2022-06-14MSIFTDiscoveryPortfolio_485B_PSP_January2023
MORGAN
STANLEY INSTITUTIONAL FUND TRUST
522 Fifth
Ave.
New York,
NY 10036
Statement
of Additional Information
January
27,
2023
Morgan
Stanley Institutional Fund Trust (the “Trust”) is a mutual fund consisting of
nine
portfolios offering a variety of investment alternatives,
all of which are included in this Statement of Additional Information (“SAI”)
(each, a “Fund” and collectively the “Funds”).
Some or all of the Funds offer the following shares: Class I, Class A, Class L,
Class C, Class IR, Class R6,
Institutional Class and
Class W. Following is a list of the nine Funds
included in this SAI:
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Share
Class and Ticker Symbol |
|
I |
A |
L1
|
C |
IR |
R6 |
Institutional |
W |
U.S.
EQUITY FUND: |
Discovery
Portfolio |
MPEGX |
MACGX |
MSKLX |
MSMFX |
— |
MMCGX |
— |
— |
Dynamic
Value Portfolio |
MAAQX |
MAAUX |
— |
MAAOX |
— |
MAADX |
— |
— |
FIXED
INCOME FUNDS: |
Core
Plus Fixed Income Portfolio |
MPFIX |
MFXAX |
MSIOX |
MSCKX |
— |
MPLRX |
— |
— |
Corporate
Bond Portfolio |
MPFDX |
MIGAX |
MGILX |
MSBOX |
— |
— |
— |
— |
High
Yield Portfolio |
MSYIX |
MSYPX |
MSYLX |
MSHDX |
MRHYX |
MSHYX |
— |
MSYWX |
Short
Duration Income Portfolio |
MPLDX |
MLDAX |
MSJLX |
MSLDX |
— |
MSDSX |
— |
— |
Ultra-Short
Income Portfolio |
— |
MUAIX |
— |
— |
MULSX |
— |
MUIIX |
— |
Ultra-Short
Municipal Income Portfolio |
— |
MUAMX |
— |
— |
MULMX |
— |
MUIMX |
— |
ASSET
ALLOCATION FUND: |
Global
Strategist Portfolio |
MPBAX |
MBAAX |
MSDLX |
MSSOX |
— |
MGPOX |
— |
— |
1 |
The
Trust has suspended offering Class L shares of each Fund to all investors.
Existing Class L shareholders may invest through reinvestment of dividends
and distributions.
Class L shares of the Dynamic Value Portfolio, Ultra-Short
Income Portfolio and Ultra-Short Municipal Income Portfolio are not being
offered at this
time. You do not currently have the option of purchasing Class L
shares. |
This SAI
is not a prospectus but should be read in conjunction with the Funds’
Prospectuses, each dated January 27,
2023, as may
be supplemented
from time to time. To obtain any of these Prospectuses, please call Shareholder
Services at the number indicated below.
Each Fund
is “diversified” and, as such, each Fund’s investments are required to meet
certain diversification requirements under federal
securities laws.
SHAREHOLDER
SERVICES: 1-800-869-6397
OR, WITH
RESPECT TO INSTITUTIONAL LIQUIDITY CLIENTS, 1-888-378-1630
PRICES AND
INVESTMENT RESULTS: WWW.MORGANSTANLEY.COM/IM
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1 |
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5 |
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47 |
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49 |
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51 |
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52 |
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54 |
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64 |
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65 |
|
68 |
|
68 |
|
72 |
|
76 |
|
81 |
|
83 |
|
90 |
|
94 |
|
100 |
|
106 |
|
A-1 |
|
B-1 |
THE
FUNDS’ INVESTMENTS AND STRATEGIES
This SAI
provides additional information about the investment policies and operations of
the Trust and the Funds. The following tables
summarize the permissible strategies and investments for each Fund. These tables
should be read in conjunction with the investment
summaries for each Fund contained in the applicable Prospectus in order to
provide a more complete description of such Fund’s
investment policies. The tables exclude investments that Funds may make solely
for temporary defensive purposes. More details
about each investment and related risks are provided in the discussion following
the tables.
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U.S.
EQUITY AND ASSET ALLOCATION FUNDS |
|
Discovery
Portfolio |
Dynamic
Value Portfolio |
Global
Strategist Portfolio |
Investments: |
Agencies |
x |
x |
x |
Asset-Backed
Securities |
|
|
x |
Bitcoin
Exposure |
x |
|
x |
Bitcoin
Cash Settled Futures |
x |
|
x |
GBTC |
x |
|
|
Borrowing |
|
x |
|
Brady
Bonds |
|
|
x |
Cash
Equivalents |
x |
x |
x |
Chinese
Fixed-Income Investments |
|
|
x |
Combined
Transactions |
|
x |
|
Commercial
Paper |
x |
|
x |
Commodity-Linked
Investments |
|
|
x |
Common
Stock |
x |
x |
x |
Contracts
for Difference |
x |
x |
|
Convertible
Securities |
x |
|
x |
Corporates |
x |
|
x |
Currency
Forwards |
x |
x |
x |
Custodial
Receipts |
|
|
|
Depositary
Receipts |
x |
x |
x |
Derivatives |
x |
|
x |
Emerging
Market Securities |
x |
|
x |
Equity
Securities |
x |
|
x |
Eurodollar
and Yankee Dollar Obligations |
x |
|
x |
Exchange-Listed
Equities via Stock Connect Program |
|
|
x |
Exchange-Traded
Funds |
|
x |
|
Fixed-Income
Securities |
x |
|
x |
Floaters |
|
|
x |
Foreign
Currency Transactions |
x |
x |
x |
Foreign
Securities |
x |
x |
x |
Funding
Agreements |
|
|
|
Futures
Contracts |
x |
x |
x |
High
Yield Securities |
|
|
x |
Illiquid
Investments |
x |
x |
|
Inverse
Floaters |
|
|
x |
Investment
Company Securities |
x |
x |
x |
Investment
Funds |
|
x |
x |
Investment
Grade Securities |
x |
x |
x |
IPOs |
x |
x |
|
Limited
Partnership and Limited Liability Company Interests |
x |
x |
x |
Loan-Related
Investments |
|
|
x |
Loans
of Portfolio Securities |
x |
x |
x |
Money
Market Instruments |
|
x |
|
|
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| |
U.S.
EQUITY AND ASSET ALLOCATION FUNDS |
|
Discovery
Portfolio |
Dynamic
Value Portfolio |
Global
Strategist Portfolio |
Mortgage-Related
Securities |
|
x |
x |
Municipals |
|
|
x |
Non-Publicly
Traded Securities, Private Placements and Restricted
Securities |
x |
|
x |
Options |
x |
x |
x |
Preferred
Stocks |
x |
x |
x |
Private
Investments in Public Equity |
x |
|
x |
Promissory
Notes |
|
|
|
Real
Estate Investing |
x |
x |
x |
-REITs |
|
x |
|
-Foreign
Real Estate Companies |
|
x |
|
-Specialized
Ownership Vehicles |
|
x |
|
Repurchase
Agreements |
x |
x |
x |
Reverse
Repurchase Agreements |
x |
|
x |
Rights |
x |
x |
x |
Short
Sales |
x |
|
x |
Special
Purpose Acquisition Company |
x |
|
|
Structured
Investments |
x |
x |
x |
Swaps |
x |
x |
x |
Temporary
Defensive Investments |
|
x |
|
U.S.
Government Securities |
x |
x |
x |
Warrants |
x |
x |
x |
When-Issued
and Delayed Delivery Securities |
x |
|
x |
When-Issued
and Delayed Delivery Securities and Forward Commitments |
|
x |
|
When,
As and If Issued Securities |
x |
x |
x |
Zero
Coupons, Pay-In-Kind Securities or Deferred Payment
Securities |
x |
x |
x |
|
|
|
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FIXED
INCOME FUNDS |
|
Core
Plus Fixed
Income Portfolio |
Corporate
Bond Portfolio |
High
Yield Portfolio |
Short
Duration Income
Portfolio |
Ultra-Short Income
Portfolio |
Ultra-Short
Municipal Income Portfolio |
Investments: |
Agencies |
x |
x |
x |
x |
x |
x |
Asset-Backed
Securities |
x |
x |
x |
x |
x |
x |
Bitcoin
Futures |
|
|
|
|
|
|
Borrowing |
x |
x |
x |
x |
x |
x |
Brady
Bonds |
x |
x |
x |
x |
|
|
Cash
Equivalents |
x |
x |
x |
x |
x |
x |
Chinese
Fixed-Income Investments |
|
|
|
|
|
|
Commercial
Paper |
x |
x |
x |
x |
x |
x |
Commodity-Linked
Investments |
|
|
|
|
|
|
Common
Stock |
|
|
x |
|
|
|
Contracts
for Difference |
|
|
|
|
|
|
Convertible
Securities |
x |
x |
x |
x |
|
|
Corporates |
x |
x |
x |
x |
x |
x |
Currency
Forwards |
x |
|
x |
x |
|
|
Custodial
Receipts |
|
|
|
|
x |
|
Depositary
Receipts |
x |
x |
x |
x |
|
|
Derivatives |
x |
x |
x |
x |
|
|
Emerging
Market Securities |
x |
x |
x |
x |
|
|
Exchange-Listed
Equities via Stock Connect Program |
|
|
|
|
|
|
Equity
Securities |
|
|
x |
|
|
|
Eurodollar
and Yankee Dollar Obligations |
x |
x |
x |
x |
x |
|
Fixed-Income
Securities |
x |
x |
x |
x |
x |
x |
Floaters |
x |
x |
x |
x |
x |
x |
Floating
and Variable Rate Obligations |
|
|
|
|
|
x |
Foreign
Currency Transactions |
x |
x |
x |
|
|
|
Foreign
Securities |
x |
x |
x |
x |
x |
|
Funding
Agreements |
|
|
|
|
x |
x |
Futures
Contracts |
x |
x |
x |
x |
|
|
High
Yield Securities |
x |
x |
x |
|
|
|
Illiquid
Investments |
x |
x |
x |
x |
x |
x |
Inverse
Floaters |
x |
x |
x |
|
|
|
Investment
Company Securities |
x |
x |
x |
x |
x |
x |
Investment
Funds |
|
|
x |
|
|
|
Investment
Grade Securities |
x |
x |
x |
x |
x |
x |
Limited
Partnership and Limited Liability Company Interests |
|
|
|
|
|
|
Loan-Related
Investments |
x |
|
x |
|
|
|
Loans
of Portfolio Securities |
x |
x |
x |
x |
x |
|
Mortgage-Related
Securities |
x |
x |
x |
x |
|
|
Municipals |
x |
x |
x |
x |
x |
x |
Non-Publicly
Traded Securities, Private Placements and Restricted
Securities |
x |
x |
x |
x |
x |
x |
Options |
x |
x |
x |
x |
|
|
Preferred
Stocks |
x |
x |
x |
x |
|
|
Private
Investments in Public Equity |
|
|
|
|
|
|
Promissory
Notes |
|
|
|
|
x |
|
Real
Estate Investing |
|
|
x |
|
|
|
|
|
|
|
|
| |
FIXED
INCOME FUNDS |
|
Core
Plus Fixed
Income Portfolio |
Corporate
Bond Portfolio |
High
Yield Portfolio |
Short
Duration Income
Portfolio |
Ultra-Short Income
Portfolio |
Ultra-Short
Municipal Income Portfolio |
Repurchase
Agreements |
x |
x |
x |
x |
x |
x |
Reverse
Repurchase Agreements |
x |
x |
x |
x |
x |
x |
Rights |
x |
|
x |
|
|
|
Short
Sales |
x |
x |
x |
x |
|
|
Special
Purpose Acquisition Company |
|
|
x |
|
|
|
Structured
Investments |
x |
x |
x |
x |
|
|
Swaps |
x |
x |
x |
x |
|
|
Tender
Option Bonds |
|
|
|
|
|
x |
U.S.
Government Securities |
x |
x |
x |
x |
x |
x |
Variable
Rate Master Demand Notes |
|
|
|
|
|
x |
Warrants |
|
|
x |
|
|
|
When-Issued
and Delayed Delivery Securities and Forward Commitments |
x |
x |
x |
x |
x |
x |
When,
As and If Issued Securities |
x |
x |
x |
x |
x |
x |
Zero
Coupons, Pay-In-Kind Securities or Deferred Payment
Securities |
x |
x |
x |
x |
x |
x |
INVESTMENTS
AND RISKS
Morgan
Stanley Investment Management Inc. is the adviser (the “Adviser”) to each Fund.
Morgan Stanley Investment Management Limited is
the investment sub-adviser (the “Sub-Adviser”) to the Global Strategist
Portfolio. References to the Adviser, when used in connection with
its
activities as investment adviser, include the Sub-Adviser acting under its
supervision.
Agencies. Agencies
refer to fixed-income securities issued or guaranteed by federal agencies and
U.S. government sponsored instrumentalities.
They may or may not be backed by the full faith and credit of the United States.
If they are not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation
for ultimate repayment, and may not be able to assert a claim against the United
States itself in the event the agency or instrumentality
does not meet its commitment. Agencies that are backed by the full faith and
credit of the United States include the Export-Import
Bank, Farmers Home Administration, Federal Financing Bank and others. Certain
debt issued by Resolution Funding
Corporation has both its principal and interest backed by the full faith and
credit of the U.S. Treasury in that its principal is backed by
U.S. Treasury zero coupon issues, while the U.S. Treasury is explicitly required
to advance funds sufficient to pay interest on it, if
needed. Certain agencies and instrumentalities, such as the Government National
Mortgage Association (“Ginnie Mae”), are, in effect,
backed by the full faith and credit of the United States through provisions in
their charters that they may make “indefinite and
unlimited” drawings on the Treasury if needed to service their debt. Debt from
certain other agencies and instrumentalities, including
the Federal Home Loan Banks, the Federal National Mortgage Association (“Fannie
Mae”) and the Federal Home Loan Mortgage
Corporation (“Freddie Mac”), are not guaranteed by the United States, but those
institutions are protected by the discretionary
authority of the U.S. Treasury to purchase certain amounts of their securities
to assist them in meeting their debt obligations.
Finally, other agencies and instrumentalities, such as the Farm Credit System,
are federally chartered institutions under U.S.
Government supervision, but their debt securities are backed only by the
creditworthiness of those institutions, not the U.S. Government.
Some of the U.S. government agencies that issue or guarantee securities include
the Export-Import Bank of the United States,
Farmers Home Administration, Federal Housing Administration, Maritime
Administration, Small Business Administration and the
Tennessee Valley Authority (“TVA”).
An
instrumentality of the U.S. Government is a government agency organized under
federal charter with government supervision. Instrumentalities
issuing or guaranteeing securities include, among others, Federal Home Loan
Banks, the Federal Land Bank, Central
Bank for Cooperatives, Federal Intermediate Credit Banks and Fannie
Mae.
Asset-Backed
Securities. Certain
Funds may invest in asset-backed securities. Asset-backed securities utilize the
securitization techniques
used to develop MBS. These techniques are also applied to a broad range of other
assets. Various types of assets, primarily automobile
and credit card receivables and home equity loans, are being securitized in
pass-through structures similar to the mortgage pass-through
structures. These types of securities are known as asset-backed securities. A
Fund may invest in any type of asset-backed security.
Asset-backed securities have risk characteristics similar to MBS. Like MBS, they
generally decrease in value as a result of interest
rate increases, but may benefit less than other fixed-income securities from
declining interest rates, principally because of prepayments.
Also, as in the case of MBS, prepayments generally increase during a period of
declining interest rates although other factors,
such as changes in credit use and payment patterns, may also influence
prepayment rates. Asset-backed securities also involve the risk
that various federal and state consumer laws and other legal, regulatory and
economic factors may result in the collateral backing
the securities being insufficient to support payment on the
securities.
Borrowing. Each Fund
is permitted to borrow money from banks in accordance with the Investment
Company Act of 1940, as amended
(the “1940 Act”), or the rules and regulations promulgated by the SEC
thereunder. Currently, the 1940 Act permits a fund to borrow
money from banks in an amount up to 33⅓% of its total assets (including the
amount borrowed) less its liabilities (not including
any borrowings but including the fair market value at the time of computation of
any other senior securities then outstanding).
A Fund may also borrow an additional 5% of its total assets without regard to
the foregoing limitation for temporary purposes
such as clearance of portfolio transactions. The Funds will only borrow when the
Adviser believes that such borrowings will benefit
the Fund after taking into account considerations such as interest income and
possible gains or losses upon liquidation. The Funds will
maintain asset coverage in accordance with the 1940 Act.
Borrowing
by the Funds creates an opportunity for increased net income but, at the same
time, creates special risks. For example, leveraging
may exaggerate changes in and increase the volatility of the net asset value per
share (“NAV”) of a Fund. This is because leverage
tends to exaggerate the effect of any increase or decrease in the value of a
Fund’s portfolio securities. The use of leverage also may cause
a Fund to liquidate portfolio positions when it may not be advantageous to do so
in order to satisfy its obligations or to maintain
asset coverage.
In
general, a Fund may not issue any class of senior security, except that the
Funds may (i) borrow from banks, provided that immediately
following any such borrowing there is an asset coverage of at least 300% for all
Fund borrowings and in the event such asset
coverage falls below 300% the Fund will within three days or such longer period
as the SEC may prescribe by rules and regulations,
reduce the amount of its borrowings to an extent that the asset coverage of such
borrowings shall be at least 300%, and (ii)
engage in trading practices that involve
the issuance of a senior security, including but not limited to options,
futures, forward
contracts
and reverse repurchase agreements, in
applicable SEC requirements. The borrowings subject to these limits include
borrowings
through reverse repurchase agreements and similar financing transactions unless
a Fund has elected to treat all such transactions
as derivatives transactions under applicable SEC requirements.
Brady
Bonds. Brady
Bonds are fixed-income securities that are created through the exchange of
existing commercial bank loans to foreign
entities for new obligations in connection with debt restructuring under a plan
introduced by Nicholas F. Brady when he was the U.S.
Secretary of the Treasury. They may be collateralized or uncollateralized and
issued in various currencies (although most are U.S.
dollar-denominated) and they are actively traded in the over-the-counter (“OTC”)
secondary market. A Fund will invest in Brady
Bonds only if they are consistent with the Fund’s quality specifications.
Dollar-denominated, collateralized Brady Bonds may be
fixed-rate par bonds or floating rate discount bonds. Interest payments on Brady
Bonds generally are collateralized by cash or securities
in an amount that, in the case of fixed-rate bonds, is equal to at least one
year of rolling interest payments or, in the case of floating
rate bonds, initially is equal to at least one year’s rolling interest payments
based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
“value recovery payments” in certain circumstances, which in
effect constitute supplemental interest payments but generally are not
collateralized.
Brady
Bonds are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity;
(ii) the collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of
principal at maturity (these uncollateralized amounts constitute the “residual
risk”). In the event of a default with respect to collateralized
Brady Bonds as a result of which the payment obligations of the issuer are
accelerated, the U.S. Treasury zero coupon obligations
held as collateral for the payment of principal will not be distributed to
investors, nor will such obligations be sold and the
proceeds distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will
continue to be outstanding, at which time the face amount of the collateral will
equal the principal payments due on the Brady
Bonds in the normal course. However, Brady Bonds should be viewed as speculative
in light of the history of defaults with respect to
commercial bank loans by public and private entities of countries issuing Brady
Bonds.
Cash
Equivalents. Cash
equivalents are short-term fixed-income securities comprising:
■ |
Time
deposits, certificates of deposit (including marketable variable rate
certificates of deposit) and bankers’ acceptances issued by a
commercial bank or savings and loan association. Time deposits are
non-negotiable deposits maintained in a banking institution
for a specified period of time at a stated interest rate. Certificates of
deposit are negotiable short-term obligations issued
by commercial banks or savings and loan associations against funds
deposited in the issuing institution. Variable rate certificates
of deposit are certificates of deposit on which the interest rate is
periodically adjusted prior to their stated maturity based
upon a specified market rate. A bankers’ acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection
with an international commercial transaction (to finance the import,
export, transfer or storage of goods); |
■ |
Obligations
of U.S. banks, foreign branches of U.S. banks (Eurodollars) and U.S.
branches of foreign banks (Yankee dollars). Eurodollar
and Yankee dollar investments will involve some of the same risks of
investing in international securities that are discussed
in various foreign investing sections of this
SAI; |
■ |
Any
security issued by a commercial bank if (i) the bank has total assets of
at least $1 billion, or the equivalent in other currencies
or, in the case of domestic banks which do not have total assets of at
least $1 billion, the aggregate investment made in
any one such bank is limited to $250,000 principal amount per certificate
and the principal amount of such investment is insured
in full by the Federal Deposit Insurance Corporation (“FDIC”), (ii) in the
case of U.S. banks, it is a member of the FDIC
and (iii) in the case of foreign branches of U.S. banks, the security is
deemed by the Adviser to be of an investment quality
comparable with other debt securities which the Fund may
purchase; |
■ |
Commercial
paper rated at time of purchase by one or more nationally recognized
statistical rating organizations (“NRSROs”) in
one of their two highest categories (e.g., A-l or A-2 by S&P Global
Ratings Group, a division of S&P Global Inc. (“S&P”), Prime
1 or Prime 2 by Moody’s Investors Service, Inc. (“Moody’s”) or F1 or F2 by
Fitch Ratings, Inc. (“Fitch”)) or, if unrated, determined
to be of comparable quality by the
Adviser; |
■ |
Short-term
corporate obligations rated high-grade at the time of purchase by an NRSRO
(e.g., A or better by Moody’s, S&P or Fitch); |
■ |
U.S.
government obligations, including bills, notes, bonds and other debt
securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in interest rates,
maturities and dates of issue; |
■ |
Government
agency securities issued or guaranteed by U.S. government sponsored
instrumentalities and Federal agencies. These include
securities issued by the Federal Home Loan Banks, Federal Land Bank,
Farmers Home Administration, Farm Credit Banks,
Federal Intermediate Credit Bank, Fannie Mae, Federal Financing Bank, the
TVA and others; and |
■ |
Repurchase
agreements collateralized by the securities listed
above. |
Chinese
Fixed-Income Investments. A Fund may
invest in Chinese fixed-income securities traded in the China Interbank Bond
Market
(“CIBM”) through the Bond Connect program (“Bond Connect”), which allows
non-Chinese-domiciled investors (such as a Fund) to
purchase certain fixed-income investments available in China’s interbank bond
market. Bond Connect utilizes the trading infrastructure
of both Hong Kong and China. Bond Connect therefore is not available when there
are trading holidays in Hong Kong. As a
result, prices of securities purchased through Bond Connect may fluctuate at
times when a Fund is unable to add to or
exit its
position. Securities offered via Bond Connect may lose their eligibility for
trading through the program at any time, in which case they
may be sold but could no longer be purchased through Bond Connect. Because Bond
Connect is relatively new, its effects on the
Chinese interbank bond are uncertain. In addition, the trading, settlement and
information technology systems required for non-Chinese
investors in Bond Connect are relatively new and continuing to evolve. In the
event that the relevant systems do not function
properly, trading via Bond Connect could be disrupted, adversely affecting the
ability of a Fund to acquire or dispose of securities
through Bond Connect in a timely manner, which in turn could adversely impact
the Fund’s performance.
Bond
Connect is subject to regulation by both Hong Kong and China. There can be no
assurance that further regulations will not affect the
availability of securities in the program, the frequency of redemptions or other
limitations. In China, Bond Connect securities
are held on behalf of ultimate investors (such as a Fund) by the Hong Kong
Monetary Authority Central Money Markets Unit via
accounts maintained with China’s two clearinghouses for fixed-income securities.
While Chinese regulators have affirmed that the
ultimate investors hold a beneficial interest in Bond Connect securities, the
law surrounding such rights continues to develop,
and the mechanisms that beneficial owners may use to enforce their rights are
untested and therefore pose uncertain risks, with legal
and regulatory risks potentially having retroactive effect. Further, courts in
China have limited experience in applying the concept of
beneficial ownership, and the law surrounding beneficial ownership will continue
to evolve as they do so. There is accordingly
a risk that, as the law is tested and developed, a Fund’s ability to enforce its
ownership rights may be negatively impacted, which
could expose the Fund to the risk of loss on such investments. A Fund may not be
able to participate in corporate actions affecting
Bond Connect securities due to time constraints or for other operational
reasons, and payments of distributions could be delayed.
Market volatility and potential lack of liquidity due to low trading volume of
certain bonds may result in prices of those bonds
fluctuating significantly; in addition, the bid-ask spreads of the prices of
such securities may be large, and a Fund may therefore
incur significant costs and suffer losses when selling such investments. More
generally, bonds traded in CIBM may be difficult
or impossible to sell, which could further impact a Fund’s ability to acquire or
dispose of such securities at their expected prices.
Bond Connect trades are settled in Renminbi (“RMB”), the Chinese currency, and
investors must have timely access to a reliable
supply of RMB in Hong Kong, which cannot be guaranteed. Moreover, securities
purchased through Bond Connect generally
may not be sold, purchased or otherwise transferred other than through Bond
Connect in accordance with applicable rules. Finally,
uncertainties in the Chinese tax rules governing taxation of income and gains
from investments via Bond Connect could result in
unexpected tax liabilities for a Fund. The withholding tax treatment of
dividends and capital gains payable to overseas investors
currently is unsettled.
Under the
prevailing applicable Bond Connect regulations, a Fund participates in Bond
Connect through an offshore custody agent, registration
agent or other third parties (as the case may be), who would be responsible for
making the relevant filings and account opening
with the relevant authorities. A Fund is therefore subject to the risk of
default or errors on the part of such agents.
Commercial
Paper.
Commercial paper refers to short-term fixed-income securities with maturities
ranging from 1 to 397 days. They are
primarily issued by corporations needing to finance large amounts of
receivables, but may be issued by banks and other borrowers.
Commercial paper is issued either directly or through broker-dealers, and may be
discounted or interest bearing. Commercial
paper is unsecured. Virtually all commercial paper is rated by Moody’s, Fitch or
S&P.
Commercial
paper rated A-1 by S&P has the following characteristics: (1) liquidity
ratios are adequate to meet cash requirements; (2) long-term
senior debt is rated “A” or better; (3) the issuer has access to at least two
additional channels of borrowing; (4) basic earnings
and cash flow have an upward trend with allowance made for unusual
circumstances; (5) typically, the issuer’s industry is well
established and the issuer has a strong position within the industry; and (6)
the reliability and quality of management are unquestioned.
Relative strength or weakness of the above factors determines whether the
issuer’s commercial paper is A-1, A-2 or A-3.
The rating
Prime-1 is the highest commercial paper rating assigned by Moody’s. Among the
factors considered by Moody’s in assigning
ratings are the following: (1) evaluation of the management of the issuer; (2)
economic evaluation of the issuer’s industry or industries
and the appraisal of speculative-type risks which may be inherent in certain
areas; (3) evaluation of the issuer’s products in relation
to competition and customer acceptance; (4) liquidity; (5) amount and quality of
long-term debt; (6) trend of earnings over a period of
ten years; (7) financial strength of a parent company and the relationships that
exist with the issuer; and (8) recognition by the
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such
obligations.
With
respect to Fitch, a short-term issuer or obligation rating is based in all cases
on the short-term vulnerability to default of the rated
entity and relates to the capacity to meet financial obligations in accordance
with the documentation governing the relevant obligation.
