ck0000890453-20231231
WILSHIRE
MUTUAL FUNDS, INC.
LARGE
COMPANY GROWTH PORTFOLIO
Investment Class Shares (DTLGX)
Institutional
Class Shares (WLCGX)
LARGE
COMPANY VALUE PORTFOLIO
Investment Class Shares (DTLVX)
Institutional
Class Shares (WLCVX)
SMALL
COMPANY GROWTH PORTFOLIO
Investment Class Shares (DTSGX)
Institutional
Class Shares (WSMGX)
SMALL
COMPANY VALUE PORTFOLIO
Investment Class Shares (DTSVX)
Institutional
Class Shares (WSMVX)
WILSHIRE
5000 INDEXSM
FUND
Investment Class Shares (WFIVX)
Institutional Class Shares
(WINDX)
WILSHIRE
INTERNATIONAL EQUITY FUND
Investment Class Shares (WLCTX)
Institutional
Class Shares (WLTTX)
WILSHIRE
INCOME OPPORTUNITIES FUND
Investment Class Shares (WIORX)
Institutional
Class Shares (WIOPX)
STATEMENT
OF ADDITIONAL INFORMATION
(http://wilshire.com)
April 30,
2024
This
Statement of Additional Information (“SAI”) provides supplementary information
for the investment portfolios of Wilshire Mutual Funds, Inc. (the “Company”):
Large Company Growth Portfolio, Large Company Value Portfolio, Small Company
Growth Portfolio, Small Company Value Portfolio, Wilshire 5000 IndexSM
Fund
(the “Index Fund”), Wilshire International Equity Fund (the “International
Fund”), and Wilshire Income Opportunities Fund (the “Income Fund”) (each a
“Portfolio” and collectively the “Portfolios”). This SAI is not a prospectus,
but should be read in conjunction with the current prospectus of the Company,
dated April 30,
2024,
as supplemented from time to time. Copies of the prospectus and the Company’s
shareholder reports are available, without charge, by writing to the Wilshire
Funds, c/o U.S. Bank Global Fund Services, P.O. Box 701, Milwaukee, Wisconsin
53201-0701, or by calling (866) 591-1568.
The
financial statements of the Portfolios for the fiscal year ended December 31,
2023
included in the Annual
Report
to shareholders and the report dated February
29, 2024
of Cohen & Company, Ltd., the independent registered public accounting firm
for the Company, related thereto are incorporated into this SAI by reference. No
other parts of the Annual Report are incorporated herein by
reference.
TABLE
OF CONTENTS
THE
PORTFOLIOS
Each
series of the Company is a diversified, open-end investment management company.
Each series of the Company currently offers two classes of shares, the
Investment Class Shares and Institutional Class Shares. Wilshire Advisors LLC
(“Wilshire” or the “Adviser”) is the investment adviser for the Portfolios. Fred
Alger Management, LLC (“Alger Management”), AllianceBernstein, L.P.
(“AllianceBernstein”), Diamond Hill Capital Management, Inc. (“Diamond Hill”),
DoubleLine®
Capital LP (“DoubleLine”), Granahan Investment Management, Inc. (“Granahan”),
Hotchkis & Wiley Capital Management, LLC (“Hotchkis & Wiley”), Lazard
Asset Management LLC (“Lazard”), Los Angeles Capital Management LLC (“Los
Angeles Capital”), Manulife Investment Management (US) LLC (“Manulife”),
Massachusetts Financial Services Company (d/b/a MFS Investment Management)
(“MFS”), Pzena Investment Management, LLC (“Pzena”), Ranger Investment
Management, L.P. (“Ranger”), Voya Investment Management Co LLC (“Voya”), and WCM
Investment Management LLC (“WCM”) (together with Alger Management,
AllianceBernstein, Diamond Hill, DoubleLine, Granahan, Hotchkis & Wiley,
Lazard, Los Angeles Capital, Manulife, MFS, Pzena, Ranger and Voya,
collectively, the “Subadvisers,”) each have entered into an agreement with
Wilshire to serve as a Subadviser to at least one of the Portfolios. Terms not
defined in this SAI have the meanings assigned to them in the
prospectus.
INVESTMENT
POLICIES AND RISKS
This
section should be read in conjunction with each Portfolio’s description in its
prospectus and each Portfolio’s fundamental and non-fundamental investment
policies.
Temporary
Investments Risk.
From time to time, in attempting to respond to adverse market, economic,
political or other conditions, a Portfolio may take temporary defensive
positions that are inconsistent with the Portfolio’s principal investment
strategies and invest all or a part of its assets in defensive investments.
These investments include U.S. government securities and high quality U.S.
dollar-denominated money market securities, including certificates of deposit,
bankers’ acceptances, commercial paper, short-term debt securities and
repurchase agreements. When following a defensive strategy, a Portfolio may not
achieve its investment objective.
General
Risk Factors.
The net asset value (“NAV”) of a Portfolio is expected to fluctuate, reflecting
fluctuations in the market value of its portfolio positions. The value of
fixed-income instruments held by a Portfolio generally fluctuates inversely with
interest rate movements. In other words, bond prices generally fall as interest
rates rise and generally rise as interest rates fall. Longer term bonds held by
a Portfolio, if applicable, are subject to greater interest rate risk. There is
no assurance that a Portfolio will achieve its investment
objective.
Management
Risk.
Each actively managed Portfolio is subject to management risk. The Subadvisers,
as applicable, will apply investment techniques and risk analysis in making
decisions for the Portfolio, but there can be no guarantee that these decisions
will produce the desired results. Furthermore, active trading will increase the
costs a Portfolio incurs because of higher brokerage charges or mark-up charges,
which are passed on to shareholders of the Portfolio and as a result, may lower
the Portfolio’s performance and have a negative tax impact. Additionally,
legislative, regulatory or tax developments may affect the investment techniques
available to the Subadvisers in connection with managing a Portfolio and may
also adversely affect the ability of a Portfolio to achieve its investment
objectives.
Exchange-Traded
Funds.
Each Portfolio may purchase shares of exchange-traded funds (“ETFs”). An
investment in an ETF generally presents the same primary risks as an investment
in a conventional fund (i.e.,
one that is not exchange-traded) that has the same investment objective,
strategies, and policies. The price of an ETF can fluctuate within a wide range,
and a fund could lose money investing in an ETF if the prices of the securities
owned by the ETF go down. In addition, ETFs are subject to the following risks
that do not apply to conventional funds: (1) the market price of the ETF’s
shares may trade at a discount to their NAV; (2) an active trading market for an
ETF’s shares may not develop or be maintained; or (3) trading of an ETF’s shares
may be halted if the listing exchange’s officials deem such action appropriate,
the shares are de-listed from the exchange, or the activation of market-wide
“circuit breakers” (which are tied to large decreases in stock prices) halts
stock trading generally.
Most
ETFs are investment companies. Therefore, a Portfolio’s purchase of ETF shares
generally are subject to the risks of the Portfolio’s investments in other
investment companies, which are described below under the heading “Investment
Companies.”
Repurchase
Agreements.
Each Portfolio may invest in repurchase agreements. A Portfolio will invest in
repurchase agreements in accordance with its fundamental investment
restrictions.
Repurchase
agreements are agreements under which the Portfolio acquires ownership of an
obligation (debt instrument or time deposit) and the seller agrees, at the time
of the sale, to repurchase the obligation at a mutually agreed upon time and
price, thereby determining the yield during the purchaser’s holding period. This
results in a fixed rate of return insulated from market fluctuations during such
period. If the seller of a repurchase agreement fails to repurchase this
obligation in accordance with the terms of the agreement, the Portfolio will
incur a loss to the extent that the proceeds on the sale are less than the
repurchase price. Repurchase agreements usually involve U.S. government or
federal agency securities and, as utilized by the Portfolio, include only those
securities in which the Portfolio may otherwise invest. Repurchase agreements
are for short periods, most often less than 30 days and usually less than one
week. In entering into a repurchase agreement, a fund is exposed to the risk
that the other party to the agreement may be unable to keep its commitment to
repurchase. In that event, the Portfolio may incur disposition costs in
connection with liquidating the collateral (i.e.,
the underlying security). Moreover, if bankruptcy proceedings are commenced with
respect to the selling party, receipt
of
the value of the collateral may be delayed or substantially limited and a loss
may be incurred if the collateral securing the repurchase agreement declines in
value during the bankruptcy proceedings. The Portfolio believes that these risks
are not material inasmuch as the applicable Subadviser will evaluate the
creditworthiness of all entities with which it proposes to enter into repurchase
agreements, and will seek to assure that each such arrangement is adequately
collateralized.
Lending
Portfolio Securities.
The Portfolios may seek additional income by lending their securities on a
short-term basis to banks, brokers and dealers. A Portfolio may return a portion
of the interest earned to the borrower or a third party which is unaffiliated
with the Company and acting as a “placing broker.” The Company has engaged U.S.
Bank, National Association, to serve as the lending agent for the Portfolios. As
securities lending agent, U.S. Bank, National Association, coordinates
securities loan agreements, including negotiating fees, with borrowers,
processes securities movements, marks to market loaned securities and collateral
daily, maintains and monitors the collateral levels, and invests collateral
balances.
The
U.S. Securities and Exchange Commission (the “SEC”) currently requires that the
following lending conditions must be met: (1) a Portfolio must receive at least
100% collateral from the borrower (cash, U.S. government securities, or
irrevocable bank letters of credit); (2) the borrower must increase the
collateral whenever the market value of the loaned securities rises above the
level of such collateral; (3) a Portfolio must be able to terminate the loan at
any time; (4) a Portfolio must receive reasonable interest on the loan, as well
as any dividends, interest or other distributions payable on the loaned
securities, and any increase in market value; (5) a Portfolio may pay only
reasonable custodian fees in connection with the loan; and (6) while voting
rights on the loaned securities may pass to the borrower, the Company’s Board of
Directors (the “Board”) must be able to terminate the loan and regain the right
to vote the securities if a material event adversely affecting the investment
occurs.
Even
though loans of portfolio securities are collateralized, a risk of loss exists
if an institution that borrows securities from a Portfolio breaches its
agreement with the Portfolio and the Portfolio is delayed or prevented from
recovering the collateral.
