rated BBB, as having good credit quality with current low
expectations of default. The capacity for payment of financial commitments is
considered adequate, but adverse business or economic conditions are more likely
to impair this capacity.” For a discussion of securities rated below investment
grade, see “High Yield Securities (“Junk Bonds”) and Securities of Distressed
Companies” below.
Corporate
Loans
The
Fund may invest in corporate loans. Commercial banks and other financial
institutions make corporate loans to companies that need capital to grow or
restructure. Borrowers generally pay interest on corporate loans at rates that
change in response to changes in market interest rates such as the London
Interbank Offered Rate (“LIBOR”)1
or the prime rates of U.S. banks. As a result, the value of corporate loan
investments is generally less responsive to shifts in market interest rates.
Because the trading market for corporate loans is less developed than the
secondary market for bonds and notes, the Fund may experience difficulties from
time to time in selling its corporate loans. Borrowers frequently provide
collateral to secure repayment of these obligations. Leading financial
institutions often act as agent for a broader group of lenders, generally
referred to as a “syndicate.” The syndicate’s agent arranges the corporate
loans, holds collateral and accepts payments of principal and interest. If the
agent developed financial problems, the Fund may not recover its investment, or
there might be a delay in the Fund’s recovery. By investing in a corporate loan,
the Fund becomes a member of the syndicate.
The
Fund may invest in corporate loans directly at the time of the loan’s closing or
by buying an assignment of all or a portion of the corporate loan from a lender.
The Fund may also invest indirectly in a corporate loan by buying a loan
participation from a lender or other purchaser of a participation. Corporate
loans may include term loans, Bridge Loans (as described below) and, to the
extent permissible for the Fund, revolving credit facilities, prefunded letters
of credit term loans, delayed draw term loans and receivables purchase
facilities. For more information on corporate loans, including commercial loans,
loan participations and assignments, see “Indebtedness, Loan Participations and
Assignments” below.
Liquidity
of Corporate Loans.
The Advisor generally considers corporate loans to be liquid. To the extent such
investments are deemed to be liquid by the Advisor, they will not be subject to
the Fund’s restrictions on investments in illiquid securities. Generally, a
liquid market with institutional buyers exists for such interests. The Advisor
monitors each type of loan and/or loan interest in which the Fund is invested to
determine whether it is liquid consistent with the liquidity
1
On
July 27, 2017, the head of the United Kingdom’s Financial Conduct Authority
announced a desire to phase out the use of LIBOR by the end of 2021. There
remains uncertainty regarding the future utilization of LIBOR and the nature of
any replacement rate. See “Regulatory Risk” below for additional
information.
procedures
adopted by the Fund. No active trading market may exist for some corporate loans
and some corporate loans may be subject to restrictions on resale. A secondary
market in corporate loans may be subject to irregular trading activity, wide
bid/ask spreads and extended trade settlement periods, which may impair the
ability to accurately value existing and prospective investments and to realize
in a timely fashion the full value on sale of a corporate loan. In addition, the
Fund may not be able to readily sell its corporate loans at prices that
approximate those at which the Fund could sell such loans if they were more
widely held and traded. As a result of such potential illiquidity, the Fund may
have to sell other investments or engage in borrowing transactions if necessary
to raise cash to meet its obligations.
Covenants.
The borrower or issuer under a corporate loan or debt security generally must
comply with various restrictive covenants contained in any corporate loan
agreement between the borrower and the lending syndicate or in any trust
indenture or comparable document in connection with a corporate debt security. A
restrictive covenant is a promise by the borrower to take certain actions that
protect, or not to take certain actions that may impair, the rights of lenders.
These covenants, in addition to requiring the scheduled payment of interest and
principal, may include restrictions on dividend payments and other distributions
to shareholders, provisions requiring the borrower to maintain specific
financial ratios or relationships regarding, and/or limits on, total debt. In
addition, a covenant may require the borrower to prepay the corporate loan or
corporate debt security with any excess cash flow. Excess cash flow generally
includes net cash flow (after scheduled debt service payments and permitted
capital expenditures) as well as the proceeds from asset dispositions or sales
of securities. A breach of a covenant (after giving effect to any cure period)
in a corporate loan agreement which is not waived by the agent bank and the
lending syndicate normally is an event of acceleration. This means that the
agent bank has the right to demand immediate repayment in full of the
outstanding corporate loan. Acceleration may also occur in the case of the
breach of a covenant in a corporate debt security document. If acceleration
occurs and the Fund receives repayment before expected, the Fund will experience
prepayment risk.
Additional
Credit Risks.
Corporate loans may be issued in leveraged or highly leveraged transactions
(such as mergers, acquisitions, consolidations, liquidations, spinoffs,
reorganizations or financial restructurings), or involving distressed companies
or those in bankruptcy (including debtor-in-possession transactions). This means
that the borrower is assuming large amounts of debt in order to have large
amounts of financial resources to attempt to achieve its business objectives;
there is no guarantee, however, that the borrower will achieve its business
objectives. Loans issued in leveraged or highly leveraged transactions are
subject to greater credit risks than other loans, including an increased
possibility that the borrower might default or go into bankruptcy.
Bridge
Financings (“Bridge Loans”).
The Fund may also acquire interests in loans which are designed to provide
temporary or “bridge” financing to a borrower pending the sale of identified
assets; the arrangement of longer-term loans; or the issuance and sale of debt
obligations. The Fund may also make a commitment to participate in a bridge loan
facility. Most bridge loans are structured as floating-rate debt with step-up
provisions under which the interest rate on the bridge loan rises the longer the
loan remains outstanding. In addition, bridge loans commonly contain a
conversion feature that allows the bridge loan investor to convert its loan
interest to senior exchange notes if the loan has not been prepaid in full on or
prior to its maturity date. Bridge loans may be subordinate to other debt and
may be unsecured or under-secured. Bridge loans are subject to the same general
risks discussed above inherent to any loan investment. Due to their subordinated
nature and possible unsecured or under-secured status, bridge loans may involve
a higher degree of overall risk than more senior loans of the same borrower.
Bridge loans also generally carry the expectation that the borrower will be able
to sell the assets, obtain permanent financing or sell other debt obligations in
the near future. Any delay in these occurrences subjects the bridge loan
investor to increased credit risk and may impair the borrower’s perceived
creditworthiness. In addition, bridge loans may become permanent.
Creditor
Liability and Participation on Creditors’ Committees
Generally,
when the Fund holds bonds or other similar fixed income securities of an issuer,
the Fund becomes a creditor of the issuer. If the Fund is a creditor of an
issuer it may be subject to challenges related to the securities that it holds,
either in connection with the bankruptcy of the issuer or in connection with
another action brought by other creditors of the issuer, shareholders of the
issuer or the issuer itself. Although under no obligation to do so, the Advisor,
as investment adviser to the Fund, may from time to time have an opportunity to
consider, on behalf of the Fund and other similarly situated clients,
negotiating or otherwise participating in the restructuring of the Fund’s
portfolio investment or the issuer of such investment. The Advisor, in its
judgment and discretion and based on the considerations deemed by the Advisor to
be relevant, may believe that it is in the best interests of the Fund to
negotiate or otherwise participate in such restructuring. Accordingly, the Fund
may from time to time participate on committees formed by creditors to negotiate
with
the
management of financially troubled issuers of securities held by the Fund. Such
participation may subject the Fund to expenses such as legal fees and may make
the Fund an “insider” of the issuer for purposes of the federal securities laws,
and therefore may restrict the Fund’s ability to trade in or acquire additional
positions in a particular security when it might otherwise desire to do so.
Participation by the Fund on such committees also may expose the Fund to
potential liabilities under the federal bankruptcy laws or other laws governing
the rights of creditors and debtors. Similarly, subject to the above-mentioned
procedures, the Advisor may actively participate in bankruptcy court and related
proceedings on behalf of the Fund in order to protect the Fund’s interests in
connection with a restructuring transaction, and the Advisor may cause the Fund
to enter into an agreement reasonably indemnifying third parties or advancing
from the Fund’s assets any legal fees or other costs to third parties, including
parties involved in or assisting the Fund with a restructuring transaction, such
as trustees, servicers and other third parties. Further, the Advisor has the
authority, subject to the above-mentioned procedures, to represent the Trust, or
the Fund, on creditors’ committees (or similar committees) or otherwise in
connection with the restructuring of an issuer’s debt and generally with respect
to challenges related to the securities held by the Fund relating to the
bankruptcy of an issuer or in connection with another action brought by other
creditors of the issuer, shareholders of the issuer or the issuer
itself.
Cybersecurity
Risk
With
the increased use of technologies such as the Internet to conduct business, the
Fund is susceptible to operational, information security and related risks. In
general, cyber incidents can result from deliberate attacks or unintentional
events. Cyber attacks include, but are not limited to, gaining unauthorized
access to digital systems (e.g.,
through “hacking” or malicious software coding) for purposes of misappropriating
assets or sensitive information, corrupting data, or causing operational
disruption. Cyber attacks may also be carried out in a manner that does not
require gaining unauthorized access, such as causing denial-of-service attacks
on websites (i.e.,
efforts to make network services unavailable to intended users). Cyber incidents
affecting the Fund or its service providers have the ability to cause
disruptions and impact business operations, potentially resulting in financial
losses, interference with the Fund’s ability to calculate its net asset value
(“NAV”), impediments to trading, the inability of Fund shareholders to transact
business, violations of applicable privacy and other laws, regulatory fines,
penalties, reputational damage, reimbursement or other compensation costs, or
additional compliance costs. Similar adverse consequences could result from
cyber incidents affecting issuers of securities in which the Fund invests,
counterparties with which the Fund engages in transactions, governmental and
other regulatory authorities, exchange and other financial market operators,
banks, brokers, dealers, insurance companies and other financial institutions
(including financial intermediaries and service providers for Fund shareholders)
and other parties. In addition, substantial costs may be incurred in order to
prevent any cyber incidents in the future. While the Fund’s service providers
have established business continuity plans in the event of, and risk management
systems to prevent, such cyber incidents, there are inherent limitations in such
plans and systems including the possibility that certain risks have not been
identified. Furthermore, the Fund cannot control the cyber security plans and
systems put in place by its service providers or any other third parties whose
operations may affect the Fund or its shareholders. The Fund and its
shareholders could be negatively impacted as a result.
Defaulted
Securities
The
Fund may invest in defaulted securities. The risk of loss due to default may be
considerably greater with lower-quality securities because they are generally
unsecured and are often subordinated to other debt of the issuer. The purchase
of defaulted debt securities involves risks such as the possibility of complete
loss of the investment where the issuer does not restructure to enable it to
resume principal and interest payments. If the issuer of a security in the
Fund’s portfolio defaults, the Fund may have unrealized losses on the security,
which may lower the Fund’s NAV. Defaulted securities tend to lose much of their
value before they default. Thus, the Fund’s NAV may be adversely affected before
an issuer defaults. In addition, the Fund may incur additional expenses if it
must try to recover principal or interest payments on a defaulted
security.
Defaulted
debt securities may be illiquid and, as such, their sale may involve substantial
delays. See the discussion under “Illiquid Securities.”
Delayed
Funding Loans and Revolving Credit Facilities
The
Fund may enter into, or acquire participations in, delayed funding loans and
revolving credit facilities, in which a lender agrees to make loans up to a
maximum amount upon demand by the borrower during a specified term. These
commitments may have the effect of requiring the Fund to increase its investment
in a company at a time when it might
not
otherwise decide to do so (including at a time when the company’s financial
condition makes it unlikely that such amounts will be repaid). Delayed funding
loans and revolving credit facilities are subject to credit, interest rate and
liquidity risk and the risks of being a lender.
The
Fund may invest in delayed funding loans and revolving credit facilities with
credit quality comparable to that of issuers of its securities investments.
Delayed funding loans and revolving credit facilities may be subject to
restrictions on transfer, and only limited opportunities may exist to resell
such instruments. As a result, the Fund may be unable to sell such investments
at an opportune time or may have to resell them at less than fair market value.
The Fund currently intends to treat delayed funding loans and revolving credit
facilities for which there is no readily available market as illiquid for
purposes of the Fund’s limitation on illiquid investments. For a further
discussion of the risks involved in investing in loan participations and other
forms of direct indebtedness see “Indebtedness, Loan Participations and
Assignments.” Participation interests in revolving credit facilities will be
subject to the limitations discussed in “Indebtedness, Loan Participations and
Assignments.” Delayed funding loans and revolving credit facilities are
considered to be debt obligations for purposes of the Trust’s investment
restriction relating to the lending of funds or assets by the Fund.
Derivative
Instruments
To
the extent consistent with its investment objectives and policies and the
investment restrictions listed in this SAI, the Fund may invest in, or obtain
exposure to, futures contracts, purchase and write call and put options on
securities, securities indexes and on foreign currencies and enter into forward
contracts, swaps, and structured instruments, including without limitations,
participation notes, certificates and warrants. The Fund also may enter into
swap agreements with respect to credit default, foreign currencies, interest
rates and securities indexes. The Fund may use these techniques to hedge against
changes in interest rates, foreign currency exchange rates, or securities prices
or as part of its overall investment strategies.
In
accordance with Rule 18f-4 under the 1940 Act, the Funds have elected to be
treated as limited derivatives users, which requires that: (i) each Fund limits
its derivatives exposure to ten percent (10%) of its net assets; and (ii) the
Funds adopt and implement written policies and procedures reasonably designed to
manage its derivatives risks. Rule 18f-4(a) defines derivatives transaction to
mean: (i) a swap, security-based swap, futures contract, forward contract,
option, any combination of the foregoing, or any similar instrument under which
a fund is or may be required to make any payment or delivery of cash or other
assets during the life of the instrument or at maturity or early termination,
whether as a margin or settlement payment or otherwise; and (ii) any short sale
borrowing. In accordance with Rule 18f-4 and pursuant to procedures approved by
the Board, the Funds have elected to treat reverse repurchase agreements and
similar financing transactions as senior securities that are not subject to the
10% limit but for which a Fund must maintain 300% asset coverage.
Participation
in the markets for derivative instruments involves investment risks and
transaction costs to which the Fund may not be subject absent the use of these
strategies. The skills needed to successfully execute derivative strategies may
be different from those needed for other types of transactions. If the Fund
incorrectly forecasts the value and/or creditworthiness of securities,
currencies, interest rates, counterparties or other economic factors involved in
a derivative transaction, the Fund might have been in a better position if the
Fund had not entered into such derivative transaction. In evaluating the risks
and contractual obligations associated with particular derivative instruments,
it is important to consider that certain derivative transactions may be modified
or terminated only by mutual consent of the Fund and its counterparty and
certain derivative transactions may be terminated by the counterparty or the
Fund, as the case may be, upon the occurrence of certain Fund-related or
counterparty-related events, which may result in losses or gains to the Fund
based on the market value of the derivative transactions entered into between
the Fund and the counterparty. In addition, such early terminations may result
in taxable events and accelerate gain or loss recognition for tax purposes. It
may not be possible for the Fund to modify, terminate, or offset the Fund’s
obligations or the Fund’s exposure to the risks associated with a derivative
transaction prior to its termination or maturity date, which may create a
possibility of increased volatility and/or decreased liquidity to the Fund. Upon
the expiration or termination of a particular contract, the Fund may wish to
retain the Fund’s position in the derivative instrument by entering into a
similar contract, but may be unable to do so if the counterparty to the original
contract is unwilling to enter into the new contract and no other appropriate
counterparty can be found, which could cause the Fund not to be able to maintain
certain desired investment exposures or not to be able to hedge other investment
positions or risks, which could cause losses to the Fund. Furthermore, after
such an expiration or termination of a particular contract, the Fund may have
fewer counterparties with which to engage in additional derivative transactions,
which could lead to potentially greater counterparty risk exposure to one or
more counterparties and which could increase the cost of entering into certain
derivatives. In such cases, the Fund may lose money.
Options
on securities, futures contracts, options on futures contracts, forward currency
exchange contracts and options on forward currency exchange contracts may be
traded on foreign (non-U.S.) exchanges. Such transactions may not be regulated
as effectively as similar transactions in the United States, may not involve a
clearing mechanism and related guarantees, and are subject to the risk of
governmental actions affecting trading in, or the prices of, foreign (non-U.S.)
securities. The value of such positions also could be adversely affected by: (i)
other complex foreign political, legal and economic factors, (ii) lesser
availability than in the United States of data on which to make trading
decisions, (iii) delays in the Fund’s ability to act upon economic events
occurring in foreign (non-U.S.) markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lesser
trading volume.
Options
on Securities and on Securities Indexes. The
Fund may purchase put options on securities or security indexes to protect
holdings in an underlying or related security against a substantial decline in
market value or for speculative purposes. The Fund may also purchase call
options on securities and security indexes. The Fund may sell put or call
options it has previously purchased, which could result in a net gain or loss
depending on whether the amount realized on the sale is more or less than the
premium and other transaction costs paid on the put or call option which is
sold. The Fund may write a call or put option only if the option is “covered” by
the Fund holding a position in the underlying securities or by other means which
would permit immediate satisfaction of the Fund’s obligation as writer of the
option. Prior to exercise or expiration, an option may be closed out by an
offsetting purchase or sale of an option of the same series.
The
Fund may also purchase put and call options on stock indexes. The amount of cash
received upon exercise of a stock index option, if any, will be the difference
between the closing price of the index and the exercise price of the option,
multiplied by a specified dollar multiple. All settlements of stock index option
transactions are in cash. Some stock index options are based on a broad market
index such as the Standard & Poor's 500 Index (the “S&P 500 Index”), the
New York Stock Exchange Composite Index, or the NYSE Arca Major Market Index, or
on a narrower index such as the Philadelphia Stock Exchange Over-the-Counter
Index. Because the value of a stock index option depends upon movements in the
level of the index rather than the price of a particular stock, whether the Fund
will realize a gain or loss from the purchase of options on an index depends
upon movements in the level of stock prices in the stock market generally or, in
the case of certain indexes, in an industry or market segment, rather than upon
movements in the price of a particular stock.
The
purchase and writing of options involve certain risks. During the option period,
the covered call writer has, in return for the premium on the option, given up
the opportunity to profit from a price increase in the underlying securities
above the exercise price, but, as long as its obligation as a writer continues,
has retained the risk of loss should the price of the underlying securities
decline. The writer of an option has no control over the time when it may be
required to fulfill its obligation as a writer of the option. Once an option
writer has received an exercise notice, it cannot effect a closing purchase
transaction in order to terminate its obligation under the option and must
deliver the underlying securities at the exercise price. If a put or call option
purchased by the Fund is not sold when it has remaining value, and if the market
price of the underlying security, in the case of a put, remains equal to or
greater than the exercise price or, in the case of a call, remains less than or
equal to the exercise price, the Fund will lose its entire investment in the
option. Also, where a put or call option on a particular security is purchased
to hedge against price movements in a related security, the price of the put or
call option may move more or less than the price of the related security. There
can be no assurance that a liquid market will exist when the Fund seeks to close
out an option position. Furthermore, if trading restrictions or suspensions are
imposed on the options markets, the Fund may be unable to close out a
position.
There
are several risks associated with transactions in options on securities and on
indexes. For example, there are significant differences between the securities
and options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. A decision
as to whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
There
can be no assurance that a liquid market will exist when the Fund seeks to close
out an option position. If the Fund were unable to close out an option that it
had purchased on a security, it would have to exercise the option in order to
realize any profit or the option may expire worthless. If the Fund were unable
to close out a covered call option that it had written on a security, it would
not be able to sell the underlying security unless the option expired without
exercise. As the writer of a covered call option, the Fund forgoes, during the
option’s life, the opportunity to profit from increases in the market value of
the security covering the call option above the sum of the premium and the
exercise price of the call.
If
trading were suspended in an option purchased by the Fund, the Fund would not be
able to close out the option. If restrictions on exercise were imposed, the Fund
might be unable to exercise an option it had purchased. Except to the extent
that a call option on an index written by the Fund is covered by an option on
the same index purchased by the Fund, movements in the index may result in a
loss to the Fund; however, such losses may be mitigated by changes in the value
of the Fund’s securities during the period the option was
outstanding.
Futures
Contracts and Options on Futures Contracts. The
Fund may use interest rate, foreign currency or index futures contracts, as
specified in the Prospectus or if permitted by its investment restrictions. An
interest rate, foreign currency or index futures contract provides for the
future sale by one party and purchase by another party of a specified quantity
of a financial instrument, foreign currency or the cash value of an index at a
specified price and time. A futures contract on an index is an agreement
pursuant to which two parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index contract was
originally written. Although the value of an index might be a function of the
value of certain specified securities, no physical delivery of these securities
is made.
The
Fund may purchase and write call and put options on futures. Options on futures
possess many of the same characteristics as options on securities and indexes
(discussed above). An option on a futures contract gives the holder the right,
in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon exercise of a call option, the holder
acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is
true.
The
Fund will use futures contracts and options on futures contracts in accordance
with the rules of the Commodities Futures Trading Commission (“CFTC”). For
example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund’s securities or the price of the securities which the Fund intends to
purchase. The Fund’s hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
that Fund’s exposure to interest rate fluctuations, the Fund may be able to
hedge its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts. Pursuant to CFTC Rule 4.5, the
Advisor has filed a notice of exclusion from registration as a commodity pool
operator in respect of the Fund. The Advisor intends to limit the Fund’s use of
commodity interests so as to remain eligible for the exclusion.
Limitations
on Use of Futures and Options Thereon.
The Fund will only enter into futures contracts and futures options which are
standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
When
a purchase or sale of a futures contract is made by the Fund, the Fund is
required to deposit with its custodian (or broker, if legally permitted) a
specified amount of cash, U.S. government securities or other securities
(“initial margin”). The margin required for a futures contract is set by the
exchange on which the contract is traded and may be modified during the term of
the contract under certain circumstances such as periods of high volatility.
Margin requirements on foreign exchanges may be different than U.S. exchanges.
The initial margin is in the nature of a performance bond or good faith deposit
on the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. Each Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by the Fund is valued at the official price of the exchange on
which it is traded. Each day the Fund pays or receives cash, called “variation
margin,” equal to the daily change in value of the futures contract. This
process is known as “marking to market.” Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset value, the Fund will mark-to-market its
open futures positions.
The
Fund is also required to deposit and maintain margin with respect to put and
call options on futures contracts written by it. Such margin deposits will vary
depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund. Customer account agreements and related
addenda govern cleared derivatives transactions such as futures, options on
futures, and cleared OTC derivatives. Such transactions require posting of
initial margin as determined by each relevant clearing agency which is
segregated in an account at a futures commission merchant (“FCM”) registered
with the CFTC. In the
United
States, counterparty risk may be reduced as creditors of an FCM cannot have a
claim to Fund assets in the segregated account. Portability of exposure reduces
risk to the Fund. Variation margin, or changes in market value, are generally
exchanged daily, but may not be netted between futures and cleared OTC
derivatives unless the parties have agreed to a separate arrangement in respect
of portfolio margining.
Although
some futures contracts call for making or taking delivery of the underlying
securities or commodities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index, and delivery month). Closing out a
futures contract sale is effected by purchasing a futures contract for the same
aggregate amount of the specific type of financial instrument or commodity with
the same delivery date. If an offsetting purchase price is less than the
original sale price, the Fund realizes a capital gain, or if it is more, the
Fund realizes a capital loss. Conversely, if an offsetting sale price is more
than the original purchase price, the Fund realizes a capital gain, or if it is
less, the Fund realizes a capital loss. The transaction costs must also be
included in these calculations.
The
requirements for qualification as a regulated investment company for federal
income tax purposes also may limit the extent to which the Fund may enter into
futures, futures options and forward contracts.
Risk
Factors in Futures Transactions and Options. Investment
in futures contracts involves the risk of imperfect correlation between
movements in the price of the futures contract and the price of the security
being hedged. The hedge will not be fully effective when there is imperfect
correlation between the movements in the prices of two financial instruments.
For example, if the price of the futures contract moves more than the price of
the hedged security, the Fund will experience either a loss or gain on the
futures contract which is not completely offset by movements in the price of the
hedged securities. To compensate for imperfect correlations, the Fund may
purchase or sell futures contracts in a greater dollar amount than the hedged
securities if the volatility of the hedged securities is historically greater
than the volatility of the futures contracts. Conversely, the Fund may purchase
or sell fewer futures contracts if the volatility of the price of the hedged
securities is historically less than that of the futures contracts.
The
particular securities comprising the index underlying the index financial
futures contract may vary from the securities held by the Fund. As a result, the
Fund’s ability to hedge effectively all or a portion of the value of its
securities through the use of such financial futures contracts will depend in
part on the degree to which price movements in the index underlying the
financial futures contract correlate with the price movements of the securities
held by the Fund. The correlation may be affected by disparities in the Fund’s
investments as compared to those comprising the index and general economic or
political factors. In addition, the correlation between movements in the value
of the index may be subject to change over time as additions to and deletions
from the index alter its structure. The trading of futures contracts also is
subject to certain market risks, such as inadequate trading activity, which
could at times make it difficult or impossible to liquidate existing
positions.
The
Fund expects to liquidate a majority of the futures contracts it enters into
through offsetting transactions on the applicable contract market. There can be
no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund’s
ability to hedge effectively its investments. The liquidity of a secondary
market in a futures contract may be adversely affected by “daily price
fluctuation limits” established by commodity exchanges which limit the amount of
fluctuation in a futures contract price during a single trading day. Once the
daily limit has been reached in the contract, no trades may be entered into at a
price beyond the limit, thus preventing the liquidation of open futures
positions. Prices have in the past moved beyond the daily limit on a number of
consecutive trading days. The Fund will enter into a futures position only if,
in the judgment of the Advisor, there appears to be an actively traded secondary
market for such futures contracts.
The
successful use of transactions in futures and related options also depends on
the ability of the Advisor to forecast correctly the direction and extent of
interest rate movements within a given time frame. To the extent interest rates
remain stable during the period in which a futures contract or option is held by
the Fund or such rates move in a direction opposite to that anticipated, the
Fund may realize a loss on a hedging transaction which is not fully or partially
offset by an increase in the value of portfolio securities. As a result, the
Fund’s total return for such period may be less than if it had not engaged in
the hedging transaction.
Because
of low initial margin deposits made upon the opening of a futures position,
futures transactions involve substantial leverage. As a result, relatively small
movements in the price of the futures contracts can result in substantial
unrealized gains or losses. There is also the risk of loss by the Fund of margin
deposits in the event of the bankruptcy of a broker with whom the Fund has an
open position in a financial futures contract.
The
amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option on
a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
option purchased.
Risks
of Potential Government Regulation of Derivatives.
It is possible that government regulation of various types of derivative
instruments, including futures, options and swap agreements, may limit or
prevent the Fund from using such instruments as a part of its investment
strategy, and could ultimately prevent the Fund from being able to achieve its
investment objective. It is impossible to fully predict the effects of past,
present and future legislation and regulation in this area, but the effects
could be substantial and adverse. It is possible that legislative or regulatory
activity could limit or restrict the ability of the Fund to use certain
instruments as part of its investment strategy. Limits or restrictions
applicable to the counterparties or issuers, as applicable, with which the Fund
engages in derivative transactions could also prevent or limit the Fund from
using certain instruments.
The
futures markets are subject to comprehensive statutes, regulations, and margin
requirements. The SEC, the CFTC and the exchanges are authorized to take
extraordinary actions in the event of a market emergency, including, for
example, the implementation or reduction of speculative position limits, the
implementation of higher margin requirements, the establishment of daily price
limits and the suspension of trading.
The
regulation of futures, options and swap transactions in the U.S. is a changing
area of law and is subject to modification by government and judicial action.
There is a possibility of future regulatory changes altering, perhaps to a
material extent, the nature of an investment in the Fund or the ability of the
Fund to continue to implement its investment strategies. In particular, the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)
sets forth a legislative framework for over-the-counter (“OTC”) derivatives,
such as swaps, in which the Fund may invest. Title VII of the Dodd-Frank Act
makes broad changes to the OTC derivatives market, grants significant new
authority to the SEC and the CFTC to regulate OTC derivatives and market
participants, and requires clearing and exchange trading of many OTC derivatives
transactions.
Provisions
in the Dodd-Frank Act include capital and margin requirements and the mandatory
use of clearinghouse mechanisms for many OTC derivative transactions. The CFTC,
SEC and other federal regulators have been developing the rules and regulations
enacting the provisions of the Dodd-Frank Act. It is not possible at this time
to gauge the exact nature and full scope of the impact of the Dodd-Frank Act on
the Fund. However, swap dealers, major market participants and swap
counterparties are experiencing, and will continue to experience, new and
additional regulations, requirements, compliance burdens and associated costs.
The Dodd-Frank Act and the rules to be promulgated thereunder may negatively
impact the Fund’s ability to meet its investment objective either through limits
or requirements imposed on it or upon its counterparties. In particular, new
position limits imposed on the Fund or its counterparties may impact that Fund’s
ability to invest in futures, options and swaps in a manner that efficiently
meets its investment objective. New requirements, even if not directly
applicable to the Fund, including margin requirements, changes to the CFTC
speculative position limits regime and mandatory clearing, may increase the cost
of the Fund’s investments and cost of doing business, which could adversely
affect shareholders.