Short-term deposit ratings may be adjusted for loss severity. 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.
An F1 rating indicates the strongest intrinsic
capacity for timely payment of financial commitments whereas an F2 rating
indicates good intrinsic capacity for timely payment of
financial commitments.
The
Ultra-Short Municipal Income Portfolio may invest in tax-exempt commercial
paper. Tax-exempt commercial paper is a short-term
obligation with a stated maturity of 397 days or less. It is issued by state and
local governments or their agencies to finance seasonal
working capital needs or as short-term financing in anticipation of longer term
financing. While tax-exempt commercial paper is
intended to be repaid from general revenues or refinanced, it frequently is
backed by a letter of credit, lending arrangement, note
repurchase agreement or other credit facility agreement offered by a bank or
financial institution.
Commodity-Linked
Investments. The
Global Strategist Portfolio may seek to provide exposure to the investment
returns of real assets
that trade in the commodity markets through investments in commodity-linked
derivative securities, such as structured notes, and other
similar investments (including commodity exchange-traded funds (“ETFs”) ) which
are designed to provide this exposure without
direct investment in physical commodities or commodities futures contracts.
The Global
Strategist Portfolio may also seek to provide
exposure to the investment returns of real assets that trade in the commodity
markets through investments in the Fund’s wholly-owned
subsidiary (the “Global Strategist Subsidiary”). Real
assets are assets such as oil, gas, industrial and precious metals, livestock,
and agricultural or meat products, or certain other tangible items, as compared
to stocks or bonds, which are intangible financial
instruments. In choosing investments, the Adviser seeks to provide exposure to
various commodities and commodity sectors.
The value of commodity-linked derivative securities held by a Global
Strategist Portfolio and/or the Global Strategist Subsidiary may be
affected by a variety of factors, including, but not limited to, overall market
movements and other factors affecting the value
of particular industries or commodities, such as weather, disease, embargoes,
acts of war or terrorism, or political and regulatory
developments.
The prices
of commodity-linked derivative securities may move in different directions than
investments in traditional equity and debt securities
when the value of those traditional securities is declining due to adverse
economic conditions. As an example, during periods of
rising inflation, debt securities have historically tended to decline in value
due to the general increase in prevailing interest rates.
Conversely, during those same periods of rising inflation, the prices of certain
commodities, such as oil and metals, have historically
tended to increase. Of course, there cannot be any guarantee that these
investments will perform in that manner in the future,
and at certain times the price movements of commodity-linked instruments have
been parallel to those of debt or equity securities.
Commodities have historically tended to increase and decrease in value during
different parts of the business cycle than financial
assets. Nevertheless, at various times, commodities prices may move in tandem
with the prices of financial assets and thus may not
provide overall portfolio diversification benefits. Under favorable economic
conditions, the Global Strategist Portfolio’s investments
may underperform an investment in traditional securities. Over the long term,
the returns on the Global Strategist Portfolio’s
investments are expected to exhibit low or negative correlation with stocks and
bonds.
Common
Stocks. Common
stocks are equity securities representing an ownership interest in a
corporation, entitling the stockholder to voting
rights and receipt of dividends paid based on proportionate
ownership.
Contracts
for Difference. Certain
Funds may purchase contracts for difference (“CFDs”). A CFD is a privately
negotiated contract between
two parties, buyer and seller, stipulating that the seller will pay to or
receive from the buyer the difference between the nominal
value of the underlying instrument at the opening of the contract and that
instrument’s value at the end of the contract. The underlying
instrument may be a single security, stock basket or index. A CFD can be set up
to take either a short or long position on the
underlying instrument. The buyer and seller are typically both required to post
margin, which is adjusted daily. The buyer will also pay
to the seller a financing rate on the notional amount of the capital employed by
the seller less the margin deposit. A CFD is usually
terminated at the buyer’s initiative. The seller of the CFD will simply match
the exposure of the underlying instrument in the open
market and the parties will exchange whatever payment is due.
As is the
case with owning any financial instrument, there is the risk of loss associated
with buying a CFD. For example, if a Fund buys a
long CFD and the underlying security is worth less at the end of the contract,
the Fund would be required to make a payment to the
seller and would suffer a loss. Also, there may be liquidity risk if the
underlying instrument is illiquid because the liquidity of a CFD is
based on the liquidity of the underlying instrument. A further risk is that
adverse movements in the underlying security will require
the buyer to post additional margin. CFDs also carry counterparty risk, i.e.,
the risk that the counterparty to the CFD transaction
may be unable or unwilling to make payments or to otherwise honor its financial
obligations under the terms of the contract.
If the counterparty were to do so, the value of the contract, and of a Fund’s
shares, may be reduced. A Fund will not enter into a CFD
transaction that is inconsistent with its investment objective, policies and
strategies.
Convertible
Securities. A
convertible security is a bond, debenture, note, preferred stock, right, warrant
or other security that may be
converted into or exchanged for a prescribed amount of common stock or other
security of the same or a different issuer or into cash
within a particular period of time at a specified price or formula. A
convertible security generally entitles the holder to receive interest
paid or accrued on debt securities or the dividend paid on preferred stock until
the convertible security matures or is redeemed,
converted or exchanged. Before conversion, convertible securities generally have
characteristics similar to both debt and equity
securities. The value of convertible securities tends to decline as interest
rates rise and, because of the conversion feature, tends to vary
with fluctuations in the market value of the underlying securities. Convertible
securities ordinarily provide a stream of income with
generally higher yields than those of common stock of the same or similar
issuers. Convertible securities generally rank senior to common
stock in a corporation’s capital structure but are usually subordinated to
comparable nonconvertible fixed-income securities
in such
capital structure. Convertible securities generally do not participate directly
in any dividend increases or decreases of the underlying
securities although the market prices of convertible securities may be affected
by any dividend changes or other changes in the
underlying securities. Certain of the convertible securities in which a Fund may
invest are rated below investment grade or are unrated.
The prices of such securities are likely to be more sensitive to adverse
economic changes than higher-rated securities, resulting
in increased volatility of market prices of these securities during periods of
economic uncertainty, or adverse individual corporate
developments. In addition, during an economic downturn or substantial period of
rising interest rates, lower rated issuers may
experience financial stress.
Corporates.
Corporates are fixed-income securities issued by private businesses. Holders, as
creditors, have a prior legal claim over holders of
equity securities of the issuer as to both income and assets for the principal
and interest due to the holder.
Currency
Forwards. A foreign
currency forward exchange contract is a negotiated agreement between two parties
to exchange specified
amounts of two or more currencies at a specified future time at a specified
rate. The rate specified by the foreign currency forward
exchange contract can be higher or lower than the spot rate between the
currencies that are the subject of the contract. A Fund may
also invest in non-deliverable foreign currency forward exchange contracts
(“NDFs”). NDFs are similar to other foreign currency
forward exchange contracts, but do not require or permit physical delivery of
currency upon settlement. Instead, settlement is made in
cash based on the difference between the contracted exchange rate and the spot
foreign exchange rate at settlement. Currency
futures are similar to foreign currency forward exchange contracts, except that
they are traded on an exchange and standardized
as to contract size and delivery date. Most currency futures call for payment or
delivery in U.S. dollars. Unanticipated changes in
currency prices may result in losses to a Fund and poorer overall performance
for a Fund than if it had not entered into foreign
currency forward exchange contracts. The typical use of a foreign currency
forward exchange contract is to “lock in” the price of a
security in U.S. dollars or some other foreign currency, which a Fund is holding
in its portfolio. By entering into a foreign currency
forward exchange contract for the purchase or sale, for a fixed amount of
dollars or other currency, of the amount of foreign currency
involved in the underlying security transactions, a Fund may be able to protect
itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar or other currency which is
being used for the security purchase and the foreign
currency in which the security is denominated during the period between the date
on which the security is purchased or sold and the
date on which payment is made or received. The Adviser also may from time to
time utilize foreign currency forward exchange
contracts for other purposes. For example, they may be used to hedge a foreign
security held in the portfolio against a decline in
value of the applicable foreign currency. They also may be used to lock in the
current exchange rate of the currency in which
those securities anticipated to be purchased are denominated. At times, a Fund
may enter into “cross-currency” hedging transactions
involving currencies other than those in which securities are held or proposed
to be purchased are denominated.
A Fund
will not enter into foreign currency forward exchange contracts or maintain a
net exposure to these contracts where the consummation
of the contracts would obligate a Fund to deliver an amount of foreign currency
in excess of the value of a Fund’s portfolio
securities.
A Fund may
be limited in its ability to enter into hedging transactions involving foreign
currency forward exchange contracts by Internal
Revenue Code of 1986, as amended (the “Code”), requirements relating to
qualification as a regulated investment company (“RIC”).
Foreign
currency forward exchange contracts may limit gains on portfolio securities that
could otherwise be realized had they not been
utilized and could result in losses. The contracts also may increase a Fund’s
volatility and may involve a significant amount of risk
relative to the investment of cash.
Custodial
Receipts. Certain
Funds may invest in custodial receipts representing interests in U.S. government
securities, municipal obligations
or other debt instruments held by a custodian or trustee. Custodial receipts
evidence ownership of future interest payments,
principal payments or both on notes or bonds issued or guaranteed as to
principal or interest by the U.S. Government, its agencies,
instrumentalities, political subdivisions or authorities, by a state or local
governmental body or authority, or by other types of
issuers. For certain securities law purposes, custodial receipts are not
considered obligations of the underlying issuers. In addition, if for tax
purposes a Fund is not considered to be the owner of the underlying securities
held in the custodial account, the Fund may suffer
adverse tax consequences. As a holder of custodial receipts, a Fund will bear
its proportionate share of the fees and expenses charged to
the custodial account.
Depositary
Receipts.
Depositary receipts represent an ownership interest in securities of foreign
companies (an “underlying issuer”) that are
deposited with a depositary. Depositary receipts are not necessarily denominated
in the same currency as the underlying securities.
Depositary receipts include American depositary receipts (“ADRs”), global
depositary receipts (“GDRs”) and other types of depositary
receipts (which, together with ADRs and GDRs, are hereinafter collectively
referred to as “Depositary Receipts”). ADRs are
dollar-denominated Depositary Receipts typically issued by a U.S. financial
institution and evidence an ownership interest in a security
or pool of securities issued by a foreign issuer. ADRs are listed and traded in
the United States. ADRs also include American depositary
shares. GDRs and other types of Depositary Receipts are typically issued by
foreign banks or trust companies, although they also
may be issued by U.S. financial institutions, and evidence ownership interests
in a security or pool of securities issued by
either a
foreign or a U.S. corporation. Generally, Depositary Receipts in registered form
are designed for use in the U.S. securities market and
Depositary Receipts in bearer form are designed for use in securities markets
outside the United States.
Depositary
Receipts may be “sponsored” or “unsponsored.” Sponsored Depositary Receipts are
established jointly by a depositary and the
underlying issuer, whereas unsponsored Depositary Receipts may be established by
a depositary without participation by the underlying
issuer. Holders of unsponsored Depositary Receipts generally bear all the costs
associated with establishing unsponsored Depositary
Receipts. In addition, the issuers of the securities underlying 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. For purposes of a Fund’s investment
policies, a Fund’s investments in Depositary Receipts will be deemed to be an
investment in the underlying securities, except
that ADRs may be deemed to be issued by a U.S. issuer.
Derivatives.
Certain
Funds may, but are not required to, use various derivatives and other
similar instruments as
described below. Derivatives
may be used for a variety of purposes including hedging, risk management,
portfolio management or to earn income. Any or all of
the investment techniques described herein may be used at any time and there is
no particular strategy that dictates the use of one
technique rather than another, as the use of any derivative by a Fund is a
function of numerous variables, including market conditions.
A Fund complies with applicable regulatory requirements when using
derivatives. Although
the Adviser seeks to use derivatives
to further a Fund’s investment objective, no assurance can be given that the use
of derivatives will achieve this result.
General
Risks of Derivatives.
Derivatives utilized by a Fund may involve the purchase and sale of derivative
instruments. A derivative is a
financial instrument the value of which depends upon (or derives from) the value
of another asset, security, interest rate, index or
financial
instrument.
Derivatives may relate to a wide variety of underlying instruments, including
equity and debt securities, indices, interest
rates, currencies and other assets. Certain derivative instruments that a Fund
may use and the risks of those instruments are described
in further detail below. A Fund may in the future also utilize derivatives
techniques, instruments and strategies that may be newly
developed or permitted as a result of regulatory changes, consistent with a
Fund’s investment objective and policies. Such newly
developed techniques, instruments and strategies may involve risks different
than or in addition to those described herein. No assurance
can be given that any derivatives strategy employed by a Fund will be
successful.
The risks
associated with the use of derivatives are different from, and possibly greater
than, the risks associated with investing directly
in the instruments underlying such derivatives. Derivatives are highly
specialized instruments that require investment techniques
and risk analyses different from other portfolio investments. The use of
derivative instruments requires an understanding not only
of the underlying instrument but also of the derivative itself. Certain risk
factors generally applicable to derivative transactions
are described below.
■ |
Derivatives
are subject to the risk that the market value of the derivative itself or
the market value of underlying instruments will change
in a way adverse to a Fund’s interests. A Fund bears the risk that the
Adviser may incorrectly forecast future market trends
and other financial or economic factors or the value of the underlying
security, index, interest rate or currency when establishing
a derivatives position for a Fund. |
■ |
Derivatives
may be subject to pricing risk, which exists when a derivative becomes
extraordinarily expensive (or inexpensive) relative
to historical prices or corresponding instruments. Under such market
conditions, it may not be economically feasible to initiate
a transaction or liquidate a position at an advantageous time or
price. |
■ |
Many
derivatives are complex and often valued subjectively. Improper valuations
can result in increased payment requirements to
counterparties or a loss of value to a Fund.
Many derivatives may also involve operational and legal
risks. |
■ |
Using
derivatives as a hedge against a portfolio investment subjects a Fund to
the risk that the derivative will have imperfect correlation
with the portfolio investment, which could result in a Fund incurring
substantial losses. This correlation risk may be greater
in the case of derivatives based on an index or other basket of
securities, as the portfolio securities being hedged may not duplicate
the components of the underlying index or the basket may not be of exactly
the same type of obligation as those underlying
the derivative. The use of derivatives for “cross hedging” purposes (using
a derivative based on one instrument as a hedge
on a different instrument) may also involve greater correlation
risks. |
■ |
While
using derivatives for hedging purposes can reduce a Fund’s risk of loss,
it may also limit a Fund’s opportunity for gains or result
in losses by offsetting or limiting a Fund’s ability to participate in
favorable price movements in portfolio
investments. |
■ |
Derivatives
transactions for non-hedging purposes involve greater risks and may result
in losses which would not be offset by increases
in the value of portfolio securities or declines in the cost of securities
to be acquired. In the event that a Fund enters into
a derivatives transaction as an alternative to purchasing or selling the
underlying instrument or in order to obtain desired exposure
to an index or market, a Fund will be exposed to the same risks as are
incurred in purchasing or selling the underlying instruments
directly as well as the additional risks associated with derivatives
transactions. |
■ |
The
use of certain derivatives transactions, including OTC derivatives,
involves the risk of loss resulting from the insolvency or bankruptcy
of the counterparty to the contract or the failure by the counterparty to
make required payments or otherwise comply
with the terms of the contract. In the event of default by a counterparty,
a Fund may have contractual remedies pursuant
to the agreements related to the
transaction. |
■ |
Liquidity
risk exists when a particular derivative is difficult to purchase or sell.
If a derivative transaction is particularly large or if
|
|
the
relevant market is illiquid, a Fund may be unable to initiate a
transaction or liquidate a position at an advantageous time or
price. |
■ |
While
some derivatives are cleared through a regulated, central clearinghouse,
many derivatives transactions are not entered into or
traded on exchanges or in markets regulated by the U.S. Commodity Futures
Trading Commission (“CFTC”) or the SEC. Instead,
in some cases, certain types of bilateral OTC derivatives are entered into
directly by a Fund and a counterparty and may be
traded only through financial institutions acting as market makers. OTC
derivatives transactions can only be entered into with
a willing counterparty that is approved by the Adviser in accordance with
guidelines established by the Board. Where no such
counterparty is available, a Fund will be unable to enter into a desired
OTC transaction. There also may be greater risk that
no liquid secondary market in the trading of OTC derivatives will exist,
in which case a Fund may be required to hold such instruments
until exercise, expiration or maturity. Many of the protections afforded
to participants in the cleared derivatives markets
are not available to participants in bilateral OTC derivatives
transactions. Bilateral OTC derivatives transactions are not subject
to the guarantee of a clearinghouse and, as a result, a Fund would bear
greater risk of default by the counterparties to such
transactions. |
■ |
A
Fund may be required to make physical delivery of portfolio securities
underlying a derivative in order to close out or
to meet margin
and payment requirements and a
derivatives position or to sell portfolio securities at a time or price at
which it may be disadvantageous
to do so in order to obtain cash to close out or to maintain a derivatives
position. |
■ |
As a
result of the structure of certain derivatives, adverse changes in, among
other things, interest rates, volatility or the value of the
underlying instrument can result in losses substantially greater than the
amount invested in the derivative itself. Certain derivatives
have the potential for unlimited loss, regardless of the size of the
initial investment. |
■ |
Certain
derivatives may be classified
as
illiquid and therefore subject to a Fund’s limitation on investments in
illiquid investments. |
■ |
Derivatives
transactions conducted outside the United States may not be conducted in
the same manner as those entered into on
U.S. exchanges, and may be subject to different margin, exercise,
settlement or expiration procedures. Brokerage commissions,
clearing costs and other transaction costs may be higher on foreign
exchanges. Many of the risks of OTC derivatives
transactions are also applicable to derivatives transactions conducted
outside the United States. Derivatives transactions
conducted outside the United States are subject to the risk of
governmental action affecting the trading in, or the prices
of, foreign securities, currencies and other instruments. The value of
such positions could be adversely affected by foreign political
and economic factors; lesser availability of data on which to make trading
decisions; delays on a Fund’s ability to act upon
economic events occurring in foreign markets; and less liquidity than U.S.
markets. |
■ |
Currency
derivatives are subject to additional risks. Currency derivatives
transactions may be negatively affected by government exchange
controls, blockages and manipulation. Currency exchange rates may be
influenced by factors extrinsic to a country’s economy.
There is no systematic reporting of last sale information with respect to
underlying foreign currencies. As a result, the available
information on which trading in currency derivatives will be based may not
be as complete as comparable data for other
transactions. Events could occur in the foreign currency market which will
not be reflected in currency derivatives until the
following day, making it more difficult for a Fund to respond to such
events in a timely manner. |
Regulatory
Matters.
Regulatory developments
affecting the exchange-traded and OTC derivatives markets may impair a Fund’s
ability to manage
or hedge its investment portfolio through the use of derivatives. In particular,
in October 2020, the SEC adopted a final rule
related to the use of derivatives, short sales, reverse repurchase agreements
and certain other transactions by registered investment companies
that rescinded
and withdrew the
guidance of the SEC and its staff regarding asset segregation and cover
transactions previously
applicable to the
Funds’ derivatives
and other transactions. These requirements may limit
the ability of a Fund to use derivatives
and reverse repurchase agreements and similar financing transactions as part of
its investment strategies. The rule
requires Funds to trade
derivatives and other transactions that create future payment or delivery
obligations (except reverse repurchase agreements
and similar financing transactions) subject to a value-at-risk (“VaR”) leverage
limit, certain derivatives risk management program
and reporting requirements. Generally, these requirements apply unless a Fund
qualifies as a “limited derivatives user.”
Under
the rule,
when a Fund trades reverse repurchase agreements or similar financing
transactions, including certain tender option bonds, it
needs to aggregate the amount of indebtedness associated with the reverse
repurchase agreements or similar financing transactions
with the aggregate amount of any other senior securities representing
indebtedness when calculating the Fund’s asset coverage
ratio or treat all such transactions as derivatives transactions. Reverse
repurchase agreements or similar financing transactions aggregated
with other indebtedness do not need to be included in the calculation of whether
a Fund is a limited derivatives user, but for funds
subject to the VaR testing, reverse repurchase agreements and similar financing
transactions must be included for purposes of such
testing whether treated as derivatives transactions or not. The SEC also
provided guidance in connection with the rule
regarding
use of securities lending collateral that may limit the Funds’ securities
lending activities. These requirements may increase the cost
of a Fund’s investments and cost of doing business, which could adversely affect
investors.
The
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)
and the rules promulgated thereunder may limit
the ability of a Fund to enter into one or more exchange-traded or OTC
derivatives transactions.
A Fund’s
use of derivatives may also be limited by the requirements of the Code for
qualification as a RIC for U.S. federal income tax purposes.
The
Adviser is subject to registration and regulation as a “commodity pool operator”
(“CPO”) under the Commodity Exchange Act, as amended
(“CEA”), with respect to its service as investment adviser to the Global
Strategist Portfolio. As a result, the Trust, on behalf of
the Global Strategist Portfolio, will be required to operate in compliance with
applicable CFTC requirements, including registration,
disclosure, reporting and other operational requirements under the CEA and
related CFTC regulations. Compliance with these
additional requirements may increase Trust expenses. The Adviser and the Global
Strategist Portfolio are exempt from certain
CFTC recordkeeping, reporting and disclosure requirements under CFTC Rule 4.7
with respect to the Global Strategist Subsidiary.
The
Adviser, with respect to each Fund except for the Global Strategist Portfolio,
has filed a notice of eligibility with the National Futures
Association (“NFA”) claiming an exclusion from the definition of the term CPO
pursuant to CFTC Regulation 4.5, as promulgated
under the CEA, with respect to each Fund’s operations. In addition, the Adviser
will operate the Bitcoin Subsidiary (as defined
below) in reliance on an exemption from registration as a CPO under CFTC
Regulation 4.13(a)(3). Therefore, neither these Funds nor
the Adviser (with respect to these Funds and the Bitcoin Subsidiary), is subject
to registration or regulation as a commodity
pool or CPO under the CEA. If any of these Funds (or the Adviser with respect to
such Fund) becomes subject to these requirements,
as well as related NFA rules, the Fund may incur additional compliance and other
expenses.
With
respect to investments in swap transactions, commodity futures, commodity
options or certain other commodity interests used for
purposes other than bona fide hedging purposes, an investment company must meet
one of the following tests under the CFTC regulations
in order for its investment adviser to claim an exemption from being considered
a CPO. First, the aggregate initial margin and
premiums required to establish an investment company’s positions in such
investments may not exceed five percent (5%) of the liquidation
value of the investment company’s portfolio (after accounting for unrealized
profits and unrealized losses on any such investments).
Alternatively, the aggregate net notional value of such instruments, determined
at the time of the most recent position established,
may not exceed one hundred percent (100%) of the liquidation value of the
investment company’s portfolio (after accounting
for unrealized profits and unrealized losses on any such positions). In addition
to meeting one of the foregoing trading limitations,
the investment company may not market itself as a commodity pool or otherwise as
a vehicle for trading in the commodity
futures, commodity options or swaps and derivatives markets.
Regulations
recently adopted by federal banking regulators under the Dodd-Frank Act require
that certain qualified financial contracts
(“QFCs”) with counterparties that are part of U.S. or foreign global
systemically important banking organizations be amended to
include contractual restrictions on close-out and cross-default rights. QFCs
include, but are not limited to, securities contracts,
commodities contracts, forward contracts, repurchase agreements, securities
lending agreements and swaps agreements, as well as
related master agreements, security agreements, credit enhancements, and
reimbursement obligations. If a covered counterparty
of a Fund or certain of the covered counterparty’s affiliates were to become
subject to certain insolvency proceedings, a Fund may
be temporarily unable to exercise certain default rights, and the QFC may be
transferred to another entity. In
addition, under the
rule, a Fund is permitted to invest in a security on a when-issued or
forward-settling basis, or with a non-standard settlement
cycle, and the transaction will be deemed not to involve a senior security under
the 1940 Act, provided that (i) the Fund intends to
physically settle the transaction and (ii) the transaction will settle within 35
days of its trade date (the “Delayed-Settlement Securities
Provision”). A Fund may otherwise engage in such transactions that do not meet
the conditions of the Delayed-Settlement Securities
Provision so long as the Fund treats any such transaction as a “derivatives
transaction” for purposes of compliance with the rule.
Furthermore, under the rule, a Fund will be permitted to enter into an unfunded
commitment agreement, and such unfunded commitment
agreement will not be subject to the asset coverage requirements under the 1940
Act, if the Fund reasonably believes, at the time
it enters into such agreement, that it will have sufficient cash and cash
equivalents to meet its obligations with respect to all such
agreements as they come due. These
requirements may impact a Fund’s credit and counterparty risks.
Combined
Transactions. Combined
transactions involve entering into multiple derivatives transactions (such as
multiple options transactions,
including purchasing and writing options in combination with each other;
multiple futures transactions; and combinations
of options, futures, forward and swap transactions) instead of a single
derivatives transaction in order to customize the risk and
return characteristics of the overall position. Combined transactions typically
contain elements of risk that are present in each of
the component transactions. A Fund may enter into a combined transaction instead
of a single derivatives transaction when, in the
opinion of the Adviser, it is in the best interest of the Fund to do so. Because
combined transactions involve multiple transactions,
they may result in higher transaction costs and may be more difficult to close
out.
Emerging
Market Securities. Certain
Funds may invest in emerging market securities. An emerging market security is a
security issued by
an emerging market foreign government or private issuer. An emerging market
foreign government or private issuer has one or more of
the following characteristics: (i) its principal securities trading market is in
an emerging market or developing country; (ii) alone or
on a consolidated basis it derives 50% or more of its annual revenue or profits
from goods produced, sales made or services performed
in an emerging market or developing country or has at least 50% of its
assets, core
business operations and/or employees
in an
emerging market or developing country; or (iii) it is organized under the laws
of, or has a principal office in, an emerging market or
developing country. Based on these criteria it is possible for a security to be
considered issued by an issuer in more than one country.
Therefore, it is possible for the securities of any issuer that has one or more
of these characteristics in
connection
with any emerging market or developing country to be considered an emerging
market security when held in one Fund, but not considered an emerging
market security when held in another Fund if it has one or more of these
characteristics in connection with a developed country.
Emerging
market describes any country that is generally considered to be an emerging or
developing country by major organizations in the
international financial community or by a Fund’s benchmark index.
The
economies of individual emerging market or developing countries may differ
favorably or unfavorably from the U.S. economy in such
respects as growth of gross domestic product, rate of inflation or deflation,
currency depreciation, capital reinvestment, resource self-sufficiency
and balance of payments position. Further, the economies of developing countries
generally are heavily dependent upon
international trade and, accordingly, have been, and may continue to be,
adversely affected by trade barriers, exchange controls, managed
adjustments in relative currency values and other protectionist measures. These
economies also have been, and may continue
to be, adversely affected by economic conditions in the countries with which
they trade.
Prior
governmental approval for foreign investments may be required under certain
circumstances in some emerging market or developing
countries, and the extent of foreign investment in certain fixed-income
securities and domestic companies may be subject to
limitation in other emerging market or developing countries. Foreign ownership
limitations also may be imposed by the charters of
individual companies in emerging market or developing countries to prevent,
among other concerns, violation of foreign investment
limitations. Repatriation of investment income, capital and the proceeds of
sales by foreign investors may require governmental
registration and/or approval in some emerging countries. A Fund could be
adversely affected by delays in, or a refusal to grant,
any required governmental registration or approval for such repatriation. Any
investment subject to such repatriation controls
will be considered illiquid if it appears reasonably likely that this process
will take more than seven days.