For
the fiscal year ended December 31,
2023,
the income earned by each Portfolio as well as the fees and/or compensation paid
by each Portfolio (in dollars) were as follows:
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Portfolio |
| Gross
income earned by the Fund from Securities lending activities |
|
Fees
and/or compensation paid by the Fund for securities lending activities and
related services |
|
Aggregate
fees / compensation paid by the Fund for securities lending
activities |
| Net
income from securities lending activities |
Large
Company Growth Portfolio |
| $5,766 |
| $4,579 |
| $4,579 |
| $1,187 |
Large
Company Value Portfolio |
| $10,308 |
| $7,308 |
| $7,308 |
| $3,000 |
Small
Company Growth Portfolio |
| $13,223 |
| $8,017 |
| $8,017 |
| $5,207 |
Small
Company Value Portfolio |
| $8,917 |
| $5,132 |
| $5,132 |
| $3,786 |
Wilshire
5000
IndexSM
Fund |
| $63,721 |
| $34,073 |
| $34,073 |
| $29,648 |
Wilshire
International Equity Fund |
| $24,877 |
| $20,630 |
| $20,630 |
| $4,247 |
Wilshire
Income Opportunities Fund |
| $92,909 |
| $65,579 |
| $65,579 |
| $27,330 |
Reverse
Repurchase Agreements and Other Borrowings.
Certain Portfolios may be authorized to borrow money and may invest in reverse
repurchase agreements. If the securities held by a Portfolio should decline in
value while borrowings are outstanding, the NAV of a Portfolio’s outstanding
shares will decline in value by proportionately more than the decline in value
suffered by the Portfolio’s securities. A Portfolio may borrow through reverse
repurchase agreements under which a Portfolio sells portfolio securities to
financial institutions such as banks and broker-dealers and agrees to repurchase
them at a particular date and price. Reverse repurchase agreements involve the
sale of securities held by a Portfolio with an agreement to repurchase the
securities at an agreed upon price, date and interest payment. If it employs
reverse repurchase agreements, a Portfolio may use the proceeds to purchase
instruments eligible for purchase by the Portfolio. At the time a Portfolio
enters into a reverse repurchase agreement, it will segregate cash, cash
equivalents or any other liquid asset, including equity securities and debt
securities, having a value at least equal to the repurchase price. A Portfolio
will generally utilize reverse repurchase agreements when the interest income to
be earned from the investment of the proceeds of the transactions is greater
than the interest expense incurred as a result of the reverse repurchase
transactions. Reverse repurchase agreements involve the risk that the market
value of securities purchased by a Portfolio with the proceeds of the
transaction may decline below the repurchase price of the securities that a fund
is obligated to repurchase. A Portfolio will invest in reverse repurchase
agreements in accordance with its fundamental investment restrictions and the
limits of the Investment Company Act of 1940, as amended (the “1940 Act”). If
the asset coverage for such borrowings falls below 300%, a Portfolio will
reduce, within three days, the amount of its borrowings to provide for 300%
asset coverage.
Leverage.
Certain Portfolios may use leverage. Leveraging a Portfolio creates an
opportunity for increased net income but, at the same time, creates special risk
considerations. For example, leveraging may exaggerate changes in the NAV of a
Portfolio’s shares and in the yield on the Portfolio’s portfolio. Although the
principal of such borrowings will be fixed, a Portfolio’s assets may change in
value during the time the borrowing is outstanding. Since any decline in value
of a Portfolio’s investments will be borne entirely by the Portfolio’s
shareholders (and not by those persons providing the leverage to the Portfolio),
the effect of leverage in a declining market would be a greater decrease in NAV
than if the Portfolio were not so leveraged. Leveraging will create interest and
other expenses for the Portfolio, which can exceed the investment return from
the borrowed funds. To the extent the investment return derived from securities
purchased with borrowed funds exceeds the interest a Portfolio will have to pay,
the Portfolio’s investment return will be greater than if leveraging were not
used. Conversely, if the investment return from the assets retained with
borrowed funds is not sufficient to cover the cost of leveraging, the investment
return of a Portfolio will be less than if leveraging were not used. Under the
1940 Act, a Portfolio is required to maintain continuous asset coverage of 300%
with respect to borrowings and to sell (within three days) sufficient portfolio
holdings to restore such coverage if it should decline to less than 300% due to
market fluctuations or otherwise, even if such liquidations of the Portfolio’s
holdings may be disadvantageous from an investment standpoint. A Portfolio’s
policy on borrowing is not intended to limit the ability to pledge assets to
secure loans permitted under the Portfolio’s policies.
High-Yield
(High-Risk) Securities.
High-yield (high-risk) securities (hereinafter referred to as “lower-quality
securities”) include (i) bonds rated as low as “C” by Moody’s Investor Service,
Inc. (“Moody’s), Standard & Poor’s Ratings Group (“S&P”) or by Fitch
Ratings Ltd. (“Fitch”); (ii) commercial paper rated as low as “C” by S&P,
“Not Prime” by Moody’s, or “Fitch 4” by Fitch; and (iii) unrated debt
obligations of comparable quality. Lower- quality securities, while generally
offering higher yields than investment grade securities with similar maturities,
involve greater risks, including the possibility of default or bankruptcy. They
are regarded as predominantly speculative with respect to the issuer’s capacity
to pay interest and repay principal. The special risk considerations in
connection with investments in these securities are discussed
below.
Effect
of Interest Rates and Economic Changes. Interest-bearing
securities typically experience appreciation when interest rates decline and
depreciation when interest rates rise. The market values of lower-quality and
comparable unrated securities tend to reflect individual corporate developments
more than do higher-rated securities, which react primarily to fluctuations in
the general level of interest rates. Lower-quality and comparable unrated
securities also tend to be more sensitive to economic conditions than are
higher-rated securities. As a result, they generally involve more credit risks
than securities in the higher-rated categories. During an economic downturn or a
sustained period of rising interest rates, highly leveraged issuers of lower-
quality and comparable unrated securities may experience financial stress and
may not have sufficient funds to meet their payment obligations. The issuer’s
ability to service its debt obligations may also be adversely affected by
specific corporate developments, the issuer’s inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by an issuer of these securities is significantly
greater than by issuers of higher-rated securities because such securities are
generally unsecured and are often subordinated to other creditors. Further, if
the issuer of a lower-quality or comparable unrated security defaulted, a fund
might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of these securities and thus in a Portfolio’s
NAV.
As
previously stated, the value of a lower-quality or comparable unrated security
will generally decrease in a rising interest rate market, and accordingly, so
will a Portfolio’s NAV. If a Portfolio experiences unexpected net redemptions in
such a market, it may be forced to liquidate a portion of its portfolio
securities without regard to their investment merits. Due to the limited
liquidity of lower-quality and comparable unrated securities in the marketplace
(discussed below in “Liquidity and Valuation”), a Portfolio may be forced to
liquidate these securities at a substantial discount. Any such liquidation would
force the Portfolio to sell the more liquid portion of its
portfolio.
Payment
Expectations.
Lower-quality and comparable unrated securities typically contain redemption,
call, or prepayment provisions that permit the issuer of such securities
containing such provisions to, at its discretion, redeem the securities. During
periods of falling interest rates, issuers of these securities are likely to
redeem or prepay the securities and refinance them with debt securities that
have a lower interest rate. To the extent an issuer can refinance the
securities, or otherwise redeem them, a Portfolio may have to replace the
securities with a lower-yielding security, which would result in a lower return
for the Portfolio.
Credit
Ratings.
Credit ratings issued by credit rating agencies are designed to evaluate the
safety of principal and interest payments of rated securities. They do not,
however, evaluate the market value risk of lower-quality securities and,
therefore, may not fully reflect the true risks of an investment. In addition,
credit rating agencies may or may not make timely changes in a rating to reflect
changes in the economy or in the condition of the issuer that affect the market
value of the security. Consequently, credit ratings are used only as a
preliminary indicator of investment quality.
Investments
in lower-quality and comparable unrated obligations may be more dependent on a
subadviser’s credit analysis than would be the case with investments in
investment-grade debt obligations. The Subadvisers to a Portfolio employ their
own credit research and analysis, which includes a study of existing debt,
capital structure, ability to service debt and to pay dividends, the issuer’s
sensitivity to economic conditions, its operating history, and the current trend
of earnings. The Subadvisers monitor the applicable Portfolio’s investments and
carefully evaluate whether to dispose of or to retain lower-quality and
comparable unrated securities whose credit ratings or credit quality may have
changed.
Liquidity
and Valuation.
Certain Portfolios may have difficulty disposing of certain lower-quality and
comparable unrated securities because there may be a thin trading market for
such securities. Because not all dealers maintain markets in all lower-quality
and comparable unrated securities, there is no established retail secondary
market for many of these securities. Such securities could be sold only to a
limited number of dealers or institutional investors. To the extent a secondary
trading market does exist, it is generally not as liquid as the secondary market
for higher-rated securities. The lack of a liquid secondary market may have an
adverse impact on the market price of the security. As a result, a Portfolio’s
NAV and ability to dispose of particular securities, when necessary to meet a
Portfolio’s liquidity needs or in response to a specific economic event, may be
impacted. The lack of a liquid secondary market for certain securities may also
make it more difficult for a Portfolio to obtain accurate market quotations for
purposes of valuing the Portfolio’s Investments. Market quotations are generally
available on many lower-quality and comparable unrated issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales. During periods of thin trading, the spread
between bid and asked prices is likely to increase significantly. In addition,
adverse publicity and investor perception, whether or not based on fundamental
analysis, may decrease the values and liquidity of lower-quality and comparable
unrated securities, especially in a thinly traded market.
Restricted
Securities.
Certain Portfolios may invest in restricted securities. Restricted securities
cannot be sold to the public without registration under the Securities Act of
1933, as amended (the “1933 Act”). Unless registered for sale, restricted
securities can be sold only in privately negotiated transactions or pursuant to
an exemption from registration. Restricted securities may be considered illiquid
and, therefore, are subject to a Portfolio’s limitation on illiquid
securities.