Emerging
Market Securities
The
Fund may invest in securities and instruments that are economically tied to
developing (or “emerging market”) countries. The Advisor generally considers an
instrument to be economically tied to an emerging market country if the issuer
or guarantor is a government of an emerging market country (or any political
subdivision, agency, authority or instrumentality of such government), if the
issuer or guarantor is organized under the laws of an emerging market country,
or if the currency of settlement of the security is a currency of an emerging
market country. With respect to derivative instruments, the Advisor generally
considers such instruments to be economically tied to emerging market countries
if the underlying assets are currencies of emerging market countries (or baskets
or indexes of such currencies), or instruments or securities that are issued or
guaranteed by governments of emerging market countries or by entities organized
under
the
laws of emerging market countries. The Advisor has broad discretion to identify
countries that it considers to qualify as emerging markets. In making
investments in emerging market securities, the Fund emphasizes countries with
relatively low gross national product per capita and with the potential for
rapid economic growth. Emerging market countries are generally located in Asia,
Africa, the Middle East, Latin America and Eastern Europe. The Advisor will
select the country and currency composition based on its evaluation of relative
interest rates, inflation rates, exchange rates, monetary and fiscal policies,
trade and current account balances, and any other specific factors it believes
to be relevant.
Investing
in emerging market securities imposes risks different from, or greater than,
risks of investing in domestic securities or in foreign, developed countries.
These risks include: smaller market capitalization of securities markets, which
may suffer periods of relative illiquidity; significant price volatility;
restrictions on foreign investment; possible repatriation of investment income
and capital. In addition, foreign investors may be required to register the
proceeds of sales; future economic or political crises could lead to price
controls, forced mergers, expropriation or confiscatory taxation, seizure,
nationalization, or creation of government monopolies. The currencies of
emerging market countries may experience significant declines against the U.S.
dollar, and devaluation may occur subsequent to investments in these currencies
by the Fund. Inflation and rapid fluctuations in inflation rates have had, and
may continue to have, negative effects on the economies and securities markets
of certain emerging market countries.
Additional
risks of emerging market securities may include: greater social, economic and
political uncertainty and instability; more substantial governmental involvement
in the economy; less governmental supervision and regulation; unavailability of
currency hedging techniques; companies that are newly organized and small;
differences in auditing and financial reporting standards, which may result in
unavailability of material information about issuers; and less developed legal
systems. In addition, emerging securities markets may have different clearance
and settlement procedures, which may be unable to keep pace with the volume of
securities transactions or otherwise make it difficult to engage in such
transactions. Settlement problems may cause the Fund to miss attractive
investment opportunities, hold a portion of its assets in cash pending
investment, or be delayed in disposing of a portfolio security. Such a delay
could result in possible liability to a purchaser of the security.
The
Fund may invest in Brady Bonds, which are securities created through the
exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with debt restructurings. Investments in Brady Bonds
may be viewed as speculative. Brady Bonds acquired by the Fund may be subject to
restructuring arrangements or to requests for new credit, which may cause the
Fund to suffer a loss of interest or principal on any of its holdings of
relevant Brady Bonds.
Foreign
investment risk may be particularly high to the extent that the Fund invests in
emerging market securities that are economically tied to countries with
developing economies. These securities may present market, credit, currency,
liquidity, legal, political and other risks different from, or greater than, the
risks of investing in developed foreign countries.
Equity
Securities
Equity
securities, such as common stock, represent an ownership interest, or the right
to acquire an ownership interest, in an issuer and have greater price volatility
than fixed income securities. The market price of equity securities owned by the
Fund may go up or down, sometimes rapidly or unpredictably.
Common
stock generally takes the form of shares in a corporation. The value of a
company’s stock may fall as a result of factors directly relating to that
company, such as decisions made by its management or lower demand for the
company’s products or services. A stock’s value also may fall because of factors
affecting not just the company, but also companies in the same industry or in a
number of different industries, such as increases in production costs. The value
of a company's stock also may be affected by changes in financial markets that
are relatively unrelated to the company or its industry, such as changes in
interest rates or currency exchange rates. In addition, a company’s stock
generally pays dividends only after the company invests in its own business and
makes required payments to holders of its bonds, other debt and preferred stock.
For this reason, the value of a company’s stock will usually react more strongly
than its bonds, other debt and preferred stock to actual or perceived changes in
the company's financial condition or prospects. Stocks of smaller companies may
be more vulnerable to adverse developments than those of larger companies.
Stocks of companies that the portfolio managers believe are fast-growing may
trade at a higher multiple of current earnings than other stocks. The value of
such stocks may be more sensitive to changes in current or expected earnings
than the values of other stocks.
Different
types of equity securities provide different voting and dividend rights and
priority in the event of the bankruptcy and/or insolvency of the issuer. In
addition to common stock, equity securities may include preferred stock,
convertible securities and warrants, which are discussed elsewhere in the
Prospectus and this SAI. Equity securities other than common stock are subject
to many of the same risks as common stock, although possibly to different
degrees. The risks of equity securities are generally magnified in the case of
equity investments in distressed companies.
Euro-
and EU-related Risks
The
global economic crisis brought several small economies in Europe to the brink of
bankruptcy and many other economies into recession and weakened the banking and
financial sectors of many European countries. In addition, due to large public
deficits, some European countries may be dependent on assistance from other
European governments and institutions or other central banks or supranational
agencies such as the International Monetary Fund. Assistance may be dependent on
a country’s implementation of reforms or reaching a certain level of
performance. Failure to reach those objectives or an insufficient level of
assistance could result in a deep economic downturn which could significantly
affect the value of the Fund’s European investments.
The
Economic and Monetary Union of the European Union (“EMU”) is comprised of the
European Union (“EU”) members that have adopted the euro currency. By adopting
the euro as its currency, a member state relinquishes control of its own
monetary policies. As a result, European countries are significantly affected by
fiscal and monetary policies implemented by the EMU and European Central Bank.
The euro currency may not fully reflect the strengths and weaknesses of the
various economies that comprise the EMU and Europe generally. It is possible
that one or more EMU member countries could abandon the euro and return to a
national currency and/or that the euro will cease to exist as a single currency
in its current form. The effects of such an abandonment or a country’s forced
expulsion from the euro on that country, the rest of the EMU, and global markets
are impossible to predict, but are likely to be negative. The exit of any
country out of the euro may have an extremely destabilizing effect on other
eurozone countries and their economies and a negative effect on the global
economy as a whole. Such an exit by one country may also increase the
possibility that additional countries may exit the euro should they face similar
financial difficulties. In addition, in the event of one or more countries’ exit
from the euro, it may be difficult to value investments denominated in euros or
in a replacement currency.
In
June 2016, the United Kingdom (the “UK”) held a referendum resulting in a vote
in favor of the exit of the UK from the EU (known as “Brexit”). On January 31,
2020, the UK ceased to be a member of the EU and the EU-UK Withdrawal Agreement
came into force. On January 1, 2021, the EU-UK Trade and Cooperation Agreement
provisionally took effect and came into force on May 1, 2021. Significant
uncertainty remains regarding ramifications of the EU-UK Trade and Cooperation
Agreement on the UK, other EU countries and the global economy.
Whether
or not the Fund invests in securities of issuers located in Europe or has
significant exposure to European issuers or countries, these events could
negatively affect the value and liquidity of the Fund’s
investments.
Event-Linked
Exposure
The
Fund may obtain event-linked exposure by investing in “event-linked bonds” or
“event-linked swaps” or implement “event-linked strategies.” Event-linked
exposure results in gains or losses that typically are contingent, or
formulaically related to, defined trigger events. Examples of trigger events
include hurricanes, earthquakes, weather-related phenomena, or statistics
relating to such events. Some event-linked bonds are commonly referred to as
“catastrophe bonds.” If a trigger event occurs, the Fund may lose a portion of
or its entire principal invested in the bond or notional amount on a swap.
Event-linked exposure often provides for an extension of maturity to process and
audit loss claims where a trigger event has, or possibly has, occurred. An
extension of maturity may increase volatility. Event-linked exposure may also
expose the Fund to certain unanticipated risks including credit risk,
counterparty risk, adverse regulatory or jurisdictional interpretations, and
adverse tax consequences. Event-linked exposures may also be subject to
liquidity risk.
Financial
Sector Risk
The
Fund may invest a significant portion of its assets in companies in the
financial sector, and therefore the performance of the Fund could be negatively
impacted by events affecting this sector. This sector can be significantly
affected by changes in interest rates, government regulation, the rate of
defaults on corporate, consumer and government debt, the availability and cost
of capital, and the impact of more stringent capital requirements.
Foreign
(Non-U.S.) Currencies
The
Fund may invest directly in foreign currencies or in securities that trade in,
or receive revenues in, foreign currencies and will be subject to currency risk.
Foreign currency exchange rates may fluctuate significantly over short periods
of time. They generally are determined by supply and demand in the foreign
exchange markets and the relative merits of investments in different countries,
actual or perceived changes in interest rates and other complex factors.
Currency exchange rates also can be affected unpredictably by intervention (or
the failure to intervene) by U.S. or foreign governments or central banks, or by
currency controls or political developments.
The
Fund may engage in foreign currency transactions on a spot (cash) basis, and
enter into forward foreign currency exchange contracts and invest in foreign
currency futures contracts and options on foreign currencies and futures. A
forward foreign currency exchange contract, which involves an obligation to
purchase or sell a specific currency at a future date at a price set at the time
of the contract, reduces the Fund’s exposure to changes in the value of the
currency it will deliver and increases its exposure to changes in the value of
the currency it will receive for the duration of the contract. Certain foreign
currency transactions may also be settled in cash rather than the actual
delivery of the relevant currency. The effect on the value of the Fund is
similar to selling securities denominated in one currency and purchasing
securities denominated in another currency. A contract to sell foreign currency
would limit any potential gain which might be realized if the value of the
hedged currency increases. The Fund may enter into these contracts to hedge
against foreign exchange risk, to increase exposure to a foreign currency or to
shift exposure to foreign currency fluctuations from one currency to another.
Suitable hedging transactions may not be available in all circumstances and
there can be no assurance that the Fund will engage in such transactions at any
given time or from time to time. Also, such transactions may not be successful
and may eliminate any chance for the Fund to benefit from favorable fluctuations
in relevant foreign currencies. The Fund may use one currency (or a basket of
currencies) to hedge against adverse changes in the value of another currency
(or a basket of currencies) when exchange rates between the two currencies are
positively correlated.
Foreign
Currency Options and Related Risks
The
Fund may take positions in options on foreign currencies to hedge against the
risk of foreign exchange rate fluctuations on foreign securities the Fund holds
in its portfolio or intend to purchase. For example, if the Fund were to enter
into a contract to purchase securities denominated in a foreign currency, it
could effectively fix the maximum U.S. dollar cost of the securities by
purchasing call options on that foreign currency. Similarly, if the Fund held
securities denominated in a foreign currency and anticipated a decline in the
value of that currency against the U.S. dollar, it could hedge against such a
decline by purchasing a put option on the currency involved. The markets in
foreign currency options are relatively new, and the Fund’s ability to establish
and close out positions in such options is subject to the maintenance of a
liquid secondary market. There can be no assurance that a liquid secondary
market will exist for a particular option at any specific time. In addition,
options on foreign currencies are affected by all of those factors that
influence foreign exchange rates and investments generally.
The
quantities of currencies underlying option contracts represent odd lots in a
market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There
is no systematic reporting of last sale information for foreign currencies or
any regulatory requirement that quotations be firm or revised on a timely basis.
Quotation information is generally representative of very large transactions in
the interbank market and may not reflect smaller transactions where rates may be
less favorable. Option markets may be closed while round-the-clock interbank
currency markets are open, and this can create price and rate
discrepancies.
Risks
of Options Trading. The
Fund may effectively terminate its rights or obligations under options by
entering into closing transactions. Closing transactions permit the Fund to
realize profits or limit losses on its options positions prior to the exercise
or expiration of the option. The value of a foreign currency option depends on
the value of the underlying currency relative to the U.S. dollar. Other factors
affecting the value of an option are the time remaining until expiration, the
relationship of the exercise price to market price, the historical price
volatility of the underlying currency and general market conditions. As a
result, changes in the value of an option position may have no relationship to
the investment merit of a foreign security. Whether a profit or loss is realized
on a closing transaction depends on the price movement of the underlying
currency and the market value of the option.
Options
normally have expiration dates of up to nine months. The exercise price may be
below, equal to or above the current market value of the underlying currency.
Options that expire unexercised have no value, and a Fund will realize a loss of
any premium paid and any transaction costs. Closing transactions may be effected
only by negotiating directly with the other party to the option contract, unless
a secondary market for the options develops. Although the Fund intends to enter
into foreign currency options only with dealers which agree to enter into, and
which are expected to be capable of entering into, closing transactions with the
Fund, there can be no assurance that the Fund will be able to liquidate an
option at a favorable price at any time prior to expiration. In the event of
insolvency of the counterparty, the Fund may be unable to liquidate a foreign
currency option. Accordingly, it may not be possible to effect closing
transactions with respect to certain options, with the result that the Fund
would have to exercise those options that it had purchased in order to realize
any profit.
Foreign
Investment Risks
Foreign
Market Risk.
The Fund may invest in foreign securities. Foreign security investment involves
special risks not present in U.S. investments that can increase the chances that
the Fund will lose money.
Foreign
Economy Risk.
The economies of certain foreign markets often do not compare favorably with
that of the United States with respect to such issues as growth of gross
national product, reinvestment of capital, resources, and balance of payments
position. Certain such economies may rely heavily on particular industries or
foreign capital and are more vulnerable to diplomatic developments, the
imposition of economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers, and other
protectionist or retaliatory measures. Investments in foreign markets may also
be adversely affected by governmental actions such as the imposition of capital
controls, nationalization of companies or industries, expropriation of assets,
or the imposition of punitive taxes. In addition, the governments of certain
countries may prohibit or impose substantial restrictions on foreign investing
in their capital markets or in certain industries. Any of these actions could
severely affect security prices, impair the Fund’s ability to purchase or sell
foreign securities or otherwise adversely affect the Fund’s operations. Other
foreign market risks include difficulties in pricing securities, defaults on
foreign government securities, difficulties in enforcing favorable legal
judgments in foreign courts, and political and social instability. Legal
remedies available to investors in certain foreign countries may be less
extensive than those available to investors in the United States or other
foreign countries.
Governmental
Supervision and Regulation/Accounting Standards. Many
foreign governments supervise and regulate stock exchanges, brokers and the sale
of securities less than the U.S. government does. Some countries may not have
laws to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund’s portfolio managers to completely and accurately determine a company’s
financial condition.
The
foreign countries in which the Fund invests may become subject to economic and
trade sanctions or embargoes imposed by the U.S. or foreign governments or the
United Nations. Such sanctions or other actions could result in the devaluation
of a country’s currency or a decline in the value and liquidity of securities of
issuers in that country. In addition, such sanctions could result in a freeze on
an issuer’s securities which would prevent the Fund from selling securities it
holds. The value of the securities issued by companies that operate in, or have
dealings with these countries may be negatively impacted by any such sanction or
embargo and may reduce the Fund’s returns. The risks related to sanctions or
embargoes are greater in emerging and frontier market countries.
Dividends
or interest on, or proceeds from the sale of, foreign securities may be subject
to foreign withholding taxes, and special U.S. tax considerations may
apply.
Foreign
(Non-U.S.) Securities
The
Fund may invest in securities and instruments that are economically tied to
foreign (non-U.S.) countries. The Advisor generally considers an instrument to
be economically tied to a non-U.S. country if the issuer is a foreign government
(or any political subdivision, agency, authority or instrumentality of such
government), or if the issuer is organized under the laws of a non-U.S. country.
In the case of certain money market instruments, such instruments will be
considered economically tied to a non-U.S. country if either the issuer or the
guarantor of such money market instrument is organized under the laws of a
non-U.S. country. With respect to derivative instruments, the Advisor generally
considers such instruments to be economically tied to non-U.S. countries if the
underlying assets are foreign currencies (or baskets or
indexes
of such currencies), or instruments or securities that are issued by foreign
governments or issuers organized under the laws of a non-U.S. country (or if the
underlying assets are certain money market instruments, if either the issuer or
the guarantor of such money market instruments is organized under the laws of a
non-U.S. country).
Investing
in foreign securities involves special risks and considerations not typically
associated with investing in U.S. securities. Shareholders should consider
carefully the substantial risks involved for the Fund from investing in
securities issued by foreign companies and governments of foreign countries.
These risks include: differences in accounting, auditing and financial reporting
standards; generally higher commission rates on foreign portfolio transactions;
the possibility of nationalization, expropriation or confiscatory taxation;
adverse changes in investment or exchange control regulations; and political
instability. Individual foreign economies may differ favorably or unfavorably
from the U.S. economy in such respects as growth of gross domestic product,
rates of inflation, capital reinvestment, resources, self-sufficiency and
balance of payments position. The securities markets, values of securities,
yields and risks associated with foreign securities markets may change
independently of each other. Also, foreign securities and dividends and interest
payable on those securities may be subject to foreign taxes, including taxes
withheld from payments on those securities. Foreign securities often trade with
less frequency and volume than domestic securities and therefore may exhibit
greater price volatility. Restrictions on global trade may have an adverse
impact on foreign securities held by the Fund. Investments in foreign securities
may also involve higher custodial costs than domestic investments and additional
transaction costs with respect to foreign currency conversions. Changes in
foreign exchange rates also will affect the value of securities denominated or
quoted in foreign currencies.
The
Fund may invest in, or obtain exposure to, the securities of foreign issuers in
the form of Depositary Receipts or other securities convertible into securities
of foreign issuers or other foreign securities. These securities may not
necessarily be denominated in the same currency as the securities into which
they may be converted. American Depositary Receipts (“ADRs”) are receipts
typically issued by an American bank or trust company that evidence ownership of
underlying securities issued by a foreign corporation. European Depositary
Receipts (“EDRs”) are receipts issued in Europe that evidence a similar
ownership arrangement. Global Depositary Receipts (“GDRs”) are receipts issued
throughout the world that evidence a similar arrangement. Generally, ADRs, in
registered form, are designed for use in the U.S. securities markets, and EDRs,
in bearer form, are designed for use in European securities markets. GDRs are
tradable both in the United States and in Europe and are designed for use
throughout the world. The Fund may invest in unsponsored Depositary Receipts.
The issuers of unsponsored Depositary Receipts are not obligated to disclose
material information in the United States, and, therefore, there may be less
information available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary Receipts.
Depositary Receipts are generally subject to the same risks as the foreign
securities that they evidence or into which they may be converted.
The
Fund also may invest in sovereign debt issued by governments, their agencies or
instrumentalities, or other government-related entities. Holders of sovereign
debt may be requested to participate in the rescheduling of such debt and to
extend further loans to governmental entities. In addition, there is no
bankruptcy proceeding by which defaulted sovereign debt may be
collected.
Forward
Foreign Currency Exchange Contracts
The
Fund may use forward foreign currency exchange contracts (“forward contracts”)
to protect against uncertainty in the level of future exchange rates.
The
Fund may enter into forward contracts with respect to specific transactions. For
example, when the Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, or when the Fund anticipates the
receipt in a foreign currency of dividend or interest payments on a security
that it holds, the Fund may desire to “lock in” the U.S. dollar price of the
security or the U.S. dollar equivalent of the payment, by entering into a
forward contract for the purchase or sale, for a fixed amount of U.S. dollars or
foreign currency, of the amount of foreign currency involved in the underlying
transaction. The Fund will thereby be able to protect itself against a possible
loss resulting from an adverse change in the relationship between the currency
exchange rates during the period between the date on which the security is
purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
The
Fund also may use forward contracts in connection with portfolio positions to
lock in the U.S. dollar value of those positions, to increase the Fund’s
exposure to foreign currencies that the Advisor believes may rise in value
relative to the U.S. dollar or to shift the Fund’s exposure to foreign currency
fluctuations from one country to another. For example, when the Advisor believes
that the currency of a particular foreign country may suffer a substantial
decline relative to the U.S.
dollar
or another currency, it may enter into a forward contract to sell the amount of
the former foreign currency approximating the value of some or all of the Fund’s
portfolio securities denominated in such foreign currency. This investment
practice generally is referred to as “cross-hedging” when another foreign
currency is used.
The
precise matching of the forward contract amounts and the value of the securities
involved will not generally be possible because the future value of such
securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. Under normal circumstances,
consideration of the prospect for currency parities will be incorporated into
the longer term investment decisions made with regard to overall diversification
strategies. However, the Advisor believes it is important to have the
flexibility to enter into such forward contracts when it determines that the
best interests of the Fund will be served.
At
or before the maturity date of a forward contract that requires the Fund to sell
a currency, the Fund may either sell a portfolio security and use the sale
proceeds to make delivery of the currency or retain the security and offset its
contractual obligation to deliver the currency by purchasing a second contract
pursuant to which the Fund will obtain, on the same maturity date, the same
amount of the currency that it is obligated to deliver. Similarly, the Fund may
close out a forward contract requiring it to purchase a specified currency by
entering into a second contract entitling it to sell the same amount of the same
currency on the maturity date of the first contract. The Fund would realize a
gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second
contracts.
The
cost to the Fund of engaging in forward contracts varies with factors such as
the currencies involved, the length of the contract period and the market
conditions then prevailing. Because forward contracts are usually entered into
on a principal basis, no fees or commissions are involved. The use of forward
contracts does not eliminate fluctuations in the prices of the underlying
securities the Fund owns or intends to acquire, but it does fix a rate of
exchange in advance. In addition, although forward contracts limit the risk of
loss due to a decline in the value of the hedged currencies, at the same time
they limit any potential gain that might result should the value of the
currencies increase.
Although
the Fund values its assets daily in terms of U.S. dollars, it does not intend to
convert holdings of foreign currencies into U.S. dollars on a daily basis. The
Fund may convert foreign currency from time to time, and investors should be
aware of the costs of currency conversion. Although foreign exchange dealers do
not charge a fee for conversion, they do realize a profit based on the
difference between the prices at which they are buying and selling various
currencies. Thus, a dealer may offer to sell a foreign currency to the Fund at
one rate, while offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
General
Market Risks
U.S.
and global markets have experienced significant volatility in recent years. The
Fund is 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, pandemics and
epidemics) and natural/environmental disasters, which can all negatively impact
the securities markets and cause the Fund to lose value. These events can also
impair the technology and other operational systems upon which the Fund’s
service providers, including the Fund’s investment adviser, rely, and could
otherwise disrupt the Fund’s service providers’ ability to fulfill their
obligations to the Fund.
The
pandemic caused by COVID-19 has caused volatility, severe market dislocations
and liquidity constraints in many markets, including markets for the securities
the Fund holds, and may adversely affect the Fund’s investments and operations.
The transmission of COVID-19 and efforts to contain its spread resulted 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 furloughs
and reductions) and supply chains, and a reduction in consumer and business
spending, as well as general concern and uncertainty that has negatively
affected the economy. These disruptions led to instability in the market place,
including equity and debt market losses and overall volatility, and the jobs
market. The impact of COVID-19, and other infectious illness outbreaks,
epidemics or pandemics that may arise in the future, could adversely affect the
economies of many nations or the entire global economy, the financial well-being
and performance of individual issuers, borrowers and sectors and the health of
the markets generally in potentially significant and unforeseen ways. In
addition, the impact of infectious illnesses, such as COVID-19, in emerging
market countries may be greater due to generally less established healthcare
systems. This crisis or other public health crises may exacerbate other
pre-existing political, social and economic risks in certain countries or
globally.
The
foregoing could lead to a significant economic downturn or recession, increased
market volatility, a greater number of market closures, 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 Fund. 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 Fund being, among other things, unable to buy or sell certain
securities or financial instruments or to accurately price its investments.
These and other developments may adversely affect the liquidity of the Fund’s
holdings.
High
Yield Securities (“Junk Bonds”) and Securities of Distressed Companies
Investments
in securities rated below investment grade are described as “speculative” by
Moody’s, S&P and Fitch. Investment in lower rated corporate debt securities
(“high yield securities” or “junk bonds”) and securities of distressed companies
generally provides greater income and increased opportunity for capital
appreciation than investments in higher quality securities, but they also
typically entail greater price volatility and principal and income risk.
Securities of distressed companies include both debt and equity securities. High
yield securities and debt securities of distressed companies are regarded as
predominantly speculative with respect to the issuer’s continuing ability to
meet principal and interest payments. Issuers of high yield and distressed
company securities may be involved in restructurings or bankruptcy proceedings
that may not be successful. Analysis of the creditworthiness of issuers of debt
securities that are high yield or debt securities of distressed companies may be
more complex than for issuers of higher quality debt securities.
High
yield securities and debt securities of distressed companies may be more
susceptible to real or perceived adverse economic and competitive industry
conditions than investment grade securities. The prices of these securities have
been found to be less sensitive to interest-rate changes than higher-rated
investments, but more sensitive to adverse economic downturns or individual
corporate developments. A projection of an economic downturn, for example, could
cause a decline in prices of high yield securities and debt securities of
distressed companies because the advent of a recession could lessen the ability
of a highly leveraged company to make principal and interest payments on its
debt securities, and a high yield security may lose significant market value
before a default occurs. If an issuer of securities defaults, in addition to
risking payment of all or a portion of interest and principal, the Fund, by
investing in such securities, may incur additional expenses to seek recovery of
its investment. In the case of securities structured as zero-coupon or
pay-in-kind securities, their market prices are affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than securities
which pay interest periodically and in cash.
High
yield and distressed company securities may not be listed on any exchange and a
secondary market for such securities may be comparatively illiquid relative to
markets for other more liquid fixed income securities. Consequently,
transactions in high yield and distressed company securities may involve greater
costs than transactions in more actively traded securities, which could
adversely affect the price at which the Fund could sell a high yield or
distressed company security, and could adversely affect the NAV of the Fund. A
lack of publicly available information, irregular trading activity and wide
bid/ask spreads among other factors, may, in certain circumstances, make high
yield debt more difficult to sell at an advantageous time or price than other
types of securities or instruments. These factors may result in the Fund being
unable to realize full value for these securities and/or may result in the Fund
not receiving the proceeds from a sale of a high yield or distressed company
security for an extended period after such sale, each of which could result in
losses to the Fund. In addition, adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the values and
liquidity of high yield and distressed company securities, especially in a
thinly-traded market. When secondary markets for high yield and distressed
company securities are less liquid than the market for other types of
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
The
Advisor
seeks to minimize the risks of investing in all securities through
diversification, in-depth analysis and attention to current market developments.
The
use of credit ratings in evaluating high yield securities and debt securities of
distressed companies can involve certain risks. For example, credit ratings
evaluate the safety of principal and interest payments of a debt security, not
the market value risk of a security. Also, credit rating agencies may fail to
change credit ratings in a timely fashion to reflect events since the security
was last rated. The Advisor does not rely solely on credit ratings when
selecting debt securities for the Fund, and develops its own independent
analysis of issuer credit quality. If a credit rating agency changes the rating
of a debt security held by the Fund, the Fund may retain the security if the
Advisor deems it in the best interest of shareholders.
Illiquid
Securities
Illiquid
securities are investments that the 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, as determined pursuant to the Fund’s liquidity risk management
program (LRM Program) adopted pursuant to Rule 22e-4 under the 1940 Act. Under
the Fund’s LRM Program, the Fund may not hold more than 15% of its net assets in
illiquid securities. The LRM Program administrator is responsible for
determining the liquidity classification of the Fund’s investments and
monitoring compliance with the 15% limit on illiquid securities. Liquidity of a
security relates to the ability to dispose easily of the security and the price
to be obtained upon disposition of the security, which may be less than would be
obtained for a comparable more liquid security. Illiquid securities may trade at
a discount from comparable, more liquid investments. Investment of the Fund’s
assets in illiquid securities may restrict the ability of the Fund to dispose of
its investments in a timely fashion and for a fair price as well as its ability
to take advantage of market opportunities. The risks associated with illiquidity
will be particularly acute where a Fund’s operations require cash, such as when
the Fund redeems shares or pays dividends, and could result in the Fund
borrowing to meet short term cash requirements or incurring capital losses on
the sale of illiquid investments.
The
Fund may invest in securities that are not registered (including securities that
can be offered and sold to “qualified institutional buyers” under Rule 144A
under the Securities Act of 1933, as amended (the “Securities Act”)).
Non-publicly traded securities may be sold in private placement transactions
between issuers and their purchasers and may be neither listed on an exchange
nor traded in other established markets. In many cases, privately placed
securities may not be freely transferable under the laws of the applicable
jurisdiction or due to contractual restrictions on resale. As a result of the
absence of a public trading market, privately placed securities may be less
liquid and more difficult to value than publicly traded securities. To the
extent that privately placed securities may be resold in privately negotiated
transactions, the prices realized from the sales, due to illiquidity, could be
less than those originally paid by the Fund or less than their fair market
value. In addition, issuers whose securities are not publicly traded may not be
subject to the disclosure and other investor protection requirements that may be
applicable if their securities were publicly traded. If any privately placed
securities held by the Fund are required to be registered under the securities
laws of one or more jurisdictions before being resold, the Fund may be required
to bear the expenses of registration. Certain of the Fund’s investments in
private placements may consist of direct investments and may include investments
in smaller, less seasoned issuers, which may involve greater risks. These
issuers may have limited product lines, markets or financial resources, or they
may be dependent on a limited management group. In making investments in such
securities, the Fund may obtain access to material nonpublic information, which
may restrict the Fund’s ability to conduct portfolio transactions in such
securities.