Certain
emerging market countries may be subject to less stringent requirements
regarding accounting, auditing, financial reporting and record
keeping and therefore, material information related to an investment may not be
available or reliable. In addition, a Fund is limited
in its ability to exercise its legal rights or enforce a counterparty’s legal
obligations in certain jurisdictions outside of the United
States, in particular, in emerging markets countries.
Investment
in emerging market or developing countries may entail purchasing securities
issued by or on behalf of entities that are insolvent,
bankrupt, in default or otherwise engaged in an attempt to reorganize or
reschedule their obligations and in entities that have
little or no proven credit rating or credit history. In any such case, the
issuer’s poor or deteriorating financial condition may increase
the likelihood that a Fund will experience losses or diminution in available
gains due to bankruptcy, insolvency or fraud. Emerging
market or developing countries also pose the risk of nationalization,
expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) that could adversely affect the economies
of such countries or the value of a Fund’s investments in those countries. In
addition, it may be difficult to obtain and enforce a
judgment in a court outside the United States.
A Fund may
also be exposed to an extra degree of custodial and/or market risk, especially
where the securities purchased are not traded on
an official exchange or where ownership records regarding the securities are
maintained by an unregulated entity (or even the issuer
itself).
Equity
Securities. Equity
securities generally represent an ownership interest in an issuer, or may be
convertible into or represent a right to
acquire an ownership interest in an issuer. While there are many types of equity
securities, prices of all equity securities will fluctuate.
Economic, political and other events may affect the prices of broad equity
markets. For example, changes in inflation or consumer
demand may affect the prices of equity securities generally in the United
States. Similar events also may affect the prices of particular
equity securities. For example, news about the success or failure of a new
product may affect the price of a particular issuer’s
equity securities.
Eurodollar
and Yankee Dollar Obligations. Certain
Funds may invest in Eurodollar and Yankee dollar obligations. Eurodollar and
Yankee
dollar obligations are fixed-income securities that include time deposits, which
are non-negotiable deposits maintained in a bank for a
specified period of time at a stated interest rate. The Eurodollar obligations
may include bonds issued and denominated in euros.
Eurodollar obligations may be issued by government and corporate issuers in
Europe. Yankee dollar obligations, which include time
deposits and certificates of deposit, are U.S. dollar-denominated obligations
issued in the U.S. capital markets by foreign banks. Eurodollar
bank obligations, which include time deposits and certificates of deposit, are
U.S. dollar-denominated obligations issued outside
the U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
The Funds may consider Yankee dollar obligations
to be domestic securities for purposes of their investment
policies.
Eurodollar
and Yankee dollar obligations are subject to the same risks as domestic issues,
notably credit risk, market risk and liquidity risk.
However, Eurodollar (and to a limited extent, Yankee dollar) obligations are
also subject to certain sovereign risks. One such risk is the
possibility that a sovereign country might prevent capital from flowing across
its borders. Other risks include adverse political and
economic developments; the extent and quality of government regulations of
financial markets and institutions; the imposition of foreign
withholding taxes; and the expropriation or nationalization of foreign
issuers.
Exchange-Listed
Equities via Stock Connect Program. The
Shanghai-Hong Kong Stock Connect program and the Shenzhen-Hong Kong
Stock Connect programs (“Stock Connect”) allow non-Chinese investors (such as a
Fund) to purchase certain listed equities
via brokers in Hong Kong. Although Stock Connect allows non-Chinese investors to
trade Chinese equities without a license,
purchases of securities through Stock Connect are subject to daily market-wide
quota limitations, which may prevent a Fund from
purchasing Stock Connect securities when it is otherwise advantageous to do so.
An investor cannot purchase and sell the same security
on the same trading day, which may restrict a Fund’s ability to invest in China
A-shares through Stock Connect and to enter into or
exit trades where it is advantageous to do so on the same trading day. Because
Stock Connect trades are routed through Hong Kong
brokers and the Hong Kong Stock Exchange, Stock Connect is affected by trading
holidays in either China or Hong Kong, and there
are trading days in China when Stock Connect investors will not be able to
trade. As a result, prices of securities purchased through
Stock Connect may fluctuate at times when a Fund is unable to add to or exit its
position. Only certain China A-shares are eligible
to be accessed through Stock Connect. Such securities may lose their eligibility
at any time, in which case they could be sold but could
no longer be purchased through Stock Connect. Because Stock Connect is
relatively new, its effects on the market for trading
China A-shares are uncertain. In addition, the trading, settlement and IT
systems required to operate Stock Connect are relatively
new and continuing to evolve. In the event that the relevant systems do not
function properly, trading through Stock Connect
could be disrupted.
Stock
Connect is subject to regulation by both Hong Kong and China. There can be no
assurance that further regulations will not affect the
availability of securities in the program, the frequency of redemptions or other
limitations. For
defaults by Hong Kong brokers
occurring on or after January 1, 2020, the Hong
Kong Investor
Compensation Fund will cover losses incurred by investors with a cap
of HK$500,000 per investor for securities traded on a stock market operated by
the Shanghai Stock Exchange and/or Shenzhen
Stock Exchange and in respect of which an order for sale or purchase is
permitted to be routed through the northbound link of
the Stock Connect. In
China, Stock Connect securities are held on behalf of ultimate investors (such
as a Fund) by the Hong Kong
Securities Clearing Company Limited (“HKSCC”) as nominee. While Chinese
regulators have affirmed that the ultimate investors
hold a beneficial interest in Stock Connect securities, the law surrounding such
rights is in its early stages and the mechanisms
that beneficial owners may use to enforce their rights are untested and
therefore pose uncertain risks. Further, courts in China have
limited experience in applying the concept of beneficial ownership and the law
surrounding beneficial ownership will continue
to evolve as they do so. Accordingly,
there is a risk
that as the law is tested and developed, a Fund’s ability to enforce its
ownership
rights may be negatively impacted. A Fund may
not be able to participate in corporate actions affecting Stock Connect
securities
due to time constraints or for other operational reasons. A Fund
will not be able to attend shareholders’ meetings. Stock Connect
trades are settled in RMB, the Chinese currency, and investors must have timely
access to a reliable supply of RMB in Hong Kong,
which cannot be guaranteed.
Stock
Connect trades are either subject to certain pre-trade requirements or must be
placed in special segregated accounts that allow brokers to
comply with these pre-trade requirements by confirming that the selling
shareholder has sufficient Stock Connect securities
to complete the sale. If a Fund does not utilize a special segregated account,
the Fund will not be able to sell the shares on any
trading day where it fails to comply with the pre-trade checks. In addition,
these pre-trade requirements may, as a practical matter,
limit the number of brokers that a Fund may use to execute trades. While a Fund
may use special segregated accounts in lieu of the
pre-trade check, some market participants have yet to fully implement IT systems
necessary to complete trades involving securities
in such accounts in a timely manner. Market practice with respect to special
segregated accounts is continuing to evolve. Investments
via Stock Connect are subject to regulation by Chinese authorities. Chinese law
may require aggregation of a Fund’s holdings
of Stock Connect securities with securities of other clients of the Adviser for
purposes of disclosing positions held in the market,
acquiescing to trading halts that may be imposed until regulatory filings are
completed or complying with China’s short-term trading
rules.
Fixed-Income
Securities.
Fixed-income securities generally represent an issuer’s obligation to repay to
the investor (or lender) the amount
borrowed plus interest over a specified time period. A typical fixed-income
security specifies a fixed date when the amount borrowed
(principal) is due in full, known as the maturity date, and specifies dates when
periodic interest (coupon) payments will be made over
the life of the security.
Fixed-income
securities come in many varieties and may differ in the way that interest is
calculated, the amount and frequency of payments,
the type of collateral, if any, and the presence of special features (e.g.,
conversion rights). Prices of fixed-income securities fluctuate
and, in particular, are subject to several key risks including, but not limited
to, interest rate risk, credit risk, prepayment risk and spread
risk.
Interest
rate risk arises due to general changes in the level of market rates after the
purchase of a fixed-income security. Generally, the values of
fixed-income securities vary inversely with changes in interest rates. During
periods of falling interest rates, the values of most
outstanding fixed-income securities generally rise and during periods of rising
interest rates, the values of most fixed-income securities
generally decline. The Funds may face a heightened level of interest rate risk
in times of monetary policy change and/or uncertainty,
such as when the Federal Reserve Board adjusts a quantitative easing program
and/or changes rates. A changing interest rate
environment increases certain risks, including the potential for periods of
volatility, increased redemptions, shortened durations
(i.e.,
prepayment risk) and extended durations (i.e., extension risk). Certain Funds
are not limited as to the maturities (when a debt security
provides its final payment) or duration (measure of interest rate sensitivity)
of the securities in which it may invest. While fixed-income
securities with longer final maturities often have higher yields than those with
shorter maturities, they usually possess greater
price sensitivity to changes in interest rates and other factors. Traditionally,
the remaining term to maturity has been used as a barometer
of a fixed-income security’s sensitivity to interest rate changes. This measure,
however, considers only the time until the final
principal payment and takes no account of the pattern or amount of principal or
interest payments prior to maturity. Duration combines
consideration of yield, coupon, interest and principal payments, final maturity
and call (prepayment) features. Duration measures
the likely percentage change in a fixed-income security’s price for a small
parallel shift in the general level of interest rates; it is also an
estimate of the weighted average life of the remaining cash flows of a
fixed-income security. In almost all cases, the duration of a
fixed-income security is shorter than its term to maturity.
Credit
risk represents the possibility that an issuer may be unable to meet scheduled
interest and principal payment obligations. It is most often
associated with corporate bonds, although it can be present in other
fixed-income securities as well. Credit
ratings and quantitative
models attempt to measure the degree of credit risk in fixed-income securities,
and provide insight as to whether prevailing
yield spreads afford sufficient compensation for such risk. Other things being
equal, fixed-income securities with high degrees of
credit risk should trade in the market at lower prices (and higher yields) than
fixed-income securities with low degrees of credit
risk.
Prepayment
risk, also known as call risk, arises due to the issuer’s ability to prepay all
or most of the fixed-income security prior to the stated
final maturity date. Prepayments generally rise in response to a decline in
interest rates as debtors take advantage of the opportunity
to refinance their obligations. This risk is often associated with mortgage
securities where the underlying mortgage loans can be
refinanced, although it can also be present in corporate or other types of bonds
with call provisions. When a prepayment occurs, a
Fund may be forced to reinvest in lower yielding fixed-income securities.
Quantitative models are designed to help assess the degree of
prepayment risk, and provide insight as to whether prevailing yield spreads
afford sufficient compensation for such risk.
Spread
risk is the potential for the value of a Fund’s assets to fall due to the
widening of spreads. Fixed-income securities generally compensate
for greater credit risk by paying interest at a higher rate. The difference (or
“spread”) between the yield of a security and the yield
of a benchmark, such as a U.S. Treasury security with a comparable maturity,
measures the additional interest paid for credit
risk. As the spread on a security widens (or increases), the price (or value) of
the security falls. Spread widening may occur, among
other reasons, as a result of market concerns over the stability of the market,
excess supply, general credit concerns in other markets,
security- or market-specific credit concerns or general reductions in risk
tolerance.
While
assets in fixed-income markets have grown rapidly in recent years, the capacity
for traditional dealer counterparties to engage in
fixed-income trading has not kept pace and in some cases has decreased. For
example, primary dealer inventories of corporate bonds,
which provide a core indication of the ability of financial intermediaries to
“make markets,” are at or near historic lows in relation
to market size. This reduction in market-making capacity may be a persistent
change, to the extent it is resulting from broader
structural changes, such as fewer proprietary trading desks at broker-dealers
and increased regulatory capital requirements. Because
market makers provide stability to a market through their intermediary services,
the significant reduction in dealer inventories
could potentially lead to decreased liquidity and increased volatility in the
fixed-income markets. Such issues may be exacerbated
during periods of economic uncertainty.
Economic,
political and other events also may affect the prices of broad fixed-income
markets, although the risks associated with such events are
transmitted to the market via changes in the prevailing levels of interest
rates, credit risk, prepayment risk or spread risk.
From time
to time, uncertainty regarding the status of negotiations in the U.S. government
to increase the statutory debt ceiling could
impact the creditworthiness of the United States and could impact the liquidity
of the U.S. Government securities markets and ultimately
the Funds.
Certain of
the Funds’ investments are subject to inflation risk, which is the risk that the
value of assets or income from investments will be
less in the future as inflation decreases the value of money (i.e., as inflation
increases, the values of the Fund’s assets can decline).
Inflation rates may change frequently and significantly as a result of various
factors, including unexpected shifts in the domestic
or global economy and changes in economic policies, and a Fund’s investments may
not keep pace with inflation, which may result
in losses to Fund shareholders. This risk is greater for fixed-income
instruments with longer maturities.
Floaters. Floaters
are fixed-income securities with a rate of interest that varies with changes in
specified market rates or indices, such as the
prime rate, or at specified intervals. Certain floating or variable rate
obligations may carry a demand feature that permits the holder to
tender them back to the issuer of the underlying instrument, or to a third
party, at par value prior to maturity. When the demand
feature of certain floating or variable rate obligations represents an
obligation of a foreign entity, the demand feature will be subject to
certain risks discussed under “Foreign Securities.”
Floating
and Variable Rate Obligations. Certain
Funds may purchase floating and variable rate obligations, including floating
and variable
rate municipal obligations and preferred shares of closed-end funds. The value
of these obligations is generally more stable than that
of a fixed rate obligation in response to changes in interest rate levels.
Subject to the conditions for using amortized cost
valuation
under the 1940 Act, a Fund may consider the maturity of a variable or floating
rate obligation to be shorter than its ultimate
stated maturity if the obligation is issued or guaranteed by U.S. government
agencies, authorities, instrumentalities or sponsored
enterprises or by the U.S. Treasury, if the obligation has a remaining maturity
of 397 calendar days or less, or if the obligation
has a demand feature that permits the Fund to receive payment at any time or at
specified intervals not exceeding 397 calendar
days. The issuers or financial intermediaries providing demand features may
support their ability to purchase the obligations by
obtaining credit with liquidity supports. These may include lines of credit,
which are conditional commitments to lend, and letters of credit,
which will ordinarily be irrevocable, both of which may be issued by domestic
banks or foreign banks which have a branch, agency or
subsidiary in the United States. A Fund may purchase variable or floating rate
obligations from the issuers or may purchase certificates
of participation, a type of floating or variable rate obligation, which are
interests in a pool of debt obligations held by a bank or
other financial institution.
Foreign
Currency Transactions. The U.S.
dollar value of the assets of the Funds, to the extent they invest in securities
denominated in foreign
currencies, may be affected favorably or unfavorably by changes in foreign
currency exchange rates and exchange control regulations,
and the Funds may incur costs in connection with conversions between various
currencies. Currency exchange rates may fluctuate
significantly over short periods of time for a number of reasons, including
changes in interest rates and the overall economic health of
the issuer. Devaluation of a currency by a country’s government or banking
authority also will have a significant impact on the value
of any investments denominated in that currency. The Funds may conduct their
foreign currency exchange transactions on a spot
(i.e., cash) basis at the then-prevailing spot rate in the foreign currency
exchange market. The Funds also may manage their foreign
currency transactions by entering into foreign currency forward exchange
contracts to purchase or sell foreign currencies or by using
other instruments and techniques described under “Derivatives.”
Under
normal circumstances, consideration of the prospect for changes in the values of
currency will be incorporated into the long-term
investment decisions made with regard to overall diversification strategies.
However, the Adviser believes that it is important to have the
flexibility to use such derivative products when it determines that it is in the
best interests of a Fund. It may not be practicable
to hedge foreign currency risk in all markets, particularly emerging
markets.
Foreign
Currency Warrants. Certain
Funds may invest in foreign currency warrants, which entitle the holder to
receive from the issuer an amount
of cash (generally, for warrants issued in the United States, in U.S. dollars)
which is calculated pursuant to a predetermined
formula and based on the exchange rate between a specified foreign currency and
the U.S. dollar as of the exercise date of the
warrant. Foreign currency warrants generally are exercisable upon their issuance
and expire as of a specified date and time.
Foreign
currency warrants have been issued in connection with U.S. dollar-denominated
debt offerings by major corporate issuers in an attempt
to reduce the foreign currency exchange risk which, from the point of view of
prospective purchasers of the securities, is inherent
in the international fixed-income marketplace. Foreign currency warrants may
attempt to reduce the foreign exchange risk assumed by
purchasers of a security by, for example, providing for a supplemental payment
in the event that the U.S. dollar depreciates
against the value of a major foreign currency such as the Japanese Yen. The
formula used to determine the amount payable
upon exercise of a foreign currency warrant may make the warrant worthless
unless the applicable foreign currency exchange rate moves
in a particular direction (e.g., unless the U.S. dollar appreciates or
depreciates against the particular foreign currency to which the
warrant is linked or indexed). Foreign currency warrants are severable from the
debt obligations with which they may be offered,
and may be listed on exchanges.
Foreign
currency warrants may be exercisable only in certain minimum amounts, and an
investor wishing to exercise warrants who possesses
less than the minimum number required for exercise may be required either to
sell the warrants or to purchase additional warrants,
thereby incurring additional transaction costs. In the case of any exercise of
warrants, there may be a delay between the time a holder
of warrants gives instructions to exercise and the time the exchange rate
relating to exercise is determined, during which time the
exchange rate could change significantly, thereby affecting both the market and
cash settlement values of the warrants being exercised.
The expiration date of the warrants may be accelerated if the warrants should be
delisted from an exchange or if their trading
should be suspended permanently, which would result in the loss of any remaining
“time value” of the warrants (i.e., the difference
between the current market value and the exercise value of the warrants), and,
in the case where the warrants were “out-of-the-money,”
in a total loss of the purchase price of the warrants.
Foreign
currency warrants are generally unsecured obligations of their issuers and are
not standardized foreign currency options issued by
the Options Clearing Corporation (“OCC”). Unlike foreign currency options issued
by the OCC, the terms of foreign exchange
warrants generally will not be amended in the event of governmental or
regulatory actions affecting exchange rates or in the event of
the imposition of other regulatory controls affecting the international currency
markets. The initial public offering price of foreign
currency warrants is generally considerably in excess of the price that a
commercial user of foreign currencies might pay in the interbank
market for a comparable option involving significantly larger amounts of foreign
currencies. Foreign currency warrants are subject to
complex political or economic factors.
Principal
Exchange Rate Linked Securities. Principal
exchange rate linked securities are debt obligations the principal of which is
payable at
maturity in an amount that may vary based on the exchange rate between the U.S.
dollar and a particular foreign currency
at or
about that time. The return on “standard” principal exchange rate linked
securities is enhanced if the foreign currency to which the
security is linked appreciates against the U.S. dollar, and is adversely
affected by increases in the foreign exchange value of the U.S.
dollar; “reverse” principal exchange rate linked securities are like the
“standard” securities, except that their return is enhanced by
increases in the value of the U.S. dollar and adversely impacted by increases in
the value of foreign currency. Interest payments on the
securities are generally made in U.S. dollars at rates that reflect the degree
of foreign currency risk assumed or given up by the purchaser
of the notes (i.e., at relatively higher interest rates if the purchaser has
assumed some foreign currency risk).
Performance
indexed paper.
Performance indexed paper is U.S. dollar-denominated commercial paper the yield
of which is linked to certain
foreign exchange rate movements. The yield to the investor will be within a
range stipulated at the time of purchase of the obligation,
generally with a guaranteed minimum rate of return that is below, and a
potential maximum rate of return that is above, market
yields on U.S. dollar-denominated commercial paper, with both the minimum and
maximum rates of return on the investment
corresponding to the minimum and maximum values of the spot exchange rate two
business days prior to maturity.
Foreign
Securities. Investing
in foreign securities involves certain special considerations which are not
typically associated with investments
in the securities of U.S. issuers. Foreign issuers are not generally subject to
uniform accounting, auditing and financial reporting
standards and may have policies that are not comparable to those of domestic
issuers. As a result, there may be less information
available about foreign issuers than about domestic issuers. Securities of some
foreign issuers may be less liquid and more volatile
than securities of comparable domestic issuers. There is generally less
stringent investor protections and disclosure standards, and less
government supervision and regulation of stock exchanges, brokers and listed
issuers than in the United States. In addition, with
respect to certain foreign countries, there is a possibility of expropriation or
confiscatory taxation, political and social instability, or
diplomatic developments which could affect U.S. investments in those countries.
The costs of investing in foreign countries frequently
are higher than the costs of investing in the United States. Although the
Adviser endeavors to achieve the most favorable execution
costs in portfolio transactions, fixed commissions on many foreign stock
exchanges are generally higher than negotiated commissions
on U.S. exchanges. In addition, investments in certain foreign markets that have
historically been considered stable may become
more volatile and subject to increased risk due to ongoing developments and
changing conditions in such markets. Moreover,
the growing interconnectivity of global economies and financial markets has
increased the probability that adverse developments
and conditions in one country or region will affect the stability of economies
and financial markets in other countries or
regions. For instance, if one or more countries leave the European Union (“EU”)
or the EU dissolves, the world’s securities markets
likely will be significantly disrupted.
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. The governments of certain countries
may prohibit or impose substantial restrictions on foreign investing in their
capital markets or in certain sectors or industries.
In addition, a foreign government may limit or cause delay in the convertibility
or repatriation of its currency which would
adversely affect the U.S. dollar value and/or liquidity of investments
denominated in that currency. Certain foreign investments
may become less liquid in response to market developments or adverse investor
perceptions, or become illiquid after purchase
by a Fund, particularly during periods of market turmoil. When a Fund holds
illiquid investments, its portfolio may be harder to
value.
Investments
in securities of foreign issuers may be denominated in foreign currencies.
Accordingly, the value of a Fund’s assets, as measured
in U.S. dollars, may be affected favorably or unfavorably by changes in currency
exchange rates and in exchange control regulations.
A Fund may incur costs in connection with conversions between various
currencies.
Certain
foreign markets 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,
organizations, companies, entities and/or
individuals, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. International trade
barriers or economic sanctions against foreign countries, organizations,
companies, entities and/or individuals, may adversely affect a
Fund’s foreign holdings or exposures. 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. Governmental actions can have a significant effect on the economic
conditions in foreign countries, which also may adversely
affect the value and liquidity of a Fund’s investments. For example, the
governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital markets or in
certain sectors or industries. In addition, a foreign government
may limit or cause delay in the convertibility or repatriation of its currency
which would adversely affect the U.S. dollar value
and/or liquidity of investments denominated in that currency. Any of these
actions could severely affect security prices, impair a Fund’s
ability to purchase or sell foreign securities or transfer a Fund’s assets back
into the U.S., or otherwise adversely affect a Fund’s operations.
Certain foreign investments may become less liquid in response to market
developments or adverse investor perceptions, or become
illiquid after purchase by a Fund, particularly during periods of market
turmoil. Certain foreign investments may become illiquid
when, for instance, there are few, if any, interested buyers and sellers or when
dealers are unwilling to make a market for certain
securities. When a Fund holds illiquid investments, its portfolio may be harder
to value.
Certain
foreign governments may levy withholding or other taxes on dividend and interest
income. Although in some countries a portion of
these taxes may be recoverable, the non-recovered portion of foreign withholding
taxes will reduce the income received from
investments in such countries. The Funds may be able to pass through to their
shareholders a credit for U.S. tax purposes with respect to
any such foreign taxes.
Unless
otherwise noted in the
Prospectus,
the Adviser may consider an issuer to be from a particular country (including
the United States) or
geographic region if: (i) its principal securities trading market is in that
country or geographic region; (ii) alone or on a consolidated
basis it derives 50% or more of its annual revenue or profits from goods
produced, sales made or services performed in that
country or geographic region or has at least 50% of its assets, core
business operations and/or employees in that
country or geographic
region; or (iii) it is organized under the laws of, or has a principal office
in, that country or geographic region. By applying these
tests, it is possible that a particular issuer could be deemed to be from more
than one country or geographic region.
Foreign
securities may include, without limitation, foreign equity securities, which are
equity securities of a non-U.S. issuer, foreign government
fixed-income securities, which are fixed-income securities issued by a
government other than the U.S. Government or government-related
issuer in a country other than the United States, and foreign corporate
fixed-income securities, which are fixed-income
securities issued by a private issuer in a country other than the United
States.
Investments
in foreign companies and countries are subject to economic sanction and trade
laws in the United States and other jurisdictions.
These laws and related governmental actions may, from time to time, prohibit a
Fund from investing in certain countries
and in certain companies. Investments in certain countries and companies may be,
and have in the past been, restricted as a result of
the imposition of economic sanctions. In addition, economic sanction laws in the
United States and other jurisdictions may prohibit a
Fund from transacting with a particular country or countries, organizations,
companies, entities and/or individuals. These types of
sanctions may significantly restrict or completely prohibit investment
activities in certain jurisdictions.
Economic
sanctions and other similar governmental actions could, among other things,
effectively restrict or eliminate a Fund’s ability to
purchase or sell securities or groups of securities, and thus may make the
Fund’s investments in such securities less liquid or more
difficult to value. In addition, as a result of economic sanctions, the Fund may
be forced to sell or otherwise dispose of investments
at inopportune times or prices, which could result in losses to the Fund and
increased transaction costs. These conditions may be in
place for a substantial period of time and enacted with limited advance notice
to the Fund.
In
addition, such economic sanctions or other government restrictions may
negatively impact the value or liquidity of a Fund’s investments,
and could impair the Fund’s ability to meet its investment objective or invest
in accordance with its investment strategy because
the Fund may, for example, be prohibited from investing in securities issued by
companies subject to such restrictions and the Fund
could be required to freeze or divest its existing investments that the Adviser
would otherwise consider to be attractive.
The risks
posed by economic sanctions against a particular foreign country, its nationals
or industries or businesses within the country may be
heightened to the extent a Fund invests significantly in the affected country or
region or in issuers from the affected country that
depend on global markets.
Referendum
on the UK’s EU Membership. In an
advisory referendum held in June 2016, the United Kingdom (“UK”) electorate
voted to leave
the EU, an event widely referred to as “Brexit.” On January 31, 2020, the UK
officially withdrew from the EU and the UK entered a
transition period which ended on December 31, 2020. On December 30, 2020, the EU
and UK signed the EU-UK Trade and
Cooperation Agreement (“TCA”), an agreement on the terms governing certain
aspects of the EU’s and the UK’s relationship following
the end of the transition period. Notwithstanding the TCA, following the
transition period, there is likely to be considerable
uncertainty as to the UK’s post-transition framework.
The impact
on the UK and the EU and the broader global economy is still unknown but could
be significant and could result in increased
volatility and illiquidity and potentially lower economic growth. Brexit may
have a negative impact on the economy and currency
of the UK and the EU as a result of anticipated, perceived or actual changes to
the UK’s economic and political relations with the
EU. The impact of Brexit, and its ultimate implementation, on the economic,
political and regulatory environment of the UK and the
EU could have global ramifications.