Restricted
securities may involve a high degree of business and financial risk which may
result in substantial losses. The securities 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 for by a Portfolio. A Portfolio may invest in restricted
securities, including securities initially offered and sold without registration
pursuant to Rule 144A (“Rule 144A Securities”) and securities of U.S. and
non-U.S. issuers initially offered and sold outside the United States without
registration with the SEC pursuant to Regulation S (“Regulation S Securities”)
under the 1933 Act. Rule 144A Securities. Regulation S Securities generally may
be traded freely among certain qualified institutional investors, such as a
Portfolio, and non-U.S. persons, but resale to a broader base of investors in
the United States may be permitted only in significantly more limited
circumstances. A qualified institutional investor is defined by Rule 144A
generally as an institution, acting for its own account or for the accounts of
other qualified institutional investors, that in the aggregate owns and invests
on a discretionary basis at least $100 million in securities of issuers not
affiliated with the institution. A dealer registered under the Securities
Exchange Act of 1934, as amended (“1934 Act”), acting for its own account or the
accounts of other qualified institutional investors, that in the aggregate owns
and invests on a discretionary basis at least $10 million in securities of
issuers not affiliated with the dealer may also qualify as a qualified
institutional investor, as well as a 1934 Act registered dealer acting in a
riskless principal transaction on behalf of a qualified institutional
investor.
Certain
Portfolios also may purchase restricted securities that are not eligible for
resale pursuant to Rule 144A or Regulation S. A Portfolio may acquire such
securities through private placement transactions, directly from the issuer or
from security holders, generally at higher yields or on terms more favorable to
investors than comparable publicly traded securities. However, the restrictions
on resale of such securities may make it difficult for a Portfolio to dispose of
such securities at the time considered most advantageous and/or may involve
expenses that would not be incurred in the sale of securities that were freely
marketable. Risks associated with restricted securities include the potential
obligation to pay all or part of the registration expenses in order to sell
certain restricted securities. A considerable period of time may elapse between
the time of the decision to sell a security and the time a Portfolio may be
permitted to sell it under an effective registration statement. If, during a
period, adverse conditions were to develop, a Portfolio might obtain a less
favorable price than prevailing when it decided to sell.
Warrants
and Rights. Certain
Portfolios may invest in warrants and rights. Warrants are instruments that
provide the owner with the right to purchase a specified security, usually an
equity security such as common stock, at a specified price (usually representing
a premium over the applicable market value of the underlying equity security at
the time of the warrant’s issuance) and usually during a specified period of
time. While warrants may be traded, there is often no secondary market for them.
Moreover, they are usually issued by the issuer of the security to which they
relate. Warrants do not have any inherent value. To the extent that the market
value of the security that may be purchased upon exercise of the warrant rises
above the exercise price, the value of the warrant will tend to rise. To the
extent that the exercise price equals or exceeds the market value of such
security, the warrants will have little or no market value. If warrants remain
unexercised at the end of the specified exercise period, they lapse and a
Portfolio’s investment in them will be lost. Rights are similar to warrants, but
generally are shorter in duration and are distributed by the issuer directly to
its shareholders. Warrants and rights have no voting rights, receive no
dividends and have no rights to the assets of the issuer.
Convertible
Preferred Stocks and Debt Securities.
Certain Portfolios may invest in convertible preferred stock and debt
securities. Certain preferred stocks and debt securities include conversion
features allowing the holder to convert securities into another specified
security (usually common stock) of the same issuer at a specified conversion
ratio (e.g.,
two shares of preferred for one share of common stock) at some specified future
date or period. The market value of convertible securities generally includes a
premium that reflects the conversion right. That premium may be negligible or
substantial. To the extent that any preferred stock or debt security remains
unconverted after the expiration of the conversion period, the market value will
fall to the extent represented by that premium.
Preferred
Equity Redemption Cumulative Stock.
Certain Portfolios may invest in preferred equity redemption cumulative stock.
Preferred equity redemption cumulative stock (“PERCS”) is a form of convertible
preferred stock which automatically converts into shares of common stock on a
predetermined conversion date. PERCS pays a fixed annual dividend rate which is
higher than the annual dividend rate of the issuing company’s common stock.
However, the terms of PERCS limit an investor’s ability to participate in the
appreciation of the common stock (usually capped at approximately 40%).
Predetermined redemption dates and prices set by the company upon the issuance
of the securities provide the mechanism for limiting the price appreciation of
PERCS.
Preferred
Stock.
A Portfolio may invest in preferred stock. Preferred stock, unlike common stock,
offers a stated dividend rate payable from a corporation’s earnings. Such
preferred stock dividends may be cumulative or noncumulative, participating or
auction rate. If interest rates rise, the fixed dividend on preferred stocks may
be less attractive, causing the price of preferred stocks to decline. Preferred
stock may have mandatory sinking fund provisions, as well as call/redemption
provisions prior to maturity, a negative feature when interest rates decline.
Dividends on some preferred stock may be “cumulative,” requiring all or a
portion of prior unpaid dividends to be paid before dividends are paid on the
issuer’s common stock. Preferred stock also generally has a preference over
common stock on the distribution of a corporation’s assets in the event of
liquidation of the corporation, and may be “participating,” which means that it
may be entitled to a dividend exceeding the stated dividend in certain cases.
The rights of preferred stocks on the distribution of a corporation’s assets in
the event of a liquidation are generally subordinate to the rights associated
with a corporation’s debt securities.
Adjustable
Rate Mortgage Securities.
Certain Portfolios may invest in adjustable rate mortgage securities, (“ARMs”),
which are pass-through mortgage securities collateralized by mortgages with
adjustable rather than fixed rates. ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index. ARMs contain maximum and
minimum rates beyond which the mortgage interest rate may not vary over the
lifetime of the security. In addition, certain ARMs provide for limitations on
the maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. Alternatively, certain ARMs contain limitations on changes in
the required monthly payment. In the event that a monthly payment is not
sufficient to pay the interest accruing on an ARM, any such excess interest is
added to the principal balance of the mortgage loan, which is repaid through
future monthly payments. If the monthly payment for such an instrument exceeds
the sum of the interest accrued at the applicable mortgage interest rate and the
principal payment required at such point to amortize the outstanding principal
balance over the remaining term of the loan, the excess is utilized to reduce
the then-outstanding principal balance of the ARM.
Types
of Credit Enhancement.
Mortgage-backed securities (“MBS”) and asset-backed securities (“ABS”) are often
backed by a pool of assets representing the obligations of a number of different
parties. To lessen the effect of failures by obligors on underlying assets to
make payments, these securities may contain elements of credit support which
fall into two categories: (i) liquidity protection and (ii) protection against
losses resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to seek to ensure that the receipt of
payments on the underlying pool occurs in a timely fashion. Protection against
losses resulting from default seeks to ensure ultimate payment of the
obligations on at least a portion of the assets in the pool. This protection may
be provided through guarantees, insurance policies or letters of credit obtained
by the issuer or sponsor from third parties, through various means of
structuring the transaction or through a combination of such approaches. The
degree of credit support provided for each issue is generally based on
historical information respecting the level of credit risk associated with the
underlying assets. Delinquencies or losses in excess of those anticipated could
adversely affect the return on an investment in a security. A Portfolio will not
pay any additional fees for credit support, although the existence of credit
support may increase the price of a security. Certain types of structured
products may also have structural features, including diversions of cash flow,
waterfalls, over-collateralization and other performance tests, and triggers,
that may provide credit protection.
Foreign
Securities.
Certain Portfolios may invest in foreign securities. Investors should recognize
that investing in foreign securities involves certain special considerations,
including those set forth below, which are not typically associated with
investing in U.S. securities and which may favorably or unfavorably affect a
Portfolio’s performance. As foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to domestic companies, there may be
less publicly available information about a foreign company than about a
domestic company. Many foreign securities markets, while growing in volume of
trading activity, have substantially less volume than the U.S. market, and
securities of some foreign issuers are less liquid and more volatile than
securities of domestic issuers. Similarly, volume and liquidity in most foreign
bond markets is less than in the U.S. and, at times, volatility of prices can be
greater than in the United States. Fixed commissions on some foreign securities
exchanges and bid-to-asked spreads in foreign bond markets are generally higher
than commissions or bid-to-asked spreads on U.S. markets, although a Portfolio
will endeavor to achieve the most favorable net results on its portfolio
transactions. There is generally less government supervision and regulation of
securities exchanges, brokers and listed companies than in the U.S. It may be
more difficult for a Portfolio’s agents to keep currently informed about
corporate actions which may affect the prices of portfolio securities.
Communications between the United States and foreign countries may be less
reliable than within the United States, thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. Payment for securities without delivery may be required in certain
foreign markets. In addition, with respect to certain foreign countries, there
is the possibility of expropriation or confiscatory taxation, political or
social instability or diplomatic
developments
which could affect U.S. investments in those countries. Russia’s assertion of
influence in its surrounding region, including its invasion of Ukraine,
increases the likelihood of additional sanctions by the United States and other
countries or the imposition of sanctions by additional countries, which may
cause volatility in the markets. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position. The management of a Portfolio
seeks to mitigate the risks associated with the foregoing considerations through
continuous professional management.
Each
Portfolio may invest in securities of foreign issuers that trade on U.S.
exchanges. These investments may include American Depositary Receipts (“ADRs”).
ADRs are dollar-denominated receipts issued generally by U.S. banks and which
represent the deposit with the bank of a foreign company’s securities. ADRs are
publicly traded on exchanges or over-the-counter (“OTC”) in the United States.
Investors should consider carefully the substantial risks involved in investing
in securities issued by companies of foreign nations, which are in addition to
the usual risks inherent in domestic investments. ADRs, European Depositary
Receipts (“EDRs”) and Global Depositary Receipts (“GDRs”) or other securities
convertible into securities of issuers based in foreign countries are not
necessarily denominated in the same currency as the securities into which they
may be converted. In general, ADRs, in registered form, are denominated in U.S.
dollars and are designed for use in the U.S. securities markets, while EDRs
(also referred to as Continental Depositary Receipts (“CDRs”)), in bearer form,
may be denominated in other currencies and are designed for use in European
securities markets. ADRs are receipts typically issued by a U.S. bank or trust
company evidencing ownership of the underlying securities. EDRs are European
receipts evidencing a similar arrangement. GDRs are global receipts evidencing a
similar arrangement. For purposes of each Portfolio’s investment policies, ADRs,
EDRs and GDRs usually are deemed to have the same classification as the
underlying securities they represent. Thus, an ADR, EDR or GDR representing
ownership of common stock will be treated as common stock.
Depositary
receipts are issued through “sponsored” or “unsponsored” facilities. A sponsored
facility is established jointly by the issuer of the underlying security and a
depositary, whereas a depositary may establish an unsponsored facility without
participation by the issuer of the deposited security. Holders of unsponsored
depositary receipts generally bear all the cost of such facilities, and the
depositary of an unsponsored facility frequently is under no obligation to
distribute shareholder communications received from the issuer of the deposited
security or to pass through voting rights to the holders of such receipts in
respect of the deposited securities. As a result, available information
regarding the issuer may not be as current as for sponsored ADRs, and the prices
of unsponsored ADRs may be more volatile than if they were sponsored by the
issuers of the underlying securities.