Over
the years, a large institutional market has developed for certain securities
that are not registered under the Securities Act, including repurchase
agreements, commercial paper, foreign securities, municipal securities,
convertible securities and corporate bonds and notes. Institutional investors
depend on an efficient institutional market in which the unregistered security
can be readily resold or on an issuer’s ability to honor a demand for repayment.
The fact that there are contractual or legal restrictions on resale to the
general public or to certain institutions may not be indicative of the liquidity
of such investments.
Indebtedness,
Loan Participations and Assignments
The
Fund may purchase indebtedness and participations in commercial loans (such as
bank loans), or may purchase assignments of such loans as well as interest
and/or servicing or similar rights as such loans. Such investments may be
secured or unsecured and may be newly-originated (and may be specifically
designed for the Fund). Indebtedness is different from traditional debt
securities in that debt securities may be part of a large issue of securities to
the public and
indebtedness
may not be a security, but may represent a specific commercial loan to a
borrower. Loan participations typically represent direct participation, together
with other parties, in a loan to a corporate borrower, and generally are offered
by banks or other financial institutions or lending syndicates. The Fund may
participate in such syndications, or can buy part of a loan, becoming a part
lender. When purchasing indebtedness and loan participations, the Fund assumes
the credit risk associated with the corporate borrower and may assume the credit
risk associated with an interposed bank or other financial intermediary. The
indebtedness and loan participations in which the Fund intends to invest may not
be rated by any nationally recognized rating service.
A
loan is often administered by an agent bank acting as agent for all holders. The
agent bank administers the terms of the loan, as specified in the loan
agreement. In addition, the agent bank is normally responsible for the
collection of principal and interest payments from the corporate borrower and
the apportionment of these payments to the credit of all institutions which are
parties to the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the corporate borrower, the
Fund may have to rely on the agent bank or other financial intermediary to apply
appropriate credit remedies or otherwise exercise the Fund’s rights against a
corporate borrower.
A
financial institution’s employment as agent bank might be terminated in the
event that it fails to observe a requisite standard of care or becomes
insolvent. A successor agent bank would generally be appointed to replace the
terminated agent bank, and assets held by the agent bank under the loan
agreement should remain available to holders of such indebtedness. However, if
assets held by the agent bank for the benefit of the Fund were determined to be
subject to the claims of the agent bank’s general creditors, the Fund might
incur certain costs and delays in realizing payment on a loan or loan
participation and could suffer a loss. In situations involving other interposed
financial institutions (e.g.,
an insurance company or governmental agency) similar risks may
arise.
Purchasers
of loans and other forms of direct indebtedness depend primarily upon the
creditworthiness of the corporate borrower for payment of principal and
interest. If the Fund does not receive scheduled interest or principal payments
on such indebtedness, the Fund’s share price and yield could be adversely
affected. Loans that are fully secured offer the Fund more protection than an
unsecured loan in the event of non-payment of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral from a secured
loan would satisfy the corporate borrower’s obligation, or that the collateral
can be liquidated. In either case, the Fund may be responsible for the costs and
liabilities associated with owning the collateral and may be subject to the
risks and responsibilities relevant to the business, property or other asset
serving as collateral. If the Fund holds certain loans, the Fund may be required
to exercise its remedies and rights with respect to the collateral or the
borrower pursuant to certain agreed-upon procedures or collectively with other
creditors or through an agent or other intermediary action on behalf of multiple
creditors. Delays or other risks associated with such procedures may cause the
value of the Fund’s investment to decline or otherwise adversely affect the
Fund’s rights relating to or interest in the collateral. For example, if an
agent bank is acting on behalf of multiple lenders in the syndicate, the Fund’s
interest in a loan may be subject to changes in terms or additional risks
resulting from actions taken or not taken by the agent bank following an
instruction from other creditors holding interests in the same loan. In
addition, bankruptcy or other court proceedings may delay, limit or negate the
Fund’s ability to collect payments on its loan investments or otherwise
adversely affect the Fund’s rights in collateral relating to the loan, if any,
and the Fund may need to retain legal or similar counsel to help in seeking to
enforce its rights.
The
Fund may invest in loan participations with credit quality comparable to that of
issuers of their other securities investments. Indebtedness of companies whose
creditworthiness is poor involves substantially greater risks, and may be highly
speculative. Some companies may never pay off their indebtedness, or may pay
only a small fraction of the amount owed. Consequently, when investing in
indebtedness of companies with poor credit, the Fund bears a substantial risk of
losing the entire amount invested.
The
Fund may invest in indebtedness and loan participations to achieve capital
appreciation, rather than seek income. The Fund will limit the amount of its
total assets that it will invest in issuers within the same industry (see
“Investment Restrictions”). For purposes of these limits, the Fund generally
will treat the corporate borrower as the “issuer” of indebtedness held by the
Fund. In the case of loan participations where a bank or other lending
institution serves as a financial intermediary between the Fund and the
corporate borrower, if the participation does not shift to the Fund the direct
debtor-creditor relationship with the corporate borrower, the Commission’s
interpretations require the Fund to treat both the lending bank or other lending
institution and the corporate borrower as “issuers”. Treating a financial
intermediary as an issuer of indebtedness may restrict the Fund’s ability to
invest in indebtedness related to a single financial intermediary, or a group of
intermediaries engaged in the same industry, even if the underlying borrowers
represent many different companies and industries.
Loan
assignments, loan participations, delayed funding loans, revolving credit
facilities, bridge loans and other types of direct indebtedness may not be
readily marketable and may be subject to restrictions on resale. In some cases,
negotiations involved in disposing of indebtedness may require weeks to
complete. Consequently, some indebtedness may be difficult or impossible to
dispose of readily at what the Advisor believes to be a fair price. Certain
types of loans, such as bridge loans, may provide certain types of equity
features such as warrants and conversion rights. Those equity-type instruments
and investments involve additional risks of an investment in equity, including
potentially significant changes in value, difficulty in accurately valuing them,
a lack of liquidity, and a significant loss on the investment, and the
possibility that the particular right could expire worthless if not
exercised.
Valuation
of illiquid indebtedness involves a greater degree of judgment in determining
the Fund’s net asset value than if that value were based on available market
quotations, and could result in significant variations in the Fund’s daily share
price. At the same time, some loan interests are traded among certain financial
institutions and accordingly may be deemed liquid. As the market for different
types of indebtedness develops, the liquidity of these instruments is expected
to improve. In addition, the Fund intends to treat indebtedness for which there
is no readily available market as illiquid for purposes of the Fund’s limitation
on illiquid investments. Investments in loan participations are considered to be
debt obligations for purposes of the Trust’s investment restriction relating to
the lending of funds or assets by the Fund.
Investments
in loans through a direct assignment of the financial institution’s interests
with respect to the loan may involve additional risks to the Fund. The purchaser
of an assignment typically succeeds to all rights and obligations as the
assigning lender under the loan agreement. Assignments may, however, be arranged
through private negotiations between potential assignees and potential
assignors, and the rights and obligations acquired by the purchaser of an
assignment may differ from, and be more limited than, those held by the
assigning lender. For example, if a loan is foreclosed, the Fund could become
owner, in whole or in part, of any collateral securing the loan, which could
include, among other assets, real estate or other real or personal property, and
would bear the costs and liabilities associated with owning and holding or
disposing of the collateral (see “Real Estate Investment Trusts” below).
Furthermore, in the event of a default by a borrower, the Fund may have
difficulty disposing of the assets used as collateral for a loan. In addition,
it is conceivable that under emerging legal theories of lender liability, the
Fund could be held liable as a co-lender. It is unclear whether loans and other
forms of direct indebtedness offer securities law protections against fraud and
misrepresentation. The Fund currently relies on the Advisor’s research in an
attempt to avoid situations where fraud or misrepresentation could adversely
affect the Fund.
The
Fund may invest in debtor-in-possession financings (commonly known as “DIP
financings”). DIP financings are arranged when an entity seeks the protections
of the bankruptcy court under Chapter 11 of the U.S. Bankruptcy Code. These
financings allow the entity to continue its business operations while
reorganizing under Chapter 11. Such financings constitute senior liens on
unencumbered security (i.e.,
security not subject to other creditors’ claims). There is a risk that the
entity will not emerge from Chapter 11 and be forced to liquidate its assets
under Chapter 7 of the U.S. Bankruptcy Code. In the event of liquidation, the
Fund’s only recourse will be against the property securing the DIP
financing.
The
Fund may act as the originator for direct loans to a borrower. Direct loans
between the Fund and a borrower may not be administered by an underwriter or
agent bank. The Fund may provide financing to commercial borrowers directly or
through companies acquired (or created) and owned by or otherwise affiliated
with the Fund. The terms of the direct loans are negotiated with borrowers in
private transactions. A direct loan may be secured or unsecured.
In
determining whether to make a direct loan, the Fund will rely primarily upon the
creditworthiness of the borrower for payment of interest and repayment of
principal and its assessment of the collateral, if any, securing the loan. In
making a direct loan, the Fund is exposed to the risk that the borrower may
default or become insolvent and, consequently, that the Fund will lose money.
Furthermore, direct loans may subject the Fund to liquidity and interest rate
risk and certain direct loans may be deemed illiquid. Direct loans are not
publicly traded and may not have a secondary market. The lack of a secondary
market for direct loans may have an adverse impact on the ability of the Fund to
dispose of a direct loan and/or to value the direct loan.
When
engaging in direct lending, the Fund’s performance may depend, in part, on the
ability of the Fund to originate loans on advantageous terms. In originating and
purchasing loans, the Fund will often compete with a broad spectrum of lenders.
Increased competition for, or a diminishment in the available supply of,
qualifying loans could result in lower yields on and/or less advantageous terms
of such loans, which could reduce Fund performance. Some loans have the benefit
of contractual restrictive covenants that limit the ability of the borrower to
increase the credit risk of the borrower or
take
actions that may impair the rights or interests of lenders (e.g.,
by further encumbering its assets or incurring other debt obligations).
Investments in loans without contractual restrictive covenants are particularly
susceptible to the risks associated with loans and other forms of
indebtedness.
As
part of its lending activities, the Fund may originate loans to companies that
are experiencing significant financial or business difficulties, including
companies involved in bankruptcy or other reorganization and liquidation
proceedings. Although the terms of such financing may result in significant
financial returns to the Fund, such loans involve a substantial degree of risk.
The level of analytical sophistication, both financial and legal, necessary for
successful financing to companies experiencing significant business and
financial difficulties is high. Different types of assets may be used as
collateral for the Fund’s loans and, accordingly, the valuation of and risks
associated with such collateral will vary by loan. There is no assurance that
the Fund will correctly evaluate the value of the assets collateralizing the
Fund’s loans or the prospects for a successful reorganization or similar action.
In any reorganization or liquidation proceeding relating to a company that the
Fund has financed, the Fund may lose all or part of the amounts advanced to the
borrower or may be required to accept collateral with a value less than the
amount of the loan advanced by the Fund or its affiliates to the
borrower.
Various
state licensing requirements could apply to the Fund with respect to investments
in, or the origination and servicing of, loans and similar assets. The licensing
requirements could apply depending on the location of the borrower, the location
of the collateral securing the loan, or the location where the Fund or Advisor
operates or has offices. In states in which it is licensed, the Fund or Advisor
will be required to comply with applicable laws and regulations, including
consumer protection and anti-fraud laws, which could impose restrictions on the
Fund’s or Advisor’s ability to take certain actions to protect the value of its
investments in such assets and impose compliance costs. Failure to comply with
such laws and regulations could lead to, among other penalties, a loss of the
Fund’s or Advisor’s license, which in turn could require the Fund to divest
assets located in or secured by real property located in that state. These risks
will also apply to issuers and entities in which the Fund invests that hold
similar assets, as well as any origination company or servicer in which the Fund
owns an interest.
Loan
origination and servicing companies are routinely involved in legal proceedings
concerning matters that arise in the ordinary course of their business. These
legal proceedings range from actions involving a single plaintiff to class
action lawsuits with potentially tens of thousands of class members. In
addition, a number of participants in the loan origination and servicing
industry (including control persons of industry participants) have been the
subject of regulatory actions by state regulators, including state Attorneys
General, and by the federal government. Governmental investigations,
examinations or regulatory actions, or private lawsuits, including purported
class action lawsuits, may adversely affect such companies’ financial results.
To the extent the Fund seeks to engage in origination and/or servicing directly,
or has a financial interest in, or is otherwise affiliated with, an origination
or servicing company, the Fund will be subject to enhanced risks of litigation,
regulatory actions and other proceedings. As a result, the Fund may be required
to pay legal fees, settlement costs, damages, penalties or other charges, any or
all of which could materially adversely affect the Fund and its
investments.
Industrial
Sector Risk
The
Fund may invest a portion of its assets in companies in the industrial sector.
The industrial sector can be significantly affected by, among other things,
worldwide economic growth, supply and demand for specific products and services,
rapid technological developments, and government regulation. Aerospace and
defense companies, a component of the industrial sector, can be significantly
affected by government spending policies because companies involved in this
industry rely, to a significant extent, on U.S. and foreign government demand
for their products and services. Thus, the financial condition of, and investor
interest in, aerospace and defense companies are heavily influenced by
governmental defense spending policies which are typically under pressure from
efforts to control the U.S. (and other) government budgets. Transportation
securities, a component of the industrial sector, are cyclical and have
occasional sharp price movements which may result from changes in the economy,
fuel prices, labor agreements and insurance costs.
Inflation-Indexed
Bonds
Inflation-indexed
bonds (other than municipal inflation-indexed bonds and certain corporate
inflation-indexed bonds) are fixed income securities whose principal value is
periodically adjusted according to the rate of inflation. If the index measuring
inflation falls, the principal value of inflation-indexed bonds (other than
municipal inflation indexed bonds and certain corporate inflation-indexed 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 in the case of U.S. Treasury inflation-indexed bonds.
For bonds that do not provide a similar guarantee, the adjusted principal value
of the bond repaid at maturity may be less than the original
principal.
With
regard to municipal inflation-indexed bonds and certain corporate
inflation-indexed bonds, the inflation adjustment is reflected in the
semi-annual coupon payment. As a result, the principal value of municipal
inflation-indexed bonds and such corporate inflation-indexed bonds does not
adjust according to the rate of inflation.
The
value of inflation-indexed bonds is expected to change in response to changes in
real interest rates. Real interest rates are tied to the relationship between
nominal interest rates and the rate of inflation. If nominal interest rates
increase at a faster rate than inflation, real interest rates may rise, leading
to a decrease in value of inflation-indexed bonds. Any increase in the principal
amount of an inflation-indexed bond will be considered taxable ordinary income
for federal income tax purposes, even though investors do not receive their
principal until maturity.
Interest
Rate Risk
Investments
in fixed income securities and financial instruments are subject to the
possibility that interest rates could rise sharply, causing the value of the
Fund’s securities and share price to decline. Longer term bonds and zero coupon
bonds are generally more sensitive to interest rate changes than shorter-term
bonds. Generally, the longer the average maturity of the bonds in the Fund, the
more the Fund’s share price will fluctuate in response to interest rate changes.
If an issuer calls or redeems an investment during a time of declining interest
rates, the Fund might have to reinvest the proceeds in an investment offering a
lower yield, and therefore might not benefit from any increase in value as a
result of declining interest rates. Securities with floating interest rates,
such as syndicated bank loans, generally are less sensitive to interest rate
changes, but may decline in value if their interest rates do not rise as much or
as fast as interest rates in general. Changes in government or central bank
policy, including changes in tax policy or changes in a central bank’s
implementation of specific policy goals, may have a substantial impact on
interest rates, and could have an adverse effect on prices for fixed income
securities and on the performance of the Fund. In particular, interest rates in
the U.S. recently have been at or near historically low levels and as a result,
fixed income securities markets may experience heightened levels of interest
rate risk. Any unexpected or sudden reversal of the fiscal policy underlying
current interest rate levels could adversely affect the value of the Fund. There
can be no guarantee that any particular government or central bank policy will
be continued, discontinued or changed, nor that any such policy will have the
desired effect on interest rates.
Changing
Fixed Income Market Conditions.
There is a risk that interest rates across the financial system may change,
sometimes unpredictably, as a result of a variety of factors, such as central
bank monetary policies, inflation rates and general economic conditions. Very
low or negative interest rates may magnify the Fund’s susceptibility to interest
rate risk and diminish yield and performance (e.g., during periods of very low
or negative interest rates, the Fund may be unable to maintain positive
returns). Changes in fixed income or related market conditions, including the
potential for changes to interest rates and negative interest rates, may expose
fixed income or related markets to heightened volatility and reduced liquidity
for Fund investments, which may be difficult to sell at favorable times or
prices, causing the value of the Fund’s investments and NAV per share to
decline. A rise in general interest rates also may result in increased
redemptions from the Fund. Very low, negative or changing interest rates also
may have unpredictable effects on securities markets in general, directly or
indirectly impacting the Fund’s investments, yield and performance.
Large
Shareholder Risk
To
the extent that a significant portion of the Fund’s shares are held by a limited
number of shareholders or their affiliates, there is a risk that the share
trading activities of these shareholders could disrupt the Fund’s investment
strategies, which could have adverse consequences for the Fund and other
shareholders (e.g.,
by requiring the Fund to sell investments at inopportune times or causing the
Fund to maintain larger-than-expected cash positions pending acquisition of
investments).
Leverage
Certain
transactions may give rise to a form of leverage. Such transactions may include,
among others, reverse repurchase agreements, loans of portfolio securities, and
the use of when-issued, delayed delivery or forward commitment transactions. The
use of derivatives may also create leveraging risk. Leveraging, including
borrowing, may cause the
Fund
to be more volatile than if the Fund had not been leveraged. This is because
leveraging tends to exaggerate the effect of any increase or decrease in the
value of the portfolio securities.
Master
Limited Partnerships
The
Fund may invest in publicly traded master limited partnerships (“MLPs”), which
are limited partnerships or limited liability companies taxable as partnerships
for federal income tax purposes. MLPs may derive income and gains from the
exploration, development, mining or production, processing, refining,
transportation (including pipelines transporting gas, oil, or products thereof),
or the marketing of any mineral or natural resources. MLPs generally have two
classes of owners, the general partner and limited partners. When investing in
an MLP, the Fund intends to purchase publicly traded common units issued to
limited partners of the MLP. The general partner is typically owned by a major
energy company, an investment fund, the direct management of the MLP or is an
entity owned by one or more of such parties. The general partner may be
structured as a private or publicly traded corporation or other entity. The
general partner typically controls the operations and management of the MLP
through an up to 2% equity interest in the MLP plus, in many cases, ownership of
common units and subordinated units. Limited partners own the remainder of the
partnership, through ownership of common units, and have a limited role in the
partnership’s operations and management.
MLPs
are typically structured such that common units and general partner interests
have first priority to receive quarterly cash distributions up to an established
minimum amount (“minimum quarterly distributions” or “MQD”). Common and general
partner interests also accrue arrearages in distributions to the extent the MQD
is not paid. Once common and general partner interests have been paid,
subordinated units receive distributions of up to the MQD; however, subordinated
units do not accrue arrearages. Distributable cash in excess of the MQD paid to
both common and subordinated units is distributed to both common and
subordinated units generally on a pro rata basis. The general partner is also
eligible to receive incentive distributions if the general partner operates the
business in a manner which results in distributions paid per common unit
surpassing specified target levels. As the general partner increases cash
distributions to the limited partners, the general partner receives an
increasingly higher percentage of the incremental cash distributions. A common
arrangement provides that the general partner can reach a tier where it receives
50% of every incremental dollar paid to common and subordinated unit holders.
These incentive distributions encourage the general partner to streamline costs,
increase capital expenditures and acquire assets in order to increase the
partnership’s cash flow and raise the quarterly, cash distribution in order to
reach higher tiers. Such results benefit all security holders of the
MLP.
MLP
common units represent a limited partnership interest in the MLP. Common units
are listed and traded on U.S. securities exchanges, with their value fluctuating
predominantly based on prevailing market conditions and the success of the MLP.
The Fund may purchase common units in market transactions. Unlike owners of
common stock of a corporation, owners of common units have limited voting rights
and have no ability annually to elect directors. In the event of liquidation,
common units have preference over subordinated units, but not over debt or
preferred units, to the remaining assets of the MLP.
Mortgage-Related
and Other Asset-Backed Securities
Mortgage-related
securities include mortgage pass-through securities, collateralized mortgage
obligations (“CMOs”), commercial mortgage-backed securities, mortgage dollar
rolls, CMO residuals, stripped mortgage-backed securities (“SMBSs”) and other
securities that directly or indirectly represent a participation in, or are
secured by and payable from, mortgage loans on real property.
The
value of some mortgage- or asset-backed securities may be particularly sensitive
to changes in prevailing interest rates. Early repayment of principal on some
mortgage-related securities may expose the Fund to lower rates of return upon
reinvestment of principal. When interest rates rise, the value of a
mortgage-related security generally will decline; however, when interest rates
are declining, the value of mortgage-related securities with prepayment features
may not increase as much as other fixed income securities. The rate of
prepayments on underlying mortgages will affect the price and volatility of a
mortgage-related security, and may shorten or extend the effective maturity of
the security beyond what was anticipated at the time of purchase. If
unanticipated rates of prepayment on underlying mortgages increase the effective
maturity of a mortgage-related security, the volatility of the security can be
expected to increase. The value of these securities may fluctuate in response to
the market’s perception of the creditworthiness of the issuers. Additionally,
although mortgages and mortgage-related securities are generally supported by
some form of government or private guarantee and/or insurance, there is no
assurance that private guarantors or insurers will meet their obligations.
Because
asset-backed
securities may not have the benefit of a security interest in underlying assets,
asset-backed securities present certain additional risks not present with
mortgage-backed securities.
One
type of SMBS has one class receiving all of the interest from the mortgage
assets (the interest-only, or “IO” class), while the other class will receive
all of the principal (the principal-only, or “PO” class). The yield to maturity
on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on a Fund’s yield to
maturity from these securities. The Fund may invest up to 5% of its total assets
in any combination of mortgage-related or other asset-backed IO, PO or inverse
floater securities.
The
Fund may invest in collateralized debt obligations (“CDOs”), which includes
collateralized bond obligations (“CBOs”), collateralized loan obligations
(“CLOs”) and other similarly structured securities. CBOs and CLOs are types of
asset-backed securities. A CBO is a trust which is backed by a diversified pool
of high-risk, below investment grade fixed income securities. A CLO is a trust
typically collateralized by a pool of loans, which may include, among others,
domestic and foreign senior secured loans, senior unsecured loans, and
subordinate corporate loans, including loans that may be rated below investment
grade or equivalent unrated loans. CLOs issue classes or “tranches” that vary in
risk and yield. A CLO may experience substantial losses attributable to defaults
on underlying assets. Such losses will be borne first by the holders of
subordinate tranches. A Fund’s investment in a CLO may decrease in market value
because of (i) loan defaults or credit impairment, (ii) the disappearance of
subordinate tranches, (iii) market anticipation of defaults, and (iv) investor
aversion to CLO securities as a class. These risks may be magnified depending on
the tranche of CLO securities in which a Fund invests. For example, investments
in a junior tranche of CLO securities will likely be more sensitive to loan
defaults or credit impairment than investments in more senior tranches. The Fund
may invest in other asset-backed securities that have been offered to
investors.
Municipal
Bonds
Municipal
bonds are generally issued by states and local governments and their agencies,
authorities and other instrumentalities. Municipal bonds are subject to interest
rate, credit and market risk. The ability of an issuer to make payments could be
affected by litigation, legislation or other political events or the bankruptcy
of the issuer. Lower-rated municipal bonds are subject to greater credit and
market risk than higher quality municipal bonds. The types of municipal bonds in
which the Fund may invest include municipal lease obligations. The Fund may also
invest in industrial development bonds, which are municipal bonds issued by a
government agency on behalf of a private sector company and, in most cases, are
not backed by the credit of the issuing municipality and may therefore involve
more risk. The Fund may also invest in securities issued by entities whose
underlying assets are municipal bonds.
The
Fund expects to invest less than 50% of its total assets in tax-exempt municipal
bonds. As a result, the Fund does not expect to be eligible to pay exempt
interest dividends to shareholders and interest on municipal bonds will be
taxable to shareholders when received as a distribution from a
Fund.
Operational
Risk
An
investment in the Fund, like any fund, can involve operational risks arising
from factors such as processing errors, human errors, inadequate or failed
internal or external processes, failures in systems and technology, changes in
personnel and errors caused by third-party service providers. The occurrence of
any of these failures, errors or breaches could result in a loss of information,
regulatory scrutiny, reputational damage or other events, any of which could
have a material adverse effect on the Fund. While the Fund seeks to minimize
such events through controls and oversight, there may still be failures that
could cause losses to the Fund.
Other
Investment Companies
The
Fund may acquire securities of other registered investment companies to the
extent that such investments are consistent with its investment objective,
policies, strategies and restrictions and the limitations of the 1940 Act.
Investment companies may include mutual funds, closed-end funds and
exchange-traded funds (“ETFs”). The Fund will indirectly bear its proportionate
share of any management fees and other expenses paid by such funds. Like all
equity investments, these investments may go up or down in value.
ETFs
and closed-end funds trade on a securities exchange and their shares may trade
at a premium or discount to their NAV. The Fund will incur brokerage costs when
it buys and sells shares of ETFs and closed-end funds. ETFs that seek to track
the composition and performance of a specific index may not replicate exactly
the performance of their specified index because of trading costs and operating
expenses incurred by the ETF. At times, there may not be an active trading
market for shares of some ETFs and closed-end funds and trading of ETF and
closed-end fund shares may be halted or delisted by the listing
exchange.
In
addition, investments in ETFs involve the risk that the market prices of ETF
shares will fluctuate, sometimes rapidly and materially, in response to changes
in the ETF’s NAV, the value of ETF holdings and supply and demand for ETF
shares. Although the creation/redemption feature of ETFs generally makes it more
likely that ETF shares will trade close to 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”) NAV. Significant
losses may result when transacting in ETF shares in these and other
circumstances. Neither the Advisor nor the Trust can predict whether ETF shares
will trade above, below or at 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.
For
purposes of evaluating whether the Fund’s investments are in companies located
outside the U.S., investments in ETFs based on foreign market indices are
considered located outside the U.S.
Participation
in Litigation or Arbitration Proceedings
The
Advisor, in its judgment and discretion and based on the considerations deemed
by the Advisor to be relevant, may believe that it is in the best interests of
the Fund to initiate or settle a claim or join a class of plaintiffs pursuing a
claim as lead plaintiff (or opt out of a class and pursue a claim directly).
Similarly, the Advisor may determine not to take or not to recommend any such
action. To the extent that the Fund has liquidated, the Advisor will generally
not take or recommend any such action. The Advisor may, on behalf of the Fund,
directly initiate or participate in litigation or an arbitration proceeding as a
named plaintiff or claimant. The Advisor may, without limitation, (i) engage
legal counsel for the Fund and/or cause the Fund to pay fair and reasonable
legal fees and expenses incurred in connection with investigating the validity
of a potential claim (or performing other due diligence relating to a potential
claim) or taking any actions considered by the Advisor to be necessary or
appropriate (a) to protect or preserve the Fund’s rights or interests in
connection with (1) defending a claim made against the Fund and (2) initiating
or otherwise engaging in preliminary measures intended to facilitate possible
future litigation or arbitration or otherwise support a judicial decision
favorable to the Fund and (b) to preserve the Fund’s ability to bring a claim
and to prevent the expiration of an applicable statute of limitations; and (ii)
on behalf of the Fund that is not acting or seeking to act as a named plaintiff
or claimant, (a) give direction to a third party (such as trustees or service
providers), (b) cause the Fund to advance fair and reasonable legal fees and
expenses to such third party, and/or (c) indemnify, on behalf of the Fund, such
third party for its fair and reasonable fees and expenses, in each such case in
connection with litigation or a claim concerning the Fund’s investment and
pursuant to the terms of the investment (including, without limitation, as a
result of the Fund’s holding of a certificate issued by a trust where the
trustee or other service provider to the trust is commencing litigation or
pursuing a claim on behalf of the trust). The Advisor may also vote for or
authorize a settlement relating to litigation or a claim described in
subparagraph (ii) above. The Fund may directly bear a portion or all of the fees
associated with the actions described above.