The Funds
may make investments in the UK, other EU members and in non-EU countries that
are directly or indirectly affected by the exit
of the UK from the EU. Adverse legal, regulatory or economic conditions
affecting the economies of the countries in which the Funds
conduct their business (including making investments) and any corresponding
deterioration in global macro-economic conditions
could have a material adverse effect on a Fund’s investment returns. Potential
consequences to which the Funds may be exposed,
directly or indirectly, as a result of the UK referendum vote include, but are
not limited to, market dislocations, economic and
financial instability in the UK and in other EU members, increased volatility
and reduced liquidity in financial markets, reduced availability
of capital, an adverse effect on investor and market sentiment, Sterling and
Euro destabilization, reduced deal flow in a Fund’s
target markets, increased counterparty risk and regulatory, legal and compliance
uncertainties. Any of the foregoing or similar risks
could have a material adverse effect on the operations, financial condition or
investment returns of a Fund and/or the Adviser in general.
The effects on the UK, European and global economies of the exit of the UK
(and/or other EU members during the term of
a Fund)
from the EU, or the exit of other EU members from the European monetary area
and/or the redenomination of financial instruments
from the Euro to a different currency, are difficult to predict and to protect
fully against. Many of the foregoing risks are outside of
the control of a Fund and the Adviser. These risks may affect a Fund, the
Adviser and other service providers given economic,
political and regulatory uncertainty created by Brexit.
Funding
Agreements. A funding
agreement is a contract between an issuer and a purchaser that obligates the
issuer to pay a guaranteed
rate of interest on a principal sum deposited by the purchaser. Funding
agreements will also guarantee the return of principal
and may guarantee a stream of payments over time. A funding agreement has a
fixed maturity and may have either a fixed, variable
or floating interest rate that is based on an index and guaranteed for a fixed
time period. The secondary market, if any, for these
funding agreements is limited; thus, such investments purchased by the Funds may
be treated as illiquid.
Futures
Contracts. A futures
contract is a standardized agreement to buy or sell a specific quantity of an
underlying asset, reference rate or
index at a specific price at a specific future time (the “settlement date”).
Futures contracts may be based on, among other things, a
specified equity security (securities futures), a specified debt security or
reference rate (interest rate futures), the value of a specified
securities index (index futures) or the value of a foreign currency (currency
futures). While the value of a futures contract tends to
increase and decrease in tandem with the value of the underlying instrument,
differences between the futures market and the market for
the underlying asset may result in an imperfect correlation. The buyer of a
futures contract agrees to purchase the underlying
instrument on the settlement date and is said to be “long” the contract. The
seller of a futures contract agrees to sell the underlying
instrument on the settlement date and is said to be “short” the contract.
Futures contracts call for settlement only on the expiration
date and cannot be “exercised” at any other time during their term.
Depending
on the terms of the particular contract, futures contracts are settled through
either physical delivery of the underlying instrument
on the settlement date (such as in the case of futures based on a specified debt
security) or by payment of a cash settlement
amount on the settlement date (such as in the case of futures contracts relating
to broad-based securities indices). In the case of
cash-settled futures contracts, the settlement amount is equal to the difference
between the reference instrument’s price on the last
trading day of the contract and the reference instrument’s price at the time the
contract was entered into. Most futures contracts, particularly
futures contracts requiring physical delivery, are not held until the settlement
date, but instead are offset before the settlement
date through the establishment of an opposite and equal futures position (buying
a contract that had been sold, or selling a contract
that had been purchased). All futures transactions are effected through a
clearinghouse associated with the exchange on which the
futures are traded.
The buyer
and seller of a futures contract are not required to deliver or pay for the
underlying commodity unless the contract is held until the
settlement date. However, both the buyer and seller are required to deposit
“initial margin” with a futures commission merchant
(“FCM”) when the futures contract is entered into. Initial margin deposits are
typically calculated as a percentage of the contract’s
market value. If the value of either party’s position declines, the party will
be required to make additional “variation margin”
payments to settle the change in value on a daily basis. The process is known as
“marking-to-market.” Upon the closing of a futures
position through the establishment of an offsetting position, a final
determination of variation margin will be made and additional
cash will be paid by or released to a Fund.
Additional
Risks of Futures Transactions. The risks
associated with futures contract transactions are different from, and possibly
greater than, the
risks associated with investing directly in the underlying instruments. Futures
are highly specialized instruments that require investment
techniques and risk analyses different from those associated with other
portfolio investments. The use of futures requires an
understanding not only of the underlying instrument but also of the futures
contract itself. Futures may be subject to the risk factors
generally applicable to derivatives transactions described herein, and may also
be subject to certain additional risk factors, including:
■ |
The
risk of loss in buying and selling futures contracts can be substantial.
Small price movements in the commodity, security, index,
currency or instrument underlying a futures position may result in
immediate and substantial loss (or gain) to a
Fund. |
■ |
Buying
and selling futures contracts may result in losses in excess of the amount
invested in the position in the form of initial margin.
In the event of adverse price movements in the underlying commodity,
security, index, currency or instrument, a Fund would
be required to make daily cash payments to maintain its required margin. A
Fund may be required to sell portfolio securities,
or make or take delivery of the underlying securities in order to meet
daily margin requirements at a time when it may be
disadvantageous to do so. A Fund could lose margin payments deposited with
an FCM if the FCM breaches its agreement with
a Fund, becomes insolvent or declares
bankruptcy. |
■ |
Most
exchanges limit the amount of fluctuation permitted in futures contract
prices during any single trading day. Once the daily
limit has been reached in a particular futures contract, no trades may be
made on that day at prices beyond that limit. If futures
contract prices were to move to the daily limit for several trading days
with little or no trading, a Fund could be prevented
from prompt liquidation of a futures position and subject to substantial
losses. The daily limit governs only price movements
during a single trading day and therefore does not limit a Fund’s
potential losses. |
■ |
Index
futures based upon a narrower index of securities may present greater
risks than futures based on broad market indices, as narrower
indices are more susceptible to rapid and extreme fluctuations as a result
of changes in value of a small number of securities. |
High
Yield Securities. High
yield securities are generally considered to include fixed-income securities
rated below the four highest rating
categories at the time of purchase (e.g., Ba through C by Moody’s, or BB through
D by S&P or Fitch) and unrated fixed-income
securities considered by the Adviser to be of equivalent quality. High yield
securities are not considered investment grade and are
commonly referred to as “junk bonds” or high yield, high risk securities.
Investment grade securities that a Fund holds may be downgraded
to below investment grade by the rating agencies. If a Fund holds a security
that is downgraded, the Fund may choose to retain the
security.
While high
yield securities offer higher yields, they also normally carry a high degree of
credit risk and are considered speculative by the major
credit rating agencies. High yield securities may be issued as a consequence of
corporate restructuring or similar events. High yield
securities are often issued by smaller, less creditworthy issuers, or by highly
leveraged (indebted) issuers, that are generally less able
than more established or less leveraged issuers to make scheduled payments of
interest and principal. In comparison to investment
grade securities, the price movement of these securities is influenced less by
changes in interest rates and more by the financial
and business position of the issuer. The values of high yield securities are
more volatile and may react with greater sensitivity to market
changes.
High yield
securities are frequently ranked junior to claims by other creditors. If the
issuer cannot meet its obligations, the senior obligations
are generally paid off before the junior obligations, which will potentially
limit a Fund’s ability to fully recover principal or to
receive interest payments when senior securities are in default. Thus, investors
in high yield securities have a lower degree of protection
with respect to principal and interest payments then do investors in higher
rated securities. In addition, lower-rated securities
frequently have call or redemption features that would permit an issuer to
repurchase the security from a Fund. If a call were
exercised by the issuer during a period of declining interest rates, a Fund
likely would have to replace such called security with a lower
yielding security, thus decreasing the net investment income to the Fund and any
dividends to investors.
The
secondary market for high yield securities is concentrated in relatively few
market makers and is dominated by institutional investors,
including mutual funds, insurance companies and other financial institutions.
Accordingly, the secondary market for such securities
is not as liquid as, and is more volatile than, the secondary market for
higher-rated securities. Because high yield securities are less
liquid, judgment may play a greater role in valuing certain of a Fund’s
securities than is the case with securities trading in a more
liquid market. Also, future legislation may have a possible negative impact on
the market for high yield, high risk securities.
The credit
rating of a high yield security does not necessarily address its market value
risk. Ratings and market value may change from time
to time, positively or negatively, to reflect new developments regarding the
issuer.
The high
yield securities markets may react strongly to adverse news about an issuer or
the economy, or to the perception or expectation
of adverse news, whether or not it is based on fundamental analysis.
Additionally, prices for high yield securities may be affected
by legislative and regulatory developments. These developments could adversely
affect a Fund’s NAV and investment practices,
the secondary market for high yield securities, the financial condition of
issuers of these securities and the value and liquidity
of outstanding high yield securities, especially in a thinly traded
market.
Inverse
Floaters. Inverse
floating rate obligations are obligations which pay interest at rates that vary
inversely with changes in market
rates of interest. Because the interest rate paid to holders of such obligations
is generally determined by subtracting a variable or
floating rate from a predetermined amount, the interest rate paid to holders of
such obligations will decrease as such variable or floating
rate increases and increase as such variable or floating rate
decreases.
Like most
other fixed-income securities, the value of inverse floaters will decrease as
interest rates increase. They are more volatile, however,
than most other fixed-income securities because the coupon rate on an inverse
floater typically changes at a multiple of the change in
the relevant index rate. Thus, any rise in the index rate (as a consequence of
an increase in interest rates) causes a correspondingly
greater drop in the coupon rate of an inverse floater while a drop in the index
rate causes a correspondingly greater increase
in the coupon of an inverse floater. Some inverse floaters may also increase or
decrease in value substantially because of changes in
the rate of prepayments.
Inverse
floating rate investments tend to underperform the market for fixed-rate bonds
in a rising interest rate environment, but tend to
outperform the market for fixed-rate bonds when interest rates decline or remain
relatively stable. Inverse floating rate investments have
varying degrees of liquidity.
Investment
Company Securities.
Investment company securities are equity securities and include securities of
other open-end, closed-end
and unregistered investment companies, including foreign investment companies,
hedge funds and ETFs. A Fund may, to the extent
noted in the Fund’s non-fundamental limitations, invest in investment company
securities as may be permitted by (i) the 1940 Act;
(ii) the rules and regulations promulgated by the SEC under the 1940 Act; or
(iii) an exemption or other relief applicable to the
Fund from provisions of the 1940 Act. The 1940 Act generally prohibits an
investment company from acquiring more than 3% of the
outstanding voting shares of an investment company and limits such investments
to no more than 5% of a Fund’s total assets in
any one investment company and no more than 10% in any combination of investment
companies. The 1940 Act also prohibits
a Fund from acquiring in the aggregate more than 10% of the outstanding voting
shares of any registered closed-end
investment
company. A Fund may invest in investment company securities of investment
companies managed by the Adviser or its affiliates
to the extent permitted under the 1940 Act or as otherwise authorized by the
SEC. To the extent a Fund invests a portion of its assets
in investment company securities, those assets will be subject to the risks of
the purchased investment company’s portfolio securities,
and a shareholder in the Fund will bear not only their proportionate share of
the expenses of the Fund, but also, indirectly the
expenses of the purchased investment company.
Money
Market Funds. To the
extent permitted by applicable law, a Fund may invest all or some of its short
term cash investments in any money
market fund advised or managed by the Adviser or its affiliates. In connection
with any such investments, a Fund, to the extent
permitted by the 1940 Act, will pay its share of all expenses (other than
advisory and administrative fees) of a money market fund in
which it invests, which may result in the Fund bearing some additional expenses.
The rules governing money market funds: (1) permit
(and, under certain circumstances, require) certain money market funds to impose
a “liquidity fee” (up to 2%), or a “redemption
gate” that temporarily restricts redemptions from a money market fund, if weekly
liquidity levels fall below the required regulatory
threshold, and (2) require “institutional money market funds” to operate with a
floating NAV per share rounded to a minimum of
the fourth decimal place in the case of a fund with a $1.0000 share price or an
equivalent or more precise level of accuracy
for money market funds with a different share price (e.g., $10.000 per share, or
$100.00 per share). These may affect the investment
strategies, performance and operating expenses of money market funds.
“Government money market funds,” as defined under Rule
2a-7 of the 1940 Act, are exempt from these requirements, though such funds may
choose to opt-in to the implementation
of liquidity fees and redemption gates.
Exchange-Traded
Funds. The Funds
may invest in ETFs. Investments in ETFs are subject to a variety of risks,
including risks of a direct
investment in the underlying securities that the ETF holds. For example, the
general level of stock prices may decline, thereby adversely
affecting the value of the underlying investments of the ETF and, consequently,
the value of the ETF. In addition, the market
value of the ETF shares may differ from their NAV because the supply and demand
in the market for ETF shares at any point is not
always identical to the supply and demand in the market for the underlying
securities. Also, ETFs that track particular indices typically
will be unable to match the performance of the index exactly due to, among other
things, the ETF’s operating expenses and transaction
costs. ETFs typically incur fees that are separate from those fees incurred
directly by the Funds. Therefore, as a shareholder
in an ETF (as with other investment companies), a Fund would bear its ratable
share of that entity’s expenses. At the same time,
the Fund would continue to pay its own investment management fees and other
expenses. As a result, a Fund and its shareholders,
in effect, will be absorbing duplicate levels of fees with respect to
investments in ETFs. Further,
certain of the ETFs in which a
Fund may invest are leveraged. Leveraged ETFs seek to deliver multiples of the
performance of the index or other benchmark they track
and use derivatives in an effort to amplify the returns of the underlying index
or benchmark. While leveraged ETFs may offer the
potential for greater return, the potential for loss and the speed at which
losses can be realized also are greater. Most leveraged
ETFs “reset” daily, meaning they are designed to achieve their stated objectives
on a daily basis. Leveraged ETFs can deviate substantially
from the performance of their underlying benchmark over longer periods of time,
particularly in volatile periods. The more a
Fund invests in such leveraged ETFs, the more this leverage will magnify any
losses on those investments.
Furthermore, disruptions
in the markets for the securities underlying ETFs purchased or sold by the Fund
could result in losses on the Fund’s investment
in ETFs.
Illiquid
Investments. In
accordance with Rule 22e-4 (the “Liquidity Rule”) under the 1940 Act, each Fund
may invest up to 15% of its net
assets in “illiquid investments” that are assets. For these purposes, “illiquid
investments” are investments that a Fund reasonably
expects cannot be sold or disposed of in current market conditions in seven
calendar days or less without the sale or disposition
significantly changing the market value of the investment. For each Fund, each
portfolio investment must be classified at least
monthly into one of four liquidity categories (illiquid, as discussed above, as
well as highly liquid, moderately liquid and less liquid),
which are defined pursuant to the Liquidity Rule and classified in accordance
with the Fund’s written liquidity risk management
program by the program administrator designated by the Trust’s Board of
Trustees. Such classification is to be made using
information obtained after reasonable inquiry and taking into account relevant
market, trading and investment-specific considerations.
In making such classifications, a Fund determines whether trading varying
portions of a position in a particular portfolio
investment or asset class, in sizes that the Fund would reasonably anticipate
trading, is reasonably expected to significantly affect its
liquidity. If so, this determination is taken into account when classifying the
liquidity of that investment. The Funds may be assisted
in classification determinations by one or more third-party service providers.
Assets classified according to this process as “illiquid
investments” are those subject to the 15% limit on illiquid
investments.
In the
event that changes in the portfolio or other external events cause a Fund to
exceed this limit, the Fund must take steps to bring its
illiquid investments that are assets to or below the applicable limit of its net
assets within a reasonable period of time. This requirement
would not force a Fund to liquidate any portfolio investment.
In
addition to the limitation set forth above with respect to illiquid investments,
the Ultra-Short Income Portfolio and the Ultra-Short
Municipal Income Portfolio will not invest more than 10% of such Fund’s net
assets in illiquid securities, in accordance with the policy
described below in Investment Limitations–Non-Fundamental
Limitations.
Investment
Funds. Some
emerging market countries have laws and regulations that currently preclude
direct investment or make it undesirable
to invest directly in the securities of their companies. However, indirect
investment in the securities of companies listed and traded
on the stock exchanges in these countries is permitted by certain emerging
market countries through investment funds that have
been specifically authorized. A Fund may invest in these investment funds
subject to the provisions of the 1940 Act, as applicable,
and other applicable laws. The Funds will invest in such investment funds only
where appropriate given that the Fund’s shareholders
will bear indirectly the layer of expenses of the underlying investment funds in
addition to their proportionate share of the
expenses of the Fund.
Investment
Grade Securities.
Investment grade securities are fixed-income securities rated by one or more of
the rating agencies in one of the
four highest rating categories at the time of purchase (e.g., AAA, AA, A or BBB
by S&P or Fitch or Aaa, Aa, A or Baa by Moody’s)
or determined to be of equivalent quality by the Adviser. Securities rated BBB
or Baa represent the lowest of four levels of investment
grade securities and are regarded as borderline between sound obligations and
those in which speculative elements predominate.
A Fund is permitted to hold investment grade securities or “high grade”
securities, and may hold unrated securities if the
Adviser considers the risks involved in owning that security to be equivalent to
the risks involved in holding an investment grade security.
Ratings assigned to fixed-income securities represent only the opinion of the
rating agency assigning the rating and are not dispositive
of the credit risk associated with the purchase of a particular fixed-income
security. Moreover, market risk also will affect the prices
of even the highest rated fixed-income securities so that their prices may rise
or fall even if the issuer’s capacity to repay its obligations
remains unchanged.
IPOs. Certain
Funds may purchase equity securities issued as part of, or a short period after,
a company’s initial public offering (“IPO”),
and may at times dispose of those securities shortly after their acquisition. A
Fund’s purchase of securities issued in IPOs exposes it
to the risks associated with companies that have little operating history as
public companies, as well as to the risks inherent in those
sectors of the market where these issuers operate. The market for IPO issuers
has been volatile, and share prices of newly-public
companies have fluctuated significantly over short periods of time.
LIBOR
Discontinuance or Unavailability Risk. A Fund’s
investments, payment obligations and financing terms may be based on
floating
rates, such as the London Interbank Offered Rates (collectively, “LIBOR”), Euro
Interbank Offered Rate and other similar types of
reference rates (each, a “Reference Rate”). These Reference Rates are generally
intended to represent the rate at which contributing
banks may obtain short-term borrowings from each other within certain financial
markets. On July 27, 2017, the Chief Executive
of the UK Financial Conduct Authority (“FCA”), which regulates LIBOR, announced
that the FCA will no longer persuade
nor require banks to submit rates for the calculation of LIBOR and certain other
Reference Rates after 2021. Such announcement
indicates that the continuation of LIBOR and other Reference Rates on the
current basis cannot and will not be guaranteed
after the end of 2021. On March 5, 2021, the FCA announced that LIBOR will
either cease to be provided by any administrator,
or no longer be representative for many LIBOR settings after December 31, 2021,
and for the most widely used tenors of U.S.
dollar LIBOR after June 30, 2023. In addition, in connection with supervisory
guidance from regulators, many
regulated entities
have ceased to enter
into new LIBOR-based contracts after January 1, 2022. These announcements and
developments and any
additional regulatory or market changes may have an adverse impact on a Fund or
its investments.
Regulators and
market participants are currently engaged in identifying successor Reference
Rates (“Alternative Reference Rates”). Additionally,
it is expected that market participants will focus on the transition mechanisms
by which the Reference Rates in existing contracts
or instruments may be amended, whether through marketwide protocols, fallback
contractual provisions, bespoke negotiations
or amendments or otherwise. Nonetheless, the termination of certain Reference
Rates presents risks to a Fund. At this time, it
is not possible to completely identify or predict the effect of any such
changes, any establishment of Alternative Reference Rates or
any other reforms to Reference Rates that may be enacted in the UK or elsewhere.
The elimination of a Reference Rate or any other
changes or reforms to the determination or supervision of Reference Rates could
have an adverse impact on the market for or value
of any securities or payments linked to those Reference Rates and other
financial obligations held by a Fund or on its overall financial
condition or results of operations. To
identify a successor rate for US dollar LIBOR, the Alternative Reference Rates
Committee
(“ARRC”), a U.S.-based group convened by the Federal Reserve Board and the
Federal Reserve Bank of New York, was formed.
The ARRC has identified Secured Overnight Financing Rate (“SOFR”) as its
preferred alternative rate for LIBOR. SOFR is a measure
of the cost of borrowing cash overnight, collateralized by the U.S. Treasury
securities, and is based on directly observable U.S.
Treasury backed repurchase transactions. On December 6, 2021, the ARRC released
a statement selecting and recommending forms of
SOFR, along with associated spread adjustments and conforming changes, to
replace references to 1-week and 2-month US dollar
LIBOR. It is expected that a substantial portion of future floating rate
investments will be linked to SOFR. At this time, it is not
possible to predict the effect of the transition to SOFR.
The
transition process might lead to increased volatility and illiquidity in markets
that currently rely on Reference Rates to determine interest
rates. It could also lead to a reduction in the value of some Reference
Rate-based investments held by a Fund and reduce the effectiveness
of new hedges placed against existing Reference Rate-based instruments. While
market participants are endeavoring to minimize
the economic impact of the transition from Reference Rates to Alternative
Reference Rates, the transition away from LIBOR and
certain other Reference Rates could, among other negative
consequences:
■ |
Adversely
impact the pricing, liquidity, value of, return on and trading for a broad
array of financial products, including any Reference
Rate-linked securities, loans and derivatives in which a Fund may
invest; |
■ |
Require
extensive negotiations of and/or amendments to agreements and other
documentation governing Reference Rate-linked investments
products; |
■ |
Lead
to disputes, litigation or other actions with counterparties or portfolio
companies regarding the interpretation and enforceability
of “fallback” provisions that provide for an alternative reference
rate in the event of Reference Rate unavailability; or |
■ |
Cause
a Fund to incur additional costs in relation to any of the above
factors. |
The risks
associated with the above factors, including decreased liquidity, are heightened
with respect to investments in Reference Rate-based
products that do not include a fallback provision that addresses how interest
rates will be determined if LIBOR and certain
other Reference Rates stop being published. Even with some Reference Rate-based
instruments that may contemplate a scenario
where Reference Rates are no longer available by providing for an alternative
rate-setting methodology and/or increased costs for
certain Reference Rate-related instruments or financing transactions, there may
be significant uncertainty regarding the effectiveness
of any such alternative methodologies, resulting in prolonged adverse market
conditions for a Fund. In many cases, in the event
that an instrument falls back to an Alternative Reference Rate, the Alternative
Reference Rate would not perform the same as
the
Reference Rate being replaced would
have and may not include adjustments to such rates that are reflective of
current economic
circumstances or differences between such rate and LIBOR. Since the usefulness
of LIBOR and certain other Reference Rates as
benchmarks could deteriorate during the transition period, these effects could
occur prior to June 2023
for those Reference Rates
which are expected to be discontinued at that time. There
also remains uncertainty and risk regarding the willingness and ability of
issuers to include enhanced provisions in new and existing contracts or
instruments. In addition, when a Reference Rate is discontinued,
the Alternative Reference Rate may be lower than market expectations, which
could have an adverse impact on the value of
preferred and debt securities with floating or fixed-to-floating rate coupons.
Various pieces of legislation, including recent
federal
legislation and laws
enacted by the states of New York and Alabama, may affect the transition of
LIBOR-based instruments as well by
permitting trustees and calculation agents to transition instruments with no
LIBOR transition language to an Alternative Reference
Rate provided
for in such legislation. Such
pieces of legislation also include safe harbors from liability, which may limit
the recourse a
Fund may have if the Alternative Reference Rate does not fully compensate the
Fund for the transition of an instrument from
LIBOR. It is uncertain what impact any such legislation may have. In addition,
any Alternative Reference
Rate and any pricing adjustments
imposed by a regulator or counterparties or otherwise may adversely affect a
Fund’s performance or NAV.
Limited
Partnership and Limited Liability Company Interests. A limited
partnership interest entitles a Fund to participate in the investment
return of the partnership’s assets as defined by the agreement among the
partners. As a limited partner, a Fund generally is not
permitted to participate in the management of the partnership. However, unlike a
general partner whose liability is not limited, a limited
partner’s liability generally is limited to the amount of its commitment to the
partnership. A Fund may invest in limited liability
company interests to the same extent it invests in limited partnership
interests. Limited liability company interests have similar
characteristics as limited partnership interests.
Loan-Related
Investments. Loan-related
investments may include, without limitation, bank loans, direct lending and loan
participations
and assignments. In addition to risks generally associated with debt
investments, loan-related investments are subject to other
risks. Loans in which a Fund may invest may not be rated by a rating agency,
will not be registered with the SEC or any state securities
commission and will not be listed on any national securities exchange. Investors
in loans, such as a Fund, may not be entitled
to rely on the anti-fraud protections of the federal securities laws, although
they may be entitled to certain contractual remedies.
The amount of public information available with respect to loans will generally
be less extensive than that available for registered
or exchange-listed securities. In evaluating the creditworthiness of borrowers,
the Adviser will consider, and may rely in part on,
analyses performed by others.
The market
for loan obligations may be subject to irregular trading activity, wide bid/ask
spreads and extended trade settlement periods.
Because transactions in many loans are subject to extended trade settlement
periods, a Fund may not receive the proceeds from the
sale of a loan for a period after the sale. As a result, sale proceeds related
to the sale of loans may not be available to make additional
investments or to meet a Fund’s redemption obligations for a period after the
sale of the loans, and, as a result, the Fund may have
to sell other investments or engage in borrowing transactions, such as borrowing
from its credit facility, if necessary to raise cash to
meet its obligations. In addition, a Fund may not be able to readily dispose of
its loans at prices that approximate those at which the
Fund could sell such loans if they were more widely-traded and, as a result of
such illiquidity, a Fund may have to hold
additional
cash or sell other
investments or engage in borrowing transactions, such as borrowing from its
credit facility, if necessary to raise cash
to meet its obligations, including redemption obligations. To the extent a
readily available market ceases to exist for a particular
investment, such investment would be treated as illiquid for purposes of a
Fund’s limitations on illiquid investments.
Loans are
subject to the risk of non-payment of scheduled interest or principal. Such
non-payment would result in a reduction of income to
a Fund, a reduction in the value of the investment and a potential decrease in
the Fund’s NAV. There can be no assurance that the
liquidation of any collateral securing a loan would satisfy a borrower’s
obligation in the event of non-payment of scheduled
interest
or principal payments, or that such collateral could be readily liquidated. In
the event of bankruptcy of a borrower, a Fund could
experience delays or limitations with respect to its ability to realize the
benefits of the collateral securing a loan. The collateral securing a
loan may lose all or substantially all of its value in the event of the
bankruptcy of a borrower. Some loans are subject to the risk that
a court, pursuant to fraudulent conveyance or other similar laws, could
subordinate such loans to presently existing or future indebtedness
of the borrower or take other action detrimental to the holders of loans
including, in certain circumstances, invalidating such loans
or causing interest previously paid to be refunded to the borrower. If interest
were required to be refunded, it could negatively
affect a Fund’s performance.
Direct
Lending. When a
Fund acts as a direct lender, it may participate in structuring the loan. Under
these circumstances, it will have a
direct contractual relationship with the borrower, may enforce compliance by the
borrower with the terms of the loan agreement
and may have rights with respect to any funds acquired by other lenders through
set-off. Lenders also have full voting and consent
rights under the applicable loan agreement. Action subject to lender vote or
consent generally requires the vote or consent of the
holders of some specified percentage of the outstanding principal amount of the
loan. Certain decisions, such as reducing the amount of
interest on or principal of a loan, releasing collateral, changing the maturity
of a loan or a change in control of the borrower,
frequently require the unanimous vote or consent of all lenders
affected.