Emerging
Markets Securities.
Certain Portfolios may each invest in emerging markets securities. Emerging
markets securities are fixed income and equity securities of foreign companies
domiciled, headquartered, or whose primary business activities or principal
trading markets are located in emerging and less developed markets (“emerging
markets”). Investments in emerging markets securities involve special risks in
addition to those generally associated with foreign investing. Many investments
in emerging markets can be considered speculative, and the value of those
investments can be more volatile than investments in more developed foreign
markets. This difference reflects the greater uncertainties of investing in less
established markets and economies. Costs associated with transactions in
emerging markets securities typically are higher than costs associated with
transactions in U.S. securities. Such transactions also may involve additional
costs for the purchase or sale of foreign currency. Certain foreign markets
(including emerging markets) may require governmental approval for the
repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. A Portfolio could be adversely affected by
delays in, or a refusal to grant, required governmental approval for
repatriation of capital, as well as by the application of any restrictions on
investments. Many emerging markets have experienced substantial rates of
inflation for extended periods. Inflation and rapid fluctuations in inflation
rates have had and may continue to have adverse effects on the economies and
securities markets of certain emerging market countries. Governments of many
emerging market countries have exercised and continue to exercise substantial
influence over many aspects of the private sector through ownership or control
of many companies. The future actions of those governments could have a
significant effect on economic conditions in emerging markets, which, in turn,
may adversely affect companies in the private sector, general market conditions
and prices and yields of certain of the securities in a Portfolio’s portfolio.
Expropriation, confiscatory taxation, nationalization and political, economic
and social instability have occurred throughout the history of certain emerging
market countries and could adversely affect a Portfolio’s assets should any of
those conditions recur. In addition, the securities laws of emerging market
countries may be less developed than those to which U.S. issuers are
subject.
Brady
Bonds.
Certain Portfolios may invest in “Brady Bonds,” which are debt restructurings
that provide for the exchange of cash and loans for newly issued bonds. Brady
Bonds are securities created through the exchange of existing commercial bank
loans to public and private entities in certain emerging markets for new bonds
in connection with debt restructuring. Brady Bonds may be collateralized or
uncollateralized, are issued in various currencies (primarily the U.S. dollar)
and are actively traded in the secondary market for Latin American debt. U.S.
dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are collateralized in full as to
principal by U.S. Treasury zero coupon bonds having the same maturity as the
bonds. Interest payments on such 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 the time and is adjusted at regular intervals
thereafter.
Forward
Foreign Currency Exchange Contracts.
Certain Portfolios may invest in foreign currencies. Forward foreign currency
exchange contracts involve an obligation to purchase or sell a specified
currency at a future date at a price set at the time of the contract. Forward
currency contracts do not eliminate fluctuations in the values of Portfolio
securities but rather allow a Portfolio to establish a rate of exchange for a
future point in time. A Portfolio may use forward foreign currency exchange
contracts to hedge against movements in the value of foreign currencies
(including the “Euro” used by certain European Countries) relative to the U.S.
dollar in connection with specific Portfolio transactions or with respect to its
positions.
Dollar
Roll Transactions.
Certain Portfolios may engage in dollar roll transactions, which consist of the
sale by the Portfolio to a bank or broker/dealer (the “counterparty”) of the
Government National Mortgage Association (“GNMA”) certificates or other MBS
together with a commitment to purchase from the counterparty similar, but not
identical, securities at a future date, at the same price. The counterparty
receives all principal and interest payments, including prepayments, made on the
security while it is the holder. A Portfolio receives a fee from the
counterparty as consideration for entering into a commitment to purchase. Dollar
rolls may be renewed over a period of several months with a different purchase
and repurchase price fixed and a cash settlement made at each renewal without
physical delivery of securities. Moreover, the transaction may be preceded by a
firm commitment agreement pursuant to which a Portfolio agrees to buy a security
on a future date. The security sold by a Portfolio that is subject to repurchase
at such future date may not be an existing security in the Portfolio’s holdings.
As part of a dollar roll transaction, this is not considered to be a short sale
event.
Dollar
rolls may be treated for purposes of the 1940 Act as borrowings of a Portfolio
because they involve the sale of a security coupled with an agreement to
repurchase. A dollar roll involves costs to a Portfolio. For example, while a
Portfolio receives a fee as consideration for agreeing to repurchase the
security, the Portfolio forgoes the right to receive all principal and interest
payments while the counterparty holds the security. These payments to the
counterparty may exceed the fee received by a Portfolio, thereby effectively
charging the Portfolio interest on its borrowing. Further, although a Portfolio
can estimate the amount of expected principal prepayment over the term of the
dollar roll, a variation in the actual amount of prepayment could increase or
decrease the cost of the Portfolio’s borrowing.
The
entry into dollar rolls involves potential risks of loss that are different from
those related to the securities underlying the transactions. For example, if the
counterparty becomes insolvent, a Portfolio’s right to purchase from the
counterparty might be restricted. Additionally, the value of such securities may
change adversely before a Portfolio is able to purchase them. Similarly, a
Portfolio may be required to purchase securities in connection with a dollar
roll at a higher price than may otherwise be available on the open market.
Since, as noted above, the counterparty is required to deliver a similar, but
not identical security to a Portfolio, the security that is required to buy
under the dollar roll may be worth less than an identical security. Finally,
there can be no assurance that a Portfolio’s use of the cash that it receives
from a dollar roll will provide a return that exceeds borrowing
costs.
Strategic
Transactions and Derivatives.
Certain Portfolios may, but are not required to, utilize various other
investment strategies as described below to hedge various market risks (such as
interest rates and broad or specific equity or fixed-income market movements),
to manage the effective maturity or duration of fixed-income securities in the
Portfolio’s portfolio or to enhance potential gain. These strategies may be
executed using derivative contracts. Such strategies are generally accepted as a
part of modern portfolio management and are regularly utilized by many mutual
funds and other institutional investors. Techniques and instruments may change
over time as new instruments and strategies are developed or regulatory changes
occur.
In
the course of pursuing these investment strategies, a Portfolio may purchase and
sell exchange-listed and OTC put and call options on securities, equity and
fixed-income indices and other financial instruments, purchase and sell
financial futures contracts and options thereon; enter into various interest
rate transactions such as swaps, caps floors or collars; and enter into various
currency transactions such as currency forward contracts, currency futures
contracts, currency swaps or options on currencies or currency futures
(collectively, all the above are called “Strategic Transactions”). Strategic
Transactions may be used without limit to attempt to protect against possible
changes in the market value of securities held in or to be purchased for a
Portfolio’s unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes, to manage the
effective maturity or duration of fixed-income securities in the Portfolio’s
portfolio or to establish a position in the derivatives markets as a temporary
substitute for purchasing or selling particular securities. Some Strategic
Transactions may also be used to enhance potential gain. Any or all of these
investment techniques may be used at any time and in any combination, and there
is no particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous variables
including market conditions. The ability of a Portfolio to utilize these
Strategic Transactions successfully will depend on a Subadviser’s ability to
predict pertinent market movements, which cannot be assured. The Portfolios will
comply with applicable regulatory requirements when implementing these
strategies, techniques and instruments. Certain Portfolios may use Strategic
Transactions for non-hedging purposes to enhance potential gain.
Strategic
Transactions, including derivative contracts, have risks associated with them,
including possible default by the other party to the transaction, illiquidity
and, to the extent a Subadviser’s view as to certain market movements is
incorrect, the risk that the use of such Strategic Transactions could result in
losses greater than if they had not been used. Use of put and call options may
result in losses to a Portfolio, force the sale or purchase of portfolio
securities at inopportune times or for prices higher than (in the case of put
options) or lower than (in the case of call options) current market values,
limit the amount of appreciation the Portfolio can realize on its investments or
cause a Portfolio to hold a security it might otherwise sell. The use of
currency transactions can result in a fund
incurring
losses as a result of a number of factors including the imposition of exchange
controls, suspension of settlements or the inability to deliver or receive a
specified currency. The use of options and futures transactions entails certain
other risks. In particular, the variable degree of correlation between price
movements of futures contracts and price movements in the related portfolio
position of a Portfolio creates the possibility that losses on the hedging
instrument may be greater than gains in the value of the Portfolio’s position.
In addition, futures and options markets may not be liquid in all circumstances
and OTC options may have no markets. As a result, in certain markets, a fund
might not be able to close out a transaction without incurring substantial
losses, if at all. Although the use of futures and options transactions for
hedging should tend to minimize the risk of loss due to a decline in the value
of the hedged position, at the same time it tends to limit any potential gain
which might result from an increase in value of such position. Finally, the
daily variation margin requirements for futures contracts would create a greater
ongoing potential financial risk than would purchases of options, where the
exposure is limited to the cost of the initial premium. Losses resulting from
the use of Strategic Transactions would reduce NAV, and possibly income, and
such losses can be greater than if the Strategic Transactions had not been
utilized.
In
addition to the instruments and strategies discussed in this section, a
Subadviser may discover additional opportunities in connection with derivatives,
strategic transactions and other similar or related techniques. These new
opportunities may become available as a Subadviser develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
derivatives, strategic transactions and other techniques are developed. A
Subadviser may utilize these opportunities and techniques to the extent that
they are consistent with a Portfolio’s respective investment objective and
investment limitations and applicable regulatory authorities. These
opportunities and techniques may involve risks different from, or in addition
to, those summarized herein.
This
discussion is not intended to limit a Portfolio’s investment flexibility, unless
such a limitation is expressly stated, and therefore will be construed by the
Portfolio as broadly as possible. Statements concerning what a Portfolio may do
are not intended to limit any other activity. Also, as with any investment or
investment technique, even when the prospectus or this discussion indicates that
a Portfolio may engage in an activity, it may not actually do so for a variety
of reasons, including cost considerations.
Derivatives.
Each Portfolio may invest in “derivatives.” These are financial instruments
which derive their performance at least in part, from the performance of an
underlying asset, index or interest rate. The derivatives a Portfolio may use
are currently comprised of stock index futures and options. A Portfolio may
invest in derivatives for a variety of reasons, including to hedge against
certain market risks, to provide a substitute for purchasing or selling
particular securities or to increase potential income gain. Derivatives may
provide a cheaper, quicker or more specifically focused way for a Portfolio to
invest than “traditional” securities.