Preferred
Stock
The
Fund may invest in preferred stock. Preferred stock represents an equity or
ownership interest in an issuer. Preferred stock normally pays dividends at a
specified rate and has precedence over common stock in the event the issuer is
liquidated or declares bankruptcy. However, in the event an issuer is liquidated
or declares bankruptcy, the claims of owners of bonds take precedence over the
claims of those who own preferred and common stock. Preferred stock, unlike
common stock, often has a stated dividend rate payable from the corporation’s
earnings. Preferred stock dividends may be cumulative or non-cumulative,
participating, or auction rate. “Cumulative” dividend provisions require all or
a portion of prior unpaid dividends to be paid before dividends can be paid to
the issuer’s common stock. “Participating” preferred stock may be entitled to a
dividend exceeding the stated dividend in certain cases. If interest rates rise,
the fixed dividend on preferred stocks may be less attractive, causing the price
of such stocks to decline. Preferred stock may have mandatory sinking fund
provisions, as well as provisions allowing the stock to be called or redeemed,
which can limit the
benefit
of a decline in interest rates. Preferred stock is subject to many of the risks
to which common stock and debt securities are subject.
Real
Estate Investment Trusts
The
Fund may invest in securities of companies in the real estate industry generally
or in real estate investment trusts (“REITs”). Unlike corporations, REITs do not
have to pay federal income taxes if they meet certain Internal Revenue Code of
1986, as amended (the “Code”), requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties.
Companies
in the real estate industry and real estate related investments may include, for
example, REITs that either own properties or make construction or mortgage
loans, real estate developers, companies with substantial real estate holdings,
and other companies whose products and services are related to the real estate
industry, such as building supply manufacturers, mortgage lenders, or mortgage
servicing companies. Changes in real estate values or economic downturns can
have a significant negative effect on issuers in the real estate industry. The
real estate industry is particularly sensitive to economic downturns. The value
of securities of issuers in the real estate industry can be affected by changes
in real estate values and rental income, property taxes, interest rates, and tax
and regulatory requirements. In addition, the value of a REIT can depend on the
structure of and cash flow generated by the REIT.
An
investment in a REIT, or in a real estate-linked derivative instrument linked to
the value of a REIT, is subject to the risks that impact the value of the
underlying properties of the REIT. These risks include loss to casualty or
condemnation, and changes in supply and demand, interest rates, zoning laws,
regulatory limitations on rents, property taxes and operating expenses. Other
factors that may adversely affect REITs include poor performance by management
of the REIT, changes to the tax laws, or failure by the REIT to qualify for
tax-free distribution of income. REITs are also subject to default by borrowers
and self-liquidation, and are heavily dependent on cash flow. Investments in
REIT equity securities could require the Fund to accrue and distribute income
not yet received by the Fund. On the other hand, investments in REIT equity
securities can also result in the Fund’s receipt of cash in excess of the REIT’s
earnings; if the Fund distributes such amounts, such distribution could
constitute a return of capital to Fund shareholders for federal income tax
purposes.
Some
REITs lack diversification because they invest in a limited number of
properties, a narrow geographic area, or a single type of property. Mortgage
REITs may be impacted by the quality of the credit extended. Dividends received
by the Fund from a REIT generally will not constitute qualified dividend income.
REITs may not provide complete tax information to the Fund until after the
calendar year-end. Consequently, because of the delay, it may be necessary for
the Fund to request permission from the IRS to extend the deadline for issuance
of Forms 1099-DIV.
Regulatory
Risk
Actions
by governmental entities may also impact certain instruments in which a Fund
invests. For example, certain instruments in which a Fund may invest rely in
some fashion upon LIBOR as the reference or benchmark rate for variable interest
rate calculations. Regulators and financial industry working groups in several
jurisdictions have worked over the past several years to identify alternative
reference rates (“ARRs”) to replace LIBOR and to assist with the transition to
the new ARRs. In connection with the transition, on March 5, 2021 the UK
Financial Conduct Authority (FCA), the regulator that oversees LIBOR, announced
that the majority of LIBOR rates would cease to be published or would no longer
be representative on January 1, 2022. Consequently, the publication of most
LIBOR rates ceased at the end of 2021, but a selection of widely used USD LIBOR
rates continues to be published until June 2023 to allow for an orderly
transition away from these rates.
Although
regulators have generally prohibited banking institutions from entering into new
contracts that reference those USD LIBOR settings that continue to exist, there
remains uncertainty and risks relating to certain “legacy” USD LIBOR instruments
that were issued or entered into before December 31, 2021 and the process by
which a replacement interest rate will be identified and implemented into these
instruments when USD LIBOR is ultimately discontinued. The effects of such
uncertainty and risks in “legacy” USD LIBOR instruments held by a Fund could
result in losses to the Fund.
In
May 2022, the SEC proposed amendments to a current rule governing fund naming
conventions. In general, the current rule requires funds with certain types of
names to adopt a policy to invest at least 80% of their assets in the type of
investment suggested by the name. The proposed amendments would expand the scope
of the current rule in a number of ways that would result in an expansion of the
types of fund names that would require the fund to adopt an 80%
investment
policy under the rule. Additionally, the proposed amendments would modify the
circumstances under which a fund may deviate from its 80% investment policy and
address the use and valuation of derivatives instruments for purposes of the
rule. The proposal’s impact on the Funds will not be known unless and until any
final rulemaking is adopted.
In
May 2022, the SEC proposed a framework that would require certain registered
funds (such as the Funds) to disclose their environmental, social, and
governance (“ESG”) investing practices. Among other things, the proposed
requirements would mandate that funds meeting three pre-defined classifications
(i.e., integrated, ESG focused and/or impact funds) provide prospectus and
shareholder report disclosure related to the ESG factors, criteria and processes
used in managing the fund. The proposal’s impact on the Funds will not be known
unless and until any final rulemaking is adopted.
Repurchase
Agreements
The
Fund may invest in repurchase agreements. A repurchase agreement is an agreement
where the seller agrees to repurchase a security from the Fund at a mutually
agreed-upon time and price. The period of maturity is usually quite short,
possibly overnight or a few days, although it may extend over a number of
months. The resale price is more than the purchase price, reflecting an
agreed-upon rate of return effective for the period of time the Fund’s money is
invested in the repurchase agreement. The Fund’s repurchase agreements will at
all times be fully collateralized in an amount at least equal to the resale
price. The instruments held as collateral are valued daily, and if the value of
those instruments declines, the Fund will require additional collateral. In the
event of a default, insolvency or bankruptcy by a seller, the Fund will promptly
seek to liquidate the collateral. In such circumstances, the Fund could
experience a delay or be prevented from disposing of the collateral. To the
extent that the proceeds from any sale of such collateral upon a default in the
obligation to repurchase are less than the repurchase price, the Fund will
suffer a loss.
Reverse
Repurchase Agreements, Dollar Rolls and Other Borrowings
The
Fund may enter into reverse repurchase agreements and dollar rolls, subject to
its limitations on borrowings. A reverse repurchase agreement or dollar roll
involves the sale of a security by the Fund and their agreement to repurchase
the instrument at a specified time and price, and may be considered a form of
borrowing for some purposes. The Fund will maintain at least 300% asset coverage
for all obligations under reverse repurchase agreements, dollar rolls and other
borrowings. Reverse repurchase agreements, dollar rolls and other forms of
borrowings may create leveraging risk for the Fund.
It
is possible that changing government regulation may affect the Fund’s use of
these strategies. If implemented, regulations could significantly limit or
impact the Fund’s ability to invest in reverse repurchase agreements, short sale
borrowings and firm or standby commitment agreements, limit the Fund’s ability
to employ certain strategies that use such instruments and adversely affect the
Fund’s performance, efficiency in implementing its strategy, liquidity and
ability to pursue its investment objective. Also, changes in regulatory
requirements concerning margin for certain types of financing transactions, such
as repurchase agreements, reverse repurchase agreements, and securities lending
and borrowing, could impact the Fund’s ability to utilize these investment
strategies and techniques.
Rule
144A Securities
The
Fund may invest in securities offered pursuant to Rule 144A under the 1933 Act
(“Rule 144A securities”), which are restricted securities. They may be less
liquid and more difficult to value than other investments because such
securities may not be readily marketable in broad public markets. The Fund may
not be able to sell a restricted security promptly or at a reasonable price.
Although there is a substantial institutional market for Rule 144A securities,
it is not possible to predict exactly how the market for Rule 144A securities
will develop. A restricted security that was liquid at the time of purchase may
subsequently become illiquid and its value may decline as a result. In addition,
transaction costs may be higher for restricted securities than for more liquid
securities. The Fund may have to bear the expense of registering Rule 144A
securities for resale and the risk of substantial delays in effecting the
registration.
Securities
Lending
The
Fund may lend portfolio securities with a value not exceeding 33 1/3% of its
total assets or the limit prescribed by applicable law to banks, brokers and
other financial institutions. In return, the Fund receives collateral in cash or
securities issued or guaranteed by the U.S. government, which will be maintained
at all times in an amount equal to at least 100% of
the
current market value of the loaned securities. The Fund maintains the ability to
obtain the right to vote or consent on proxy proposals involving material events
affecting securities loaned. The Fund receives the income on the loaned
securities. Where the Fund receives securities as collateral, the Fund receives
a fee for its loans from the borrower and does not receive the income on the
collateral. Where the Fund receives cash collateral, it may invest such
collateral and retain the amount earned, net of any amount rebated to the
borrower. The Fund is subject to all investment risks associated with the
reinvestment of any cash collateral received, including, but not limited to,
interest rate, credit and liquidity risk associated with such investments. To
the extent the value or return of the Fund’s investments of the cash collateral
declines below the amount owed to a borrower, the Fund may incur losses that
exceed the amount it earned on lending the security. If the borrower defaults on
its obligation to return securities lent because of insolvency or other reasons,
the Fund could experience delays and costs in recovering the securities lent or
gaining access to collateral. As a result, the Fund’s yield may increase. Loans
of securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within the standard time period for
settlement of securities transactions. The Fund is obligated to return the
collateral to the borrower at the termination of the loan. The Fund could suffer
a loss in the event the Fund must return the cash collateral and there are
losses on investments made with the cash collateral. In the event the borrower
defaults on any of its obligations with respect to a securities loan, the Fund
could suffer a loss where there are losses on investments made with the cash
collateral or where the value of the securities collateral falls below the
market value of the borrowed securities. The Fund could also experience delays
and costs in gaining access to the collateral. The Fund may pay reasonable
finder’s, lending agent, administrative and custodial fees in connection with
its loans.
Short
Sales
The
Fund may make short sales as part of its overall portfolio management strategies
or to offset a potential decline in value of a security. A short sale involves
the sale of a security that is borrowed from a broker or other institution to
complete the sale. The Fund may also enter into a short derivative position
through a futures contract or swap agreement. If the price of the security or
derivative has increased during this time, then the Fund will incur a loss equal
to the increase in price from the time that the short sale was entered into plus
any premiums and interest paid to the third party. Therefore, short sales
involve the risk that losses may be exaggerated, potentially losing more money
than the actual cost of the investment. Also, there is the risk that the third
party to the short sale may fail to honor its contract terms, causing a loss to
the Fund. Short sales expose the Fund to the risk that it will be required to
acquire, convert or exchange securities to replace the borrowed securities (also
known as “covering” the short position) at a time when the securities sold short
have appreciated in value, thus resulting in a loss to the Fund. The Fund may
engage in short selling to the extent permitted by the 1940 Act and rules and
interpretations thereunder.
Short
Sales Against-the-Box
The
Fund can borrow and sell “short” securities when the Fund also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund’s
net assets can be held as collateral for short sales at any one time.
Structured
Instruments
The
Fund may invest in structured instruments, including, without limitation,
participation notes, certificates and warrants. Structured instruments may be
derived from or based on a single security or securities, an index, a commodity,
debt issuance or a foreign currency (a “reference”), and their interest rate or
principal may be determined by an unrelated indicator. Structured securities may
be positively or negatively indexed, so that appreciation of the reference may
produce an increase or a decrease in the value of the structured security at
maturity, or in the interest rate of the structured security. Structured
securities may entail a greater degree of risk than other types of securities
because the Fund bears the risk of the reference in addition to the risk that
the counterparty to the structured security will be unable or unwilling to
fulfill its obligations under the structured security to the Fund when due. The
Fund bears the risk of loss of the amount expected to be received in connection
with a structured security in the event of the default or bankruptcy of the
counterparty to the structured security. Structured securities may also be more
volatile, less liquid, and more difficult to accurately price than less complex
securities or more traditional debt securities.
Swap
Agreements
The
Fund may enter into swap agreements, including, but not limited to, credit
default, interest rate, index and currency exchange rate swap agreements. The
Fund may enter into swap transactions for any legal purpose consistent with its
investment
objectives and policies, such as attempting to obtain or preserve a particular
return or spread at a lower cost than obtaining a return or spread through
purchases and/or sales of instruments in other markets, to protect against
currency fluctuations, as a duration management technique, to protect against
any increase in the price of securities the Fund anticipates purchasing at a
later date, or to gain exposure to certain markets in a more cost efficient
manner. To the extent the Fund invests in foreign currency-denominated
securities, the Fund also may invest in currency exchange rate swap
agreements.
Swap
agreements are two-party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard OTC swap transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular predetermined
investments or instruments. The gross returns to be exchanged or “swapped”
between the parties are generally calculated with respect to a “notional
amount,” i.e.,
the return on or change in value of a particular dollar amount invested at a
particular interest rate, in a particular foreign currency, or in a “basket” of
securities representing a particular index. The “notional amount” of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. The Fund’s obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the “net amount”). The
Fund’s obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund).
Other
forms of swap agreements include interest rate caps, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or “cap”; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified rate, or “floor”; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels. A total return swap agreement is a
contract in which one party agrees to make periodic payments to another party
based on the change in market value of underlying assets, which may include a
single stock, a basket of stocks, or a stock index during the specified period,
in return for periodic payments based on a fixed or variable interest rate or
the total return from other underlying assets.
The
Fund also may enter into swaptions. A swaption is a contract that gives a
counterparty the right (but not the obligation) in return for payment of a
premium, to enter into a new swap agreement or to shorten, extend, cancel or
otherwise modify an existing swap agreement, at some designated future time on
specified terms. The Fund may write (sell) and purchase put and call swaptions.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swaption than it will
incur when it purchases a swaption. When the Fund purchases a swaption, it risks
losing only the amount of the premium it has paid should it decide to let the
option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Most
types of swap agreements entered into by the Funds will calculate the
obligations of the parties to the agreement on a “net basis.” Consequently, the
Fund’s current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to the agreement (the
“net amount”). The Fund’s current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund).
The
Fund also may enter into OTC and cleared credit default swap agreements. A
credit default swap agreement may reference one or more debt securities or
obligations that are not currently held by the Fund. The protection “buyer” in
an OTC credit default contract is generally obligated to pay the protection
“seller” an upfront or a periodic stream of payments over the term of the
contract until a credit event, such as a default, on a reference obligation has
occurred. If a credit event occurs, the seller generally must pay the buyer the
“par value” (full notional value) of the swap in exchange for an equal face
amount of deliverable obligations of the reference entity described in the swap,
or the seller may be required to deliver the related net cash amount if the swap
is cash settled. The Fund may be either the buyer or seller in the transaction.
If the Fund is a buyer and no credit event occurs, the Fund may recover nothing
if the swap is held through its termination date. However, if a credit event
occurs, the buyer may receive the full notional value of the swap in exchange
for an equal face amount of deliverable obligations of the reference entity
whose value may have significantly decreased. As a seller, the Fund generally
receives an upfront payment or a fixed rate of income throughout the term of the
swap provided that there is no credit event. As the seller, the Fund would
effectively add leverage to its portfolio because, in addition to its total net
assets, the Fund would be subject to investment exposure on the notional amount
of the swap.
The
spread of a credit default swap is the annual amount the protection buyer must
pay the protection seller over the length of the contract, expressed as a
percentage of the notional amount. When spreads rise, market perceived credit
risk rises and when spreads fall, market perceived credit risk falls. Wider
credit spreads and decreasing market values, when compared to the notional
amount of the swap, represent a deterioration of the credit soundness of the
issuer of the reference obligation and a greater likelihood or risk of default
or other credit event occurring as defined under the terms of the agreement. For
credit default swap agreements on asset-backed securities and credit indices,
the quoted market prices and resulting values, as well as the annual payment
rate, serve as an indication of the current status of the payment/performance
risk.
Credit
default swap agreements sold by the Fund may involve greater risks than if the
Fund had invested in the reference obligation directly since, in addition to
general market risks, credit default swaps are subject to illiquidity risk,
counterparty risk (with respect to OTC credit default swaps) and credit risk.
The Fund will enter into uncleared credit default swap agreements only with
counterparties that meet certain standards of creditworthiness. A buyer
generally also will lose its investment and recover nothing should no credit
event occur and the swap is held to its termination date. If a credit event were
to occur, the value of any deliverable obligation received by the seller,
coupled with the upfront or periodic payments previously received, may be less
than the full notional value it pays to the buyer, resulting in a loss of value
to the seller. In addition, there may be disputes between the buyer and seller
of a credit default swap agreement or within the swaps market as a whole as to
whether a credit event has occurred or what the payment should be. Such disputes
could result in litigation or other delays, and the outcome could be adverse for
the buyer or seller. The Fund’s obligations under a credit default swap
agreement will be accrued daily (offset against any amounts owing to the
Fund).
The
Dodd-Frank Act and related regulatory developments require the clearing and
exchange-trading of certain standardized OTC derivative instruments that the
CFTC and SEC have defined as “swaps.” The CFTC has implemented mandatory
exchange-trading and clearing certain requirements under the Dodd-Frank Act and
the CFTC continues to approve contracts for central clearing. Uncleared swaps
are subject to margin requirements that mandate the posting and collection of
minimum margin amounts on certain uncleared swaps transactions, which may result
in the Fund and its counterparties posting higher margin amounts for uncleared
swaps than would otherwise be the case. The Advisor will continue to monitor
developments in this area, particularly to the extent regulatory changes affect
the Funds’ ability to enter into swap agreements.
In
the event of a counterparty’s (or its affiliate’s) insolvency, the Fund’s
ability to exercise remedies, such as the termination of transactions, netting
of obligations and realization on collateral, could be stayed or eliminated
under special resolution regimes adopted in the United States, the EU and
various other jurisdictions. Such regimes generally provide government
authorities with broad authority to intervene when a financial institution is
experiencing financial difficulty. In the EU, the regulatory authorities could
reduce, eliminate or convert to equity the liabilities to a fund of a
counterparty subject to such proceedings (sometimes referred to as a “bail
in”).
Whether
the Fund’s use of swap agreements will be successful in furthering its
investment objective will depend on the Advisor’s ability to correctly predict
whether certain types of investments are likely to produce greater returns than
other investments. Because they are two party contracts and because they may
have terms of greater than seven days, swap agreements may be considered to be
illiquid. Moreover, the Fund bears the risk of loss of the amount expected to be
received under a swap agreement in the event of the default or bankruptcy of a
swap agreement counterparty. Restrictions imposed by the Code for qualification
as a regulated investment company may limit the Fund’s ability to use swap
agreements.
The
swaps market is subject to increasing regulations, in both U.S. and non-U.S.
markets. It is possible that developments in the swaps market, including
additional government regulation, could adversely affect the Fund’s ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Swaps
are highly specialized instruments that require investment techniques, risk
analyses, and tax planning different from those associated with traditional
investments. The use of a swap requires an understanding not only of the
reference asset, reference rate, or index but also of the swap itself, without
the benefit of observing the performance of the swap under all possible market
conditions. Because OTC swap agreements are bilateral contracts that may be
subject to contractual restrictions on transferability and termination and
because they may have remaining terms of greater than seven days, swap
agreements may be considered illiquid and subject to the Fund’s limitation on
investments in illiquid securities. See the discussion under “Illiquid
Securities.”
Like
most other investments, swap agreements are subject to the risk that the market
value of the instrument will change in a way detrimental to the Fund’s interest.
The Fund bears the risk that the Advisor will not accurately forecast future
market trends or the values of assets, reference rates, indexes, or other
economic factors in establishing swap positions for the Fund. If the Advisor
attempts to use a swap as a hedge against, or as a substitute for, a portfolio
investment, the Fund will be exposed to the risk that the swap will have or will
develop imperfect or no correlation with the portfolio investment. This could
cause substantial losses for the Fund. While hedging strategies involving swap
instruments can reduce the risk of loss, they can also reduce the opportunity
for gain or even result in losses by offsetting favorable price movements in
other Fund investments. Many swaps are complex and often valued
subjectively.
Senior
Loans
To
the extent the Fund invests in senior loans, the Fund may be subject to greater
levels of credit risk, call risk, settlement risk and liquidity risk, than funds
that do not invest in such securities. These instruments are considered
predominantly speculative with respect to an issuer’s continuing ability to make
principal and interest payments, and may be more volatile than other types of
securities. An economic downturn or individual corporate developments could
adversely affect the market for these instruments and reduce the Fund’s ability
to sell these instruments at an advantageous time or price. An economic downturn
would generally lead to a higher non-payment rate and, a senior loan may lose
significant market value before a default occurs. The Fund may also be subject
to greater levels of liquidity risk than funds that do not invest in senior
loans. In addition, the senior loans in which the Fund invests may not be listed
on any exchange and a secondary market for such loans may be comparatively
illiquid relative to markets for other more liquid fixed income securities.
Consequently, transactions in senior loans may involve greater costs than
transactions in more actively traded securities. Restrictions on transfers in
loan agreements, a lack of publicly-available information, irregular trading
activity and wide bid/ask spreads among other factors, may, in certain
circumstances, make senior loans difficult to sell at an advantageous time or
price than other types of securities or instruments. These factors may result in
the Fund being unable to realize full value for the senior loans and/or may
result in the Fund not receiving the proceeds from a sale of a senior loan for
an extended period after such sale, each of which could result in losses to the
Fund. Senior loans may have extended trade settlement periods which may result
in cash not being immediately available to the Fund. As a result, transactions
in senior loans that settle on a delayed basis may limit the Fund’s ability to
make additional investments or satisfy the Fund’s redemption obligations. The
Fund may seek to satisfy any short-term liquidity needs resulting from an
extended trade settlement process by, among other things, selling portfolio
assets, holding additional cash or entering into temporary borrowing
arrangements with banks and other potential funding sources. If an issuer of a
senior loan prepays or redeems the loan prior to maturity, the Fund will have to
reinvest the proceeds in other senior loans or similar instruments that may pay
lower interest rates.
Senior
loans may not be considered securities under the federal securities laws. In
such circumstances, fewer legal protections may be available with respect to a
Fund’s investment in senior loans. In particular, if a senior loan is not
considered a security under the federal securities laws, certain legal
protections normally available to securities investors under the federal
securities laws, such as those against fraud and misrepresentation, may not be
available. Because of the risks involved in investing in senior loans, an
investment in the Fund that invests in such instruments should be considered
speculative.Senior loans that are covenant-lite obligations contain fewer
maintenance covenants than other types of loans, or no maintenance covenants,
and may not include terms that allow the lender to monitor the performance of
the borrower and declare a default if certain criteria are breached.
Covenant-lite obligations may carry more risk than traditional loans as they
allow borrowers to engage in activities that would otherwise be difficult or
impossible under a covenant-heavy loan agreement. In the event of default,
covenant-lite obligations may exhibit diminished recovery values as the lender
may not have the opportunity to negotiate with the borrower prior to default.
The Fund may have a greater risk of loss on investments in covenant-lite
obligations as compared to investments in traditional loans.
Secondary
trades of senior loans may have extended settlement periods. Any settlement of a
secondary market purchase of senior loans in the ordinary course, on a
settlement date beyond the period expected by loan market participants (i.e.,
T+7 for par/near par loans and T+20 for distressed loans, in other words more
than seven or twenty business days beyond the trade date, respectively) is
subject to the “delayed compensation” rules prescribed by the Loan Syndications
and Trading Association (“LSTA”) and addressed in the LSTA’s standard loan
documentation for par/near par trades and for distressed trades. “Delayed
compensation” is a pricing adjustment comprised of certain interest and fees,
which is payable between the parties to a secondary loan trade. The LSTA
introduced a requirements-based rules program in order to incentivize shorter
settlement times for secondary transactions and discourage certain delay tactics
that create friction in the loan syndications market by, among other things,
mandating that the buyer of a senior loan satisfy certain
“basic
requirements” as prescribed by the LSTA no later than T+5 in order for the buyer
to receive the benefit of interest and other fees accruing on the purchased loan
from and after T+7 for par/near par loans (for distressed trades, T+20) until
the settlement date, subject to certain specific exceptions. These “basic
requirements” generally require a buyer to execute the required trade
documentation and to be, and remain, financially able to settle the trade no
later than T+7 for par/near par loans (and T+20 for distressed trades). In
addition, buyers are required to fund the purchase price for a secondary trade
upon receiving notice from the agent of the effectiveness of the trade in the
agent’s loan register. A Fund, as a buyer of a senior loan in the secondary
market, would need to meet these “basic requirements” or risk forfeiting all or
some portion of the interest and other fees accruing on the loan from and after
T+7 for par/near par loans (for distressed trades, T+20) until the settlement
date. The “delayed compensation” mechanism does not mitigate the other risks of
delayed settlement or other risks associated with investments in senior
loans.
Investors
should be aware that the Fund’s investment in a senior loan may result in the
Fund or Advisor receiving information about the issuer that may be deemed
material, non-public information. Under such circumstances, the Fund’s
investment opportunities may be limited, as trading in securities of such issuer
may be restricted. Additionally, the Advisor may seek to avoid receiving
material, non-public information about issuers of senior loans. As a result, the
Advisor may forgo certain investment opportunities or be disadvantaged as
compared to other investors that do not restrict information that they receive
from senior loan issuers.
Trust
Preferred Securities
The
Fund may invest in trust preferred securities. Trust preferred securities have
the characteristics of both subordinated debt and preferred stock. Generally,
trust preferred securities are issued by a trust that is wholly-owned by a
financial institution or other corporate entity, typically a bank holding
company. The financial institution creates the trust and owns the trust’s common
securities. The trust uses the sale proceeds of its common securities to
purchase subordinated debt issued by the financial institution. The financial
institution uses the proceeds from the subordinated debt sale to increase its
capital while the trust receives periodic interest payments from the financial
institution for holding the subordinated debt. The trust uses the funds received
to make dividend payments to the holders of the trust preferred securities. The
primary advantage of this structure is that the trust preferred securities are
treated by the financial institution as debt securities for tax purposes and as
equity for the calculation of capital requirements.
Trust
preferred securities typically bear a market rate coupon comparable to interest
rates available on debt of a similarly rated issuer. Typical characteristics
include long-term maturities, early redemption by the issuer, periodic fixed or
variable interest payments, and maturities at face value. Holders of trust
preferred securities have limited voting rights to control the activities of the
trust and no voting rights with respect to the financial institution. The market
value of trust preferred securities may be more volatile than those of
conventional debt securities. Trust preferred securities may be issued in
reliance on Rule 144A under the Securities Act and subject to restrictions on
resale. There can be no assurance as to the liquidity of trust preferred
securities and the ability of holders, such as the Fund, to sell their holdings.
In identifying the risks of the trust preferred securities, the Advisor will
look to the condition of the financial institution as the trust typically has no
business operations other than to issue the trust preferred securities. If the
financial institution defaults on interest payments to the trust, the trust will
not be able to make dividend payments to holders of its securities, such as the
Fund.
As
a result of trust preferred securities being phased out of Tier I and Tier II
capital of banking organizations, the Fund’s ability to invest in trust
preferred securities may be limited. This may impact the Fund’s ability to
achieve its investment objective.
U.S.
Government Securities
U.S.
Government securities are obligations of and, in certain cases, guaranteed by,
the U.S. Government, its agencies or instrumentalities. The U.S. Government does
not guarantee the net asset value of a Fund’s shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the Government National Mortgage Association (“GNMA”), are supported by the
full faith and credit of the United States; others, such as those of the Federal
Home Loan Banks, are supported by the right of the issuer to borrow from the
U.S. Department of the Treasury (the “U.S. Treasury”); others, such as those of
the Federal National Mortgage Association (“FNMA”), are supported by the
discretionary authority of the U.S. Government to purchase the agency’s
obligations; and still others, such as securities issued by members of the Farm
Credit System, are supported only by the credit of the agency, instrumentality
or corporation. U.S. Government securities may include zero coupon securities,
which do not distribute interest on a current basis and tend to be subject to
greater risk than interest-paying securities of similar maturities.
Securities
issued by U.S. Government agencies or government-sponsored enterprises may not
be guaranteed by the U.S. Treasury. GNMA, a wholly owned U.S. Government
corporation, is authorized to guarantee, with the full faith and credit of the
U.S. Government, the timely payment of principal and interest on securities
issued by institutions approved by GNMA and backed by pools of mortgages insured
by the Federal Housing Administration or guaranteed by the Department of
Veterans Affairs. Government-related guarantors (i.e., not backed by the full
faith and credit of the U.S. Government) include the FNMA and the Federal Home
Loan Mortgage Corporation (“FHLMC”). Pass-through securities issued by FNMA are
guaranteed as to timely payment of principal and interest by FNMA but are not
backed by the full faith and credit of the U.S. Government. FHLMC guarantees the
timely payment of interest and ultimate collection of principal, but its
participation certificates are not backed by the full faith and credit of the
U.S. Government. Instead, they are supported only by the discretionary authority
of the U.S. Government to purchase the agency’s obligations. Under the direction
of the Federal Housing Finance Agency (“FHFA”), FNMA and FHLMC have entered into
a joint initiative to develop a common securitization platform for the issuance
of a uniform mortgage-backed security (“UMBS”) (the “Single Security
Initiative”) that aligns the characteristics of FNMA and FHLMC certificates. The
Single Security Initiative was implemented in June 2019, and the long-term
effects it may have on the market for mortgage-backed securities are
uncertain.