Loan
Participations and Assignments. Loan
participations are interests in loans or other direct debt instruments relating
to amounts owed by a
corporate, governmental or other borrower to another party. These loans may
represent amounts owed to lenders or lending
syndicates, to suppliers of goods or services (trade claims or other
receivables), or to other parties (“Lenders”) and may be fixed-rate
or floating rate. These loans also may be arranged through private negotiations
between an issuer of sovereign debt obligations
and Lenders.
A Fund’s
investments in loans may be in the form of a participation in loans
(“Participations”) and assignments of all or a portion of loans
(“Assignments”) from third parties. In the case of a Participation, a Fund will
have the right to receive payments of principal, interest
and any fees to which it is entitled only from the Lender selling the
Participation and only upon receipt by the Lender of the payments
from the borrower. In the event of an insolvency of the Lender selling a
Participation, a Fund may be treated as a general creditor
of the Lender and may not benefit from any set-off between the Lender and the
borrower. Certain Participations may be structured
in a manner designed to avoid purchasers of Participations being subject to the
credit risk of the Lender with respect to the Participation.
Even under such a structure, in the event of a Lender’s insolvency, the Lender’s
servicing of the Participation may be delayed
and the assignability of the Participation may be impaired. A Fund will acquire
Participations only if the Lender interpositioned
between a Fund and the borrower is determined by the Adviser to be
creditworthy.
When a
Fund purchases Assignments from Lenders it will acquire direct rights against
the borrower on the loan. However, because Assignments
are arranged through private negotiations between potential assignees and
potential assignors, the rights and obligations acquired
by a Fund as the purchaser of an Assignment may differ from, and be more limited
than, those held by the assigning Lender.
Because there is no liquid market for Participations and Assignments, it is
likely that such securities could be sold only to a limited
number of institutional investors. The lack of a liquid secondary market may
have an adverse impact on the value of such securities
and a Fund’s ability to dispose of particular Assignments or Participations when
necessary to meet a Fund’s liquidity needs or in
response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower. The lack of a liquid secondary
market for Participations and Assignments also may make it more difficult for a
Fund to assign a value to these securities for
purposes of valuing a Fund’s securities and calculating its NAV.
Participations
and Assignments involve a risk of loss in case of default or insolvency of the
borrower. In addition, they may offer less legal
protection to a Fund in the event of fraud or misrepresentation and may involve
a risk of insolvency of the Lender. Certain Participations
and Assignments may also include standby financing commitments that obligate the
investing Fund to supply additional
cash to the borrower on demand. Participations involving emerging market country
issuers may relate to loans as to which there has
been or currently exists an event of default or other failure to make payment
when due, and may represent amounts owed to Lenders
that are themselves subject to political and economic risks, including the risk
of currency devaluation, expropriation, or failure.
Such Participations and Assignments present additional risk of default or
loss.
Bank loans
generally are negotiated between a borrower and several financial institutional
lenders represented by one or more lenders acting as
agent of all the lenders. The agent is responsible for negotiating the loan
agreement that establishes the terms and conditions of the
loan and the rights of the borrower and the lenders, monitoring any collateral,
and collecting principal and interest on the loan. By
investing in a loan, a Fund becomes a member of a syndicate of lenders.
Investments in bank loans entail those risks described
above, such as liquidity risk and risk of default.
Some of
the loans in which a Fund may invest or obtain exposure to may be “covenant
lite” loans. Certain financial institutions may define
“covenant lite” loans differently. Covenant lite loans or securities, which have
varied terms and conditions, may contain fewer or no
restrictive covenants compared to other loans that might enable an investor to
proactively enforce financial covenants or prevent
undesired actions by the borrower. As a result, a Fund may experience relatively
greater difficulty or delays in enforcing its
rights on
its holdings of certain covenant lite loans and debt securities than its
holdings of loans or securities with more traditional financial
covenants, which may result in losses to the Fund.
Loans
of Portfolio Securities. Each Fund
may lend its portfolio securities to brokers, dealers, banks and other
institutional investors. By lending
its portfolio securities, a Fund attempts to increase its net investment income
through the receipt of interest on the cash collateral
with respect to the loan or fees received from the borrower in connection with
the loan. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for the
account of the Fund. Each Fund employs an agent to
implement the securities lending program and the agent receives a fee from the
Funds for its services. A Fund will not lend more than
33⅓% of the value of its total assets.
Each Fund
may lend its portfolio securities so long as the terms, structure and the
aggregate amount of such loans are not inconsistent
with the 1940 Act or the rules and regulations or interpretations of the SEC
thereunder, which currently require that (i) the
borrower pledge and maintain with the Fund collateral consisting of liquid,
unencumbered assets having a value not less than 100% of
the value of the securities loaned; (ii) the borrower adds to such collateral
whenever the price of the securities loaned rises (i.e., the
borrower “marks-to-market” on a daily basis); (iii) the loan be made subject to
termination by the Fund at any time; and (iv) the Fund
receives a reasonable return on the loan (which may include the Fund investing
any cash collateral in interest bearing short-term
investments), any distributions on the loaned securities and any increase in
their market value. In addition, voting rights may pass with
the loaned securities, but a Fund will retain the right to call any security in
anticipation of a vote that the Adviser deems material
to the security on loan.
Loans of
securities involve a risk that the borrower may fail to return the securities or
may fail to maintain the proper amount of collateral,
which may result in a loss of money by a Fund. There may be risks of delay and
costs involved in recovery of securities or even loss
of rights in the collateral should the borrower of the securities fail
financially. These delays and costs could be greater for foreign
securities. However, loans will be made only to borrowers deemed by the Adviser
to be creditworthy and when, in the judgment
of the Adviser, the income that can be earned from such securities loans
justifies the attendant risk. All relevant facts and circumstances,
including the creditworthiness of the broker, dealer, bank or institution, will
be considered in making decisions with respect to
the lending of securities, subject to review by the Trust’s Board of Trustees.
Each Fund also bears the risk that the reinvestment
of collateral will result in a principal loss. Finally, there is the risk that
the price of the securities will increase while they are on
loan and the collateral will not be adequate to cover their value.
Mortgage-Related
Securities.
Mortgage-related securities are securities that, directly or indirectly,
represent a participation in, or are secured by
and payable from, mortgage loans on real property. Mortgage-related securities
include collateralized mortgage obligations and MBS
issued or guaranteed by agencies or instrumentalities of the U.S. Government or
by private sector entities.
Mortgage-Backed
Securities. With MBS,
many mortgagees’ obligations to make monthly payments to their lending
institution are pooled
together and the risk of the mortgagees’ payment obligations is passed through
to investors. The pools are assembled by various
governmental, government-related and private organizations. A Fund may invest in
securities issued or guaranteed by Ginnie Mae,
Freddie Mac or Fannie Mae, private issuers and other government agencies. MBS
issued by non-agency issuers, whether or not such
securities are subject to guarantees, may entail greater risk, since private
issuers may not be able to meet their obligations under the
policies. If there is no guarantee provided by the issuer, a Fund will purchase
only MBS that, at the time of purchase, are rated investment
grade by one or more NRSROs or, if unrated, are deemed by the Adviser to be of
comparable quality.
MBS are
issued or guaranteed by private sector originators of or investors in mortgage
loans and structured similarly to governmental pass-through
securities. Because private pass-throughs typically lack a guarantee by an
entity having the credit status of a governmental
agency or instrumentality, however, they are generally structured with one or
more of the types of credit enhancement described
below. Fannie Mae and Freddie Mac obligations are not backed by the full faith
and credit of the U.S. Government as Ginnie Mae
certificates are. Freddie Mac securities are supported by Freddie Mac’s right to
borrow from the U.S. Treasury. Each of Ginnie
Mae, Fannie Mae and Freddie Mac guarantees timely distributions of interest to
certificate holders. Each of Ginnie Mae and Fannie Mae
also guarantees timely distributions of scheduled principal. Although Freddie
Mac has in the past guaranteed only the ultimate
collection of principal of the underlying mortgage loan, Freddie Mac now issues
MBS (Freddie Mac Gold PCS) that also guarantee
timely payment of monthly principal reductions. Resolution Funding Corporation
obligations are backed, as to principal payments,
by zero coupon U.S. Treasury bonds and, as to interest payments, ultimately by
the U.S. Treasury.
There are
two methods of trading MBS. A specified pool transaction is a trade in which the
pool number of the security to be delivered
on the settlement date is known at the time the trade is made. This is in
contrast with the typical MBS transaction, called a to-be-announced
(“TBA”) transaction, in which the type of MBS to be delivered is specified at
the time of trade but the actual pool numbers of
the securities that will be delivered are not known at the time of the trade.
The pool numbers of the pools to be delivered at
settlement are announced shortly before settlement takes place. The terms of the
TBA trade may be made more specific if desired. Generally,
agency pass-through MBS are traded on a TBA basis. Investments in TBAs may give
rise to a form of leverage and may cause a
Fund’s portfolio turnover rate to appear higher. Leverage may cause a Fund to be
more volatile than if the Fund had not been leveraged.
Like
fixed-income securities in general, MBS will generally decline in price when
interest rates rise. Rising interest rates also tend to discourage
refinancings of home mortgages, with the result that the average life of MBS
held by a Fund may be lengthened. As average
life extends, price volatility generally increases. This extension of average
life causes the market price of the MBS to decrease further
when interest rates rise than if their average lives were fixed. However, when
interest rates fall, mortgages may not enjoy as large a
gain in market value due to prepayment risk because additional mortgage
prepayments must be reinvested at lower interest rates.
Faster prepayment will shorten the average life and slower prepayments will
lengthen it. However, it is possible to determine what the
range of the average life movement could be and to calculate the effect that it
will have on the price of the MBS. In selecting MBS, the
Adviser looks for those that offer a higher yield to compensate for any
variation in average maturity. If the underlying mortgage
assets experience greater than anticipated prepayments of principal, a Fund may
fail to fully recoup its initial investment in these
securities, even if the security is in one of the highest rating categories. A
Fund may invest, without limit, in MBS issued by private
issuers when the Adviser deems that the quality of the investment, the quality
of the issuer, and market conditions warrant such
investments. A Fund will purchase securities issued by private issuers that are
rated investment grade at the time of purchase by Moody’s,
Fitch or S&P or are deemed by the Adviser to be of comparable investment
quality.
Fannie
Mae Certificates. Fannie
Mae is a federally chartered and privately owned corporation organized and
existing under the Federal National
Mortgage Association Charter Act of 1938. Each Fannie Mae certificate represents
a pro rata interest in one or more pools of
mortgage loans insured by the Federal Housing Administration under the National
Housing Act of 1934, as amended (the “Housing
Act”), or Title V of the Housing Act of 1949 (“FHA Loans”), or guaranteed by the
Department of Veteran Affairs under the
Servicemen’s Readjustment Act of 1944, as amended (“VA Loans”), or conventional
mortgage loans (i.e., mortgage loans that are not
insured or guaranteed by any governmental agency) of the following types: (i)
fixed rate level payment mortgage loans; (ii) fixed rate
growing equity mortgage loans; (iii) fixed rate graduated payment mortgage
loans; (iv) variable rate California mortgage loans; (v) other
adjustable rate mortgage loans; and (vi) fixed rate and adjustable mortgage
loans secured by multi-family projects.
Freddie
Mac Certificates. Freddie
Mac is a corporate instrumentality of the United States created pursuant to the
Emergency Home Finance
Act of 1970, as amended (the “FHLMC Act”). Freddie Mac certificates represent a
pro rata interest in a group of mortgage loans (a
“Freddie Mac Certificate group”) purchased by Freddie Mac. The mortgage loans
underlying the Freddie Mac Certificates consist of
fixed rate or adjustable rate mortgage loans with original terms to maturity of
between ten and thirty years, substantially all of which
are secured by first liens on one-to-four-family residential properties or
multi-family projects. Each mortgage loan must meet the
applicable standards set forth in the FHLMC Act. A Freddie Mac Certificate group
may include whole loans, participation interests
in whole loans and undivided interests in whole loans and participations
comprising another Freddie Mac Certificate group.
Ginnie
Mae Certificates. Ginnie
Mae is a wholly-owned corporate instrumentality of the United States within the
Department of Housing
and Urban Development. The Housing Act authorizes Ginnie Mae to guarantee the
timely payment of the principal and interest
on certificates that are based on and backed by a pool of FHA Loans, VA Loans or
by pools of other eligible mortgage loans. The
Housing Act provides that the full faith and credit of the United States is
pledged to the payment of all amounts that may be required
to be paid under any guaranty. In order to meet its obligations under such
guaranty, Ginnie Mae is authorized to borrow from the
U.S. Treasury with no limitations as to amount.
Each
Ginnie Mae certificate represents a pro rata interest in one or more of the
following types of mortgage loans: (i) fixed rate level payment
mortgage loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed
rate growing equity mortgage loans; (iv) fixed rate
mortgage loans secured by manufactured (mobile) homes; (v) mortgage loans on
multi-family residential properties under construction;
(vi) mortgage loans on completed multi-family projects; (vii) fixed rate
mortgage loans as to which escrowed funds are used to
reduce the borrower’s monthly payments during the early years of the mortgage
loans (“buydown” mortgage loans); (viii) mortgage
loans that provide for adjustments in payments based on periodic changes in
interest rates or in other payment terms of the mortgage
loans; and (ix) mortgage-backed serial notes. All of these mortgage loans will
be FHA Loans or VA loans and, except as otherwise
specified above, will be fully-amortizing loans secured by first liens on
one-to-four-family housing units.
Collateralized
Mortgage Obligations. Certain
Funds may invest in collateralized mortgage obligations (“CMOs”), which are MBS
that are
collateralized by mortgage loans or mortgage pass-through securities, and
multi-class pass-through securities, which are equity interests
in a trust composed of mortgage loans or other MBS. Unless the context indicates
otherwise, the discussion of CMOs below also
applies to multi-class pass-through securities.
CMOs may
be issued by governmental or government-related entities or by private entities,
such as banks, savings and loan institutions,
private mortgage insurance companies, mortgage bankers and other secondary
market traders. CMOs are issued in multiple
classes, often referred to as “tranches,” with each tranche having a specific
fixed or floating coupon rate and stated maturity or final
distribution date. Under the traditional CMO structure, the cash flows generated
by the mortgages or mortgage pass-through securities
in the collateral pool are used to first pay interest and then pay principal to
the holders of the CMOs. Subject to the various provisions
of individual CMO issues, the cash flow generated by the underlying collateral
(to the extent it exceeds the amount required
to pay the stated interest) is used to retire the bonds.
The
principal and interest on the underlying collateral may be allocated among the
several tranches of a CMO in innumerable ways, including
“interest only” and “inverse interest only” tranches. In a common CMO structure,
the tranches are retired sequentially in the order
of their respective stated maturities or final distribution dates (as opposed to
the pro-rata return of principal found in traditional
pass-through obligations). The fastest-pay tranches would initially receive all
principal payments. When those tranches are retired,
the next tranches in the sequence receive all of the principal payments until
they are retired. The sequential retirement of bond
groups continues until the last tranche is retired. Accordingly, the CMO
structure allows the issuer to use cash flows of long maturity,
monthly-pay collateral to formulate securities with short, intermediate, and
long final maturities and expected average lives and risk
characteristics.
The
primary risk of CMOs is the uncertainty of the timing of cash flows that results
from the rate of prepayments on the underlying mortgages
serving as collateral and from the structure of the particular CMO transaction
(that is, the priority of the individual tranches).
An increase or decrease in prepayment rates (resulting from a decrease or
increase in mortgage interest rates) may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates and will affect the yield and price of CMOs. In
addition, if the collateral securing CMOs or any third-party guarantees are
insufficient to make payments, a Fund could sustain a
loss. The prices of certain CMOs, depending on their structure and the rate of
prepayments, can be volatile. Some CMOs may also
not be as liquid as other types of mortgage-backed securities. As a result, it
may be difficult or impossible to sell the securities
at an advantageous time or price.
Privately
issued CMOs are arrangements in which the underlying mortgages are held by the
issuer, which then issues debt collateralized
by the underlying mortgage assets. Such securities may be backed by mortgage
insurance, letters of credit, or other credit
enhancing features. Although payment of the principal of, and interest on, the
underlying collateral securing privately issued CMOs may
be guaranteed by the U.S. Government or its agencies and instrumentalities,
these CMOs represent obligations solely of the
private issuer and are not insured or guaranteed by the U.S. Government, its
agencies and instrumentalities or any other person or entity.
Privately issued CMOs are subject to prepayment risk due to the possibility that
prepayments on the underlying assets will alter the
cash flow. Yields on privately issued CMOs have been historically higher than
the yields on CMOs backed by mortgages guaranteed
by U.S. government agencies and instrumentalities. The risk of loss due to
default on privately issued CMOs, however, is historically
higher since the U.S. Government has not guaranteed them.
New types
of CMO tranches have evolved. These include floating rate CMOs, planned
amortization classes, accrual bonds and CMO
residuals. These newer structures affect the amount and timing of principal and
interest received by each tranche from the underlying
collateral. For example, an inverse interest-only class CMO entitles holders to
receive no payments of principal and to receive
interest at a rate that will vary inversely with a specified index or a multiple
thereof. Under certain of these newer structures, given
classes of CMOs have priority over others with respect to the receipt of
prepayments on the mortgages. Therefore, depending on the
type of CMOs in which a Fund invests, the investment may be subject to a greater
or lesser risk of prepayment than other types of
MBS.
CMOs may
include real estate mortgage investment conduits (“REMICs”). REMICs, which were
authorized under the Tax Reform Act of
1986, are private entities formed for the purpose of holding a fixed pool of
mortgages secured by an interest in real property. A REMIC is a
CMO that qualifies for special tax treatment under the Code, and invests in
certain mortgages principally secured by interests
in real property.
A Fund may
invest in, among others, parallel pay CMOs and planned amortization class CMOs
(“PAC Bonds”). Parallel pay CMOs are
structured to provide payments of principal on each payment date to more than
one tranche. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each tranche which, as with other CMO structures,
must be retired by its stated maturity date or final distribution date but may
be retired earlier. PAC Bonds are a form of parallel
pay CMO, with the required principal payment on such securities having the
highest priority after interest has been paid to all
classes. PAC Bonds generally require payments of a specified amount of principal
on each payment date.
Stripped
Mortgage-Backed Securities. Certain
Funds may invest in stripped mortgage-backed securities (“SMBS”). An SMBS is a
derivative
multi-class mortgage-backed security. SMBS usually are structured with two
classes that receive different proportions of the interest
and principal distribution on a pool of mortgage assets. In the most extreme
case, one class will receive all of the interest (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 related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on such security’s yield to maturity. If the underlying
mortgage assets experience greater than anticipated prepayments of principal, a
Fund may fail to fully recoup its initial investment
in these securities. Conversely, if the underlying mortgage assets experience
less than anticipated prepayments of principal, the yield
of POs could be materially adversely affected. The market values of IOs and POs
are subject to greater risk of fluctuation in response
to changes in market rates of interest than many other types of mortgage-backed
securities. To the extent a Fund invests in IOs and
POs, it may increase the risk of fluctuations in the NAV of a
Fund.
Credit
Enhancement.
Mortgage-related securities are often backed by a pool of assets representing
the obligations of a number of parties.
To lessen the effect of failure by obligors on underlying assets to make
payments, these securities may have various types of credit
support. Credit support falls into two primary categories: (i) liquidity
protection, and (ii) protection against losses resulting from
ultimate default by an obligor on the underlying assets. Liquidity protection
generally refers to the provision of advances, typically
by the entity administering the pool of assets, to ensure that the pass-through
of payments due on the underlying pool occurs in
a timely fashion. Protection against losses resulting from ultimate default
enhances the likelihood of ultimate payment of the
obligations on at least a portion of the assets in the pool. Such protection may
be provided through guarantees, insurance policies or letters
of credit obtained by the issuer or sponsor from third-parties (referred to
herein as “third-party credit support”), through various
means of structuring the transaction or through a combination of such
approaches.
The
ratings of mortgage-related securities for which third-party credit enhancement
provides liquidity protection or protection against
losses from default are generally dependent upon the continued creditworthiness
of the provider of the credit enhancement. The
ratings of such securities could decline in the event of deterioration in the
creditworthiness of the credit enhancement provider even in
cases where the delinquency and loss experience on the underlying pool of assets
is better than expected.
Examples
of credit support arising out of the structure of the transaction include
“senior-subordinated securities” (multiple class securities
with one or more classes subordinate to other classes as to the payment of
principal and interest thereon, with defaults on the
underlying assets being borne first by the holders of the most subordinated
class), creation of “reserve funds” (where cash or investments,
sometimes funded from a portion of the payments on the underlying assets, are
held in reserve against future losses) and “over-collateralization”
(where the scheduled payments on, or the principal amount of, the underlying
assets exceed those required to make
payment of the securities and pay any servicing or other fees). The degree of
credit support provided for each security is generally
based on historical information with respect to the level of credit risk
associated with the underlying assets. Delinquency or loss in
excess of that which is anticipated could adversely affect the return on an
investment in such a security.
Commercial
Mortgage-Backed Securities.
Commercial mortgage-backed securities (“CMBS”) are generally multi-class or
pass-through
securities issued by special purpose entities that represent an undivided
interest in a portfolio of mortgage loans backed by commercial
properties, including, but not limited to, industrial and warehouse properties,
office buildings, retail space and shopping malls,
hotels, healthcare facilities, multifamily properties and cooperative
apartments. Private lenders, such as banks or insurance companies,
originate these loans and then sell the loans directly into a CMBS trust or
other entity. The commercial mortgage loans that
underlie CMBS are generally not amortizing or not fully amortizing. That is, at
their maturity date, repayment of the remaining principal
balance or “balloon” is due and is repaid through the attainment of an
additional loan or sale of this property. An extension of the
final payment on commercial mortgages will increase the average life of the
CMBS, generally resulting in a lower yield for discount
bonds and a higher yield for premium bonds.
CMBS are
subject to credit risk and prepayment risk. Although prepayment risk is present,
it is of a lesser degree in the CMBS than in the
residential mortgage market; commercial real estate property loans often contain
provisions which substantially reduce the likelihood
that such securities will be prepaid (e.g., significant prepayment penalties on
loans and, in some cases, prohibition on principal
payments for several years following origination).
Municipals. Municipal
securities include debt obligations of states, territories or possessions of the
United States and the District of Columbia
and their political subdivisions, agencies and instrumentalities, the income on
which is exempt from federal income tax at the time
of issuance, in the opinion of bond counsel or other counsel to the issuers of
such securities. Municipals include both municipal
bonds (those securities with maturities of five years or more) and municipal
notes (those with maturities of less than five years).
Municipal bonds are issued for a wide variety of reasons: to construct public
facilities, such as airports, highways, bridges, schools,
hospitals, mass transportation, streets, water and sewer works; to obtain funds
for operating expenses; to refund outstanding municipal
obligations; and to loan funds to various public institutions and facilities.
Certain industrial development bonds are also considered
municipal bonds if their interest is exempt from federal income tax. Industrial
development bonds are issued by, or on behalf of,
public authorities to obtain funds for various privately-operated manufacturing
facilities, housing, sports arenas, convention centers,
airports, mass transportation systems and water, gas or sewage works. Industrial
development bonds are ordinarily dependent on the
credit quality of a private user, not the public issuer. Private activity bonds
are another type of municipal security.
The two
principal classifications of municipal bonds are “general obligation” and
“revenue” or “special tax” bonds. General obligation
bonds are secured by the issuer’s pledge of its full faith, credit and taxing
power for the payment of principal and interest. Thus,
these bonds may be vulnerable to limits on a government’s power or ability to
raise revenue or increase taxes and its ability to maintain a
fiscally sound budget. The timely payments may also be influenced by any
unfunded pension liabilities or other post-employee
benefit plan liabilities. These bonds may also depend on legislative
appropriation and/or funding or other support from other
governmental bodies in order to make payments. Revenue or special tax bonds are
payable only from the revenues derived from a
particular facility or class of facilities or, in some cases, from the proceeds
of a special excise or other tax, but not from general tax revenues.
As a result, these bonds historically have been subject to a greater risk of
default than general obligation bonds because investors
can look only to the revenue generated by the project or other revenue source
backing the project, rather than to the general taxing
authority of the state or local government issuer of the
obligations.
Industrial
revenue bonds in most cases are revenue bonds and generally do not have the
pledge of the credit of the issuer. The payment of
the principal and interest on such industrial revenue bonds is dependent solely
on the ability of the user of the facilities financed
by the bonds to meet its financial obligations and the pledge, if any, of real
and personal property so financed as security for such
payment. Short-term municipal obligations issued by states, cities,
municipalities or municipal agencies, include tax anticipation notes,
revenue anticipation notes, bond anticipation notes, construction loan notes and
short-term discount notes.
Private
activity bonds may be used by municipalities to finance the development of
industrial facilities for use by private enterprise. Principal
and interest payments are to be made by the private enterprise benefitting from
the development, which means that the holder of
the bond is exposed to the risk that the private issuer may default on the bond.
The credit and quality of private activity bonds and
industrial development bonds are usually related to the credit of the corporate
user of the facilities. Payment of interest on and
repayment of principal of such bonds is the responsibility of the corporate user
(and/or any guarantor).
Municipal
notes are issued to meet the short-term funding requirements of local, regional
and state governments. Municipal notes include
bond anticipation notes, revenue anticipation notes and tax and revenue
anticipation notes. These are short-term debt obligations
issued by state and local governments to aid cash flows while waiting for taxes
or revenue to be collected, at which time the debt
is retired. Other types of municipal notes in which a Fund may
invest are construction loan notes, short-term discount notes,
tax-exempt commercial paper, demand notes and similar instruments.
Municipal
bonds generally include debt obligations issued by states and their political
subdivisions, and duly constituted authorities and
corporations, to obtain funds to construct, repair or improve various public
facilities such as airports, bridges, highways, hospitals,
housing, schools, streets and water and sewer works. Municipal bonds may also be
issued to refinance outstanding obligations
as well as to obtain funds for general operating expenses and for loans to other
public institutions and facilities. In addition,
municipal bonds may include obligations of municipal housing authorities and
single-family mortgage revenue bonds. Weaknesses
in federal housing subsidy programs and their administration may result in a
decrease of subsidies available for payment of
principal and interest on housing authority bonds. Economic developments,
including fluctuations in interest rates and increasing construction
and operating costs, may also adversely impact revenues of housing authorities.
In the case of some housing authorities, inability
to obtain additional financing could also reduce revenues available to pay
existing obligations. Single-family mortgage revenue
bonds are subject to extraordinary mandatory redemption at par in whole or in
part from the proceeds derived from prepayments
of underlying mortgage loans and also from the unused proceeds of the issue
within a stated period which may be within a
year from the date of issue.
Note
obligations with demand or put options may have a stated maturity in excess of
one year, but permit any holder to demand payment of
principal plus accrued interest upon a specified number of days’ notice.