Although
certain Portfolios do not currently intend to invest in derivatives, a Portfolio
may do so in the future.
Derivatives
permit a Portfolio to increase, decrease or change the level of risk to which
its securities are exposed in much the same way as a Portfolio can increase,
decrease or change the risk of its investments by making investments in specific
securities. However, derivatives can be volatile and involve various types and
degrees of risk, depending upon the characteristics of the particular derivative
and a Portfolio as a whole. Under certain market conditions, they can increase
the volatility of a Portfolio’s NAV, decrease the liquidity of a Portfolio’s
investments and make more difficult the accurate pricing of a Portfolio’s
shares.
In
addition, derivatives may entail investment exposures that are greater than
their cost would suggest, meaning that a small investment in derivatives could
have a large potential impact on a Portfolio’s performance. If a Portfolio
invests in derivatives at inappropriate times or judges market conditions
incorrectly, such investments may lower a Portfolio’s return or result in a
loss. A Portfolio also could experience losses if its derivatives were poorly
correlated with its other investments, or if a Portfolio were unable to
liquidate its position because of an illiquid secondary market. The market for
many derivatives is, or suddenly can become, illiquid. Changes in liquidity may
result in significant, rapid and unpredictable changes in the prices for
derivatives.
Derivatives
may be purchased on established exchanges (“exchange-traded” derivatives) or
through privately negotiated transactions (OTC derivatives). Exchange-traded
derivatives generally are guaranteed by the clearing agency which is the issuer
or counterparty to such derivatives. This guarantee usually is supported by a
daily payment system operated by the clearing agency in order to reduce overall
credit risk. As a result, unless the clearing agency defaults, there is
relatively little counterparty credit risk associated with derivatives purchased
on an exchange. By contrast, no clearing agency guarantees OTC derivatives.
Therefore, each party to an OTC derivative transaction bears the risk that the
counterparty will default. Accordingly, a Subadviser will consider the
creditworthiness of counterparties to OTC derivative transactions in the same
manner as it would review the credit quality of a security to be purchased by a
Portfolio. OTC derivatives are less liquid than exchange-traded derivatives
since the other party to the transaction may be the only investor with
sufficient understanding of the derivative to be interested in bidding for
it.
Other
Derivatives.
A Portfolio may take advantage of opportunities in futures contracts and any
other derivatives which presently are not contemplated for use by the Portfolio
or which currently are not available but which may be developed, to the extent
such opportunities are both consistent with the Portfolio’s investment objective
and legally permissible for the Portfolio. Before entering into such
transactions or making any such investment, the Company will provide appropriate
disclosure in its prospectus or SAI.
General
Characteristics of Options.
The Portfolios may invest in options. Put options and call options typically
have similar structural characteristics and operational mechanics regardless of
the underlying instruments on which they are purchased or sold. Thus, the
following
general discussion relates to each of the particular types of options discussed
in greater detail below. In addition, many Strategic Transactions involving
options require segregation of Portfolio assets in special
accounts.
A
put option gives the purchaser of the option, upon payment of a premium, the
right to sell, and the writer the obligation to buy, the underlying security,
commodity, index, currency or other instrument at the exercise price. For
instance, a Portfolio’s purchase of a put option on a security might be designed
to protect its holdings in the underlying instrument (or, in some cases, a
similar instrument) against a substantial decline in the market value by giving
the fund, the right to sell such instrument at the option exercise price. A call
option, upon payment of a premium, gives the purchaser of the option the right
to buy, and the seller the obligation to sell, the underlying instrument at the
exercise price. A Portfolio’s purchase of a call option, on a security,
financial future, index, currency or other instrument might be intended to
protect the Portfolio against an increase in the price of the underlying
instrument that it intends to purchase in the future by fixing the price at
which it may purchase such instrument. An American-style put or call option may
be exercised at any time during the option period thereto. A Portfolio may
purchase and sell exchange-listed options and OTC options. Exchange-listed
options are issued by a regulated intermediary such as the Options Clearing
Corporation (“OCC”), which guarantees the performance of the obligations of the
parties to such options. The discussion below uses the OCC as an example, but is
also applicable to other financial intermediaries.
With
certain exceptions, OCC issued and exchange listed options generally settle by
physical delivery of the underlying security or currency, although in the future
cash settlement may become available. Index options and Eurodollar instruments
are cash settled for the net amount, if any, by which the option is
“in-the-money” (i.e.,
where the value of the underlying instrument exceeds, in the case of a call
option, or is less than, in the case of a put option, the exercise price of the
option) at the time the option is exercised. Frequently, rather than taking or
making delivery of the underlying instrument through the process of exercising
the option, listed options are closed by entering into offsetting purchase or
sale transactions that do not result in ownership of the underlying
instrument.
A
Portfolio’s ability to close out its position as a purchaser or seller of an OCC
or exchange listed put or call option is dependent, in part, upon the liquidity
of the option market. Among the possible reasons for the absence of a liquid
option market on an exchange are: (i) insufficient trading interest in certain
options; (ii) restrictions on transactions imposed by an exchange; (iii) trading
halts, suspensions or other restrictions imposed with respect to particular
classes or series of options or underlying securities including reaching daily
price limits; (iv) interruption of the normal operations of the OCC or an
exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options for a particular class or series of options,
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The
hours of trading for listed options may not coincide with the hours during which
the underlying financial instruments are traded. To the extent that the option
markets close before the markets for the underlying financial instruments,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the option markets.
OTC
options are purchased from or sold to securities dealers, financial
institutions, or other parties (collectively “Counterparties”) through direct
bilateral agreement with the Counterparty. In contracts to exchange listed
options, which generally have standardized terms and performance mechanics, all
the terms of an OTC option, including such terms as method of settlement, term,
exercise price, premium, guarantees and security, are set by negotiation of the
parties. The Portfolios expect generally to enter into OTC options that have
cash settlement provisions, although they are not required to do
so.
Unless
the parties provide for it, there is no central clearing or guaranty function in
an OTC option. As a result, if the Counterparty fails to make or take delivery
of the security, currency or other instrument underlying an OTC option it has
entered into with the Portfolio fails to make a cash settlement payment due in
accordance with the terms of that option, the Portfolio will lose any premium it
paid for the option as well as any anticipated benefit of the transaction.
Accordingly, the Subadviser or Adviser must assess the creditworthiness of each
such Counterparty or any guarantor or credit enhancement of the Counterparty’s
credit to determine the likelihood that the terms of the OTC option will be
satisfied. The staff of the SEC currently takes the position that OTC options
purchased by the Portfolio, and portfolio securities “covering” the amount of
the Portfolio’s obligation pursuant to an OTC option sold by it (the cost of the
sell-back plus the in-the-money amount, if any), are illiquid, and may be
subject to the Portfolio’s, limitation on investing in illiquid securities. If
the Portfolio exceeds the limits specified above, the Portfolio will take prompt
steps to reduce its holdings in illiquid securities.
If
a Portfolio sells a call option, the premium that it receives may serve as a
partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio, or will
increase the Portfolio’s income. The sale of put options can also provide
income. A Portfolio may purchase and sell call options on securities including
U.S. Treasury and agency securities, MBS, corporate debt securities, equity
securities (including convertible securities) and Eurodollar instruments that
are traded on U.S. and foreign securities exchanges and in the OTC markets, and
on securities, indices, currencies and futures contracts. All calls sold by the
Portfolio must be “covered” (i.e.,
the Portfolio, must own the securities or futures contract subject to the call).
Even though the Portfolio will receive the option premium to help protect it
against loss, a call sold by the Portfolio exposes the Portfolio during the term
of the option to possible loss of opportunity to realize appreciation in the
market price of the underlying security or instrument and may require the fund
to hold a security or instrument which it might otherwise have
sold.
A
Portfolio may purchase and sell put options on securities including U.S.
Treasury and agency securities, MBS, foreign sovereign debt, corporate debt
securities (including convertible securities) and Eurodollar instruments
(whether or not it holds the above securities in its portfolio), and on
securities indices, currencies and futures contracts other than futures on
individual corporate debt and individual equity securities. The Portfolio will
sell put options in accordance with the 1940 Act. In selling put options, there
is a risk that the Portfolio may be required to buy the underlying security at a
disadvantageous price above the market price.
When
a Portfolio purchases a put option, the premium paid by it is recorded as an
asset of the Portfolio. When a Portfolio writes an option, an amount equal to
the net premium (the premium less the commission) received by the Portfolio is
included in the liability section of the Portfolio’s statement of assets and
liabilities as a deferred credit. The amount of this asset or deferred credit
will be subsequently marked to market to reflect the current value of the option
purchased or written. The current value of the traded option is the last sale
price or, in the absence of sale, the mean between the last bid and asked price.
If an option purchased by the Portfolio expires unexercised, the Portfolio
realizes a loss equal to the premium paid. If the Portfolio enters into a
closing sale transaction on an option purchased by it, the Portfolio will
realize a gain if the premium received by the Portfolio on the closing
transaction is more than the premium paid to purchase the option, or a loss if
it is less. If an option written by the Portfolio expires on the stipulated
expiration date or if the Portfolio enters into a closing purchase transaction,
it will realize a gain (or loss if the cost of a closing purchase transaction
exceeds the net premium received when the option is sold) and the deferred
credit related to such option will be eliminated. If an option written by the
Portfolio is exercised, the proceeds of the sale will be increased by the net
premium originally received and the Portfolio will realize a gain or
loss.
There
are several risks associated with transactions in options on securities and
indexes. For example, there are significant differences between the securities
and options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. In addition,
a liquid secondary market for particular options, whether traded OTC or on a
national securities exchange (an “Exchange”), may be absent for reasons which
include the following: there may be insufficient trading interest in certain
options; restrictions may be imposed by an Exchange on opening transactions or
closing transactions or both; trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options or
underlying securities; unusual or unforeseen circumstances may interrupt normal
operations on an Exchange; the facilities of an Exchange or the OCC may not at
all times be adequate to handle current trading volume; or one or more Exchanges
could, for economic or other reasons, decide or be compelled at some future date
to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that class
or series of options) would cease to exist, although outstanding options that
had been issued by the OCC as a result of trades on that Exchange would continue
to be exercisable in accordance with their terms.
General
Characteristics of Futures.