The
Funds may invest in component parts of U.S. Treasury notes or bonds, namely,
either the corpus (principal) of such U.S. Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) U.S. Treasury obligations from which the interest
coupons have been stripped; (2) the interest coupons that are stripped; (3)
book-entries at a Federal Reserve member bank representing ownership of U.S.
Treasury obligation components; or (4) receipts evidencing the component parts
(corpus or coupons) of U.S. Treasury obligations that have not actually been
stripped. Such receipts evidence ownership of component parts of U.S. Treasury
obligations (corpus or coupons) purchased by a third party (typically an
investment banking firm) and held on behalf of the third party in physical or
book-entry form by a major commercial bank or trust company pursuant to a
custody agreement with the third party.
Variable
and Floating Rate Securities
Variable
and floating rate securities provide for a periodic adjustment in the interest
rate paid on the obligations. The Fund may invest in floating rate debt
instruments (“floaters”) and engage in credit spread trades. Variable and
floating rate 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 securities will
not generally increase in value if interest rates decline. The absence of an
active secondary market for certain variable and floating rate notes could make
it difficult to dispose of the instruments, and the Fund could suffer a loss if
the issuer defaults or during periods in which the Fund is not entitled to
exercise its demand rights. When a reliable trading market for the variable and
floating rate instruments held by the Fund does not exist and the Fund may not
demand payment of the principal amount of such instruments within seven days,
the instruments may be deemed illiquid and therefore subject to the Fund’s
limitation on investments in illiquid securities. See the discussion under
“Illiquid Securities.” The Fund may also invest in inverse floating rate debt
instruments (“inverse floaters”). An inverse floater may exhibit greater price
volatility than a fixed rate obligation of similar credit quality. The Fund may
invest up to 5% of its total assets in any combination of mortgage-related or
other asset-backed IO, PO or inverse floater securities. Additionally, the Fund
may invest, without limitation, in RIBs.
Warrants
The
Fund may invest in warrants. Warrants are instruments that give the holder the
right, but not the obligation, to buy a security directly from the issuer at a
specific price for a specific period of time. Changes in the value of a warrant
do not necessarily correspond to changes in the value of its underlying
security. The price of a warrant may be more volatile than the price of its
underlying security, and a warrant may offer greater potential for capital
appreciation as well as capital loss. Warrants do not entitle a holder to
dividends or voting rights with respect to the underlying security, do not
represent any rights in the assets of the issuing company and are subject to the
risk that the issuer-counterparty may fail to honor its obligations. A warrant
ceases to have value if it is not exercised prior to its expiration date. These
factors can make warrants more speculative than other types of investments.
Bonds with warrants attached to purchase equity securities have many
characteristics of convertible bonds and their prices may, to some degree,
reflect the performance of the underlying stock. Bonds also may be issued with
warrants attached to purchase additional fixed income securities at the same
coupon rate. A decline in interest rates would permit the Fund to buy additional
bonds at the favorable rate or to sell the warrants at a profit. If interest
rates rise, the warrants would generally expire with no value.
When-Issued
Securities, Delayed Delivery Securities and Forward Commitments
The
Fund may purchase or sell securities on a when-issued, delayed delivery or
forward commitment basis. These transactions involve the purchase or sale of
securities by the Fund at an established price with payment and delivery taking
place in the future. The Fund enters into these transactions to obtain what is
considered an advantageous price to the Fund at the time of entering into the
transaction. When such purchases or sales are outstanding, the Fund will
maintain 300% asset coverage of its obligation unless exempted from being
considered a senior security pursuant to Rule 18f-4(f) of the 1940
Act.
There
can be no assurance that a security purchased on a when-issued basis will be
issued or that a security purchased or sold on a delayed delivery basis or
through a forward commitment will be delivered. Also, the value of securities in
these transactions on the delivery date may be more or less than the price paid
by the Fund to purchase the securities. The Fund will lose money if the value of
the security in such a transaction declines below the purchase price and will
not benefit if the value of the security appreciates above the sale price during
the commitment period.
The
Fund may dispose of or renegotiate a transaction after it is entered into, and
may purchase or sell when-issued, delayed delivery or forward commitment
securities before the settlement date, which may result in a gain or loss. There
is no percentage limitation on the extent to which the Fund may purchase or sell
securities on a when-issued, delayed delivery, or forward commitment
basis.
PORTFOLIO
TURNOVER
The
frequency of the Fund’s portfolio transactions (the portfolio turnover rate)
will vary from year to year depending on many factors. Although the Fund
generally will not invest for short-term trading purposes, portfolio securities
may be sold without regard to the length of time they have been held when, in
the opinion of the Advisor, investment considerations warrant such action.
Higher portfolio turnover rates may result in increased brokerage costs to the
Fund and a possible increase in short-term capital gains or losses. The Fund’s
portfolio turnover rate for the most recent fiscal years ended June 30 was as
follows:
PORTFOLIO
HOLDINGS INFORMATION
The
Trust, on behalf of the Fund, has adopted a portfolio holdings disclosure policy
that governs the timing and circumstances of disclosure of portfolio holdings of
the Fund. The Advisor has also adopted a policy with respect to disclosure of
Fund’s portfolio holdings (the “Advisor’s Policy”). Information about the Fund’s
portfolio holdings will not be distributed to any third party except in
accordance with the portfolio holdings policies and the Advisor’s Policy (the
“Disclosure Policies”). The Advisor and the Board considered the circumstances
under which the Fund’s portfolio holdings may be disclosed under the Disclosure
Policies and the actual and potential material conflicts that could arise in
such circumstances between the interests of the Fund’s shareholders and the
interests of the Advisor, distributor or any other affiliated person of the
Fund. After due consideration, the Advisor and the Board determined that the
Fund has a legitimate business purpose for disclosing portfolio holdings to
persons described in the Disclosure Policies, including mutual fund rating or
statistical agencies, or persons performing similar functions, and internal
parties involved in the investment process, administration or custody of the
Fund. Pursuant to the Disclosure Policies, the Trust’s Chief Compliance Officer
(“CCO”) is authorized to consider and authorize dissemination of portfolio
holdings information to additional third parties, after considering the best
interests of the Fund shareholders and potential conflicts of interest in making
such disclosures.
The
Board exercises continuing oversight of the disclosure of the Fund’s portfolio
holdings by (1) overseeing the implementation and enforcement of the Disclosure
Policies, Codes of Ethics and other relevant policies of the Fund and its
service providers by the Trust’s CCO, (2) by considering reports and
recommendations by the Trust’s CCO concerning any material compliance matters
(as defined in Rule 38a-1 under the 1940 Act), and (3) by considering the
approval of any amendment to the Disclosure Policies. The Board reserves the
right to amend the Disclosure Policies at any time without prior notice to
shareholders in its sole discretion.
Regulatory
Filings
Disclosure
of the Fund’s complete holdings is required to be made quarterly within 60 days
of the end of each period covered by the annual report and semi-annual report to
Fund shareholders and in the holdings report on Part F of Form N-PORT. These
reports will be available, free of charge, on the EDGAR database on the SEC’s
website at www.sec.gov or on the Fund’s website at https://hwcm.onlineprospectus.net/HWCM/HOMPX.
Portfolio
Holdings on the Fund’s Website and in Marketing Materials
The
Fund may disclose the following information on its website:
–Unaudited
portfolio holdings of the Fund as of the previous month-end.
–The
Fund’s quarter-end top 10 holdings and sector classifications, portfolio
characteristics including price-to-book ratio, and market cap of the Fund.
–Quarterly
commentary for the Fund, which may discuss the Fund’s sectors, industries and
individual holding.
–Quarterly
fact sheets for the Fund, which may include Top 10 holdings and sector
classifications, and portfolio characteristics of the Fund.
–Quarterly
attribution reports (quarter-to-date and year-to-date) that may include top and
bottom five contributors to performance, as well as bullet points which may
discuss a Fund’s sectors, industries and individual holdings.
Quarter-end
information will, at a minimum, remain on the Fund’s website until the Fund
files a list of their holdings with the SEC for the relevant periods.
The
Advisor may not selectively disclose such information unless all of the
information is disclosed by one of the above methods on its website and are
available to all shareholders.
In
the event of a conflict between the interests of the Fund and the interests of
the Advisor or an affiliated person of the Advisor, the CCO of the Advisor, in
consultation with the Trust’s CCO, shall make a determination in the best
interests of the Fund, and shall report such determination to the Board at a
board meeting after the end of the quarter in which such determination was made.
Any employee of the Advisor who suspects a breach of this obligation must report
the matter immediately to the Advisor’s CCO or to his or her
supervisor.
Disclosure
of Holdings to Service Providers and Other Parties
In
addition, material non-public holdings information may be provided without lag
as part of the normal investment activities of the Fund to each of the following
entities, which, by explicit agreement or by virtue of their respective duties
to the Fund, are required to maintain the confidentiality of the information
disclosed, including a duty not to trade on non-public information: the fund
administrator, fund accountant, custodian, transfer agent, auditors, counsel to
the Fund or the Board, broker-dealers (in connection with the purchase or sale
of securities, requests for price quotations or bids on one or more securities
or receipt of relevant research) and regulatory authorities. Portfolio holdings
information not publicly available with the SEC or through the Fund’s website
may only be provided to additional third parties, including mutual fund ratings
or statistical agencies, in accordance with the Disclosure Policies, when the
Fund has a legitimate business purpose and the third-party recipient is subject
to a confidentiality agreement that includes a duty not to trade on non-public
information.
Disclosure
of Holdings to Analytical Companies
The
Fund’s portfolio holdings are generally sent to certain analytical companies
(Morningstar, Bloomberg, S&P, Thomson Financial, FactSet, etc,) and
investment consultants either monthly or quarterly after a complete set of
holdings is available on the Fund’s website.
Other
Clients of the Advisor
Various
non-Fund portfolios of other clients of the Advisor may hold securities
substantially similar to those held by the Fund, since the Advisor maintains a
“target portfolio” for each of its investment strategies which often utilizes
similar securities for various client portfolios (including the Fund) managed
with a particular investment strategy. These clients generally have access to
current portfolio holding information for their accounts and do not owe the Fund
or the Advisor a
duty
of confidentiality with respect to disclosure of their portfolio holdings. The
Advisor has implemented separate policies and procedures with respect to
appropriate disclosure of the Advisor’s representative or target portfolios,
including to the Advisor's other clients and/or other third-parties, which may
differ from the Fund’s public disclosure procedures. It is possible that such
persons or other market participants may use such information for their own
benefit, which could negatively impact the Fund’s execution of purchase and sale
transactions.
In
no event shall the Advisor, its affiliates or employees, the Fund, or any other
party receive any direct or indirect compensation in connection with the
disclosure of information about the Fund’s portfolio holdings.
TRUSTEES
AND EXECUTIVE OFFICERS
The
Board oversees the management and operations of the Trust. The Board, in turn,
elects the officers of the Trust, who are responsible for the day-to-day
operations of the Trust and its separate series. The current Trustees and
officers of the Trust, their year of birth, positions with the Trust, terms of
office with the Trust and length of time served, principal occupations during
the past five years and other directorships are set forth in the table below.
Unless noted otherwise, the principal business address of each Trustee is c/o
U.S. Bank Global Fund Services, 615 East Michigan Street, Milwaukee, Wisconsin
53202.
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Name
and Year of Birth |
Positions
with the Trust |
Term
of Office and Length of Time Served |
Principal
Occupations During Past Five Years |
Number
of Portfolios in Fund Complex(2)
Overseen
by Trustees |
Other
Directorships Held During Past Five Years |
Independent
Trustees of the Trust(1) |
Koji
Felton (born 1961)
|
Trustee |
Indefinite
Term; Since September 2015. |
Retired. |
1 |
Independent
Trustee, Listed Funds Trust (52 portfolios) (Since 2019).
|
Debra
McGinty-Poteet (born 1956)
|
Trustee |
Indefinite
Term; Since September 2015. |
Retired. |
1 |
Independent
Trustee, F/m Funds Trust (4 portfolios) (Since May 2015). |
Daniel
B. Willey (born 1955)
|
Trustee |
Indefinite
Term; Since September 2015. |
Retired.
Chief Compliance Officer, United Nations Joint Staff Pension Fund (2009 -
2017). |
1 |
None |
Interested
Trustee |
Elaine
E. Richards(3)
(born
1968)
|
Chair,
Trustee |
Indefinite
Term; Since July 2021. |
Senior
Vice President, U.S. Bank Global Fund Services (since
2007). |
1 |
None |
Officers
of the Trust |
Ryan
L. Roell (born 1973) |
President
and Principal Executive Officer |
Indefinite
Term; Since July 2019. |
Vice
President, U.S. Bank Global Fund Services (since 2005). |
Not
Applicable |
Not Applicable |
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Name
and Year of Birth |
Positions
with the Trust |
Term
of Office and Length of Time Served |
Principal
Occupations During Past Five Years |
Number
of Portfolios in Fund Complex(2)
Overseen
by Trustees |
Other
Directorships Held During Past Five Years |
Cullen
O. Small (born 1987)
|
Vice
President, Treasurer and Principal Financial Officer |
Indefinite
Term; Since January 2019. |
Vice
President, U.S. Bank Global Fund Services (since 2010). |
Not
Applicable |
Not
Applicable |
Donna
Barrette (born 1966)
|
Vice
President, Chief Compliance Officer and Anti-Money Laundering
Officer |
Indefinite
Term; Since November 2019. |
Senior
Vice President and Compliance Officer, U.S. Bank Global Fund Services
(since 2004). |
Not Applicable |
Not Applicable |
Adam
W. Smith (born 1981) |
Secretary |
Indefinite
Term; Since June 2019. |
Vice
President, U.S. Bank Global Fund Services (since 2012). |
Not
Applicable |
Not
Applicable |
Richard
E. Grange (born 1982)
|
Assistant
Treasurer
|
Indefinite
Term; Since October 2022.
|
Officer,
U.S. Bank Global Fund Services (since 2017). |
Not
Applicable
|
Not
Applicable
|
(1) The
Trustees of the Trust who are not “interested persons” of the Trust as defined
by the 1940 Act (“Independent Trustees”).
(2) As
of the date of this SAI, the Trust was comprised of 19 portfolios (including the
Fund) managed by unaffiliated investment advisers. The term “Fund Complex”
applies only to the Fund. The Fund does not hold itself out as related to any
other series within the Trust for investment purposes, nor does it share the
same investment adviser with any other series within the Trust.
(3) Ms.
Richards, as a result of her employment with U.S. Bank Global Fund Services,
which acts as transfer agent, administrator, and fund accountant to the Trust,
is considered to be an “interested person” of the Trust, as defined by the 1940
Act.
Additional
Information Concerning the Board of Trustees
The
Role of the Board
The
Board oversees the management and operations of the Trust. Like all mutual
funds, the day-to-day management and operation of the Trust is the
responsibility of the various service providers to the Trust, such as the
Advisor, the Distributor, the Administrator, the Custodian, and the Transfer
Agent, each of whom are discussed in greater detail in this SAI. The Board has
appointed various senior employees of the Administrator as officers of the
Trust, with responsibility to monitor and report to the Board on the Trust’s
operations. In conducting this oversight, the Board receives regular reports
from these officers and the service providers. For example, the Treasurer
provides reports as to financial reporting matters and the President provides
reports as to matters relating to the Trust’s operations. In addition, the
Advisor provides regular reports on the investment strategy and performance of
the Fund. The Board has appointed a CCO who administers the Trust’s compliance
program and regularly reports to the Board as to compliance matters. These
reports are provided as part of formal “Board Meetings” which are typically held
quarterly, in person, and involve the Board’s review of recent operations. In
addition, various members of the Board also meet with management in less formal
settings, between formal “Board Meetings,” to discuss various topics. In all
cases, however, the role of the Board and of any individual Trustee is one of
oversight and not of management of the day-to-day affairs of the Trust and its
oversight role does not make the Board a guarantor of the Trust’s investments,
operations or activities.
Board
Structure, Leadership
The
Board has structured itself in a manner that it believes allows it to perform
its oversight function effectively. It has established two standing committees:
a Governance and Nominating Committee and an Audit Committee, which also
serves
as the Qualified Legal Compliance Committee, which are discussed in greater
detail below under “Trust Committees.” The Board is comprised of one Interested
Trustee and three Independent Trustees, which are Trustees that are not
affiliated with the Advisor, the principal underwriter, or their affiliates. The
Governance and Nominating Committee, Audit Committee and Qualified Legal
Compliance Committee are comprised entirely of Independent Trustees. The Chair
of the Board is an Interested Trustee. The Board has determined not to appoint a
lead Independent Trustee; however, the Independent Trustees are advised by
independent counsel. The President and Principal Executive Officer of the Trust
is not a Trustee, but rather is a senior employee of the Administrator who
routinely interacts with the unaffiliated investment advisers of the Trust and
comprehensively manages the operational aspects of the funds in the Trust. The
Trust has determined that it is appropriate to separate the Principal Executive
Officer and Chair of the Board positions because the day-to day responsibilities
of the Principal Executive Officer are not consistent with the oversight role of
the Trustees and because of the potential conflict of interest that may arise
from the Administrator’s duties with the Trust. The Board reviews its structure
and the structure of its committees annually. Given the specific characteristics
of the Trust, as described above, the Board has determined that the structure of
the Interested Chair, the composition of the Board, and the function and
composition of its various committees are appropriate means to address any
potential conflicts of interest that may arise.
Board
Oversight of Risk Management
As
part of its oversight function, the Board receives and reviews various risk
management reports and discusses these matters with appropriate management and
other personnel. Because risk management is a broad concept comprised of many
elements (e.g.,
investment risk, issuer and counterparty risk, compliance risk, operational
risks, business continuity risks, etc.), the oversight of different types of
risks is handled in different ways. For example, the Audit Committee meets with
the Treasurer and the Trust’s independent registered public accounting firm to
discuss, among other things, the internal control structure of the Trust’s
financial reporting function. The Board meets regularly with the CCO to discuss
compliance and operational risks and how they are managed. The Board also
receives reports from the Advisor as to investment risks of the Fund. In
addition to these reports, from time to time the Board receives reports from the
Administrator and the Advisor as to enterprise risk management.
The
Board oversees the Fund’s liquidity risk through, among other things, receiving
periodic reporting from the CCO. Additionally, as required by Rule 22e-4 under
the 1940 Act, the Trust implemented the Liquidity Program pursuant to the
provisions of Rule 22e-4, as it relates to the Fund. The Board, including a
majority of the Independent Trustees approved the designation of a liquidity
risk management program administrator (the “Liquidity Program Administrator”)
who is responsible for administering the Liquidity Program. The Board reviews,
no less frequently than annually, a written report prepared by the Liquidity
Program Administrator that addresses the operation of the Liquidity Program and
assesses its adequacy and effectiveness of implementation.
Information
about Each Trustee’s Qualification, Experience, Attributes or Skills
The
Board believes that each of the Trustees has the qualifications, experience,
attributes and skills (“Trustee Attributes”) appropriate to their continued
service as Trustees of the Trust in light of the Trust’s business and structure.
The Board annually conducts a “self-assessment” wherein the effectiveness of the
Board and individual Trustees is reviewed.
In
addition to the information provided in the chart above, below is certain
additional information concerning each particular Trustee and his/her Trustee
Attributes. The information is not all-inclusive. Many Trustee Attributes
involve intangible elements, such as intelligence, integrity, work ethic, the
ability to work together, the ability to communicate effectively, the ability to
exercise judgment, to ask incisive questions, and commitment to shareholder
interests.
Koji
Felton.
Mr. Felton has served as a Trustee since 2015 and has substantial experience
with the mutual fund industry and familiarity with federal securities laws and
regulations. Mr. Felton’s prior experience includes serving as Director and
Counsel for KKR Credit Advisors LLC, the asset manager arm of Kohlberg Kravis
Roberts & Co. L.P. (2013 – 2015). Prior to that Mr. Felton served as counsel
in the Financial Services Group at Dechert LLP from (2011 – 2013), as well as in
various capacities, and ultimately as Senior Vice President and Deputy General
Counsel for mutual funds, at Charles Schwab & Co., Inc. (1998 – 2011). Mr.
Felton also worked as a staff attorney and served as the Enforcement Branch
Chief for the San Francisco District Office of the SEC (1992 – 1998). Mr. Felton
began his career as a litigation associate specializing in securities and
banking litigation at Shearman & Sterling (1986 – 1992).
Debra
McGinty-Poteet.
Ms.
McGinty-Poteet has served as a Trustee since 2015 and has significant mutual
fund industry experience, including her current and prior experience on mutual
fund boards. Ms. McGinty-Poteet currently also serves as Lead Independent
Trustee and Chair of the Audit Committee for F/m Funds Trust. Prior to becoming
a Trustee of the
Trust,
Ms. McGinty-Poteet served as the President, Interested Trustee and Chair of the
Board for Brandes Investment Trust where she also oversaw the proprietary and
sub-advisory mutual fund business for Brandes Investment Advisors (1999 – 2012).
Ms. McGinty-Poteet previously served as Chief Operating Officer of North
American Trust Company (1997 – 1998); Global Managing Director of Mutual Funds
at Bank of America (1992 – 1996); and in various capacities, and ultimately as
Global Head of Mutual Funds, at Security Pacific Bank (1982 –
1992).
Daniel
Willey.
Mr. Willey has served as a Trustee since 2015 and has significant work history
and experience in the investment management industry. As a chief compliance
officer, Mr. Willey has valuable experience in an oversight role and in working
with regulatory compliance matters. Mr. Willey served as the Chief Compliance
Officer of the United Nations Joint Staff Pension Fund (2009-2017). Prior to his
current role, Mr. Willey served as the Chief Operating and Chief Compliance
Officer of Barrett Associates, Inc. (investment adviser and affiliate of Legg
Mason (2007 – 2009); President and Chief Executive Officer of TIMCO, Citigroup
Asset Management (2004 – 2006); Head Equity Trader of TIMCO (1994 – 2004); Vice
President, Shawmut National Bank (1992 – 1994); Investment Officer, State of
Connecticut (1990 – 1992); Vice President, Bank of New England (Connecticut Bank
& Trust) (1981 – 1990); Registered Representative, Tucker Anthony and R.L.
Day, Inc. (1979 – 1981); and Assistant Analyst, The Travelers Insurance Company
(1977 – 1979).
Elaine
Richards.
Ms. Richards has served as a Trustee since 2021 and has over 25 years of
experience, knowledge, and understanding of the mutual fund industry. Ms.
Richards currently serves as a Senior Vice President of U.S. Bank Global Fund
Services and has extensive experience in the 1940 Act, securities law in general
and SEC compliance and regulatory matters. In addition, Ms. Richards has
extensive experience in the oversight of regulatory examinations and providing
support and assistance to mutual fund clients implementing new regulatory
requirements. Prior to joining U.S. Bank Global Fund Services, Ms. Richards was
Vice President and senior counsel at Wells Fargo Funds Management.
Trust
Committees
The
Trust has two standing committees: the Governance and Nominating Committee and
the Audit Committee, which also serves as the Qualified Legal Compliance
Committee (“QLCC”).
The
Governance and Nominating Committee, comprised of all the Independent Trustees,
is responsible for making recommendations to the Board regarding various
governance-related aspects of the Board’s responsibilities and seeking and
reviewing candidates for consideration as nominees for Trustees and meets only
as necessary. The Governance and Nominating Committee will consider nominees
nominated by shareholders. Recommendations by shareholders for consideration by
the Governance and Nominating Committee should be sent to the President of the
Trust in writing together with the appropriate biographical information
concerning each such proposed Nominee, and such recommendation must comply with
the notice provisions set forth in the Trust Bylaws. In general, to comply with
such procedures, such nominations, together with all required biographical
information, must be delivered to and received by the President of the Trust at
the principal executive offices of the Trust no less than 120 days and no more
than 150 days prior to the shareholder meeting at which any such nominee would
be voted on. The Governance and Nominating Committee met once during the Fund’s
most recent fiscal year ended June 30, 2023.
The
Audit Committee is comprised of all of the Independent Trustees. The Audit
Committee generally meets on a quarterly basis with respect to the various
series of the Trust, and may meet more frequently. The function of the Audit
Committee, with respect to each series of the Trust, is to review the scope and
results of the audit of such series’ financial statements and any matters
bearing on the audit or the financial statements, and to ensure the integrity of
the series’ pricing and financial reporting. The Audit Committee met four times
during the Fund’s most recent fiscal year ended June 30, 2023.
The
function of the QLCC is to receive reports from an attorney retained by the
Trust of evidence of a material violation by the Trust or by any officer,
director, employee or agent of the Trust.
Trustee
Ownership of Fund Shares and Other Interests
No
Trustee beneficially owned shares of the Fund as of the calendar year ended
December 31, 2022. Furthermore, neither the Independent Trustees nor members of
their immediate family, own securities beneficially or of record in the Advisor,
the Fund’s principal underwriter, or any of their affiliates as of the same
date.
Compensation
The
Independent Trustees each will receive an annual retainer of $50,000. Prior to
January 1, 2023, Independent Trustees received an annual retainer of $40,000.
Independent Trustees will also be reimbursed for expenses in connection with
each Board meeting attended. These reimbursements will be allocated among
applicable portfolios of the
Trust.
The Trust has no pension or retirement plan. No other entity affiliated with the
Trust pays any compensation to the Trustees. The Trust does not pay any fees to,
or reimburse expenses of, the Interested Trustee.
Set
forth below is the compensation received by the following Independent Trustees
from the Fund for the fiscal year ended June 30, 2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Name
of Person/ Position |
Aggregate
Compensation From the Fund(1) |
Pension
or Retirement Benefits Accrued as Part of Fund Expenses |
Estimated
Annual Benefits Upon Retirement |
Total
Compensation from Fund and Fund Complex(2)
Paid to Trustees |
Koji
Felton, Independent Trustee |
$3,645 |
None |
None |
$3,645 |
Debra
McGinty Poteet, Independent Trustee |
$3,645 |
None |
None |
$3,645 |
Daniel
Willey, Independent Trustee |
$3,645 |
None |
None |
$3,645 |
(1)Trustees’
fees and expenses are allocated among the Fund and all other series comprising
the Trust.
(2)As
of the date of this SAI, the Trust was comprised of 19 portfolios (including the
Fund) managed by unaffiliated investment advisers. The term “Fund Complex”
applies only to the Fund, and not to other series of the Trust. For the year
ending June 30, 2023, aggregate Independent Trustees’ fees and expenses amounted
to $135,000.
Codes
of Ethics
The
Trust, the Advisor and the distributor have each adopted separate codes of
ethics pursuant to Rule 17j-1 of the 1940 Act. These codes of ethics
permit, subject to certain conditions, personnel of the Advisor and the
distributor to invest in securities that may be purchased or held by the
Fund.
PROXY
VOTING POLICIES AND PROCEDURES
The
Board has adopted Proxy Voting Policies and Procedures (the “Trust Proxy
Policies”) on behalf of the Trust which delegate the responsibility for voting
proxies to the Advisor or its designee, subject to the Board’s continuing
oversight. The Trust’s Proxy Policies require that the Advisor or its designee
vote proxies received in a manner consistent with the best interests of the Fund
and its shareholders. The Trust Proxy Policies also require the Advisor to
present to the Board, at least annually, the Advisor’s proxy policies and a
record of each proxy voted by the Advisor on behalf of the Fund, including a
report on the resolution of all proxies identified by the Advisor as involving a
conflict of interest.
The
Advisor has adopted proxy policies, which may be amended from time to time. In
voting proxies, the Advisor is guided by fiduciary principles. All proxies are
to be voted solely in the best interests of the beneficial owners of the
securities. A copy of the Advisor’s proxy voting policies and procedures is
attached to this SAI as Appendix A.
The
Trust is required to file a Form N-PX, with the Fund’s complete proxy voting
record for the 12 months ended June 30, no later than August 31 of each year.
Form N-PX for the Fund is available without charge, upon request, by calling
888-458-1963 and on the SEC’s website at www.sec.gov.
CONTROL
PERSONS, PRINCIPAL SHAREHOLDERS AND MANAGEMENT OWNERSHIP
A
principal shareholder is any person who owns of record or beneficially owns 5%
or more of the outstanding shares of the Fund. A control person is any person
who owns beneficially or through controlled companies more than 25% of the
voting securities of the Fund or acknowledges the existence of
control.
As
of October 1, 2023, the following shareholders owned 5% or more of the
outstanding shares of each class of the Fund:
|
|
|
|
|
|
|
| |
Name
and Address |
%
Ownership |
Type
of Ownership |
Merrill
Lynch Pierce Fenner & Smith
For
the Sole Benefit of its Customers
4800
Deer Lake Drive E
Jacksonville,
FL 32246-6484 |
98.67% |
Record |
As
of December 31, 2022, the Trustees and officers of the Trust as a group did not
own more than 1% of the outstanding shares of the Fund.