Frequently, such obligations are secured by letters of credit
or other credit support arrangements provided by banks. The issuer of such notes
normally has a corresponding right, after a given
period, to repay at its discretion the outstanding principal of the note plus
accrued interest upon a specific number of days’ notice to
the bondholders. The interest rate on a demand note may be based upon a known
lending rate, such as the prime lending rate, and
be adjusted when such rate changes, or the interest rate on a demand note may be
a market rate that is adjusted at specified intervals.
Each note purchased by the Funds will meet the quality criteria set out in the
Prospectus for the Funds.
The yields
of municipal bonds depend on, among other things, general money market
conditions, conditions in the municipal bond market,
the size of a particular offering, the maturity of the obligation, and the
rating of the issue. The ratings of Moody’s and S&P represent
their opinions of the quality of the municipal bonds rated by them. It should be
emphasized that such ratings are general and are
not absolute standards of quality. Consequently, municipal bonds with the same
maturity, coupon and rating may have different
yields, while municipal bonds of the same maturity and coupon, but with
different ratings, may have the same yield. It will be the
responsibility of the Adviser and/or Sub-Adviser to appraise independently the
fundamental quality of the bonds held by the Funds.
Municipal
bonds are sometimes purchased on a “when-issued” or “delayed-delivery” basis,
which means the Fund has committed to purchase
certain specified securities at an agreed-upon price when they are issued. The
period between commitment date and issuance
date can be a month or more. It is possible that the securities will never be
issued and the commitment canceled.
From time
to time proposals have been introduced before Congress to restrict or eliminate
the federal income tax exemption for interest
on municipal bonds. Similar proposals may be introduced in the
future.
Similarly,
from time to time proposals have been introduced before state and local
legislatures to restrict or eliminate the state and local
income tax exemption for interest on municipal bonds. Similar proposals may be
introduced in the future.
The Funds
may also purchase bonds the income on which is subject to the alternative
minimum tax (“AMT bonds”). AMT bonds are
tax-exempt private activity bonds issued after August 7, 1986, the proceeds of
which are directed, at least in part, to private, for-profit
organizations. While the income from AMT bonds is exempt from regular federal
income tax, it is a tax preference item in the calculation
of the alternative minimum tax. The alternative minimum tax is a special
separate tax that applies to some taxpayers who have
certain adjustments to income or tax preference items.
An issuer
of municipal securities may file for bankruptcy or otherwise seek to reorganize
its debts by extending debt maturities, reducing
the amount of principal or interest, refinancing the debt or taking other
measures, in each case which may significantly affect the
rights of creditors and the value of the municipal securities and the value of a
Fund’s investments in such municipal securities.
In addition, changes to bankruptcy laws may adversely impact a Fund’s
investments in municipal securities, including creditor
rights, if the issuer seeks bankruptcy protection.
Build
America Bonds are taxable municipal securities on which the issuer receives
federal support of the interest paid. Assuming certain
specified conditions are satisfied, issuers of Build America Bonds may either
(i) receive reimbursement from the U.S. Treasury with
respect to a portion of its interest payments on the bonds (“direct pay” Build
America Bonds) or (ii) provide tax credits to investors
in the bonds (“tax credit” Build America Bonds). Unlike most other municipal
securities, interest received on Build America Bonds is
subject to federal and state income tax. Issuance of Build America Bonds ceased
on December 31, 2010. The number of Build
America Bonds available in the market is limited, which may negatively affect
the value of the Build America Bonds.
The Trust
may hold municipal private placements. These securities are sold through private
negotiations, usually to institutions or mutual
funds, and generally have resale restrictions. Their yields are usually higher
than comparable public securities to compensate the
investor for their limited marketability.
Lease
Obligations. Included
within the revenue bonds category in which a Fund may invest are participations
in lease obligations or installment
purchase contracts (hereinafter collectively called “lease obligations”) of
municipalities. State and local governments, agencies
or authorities issue lease obligations to acquire equipment and facilities.
Lease obligations may have risks not normally associated
with general obligation or other revenue bonds. Leases, and installment purchase
or conditional sale contracts (which may provide
for title to the leased asset to pass eventually to the issuer), have developed
as a means for governmental issuers to acquire property
and equipment without the necessity of complying with the constitutional and
statutory requirements generally applicable for the
issuance of debt. Certain lease obligations contain “non-appropriation” clauses
that provide that the governmental issuer has no
obligation to make future payments under the lease or contract unless money is
appropriated for such purpose by the appropriate legislative
body on an annual or other periodic basis. Consequently, continued lease
payments on those lease obligations containing “non-appropriation”
clauses are dependent on future legislative actions. If such legislative actions
do not occur, the holders of the lease
obligation may experience difficulty in exercising their rights, including
disposition of the property.
In
addition, lease obligations do not have the depth of marketability associated
with more conventional municipal obligations, and, as a
result, certain of such lease obligations may be considered illiquid securities.
The Adviser, pursuant to procedures adopted by the Trustees,
will make a determination as to the liquidity of each lease obligation purchased
by the Funds. If a lease obligation is determined
to be “liquid,” the security will not be included within the category “illiquid
securities.”
Non-Publicly
Traded Securities, Private Placements and Restricted Securities. The Funds
may invest in securities that are neither listed on
a stock exchange nor traded OTC, including privately placed and restricted
securities. Such unlisted securities may involve a higher
degree of business and financial risk that can result in substantial losses. As
a result of the absence of a public trading market for these
securities, they may be less liquid than publicly traded securities. Although
these securities may be resold in privately negotiated
transactions, the prices realized from these sales could be less than those
originally paid by the Fund or less than what may be
considered the fair value of such securities. Furthermore, companies whose
securities are not publicly traded may not be subject to the
disclosure and other investor protection requirements which might be applicable
if their securities were publicly traded. The illiquidity
of the market, as well as the lack of publicly available information regarding
these securities, may also adversely affect the ability of
the Funds to arrive at a fair value for certain securities at certain times and
could make it difficult for the Funds to sell certain
securities. If such securities are required to be registered under the
securities laws of one or more jurisdictions before being sold, a
Fund may be required to bear the expenses of registration.
The Funds
may purchase equity securities, in a private placement, that are issued by
issuers who have outstanding, publicly-traded equity
securities of the same class (“private investments in public equity” or
“PIPEs”). Shares in PIPEs generally are not registered with the
SEC until after a certain time period from the date the private sale is
completed. This restricted period can last many months.
Until the public registration process is completed, PIPEs are restricted as to
resale and the Funds cannot freely trade the securities.
Generally, such restrictions cause the PIPEs to be illiquid during this time.
PIPEs may contain provisions that the issuer will pay
specified financial penalties to the holder if the issuer does not publicly
register the restricted equity securities within a specified
period of time, but there is no assurance that the restricted equity securities
will be publicly registered, or that the registration
will remain in effect.
Options. An option
is a contract that gives the holder of the option the right, but not the
obligation, to buy from (in the case of a call
option) or sell to (in the case of a put option) the buyer or seller, as
applicable, of the option (the “option writer”) the underlying instrument
at a specified fixed price (the “exercise price”) on or prior to a specified
date for American options or only at expiration for European
options (the “expiration date”). The buyer of the option pays to the option
writer the option premium, which is the purchase
price of the option.
Exchange-traded
options are issued by a regulated intermediary such as the OCC, which guarantees
the performance of the obligations
of the parties to such options. OTC options are purchased from or sold to
counterparties through direct bilateral agreements
between a Fund and its counterparties. Certain options, such as options on
individual securities, are settled through physical
delivery of the underlying security, whereas other options, such as index
options, may be settled in cash in an amount based on the
difference between the value of the underlying instrument and the strike price,
which is then multiplied by a specified multiplier.
Writing
Options. Certain
Funds may write call and put options. As the writer of a call option, a Fund
receives the premium from the purchaser
of the option and has the obligation, upon exercise of the option, to deliver
the underlying security upon payment of the exercise
price. If the option expires without being exercised a Fund is not required to
deliver the underlying security and retains the premium
received.
Certain
Funds may only write call options that are “covered.” A call option on a
security is covered if (a) a Fund owns the security underlying
the call or has an absolute and immediate right to acquire that security without
additional cash consideration (or, if additional
cash consideration is required, such amount is maintained by a Fund in earmarked
or segregated cash or liquid assets) upon
conversion or exchange of other securities held by a Fund; or (b) a Fund has
purchased a call on the underlying security, the exercise
price of which is (i) equal to or less than the exercise price of the call
written, or (ii) greater than the exercise price of the call written,
provided the difference is maintained by a Fund in earmarked or segregated cash
or liquid assets.
Selling
call options involves the risk that a Fund may be required to sell the
underlying security at a disadvantageous price, below the market
price of such security, at the time the option is exercised. As the writer of a
covered call option, a Fund forgoes, during the option’s
life, the opportunity to profit from increases in the market value of the
underlying security covering the option above the sum of the
premium and the exercise price but retains the risk of loss should the price of
the underlying security decline.
Certain
Funds may write put options. As the writer of a put option, a Fund receives the
premium from the purchaser of the option and has
the obligation, upon exercise of the option, to pay the exercise price and
receive delivery of the underlying security. If the option
expires without being exercised, a Fund is not required to receive the
underlying security in exchange for the exercise price and retains
the option premium.
A Fund may
only write put options that are “covered.” A put option on a security is covered
if (a) a Fund earmarks or segregates cash or liquid
assets equal to the exercise price; or (b) a Fund has purchased a put on the
same security as the put written, the exercise price of which
is (i) equal to or greater than the exercise price of the put written, or (ii)
less than the exercise price of the put written, provided
the difference is maintained by a Fund in earmarked or segregated cash or liquid
assets.
Selling
put options involves the risk that a Fund may be required to buy the underlying
security at a disadvantageous price, above the market
price of such security, at the time the option is exercised. While a Fund’s
potential gain in writing a covered put option is limited to
the premium received plus the interest earned on the liquid assets covering the
put option, a Fund’s risk of loss is equal to the entire
value of the underlying security, offset only by the amount of the premium
received.
A Fund may
close out an options position that it has written through a closing purchase
transaction. A Fund could execute a closing purchase
transaction with respect to a written call option by purchasing a call option on
the same underlying security that has the same
exercise price and expiration date as the call option written by a Fund. A Fund
could execute a closing purchase transaction with
respect to a put option written by purchasing a put option on the same
underlying security and having the same exercise price and
expiration date as the put option written by a Fund. A closing purchase
transaction may or may not result in a profit to a Fund. A Fund can
close out its position as an option writer only if a liquid market exists for
options on the same underlying security that have the
same exercise price and expiration date as the option written by a Fund. There
is no assurance that such a market will exist with
respect to any particular option.
The writer
of an American option generally has no control over the time when the option is
exercised and the option writer is required
to deliver or acquire the underlying security. 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. Thus, the use
of options may require a Fund to buy or sell portfolio
securities at inopportune times or for prices other than the current market
values of such securities, which may limit the amount of
appreciation a Fund can realize on an investment, or may cause a Fund to hold a
security that it might otherwise sell.
Purchasing
Options. Certain
Funds may purchase call and put options. As the buyer of a call option, a Fund
pays the premium to the option
writer and has the right to purchase the underlying security from the option
writer at the exercise price. If the market price of the
underlying security rises above the exercise price, a Fund could exercise the
option and acquire the underlying security at a below-market
price, which could result in a gain to a Fund, minus the premium paid. As the
buyer of a put option, a Fund pays the premium to
the option writer and has the right to sell the underlying security to the
option writer at the exercise price. If the market price of
the underlying security declines below the exercise price, a Fund could exercise
the option and sell the underlying security at an
above-market price, which could result in a gain to a Fund, minus the premium
paid. A Fund may buy call and put options whether or
not it holds the underlying securities.
As a buyer
of a call or put option, a Fund may sell put or call options that it has
purchased at any time prior to such option’s expiration
date through a closing sale transaction. The principal factors affecting the
market value of a put or a call option include supply and
demand, interest rates, the current market price of the underlying security in
relation to the exercise price of the option, the
volatility of the underlying security, the underlying security’s dividend
policy, and the time remaining until the expiration date. A closing
sale transaction may or may not result in a profit to a Fund. A Fund’s ability
to initiate a closing sale transaction is dependent upon the
liquidity of the options market and there is no assurance that such a market
will exist with respect to any particular option. If a Fund
does not exercise or sell an option prior to its expiration date, the option
expires and becomes worthless.
OTC
Options. Unlike
exchange-traded options, which are standardized with respect to the underlying
instrument, expiration date, contract
size and strike price, the terms of OTC options generally are established
through negotiation between the parties to the options
contract. This type of arrangement allows the purchaser and writer greater
flexibility to tailor the option to their needs. OTC options
are available for a greater variety of securities or baskets of securities, and
in a wider range of expiration dates and exercise prices,
than exchange-traded options. However, unlike exchange-traded options, which are
issued and guaranteed by a regulated intermediary,
such as the OCC, OTC options are entered into directly with the counterparty.
Unless the counterparties provide for it, there
is no central clearing or guaranty function for an OTC option. Therefore, OTC
options are subject to the risk of default or non-performance
by the counterparty. Accordingly, the Adviser must assess the creditworthiness
of the counterparty to determine the likelihood
that the terms of the option will be satisfied. There can be no assurance that a
continuous liquid secondary market will exist for
any particular OTC option at any specific time. As a result, a Fund may be
unable to enter into closing sale transactions with respect to
OTC options.
Index
Options. Call and
put options on indices operate similarly to options on securities. Rather than
the right to buy or sell a single security
at a specified price, options on an index give the holder the right to receive,
upon exercise of the option, an amount of cash determined
by reference to the difference between the value of the underlying index and the
strike price. The underlying index may be a
broad-based index or a narrower market index. Unlike many options on securities,
all settlements are in cash. The settlement amount,
which the writer of an index option must pay to the holder of the option upon
exercise, is generally equal to the difference between
the strike price of the option and the value of the underlying index, multiplied
by a specified multiplier. The multiplier determines
the size of the investment position the option represents. Gain or loss to a
Fund on index options transactions will depend, in
part, on price movements of the underlying index generally or in a particular
segment of the index rather than price movements
of individual components of the index. As with other options, a Fund may close
out its position in index options through closing
purchase transactions and closing sale transactions provided that a liquid
secondary market exists for such options.
Index
options written by a Fund will generally be covered in a manner similar to the
covering of other types of options, by holding an offsetting
financial position and/or earmarking or segregating cash or liquid assets. A
Fund may cover call options written on an index by owning
securities or other assets whose price changes, in the opinion of the Adviser,
are expected to correlate to those of the underlying
index.
Foreign
Currency Options. Options
on foreign currencies operate similarly to options on securities. Rather than
the right to buy or sell a single
security at a specified price, options on foreign currencies give the holder the
right to buy or sell foreign currency for a fixed amount in
U.S. dollars or other base currencies. Options on foreign currencies are traded
primarily in the OTC market, but may also be traded
on U.S. and foreign exchanges. The value of a foreign currency option is
dependent upon the value of the underlying foreign
currency relative to the U.S. dollar or other base currency. The price of the
option may vary with changes, among other things, in
the value of either or both currencies and has no relationship to the investment
merits of a foreign security. Options on foreign
currencies are affected by all of those factors that influence foreign exchange
rates and foreign investment generally. As with other
options, a Fund may close out its position in foreign currency options through
closing purchase transactions and closing sale transactions
provided that a liquid market exists for such options.
Foreign
currency options written by a Fund will generally be covered in a manner similar
to the covering of other types of options, by holding an
offsetting financial position and/or earmarking or segregating cash or liquid
assets.
Options
on Futures Contracts. Options
on futures contracts are similar to options on securities except that options on
futures contracts give the
purchasers the right, in return for the premium paid, to assume a position in a
futures contract (a long position in the case of a call
option and a short position in the case of a put option) at a specified exercise
price at any time prior to the expiration of the option.
Upon exercise of the option, the parties will be subject to all of the risks
associated with futures transactions and subject to margin
requirements. As the writer of options on futures contracts, a Fund would also
be subject to initial and variation margin requirements
on the option position.
Options on
futures contracts written by a Fund will generally be covered in a manner
similar to the covering of other types of options,
by holding an offsetting financial position and/or earmarking or segregating
cash or liquid assets. A Fund may cover an option on
a futures contract by purchasing or selling the underlying futures contract. In
such instances the exercise of the option will serve to
close out a Fund’s futures position.
Additional
Risks of Options Transactions. The risks
associated with options transactions are different from, and possibly greater
than, the risks
associated with investing directly in the underlying instruments. Options are
highly specialized instruments that require investment
techniques and risk analyses different from those associated with other
portfolio investments. The use of options requires an
understanding not only of the underlying instrument but also of the option
itself. Options may be subject to the risk factors generally
applicable to derivatives transactions described herein, and may also be subject
to certain additional risk factors, including:
■ |
The
exercise of options written or purchased by a Fund could cause a Fund to
sell portfolio securities, thus increasing a Fund’s portfolio
turnover. |
■ |
A
Fund pays brokerage commissions each time it writes or purchases an option
or buys or sells an underlying security in connection
with the exercise of an option. Such brokerage commissions could be higher
relative to the commissions for direct purchases
of sales of the underlying securities. |
■ |
A
Fund’s options transactions may be subject to limitations on options
positions established by the SEC, the CFTC or the exchanges
on which such options are traded. |
■ |
The
hours of trading for exchange-listed options may not coincide with the
hours during which the underlying securities are traded.
To the extent that the options markets close before the markets for the
underlying securities, significant price and rate movements
can take place in the underlying securities that cannot be reflected in
the options markets. |
■ |
Index
options based upon a narrow index of securities or other assets may
present greater risks than options based on broad market
indices, as narrower indices are more susceptible to rapid and extreme
fluctuations as a result of changes in the values of a
smaller number of securities or other
assets. |
■ |
A
Fund is subject to the risk of market movements between the time that an
option is exercised and the time of performance thereunder,
which could increase the extent of any losses suffered by a Fund in
connection with options transactions. |
Preferred
Stocks. Preferred
stocks are securities that evidence ownership in a corporation and pay a fixed
or variable stream of dividends.
Preferred stocks have a preference over common stocks in the event of the
liquidation of an issuer and usually do not carry voting
rights. Preferred stocks have many of the characteristics of both equity
securities and fixed-income securities.
Promissory
Notes.
Promissory notes are generally debt obligations of the issuing entity and are
subject to the risks of investing in corporate
debt.
Real
Estate Investing.
Investments in securities of issuers engaged in the real estate industry entail
special risks and considerations. In particular,
securities of such issuers may be subject to risks associated with the direct
ownership of real estate. These risks include the cyclical
nature of real estate values, risks related to general and local economic
conditions, overbuilding and increased competition, increases
in property taxes and operating expenses, demographic trends and variations in
rental income, changes in zoning laws, casualty
or condemnation losses, environmental risks, regulatory limitations on rents,
changes in neighborhood values, changes in the appeal of
properties to tenants, increases in interest rates and other real estate capital
market influences. Generally, increases in interest
rates will increase the costs of obtaining financing, which could directly and
indirectly decrease the value of a Fund’s investments.
Real
Estate Investment Trusts and Foreign Real Estate Companies.
Certain
Funds may invest in real estate investment trusts (“REITs”) and/or
foreign real estate companies, which are similar to entities organized and
operated as REITs in the United States. REITs and foreign
real estate companies pool investors’ funds for investment primarily in real
estate properties or real estate-related loans. REITs and
foreign real estate companies generally derive their income from rents on the
underlying properties or interest on the underlying loans, and
their value is impacted by changes in the value of the underlying property or
changes in interest rates affecting the underlying
loans owned by the REITs and/or foreign real estate companies. REITs and foreign
real estate companies are more susceptible
to risks associated with the ownership of real estate and the real estate
industry in general. These risks can include fluctuations
in the value of underlying properties; defaults by borrowers or tenants; market
saturation; changes in general and local economic
conditions; decreases in market rates for rents; increases in competition,
property taxes, capital expenditures or operating expenses;
and other economic, political or regulatory occurrences affecting the real
estate industry. In addition, REITs and foreign real
estate companies depend upon specialized management skills, may not be
diversified (which may increase the volatility of a REIT’s
and/or foreign real estate company’s value), may have less trading volume and
may be subject to more abrupt or erratic price movements
than the overall securities market. Foreign real estate companies may be subject
to laws, rules and regulations governing those
entities and their failure to comply with those laws, rules and regulations
could negatively impact the performance of those entities.
Operating REITs and foreign real estate companies requires specialized
management skills and a Fund indirectly bears REIT and
foreign real estate company management expenses along with the direct expenses
of the Fund. REITs are generally not taxed on income
distributed to shareholders provided they comply with several requirements of
the Code. REITs are subject to the risk of failing to
qualify for tax-free pass-through income under the Code.
Specialized
Ownership Vehicles.
Specialized ownership vehicles pool investors’ funds for investment primarily in
income-producing real
estate or real estate-related loans or interests. Such specialized ownership
vehicles in which the Funds may invest include property unit
trusts, foreign real estate companies, REITs and other similar specialized
investment vehicles. Investments in such specialized ownership
vehicles may have favorable or unfavorable legal, regulatory or tax implications
for a Fund and, to the extent such vehicles
are
structured similarly to investment funds, a shareholder in the Fund will bear
not only their proportionate share of the expenses of the Fund,
but also, indirectly the expenses of the specialized ownership
vehicle.
Regulatory
and Legal Risk. U.S. and
non-U.S. governmental agencies and other regulators regularly implement
additional regulations
and legislators pass new laws that affect the investments held by a Fund, the
strategies used by a Fund or the level of regulation
or taxation applying to a Fund (such as regulations related to investments in
derivatives and other transactions). These regulations
and laws impact the investment strategies, performance, costs and operations of
a Fund or taxation of shareholders.
Repurchase
Agreements.
Repurchase agreements are transactions in which a Fund purchases a security or
basket of securities and simultaneously
commits to resell that security or basket to the seller (a bank, broker or
dealer) at a mutually agreed-upon date and price. The
resale price reflects the purchase price plus an agreed-upon market rate of
interest which is unrelated to the coupon rate or date of
maturity of the purchased security. The term of these agreements usually ranges
from overnight to one week, and never exceeds
one year. Repurchase agreements with a term of over seven days are considered
illiquid.
In these
transactions, a Fund receives securities that have a market value at least equal
to the purchase price (including accrued interest)
of the repurchase agreement, and this value is maintained during the term of the
agreement. These securities are held by State
Street Bank and Trust Company (the “Custodian”) or an approved third-party for
the benefit of the Fund until repurchased. Repurchase
agreements permit a Fund to remain fully invested while retaining overnight
flexibility to pursue investments of a longer-term
nature. If the seller defaults and the value of the repurchased securities
declines, a Fund might incur a loss. If bankruptcy proceedings
are commenced with respect to the seller, a Fund’s realization upon the
collateral may be delayed.
While
repurchase agreements involve certain risks not associated with direct
investments in debt securities, each Fund follows procedures
approved by the Trustees that are designed to minimize such risks. These
procedures include effecting repurchase transactions
only with large, well-capitalized and well-established financial institutions
whose financial condition will be continually monitored
by the Adviser. In addition, as described above, the value of the collateral
underlying the repurchase agreement will be at least
equal to the repurchase price, including any accrued interest earned on the
repurchase agreement. In the event of a default or bankruptcy
by a selling financial institution, the Funds will seek to liquidate such
collateral. However, the exercising of the Fund’s right to
liquidate such collateral could involve certain costs or delays and, to the
extent that proceeds from any sale upon a default of the
obligation to repurchase were less than the repurchase price, the Fund could
suffer a loss. Repurchase agreements involving obligations
other than U.S. government securities may be subject to special risks.
Repurchase agreements secured by obligations that are not
eligible for direct investment under a Fund’s investment objectives and
restrictions may require the Fund to promptly dispose of such
collateral if the seller or guarantor becomes insolvent.
A Fund may
enter into repurchase agreements on a forward commitment basis. To the extent a
Fund does so and the counterparty to the trade
fails to effectuate the trade at the scheduled time, a Fund may be forced to
deploy its capital in a repurchase agreement with a less
favorable rate of return than it otherwise may have achieved or may be unable to
enter into a repurchase agreement at all at the desired
time.
Reverse
Repurchase Agreements. Under a
reverse repurchase agreement, a Fund sells a security and promises to repurchase
that security
at an agreed-upon future date and price. The price paid to repurchase the
security reflects interest accrued during the term of the
agreement. Reverse repurchase agreements may be entered into for, among other
things, obtaining leverage, facilitating short-term
liquidity or when the Adviser expects that the interest income to be earned from
the investment of the transaction proceeds will be greater
than the related interest expense.
Please see
“Derivatives Agreements -- Regulatory Matters.” Reverse
repurchase agreements
may be viewed as a speculative form of borrowing called leveraging. Furthermore,
reverse repurchase agreements involve the risks
that (i) the interest income earned in the investment of the proceeds will be
less than the interest expense, (ii) the market value of
the securities retained in lieu of sale by a Fund may decline below the price of
the securities the Fund has sold but is obligated
to repurchase, (iii) the market value of the securities sold will decline below
the price at which the Fund is required to repurchase
them and (iv) the securities will not be returned to the Fund.
In
addition, the use of leverage may cause a Fund to liquidate portfolio positions
when it may not be advantageous to do so to satisfy its
obligations.
Leverage, including borrowing, may cause a Fund to be more volatile than if the
Fund had not been leveraged. This is because
leverage tends to exaggerate the effect of any increase or decrease in the value
of a Fund’s portfolio securities. All forms
of borrowing
(including reverse repurchase agreements) are limited in the aggregate and may
not exceed 33⅓% of the Fund’s total assets,
except as permitted by law.
Rights. Rights
represent the right, but not the obligation, for a fixed period of time to
purchase additional shares of an issuer’s common
stock at the time of a new issuance, usually at a price below the initial
offering price of the common stock and before the common
stock is offered to the general public. Rights are usually freely transferable.
The risk of investing in a right is that the right may expire
prior to the market value of the common stock exceeding the price fixed by the
right.
Sector
Risk. Each Fund
may, from time to time, invest more heavily in companies in a particular
economic sector or sectors. Economic
or regulatory changes adversely affecting such sectors may have more of an
impact on a Fund’s performance than if the Fund held
a broader range of investments.
Short
Sales. A short
sale is a transaction in which a Fund sells securities that it owns or has the
right to acquire at no added cost (i.e., “against
the box”) or does not own (but has borrowed) in anticipation of a decline in the
market price of the securities. To deliver the securities
to the buyer, a Fund arranges through a broker to borrow the securities and, in
so doing, the Fund becomes obligated to replace
the securities borrowed at their market price at the time of replacement. When
selling short, a Fund intends to replace the securities
at a lower price and therefore, profit from the difference between the cost to
replace the securities and the proceeds received from the
sale of the securities. When a Fund makes a short sale, the proceeds it receives
from the sale will be held on behalf of a broker
until the Fund replaces the borrowed securities. A Fund may have to pay a
premium to borrow the securities and must pay any
dividends or interest payable on the securities until they are
replaced.
A Fund’s
obligation to replace the securities borrowed in connection with a short sale
will be secured by collateral deposited with the broker
that consists of cash or other liquid securities. Short
sales by a Fund involve certain risks and special considerations. If the
Adviser
incorrectly predicts that the price of the borrowed security will decline, a
Fund will have to replace the securities with securities
with a greater value than the amount received from the sale. As a result, losses
from short sales differ from losses that could be
incurred from a purchase of a security, because losses from short sales may be
unlimited, whereas losses from purchases can equal only the
total amount invested. Please see “Derivatives Agreements -- Regulatory
Matters”.