The Portfolios may enter into financial futures contracts or purchase or sell
put and call options on such futures primarily as a hedge against anticipated
interest rate, currency or equity market changes, for duration management and
for risk management purposes. The Portfolios may also engage in futures for
speculative purposes. Futures are generally bought and sold on the commodities
exchanges where they are listed with payment of initial and variation margin as
described below.
The
sale of a futures contract creates a firm obligation by the Portfolio, as
seller, to deliver to the buyer the specific type of financial instrument called
for in the contract at a specific future time for a specified price (or, with
respect to index futures and Eurodollar instruments, the net cash amount).
Options on futures contracts are similar to options on securities except that an
option on a futures contract gives the purchaser the right in return for the
premium paid to assume a position in a futures contract and obligates the seller
to deliver such position.
A
Portfolio’s use of financial futures and options thereon will be consistent with
applicable regulatory requirements and in particular the rules and regulations
of the Commodity Futures Trading Commission (the “CFTC”). Typically, maintaining
a futures contract or selling an option thereon requires a fund to deposit with
a financial intermediary as security for its obligations an amount of cash or
other specified assets (initial margin) which initially is typically 1% to 10%
of the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets (variation margin) may be required to be deposited
thereafter on a daily basis as the mark-to-market value of the contract
fluctuates. The purchase of an option on financial futures involves payment of a
premium for the option without any further obligation on the part of the
Portfolio. If the Portfolio exercises an option on a futures contract, it will
be obligated to post initial margin (and potential subsequent variation margin)
for the resulting futures position just as it would for any position. Futures
contracts and options thereon are generally settled by entering into an
offsetting transaction, but there can be no assurance that the position can be
offset prior to settlement at an advantageous price, nor that delivery will
occur.
Wilshire
is registered with the National Futures Association as a commodity pool operator
(“CPO”) and commodity trading advisor (“CTA”) under the Commodity Exchange Act
of 1936 (“CEA”). Rule 4.5 under the CEA permits an investment company registered
under the Investment Company Act of 1940, as amended, to rely on an exclusion
from registration under the CEA as a commodity pool. Among other conditions,
under amended Rule 4.5, the adviser to a registered investment company can claim
exclusion only if the registered investment company uses commodity interests,
such as commodity futures and commodity options, solely for “bona fide hedging
purposes,” or limits its use of commodity interests not used solely for bona
fide hedging purposes to certain minimal amounts. Wilshire has filed a notice of
eligibility for exclusion from registration as a commodity pool on behalf
of
the Large Company Growth Portfolio, Large Company Value Portfolio, International
Fund, and Income Fund.
If a
Portfolio
no longer qualifies for the exclusion,
that
Portfolio would be subject to regulations as a commodity pool under the CEA and
the Adviser would need to register as the CPO to the Portfolio.
Options
on Securities Indices and Other Financial Indices.
The Portfolios also may purchase and sell call and put options on securities
indices and other financial indices and in so doing can achieve many of the same
objectives they would achieve through the sale or purchase of options on
individual securities or other instruments. Options on securities indices and
other financial indices are similar to options on a security or other instrument
except that, rather than settling by physical delivery of the underlying
instrument, they settle by cash settlement (i.e., an option on an index gives
the holder the right to receive, upon exercise of the option, an amount of cash
if the closing level of the index upon which the option is based exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of the
option (except if, in the case of an OTC option, physical delivery is
specified)). This amount of cash is equal to the excess of the closing price of
the index over the exercise price of the option, which also may be multiplied by
a formula value. The seller of the option is obligated, in return for the
premium received, to make delivery of this amount. The gain or loss on an option
on an index depends on price movements in the instruments making up the market,
market segment, industry or other composite on which the underlying index is
based, rather than price movements in individual securities, as is the case with
respect to options on securities.
Synthetic
Investment Risk.
Certain Portfolios may be exposed to certain additional risks should a
Subadviser use derivatives transactions to synthetically implement a Portfolio’s
investment strategies. Customized derivative instruments will likely be highly
illiquid, and it is possible that a Portfolio will not be able to terminate such
derivative instruments prior to their expiration date or that the penalties
associated with such a termination might impact a Portfolio’s performance in a
materially adverse manner. Synthetic investments may be imperfectly correlated
to the investment a Subadviser is seeking to replicate. There can be no
assurance that a Subadviser’s judgments regarding the correlation of any
particular synthetic investment will be correct. A Portfolio may be exposed to
certain additional risks associated with derivatives transactions should a
Subadviser use derivatives to synthetically implement the Portfolio’s investment
strategies. A Portfolio would be subject to counterparty risk in connection with
such transactions. If a Portfolio enters into a derivative instrument whereby it
agrees to receive the return of a security or financial instrument or a basket
of securities or financial instruments, it will typically contract to receive
such returns for a predetermined period of time. During such period, a Portfolio
may not have the ability to increase or decrease its exposure. In addition, such
customized derivative instruments will likely be highly illiquid, and it is
possible that a Portfolio will not be able to terminate such derivative
instruments prior to their expiration date or that the penalties associated with
such a termination might impact the Portfolio’s performance in a material
adverse manner. Furthermore, derivative instruments typically contain provisions
giving the counterparty the right to terminate the contract upon the occurrence
of certain events, such as a decline in the value of the reference securities
and material violations of the terms of the contract or the portfolio guidelines
as well as other events determined by the counterparty. If a termination were to
occur, a Portfolio’s return could be adversely affected as it would lose the
benefit of the indirect exposure to the reference securities and it may incur
significant termination expenses.
Currency
Transactions.
In general, certain Portfolios’ dealings in forward currency contracts and other
currency transactions such as futures, options, options on futures and swaps
will be limited to hedging involving either specific transactions or portfolio
positions. Each Portfolio, however, can invest up to the 1940 Act limits of its
assets in such transactions for non-hedging purposes. Currency transactions
include forward currency contracts, exchange listed currency futures, exchange
listed and OTC options on currencies, and currency swaps. A forward currency
contract involves a privately negotiated obligation to purchase or sell (with
delivery generally required) a specific currency at a future date, which may be
any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. A currency swap is an
agreement to exchange cash flows based on the notional difference among two or
more currencies and operates similarly to an interest rate swap, which is
described below.
Transaction
hedging is entering into a currency transaction with respect to specific assets
or liabilities of a Portfolio, which will generally arise in connection with the
purchase or sale of its portfolio securities or the receipt of income therefrom.
Position hedging is entering into a currency transaction with respect to
portfolio security positions denominated or generally quoted in that
currency.
Certain
Portfolios may also cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which it has or in which the Portfolio expects
to have portfolio exposure.
To
reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, a Portfolio may also engage in
proxy hedging. Proxy hedging is often used when the currency to which the
Portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy
hedging entails entering into a commitment or option to sell a currency whose
changes in value are generally considered to be correlated to a currency or
currencies in which some or all of a Portfolio’s portfolio securities are or are
expected to be denominated, in exchange for U.S. dollars. The amount of the
commitment or option would not exceed the value of a Portfolio’s securities
denominated in correlated currencies. Currency hedging involves some of the same
risks and considerations as other transactions with similar instruments.
Currency transactions can result in losses to a Portfolio if the currency being
hedged fluctuates in value to a degree or in a direction that is not
anticipated. Further, there is the risk that the perceived correlation between
various currencies may not be present, or may not be present during the
particular time that a Portfolio is engaging in proxy hedging. If a Portfolio
enters into a currency hedging transaction, the Portfolio will comply with the
asset segregation requirements described below.
Risks
of Currency Transactions.
Currency transactions are subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to the
issuing governments and influences economic planning and policy, purchases and
sales of currency and related instruments can be negatively affected by
government exchange controls, blockages and manipulations or exchange
restrictions imposed by governments. These can result in losses to a Portfolio
if it is unable to deliver or receive currency or funds in settlement of
obligations, and could also cause hedges it has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Buyers and sellers of currency futures are subject to the same risks that
apply to the use of futures generally. Further, settlement of currency futures
contracts for the purchase of most currencies must occur at a bank based in the
issuing nation. The ability to establish and close out positions on options on
currency futures is subject to the maintenance of a liquid market which may not
always be available. Currency exchange rates may fluctuate based on factors
extrinsic to that country’s economy.
Combined
Transactions.
Certain Portfolios may enter into multiple transactions, which may include
multiple options transactions, multiple futures transactions, multiple currency
transactions (including forward currency contracts) and multiple interest rate
transactions and any combination of futures, options, currency and interest rate
transactions (“component” transactions), instead of a single Strategic
Transaction, as part of a single or combined strategy when, in the opinion of a
Subadviser, it is in the best interests of a fund to do so. A combined
transaction will usually contain elements of risk that are present in each of
its component transactions. Although combined transactions are normally entered
into based on a Subadviser’s judgment that the combined strategies will reduce
risk or otherwise more effectively achieve the desired portfolio management
goal, it is possible that the combination will instead increase such risks or
hinder achievement of the portfolio management objective.
Swaps,
Caps, Floors and Collars.
Among the Strategic Transactions into which a Portfolio may enter are interest
rate, currency, credit default and index swaps and the purchase or sale of
related caps, floors and collars. A Portfolio may enter into these transactions
primarily to preserve a return or spread on a particular investment or portion
of its portfolio, to protect against currency fluctuations, as a duration
management technique or to protect against any increase in the price of
securities the Portfolio anticipates purchasing at a later date. Interest rate
swaps involve the exchange by a Portfolio with another party of their respective
commitments to pay or receive interest, e.g.,
an exchange of floating rate payments for fixed rate payments with respect to a
notional amount of principal. The purchase of a cap entitles the purchaser to
receive payments on a notional principal amount from the party selling such cap
to the extent that a specific index exceeds a predetermined interest rate or
amount. The purchase of a floor entitles the purchaser to receive payments on a
notional principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount. A collar is
a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
A
Portfolio will usually enter into swaps on a net basis, i.e.,
the two payment streams are netted out in a cash settlement on the payment date
or dates specified in the instrument, with the fund receiving or paying, as the
case may be, only the net amount of the two payments. Inasmuch as these swaps,
caps, floors and collars are entered into for good-faith hedging purposes, the
Portfolio believes such obligations do not constitute senior securities under
the 1940 Act, and, accordingly, will not treat them as being subject to the 1940
Act’s borrowing restrictions.
Hybrid
Instruments.