MANAGEMENT
The
Fund’s Investment Advisor
Hotchkis
& Wiley Capital Management, LLC (previously defined as the “Advisor”) serves
as the investment adviser to the Fund pursuant to an Investment Advisory
Agreement (the “Advisory Agreement”) and is located at 601 South Figueroa
Street, 39th Floor, Los Angeles, California 90017-5704. The Advisor is a
Delaware limited liability company, the primary members of which are HWCap
Holdings, a limited liability company whose members are current and former
employees of the Advisor, and Stephens - H&W, LLC, a limited liability
company whose primary member is SF Holding Corp., which is a diversified holding
company. The Advisor supervises and arranges the purchase and sale of securities
held in the Fund’s portfolio and manages the Fund. The Advisor also manages
other investment company portfolios and separate investment advisory
accounts.
The
Advisory Agreement continues in effect for an initial two-year period, and from
year to year thereafter only if such continuance is specifically approved at
least annually by the Board or by vote of a majority of the Fund’s outstanding
voting securities and by a majority of the Independent Trustees, who are not
parties to the Advisory Agreement or interested persons of any such party, in
each case cast in person at a meeting called for the purpose of voting on the
Advisory Agreement. The Advisory Agreement is terminable without penalty by the
Trust on behalf of the Fund on not more than 60 days’, nor less than 30 days’,
written notice to the Advisor when authorized either by a majority vote of the
Fund’s shareholders or by a vote of a majority of the Trustees, or by the
Advisor on not more than 60 days’ written notice to the Trust, and will
automatically terminate in the event of its “assignment” (as defined in the 1940
Act). The Advisory Agreement provides that the Advisor shall not be liable under
such agreement for any error of judgment or mistake of law or for any loss
arising out of any investment or for any act or omission in the execution of
portfolio transactions for the Fund, except for willful misfeasance, bad faith
or gross negligence in the performance of its duties, or by reason of reckless
disregard of its obligations and duties thereunder.
The
Fund does not pay advisory fees to the Advisor.
The
Advisor has agreed to reimburse the Fund for all operating expenses incurred so
that regular annual operating expenses of the Fund will be 0.00%. The expense
limitations and/or reimbursements do not cover (a) any front-end or contingent
deferred loads, (b) Rule 12b-1 fees, (c) shareholder servicing plan fees, (d)
taxes, (e) leverage/borrowing interest (including interest incurred in
connection with bank and custody overdrafts), (f) interest expense, (g)
dividends paid on short sales, (h) brokerage and other transactional expenses,
(i) acquired fund fees and expenses, (j) securities lending fees, (k) expenses
incurred in connection with any merger or reorganization, or (l) any
extraordinary expenses, including but not limited to litigation expenses and
judgments and indemnification expenses. The Advisor has agreed to these expense
limits through December 31, 2024 and may be terminated at any time thereafter
upon 60 days’ written notice by the Board or the Advisor, with the consent of
the Board.
There
are no advisory or other fees payable to the Advisor for its services under the
Advisory Agreement. However, all fund shareholders are participants in
separately managed account programs where the Advisor or an affiliate of the
Advisor receives a fee from the managed account program sponsor (the “Program
Sponsor”) (typically, a registered investment adviser or broker/dealer) or from
the program participant for managing or advising assets in the program
participant’s managed account, including assets that may be invested in the
Fund.
For
the fiscal years ended June 30, 2023 and June 30, 2022 and for the fiscal period
from December 30, 2020 (the Fund’s inception) through June 30, 2021, the Fund
did not pay any management fees to the Advisor.
Portfolio
Managers
The
Fund is managed by the investment team of the Advisor (“Investment Team”),
including portfolio managers. The Investment Team also has responsibilities for
the day-to-day management of accounts other than the Fund. The Advisor has
identified the portfolio managers with the most significant responsibility for
the Fund’s portfolio. The list does not include all members of the investment
team.
George
H. Davis, Jr. and David Green each serve as a portfolio manager for the Fund and
are jointly and primarily responsible for the day-to-day management of the Fund.
Information regarding other accounts managed by the portfolio managers as of
June 30, 2023 is set forth below.
|
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|
|
|
|
|
|
|
|
|
| |
| Number
of Other Accounts Managed and Assets by Account Type |
Number
of Accounts and Assets for Which Advisory Fee is
Performance-Based |
Portfolio
Managers |
Registered
Investment Companies |
Other
Pooled Investment Vehicles |
Other
Accounts |
Registered
Investment Companies |
Other
Pooled Investment Vehicles |
Other
Accounts |
George
H. Davis, Jr. David Green CFA
|
23
$18.9
billion |
10
$2.1
billion |
57
$7.1
billion |
2
$12.1
billion |
1
$45.0
million |
4
$879.4
million |
Conflicts
of Interest and Compensation
From
time to time, potential and actual conflicts of interest may arise between a
portfolio manager’s management of the investments of the Fund, on the one hand,
and the management of other accounts, on the other hand. For example, the
portfolio managers also manage institutional accounts and other mutual funds in
several different investment strategies. The portfolios within an investment
strategy are managed using a target portfolio; however, each portfolio may have
different restrictions, cash flows, tax and other relevant considerations which
may preclude a portfolio from participating in certain transactions for that
investment strategy. Consequently, the performance of portfolios may vary due to
these different considerations. The portfolio managers may place transactions
for one investment strategy that are directly or indirectly contrary to
investment decisions made on behalf of another investment strategy. The Advisor
may be restricted from purchasing more than a limited percentage of the
outstanding shares of a company or otherwise restricted from trading in a
company’s securities due to other regulatory limitations. If a company is a
viable investment for more than one investment strategy, the Advisor has adopted
policies and procedures reasonably designed to ensure that all of its clients
are treated fairly and equitably. Additionally, potential and actual conflicts
of interest may also arise as a result of the Advisor’s other business
activities and the Advisor’s possession of material non-public information about
an issuer.
Different
types of accounts and investment strategies may have different fee structures.
Additionally, certain accounts pay the Advisor performance-based fees, which may
vary depending on how well the account performs compared to a benchmark. Because
such fee arrangements have the potential to create an incentive for the Advisor
to favor such accounts in making investment decisions and allocations, the
Advisor has adopted policies and procedures reasonably designed to ensure that
all of its clients are treated fairly and equitably, including in respect of
allocation decisions, such as initial public offerings.
Since
accounts are managed to a target portfolio by the portfolio managers, adequate
time and resources are consistently applied to all accounts in the same
investment strategy.
The
portfolio managers are compensated in various forms, which may include one or
more of the following: (i) a base salary, (ii) bonus, (iii) profit sharing and
(iv) equity ownership. Compensation is used to reward, attract and retain high
quality investment professionals.
The
portfolio managers are evaluated and accountable at three levels. The first
level is individual contribution to the research and decision-making process,
including the quality and quantity of work achieved. The second level is
teamwork, generally evaluated through contribution within sector teams. The
third level pertains to overall portfolio and firm performance.
Fixed
salaries and discretionary bonuses for investment professionals are determined
by the Chief Executive Officer of the Advisor using tools which may include
annual evaluations, compensation surveys, feedback from other employees and
advice from members of the firm’s Executive and Compensation Committees. The
amount of the bonus is determined by the total amount of the firm’s bonus pool
available for the year, which is generally a function of revenues. No investment
professional receives a bonus that is a pre-determined percentage of revenues or
net income. Compensation is thus subjective rather than formulaic.
The
portfolio managers of the Fund own equity in the Advisor. The Advisor believes
that the employee ownership structure of the firm will be a significant factor
in ensuring a motivated and stable employee base going forward. The Advisor
believes that the combination of competitive compensation levels and equity
ownership provides the Advisor with a demonstrable advantage in the retention
and motivation of employees. Portfolio managers who own equity in the Advisor
receive their pro rata share of the Advisor’s profits. Investment professionals
may also receive contributions under the Advisor’s profit sharing/401(k)
plan.
Finally,
the Advisor maintains a bank of unallocated equity to be used for those
individuals whose contributions to the firm grow over time. If any owner should
retire or leave the firm, the Advisor has the right to repurchase their
ownership thereby increasing the equity bank. This should provide for smooth
succession through the gradual rotation of the firm’s ownership from one
generation to the next.
The
Advisor believes that its compensation structure/levels are more attractive than
the industry norm, which is illustrated by the firm’s lower-than-industry-norm
investment personnel turnover.
Ownership
of Shares
As
of the date of this SAI, the portfolio managers do not beneficially own any
shares of the Fund.
SERVICE
PROVIDERS
Administrator,
Transfer Agent and Fund Accountant
Pursuant
to an administration agreement (the “Administration Agreement”), U.S. Bancorp
Fund Services, LLC, doing business as U.S. Bank Global Fund Services (“Fund
Services”), 615 East Michigan Street, Milwaukee, Wisconsin 53202, acts as the
administrator to the Fund. Fund Services provides certain services to the Fund
including, among other responsibilities, coordinating the negotiation of
contracts and fees with, and the monitoring of performance and billing of, the
Fund’s independent contractors and agents; preparation for signature by an
officer of the Trust of all documents required to be filed for compliance by the
Trust and the Fund with applicable laws and regulations, excluding those of the
securities laws of various states; arranging for the computation of performance
data, including NAV and yield; responding to shareholder inquiries; and
arranging for the maintenance of books and records of the Fund, and providing,
at its own expense, office facilities, equipment and personnel necessary to
carry out its duties. In this capacity, Fund Services does not have any
responsibility or authority for the management of the Fund, the determination of
investment policy, or for any matter pertaining to the distribution of the
Fund’s shares.
Pursuant
to the Administration Agreement, as compensation for its services, Fund Services
receives from the Fund, a fee based on the Fund’s current average daily net
assets, subject to a minimum annual fee. Fund Services also is entitled to
certain out-of-pocket expenses. Fund Services also acts as fund accountant,
transfer agent and dividend disbursing agent under separate
agreements.
For
services rendered to the Fund, Fund Services received the following in fund
administration and fund accounting fees for the fiscal period/years ended June
30:
|
|
|
|
|
|
|
| |
2023 |
2022 |
2021(1) |
$110,124 |
$103,770 |
$49,737 |
(1)
For the period from December 30, 2020 to June 30, 2022.
Custodian
U.S.
Bank National Association is the custodian of the assets of the Fund (the
“Custodian”) pursuant to a custody agreement between the Custodian and the
Trust. For its services, the Custodian receives a monthly fee based on a
percentage
of the Fund’s assets, in addition to certain transaction based fees, and is
reimbursed for out of pocket expenses. The Custodian’s address is 1555 N.
Rivercenter Drive, Suite 302, Milwaukee, Wisconsin 53212. The Custodian does not
participate in decisions relating to the purchase and sale of securities by the
Fund. Fund Services, the Custodian, and the Fund’s principal underwriter are
affiliated entities under the common control of U.S. Bancorp. The Custodian and
its affiliates may participate in revenue sharing arrangements with the service
providers of mutual funds in which the Fund may invest.
Independent
Registered Public Accounting Firm and Legal Counsel
Cohen
& Company, Ltd. is the independent registered public accounting firm for the
Fund and performs an annual audit of the Fund’s financial statements and advises
the Fund as to certain accounting matters.
Goodwin
Procter LLP, 1900 N Street, NW, Washington, DC 20036, serves as legal counsel to
the Trust and to the Independent Trustees.
EXECUTION
OF PORTFOLIO TRANSACTIONS
Pursuant
to the Advisory Agreement, the Advisor determines which securities are to be
purchased and sold by the Fund and which broker-dealers are eligible to execute
the Fund’s portfolio transactions. Purchases and sales of securities on an
exchange are affected through brokers that charge a commission while purchases
and sales of securities in the over-the-counter market will generally be
executed directly with the primary “market-maker” unless, in the opinion of the
Advisor, a better price and execution can otherwise be obtained by using a
broker for the transaction. Purchases and sales of portfolio securities that are
fixed income securities (for instance, money market instruments and bonds, notes
and bills) usually are principal transactions. In a principal transaction, the
party from whom the Fund purchases or to whom the Fund sells is acting on its
own behalf (and not as the agent of some other party, such as its customers).
These securities normally are purchased directly from the issuer or from an
underwriter or market maker for the securities. The price of securities
purchased from underwriters includes a disclosed fixed commission or concession
paid by the issuer to the underwriter, and prices of securities purchased from
dealers serving as market makers reflects the spread between the bid and asked
price. The price of over-the-counter securities usually includes an undisclosed
commission or markup.
Transactions
on U.S. stock exchanges, commodities markets and futures markets and other
agency transactions involve the payment by the Fund of negotiated brokerage
commissions. Such commissions vary among different brokers. A particular broker
may charge different commissions according to such factors as the difficulty and
size of the transaction. Transactions in foreign investments often involve the
payment of fixed brokerage commissions, which may be higher than those in the
United States. In the case of securities traded in the over-the-counter markets,
the price paid by the Fund usually includes an undisclosed dealer commission or
mark-up. In underwritten offerings, the price paid by the Fund includes a
disclosed, fixed commission or discount retained by the underwriter or
dealer.
It
has for many years been a common practice in the investment advisory business
for advisers of investment companies and other investors to receive brokerage
and research services (as defined in the Securities Exchange Act of 1934, as
amended, and the rules promulgated thereunder (the "1934 Act")) from
broker-dealers that execute portfolio transactions for the clients of such
advisers and from third parties with which such broker-dealers have
arrangements. Consistent with this practice, the Advisor may receive brokerage
and research services and other similar services from many broker-dealers with
which the Advisor places the Fund’s portfolio transactions. These services may
include such matters as trade execution services, general economic and market
reviews, industry and company reviews, evaluations of investments,
recommendations as to the purchase and sale of investments, trade magazines,
company financial data, market data, pricing services, quotation services, and
news services utilized by the Advisor’s investment professionals. Where the
services referred to above are not used exclusively by the Advisor for brokerage
or research purposes, the Advisor, based upon allocations of expected use, would
bear that portion of the cost of these services which directly relates to their
non-brokerage or non-research use. Some of these services may be of value to the
Advisor in advising a variety of its clients (including the Fund), although not
all of these services would necessarily be useful and of value in managing the
Fund. The management fee paid by the Fund is not reduced because the Advisor may
receive these services even though the Advisor might otherwise be required to
purchase some of these services for cash.
The
Advisor places orders for the purchase and sale of portfolio investments for the
Fund and buys and sells investments for the Fund through a substantial number of
brokers and dealers. In so doing, the Advisor uses its best efforts to obtain
for the Fund the most favorable price and execution available, except to the
extent it may be permitted to pay higher brokerage commissions as described
below. In seeking the most favorable price and execution, the Advisor, having in
mind
the Fund's best interests, considers all factors it deems relevant, including,
by way of illustration, price, the size of the transaction, the nature of the
market for the security or other investment, the amount of the commission, the
timing of the transaction taking into account market prices and trends, the
reputation, experience and financial stability of the broker-dealer involved and
the quality of service rendered by the broker-dealer in other
transactions.
Foreign
currency transactions for the Fund are generally executed in two different
manners. As a general matter, foreign currency transactions are executed by the
Fund’s custodian pursuant to standing instructions. These transactions are
executed automatically by the custodian at its discretion or on its schedule
following receipt of securities trade or other data from the Advisor, an
executing broker, custodial affiliate, or another party. The terms under which
the custodian performs these standing instruction foreign currency transactions
such as timing, pricing, fees/spreads, reporting, etc. are on terms agreed
between the Fund and the custodian. Transactions in restricted currencies,
i.e.,
currencies that do not trade on global foreign currency markets, as well as
foreign currency transactions needed to repatriate dividends and income,
interest, and other cash proceeds accumulated as a result of ownership of
foreign ordinary shares and held in foreign custodial accounts, are executed by
custodians pursuant to standing instructions. Foreign currency rates charged by
the custodian for these transactions are often higher than the lowest available
rates and custodians’ foreign currency transactions may or may not be
competitive or transparent. Alternatively, the Advisor may execute trades with
third-party brokers particularly when settling trades in foreign
securities.
As
permitted by Section 28(e) of the 1934 Act, and by each Investment Advisory
Agreement, the Advisor may cause the Fund to pay a broker-dealer which provides
"brokerage and research services" (as defined in the 1934 Act) to the Advisor an
amount of disclosed commission for effecting securities transactions for the
Fund in excess of the commission which another broker-dealer would have charged
for effecting that transaction. The provision of research and brokerage products
and services is often referred to as “soft dollar arrangements.” The Advisor’s
authority to cause the Fund to pay any such greater commissions is also subject
to such policies as the Trustees may adopt from time to time.
For
transactions in fixed income and convertible securities, the provision of
brokerage and research services is not typically considered, although the
Advisor may receive research or research-related credits from broker-dealers
which are generated from underwriting commissions when purchasing new issues of
fixed income securities or other assets for the Fund. Since the securities in
which other clients of the Advisor invest consist primarily of fixed income
securities, which are generally not subject to stated brokerage commissions, as
described above, their investments in securities subject to stated commissions
generally constitute a small percentage of the aggregate dollar amount of their
transactions. Accordingly, other clients of the Advisor which invest primarily
in fixed income securities will generate less brokerage commissions to pay for
research services which may result in a less proportionate amount of commissions
paid for research services than equity accounts.
The
Advisor also may participate in client commission arrangements, commission
sharing arrangements and step-out transactions to receive eligible research and
brokerage products and services. In “client commission arrangements” or
“commission sharing arrangements,” the Advisor may effect transactions, subject
to best execution, through a broker and request that the broker allocate a
portion of the commission or commission credits to a segregated “research
pool(s)” maintained by the broker. The Advisor may then direct such broker to
pay for various products and services that are eligible under the safe harbor of
Section 28(e). Participating in client commission arrangements or commission
sharing arrangements may enable the Advisor to (1) strengthen its key brokerage
relationships; (2) consolidate payments for research and brokerage products and
services; and (3) continue to receive a variety of high quality research and
brokerage products and services while facilitating best execution in the trading
process.
In
a step-out transaction, the Advisor directs a trade to a broker with
instructions that the broker execute the transaction, but “step-out” all or
portion of the transaction or commission in favor of another broker that
provides eligible research and brokerage products or services. The second broker
may clear and/or settle the transaction and receive commissions for the
stepped-in portion. The Advisor only enters into step-out transactions if it
will not hinder best execution.
In
addition to trading with client commission arrangement brokers as discussed
above, the Advisor effects trades with full service and introducing brokers,
Electronic Communication Networks, Alternative Trading Systems, and other
execution services.
From
time to time, the Advisor may purchase new issues of securities for clients,
including the Fund, in a fixed price offering. In these situations, the broker
may be a member of the selling group that will, in addition to selling
securities, provide the Advisor with research services. FINRA has adopted rules
expressly permitting these types of arrangements
under
certain circumstances. Generally, the broker 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).
The
Fund anticipates that its brokerage transactions involving securities of issuers
domiciled outside of the United States will generally be conducted on the
principal stock exchanges of such countries. Brokerage transactions and other
transaction costs on foreign stock exchanges generally are higher than in the
U.S., although the Fund will attempt to achieve the best net results in
effecting its portfolio transactions. There is generally less governmental
supervision and regulation of foreign brokers and foreign stock exchanges than
in the U.S.
Foreign
equity securities may be held by the Fund in the form of ADRs, EDRs, GDRs or
other securities convertible into foreign equity securities. ADRs, EDRs and GDRs
may be listed on stock exchanges, or traded in the Over-the-Counter markets in
the United States or Europe, as the case may be. ADRs traded in the United
States, like other securities traded in the United States, will be subject to
negotiated commission rates. The Fund’s ability and decisions to purchase or
sell portfolio securities of foreign issuers may be affected by laws or
regulations relating to the convertibility and repatriation of
assets.
Because
the Fund’s shares are redeemable on a daily basis in U.S. dollars, the Advisor
intends to manage the Fund so as to give reasonable assurance that it will be
able to obtain U.S. dollars to the extent necessary to meet anticipated
redemptions. Under present conditions, it is not believed that these
considerations will have significant effect on the Fund’s portfolio
strategies.
Securities
held by the Fund may also be held by, or be appropriate investments for, other
funds or investment advisory clients for which the Advisor acts as an adviser.
Because of different objectives or other factors, a particular security may be
bought for one or more clients of the Advisor when one or more clients of the
Advisor are selling the same security. If purchases or sales of securities arise
for consideration at or about the same time that would involve the Fund or other
clients or funds for which the Advisor acts as adviser, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Advisor during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
For
the fiscal periods/years ended June 30, the Fund paid the following in aggregate
brokerage commissions:
|
|
|
|
|
|
|
| |
2023 |
2022(2) |
2021(1) |
$101,930 |
$67,841 |
$833 |
(1)For
the period from December 30, 2020 to June 30, 2022
(2)In
increase in brokerage commissions during the the fiscal year ended June 30,
2022, was due to an increase in the Fund’s net assets.
The
table below indicates the portion of the Fund’s aggregate brokerage for the
fiscal year ended June 30, 2023 that was directed to brokers who, in addition to
providing trade execution, also supplied the Fund with research
services.
|
|
|
|
| |
Dollar
Value of
Securities
Traded |
Related
Soft Dollar
Brokerage
Commissions |
$23,999,037 |
$36,675 |
As
of June 30, 2023, the Fund owned $2,348,210 of securities issued by Evercore,
Inc., $575,326 of securities issued by Wells Fargo Company and $561,688 of
securities issued by Citigroup, Inc., each a regular broker-dealer.
CAPITAL
STOCK
Shares
issued by the Fund have no preemptive, conversion, or subscription rights.
Shares issued and sold by the Fund are deemed to be validly issued, fully paid
and non-assessable by the Trust. Shareholders have equal and exclusive rights as
to dividends and distributions as declared by the Fund and to the net assets of
the Fund upon liquidation or dissolution. The Fund, as a separate series of the
Trust, votes separately on matters affecting only the Fund (e.g., approval of
the Advisory Agreement); all series of the Trust vote as a single class on
matters affecting all series jointly or the Trust as a
whole
(e.g., election or removal of Trustees). Voting rights are not cumulative, so
that the holders of more than 50% of the shares voting in any election of
Trustees can, if they so choose, elect all of the Trustees. While the Trust is
not required and does not intend to hold annual meetings of shareholders, such
meetings may be called by the Board in its discretion, or upon demand by the
holders of 10% or more of the outstanding shares of the Trust, for the purpose
of electing or removing Trustees.
The
Delaware Statutory Trust Act provides that a shareholder of a Delaware statutory
trust shall be entitled to the same limitation of personal liability extended to
shareholders of Delaware corporations. The Declaration of Trust further provides
that Trustees shall have no power to bind any shareholder personally for the
payment of any sum of money other than such as the shareholder may personally
agree to pay.
DETERMINATION
OF SHARE PRICE
The
NAV of shares of the Fund will be determined once daily ordinarily as of the
scheduled close of public trading on the New York Stock Exchange (“NYSE”)
(normally, 4:00 p.m. Eastern Time) on each day that the NYSE is open for
trading. It is expected that the NYSE will be closed on Saturdays and Sundays
and on New Year’s Day, Martin Luther King Jr. Day, Presidents’ Day, Good Friday,
Memorial Day, Juneteenth National Day, Independence Day, Labor Day, Thanksgiving
Day and Christmas Day. The Fund does not expect to determine the NAV of shares
on any day when the NYSE is not open for trading even if there is sufficient
trading in its portfolio securities on such days to materially affect the NAV
per share.
In
valuing the Fund’s assets for calculating NAV, readily marketable portfolio
securities listed on a national securities exchange are valued at the last sale
price on the business day as of which such value is being determined. If there
has been no sale on such exchange on such day, the security is valued at the
mean between the bid and asked prices on such day. Securities primarily traded
in the Nasdaq National Market System (“NASDAQ”) for which market quotations are
readily available shall be valued using the Nasdaq Official Closing Price
(“NOCP”). If the NOCP is not available, such securities shall be valued at the
last sale price on the day of valuation, or if there has been no sale on such
day, at the mean between the bid and asked prices. Readily marketable securities
traded only in the over-the market and not on NASDAQ are valued at the most
recent trade price. All other assets of the Fund are valued in such manner as
the Advisor in good faith deems appropriate to reflect their fair value, subject
to Board oversight.
Trading
in foreign securities markets is normally completed well before the close of the
NYSE. In addition, foreign securities trading may not take place on all days on
which the NYSE is open for trading, and may occur in certain foreign markets on
days on which the Fund’s NAV is not calculated. Events affecting the values of
portfolio securities that occur between the time their prices are determined and
the close of the NYSE will not be reflected in the calculation of NAV unless the
Advisor deems that the particular event would affect NAV, in which case an
adjustment will be made in such manner as the Advisor in good faith deems
appropriate to determine fair market value. Assets or liabilities expressed in
foreign currencies are translated, in determining NAV, into U.S. dollars based
on the spot exchange rates, or at such other rates as the Advisor, pursuant to
fair value procedures approved by the Board, may determine to be
appropriate.
The
Advisor has been designated by the Board as the valuation designee for the Funds
pursuant to Rule 2a-5 under the 1940 Act. In its capacity as valuation designee,
the Advisor performs the fair value determinations relating to any or all Fund
investments, subject to Board oversight. The Advisor has established procedures
for its fair valuation of the Fund’s investments. These procedures address,
among other things, determining when market quotations are not readily available
or reliable and the methodologies to be used for determining the fair value of
investments, as well as the use and oversight of third-party pricing services
for fair valuation.
Fair
value represents a good faith approximation of the value of a security. Fair
value determinations involve the consideration of a number of subjective
factors, an analysis of applicable facts and circumstances and the exercise of
judgment. As a result, it is possible that the fair value for a security
determined in good faith in accordance with the Advisor fair value procedures
may differ from valuations for the same security determined by other funds using
their own valuation procedures. Although the Advisor fair value procedures are
designed to value a security at the price the Fund may reasonably expect to
receive upon its sale in an orderly transaction, there can be no assurance that
any fair value determination thereunder would, in fact, approximate the amount
that the Fund would actually realize upon the sale of the security or the price
at which the security would trade if a reliable market price were readily
available.
ADDITIONAL
PURCHASE AND REDEMPTION INFORMATION
The
information provided below supplements the information contained in the
Prospectus regarding the purchase and redemption of the Fund’s
shares.
How
to Buy Shares
The
Fund may not be available for sale in certain states. Prospective investors
should inquire as to whether the Fund is available for sale in their state of
residence. Shares of the Fund have not been registered for sale outside of the
United States.
Shares
of the Fund may be purchased only by or on behalf of separately managed account
clients where the Advisor has an agreement with the Program Sponsor, or directly
with the client, to provide management or advisory services to the managed
account. The Fund does not issue share certificates.
There
are no maximum or minimum investment requirements in the fund (although your
Program Sponsor may have certain investment requirements). Purchase orders are
made based on instructions from the Advisor or Program Sponsor to the
broker/dealer who executes trades for your account. To make a purchase, your
broker/dealer must submit a purchase order to the Fund’s transfer agent, either
directly or through an appropriate clearing agency.
The
public offering price for shares of the Fund is equal to the NAV per share at
the time of purchase. Shares are purchased at the public offering price next
determined after the Transfer Agent receives your order in proper form, as
discussed in the Fund’s Prospectus. In order to receive that day’s public
offering price, the Transfer Agent must receive your order in proper form before
the close of regular trading on the NYSE, generally, 4:00 p.m., Eastern
Time.
The
Trust reserves the right in its sole discretion (i) to suspend the continued
offering of the Fund’s shares, and (ii) to reject purchase orders in whole or in
part when in the judgment of the Advisor or the distributor such rejection is in
the best interest of the Fund.
In
addition to cash purchases, the Fund’s shares may be purchased by tendering
payment in-kind in the form of shares of stock, bonds or other securities. Any
securities used to buy the Fund’s shares must be readily marketable; their
acquisition consistent with the Fund’s objective and otherwise acceptable to the
Advisor and the Board.
How
to Sell Shares and Delivery of Redemption Proceeds
You
can sell your Fund shares any day the NYSE is open for regular trading, either
directly to the Fund or through your Financial Intermediary.
Payments
to shareholders for shares of the Fund redeemed directly from the Fund will be
made as promptly as possible, but no later than seven days after receipt by the
Fund’s Transfer Agent of the written request in proper form, with the
appropriate documentation as stated in the Prospectus, except that the Fund may
suspend the right of redemption or postpone the date of payment during any
period when (a) trading on the NYSE is restricted as determined by the SEC or
the NYSE is closed for other than weekends and holidays; (b) an emergency exists
as determined by the SEC making disposal of portfolio securities or valuation of
net assets of the Fund not reasonably practicable; or (c) for such other period
as the SEC may permit for the protection of the Fund’s shareholders. Under
unusual circumstances, the Fund may suspend redemptions, or postpone payment for
more than seven days, but only as authorized by SEC rules.
A
redemption is generally treated for U.S. federal income tax purposes as a
taxable sale of the redeemed shares, the consequences of which are described
below in “Tax Information”.
The
value of shares on redemption or repurchase may be more or less than the
investor’s cost, depending upon the market value of the Fund’s portfolio
securities at the time of redemption or repurchase.