Special
Purpose Acquisition Companies. A Fund may
invest in stock, warrants, rights and other securities of special purpose
acquisition
companies (“SPAC”), which typically are publicly traded companies that raise
investment capital for the purpose of acquiring
or merging with an existing company that is identified subsequent to the SPAC’s
initial public offering (“IPO”), or similar special
purpose entities. Typically, the acquisition target is an existing privately
held company that wants to trade publicly, which it accomplishes
through a combination with a SPAC rather than by conducting a traditional IPO.
SPACs and similar entities are blank check
companies and do not have any operating history or ongoing business other than
seeking acquisitions. The long term value of a SPAC’s
securities is particularly dependent on the ability of the SPAC’s management to
identify a merger target and complete an attractive
acquisition. Some SPACs pursue acquisitions only within certain sectors,
industries or regions, which may increase the time horizon
for an acquisition as well as other risks associated with these investments,
including price volatility. Conversely, other SPACs may invest
without such limitations, in which case the SPAC’s management may have limited
experience or knowledge of the market sector,
industry or region in which the transaction is contemplated. In addition,
certain securities issued by a SPAC, particularly in private
placements conducted by the SPAC after its IPO, may be classified as illiquid
and/or be subject to restrictions on resale, which
restrictions may be imposed for at least a year or possibly a more extended
time, and may potentially be traded only in the over-the-counter
market.
Until an
acquisition or merger is completed, a SPAC generally invests its assets, less a
portion retained to cover expenses, in U.S. government
securities, money market securities and cash and does not typically pay
dividends in respect of its common stock. To the extent a
SPAC is invested in these securities or cash, the SPAC may not perform similar
to other equity securities and this may impact the
Fund’s ability to meet its investment objective. SPAC shareholders may not
approve any proposed acquisition or merger, or an
acquisition or merger, once effected, may prove unsuccessful. If an acquisition
or merger that meets the requirements of the SPAC is
not completed within a pre-established period of time (typically, two years),
the funds invested in the SPAC plus any interest paid on
such funds while held in trust (less any permitted expenses and any losses
experienced by the SPAC) are returned to its shareholders unless
the shareholders approve alternative options. As a
result, a Fund may be subject to opportunity costs to the extent that
alternative investments would have produced higher returns. Any warrants or
other rights with respect to a SPAC held by a Fund may expire
worthless or may be repurchased or retired by the SPAC at an unfavorable
price.
In
connection with a proposed acquisition, a SPAC may raise additional funds in
order to fund the acquisition, post-acquisition working
capital, redemptions or some combination of those purposes. This additional
fundraising may be in the form of a private placement
of a class of equity securities or debt. The debt could be secured by the assets
of the SPAC or the operating company existing
after the acquisition or it could be unsecured. The debt may also be investment
grade debt or below investment grade debt.
A Fund may
invest in stock, warrants, rights and other securities of SPACs or similar
special purpose entities in a private placement transaction
or as part of a public offering. If the Fund purchases securities in the SPAC’s
IPO, typically it will receive publicly-traded securities
called “units” that include one share of common stock and one right or warrant
(or partial right or warrant) conveying the right to
purchase additional shares of common stock. At a specified time, the rights and
warrants may be separated from the common stock at
the election of the holder, after which each security typically is freely
tradeable. An investment in the IPO securities of a SPAC may
be diluted by additional, later offerings of securities by the SPAC or by other
investors exercising existing rights to purchase
securities of the SPAC. If the Fund invests in equity securities issued in a
private placement after the IPO, those shares will not be
publicly tradable unless and until there is a registration statement filed by
the SPAC and approved by the SEC or if an exemption
from registration is available, which exemptions typically become available at
least a year after the date of the business
combination.
Equity investments in the SPAC made in connection with a proposed business
combination will be diluted by the acquisition
itself and further fundraising by the ongoing operating business.
If there
is no market for the shares of the SPAC or only a thinly traded market for
shares or interests in the SPAC develops, a Fund may not be
able to sell its interest in a SPAC or it may only sell its interest at a price
below what the Fund believes is the SPAC interest’s
value. If not subject to a restriction on resale, a Fund may sell its
investments in a SPAC at any time, including before, at or after the
time of an acquisition or merger. Generally, SPACs provide the opportunity for
common shareholders who hold publicly traded
shares to have some or all of their shares redeemed by the SPAC at or around the
time of a proposed acquisition or merger. However,
there is often a limit to the number of shares that can be redeemed in
connection with a business combination. If a Fund holds
shares of publicly traded SPAC stock, this means that a Fund may not be able to
redeem those shares prior to an acquisition and may
have to hold those shares until after the completion of the acquisition. If a
Fund purchases shares in a private placement, those
shares will not be redeemable in connection with a transaction. In addition, a
Fund may elect not to participate in a proposed SPAC
transaction or may be required to divest its interests in the SPAC due to
regulatory or other considerations.
An
investment in a SPAC is subject to the risks that any proposed acquisition or
merger may not obtain the requisite approval of SPAC
shareholders, may require governmental or other approvals that it fails to
obtain or that an acquisition or merger, once effected,
may prove unsuccessful and lose value. In addition, among other conflicts of
interest, the economic interests of the management,
directors, officers and related parties of a SPAC can differ from the economic
interests of public shareholders, which may lead
to conflicts as they evaluate, negotiate and recommend business combination
transactions to shareholders. This risk may become
more acute as the deadline for the completion of a business combination nears or
in the event that attractive acquisition or merger
targets become scarce.
An
investment in a SPAC is subject to the risks that any proposed acquisition or
merger may not obtain the requisite approval of SPAC
shareholders, may require governmental or other approvals that it fails to
obtain or that an acquisition or merger, once effected,
may prove unsuccessful and lose value. In addition, among other conflicts of
interest, the economic interests of the management,
directors, officers and related parties of a SPAC can differ from the economic
interests of public shareholders, which may lead
to conflicts as they evaluate, negotiate and recommend business combination
transactions to shareholders. For example, because
the sponsor, directors and officers of a SPAC may directly or indirectly own
interests in a SPAC, the sponsor, directors and officers
may have a conflict of interest in determining whether a particular target
business is an appropriate business with which to effectuate
a business combination. SPAC sponsors generally purchase equity in the SPAC at
more favorable terms than investors in the IPO or
subsequent investors on the open market. As a result, although most of the
SPAC’s capital has been provided by IPO investors,
the sponsors and potentially other initial investors will benefit more than
investors from the SPAC’s completion of an initial
business combination and may have an incentive to complete a transaction on
terms that may be less favorable to other investors.
This risk may become more acute as the deadline for the completion of a business
combination nears or in the event that attractive
acquisition or merger targets become scarce. In addition, the requirement that a
SPAC complete a business combination within a
prescribed time frame may give potential target businesses leverage over the
SPAC in negotiating a business combination and may limit
the time the SPAC has in which to conduct due diligence on potential business
combination targets, which could undermine
the SPAC’s ability to complete a business combination on terms that would
produce value for its shareholders. An investment
in a SPAC is also subject to the risk that a significant portion of the funds
raised by the SPAC may be expended during the search
for a target acquisition or merger. The value of investments in SPACs may be
highly volatile and may depreciate over time.
In
addition, investments in SPACs may be subject to the same risks as investing in
any initial public offering, including the risks associated
with companies that have little operating history as public companies, including
unseasoned trading, small number of shares
available for trading and limited information about the issuer. In addition, the
market for IPO issuers may be volatile, and share
prices of newly-public companies have fluctuated significantly over short
periods of time. Although some IPOs may produce high
returns, such returns are not typical and may not be sustainable. Certain
investments in SPACs are privately placed securities and are
also subject to the risks of such securities.
Debt
associated with a SPAC, whether issued by the SPAC, by a subsidiary or acquired
issuer, is subject to the same types of risks as exist in
other types of fixed income investing, including credit risk, default risk and
the potential for a restructuring, work-out or bankruptcy.
Structured
Investments. Certain
Funds may invest in structured investments. A structured investment is a
derivative security designed
to offer a return linked to a particular underlying security, currency,
commodity or market, for which the amount of principal
repayment and/or interest payments is based on the change in value of such
underlying security, currency, commodity or market,
including, among others, currency exchange rates, interest rates, referenced
bonds and stock indices or other financial references.
Structured investments may come in various forms, including notes, warrants and
options to purchase securities, and may be listed
and traded on an exchange or otherwise traded in the OTC market.
The Funds
will typically use structured investments to gain exposure to a permitted
underlying security, currency, commodity or market
when direct access to such security, currency, commodity or market is limited or
inefficient from a tax, cost or regulatory
standpoint.
Investments in structured investments involve risks including issuer risk,
counterparty risk and market risk. Holders of structured
investments bear risks of the underlying investment and are subject to issuer or
counterparty risk because the holders are relying on
the creditworthiness of such issuer or counterparty and have no rights with
respect to the underlying investment. Certain structured
investments may be thinly traded or have a limited trading market and may have
the effect of increasing a Fund’s illiquidity
to the extent that the Fund, at a particular point in time, may be unable to
find qualified buyers for these investments.
A
structured investment may be linked either positively or negatively to an
underlying security, currency, commodity, index or market and
a change in interest rates, principal amount, volatility, currency values or
other factors, depending on the structured investment’s
design, may result in a gain or loss that is a multiple of the movement of such
interest rates, principal amount, volatility, currency
values or other factors. Application of a multiplier is comparable to the use of
financial leverage, a speculative technique. Leverage
magnifies the potential for gain and the risk of loss. As a result, a relatively
small decline in the value of the referenced factor could
result in a relatively large loss in the value of a structured
investment.
Other
types of structured investments include interests in entities organized and
operated for the purpose of restructuring the investment
characteristics of underlying investment interests or securities. This type of
securitization or restructuring usually involves the
deposit or purchase of an underlying security by a U.S. or foreign entity, such
as a corporation or trust of specified instruments, and the
issuance by that entity of one or more classes of securities backed by, or
representing an interest in, the underlying instruments.
The cash flow or rate of return on the underlying investments may be apportioned
among the newly issued securities to create
different investment characteristics, such as varying maturities, credit
quality, payment priorities and interest rate provisions. Structured
investments that are subordinated, for example, in payment priority often offer
higher returns, but may result in increased risks
compared to other investments.
Swaps. An OTC
swap contract is an agreement between two parties pursuant to which the parties
exchange payments at specified dates on
the basis of a specified notional amount, with the payments calculated by
reference to specified securities, indices, reference rates,
currencies or other instruments. Most swap agreements provide that when the
period payment dates for both parties are the same, the
payments are made on a net basis (i.e., the two payment streams are netted out,
with only the net amount paid by one party to
the other). A Fund’s obligations or rights under a swap contract entered into on
a net basis 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 counterparty. Many swap
agreements are not entered into or traded on exchanges and often there is no
central clearing or guaranty function for swaps. These OTC
swaps are often subject to the risk of default or non-performance by the
counterparty. Accordingly, the Adviser must assess the
creditworthiness of the counterparty to determine the likelihood that the terms
of the swap will be satisfied.
Swap
agreements allow for a wide variety of transactions. For example, fixed-rate
payments may be exchanged for floating rate payments,
U.S. dollar-denominated payments may be exchanged for payments denominated in
foreign currencies, and payments tied to the
price of one security, index, reference rate, currency or other instrument may
be exchanged for payments tied to the price of a different
security, index, reference rate, currency or other instrument. Swap contracts
are typically individually negotiated and structured
to provide exposure to a variety of particular types of investments or market
factors. Swap contracts can take many different
forms and are known by a variety of names. To the extent consistent with a
Fund’s investment objective and policies, a Fund is
not limited to any particular form or variety of swap contract. A Fund may
utilize swaps to increase or decrease its exposure to the
underlying instrument, reference rate, foreign currency, market index or other
asset. Certain Funds may also enter into related derivative
instruments including caps, floors and collars.
The
Dodd-Frank Act and related regulatory developments require the eventual clearing
and exchange-trading of many standardized OTC
derivative instruments that the CFTC and SEC defined as “swaps” and “security
based swaps,” respectively. Mandatory exchange-trading
and clearing is occurring on a phased-in basis based on the type of market
participant and CFTC approval of contracts
for central clearing and exchange-trading. In a cleared swap, a Fund’s ultimate
counterparty is a central clearinghouse rather than a
brokerage firm, bank or other financial institution. A Fund initially will enter
into cleared swaps through an executing broker. Such
transactions will then be submitted for clearing and, if cleared, will be held
at regulated FCMs that are members of the clearinghouse
that serves as the central counterparty. When a Fund enters into a cleared swap,
it must deliver to the central counterparty
(via an FCM) an amount referred to as “initial margin.” Initial margin
requirements are determined by the central counterparty,
but an FCM may require additional initial margin above the amount required by
the central counterparty. During the term of
the swap agreement, a “variation margin” amount may also be required to be paid
by a Fund or may be received by a Fund in accordance
with margin controls set for such accounts, depending upon changes in the price
of the underlying reference asset subject to the
swap agreement. At the conclusion of the term of the swap agreement, if a Fund
has a loss equal to or greater than the margin amount,
the margin amount is paid to the FCM along with any loss that is greater than
such margin amount. If a Fund has a loss of less than
the margin amount, the excess margin is returned to the Fund. If a Fund has a
gain, the full margin amount and the amount of the
gain is paid to the Fund.
Central
clearing is designed to reduce counterparty credit risk compared to uncleared
swaps because central clearing interposes the central
clearinghouse as the counterparty to each participant’s swap, but it does not
eliminate those risks completely. There is also a risk of
loss by a Fund of the initial and variation margin deposits in the event of
bankruptcy of the FCM with which the Fund has an
open
position in a swap contract. The assets of a Fund may not be fully protected in
the event of the bankruptcy of the FCM or central
counterparty because the Fund might be limited to recovering only a pro rata
share of all available funds and margin segregated
on behalf of an FCM’s or central counterparty’s customers or clearing members.
If the FCM does not provide accurate reporting,
a Fund is also subject to the risk that the FCM could use the Fund’s assets,
which are held in an omnibus account with assets
belonging to the FCM’s other customers, to satisfy its own financial obligations
or the payment obligations of another customer
to the central counterparty.
As a
result of recent regulatory developments, certain standardized swaps are
currently subject to mandatory central clearing and some of these
cleared swaps must be traded on an exchange or swap execution facility (“SEF”).
An SEF is an electronic trading platform in which
multiple market participants can execute swap transactions by accepting bids and
offers made by multiple other participants on the
platform. Transactions executed on an SEF may increase market transparency and
liquidity but may cause a Fund to incur increased
expenses to execute swaps. Central clearing should decrease counterparty risk
and increase liquidity compared to bilateral swaps
because central clearing interposes the central clearinghouse as the
counterparty to each participant’s swap. However, central clearing
does not eliminate counterparty risk or liquidity risk entirely. In addition,
depending on the size of a Fund and other factors, the margin
required under the rules of a clearinghouse and by a clearing member may be in
excess of the collateral required to be posted by
a Fund to support its obligations under a similar bilateral swap. However, the
CFTC and other applicable regulators have adopted
rules imposing certain margin requirements, including minimums, on uncleared
swaps which may result in a Fund and its counterparties
posting higher margin amounts for uncleared swaps. Requiring margin on uncleared
swaps may reduce, but not eliminate,
counterparty credit risk.
In
addition, with respect to cleared swaps, a Fund may not be able to obtain as
favorable terms as it would be able to negotiate for an uncleared
swap. In addition, an FCM may unilaterally impose position limits or additional
margin requirements for certain types of swaps in
which a Fund may invest. Central counterparties and FCMs generally can require
termination of existing cleared swap transactions
at any time, and can also require increases in margin above the margin that is
required at the initiation of the swap agreement.
Margin requirements for cleared swaps vary on a number of factors, and the
margin required under the rules of the clearinghouse
and FCM may be in excess of the collateral required to be posted by a Fund to
support its obligations under a similar uncleared
swap. However, as noted above, regulators have adopted rules imposing certain
margin requirements, including minimums,
on uncleared swaps, which may result in a Fund and its counterparties posting
higher margin amounts for uncleared swaps.
Requiring margin on uncleared swaps may reduce, but not eliminate, counterparty
credit risk.
A Fund is
also subject to the risk that, after entering into a cleared swap with an
executing broker, no FCM or central counterparty is willing or
able to clear the transaction. In such an event, the central counterparty would
void the trade. Before a Fund can enter into a new
trade, market conditions may become less favorable to the Fund.
The
Adviser will continue to monitor developments regarding trading and execution of
cleared swaps on exchanges, particularly to the extent
regulatory changes affect a Fund’s ability to enter into swap agreements and the
costs and risks associated with such investments.
Interest
Rate Swaps, Caps, Floors and Collars. Interest
rate swaps consist of an agreement between two parties to exchange their
respective
commitments to pay or receive interest (e.g., an exchange of floating rate
payments for fixed-rate payments). Interest rate swaps are
generally entered into on a net basis. Interest rate swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of market loss with respect to interest rate and total
rate of return swaps is typically limited to the net amount of
interest payments that a Fund is contractually obligated to make.
Certain
Funds may also buy or sell interest rate caps, floors and collars. The purchase
of an interest rate cap entitles the purchaser, to the extent
that a specified interest rate index exceeds a predetermined level, to receive
payments of interest on a specified notional amount
from the party selling the interest rate cap. The purchase of an interest rate
floor entitles the purchaser, to the extent that a specified
interest rate falls below a predetermined level, to receive payments of interest
on a specified notional amount from the party selling
the interest rate floor. A collar is a combination of a cap and a floor that
preserves a certain return within a predetermined range of
interest rates. Caps, floors and collars may be less liquid than other types of
derivatives.
Total
Return Swaps. Total
return swaps are contracts in which one party agrees to make periodic payments
to another party based on the change
in market value of the assets underlying the contract, which may include, but
not be limited to, a specified security, basket of
securities or securities indices 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. Total return swaps may be used to
obtain long or short exposure to a security or market
without owning or taking physical custody of such security or investing directly
in such market. Total return swaps may effectively
add leverage to a Fund’s portfolio because, in addition to its total net assets,
a Fund would be subject to investment exposure
on the notional amount of the swap.
Total
return swaps are subject to the risk that a counterparty will default on its
payment obligations to a Fund thereunder, and conversely,
that a Fund will not be able to meet its obligation to the counterparty.
Generally, a Fund will enter into total return
swaps on a
net basis (i.e., the two payment streams are netted against one another with a
Fund receiving or paying, as the case may be, only
the net amount of the two payments).
Index
Swaps. An index
swap consists of an agreement between two parties in which a party typically
exchanges a cash flow based on a notional
amount of a reference index for a cash flow based on a different index or on
another specified instrument or reference rate. Index
swaps are generally entered into on a net basis.
Inflation
Swaps. Inflation
swap agreements are contracts in which one party typically agrees to pay the
cumulative percentage increase in a price
index, such as the Consumer Price Index, over the term of the swap (with some
lag on the referenced inflation index), and the other
party pays a compounded fixed rate. Inflation swap agreements may be used to
protect the NAV of a Fund against an unexpected
change in the rate of inflation measured by an inflation index. The value of
inflation swap agreements 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.
Currency
Swaps. A
currency swap consists of an agreement between two parties to exchange cash
flows on a notional amount of two or more
currencies based on the relative value differential among them, such as
exchanging a right to receive a payment in foreign currency
for the right to receive U.S. dollars. Currency swap agreements may be entered
into on a net basis or may involve the delivery
of the entire principal value of one designated currency in exchange for the
entire principal value of another designated currency.
In such cases, the entire principal value of a currency swap is subject to the
risk that the counterparty will default on its contractual
delivery obligations.
Credit
Default Swaps. A credit
default swap consists of an agreement between two parties in which the “buyer”
typically agrees to pay to the
“seller” a periodic stream of payments over the term of the contract and the
seller agrees to pay the buyer the par (or other agreed-upon)
value of a referenced debt obligation upon the occurrence of a credit event with
respect to the issuer of that referenced debt
obligation. Generally, a credit event means bankruptcy, failure to pay,
obligation acceleration or modified restructuring. A Fund may be
either the buyer or seller in a credit default swap. Where a Fund is the buyer
of a credit default swap contract, it would typically
be entitled to receive the par (or other agreed-upon) value of a referenced debt
obligation from the counterparty to the contract
only in the event of a default or similar event by the issuer of the debt
obligation. If no default occurs, a Fund would have paid to
the counterparty a periodic stream of payments over the term of the contract and
received no benefit from the contract. The
use of
credit default swaps could result in losses to a Fund if the Adviser fails to
correctly evaluate the creditworthiness of the issuer of the
referenced debt obligation.
Swaptions. An option
on a swap agreement, also called a “swaption,” is an option that gives the buyer
the right, but not the obligation,
to enter into a swap on a future date in exchange for a premium. A receiver
swaption gives the owner the right to receive the return
of a specified asset, reference rate, or index. A payer swaption gives the owner
the right to pay the return of a specified asset,
reference rate, or index. Swaptions also include options that allow an existing
swap to be terminated or extended by one of the counterparties.
General
Risks of Swaps. The risks
associated with swap transactions are different from, and possibly greater than,
the risks associated with
investing directly in the underlying instruments. Swaps are highly specialized
instruments that require investment techniques and risk
analyses different from those associated with other portfolio investments. The
use of swaps requires an understanding not only of
the underlying instrument but also of the swap contract itself. Swap
transactions may be subject to the risk factors generally applicable
to derivatives transactions described above, and may also be subject to certain
additional risk factors, including:
■ |
OTC
swap agreements are not traded on exchanges and may be subject to
liquidity risk, which exists when a particular swap is difficult
to purchase or sell. |
■ |
In
addition to the risk of default by the counterparty, if the
creditworthiness of a counterparty to a swap agreement declines, the
value
of the swap agreement would be likely to decline, potentially resulting in
losses. |
■ |
The
swaps market is subject to extensive regulation under the Dodd-Frank Act
and certain CFTC and SEC rules promulgated thereunder.
It is possible that further developments in the swaps market, including
new and additional governmental regulation, could
result in higher Fund costs and expenses and could adversely affect a
Fund’s ability to utilize swaps, terminate existing swap
agreements or realize amounts to be received under such
agreements. |
Municipal
Interest Rate Swap Transactions. In order
to hedge the value of a Fund against interest rate fluctuations or to enhance a
Fund’s
income, a Fund may enter into interest rate swap transactions such as Municipal
Market Data AAA Cash Curve swaps (“MMD
Swaps”) or Securities Industry and Financial Markets Association Municipal Swap
Index swaps (“SIFMA Swaps”). To the extent
that a Fund enters into these transactions, the Fund expects to do so primarily
to preserve a return or spread on a particular investment
or portion of its portfolio or to protect against any increase in the price of
securities the Fund anticipates purchasing at a later
date. A Fund intends to use these transactions primarily as a hedge rather than
as a speculative investment. However, a Fund also may
invest in MMD Swaps and SIFMA Swaps to enhance income or gain or to increase the
Fund’s yield, for example, during periods of
steep interest rate yield curves (i.e., wide differences between short term and
long term interest rates).
A Fund may
purchase and sell SIFMA Swaps in the SIFMA swap market. In a SIFMA Swap, a Fund
exchanges with another party their
respective commitments to pay or receive interest (e.g., an exchange of fixed
rate payments for floating rate payments linked to the SIFMA
Municipal Swap Index). Because the underlying index is a tax-exempt index, SIFMA
Swaps may reduce cross-market risks
incurred by a Fund and increase a Fund’s ability to hedge effectively. SIFMA
Swaps are typically quoted for the entire yield curve,
beginning with a seven day floating rate index out to 30 years. The duration of
a SIFMA Swap is approximately equal to the duration
of a fixed-rate Municipal Bond with the same attributes as the swap (e.g.,
coupon, maturity, call feature).
A Fund may
also purchase and sell MMD Swaps, also known as MMD rate locks. An MMD Swap
permits a Fund to lock in a specified
municipal interest rate for a portion of its portfolio to preserve a return on a
particular investment or a portion of its portfolio
as a duration management technique or to protect against any increase in the
price of securities to be purchased at a later date. By
using an MMD Swap, a Fund can create a synthetic long or short position,
allowing the Fund to select the most attractive part of
the yield curve. An MMD Swap is a contract between a Fund and an MMD Swap
provider pursuant to which the parties agree to
make payments to each other on a notional amount, contingent upon whether the
Municipal Market Data AAA General Obligation
Scale is above or below a specified level on the expiration date of the
contract. For example, if a Fund buys an MMD Swap and
the Municipal Market Data AAA General Obligation Scale is below the specified
level on the expiration date, the counterparty
to the contract will make a payment to the Fund equal to the specified level
minus the actual level, multiplied by the notional
amount of the contract. If the Municipal Market Data AAA General Obligation
Scale is above the specified level on the expiration
date, a Fund will make a payment to the counterparty equal to the actual level
minus the specified level, multiplied by the notional
amount of the contract.
In
connection with investments in SIFMA and MMD Swaps, there is a risk that
municipal yields will move in the opposite direction than
anticipated by a Fund, which would cause the Fund to make payments to its
counterparty in the transaction that could adversely
affect the Fund’s performance. A Fund has no obligation to enter into SIFMA or
MMD Swaps and may not do so. The net amount of
the excess, if any, of a Fund’s obligations over its entitlements with respect
to each interest rate swap will be accrued on a daily
basis and a number of liquid assets that have an aggregate NAV at least equal to
the accrued excess will be maintained in a segregated
account by the Fund.
Tender
Option Bonds. A tender
option bond is a municipal obligation (generally held pursuant to a custodial
arrangement) created by
dividing the income stream provided by an underlying municipal bond having a
relatively long maturity and bearing interest at a fixed rate
substantially higher than prevailing short-term tax-exempt rates to create two
securities issued by a special-purpose trust – floating
rate certificates and residual interest securities. Tender option bonds are
typically issued in conjunction with the agreement of a third
party, such as a bank, broker-dealer or other financial institution, pursuant to
which the institution grants the security holder the
option, at periodic intervals, to tender its securities to the institution. A
Fund holds the class of interest, or floating rate certificate,
which receives tax-exempt interest based on short-term rates and has the ability
to tender the certificate at par. As consideration
for providing the tender option, the financial institution receives periodic
fees equal to the difference between the bond’s
fixed coupon rate and the rate, as determined by a remarketing or similar agent,
that would cause the securities, coupled with the tender
option, to trade at par on the date of such determination. Thus, after payment
of this fee, the security holder effectively holds a
demand obligation that bears interest at the prevailing short-term, tax-exempt
rate. The tender option will be taken into account in
determining the maturity of the tender option bonds and a Fund’s average
portfolio maturity. There is a risk that a Fund may not be
considered the owner of a tender option bond for federal income tax purposes,
and thus will not be entitled to treat such interest
as exempt from federal income tax. Certain tender option bonds may be illiquid
or may become illiquid as a result of a credit rating
downgrade, a payment default or a disqualification from tax-exempt status.
Additionally, the Dodd-Frank Act, including the Volcker
Rule, among other regulatory changes, may affect the ability of bank-sponsored
tender option bonds to continue to operate or remain
cost-effective investments for a Fund.