Certain Portfolios may invest in hybrid instruments. A hybrid instrument is a
type of potentially high-risk derivative that combines a traditional stock,
bond, or commodity with an option or forward contract. Generally, the principal
amount, amount payable upon maturity or redemption, or interest rate of a hybrid
is tied (positively or negatively) to the price of some commodity, currency or
securities index or another interest rate or some other economic factor
(“underlying benchmark”). The interest rate or (unlike most fixed-income
securities) the principal amount payable at maturity of a hybrid security may be
increased or decreased, depending on changes in the value of the underlying
benchmark. An example of a hybrid instrument could be a bond issued by an oil
company that pays a small base level of interest with additional interest that
accrues in correlation to the extent to which oil prices exceed a certain
predetermined level. Such a hybrid instrument would be a combination of a bond
and a call option on oil.
Hybrid
instruments can be used as an efficient means of pursuing a variety of
investment goals, including currency hedging, and increased total return. Hybrid
instruments may not bear interest or pay dividends. The value of a hybrid
instrument or its interest rate may be a multiple of the underlying benchmark
and, as a result, may be leveraged and move (up or down) more steeply and
rapidly than the underlying benchmark. These underlying benchmarks may be
sensitive to economic and political events, such as commodity shortages and
currency devaluations, which cannot be readily foreseen by the purchaser of a
hybrid instrument. Under certain conditions, the redemption value of a hybrid
instrument could be zero. Thus, an investment in a hybrid instrument may entail
significant market risks that are not associated with a similar investment in a
traditional, U.S. dollar-denominated bond that has a fixed principal amount and
pays a fixed rate or floating rate of interest. The purchase of hybrid
instruments also exposes a Portfolio to the credit risk of the issuer of the
hybrid instruments. These risks may cause significant fluctuations in the NAV of
a Portfolio.
Certain
hybrid instruments may provide exposure to the commodities markets. These are
derivative securities with one or more commodity-linked components that have
payment features similar to commodity futures contracts, commodity options, or
similar instruments. Commodity-linked hybrid instruments may be either equity or
debt securities, and are considered hybrid instruments because they have both
security and commodity-like characteristics. A portion of the value of these
instruments may be derived from the value of a commodity, futures contract,
index or other economic variable. A Portfolio would only invest in
commodity-linked hybrid instruments that qualify, under applicable rules of the
CFTC, for an exemption from the provisions of the CEA. The
requirements
for qualification as a regulated investment company for federal income tax
purposes may limit a Portfolio’s ability to invest in commodity-linked
instruments.
Certain
issuers of structured products such as hybrid instruments may be deemed to be
investment companies as defined in the 1940 Act. As a result, a Portfolio’s
investments in these products may be subject to limits applicable to investments
in investment companies and other restrictions contained in the 1940
Act.
Risk
Linked Securities.
Risk-linked securities (“RLS”) are a form of derivative issued by insurance
companies and insurance-related special purpose vehicles that apply
securitization techniques to catastrophic property and casualty damages. RLS are
typically debt obligations for which the return of principal and the payment of
interest are contingent on the non-occurrence of a pre-defined “trigger event.”
Depending on the specific terms and structure of the RLS, this trigger could be
the result of a hurricane, earthquake or some other catastrophic event.
Insurance companies securitize this risk to transfer the truly catastrophic part
of the risk exposure to the capital markets. A typical RLS provides for income
and return of capital similar to other fixed-income investments, but would
involve full or partial default if losses resulting from a certain catastrophe
exceeded a predetermined amount. RLS typically have relatively high yields
compared with similarly rated fixed-income securities, and have low correlation
with the returns of traditional securities. Investments in RLS may be linked to
a broad range of insurance risks, which can be broken down into three major
categories: natural risks (such as hurricanes and earthquakes), weather risks
(such as insurance based on a regional average temperature) and non-natural
events (such as aerospace and shipping catastrophes). Although property-casualty
RLS have been in existence for over a decade, significant developments have
started to occur in securitizations done by life insurance companies. In
general, life insurance industry securitizations could fall into a number of
categories. Some are driven primarily by the desire to transfer risk to the
capital markets, such as the transfer of extreme mortality risk (mortality
bonds). Others, while also including the element of risk transfer, are driven by
other considerations. For example, a securitization could be undertaken to
relieve the capital strain on life insurance companies caused by the regulatory
requirements of establishing very conservative reserves for some types of
products. Another example is the securitization of the stream of future cash
flows from a particular block of business, including the securitization of
embedded values of life insurance business or securitization for the purpose of
funding acquisition costs.
Spread
Transactions.
Certain Portfolios may purchase covered spread options from securities dealers.
Such covered spread options are not presently exchange-listed or
exchange-traded. The purchase of a spread option gives a Portfolio the right to
put, or sell, a security that it owns at a fixed dollar spread or fixed yield
spread in relationship to another security that a Portfolio does not own, but
which is used as a benchmark. The risk to a Portfolio in purchasing covered
spread options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing transactions
will be available. The purchase of spread options will be used to protect a
Portfolio against adverse changes in prevailing credit quality spreads,
i.e.,
the yield spread between high quality and lower quality securities. Such
protection is only provided during the life of the spread option.
Derivatives
Regulations.
The laws and regulations that apply to derivatives (e.g.,
swaps, futures, etc.) and persons who use them (including, as applicable, the
Portfolios, the Subadvisers, and others) are rapidly changing in the U.S. and
abroad. As a result, restrictions and additional regulations may be imposed on
these parties, trading restrictions may be adopted and additional trading costs
are possible. The impact of these changes on each Portfolio’s investment
strategies is not yet fully ascertainable.
In
particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
“Dodd-Frank Act”), which was signed into law in July 2010, significantly revised
and expanded the rulemaking, supervisory and enforcement authority of federal
bank, securities and commodities regulators. While certain of the Dodd-Frank
provisions have been adopted, other rules are not yet final; therefore, it is
unclear how regulators will exercise their expanded powers and whether they will
undertake rulemaking, supervisory or enforcement actions that would adversely
affect a Portfolio or its investments. Possible regulatory actions taken under
these revised and expanded powers may include actions related to financial
consumer protection, proprietary trading and derivatives. There is a risk that
new and additional government regulation authorized by the Dodd-Frank Act could
restrict the ability of a Portfolio to use certain instruments as part of its
investment strategy, increase the costs of using these instruments or make them
less effective. Legislators and regulators in the United States are currently
considering a wide range of proposals in addition to the Dodd-Frank Act that, if
enacted, could result in major changes to the way the financial services
industry is regulated. In particular, new position limits imposed on a
Portfolio’s counterparties may impact the Portfolio’s ability to invest in
futures, options, and swaps in a manner that efficiently meets its investment
objective. New requirements even if not directly applicable to a Portfolio,
including capital requirements, changes to the CFTC speculative position limits
regime, and mandatory clearing, may increase the cost of the Portfolio’s
investments and cost of doing business, which would adversely affect
investors.
Rule
18f-4 under the 1940 Act governs the use of derivatives by registered investment
companies. Rule 18f-4 imposes limits on the amount of derivatives a fund may
enter into, eliminates the asset segregation framework previously used by the
Portfolios to comply with Section 18 of the 1940 Act, treats derivatives as
senior securities so that a failure to comply with the limits would result in a
statutory violation and require funds whose use of derivatives is more than a
limited specific exposure amount to establish and maintain a comprehensive
derivatives risk management program and to appoint a derivatives risk manager.
Certain of the Portfolios are “limited derivatives users” and are not subject to
the full requirements of Rule 18f-4, while the other Portfolios are derivatives
users subject to the full requirements of the Rule. The requirements of Rule
18f-4 may limit a Portfolio’s ability to engage in derivatives transactions, as
well as certain other transactions that create future payment and/or delivery
obligations by a fund, as part
of
its investment strategies. These requirements may also increase the cost of
doing business, which could adversely affect the performance of a
Portfolio.
Eurodollar
Instruments. Certain
Portfolios may make investments in Eurodollar instruments. Eurodollar
instruments are U.S. dollar-denominated futures contracts or options that are
linked to the London Interbank Offered Rate (“LIBOR”) or another reference rate.
Eurodollar futures contracts enable purchasers to obtain a fixed rate for the
lending of funds and sellers to obtain a fixed rate for borrowings. Certain
Portfolios may use Eurodollar futures contracts and options thereon to hedge
against changes in LIBOR, to which many interest rate swaps and fixed income
instruments are linked.
Euro
Risk.
Certain Portfolios may invest in securities issued by companies operating in
Europe. Investments in a single region, even though representing many different
countries within the region, may be affected by common economic forces and other
factors. A Portfolio may be subject to greater risk of adverse events which
occur in the European region and may experience greater volatility than a fund
that is more broadly diversified geographically. Political or economic
disruptions in European countries, even in countries in which a Portfolio is not
invested may adversely affect the security values and thus a Portfolio’s
holdings. A significant number of countries in Europe are member states in the
European Union (the “EU”), and these member states no longer have the ability to
implement an independent monetary policy and may be significantly affected by
requirements that limit their fiscal options. European financial markets have
recently experienced volatility and have been adversely affected by concerns of
economic downturns, credit rating downgrades, rising government debt and
possible default on or restructuring of government debt in several European
countries. The United Kingdom withdrew from the EU on January 31, 2020,
following a June 2016 referendum referred to as “Brexit.” There is significant
market uncertainty regarding Brexit’s longer term ramifications, and the range
of possible political, regulatory, economic and market outcomes are difficult to
predict. The uncertainty surrounding the United Kingdom’s economy may continue
to be a source of instability and cause considerable disruption in securities
markets, including increased volatility and illiquidity, as well as currency
fluctuations in the British pound’s exchange rate against the U.S. dollar.
Risks
of Strategic Transactions Outside the United States.
When conducted outside the United States, Strategic Transactions may not be
regulated as rigorously as in the United States, may not involve a clearing
mechanism and related guarantees and are subject to the risk of governmental
actions affecting trading in, or the prices of, foreign securities, currencies
and other instruments. The value of such positions also could be adversely
affected by (i) other complex foreign, political, legal and economic factors,
(ii) lesser availability than in the United States of data on which to make
trading decisions, (iii) delays in a fund’s ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States and (v) lower trading volume
and liquidity.