Redemptions
In-Kind
The
Trust has filed an election under Rule 18f-1 of the 1940 Act committing to pay
in cash all redemptions by a shareholder of record up to amounts specified by
the rule (in excess of the lesser of (1) $250,000 or (2) 1% of the Fund’s
assets). The Fund has reserved the right to pay the redemption price of its
shares in excess of the amounts specified by the rule, either totally or
partially, by a distribution in-kind of portfolio securities (instead of cash).
The securities so distributed would be valued at the same amount as that
assigned to them in calculating the NAV for the shares being sold.
If
a shareholder receives a distribution in-kind, the shareholder could incur
brokerage or other charges in converting the securities to cash and will bear
any market risks associated with such securities until they are converted into
cash. An in-kind redemption is generally treated for U.S. federal income tax
purposes as a taxable sale of the redeemed shares, the consequences of which are
described below in “Tax Information.”
The
Fund may hold up to 15% of its net assets (plus any borrowings for investment
purposes) in illiquid securities. In the unlikely event the Fund were to elect
to make an in-kind redemption, the Fund expects that it would follow the normal
protocol of making such distribution by way of a pro rata distribution based on
its entire portfolio. Because the Fund may hold illiquid securities, such
distribution may contain a pro rata portion of such illiquid securities or the
Fund may determine, based on a materiality assessment, not to include illiquid
securities in the in-kind redemption. The Fund does not anticipate that it would
ever selectively distribute a greater than pro rata portion of any illiquid
securities to satisfy a redemption request. If such securities are included in
the distribution, shareholders may not be able to liquidate such securities and
may be required to hold such securities indefinitely. Shareholders’ ability to
liquidate such securities distributed in-kind may be restricted by resale
limitations or substantial restrictions on transfer imposed by the issuers of
the securities or by law. Shareholders may only be able to liquidate such
securities distributed in-kind at a substantial discount from their value, and
there may be higher brokerage costs associated with any subsequent disposition
of these securities by the recipient.
DISTRIBUTIONS
AND TAX INFORMATION
Distributions
Dividends
and distributions of net investment income and return of capital are generally
made annually, as described in the Prospectus. The Fund typically distributes
any undistributed net investment income by December 31 of each year. Any net
capital gains will also typically be distributed by December 31 of each
year.
All
distributions generally reduce the NAV of the Fund’s shares by the amount of the
distribution. If you purchase shares prior to a distribution, the distribution
will be taxable to you even though economically it may represent a return on
your investment.
Each
distribution by the Fund is accompanied by a brief explanation of the form and
character of the distribution. In January of each year, the Fund will issue to
each shareholder a statement addressing the U.S. federal income tax status of
all distributions that relate to the previous year. You are responsible for the
payment of taxes with respect to your investment in the Fund.
Tax
Information
The
following summary describes the material U.S. federal income tax consequences to
United States Holders (as defined below) of shares in the Fund. This summary is
based upon the Code, Treasury regulations promulgated thereunder, administrative
pronouncements and judicial decisions, all as in effect as of the date of this
SAI and all of which are subject to change, possibly with retroactive effect.
This summary addresses only shares that are held as capital assets within the
meaning of Section 1221 of the Code and does not address all of the tax
consequences that may be relevant to shareholders in light of their particular
circumstances or to certain types of Shareholders subject to special treatment
under the Code, including, without limitation, certain financial institutions,
dealers in securities or commodities, traders in securities who elect to apply a
mark-to-market method of accounting, insurance companies, tax-exempt
organizations, partnerships or S-corporations (and persons who own their
interest in shares through a partnership or S-corporation), expatriates of the
United States, persons who are subject to alternative minimum tax, persons that
have a “functional currency” other than the United States dollar, persons who
hold shares as a position in a “straddle” or as a part of a “hedging,”
“conversion” or “constructive sale” transaction for U.S. federal income tax
purposes or persons who received their shares as compensation. This summary also
does not address the state, local or foreign tax consequences of an investment
in the Fund.
For
purposes of this discussion, a “United States Holder” means a holder of shares
that for U.S. federal income tax purposes is:
•a
citizen or resident of the United States;
•a
corporation (or other entity treated as a corporation for U.S. federal income
tax purposes) created or organized in the United States or under the laws of the
United States, any State or the District of Columbia;
•an
estate, the income of which is includable in gross income for U.S. federal
income tax purposes regardless of its source; or
•a
trust whose administration is subject to the primary supervision of a United
States court and which has one or more United States persons who have the
authority to control all of its substantial decisions, or which has a valid
election in effect under applicable Treasury regulations to be treated as a
United States person.
If
a partnership (or other entity treated as a partnership for U.S. federal income
tax purposes) holds shares, the tax treatment of a partner will generally depend
upon the status of such person and the activities of the limited liability
company or partnership. A shareholder that is a partnership should consult its
own tax advisors regarding the treatment of its partners.
Prospective
shareholders are urged to consult with their own tax advisors and financial
planners regarding the U.S. federal income tax consequences of an investment in
the Fund, the application of state, local, or foreign laws, and the effect of
any possible changes in applicable tax laws on their investment in the
Fund.
Tax
Treatment of the Fund
Each
series of the Trust is treated as a separate entity for U.S. federal income tax
purposes. The Fund has elected to qualify and intends to continue to qualify
annually as a regulated investment company under Subchapter M of the Code,
requiring it to comply with all applicable requirements regarding its income,
assets and distributions. Provided that the Fund qualifies as a regulated
investment company, it is eligible for a dividends paid deduction, allowing it
to offset dividends it pays to shareholders against its taxable income; if the
Fund fails to qualify as a regulated investment company under Subchapter M, it
will be taxed as a regular corporation.
The
Fund’s policy is to distribute to its shareholders all of its taxable income,
including any net realized capital gains (taking into account any capital loss
carry-forward of the Fund), each year in a manner that complies with the
distribution requirements applicable to regulated investment companies under the
Code, and results in the Fund not being subject to any U.S. federal income or
excise taxes. In particular, in order to avoid the non-deductible 4% excise tax,
the Fund must also distribute (or be deemed to have distributed) by December 31
of each calendar year (1) at least 98% of its ordinary income for such year, (2)
at least 98.2% of the excess of its realized capital gains over its realized
capital losses for the 12-month period ending on October 31 during such year and
(3) any amounts from the prior calendar year that were not distributed and on
which the Fund paid no federal income tax. However, the Fund can give no
assurances that its distributions will be sufficient to eliminate all U.S.
federal income taxes. The Fund is not required to consider tax consequences in
making or disposing of investments.
In
order to qualify as a regulated investment company, the Fund must, among other
things, derive at least 90% of its gross income each year from dividends,
interest, payments with respect to securities loans, gains from the sale or
other disposition of stock or securities or foreign currencies, or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to the business of investing in stock,
securities or currencies, and net income derived from an interest in a qualified
publicly traded partnership. The Fund must also satisfy the following two asset
diversification tests. At the end of each quarter of each taxable year, (i) at
least 50% of the value of the Fund’s total assets must be represented by cash
and cash items (including receivables), U.S. government securities, the
securities of other regulated investment companies, and other securities, with
such other securities being limited in respect of any one issuer to an amount
not greater than 5% of the value of the Fund’s total assets and not more than
10% of the outstanding voting securities of such issuer, and (ii) not more than
25% of the value of the Fund’s total assets may be invested in the securities of
any one issuer (other than U.S. government securities or the securities of other
regulated investment companies), the securities of any two or more issuers
(other than the securities of other regulated investment companies) that the
Fund controls (by owning 20% or more of their outstanding voting stock) and
which are determined under Treasury regulations to be engaged in the same or
similar trades or businesses or related trades or businesses, or the securities
of one or more qualified publicly traded partnerships. The Fund must also
distribute each taxable year sufficient dividends to its shareholders to claim a
dividends paid deduction equal to at least the sum of 90% of the Fund’s
investment company taxable income (as adjusted under Section 852(b)(2) of the
Code, but not taking into account the Fund’s dividends paid deduction; in the
case of the Fund generally consisting of interest and dividend income, less
expenses)) and 90% of the Fund’s net tax-exempt interest, if any.
The
Fund’s ordinary income generally consists of interest and dividend income, less
expenses. Net realized capital gains for a fiscal period are computed by taking
into account any capital loss carry-forward of the Fund.
Distributions
of net investment income and net short-term capital gains are taxable to
shareholders as ordinary income. For individual shareholders, a portion of the
distributions paid by the Fund may be qualified dividends currently eligible for
federal income taxation at long-term capital gain rates to the extent the Fund
reports the amount distributed as a qualifying dividend and certain holding
period requirements are met. In the case of corporate shareholders, a portion of
the distributions may qualify for the inter-corporate dividends-received
deduction to the extent the Fund reports the amount distributed as a qualifying
dividend and certain holding period requirements are met. The aggregate amount
so reported to either individual or corporate shareholders cannot, however,
exceed the aggregate amount of qualifying dividends received by the Fund for its
taxable year. In view of the Fund’s investment policy, it is expected that
dividends from domestic corporations will be part of the Fund’s gross income and
that, accordingly, part of the distributions by the Fund may be eligible for
treatment as qualified dividend income by individual shareholders, or for the
dividends-received deduction for corporate shareholders under federal tax law.
However, the portion of the Fund’s gross income attributable to qualifying
dividends is largely dependent on the Fund’s investment activities for a
particular year and therefore cannot be predicted with any certainty. The
Qualified dividend treatment may be eliminated if the Fund shares held by an
individual investor are held for less than 61 days, and the corporate-dividends
received deduction may be eliminated if the Fund shares held by a corporate
investor are treated as debt-financed or are held for less than 46 days.
Distributions will be taxable to you even if the share price of the Fund has
declined.
The
sale or exchange of Fund shares is a taxable transaction for federal income tax
purposes. You will generally recognize a gain or loss on such transactions equal
to the difference, if any, between the amount of your net sales proceeds and
your adjusted tax basis in the Fund shares. Such gain or loss will be capital
gain or loss if you held your Fund shares as capital assets. Any capital gain or
loss will be treated as long-term capital gain or loss if you held the Fund
shares for more than one year at the time of the sale or exchange. Any capital
loss arising from the sale or exchange of shares held for six months or less,
however, will be treated as long-term capital loss to the extent of the amount
of net long-term capital gain distributions with regard to these
shares.
Tax
Treatment of United States Holders – Taxation of Distributions
Distributions
paid out of the Fund’s current and accumulated earnings and profits are
generally dividends taxable at ordinary income rates to each shareholder.
Dividends will be taxable to you even if the share price of the Fund has
declined. Distributions in excess of the Fund’s current and accumulated earnings
and profits will first be treated as a nontaxable return of capital up to the
amount of a shareholder’s tax basis in its shares, and then as capital
gain.
For
individual shareholders, a portion of the dividends paid by the Fund may be
qualified dividends currently eligible for U.S. federal income taxation at
long-term capital gain rates to the extent the Fund reports the amount
distributed as a qualifying dividend and certain shareholder level holding
period requirements (discussed further below) are met. In the case of corporate
shareholders, subject to certain limitations (not all of which are discussed
herein), a portion of the distributions may qualify for the inter-corporate
dividends-received deduction to the extent the Fund reports the amount
distributed as a qualifying dividend and certain shareholder level holding
period requirements (discussed further below) are met. The aggregate amount so
reported to either individual or corporate shareholders cannot exceed the
aggregate amount of qualifying dividends received by the Fund for its taxable
year. Although no assurances can be provided, the Fund generally expects that
dividends from domestic corporations will be part of the Fund’s gross income and
that, accordingly, part of the distributions by the Fund may be eligible for
treatment as qualified dividend income by individual shareholders, or for the
dividends-received deduction for corporate shareholders. Qualified dividend
treatment may be eliminated if the Fund shares held by an individual investor
are held for less than 61 days, and the corporate dividends-received deduction
may be eliminated if Fund shares held by a corporate investor are treated as
debt-financed or are held for less than 46 days.
Distributions
properly reported by the Fund as capital gain dividends (Capital Gain Dividends)
will be taxable to shareholders as long-term capital gain (to the extent such
distributions do not exceed the Fund’s actual net long-term capital gain for the
taxable year), regardless of how long a shareholder has held Fund shares, and do
not qualify as dividends for purposes of the dividends received deduction or as
qualified dividend income. The Fund will report Capital Gain Dividends, if any,
in written statements furnished to its shareholders.
Tax
Treatment of United States Holders - Sales and Dispositions of
Shares
The
sale or exchange of Fund shares, including a redemption of Fund shares treated
as a sale or exchange, is a taxable transaction for U.S. federal income tax
purposes. A shareholder will generally recognize a capital gain or loss on any
such transaction equal to the difference, if any, between the amount of its net
sales proceeds and its adjusted tax basis in its Fund shares. Any capital gain
or loss will be treated as long-term capital gain or loss if you held the Fund
shares for more
than
one year at the time of the sale or exchange. Any capital loss arising from the
sale or exchange of shares held for six months or less, however, will be treated
as long-term capital loss to the extent of the amount of net long-term capital
gain distributions with regard to these shares.
Holders
of “publicly offered” shares in a regulated investment company are generally
entitled to treat proceeds from a redemption upon demand of their shares as
distributions in part or full payment in exchange for such their shares. The
definition of publicly offered for this purpose, however, requires the shares to
be (a) continuously offered pursuant to a public offering (within the meaning of
section 4 of the Securities Act of 1933),(b) regularly traded on an established
securities market, or (c) held by or for no fewer than 500 persons at all times
during the taxable year. Holders of any class of interests in the Fund that do
not satisfy these requirements should consult their tax advisors in connection
with a redemption of their shares.
Tax
Treatment of United States Holders - Medicare Tax
A
3.8% Medicare tax is currently imposed on net investment income earned by
certain individuals, estates and trusts. “Net investment income,” for these
purposes, means investment income, including ordinary and Capital Gain dividends
and net gains from taxable dispositions of Fund shares, reduced by the
deductions properly allocable to such income. In the case of an individual, the
tax will be imposed on the lesser of (1) the shareholder’s net investment income
or (2) the amount by which the shareholder’s modified adjusted gross income
exceeds $250,000 (if the shareholder is married and filing jointly or a
surviving spouse), $125,000 (if the shareholder is married and filing
separately) or $200,000 (in any other case). This Medicare tax, if applicable,
is reported by you on, and paid with, your U.S. federal income tax
return.
Tax
Treatment of Non-U.S. Shareholders
The
foregoing discussion of U.S. federal income tax law relates solely to the
application of that law to U.S. citizens or residents and U.S. domestic
corporations, partnerships, trusts and estates. Each shareholder who is not a
U.S. person should consider the U.S. and foreign tax consequences of ownership
of shares of the Fund, including the possibility that such a shareholder may be
subject to a U.S. withholding tax at a rate of 30% (or at a lower rate under an
applicable income tax treaty) on amounts constituting ordinary
income.
Backup
Withholding
The
Fund may be required to withhold proceeds at a rate set under Section 3406 of
the Code for U.S. residents of certain payments to a shareholder unless the
shareholder has completed and submitted to the Fund a Form W-9 providing the
shareholder’s taxpayer identification number and certifying under penalties of
perjury: (i) that such number is correct, (ii) that (A) the shareholder is
exempt from backup withholding, (B) the shareholder has not been notified by the
IRS that the shareholder is subject to backup withholding as a result of an
under-reporting of interest or dividends, or (C) the IRS has notified the
shareholder that the shareholder is no longer subject to backup withholding, and
(iii) the shareholder is a U.S. citizen or other U.S. person (as defined in IRS
Form W-9); or (b) an exception applies under applicable law and Treasury
regulations. Backup withholding is not an additional tax, and any amounts
withheld may be credited against a shareholder’s ultimate U.S. federal income
tax liability if proper documentation is provided. The Fund reserves the right
to refuse to open an account for any person failing to provide a certified
taxpayer identification number.
FATCA
and Similar Foreign Rules
The
Foreign Account Tax Compliance Act, (“FATCA”) provisions of the Code impose a
withholding tax of 30% on certain types of U.S. sourced income (e.g., dividends,
interest, and other types of passive income) paid, and will be required to
impose a 30% withholding tax on proceeds from the sale or other disposition of
property producing U.S. sourced income paid effective January 1, 2019 to (i)
foreign financial institutions (“FFIs”), including non-U.S. investment funds,
unless they agree to collect and disclose to the IRS information regarding their
direct and indirect U.S. account holders and (ii) certain nonfinancial foreign
entities (“NFFEs”), unless they certify certain information regarding their
direct and indirect U.S. owners. FATCA withholding will apply to any shareholder
that does not properly certify its status as a U.S. person, or, in the case of a
non-U.S. shareholder, the basis for its exemption from FATCA withholding. If the
Fund is required to withhold amounts from payments pursuant to FATCA, investors
will receive distributions that are reduced by such withholding
amounts.
To
implement FATCA, the U.S. government has entered into agreements with non-U.S.
governments (and is otherwise bound via automatic exchange of information
agreements in treaties) to provide reciprocal exchanges of taxpayer information
to non-U.S. governments. The Fund will be required to perform due diligence
reviews to classify non-U.S. entity investors for FATCA purposes. Shareholders
agree to provide information necessary to allow the Fund to comply with the
FATCA and similar foreign rules.
THE
FUND’S PRINCIPAL UNDERWRITER AND DISTRIBUTOR
Quasar
Distributors, LLC (“Quasar”), 111 E. Kilbourn Avenue, Suite 2200, Milwaukee,
Wisconsin 53202 (“Quasar”), serves as the Fund’s principal underwriter and
distributor in a continuous public offering of the Fund’s shares. Pursuant to a
distribution agreement between the Trust and Quasar (the “Distribution
Agreement”), Quasar acts as the Fund’s principal underwriter and distributor and
provides certain administrative services and arranges for the sale of the Fund’s
shares. Quasar is a registered broker-dealer under the Securities Exchange Act
of 1934, as amended, and is a member of FINRA.
The
Distribution Agreement between the Trust and Quasar will continue in effect only
if such continuance is specifically approved at least annually by the Board or
by vote of a majority of the Fund’s outstanding voting securities and, in either
case, by a majority of the Independent Trustees. The Distribution Agreement is
terminable without penalty by the Trust on behalf of the Fund on a 60-day
written notice when authorized either by a majority vote of the Fund’s
shareholders or by vote of a majority of the Board, including a majority of the
Independent Trustees, or by Quasar upon a 60-day written notice, and will
automatically terminate in the event of its “assignment” (as defined in the 1940
Act).
MARKETING
AND SUPPORT PAYMENTS
The
Advisor, out of its own resources and without additional cost to the Fund or its
shareholders, may provide additional cash payments or other compensation to
certain financial intermediaries who sell shares of the Fund. The Advisor does
not currently intend to make such payments, but reserves the right to initiate
payments in the future without notice to shareholders. These payments may be
divided into categories as follows:
Support
Payments
Payments
may be made by the Advisor to certain financial intermediaries in connection
with the eligibility of the Fund to be offered in certain programs and/or in
connection with meetings between the Fund’s representatives and Financial
Intermediaries and their sales representatives. Such meetings may be held for
various purposes, including providing education and training about the Fund and
other general financial topics to assist financial intermediaries’ sales
representatives in making informed recommendations to, and decisions on behalf
of, their clients.
Entertainment,
Conferences and Events
The
Advisor also may pay cash or non-cash compensation to sales representatives of
Financial Intermediaries in the form of (1) occasional gifts; (2) occasional
meals, tickets or other entertainments; and/or (3) sponsorship support for the
Financial Intermediaries’ client seminars and cooperative advertising. In
addition, the Advisor pays for exhibit space or sponsorships at regional or
national events of Financial Intermediaries.
The
prospect of receiving, or the receipt of additional payments or other
compensation as described above by Financial Intermediaries may provide such
Financial Intermediaries and/or their salespersons with an incentive to favor
sales of shares of the Fund, and other mutual funds whose affiliates make
similar compensation available, over sale of shares of mutual funds (or
non-mutual fund investments) not making such payments. You may wish to take such
payment arrangements into account when considering and evaluating any
recommendations relating to Fund shares.
As
of the date of this SAI, the Advisor does not have agreements with any firms to
pay such support payments to the Fund. Future support payments may be structured
in three ways: (1) as a percentage of net sales; (2) as a percentage of net
assets; and/or (3) a flat fee.
GENERAL
INFORMATION
Large
Trade Notifications
A
Fund or its agent may from time to time receive notice that a current or
prospective shareholder will place, or that a financial intermediary has
received, an order for a large trade in the Fund’s shares. The Fund may
determine to enter into portfolio transactions in anticipation of that order,
even though the order will not be placed or processed until the following
business day, as applicable. This practice provides for a closer correlation
between the time shareholders place trade orders and the time the Fund enters
into portfolio transactions based on those orders, and permits the Fund to be
more fully invested in investment securities, in the case of purchase orders,
and to more orderly liquidate its investment positions, in the case of
redemption orders. On the other hand, the current or prospective shareholder or
financial
intermediary,
as applicable, may not ultimately place or process the order. In this case, the
Fund may be required to borrow assets to settle the portfolio transactions
entered into in anticipation of that order, and would therefore incur borrowing
costs. The Fund may also suffer investment losses on those portfolio
transactions. Conversely, the Fund would benefit from any earnings and
investment gains resulting from such portfolio transactions.
Issuance
of Fund Shares for Securities
Investors
may purchase Fund shares for consideration consisting of securities rather than
cash when, in the judgment of the Advisor, the securities: (a) meet the
investment objective and policies of the Fund, (b) are liquid and not subject to
restrictions on resale, and (c) have a value that is readily ascertainable via
listing on or trading in a recognized United States or international exchange or
market.
Purchase
in Kind
In
limited circumstances and subject to the prior consent of a Fund, the Fund may
accept payment for shares in securities. Shares may be purchased by tendering
payment in kind in the form of marketable securities, including but not limited
to shares of common stock, provided the acquisition of such securities is
consistent with the applicable Fund's investment strategy and is otherwise
acceptable to the Advisor. Transactions of this type are generally a taxable
transaction. Before purchasing shares by tendering payment in kind, investors
are urged and advised to consult with their own tax advisor regarding the tax
consequences of such a transaction.
Reports
to Shareholders
The
fiscal year of the Fund ends on June 30 of each year. The Fund will send to its
shareholders at least semi-annually reports showing the Fund’s portfolio and
other information. An annual report containing financial statements audited by
the independent registered public accounting firm will be sent to shareholders
each year. After the end of each year, shareholders will receive federal income
tax information regarding dividends and capital gains distributions. Only one
copy of these reports will be sent to the same household, unless a shareholder
instructs otherwise.
Shareholder
Inquiries
Shareholder
inquiries may be addressed to the Fund at the address or telephone number set
forth on the cover page of this SAI.
Additional
Information
The
Prospectus and this SAI do not contain all the information set forth in the
Registration Statement and the exhibits relating thereto, which the Trust has
filed with the Commission, Washington, D.C., under the Securities Act and the
1940 Act, to which reference is hereby made.
The
Advisor has granted the Trust the right to use the “HW” name and has reserved
the right to withdraw its consent to the use of such name by the Trust at any
time or to grant the use of such name to any other company.
FINANCIAL
STATEMENTS
The
audited financial statements and financial highlights of the Fund for the fiscal
year ended June 30, 2023, as set forth in the Fund’s annual
report
to shareholders, including the notes thereto and the report of the registered
independent public accounting firm, are incorporated by reference into this SAI.
You can obtain a copy of the financial statements contained in the Fund’s Annual
or Semi-Annual Report without charge by calling the Fund toll-free at
888-458-1963.
APPENDIX
A – PROXY VOTING POLICIES AND PROCEDURES
HOTCHKIS
& WILEY CAPITAL MANAGEMENT
OUR
MANDATE
Our
primary responsibility is to act as a fiduciary for our clients when voting
proxies. We evaluate and vote each proposed proxy in a manner that encourages
sustainable business practices which in turn maximizes long-term shareholder
value.
There
are instances such as unique client guidelines, regulatory requirements, share
blocking, securities lending, or other technical limitations where we are unable
to vote a particular proxy. In those instances where we do not have voting
responsibility, we will generally forward our recommendation to such person our
client designates.
OUR
PROCESS
Analyst
Role
To
the extent we are asked to vote a client’s proxy, our investment analysts are
given the final authority on how to vote a particular proposal as these
analysts’ understanding of the company makes them the best person to apply our
policy to a particular company’s proxy ballot.
Voting
Resources
To
assist our analysts in their voting, we provide them with a report that compares
the company’s board of directors’ recommendation against H&W’s proxy policy
guideline recommendation and with third-party proxy research (Institutional
Shareholder Services “ISS” sustainability and climate benchmarks) and
third-party ESG analysis (Morgan Stanley Capital International “MSCI”).
Engagement
As
part of our normal due diligence and monitoring of investments, we engage
management, board members, or their representatives on material business issues
including environmental, social, and governance (“ESG”) matters. Each proxy to
be voted is an opportunity to give company management and board members formal
feedback on these important matters.
If
our policy recommendation is contrary to management’s recommendation, our
analyst is expected, but not required, to engage management. If the ballot issue
is a materially important issue (i.e., the issue impacts the intrinsic value of
the company), the analyst is required to engage with the company. Based on the
engagement and the analyst’s investment judgment, the analyst will submit a vote
instruction to the Managing Director of Portfolio Services via email.
Collaboration
We
are not “activists” and we do not form ”groups” as defined by the SEC. However,
we do engage with other institutional shareholders on important ESG proxy
matters.
Exceptions
To Policy
Any
deviation from the H&W policy recommendation requires a written statement
from the analyst that summarizes their decision to deviate from policy. Typical
rationales include the issue raised is not material, the proposal is moot (e.g.,
the company already complies with proposal), the company has a credible plan to
improve, policy does not fit unique circumstances of company, analyst’s
assessment of the issue is in-line with intent of policy, or the proposal usurps
management's role in managing the company.
Exceptions
to policy are reviewed annually by the ESG Investment Oversight
Group.
Administration
The
Managing Director of Portfolio Services coordinates the solicitation of
analysts’ votes, the collection of exception rationales, and the implementation
of those votes by our third-party proxy advisor, ISS.
CONFLICTS
OF INTEREST
All
conflicts of interest are adjudicated based on what is deemed to be in the best
interest of our clients and their beneficiaries. Our Proxy Oversight Committee
(“POC”) is responsible for reviewing proxies voted by the firm to determine
that
the vote was consistent with established guidelines in situations where
potential conflicts of interests may exist when voting proxies. In general, when
a conflict presents itself, we will follow the recommendation of our third-party
proxy advisor, ISS.
OVERSIGHT
AND ROLES
ESG
Investment Oversight Group
The
ESG Investment Oversight Group is responsible for overseeing all ESG investment
related issues. This mandate includes oversight of proxy voting policies and
procedures as they relate to investment activity including the monitoring of
proxy engagements, review of proxy voting exceptions and rationales, assessment
of proxy voting issues, determination of ESG proxy goals, and education of
investment staff on proxy matters. The group is staffed by members of the
investment team and reports to the firm’s Chief Executive Officer.
Proxy
Oversight Committee
The
Proxy Oversight Committee is responsible for overseeing proxy administration and
conflicts of interest issues. The committee is comprised of the Chief Operating
Officer, Chief Compliance Officer, the chair of the ESG Investment Oversight
Group, and Managing Director of Portfolio Services. This group oversees
H&W’s proxy voting policies and procedures by providing an administrative
framework to facilitate and monitor the exercise of such proxy voting and to
fulfill the obligations of reporting and recordkeeping under the federal
securities laws. This committee manages our third-party proxy advisory
relationship.
Investment
Analyst
The
investment analyst is responsible for analyzing and voting all proxies. The
investment analyst has the final authority on individual proxy votes. The ESG
Investment Oversight Group has final authority on creating and amending the
proxy policy.
VOTING
GUIDELINES
This
section summarizes our stance on important issues that are commonly found on
proxy ballots, though each vote is unique and there will be occasional
exceptions to these guidelines. The purpose of our proxy guidelines is to ensure
decision making is consistent with our responsibilities as a
fiduciary.
These
guidelines are divided into seven categories based on issues that frequently
appear on proxy ballots.
•Boards
and Directors
•Environmental
and Social Matters
•Auditors
and Related Matters
•Shareholder
Rights
•Capital
and Restructuring
•Executive
and Board Compensation
•Routine
and Miscellaneous Matters
Boards
and Directors
Board
Independence
We
believe an independent board is crucial to protecting and serving the interests
of public shareholders. We will generally withhold from or vote against any
insiders when such insider sits on the audit, compensation, or nominating
committees; or if independent directors comprise less than 50% of the board.
Insiders are non- independent directors who may have inherent conflicts of
interest that could prevent them from acting in the best interest of
shareholders. Examples of non-independent directors include current and former
company executives, persons with personal or professional relationships with the
company and or its executives, and shareholders with large ownership
positions.
Board
Composition
We
believe directors should attend meetings, be focused on the company, be
responsive to shareholders, and be accountable for their decisions.
We
will generally withhold from or vote against directors who attend less than 75%
of meetings held during their tenure without just cause, sit on more than 5
public company boards (for CEOs only 2 outside boards), support measures that
limit shareholder rights, or fail to act on shareholder proposals that passed
with a majority of votes.