Temporary
Defensive Investments. When the
Adviser believes that changes in market, economic, political or other conditions
make it
advisable, a Fund may invest up to 100% of its assets in cash, cash equivalents
and other fixed-income securities for temporary defensive
purposes that may be inconsistent with the Fund’s investment strategies. These
temporary investments may consist of obligations
of the U.S. or foreign governments, their agencies and instrumentalities; money
market instruments; and instruments issued by
international development agencies.
U.S.
Government Securities. U.S.
government securities refer to a variety of fixed-income securities issued or
guaranteed by the U.S. Government
and its various instrumentalities and agencies. The U.S. government securities
that certain Funds may purchase include U.S.
Treasury bills, notes and bonds, all of which are direct obligations of the U.S.
Government. In addition, certain Funds may purchase
securities issued by agencies and instrumentalities of the U.S. Government that
are backed by the full faith and credit of the United
States. Among the agencies and instrumentalities issuing these obligations are
Ginnie Mae and the Federal Housing Administration.
Certain Funds may also purchase securities issued by agencies and
instrumentalities that are not backed by the full faith and
credit of the United States, but whose issuing agency or instrumentality has the
right to borrow, to meet its obligations, from the
U.S. Treasury. Among these agencies and instrumentalities are Fannie Mae,
Freddie Mac and the Federal Home Loan
Banks.
Further, certain Funds may purchase securities issued by agencies and
instrumentalities that are backed solely by the credit of the
issuing agency or instrumentality. Among these agencies and instrumentalities is
the Federal Farm Credit System.
Variable
Rate Master Demand Notes. These are
obligations that permit a Fund to invest fluctuating amounts, at varying rates
of interest,
pursuant to direct arrangements between the Fund, as lender, and the borrower.
These obligations permit daily changes in the
amounts borrowed. Because these obligations are direct lending arrangements
between the lender and borrower, it is not contemplated
that such instruments generally will be traded, and there generally is no
established secondary market for these obligations,
although they are redeemable at face value, plus accrued interest. Accordingly,
where these obligations are not secured by letters of
credit or other credit support arrangements, a Fund’s right to redeem is
dependent on the ability of the borrower to pay principal
and interest on demand.
Warrants. Warrants
give holders the right, but not the obligation, to buy common stock of an issuer
at a given price, usually higher than the
market price at the time of issuance, during a specified period. Warrants are
usually freely transferable. The risk of investing in a
warrant is that the warrant may expire prior to the market value of the common
stock exceeding the price fixed by the warrant.
When-Issued
and Delayed Delivery Securities and Forward Commitments. From time
to time, the Funds may purchase securities on a
when-issued or delayed delivery basis or may purchase or sell securities on a
forward commitment basis. When these transactions are
negotiated, the price is fixed at the time of the commitment, but delivery and
payment can take place a month or more after the date of
commitment. The Funds may sell the securities before the settlement date if it
is deemed advisable. The securities so purchased
or sold are subject to market fluctuation and no interest or dividends accrue to
the purchaser prior to the settlement date.
At the
time a Fund makes the commitment to purchase or sell securities on a
when-issued, delayed delivery or forward commitment basis, it
will record the transaction and thereafter reflect the value, each day, of such
security purchased, or if a sale, the proceeds to be received,
in determining its NAV. At the time of delivery of the securities, their value
may be more or less than the purchase or sale price. An
increase in the percentage of a Fund’s assets committed to the purchase of
securities on a when-issued, delayed delivery or forward
commitment basis may increase the volatility of its NAV.
When,
As and If Issued Securities. A Fund
may purchase securities on a “when, as and if issued” basis, under which the
issuance of the
security depends upon the occurrence of a subsequent event, such as approval of
a merger, corporate reorganization or debt restructuring.
The commitment for the purchase of any such security will not be recognized in
the portfolio of a Fund until the Adviser
determines that issuance of the security is probable. At that time, a Fund will
record the transaction and, in determining its NAV, will
reflect the value of the security daily. At that time, under current SEC and SEC
Staff guidance, a Fund will also earmark cash or
liquid assets or establish a segregated account on its books in which it will
maintain cash, cash equivalents or other liquid portfolio
securities equal in value to recognized commitments for such
securities.
An
increase in the percentage of a Fund’s assets committed to the purchase of
securities on a “when, as and if issued” basis may increase
the volatility of its NAV. A Fund may also sell securities on a “when, as and if
issued” basis provided that the issuance of the security
will result automatically from the exchange or conversion of a security owned by
the Fund at the time of sale.
Zero
Coupons, Pay-In-Kind Securities or Deferred Payment Securities. Zero
coupon, pay-in-kind and deferred payment securities
are all types of fixed-income securities on which the holder does not receive
periodic cash payments of interest or principal. Generally,
these securities are subject to greater price volatility and lesser liquidity in
the event of adverse market conditions than comparably
rated securities paying cash interest at regular intervals. Although a Fund will
not receive cash periodic coupon payments on these
securities, the Fund may be deemed to have received interest income, or “phantom
income” during the life of the obligation. The Fund
may have to distribute such phantom income to avoid taxes at the Fund level,
although it has not received any cash payment.
Zero
Coupons. Zero
coupons are fixed-income securities that do not make regular interest payments.
Instead, zero coupons are sold at a discount
from their face value. The difference between a zero coupon’s issue or purchase
price and its face value represents the imputed
interest an investor will earn if the obligation is held until maturity. For tax
purposes, a portion of this imputed interest is deemed as
income received by zero coupon bondholders each year. Each Fund intends to pass
along such interest as a component of the Fund’s
distributions of net investment income.
Zero
coupons may offer investors the opportunity to earn a higher yield than that
available on ordinary interest-paying obligations of similar
credit quality and maturity. However, zero coupon prices may also exhibit
greater price volatility than ordinary fixed-income securities
because of the manner in which their principal and interest are returned to the
investor.
Pay-In-Kind
Securities.
Pay-in-kind securities are securities that have interest payable by delivery of
additional securities. Upon maturity,
the holder is entitled to receive the aggregate par value of the
securities.
Deferred
Payment Securities. Deferred
payment securities are securities that remain zero coupons until a predetermined
date, at which time the
stated coupon rate becomes effective and interest becomes payable at regular
intervals.
Special
Risks Related to Cyber Security. The Trust
and its service providers are susceptible to cyber security risks that include,
among
other things, theft, unauthorized monitoring, release, misuse, loss, destruction
or corruption of confidential and highly restricted
data; denial of service attacks; unauthorized access to relevant systems;
compromises to networks or devices that the Trust and its
service providers use to service the Trust’s operations; or operational
disruption or failures in the physical infrastructure or operating
systems that support the Trust and its service providers. Cyber attacks against
or security breakdowns of the Trust or its service
providers may adversely impact the Trust and its shareholders, potentially
resulting in, among other things, financial losses; the
inability of Fund shareholders to transact business and a Fund to process
transactions; inability to calculate a Fund’s NAV; violations
of applicable privacy and other laws; regulatory fines, penalties, reputational
damage, reimbursement or other compensation
costs; and/or additional compliance costs. The Trust may incur additional costs
for cyber security risk management and
remediation purposes. In addition, cyber security risks may also impact issuers
of securities in which a Fund invests, which may cause a
Fund’s investment in such issuers to lose value. There can be no assurance that
the Trust or its service providers will not suffer losses
relating to cyber attacks or other information security breaches in the
future.
ESG
Investment Risk. To the
extent that a Fund considers environmental, social and governance (“ESG”)
criteria and application of related
analyses when selecting investments, the Fund’s performance may be affected
depending on whether such investments are in or out of
favor and relative to similar funds that do not adhere to such criteria or apply
such analyses. A company’s ESG practices or the
Adviser’s assessment of such may change over time. Additionally, a Fund’s
adherence to its ESG criteria and application of related analyses
in connection with identifying and selecting investments may require subjective
analysis and may be difficult if data about a particular
company is limited. A Fund’s consideration of ESG criteria may result in the
Fund buying certain securities or forgoing opportunities
to buy certain securities. A Fund’s investments in certain companies may be
susceptible to various factors that may impact
their businesses or operations, including the effects of general economic
conditions throughout the world, increased competition
from other providers of services, unfavorable tax laws or accounting policies
and high leverage.
Market
and Geopolitical Risk. The value
of your investment in a Fund is based on the values of a Fund’s investments.
These values change
daily due to economic and other events that affect markets generally, as well as
those that affect particular regions, countries, industries,
companies or governments. Price movements, sometimes called volatility, may be
greater or less depending on the types of securities
a Fund owns and the markets in which the securities trade. The increasing
interconnectivity between global economies and financial
markets increases the likelihood that events or conditions in one region or
financial market may adversely impact issuers in a different
country, region or financial market. Securities in a Fund’s portfolio may
underperform due to inflation (or expectations for inflation),
interest rates, global demand for particular products or resources, natural
disasters, pandemics, epidemics, terrorism, regulatory
events and governmental or quasi-governmental actions. The occurrence of global
events similar to those in recent years, such as
terrorist attacks around the world, natural disasters, social and political
discord or debt crises and downgrades, among others, may result
in market volatility and may have long term effects on both the U.S. and global
financial markets. The occurrence of such events may
be sudden and unexpected, and it is difficult to predict when similar events
affecting the U.S. or global financial markets may occur,
the effects that such events may have and the duration of those effects. Any
such event(s) could have a significant adverse impact on
the value, liquidity and risk profile of a Fund’s portfolio, as well as its
ability to sell securities to meet redemptions. There is a risk
that you may lose money by investing in a Fund.
Social,
political, economic and other conditions and events, such as war, natural
disasters, health emergencies (e.g., epidemics and pandemics),
terrorism, conflicts may occur
and could significantly impact issuers, industries, governments and other
systems, including
the financial markets. As global systems, economies and financial markets are
increasingly interconnected, events that once had only
local impact are now more likely to have regional or even global effects. Events
that occur in one country, region or financial market
will, more frequently, adversely impact issuers in other countries, regions or
markets. These impacts can be exacerbated by failures
of governments and societies to adequately respond to an emerging event or
threat. These types of events quickly and significantly
impact markets in the U.S. and across the globe leading to extreme market
volatility and disruption. The extent and nature of
the impact on supply chains or economies and markets from these events is
unknown, particularly if a health emergency or other
similar event, such as the recent COVID-19 (the “Coronavirus”) outbreak,
persists for an extended period of time. Social, political,
economic and other conditions and events, such as natural disasters, health
emergencies (e.g., epidemics and pandemics), terrorism,
conflicts, social
unrest, recessions,
inflation, rapid interest rate changes and supply chain disruption could
reduce consumer demand or
economic output, result in market closures, travel restrictions or quarantines,
and generally have a significant impact on the
economies and financial markets and the Adviser’s investment advisory activities
and services of other service providers, which in turn could
adversely affect a Fund’s investments and other operations. The value of a
Fund’s investment may decrease as a result of such
events, particularly if these events adversely impact the operations and
effectiveness of the Adviser or key service providers or if these
events disrupt systems and processes necessary or beneficial to the investment
advisory or other activities on behalf a Fund.
Many
countries have experienced outbreaks of infectious illnesses in recent decades,
including swine flu, avian influenza, SARS and the
Coronavirus, and may experience similar outbreaks in the future. For example,
the Coronavirus outbreak has resulted in numerous
deaths and the imposition of both local and more widespread “work from home” and
other quarantine measures, border
closures
and other travel restrictions, causing social unrest and commercial disruption
on a global scale and significant volatility in financial markets.
The
ongoing spread of the Coronavirus has had, and is expected to continue to have,
a material adverse impact on local economies in the
affected jurisdictions and also on the global economy, as cross border
commercial activity and market sentiment are increasingly impacted
by the outbreak and government and other measures seeking to contain its spread.
The global impact of the outbreak has been
rapidly evolving, and many countries have reacted by instituting quarantines and
restrictions on travel. These actions are creating
disruption in supply chains, and adversely impacting a number of industries,
including but not limited to retail, transportation,
hospitality and entertainment. In addition to these developments having adverse
consequences for certain companies and other
issuers in which a Fund invests and the value of a Fund’s investments therein,
the operations of the Adviser (including those
relating to the Fund) could be impacted adversely, including through quarantine
measures and travel restrictions imposed on the
Adviser’s or service providers’ personnel located in affected countries, regions
or local areas, or any related health issues of such personnel.
Any of the foregoing events could materially and adversely affect the Adviser’s
ability to source, manage and divest investments
on behalf of a Fund and pursue a Fund’s investment objectives and strategies.
Similar consequences could arise with respect to
other infectious diseases. Given the significant economic and financial market
disruptions and general uncertainty associated
with the Coronavirus pandemic, the valuation and performance of the Fund’s
investments may be impacted adversely.
In light
of current market conditions, until
recently interest
rates and bond yields in the United States and many other countries were
at or near
historic lows, and in some cases, such rates and yields are negative. During
periods of very low or negative interest rates, a Fund’s
susceptibility to interest rate risk (i.e., the risks associated with changes in
interest rates) may be magnified, its yield and income may
be diminished and its performance may be adversely affected (e.g., during
periods of very low or negative interest rates, the Fund
may be unable to maintain positive returns). These levels of interest rates (or
negative interest rates) may magnify the risks associated
with rising interest rates. Changing interest rates, including rates that fall
below zero, may have unpredictable effects on markets,
including market volatility and reduced liquidity, and may adversely affect a
Fund’s yield, income and performance.
Government
and other public debt, including municipal obligations in which a Fund may
invest, can be adversely affected by large and sudden
changes in local and global economic conditions that result in increased debt
levels. Although high levels of government and other
public debt do not necessarily indicate or cause economic problems, high levels
of debt may create certain systemic risks if sound debt
management practices are not implemented. A high debt level may increase market
pressures to meet an issuer’s funding needs,
which may increase borrowing costs and cause a government or public or municipal
entity to issue additional debt, thereby increasing
the risk of refinancing. A high debt level also raises concerns that the issuer
may be unable or unwilling to repay the principal
or interest on its debt, which may adversely impact instruments held by a Fund
that rely on such payments. Governmental and
quasi-governmental responses to certain economic or other conditions may lead to
increasing government and other public debt, which
heighten these risks. Unsustainable debt levels can lead to declines in the
value of currency, and can prevent a government from
implementing effective counter-cyclical fiscal policy during economic downturns,
can generate or contribute to an economic downturn
or cause other adverse economic or market developments, such as increases in
inflation or volatility. Increasing government and other
public debt may adversely affect issuers, obligors, guarantors or instruments
across a variety of asset classes.
Bitcoin
Exposure. The
Discovery Portfolio may have exposure to bitcoin indirectly through cash settled
futures or indirectly through
investments in Grayscale Bitcoin Trust (BTC) (“GBTC”), a privately offered
investment vehicle that invests in bitcoin. In
addition,
the Global Strategist Portfolio may have exposure to bitcoin indirectly through
cash settled futures. To the
extent either
Fund invests
in bitcoin futures or the
Discovery Portfolio invests in GBTC, it
will do so through a wholly-owned subsidiary, which is organized
as an exempted company under the laws of the Cayman Islands (the “Bitcoin
Subsidiary” and together with either the
Discovery
Portfolio Subsidiary or Global
Strategist Subsidiary, referred
to as a
“Subsidiary”). Each
Fund may at
times have no exposure
to bitcoin. Although
neither Fund directly invests in bitcoin, each Fund’s indirect investments in
bitcoin are exposed to risks
associated with the price of bitcoin, which is subject to numerous factors and
risks.
Bitcoin is
a digital asset whose ownership and behavior are determined by participants in
an online, peer-to-peer network that connects
computers that run publicly accessible, or “open source,” software that follows
the rules and procedures governing the bitcoin
network (commonly referred to as the bitcoin protocol). The value of bitcoin,
like the value of other cryptocurrencies, is not backed by
any government, corporation, or other identified body. The value of
bitcoin is determined in part by the supply of (which is
limited), and demand for, bitcoin in the markets for exchange that have been
organized to facilitate the trading of bitcoin. The further
development of the bitcoin network, which is part of a new and rapidly changing
industry, is subject to a variety of factors that are
difficult to evaluate.
Risks
Related to Bitcoin. Cryptocurrencies (also referred to as “virtual currencies”
and “digital currencies”) are digital assets designed to act as
a medium of exchange. Although there are
thousands of cryptocurrencies, the most well-known of which is bitcoin.
Cryptocurrency
is an
emerging asset class with a
limited history. Investments in or exposure to bitcoin are subject to
substantial risks, including
significant price volatility and fraud and manipulation, which are generally
more pronounced in the crypto asset market. In addition,
performance and value of indirect investments in bitcoin may differ
significantly from the performance or value of
bitcoin.
Cryptocurrency
facilitates decentralized, peer-to-peer financial exchange and value storage
that is used like money, without the oversight
of a central authority or banks. The value of cryptocurrency is not backed by
any government, corporation, or other identified
body. Similar to fiat currencies (i.e., a currency that is backed by a central
bank or a national, supra-national or quasi-national organization),
cryptocurrencies are susceptible to theft, loss and destruction. For example,
the bitcoin held by GBTC (and the
Discovery Portfolio’s indirect exposure to such bitcoin) is also susceptible to
these risks.
The value
of a Fund’s
indirect investments in bitcoin is
subject to significant
fluctuations
in the value of the cryptocurrency, which have been
and may in the future be highly volatile and
subject to sharp declines. The
value of cryptocurrencies is determined by the supply and
demand for cryptocurrency in the global market for the trading of
cryptocurrency, which consists primarily of transactions
on electronic exchanges. The price of bitcoin could drop precipitously
(including to zero) for a variety of reasons, including,
but not limited to, regulatory changes, a crisis of confidence, flaw or
operational issue in the bitcoin network or a change in user
preference to competing cryptocurrencies. A
Fund’s exposure
to bitcoin could
result in substantial losses to the Fund.
Cryptocurrencies
trade on exchanges, which are largely unregulated and, therefore, are more
exposed to fraud, market manipulation and
failure than established, regulated exchanges for securities and other
traditional assets, derivatives, and other currencies. Cryptocurrency
exchanges have in the past, and may in the future, fail or otherwise cease
operating temporarily or even permanently, resulting
in the potential loss of users’ cryptocurrency or other market
disruptions.
Cryptocurrency
exchanges that are
regulated typically must comply with minimum net capital, cybersecurity, and
anti-money laundering
requirements, but are not typically required to protect customers or their
markets to the same extent that regulated securities
exchanges or futures exchanges are required to do so. Furthermore, many
cryptocurrency exchanges lack certain safeguards established
by traditional exchanges to enhance the stability of trading on the exchange,
such as measures designed to prevent sudden drops in
value of items traded on the exchange (i.e., “flash crashes”). As a result, the
prices of cryptocurrencies on exchanges may be subject to
larger and more frequent sudden declines than assets traded on traditional
exchanges. In addition, cryptocurrency exchanges
are also subject to the risk of cybersecurity threats and have been breached,
resulting in the theft and/or loss of bitcoin and other
cryptocurrencies. A cyber or other security breach or a business failure of a
cryptocurrency exchange or custodian may affect the price of a
particular cryptocurrency or cryptocurrencies generally. A risk also exists with
respect to malicious actors or previously unknown
vulnerabilities, which may adversely affect the value of bitcoin.
Disruptions
at bitcoin exchanges and potential consequences of a bitcoin exchange’s failure
could adversely affect a Fund’s indirect investments
in bitcoin. In 2022 and early 2023, several large participants in the
cryptocurrency industry, including exchanges, lenders and
investment firms, declared bankruptcy, which has resulted in a loss of
confidence in participants of the digital asset ecosystem and
negative publicity surrounding digital assets more broadly. These events have
also contributed to financial distress among crypto asset
market participants and widespread disruption in those markets. The collateral
impacts of these types of failures, or of fraud or other
adverse developments in the crypto asset markets, is difficult to predict.
Extreme volatility in the future, including further declines
in the trading prices of the bitcoin, could have a material adverse effect on
the value of the Funds’ indirect investments in bitcoin.
Furthermore, negative perception and/or a lack of stability and standardized
regulation in the digital asset economy may reduce
confidence in the digital asset economy and may result in greater volatility in
the prices of bitcoin and other digital assets, including
a depreciation in value. Further, regulation of crypto asset markets is still
developing and federal, state or foreign governmental
authorities may restrict the development, use or exchange or cryptocurrencies.
In addition, events that impact one cryptocurrency
may lead to a volatility or a decline in the value or another cryptocurrency,
such as bitcoin.
The market
for bitcoin (and bitcoin futures) depends on, among other things: the supply and
demand for bitcoin (and bitcoin futures);
the adoption of bitcoin for commercial uses; the anticipated increase of
investments in bitcoin-related investment products by retail
and institutional investors; speculative interest in bitcoin, bitcoin futures,
and bitcoin-related investment products; regulatory
or other restrictions on investors’ ability to invest in bitcoin futures; and
the potential ability to hedge against the price of bitcoin
with bitcoin futures (and vice versa). At times, there has been, and may in the
future be, significant disruption to the crypto asset
market, which could adversely impact a Fund’s indirect investments in
bitcoin.
Factors
affecting the further development of cryptocurrency include, but are not limited
to: continued worldwide growth or possible cessation
or reversal in the adoption and use of cryptocurrency and other digital assets;
government and quasi-government regulation or
restrictions on or regulation of access to and operation of digital asset
networks; changes in consumer demographics and public preferences;
maintenance and development of open-source software protocol; availability and
popularity of other forms or methods of buying and
selling goods and services; the use of the networks supporting digital assets,
such as those for developing smart contracts and
distributed applications; general economic conditions and the regulatory
environment relating to digital assets; negative consumer
or public perception; and general risks tied to the use of information
technologies, including cyber risks. A breach or failure of one
cryptocurrency may lead to a loss in confidence in, and thus decreased usage
and or
value of, other cryptocurrencies.
Bitcoin
mining operations consume significant amounts of electricity, which may have a
negative environmental impact and give rise to public
opinion against allowing, or government regulations restricting, the use of
electricity for mining operations. Additionally, miners may
be forced to cease operations during an electricity shortage or power outage.
Given the energy-intensiveness and electricity
costs of mining, miners are restricted in where they can locate mining
operations. Any shortage of electricity supply or
increase
in related costs (or if miners otherwise cease expanding processing power) will
negatively impact the viability and expected economic
return from bitcoin mining, which will affect the availability of bitcoin in the
marketplace. Today, many bitcoin mining operations
rely on fossil fuels to power their operations. Public perception of the impact
of bitcoin mining on climate change may reduce the
demand for bitcoin and increase the likelihood of government regulation. Such
events could have a negative impact on the price of
bitcoin, bitcoin futures, and a Fund’s performance. In addition, sales of newly
mined bitcoin (and sales of bitcoin by large holders)
may impact the price of bitcoin.
Currently,
there is relatively limited use of cryptocurrency in the retail and commercial
marketplace, which contributes to price volatility.
A lack of expansion by cryptocurrencies into retail and commercial markets, or a
contraction of such use, may result in increased
volatility or a reduction in the value of cryptocurrencies, either of which
could adversely impact a Fund’s
indirect investment
in bitcoin. In
addition, to the extent market participants develop a preference for one
cryptocurrency over another, the value of
the less preferred cryptocurrency would likely be adversely
affected.
Cryptocurrency
is a new technological innovation with a limited history; it is a highly
speculative asset and future U.S. or
foreign government
or regulatory
actions or policies may limit, perhaps to a materially adverse extent, the value
of a
Fund’s indirect
investment
in bitcoin and the
ability to exchange a cryptocurrency or utilize it for payments.
Many
significant aspects of the tax treatment of investments in cryptocurrency are
uncertain, and a direct or indirect investment in cryptocurrency
may produce income that if directly earned by a RIC, like each
Fund, would be
treated as non-qualifying income for purposes
of the income test applicable to RICs. Accordingly, to the extent the
Global
Strategist Portfolio invests in bitcoin futures or the
Discovery
Portfolio invests in bitcoin futures or GBTC, it will do so through its
Subsidiary.
In 2014,
the IRS released a notice (the “Notice”) discussing certain aspects of
“convertible virtual currency” (that is, digital assets that have an
equivalent value in fiat currency or that act as a substitute for fiat currency)
for U.S. federal income tax purposes and, in particular,
stating that such a digital asset (i) is “property,” (ii) is not “currency” for
purposes of the rules relating to foreign currency gain or
loss and (iii) may be held as a capital asset. In 2019, the IRS released a
revenue ruling and a set of “Frequently Asked Questions”
(the “Ruling & FAQs”) that provide some additional guidance. However, the
Notice and the Ruling & FAQs do not address
other significant aspects of the U.S. federal income tax treatment of digital
assets. Moreover, although the Ruling & FAQs address
the treatment of hard forks, there continues to be uncertainty with respect to
the income and withholding taxation of incidental
rights received through a fork in the blockchain, airdrops offered to bitcoin
holders and other similar events, including situations
where such rights are disclaimed, as is expected with respect to GBTC’s intended
treatment of such events.
The taxing
authorities of certain states (i) have announced that they will follow the
Notice with respect to the treatment of digital assets for
state income tax purposes and/or (ii) have issued guidance exempting the
purchase and/or sale of digital assets for fiat currency
from state sales tax. It is unclear what further guidance on the treatment of
digital assets for state tax purposes may be issued in the
future.
It is
unclear what additional guidance on the treatment of digital assets for U.S.
federal, state and local income tax purposes may be issued in
the future. Because of the evolving nature of digital assets, it is not possible
to predict potential future developments that may arise
with respect to digital assets. Any future guidance on the treatment of digital
assets for federal, state or local tax purposes could
result in adverse tax consequences for investors in each
Fund and could
have an adverse effect on the value of bitcoin.
Bitcoin
Cash Settled Futures. The
Discovery Portfolio
may engage in futures contracts based on bitcoin to obtain
long exposure to bitcoin.
The Global Strategist Portfolio may engage in futures contracts based on
bitcoin to obtain
long or short exposure to bitcoin. A long
exposure reflects an investment contemplating an increase in the value of the
underlying asset whereas a short exposure contemplates
a decrease in value of the
underlying asset.
The only
bitcoin futures in which each Fund may invest are cash settled bitcoin futures
traded on futures exchanges registered with the CFTC.
The value of bitcoin futures is determined by reference to the CME CF Bitcoin
Reference Rate, which provides an indication
of the price of bitcoin across certain cash bitcoin exchanges.
Bitcoin
futures expose a
Fund to all of
the risks related to bitcoin discussed above and also
expose a Fund to
risks related to futures, and
specifically risks related to
bitcoin futures. The price
of bitcoin futures is based on a variety of factors. For example,
regulatory
changes or
actions may alter the nature of an investment in bitcoin futures or restrict the
use of bitcoin or the operations of the bitcoin
network or exchanges on which bitcoin trades in a manner that adversely affects
the price of bitcoin futures, which could adversely
impact a
Fund and
necessitate the payment of large daily variation margin payments to settle
a
Fund’s
losses.
The
market for
bitcoin futures is still developing and a Fund’s
investment in bitcoin futures may involve illiquidity risk, as bitcoin
futures
are not as heavily traded as other futures given that the bitcoin futures market
is relatively new, which
means a Fund may be unable to
purchase or sell a futures contract at a desired price or time. In
addition, bitcoin
futures markets may be more volatile than traditional
futures markets and exchanges
on which bitcoin futures are traded and their related clearinghouses and
a
Fund’s FCMs
generally
require the Fund to
maintain relatively high levels of initial margin at the clearinghouse and FCM
in connection with