Board
Diversity
Boards
should consider diversity when nominating new candidates, including gender,
race, ethnicity, age, and professional experience. We encourage
companies to have at least one female and one diverse (e.g., race, ethnicity)
director or have a plan to do so.
Board
Size
We
do not see a standard number of directors that is ideal for all companies. In
general, we do not want to see board sizes changed without shareholder approval
as changing board size can be abused in the context of a takeover
battle.
Board
Tenure
In
general, we will evaluate on a case-by-case basis whether the board is
adequately refreshed with new talent and the proposed changes are not designed
to reduce board independence.
Classified
Boards
We
oppose classified boards because, among other things, it can make change in
control more difficult to achieve and limit shareholder rights by reducing board
accountability.
Cumulative
Voting
Generally,
we oppose cumulative voting because we believe that economic interests and
voting interests should be aligned in most circumstances.
Independent
Board Chair
Generally,
we favor a separate independent chair that is not filled by an insider. If the
CEO is also the board chair, we require 2/3 of the board to be independent, a
strong independent director (i.e., has formal input on board agendas and can
call/preside over meetings of independent directors), and the CEO cannot serve
on the nominating or compensation committees.
Proxy
Contests
Proxy
contests are unusual events that require a case-by-case assessment of the unique
facts and circumstances of each contested proxy campaign. Our policy is to defer
to the judgement of our analysts on what best serves our clients’ interests. Our
analysts will evaluate the validity of the dissident’s concerns, the likelihood
that the dissident plan will improve shareholder value, the qualifications of
the dissident’s candidates, and management’s historical record of creating or
destroying shareholder value.
Risk
Oversight
Generally,
companies should have established processes for managing material threats to
their businesses, including ESG risks. We encourage transparency and vote to
improve transparency to help facilitate appropriate risk oversight.
Environmental
and Social Matters
We
believe the oversight of ESG risks is an important responsibility of the board
of directors and is a prerequisite for a well-managed company. Transparent
disclosures are necessary to identify and evaluate environmental and social
risks and opportunities. A lack of transparency will increase the likelihood
that environmental and social risks are not being sufficiently
managed/limited/mitigated. In general, we will engage companies with substandard
disclosure to encourage them to provide adequate disclosure on E&S risks
that typically align with Sustainability Accounting Standards Board (“SASB”)
recommendations.
In
general, we support proposals that encourage disclosure of risks provided they
are not overly burdensome or disclose sensitive competitive information balanced
against the materiality of the risk. We also consider whether the proposal is
more effectively addressed through other means, like legislation or
regulation.
Environmental
Issues
Climate
Change and Green House Gas Emissions
Climate
change has become an important factor in companies’ long-term sustainability.
Understanding a company’s strategy in managing these risks and opportunities is
necessary in evaluating an investment’s prospects. We support disclosures
related to the risks and/or opportunities a company faces related to climate
change, including information on how the company identifies and manages such
risks/opportunities.
Energy
Efficiency
We
generally support proposals requesting that a company report on its energy
efficiency policies. Exceptions may include a request that is overly burdensome
or provides unrealistic deadlines.
Renewable
Energy
We
support requests for reports on renewable energy accomplishments and future
plans. Exceptions may include duplicative, irrelevant, or otherwise unreasonable
requests.
Social
Issues
Equal
Opportunity
We
support proposals requesting disclosures of companies’ policies and/or future
initiatives related to diversity, including current data regarding the diversity
of its workforce.
Gender
Identity and Sexual Orientation
We
support proposals to revise diversity policies to prohibit discrimination based
on sexual orientation and/or gender identity.
Human
Rights Proposals
We
support proposals requesting disclosure related to labor and/or human rights
policies.
Political
Activities
We
support the disclosure of a company’s policies and procedures related to
political contributions and lobbying activities.
Sexual
Harassment
We
vote on a case-by-case basis regarding proposals seeking reports on company
actions related to sexual harassment. We evaluate the company’s current
policies, oversight, and disclosures. We also consider the company’s history and
any related litigation or regulatory actions related to sexual harassment, and
support proposals we believe will prevent such behavior when systemic issues are
suspected.
Auditors
and Related Matters
Generally,
we will support the board’s recommendation of auditors provided that the
auditors are independent, non-audit fees are less than the sum of all audit and
tax related fees, and there are no indications of fraud or misleading audit
opinions.
Shareholder
Rights
We
do not support proposals that limit shareholder rights. When a company
chronically underperforms minimal expectations due to poor execution, poor
strategic decisions, or poor capital allocation, there may arise the need for
shareholders to effect change at the board level. Proposals that have the effect
of entrenching boards or managements, thwarting the will of the majority of
shareholders, or advantaging one class of shareholders at the expense of other
shareholders will not be supported.
Amendment
to Charter/Articles/Bylaws
We
do not support proposals that give the board exclusive authority to amend the
bylaws. We believe amendments to charter/articles/bylaws should be approved by a
vote of the majority of shareholders.
One
Share, One Vote
Generally,
we do not support proposals to create dual class voting structures that give one
set of shareholders super voting rights that are disproportionate from their
economic interest in the company. Generally, we will support proposals to
eliminate dual class structures.
Poison
Pills
In
general, we do not support anti-takeover measures such as poison pills. Such
actions can lead to outcomes that are not in shareholders’ bests interests and
impede maximum shareholder returns. It can also lead to management entrenchment.
We may support poison pills intended to protect NOL assets.
Proxy
Access
Generally,
we support proposals that enable shareholders with an ownership level of 3% for
a period of three years or more, or an ownership level of 10% and a holding
period of one year or more.
Right
to Act by Written Consent
We
believe that shareholders should have the right to solicit votes by written
consent in certain circumstances. These circumstances generally include but are
not limited to situations where more than a narrow group of shareholders support
the cause to avoid unnecessary resource waste, the proposal does not exclude
minority shareholders to the benefit of a large/majority shareholder, and
shareholders receive more than 50% support to set up action by written
consent.
Special
Meetings
Generally,
we support proposals that enable shareholders to call a special meeting provided
shareholders own at least 15% of the outstanding shares.
Virtual
Meetings
We
believe shareholders should have the opportunity to participate in the annual
and special meetings, as current communications technology such as video
conferencing is broadly available to facilitate such interactions. This improves
shareholders’ ability to hear directly from management and the board of the
directors, and to provide feedback as needed.
Capital
and Restructuring
Events
such as takeover offers, buyouts, mergers, asset purchases and sales, corporate
restructuring, recapitalizations, dilutive equity issuance, or other major
corporate events are considered by our analysts on a case-by-case basis. Our
policy is to vote for transactions that maximize the long-term risk adjusted
return to shareholders considering management’s historical record of creating
shareholder value, the likelihood of success, and the risk of not supporting the
proposal.
Dual
Class Shares
We
do not support dual class shares unless the economic and voting interests are
equal.
Issuance
of Common Stock
In
general, we will consider the issuance of additional shares in light of the
stated purpose, the magnitude of the increase, the company’s historical
shareholder value creation, and historical use of shares. We are less likely to
support issuance when discounts or re-pricing of options has been an issue in
the past.
Executive
and Board Compensation
We
expect the board of directors to design, implement, and monitor pay practices
that promote pay-for-performance, alignment of interest with long-term
shareholder value creation, retention and attraction of key employees. In
general, we will evaluate executive compensation in light of historical value
creation, peer group pay practices, and our view on management’s stewardship of
the company.
We
expect the board of directors to maintain an independent and effective
compensation committee that has members with the appropriate skills, knowledge,
experience, and ability to access third-party advice.
We
expect the board of directors to provide shareholders with clear and
understandable compensation disclosures that enable shareholders to evaluate the
effectiveness and fairness of executive pay packages.
And
finally, we expect the board of directors’ own compensation to be reasonable and
not set at a level that undermines their independence from
management.
Golden
Parachutes
Golden
parachutes can serve as encouragement to management to consider transactions
that benefit shareholders; however, substantial payouts may present a conflict
of interest where management is incentivized to support a suboptimal deal. We
view cash severance greater than 3x base salary and bonus to be excessive unless
approved by a majority of shareholders in a say-on-pay advisory
vote.
Incentive
Options and Repricing
We
generally support long-term incentive programs tied to pay-for-performance. In
general, we believe 50% or more of top executive pay should be tied to long-term
performance goals and that those goals should be tied to shareholder value
creation metrics. We do not support plans that reset when management fails to
attain goals or require more than 10% of outstanding shares to be issued. In
general, we do not support the exchange or repricing of options.
Say-on-Pay
We
believe annual say-on-pay votes are an effective mechanism to provide feedback
to the board on executive pay and performance. We support non-binding proposals
that are worded in a manner such that the actual implementation of the plan is
not restricted. In general, we will vote against plans where there is a serious
misalignment of CEO pay and performance or the company maintains problematic pay
practices. In general, we will withhold votes from members of the compensation
committee if there is no say-on-pay on the ballot, the board fails to respond to
a previous say-on-pay proposal that received less than 70% support, the company
has implemented problematic pay practices such as repricing options or its pay
plans are egregious.
Routine
and Miscellaneous Matters
We
generally support routine board proposals such as updating bylaws (provided they
are of a housekeeping nature), change of the corporate name or change of the
time or location of the annual meeting.
Adjournment
of Meeting
We
do not support proposals that give management the authority to adjourn a special
meeting absent compelling reasons to support the proposal.
Amend
Quorum Requirements
We
do not support proposals to reduce quorum requirements for shareholder meetings
without support from a majority of the shares outstanding without compelling
justification.
Other
Business
We
do not support proposals on matters where we have not been provided sufficient
opportunity to review the matters at hand.
APPENDIX
B — DESCRIPTION OF RATINGS
Short-Term
Credit Ratings
An
S&P
Global Ratings (“S&P”)
issue credit rating is a forward-looking opinion about the creditworthiness of
an obligor with respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program (including ratings on
medium-term note programs and commercial paper programs). Short-term issue
credit ratings are generally assigned to those obligations considered short-term
in the relevant market. Short-term issue credit ratings are also used to
indicate the creditworthiness of an obligor with respect to put features on
long-term obligations. The following summarizes the rating categories used by
S&P for short-term issues:
“A-1”
– A short-term obligation rated “A-1” is rated in the highest category by
S&P. The obligor’s capacity to meet its financial commitments on the
obligation is strong. Within this category, certain obligations are designated
with a plus sign (+). This indicates that the obligor’s capacity to meet its
financial commitments on these obligations is extremely strong.
“A-2”
– A short-term obligation rated “A-2” is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor’s capacity to meet
its financial commitments on the obligation is satisfactory.
“A-3”
– A short-term obligation rated “A-3” exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to weaken an obligor's capacity to meet its financial commitments on the
obligation.
“B”
– A short-term obligation rated “B” is regarded as vulnerable and has
significant speculative characteristics. The obligor currently has the capacity
to meet its financial commitments; however, it faces major ongoing uncertainties
that could lead to the obligor’s inadequate capacity to meet its financial
commitments.
“C”
– A short-term obligation rated “C” is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitments on the obligation.
“D”
– A short-term obligation rated “D” is in default or in breach of an imputed
promise. For non-hybrid capital instruments, the “D” rating category is used
when payments on an obligation are not made on the date due, unless S&P
believes that such payments will be made within any stated grace period.
However, any stated grace period longer than five business days will be treated
as five business days. The “D” rating also will be used upon the filing of a
bankruptcy petition or the taking of a similar action and where default on an
obligation is a virtual certainty, for example due to automatic stay provisions.
A rating on an obligation is lowered to “D” if it is subject to a distressed
exchange offer.
Local
Currency and Foreign Currency Risks – S&P issuer credit ratings make a
distinction between foreign currency ratings and local currency ratings. A
foreign currency rating on an issuer will differ from the local currency rating
on it when the obligor has a different capacity to meet its obligations
denominated in its local currency versus obligations denominated in a foreign
currency.
Moody’s
Investors Service, Inc. (“Moody’s”)
short-term
ratings are forward-looking opinions of the relative credit risks of financial
obligations issued by non-financial corporates, financial institutions,
structured finance vehicles, project finance vehicles, and public sector
entities with an original maturity of thirteen months or less and reflect both
on the likelihood of a default or impairment on contractual financial
obligations and the expected financial loss suffered in the event of default or
impairment. Moody’s issues ratings at the issuer level and instrument level on
both the long-term scale and the short-term scale.
Moody’s
employs the following designations to indicate the relative repayment ability of
rated issuers:
“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.
A
Fitch Ratings (“Fitch”)
short-term issuer or obligation rating is based in all cases on the short-term
vulnerability to default of the rated entity or security stream and relates to
the capacity to meet financial obligations in accordance with the documentation
governing the relevant obligation. Short-term ratings are assigned to
obligations whose initial maturity is viewed as “short-term” based on market
convention. Typically, this means up to 13 months for corporate, sovereign, and
structured obligations and up to 36 months for obligations in U.S. public
finance markets. The following summarizes the rating categories used by Fitch
for short-term obligations:
“F1”
– Securities possess the highest short-term credit quality. This designation
indicates the strongest intrinsic capacity for timely payment of financial
commitments; may have an added “+” to denote any exceptionally strong credit
feature.
“F2”
– Securities possess good short-term credit quality. This designation indicates
good intrinsic capacity for timely payment of financial
commitments.
“F3”
– Securities possess fair short-term credit quality. This designation indicates
that the intrinsic capacity for timely payment of financial commitments is
adequate.
“B”
– Securities possess speculative short-term credit quality. This designation
indicates minimal capacity for timely payment of financial commitments, plus
heightened vulnerability to near term adverse changes in financial and economic
conditions.
“C”
– Securities possess high short-term default risk. Default is a real
possibility.
“RD”
– Restricted Default. Indicates an entity that has defaulted on one or more of
its financial commitments, although it continues to meet other financial
obligations. Typically applicable to entity ratings only.
“D”
– Default. Indicates a broad-based default event for an entity, or the default
of a short-term obligation.
The
DBRS®
Ratings Limited (“DBRS”)
short-term debt rating scale provides an opinion on the risk that an issuer will
not meet its short-term financial obligations in a timely manner. Ratings are
based on quantitative and qualitative considerations relevant to the issuer and
the relative ranking of claims. The R-1 and R-2 rating categories are further
denoted by the sub-categories “(high)”, “(middle)”, and “(low)”.
The
following summarizes the ratings used by DBRS for commercial paper and
short-term debt:
“R-1
(high)”
-
Short-term
debt rated “R-1 (high)” is of the highest credit quality. The capacity for the
payment of short-term financial obligations as they fall due is exceptionally
high. Unlikely to be adversely affected by future events.
“R-1
(middle)” – Short-term debt rated “R-1 (middle)” is of superior credit quality.
The capacity for the payment of short-term financial obligations as they fall
due is very high. Differs from “R-1 (high)” by a relatively modest degree.
Unlikely to be significantly vulnerable to future events.
“R-1
(low)” – Short-term debt rated “R-1 (low)” is of good credit quality. The
capacity for the payment of short-term financial obligations as they fall due is
substantial. Overall strength is not as favorable as higher rating categories.
May be vulnerable to future events, but qualifying negative factors are
considered manageable.
“R-2
(high)” – Short-term debt rated “R-2 (high)” is considered to be at the upper
end of adequate credit quality. The capacity for the payment of short-term
financial obligations as they fall due is acceptable. May be vulnerable to
future events.
“R-2
(middle)” – Short-term debt rated “R-2 (middle)” is considered to be of adequate
credit quality. The capacity for the payment of short-term financial obligations
as they fall due is acceptable. May be vulnerable to future events or may be
exposed to other factors that could reduce credit quality.
“R-2
(low)” – Short-term debt rated “R-2 (low)” is considered to be at the lower end
of adequate credit quality. The capacity for the payment of short-term financial
obligations as they fall due is acceptable. May be vulnerable to future events.
A number of challenges are present that could affect the issuer’s ability to
meet such obligations.
“R-3”
– Short-term debt rated “R-3” is considered to be at the lowest end of adequate
credit quality. There is a capacity for the payment of short-term financial
obligations as they fall due. May be vulnerable to future events and the
certainty of meeting such obligations could be impacted by a variety of
developments.
“R-4”
– Short-term debt rated “R-4” is considered to be of speculative credit quality.
The capacity for the payment of short-term financial obligations as they fall
due is uncertain.
“R-5”
– Short-term debt rated “R-5” is considered to be of highly speculative credit
quality. There is a high level of uncertainty as to the capacity to meet
short-term financial obligations as they fall due.
“D”
– Short-term debt rated “D” is assigned when the issuer has filed under any
applicable bankruptcy, insolvency or winding up statute or there is a failure to
satisfy an obligation after the exhaustion of grace periods, a downgrade to “D”
may occur. DBRS may also use “SD” (Selective Default) in cases where only some
securities are impacted, such as the case of a “distressed
exchange”.
Long-Term
Credit Ratings
The
following summarizes the ratings used by S&P
for long-term issue credit ratings:
“AAA”
– An obligation rated “AAA” has the highest rating assigned by S&P. The
obligor’s capacity to meet its financial commitments on the obligation is
extremely strong.
“AA”
– An obligation rated “AA” differs from the highest-rated obligations only to a
small degree. The obligor’s capacity to meet its financial commitments on the
obligation is very strong.
“A”
– An obligation rated “A” is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor’s capacity to meet its financial
commitments on the obligation is still strong.
“BBB”
– An obligation rated “BBB” exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to weaken
the obligor's capacity to meet its financial commitments on the
obligation.
“BB,”
“B,” “CCC,” “CC” and “C” – Obligations rated “BB,” “B,” “CCC,” “CC” and “C” are
regarded as having significant speculative characteristics. “BB” indicates the
least degree of speculation and “C” the highest. While such obligations will
likely have some quality and protective characteristics, these may be outweighed
by large uncertainties or major exposure to adverse conditions.
“BB”
– An obligation rated “BB” is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions that could lead to the
obligor’s inadequate capacity to meet its financial commitments on the
obligation.
“B”
– An obligation rated “B” is more vulnerable to nonpayment than obligations
rated “BB”, but the obligor currently has the capacity to meet its financial
commitments on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor’s capacity or willingness to meet its
financial commitments on the obligation.
“CCC”
– An obligation rated “CCC” is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial and economic conditions for the
obligor to meet its financial commitments on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial 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 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 believes that such
payments will be made within five business days in the absence of a stated grace
period or within the earlier of the stated grace period or 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 exchange
offer.
Plus
(+) or minus (-) – The ratings from “AA” to “CCC” may be modified by the
addition of a plus (+) or minus (-) sign to show relative standing within the
major rating categories.
“NR”
– This indicates that no rating has been requested, or that there is
insufficient information on which to base a rating, or that S&P does not
rate a particular obligation as a matter of policy.
Local
Currency and Foreign Currency Risks - S&P issuer credit ratings make a
distinction between foreign currency ratings and local currency ratings. A
foreign currency rating on an issuer will differ from the local currency rating
on it when the obligor has a different capacity to meet its obligations
denominated in its local currency versus obligations denominated in a foreign
currency.
Moody’s
long-term ratings are forward-looking opinions of the relative credit risks of
financial obligations issuer by non-financial corporates, financial
institutions, structured finance vehicles, project finance vehicles, and public
sector entities with an original maturity of one year or more and reflect on the
likelihood of a default or impairment on contractual financial obligations and
the expected financial loss suffered in the event of default or impairment. The
following summarizes the ratings used by Moody’s for long-term
debt:
“Aaa”
– Obligations rated “Aaa” are judged to be of the highest quality, subject to
the lowest level of credit risk.
“Aa”
– Obligations rated “Aa” are judged to be of high quality and are subject to
very low credit risk.
“A”
– Obligations rated “A” are judged to be upper-medium grade and are subject to
low credit risk.
“Baa”
– Obligations rated “Baa” are judged to be medium-grade and subject to moderate
credit risk and as such may possess certain speculative characteristics.
“Ba”
– Obligations rated “Ba” are judged to be speculative and are subject to
substantial credit risk.
“B”
– Obligations rated “B” are considered speculative and are subject to high
credit risk.
“Caa”
– Obligations rated “Caa” are judged to be speculative of poor standing and are
subject to very high credit risk.
“Ca”
– Obligations rated “Ca” are highly speculative and are likely in, or very near,
default, with some prospect of recovery of principal and interest.
“C”
– Obligations rated “C” are the lowest rated and are typically in default, with
little prospect for recovery of principal or interest.
Note:
Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating
classification from “Aa” through “Caa.” The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
The
following summarizes long-term ratings used by Fitch:
“AAA”
– Securities considered to be of the highest credit quality. “AAA” ratings
denote the lowest expectation of credit 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”
– Securities considered to be of very high credit quality. “AA” ratings denote
expectations of very low credit risk. They indicate very strong capacity for
payment of financial commitments. This capacity is not significantly vulnerable
to foreseeable events.
“A”
– Securities considered to be of high credit quality. “A” ratings denote
expectations of low credit 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”
– Securities considered to be of good credit quality. “BBB” ratings indicate
that expectations of credit 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”
– Securities considered to be speculative. “BB” ratings indicate an elevated
vulnerability to credit risk, particularly in the event of adverse changes in
business or economic conditions over time; however, business or financial
alternatives may be available to allow financial commitments to be
met.
“B”
– Securities considered to be highly speculative. “B” ratings indicate that
material credit risk is present.
“CCC”
– “CCC” ratings indicate that substantial credit risk is present.
“CC”
– “CC” ratings indicate very high levels of credit risk.
“C”
– “C” ratings indicate exceptionally high levels of credit risk.
Defaulted
obligations typically are not assigned “RD” or “D” ratings, but are instead
rated in the “B” to “C” rating categories, depending upon their recovery
prospects and other relevant characteristics. Fitch believes that this approach
better aligns obligations that have comparable overall expected loss but varying
vulnerability to default and loss.
Plus
(+) or minus (-) may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the “AAA” obligation
rating category, or to corporate finance obligation ratings in the categories
below “CCC”.
The
DBRS
long-term rating scale provides an opinion on the risk of default. That is, the
risk that an issuer will fail to satisfy its financial obligations in accordance
with the terms under which an obligation has been issued. Ratings are based on
quantitative and qualitative considerations relevant to the issuer, and the
relative ranking of claims. All rating categories other than AAA and D also
contain
subcategories “(high)” and “(low)”. The absence of either a “(high)” or “(low)”
designation indicates the rating is in the middle of the category. The following
summarizes the ratings used by DBRS for long-term debt:
“AAA”
- Long-term debt rated “AAA” is of the highest credit quality. The capacity for
the payment of financial obligations is exceptionally high and unlikely to be
adversely affected by future events.
“AA”
– Long-term debt rated “AA” is of superior credit quality. The capacity for the
payment of financial obligations is considered high. Credit quality differs from
“AAA” only to a small degree. Unlikely to be significantly vulnerable to future
events.
“A”
– Long-term debt rated “A” is of good credit quality. The capacity for the
payment of financial obligations is substantial, but of lesser credit quality
than “AA.” May be vulnerable to future events, but qualifying negative factors
are considered manageable.
“BBB”
– Long-term debt rated “BBB” is of adequate credit quality. The capacity for the
payment of financial obligations is considered acceptable. May be vulnerable to
future events.
“BB”
–
Long-term
debt rated “BB” is of speculative, non-investment grade credit quality. The
capacity for the payment of financial obligations is uncertain. Vulnerable to
future events.
“B”
– Long-term debt rated “B” is of highly speculative credit quality. There is a
high level of uncertainty as to the capacity to meet financial
obligations.
“CCC”,
“CC” and “C” – Long-term debt rated in any of these categories is of very highly
speculative credit quality. In danger of defaulting on financial obligations.
There is little difference between these three categories, although “CC” and “C”
ratings are normally applied to obligations that are seen as highly likely to
default, or subordinated to obligations rated in the “CCC” to “B” range.
Obligations in respect of which default has not technically taken place but is
considered inevitable may be rated in the “C” category.
“D”
– A
security rated “D” is assigned when the issuer has filed under any applicable
bankruptcy, insolvency or winding up statute or there is a failure to satisfy an
obligation after the exhaustion of grace periods, a downgrade to “D” may occur.
DBRS may also use “SD” (Selective Default) in cases where only some securities
are impacted, such as the case of a “distressed exchange”.
Municipal
Note Ratings
An
S&P
U.S. municipal note rating reflects S&P opinion about the liquidity factors
and market access risks unique to the notes. Notes due in three years or less
will likely receive a note rating. Notes with an original maturity of more than
three years will most likely receive a long-term debt rating. In determining
which type of rating, if any, to assign, S&P's analysis will review the
following considerations:
•Amortization
schedule - the larger the final maturity relative to other maturities, the more
likely it will be treated as a note; and
•Source
of payment - the more dependent the issue is on the market for its refinancing,
the more likely it will be treated as a note.
Municipal
Short-Term Note rating symbols are as follows:
“SP-1”
– A municipal note rated “SP-1” exhibits a strong capacity to pay principal and
interest. An issue determined to possess a very strong capacity to pay debt
service is given a plus (+) designation.
“SP-2”
– A municipal note rated “SP-2” exhibits a satisfactory capacity to pay
principal and interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
“SP-3”
– A municipal note rated “SP-3” exhibits a speculative capacity to pay principal
and interest.
Moody’s
uses the Municipal Investment Grade (“MIG”) scale to rate U.S. municipal bond
anticipation notes of up to five years maturity. Municipal notes rated on the
MIG scale may be secured by either pledged revenues or proceeds of a take-out
financing received prior to note maturity. MIG ratings expire at the maturity of
the obligation, and the issuer’s long-term rating is only one consideration in
assigning the MIG rating. MIG ratings are divided into three levels – “MIG-1”
through “MIG-3” while speculative grade short-term obligations are designated
“SG”. The following summarizes the ratings used by Moody’s for short-term
municipal obligations:
“MIG-1”
– This designation denotes superior credit quality. Excellent protection is
afforded by established cash flows, highly reliable liquidity support, or
demonstrated broad-based access to the market for refinancing.
“MIG-2”
– This designation denotes strong credit quality. Margins of protection are
ample, although not as large as in the preceding group.
“MIG-3”
– This designation denotes acceptable credit quality. Liquidity and cash-flow
protection may be narrow, and market access for refinancing is likely to be less
well-established.
“SG”
– This designation denotes speculative-grade credit quality. Debt instruments in
this category may lack sufficient margins of protection.
“NR”
– Is assigned to an unrated obligation.
In
the case of variable rate demand obligations (“VRDOs”), a two-component rating
is assigned: a long or short-term debt rating and a demand obligation rating.
The first element represents Moody’s evaluation of risk associated with
scheduled principal and interest payments. The second element represents Moody’s
evaluation of risk associated with the ability to receive purchase price upon
demand (“demand feature”). The second element uses a rating from a variation of
the MIG rating scale called the Variable Municipal Investment Grade or “VMIG”
scale. The rating transitions on the VMIG scale differ from those on the Prime
scale to reflect the risk that external liquidity support generally will
terminate if the issuer’s long-term rating drops below investment
grade.
VMIG
rating expirations are a function of each issue’s specific structural or credit
features.
“VMIG-1”
– This designation denotes superior credit quality. Excellent protection is
afforded by the superior short-term credit strength of the liquidity provider
and structural and legal protections that ensure the timely payment of purchase
price upon demand.
“VMIG-2”
– This designation denotes strong credit quality. Good protection is afforded by
the strong short-term credit strength of the liquidity provider and structural
and legal protections that ensure the timely payment of purchase price upon
demand.
“VMIG-3”
– This designation denotes acceptable credit quality. Adequate protection is
afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
“SG”
– This designation denotes speculative-grade credit quality. Demand features
rated in this category may be supported by a liquidity provider that does not
have an investment grade short-term rating or may lack the structural and/or
legal protections necessary to ensure the timely payment of purchase price upon
demand.
“NR”
– Is assigned to an unrated obligation.
About
Credit Ratings
An
S&P
issue credit rating is a forward-looking opinion about the creditworthiness of
an obligor with respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program (including ratings on
medium-term note programs and commercial paper programs). It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation and takes into account the currency in
which the obligation is denominated. The opinion reflects S&P's view of the
obligor’s capacity and willingness to meet its financial commitments as they
come due, and may assess terms, such as collateral security and subordination,
which could affect ultimate payment in the event of default.
Moody’s
credit ratings must be construed solely as statements of opinion and not
statements of fact or recommendations to purchase, sell or hold any
securities.
Fitch’s
credit
ratings provide an opinion on the relative ability of an entity to meet
financial commitments, such as interest, preferred dividends, repayment of
principal, insurance claims or counterparty obligations. Fitch credit ratings
are used by investors as indications of the likelihood of receiving the money
owed to them in accordance with the terms on which they invested. Fitch’s credit
ratings cover the global spectrum of corporate, sovereign, financial, bank,
insurance and other public finance entities (including supranational and
sub-national entities) and the securities or other obligations they issue, as
well as structured finance securities backed by receivables or other financial
assets.
DBRS
credit ratings are opinions based on the quantitative and qualitative analysis
of information sourced and received by DBRS, which information is not audited or
verified by DBRS. Ratings are not buy, hold or sell recommendations and they do
not address the market price of a security. Ratings may be upgraded, downgraded,
placed under review, confirmed and discontinued.