Greater
China and China A-Shares Risk. There
are special risks associated with investments in China, Hong Kong and Taiwan,
including exposure to currency fluctuations, less liquidity, expropriation,
confiscatory taxation, nationalization and exchange control regulations
(including currency blockage). Inflation and rapid fluctuations in inflation and
interest rates have had, and may continue to have, negative effects on the
economy and securities markets of China, Hong Kong and Taiwan. In addition,
investments in Taiwan could be adversely affected by its political and economic
relationship with China. Certain securities issued by companies located or
operating in Greater China, such as China A-shares, are subject to trading
restrictions, quota limitations and less market liquidity. Additionally,
developing countries, such as those in Greater China, may subject the
Portfolio’s investments to a number of tax rules, and the application of many of
those rules may be uncertain. Moreover, China has implemented a number of tax
reforms in recent years, and may amend or revise its existing; tax laws and/or
procedures in the future, possibly with retroactive effect. Changes in
applicable Chinese tax law could reduce the after-tax profits of the Portfolio,
directly or indirectly, including by reducing the after-tax profits of companies
in China in which the Portfolio invests. Uncertainties in Chinese tax rules
could result in unexpected tax liabilities for the Portfolio. China A-shares
listed and traded through the Shanghai-Hong Kong Stock Connect program and the
Shenzhen-Hong Kong Stock Connect program (“Stock Connect”), mutual market access
programs designed to, among other things, enable foreign investment in the
People’s Republic of China (“PRC”) via brokers in Hong Kong, are subject to a
number of restrictions imposed by Chinese securities regulations and listing
rules. Because Stock Connect is in its initial stages, developments are likely,
which may restrict or otherwise affect the Portfolio’s investments or returns.
Furthermore, any changes in laws, regulations and policies of the China A-shares
market or rules in relation to Stock Connect may affect China A-share prices.
These risks are heightened by the underdeveloped state of the PRC’s investment
and banking systems in general.
Guaranteed
Investment Contracts (“GICs”).
Certain Portfolios may invest in GICs. When investing in GICs, a Portfolio makes
cash contributions to a deposit fund of an insurance company’s general account.
The insurance company then credits guaranteed interest to the deposit fund
monthly. The GICs provide that this guaranteed interest will not be less than a
certain minimum rate. The insurance company may assess periodic charges against
a GIC for expenses and service costs allocable to it, and the charges will be
deducted from the value of the deposit fund. Because a Portfolio may not receive
the principal amount of a GIC from the insurance company on 7 days’ notice or
less, the GIC is considered an illiquid investment. In determining average
portfolio maturity, GICs generally will be deemed to have a maturity equal to
the period remaining until the next readjustment of the guaranteed interest
rate.
Variable
and Floating Rate Instruments.
Certain Portfolios may invest in variable and floating rate instruments. With
respect to purchasable variable and floating rate instruments, a Subadviser will
consider the earning power, cash flows and liquidity ratios of the issuers and
guarantors of such instruments and, if the instruments are subject to a demand
feature, will monitor their financial status to meet payment on demand. Such
instruments may include variable amount demand notes that permit the
indebtedness thereunder to
vary
in addition to providing for periodic adjustments in the interest rate. The
absence of an active secondary market with respect to particular variable and
floating rate instruments could make it difficult for a Portfolio to dispose of
a variable or floating rate note if the issuer defaulted on its payment
obligation or during periods that the Portfolio is not entitled to exercise its
demand rights, and the Portfolio could, for these or other reasons, suffer a
loss with respect to such instruments. In determining average-weighted a
Portfolio maturity, an instrument will be deemed to have a maturity equal to
either the period remaining until the next interest rate adjustment or the time
a fund involved can recover payment of principal as specified in the instrument,
depending on the type of instrument involved.
Money
Market Obligations of Domestic Banks, Foreign Banks and Foreign Branches of U.S.
Banks.
Certain Portfolios may purchase bank obligations, such as certificates of
deposit, bankers’ acceptances and time deposits, including instruments issued or
supported by the credit of U.S. or foreign banks or savings institutions having
total assets at the time of purchase in excess of $1 billion. The assets of a
bank or savings institution will be deemed to include the assets of its domestic
and foreign branches for purposes of a Portfolio’s investment policies.
Investments in short-term bank obligations may include obligations of foreign
banks and domestic branches of foreign banks, and foreign branches of domestic
banks.
Certificates
of deposit are receipts issued by a depository institution in exchange for the
deposit of funds. The issuer agrees to pay the amount deposited plus interest to
the bearer of the receipt on the date specified on the certificate. The
certificate usually can be traded in the secondary market prior to maturity.
Bankers’ acceptances typically arise from short-term credit arrangements
designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then “accepted” by a bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or
less.
Money
Market Instruments.
Each Portfolio may invest in money market instruments, including certificates of
deposit, time deposits, bankers’ acceptances and other short-term obligations
issued by domestic banks, foreign subsidiaries or branches of domestic banks,
domestic and foreign branches of foreign banks, domestic savings and loan
associations and other banking institutions.
A
certificate of deposit is a negotiable certificate requiring a bank to repay
funds deposited with it for a specified period.
A
time deposit is a non-negotiable deposit maintained in a banking institution for
a specified period at a stated interest rate. A Portfolio will only invest in
time deposits of domestic banks that have total assets in excess of one billion
dollars. Time deposits held by the Portfolios will not benefit from insurance
administered by the Federal Deposit Insurance Corporation.
A
bankers’ acceptance is a credit instrument requiring a bank to pay a draft drawn
on it by a customer. These instruments reflect the obligation both of the bank
and of the drawer to pay the face amount of the instrument upon maturity. Other
short-term bank obligations in which the Portfolios may invest may include
uninsured, direct obligations bearing fixed, floating or variable interest
rates. With respect to such securities issued by foreign branches and
subsidiaries of domestic banks, and domestic and foreign branches of foreign
banks, a Portfolio may be subject to additional investment risks that are
different in some respects from those incurred by a Portfolio which invests only
in debt obligations of U.S. domestic issuers. Such risks include possible
political and economic developments, possible seizure or nationalization of
foreign deposits, the possible imposition of foreign withholding taxes on
interest income, the possible establishment of exchange controls or the adoption
of other foreign governmental restrictions which may adversely affect the
payment of principal and interest on these securities.
Mortgage-Backed
Securities.
Certain Portfolios may invest in MBS, which are securities that represent
interests in pools of mortgage loans. MBS, including mortgage pass-through
securities and collateralized mortgage obligations, include certain securities
issued or guaranteed by the U.S. government or one of its agencies or
instrumentalities, such as GNMA, the Federal National Mortgage Association
(“FNMA”), or the Federal Home Loan Mortgage Corporation (“FHLMC”); securities
issued by private issuers that represent an interest in or are collateralized by
MBS issued or guaranteed by the U.S. government or one of its agencies or
instrumentalities; securities issued by private issuers that represent an
interest in or are collateralized by mortgage loans; and
reperforming/non-performing loans, reperforming/non-performing loan
securitizations, and resecuritizations of existing MBS and/or ABS
(“Re-REMICS”).There are a number of important differences among the agencies and
instrumentalities of the U.S. government that issue MBS and among the securities
that they issue.
MBS
guaranteed by the GNMA include GNMA Mortgage Pass-Through Certificates (also
known as “Ginnie Maes”) which are guaranteed as to the timely payment of
principal and interest by GNMA and such guarantee is backed by the full faith
and credit of the United States. GNMA is a wholly-owned U.S. government
corporation within the Department of Housing and Urban Development. GNMA
certificates also are supported by the authority of GNMA to borrow funds from
the U.S. Treasury to make payments under its guarantee. MBS issued by the FNMA
include FNMA-guaranteed Mortgage Pass-Through Certificates (also known as
“Fannie Maes”) which are solely the obligations of the FNMA, are not backed by
or entitled to the full faith and credit of the United States and are supported
by the right of the issuer to borrow from the Treasury. FNMA is a government-
sponsored organization owned entirely by private stockholders. Fannie Maes are
guaranteed as to timely payment of principal and interest by FNMA. MBS issued by
the FHLMC include FHLMC Mortgage Participation Certificates (also known as
“Freddie Macs” or “PCs”). FHLMC is a corporate instrumentality of the United
States, created pursuant to an Act of Congress, which is owned entirely by
Federal Home Loan Banks.
Freddie
Macs are not guaranteed by the United States or by any Federal Home Loan Banks
and do not constitute a debt or obligation of the United States or of any
Federal Home Loan Bank. Freddie Macs entitle the holder to timely payment of
interest, which is guaranteed by the FHLMC. FHLMC guarantees either ultimate
collection or timely payment of all principal payments on the underlying
mortgage loans. When FHLMC does not guarantee timely payment of principal, FHLMC
may remit the amount due on account of its guarantee of ultimate payment of
principal at any time after default on an underlying mortgage, but in no event
later than one year after it becomes payable.
On
September 7, 2008, the U.S. Treasury announced a federal takeover of FNMA and
FHLMC, placing the two federal instrumentalities in conservatorship. Under the
takeover, the U.S. Treasury agreed to acquire senior preferred stock of each
instrumentality and obtained warrants for the purchase of common stock of each
instrumentality. The U.S. Treasury also pledged to make additional capital
contributions as needed to help ensure that the instrumentalities maintain a
positive net worth and meet their financial obligations, preventing mandatory
triggering of receivership. While the purchase programs for MBS ended in 2010,
the U.S. Treasury continued its support of the entities’ capital as necessary to
prevent a negative net worth. FNMA and FHLMC continue to rely on the support of
the U.S. Treasury to continue operations, and it is not known when the
conservatorships will be terminated or what changes will be made to their
operations following the conservatorships.
The
performance of private label MBS issued by private institutions is based on the
financial health of those institutions. There is no guarantee that a Portfolio’s
investment in MBS will be successful, and the Portfolio’s total return could be
adversely affected as a result. In the reperforming/non-performing loan
securitization market additional consideration must be given to sponsor risk and
sponsor concentration.
MBS
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
generally may be prepaid at any time. Since prepayment rates vary widely, it is
not possible to accurately predict the average maturity of a particular
mortgage-backed pool; however, statistics published by the Federal Housing
Authority indicate that the average life of mortgages with 25- to 30-year
maturities (the type of mortgages backing the vast majority of MBS) is
approximately 12 years. MBS may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment.
Collateralized
Mortgage Obligations (“CMOs”) and Multiclass Pass-Through
Securities.
CMOs are debt obligations collateralized by mortgage loans or mortgage
pass-through securities. Typically, CMOs are collateralized by GNMA, FNMA or
FHLMC Certificates, but also may be collateralized by whole loans or private
mortgage pass-through securities (“Mortgage Assets”). Multiclass pass-through
securities are equity interests held in a trust composed of Mortgage Assets.
Payments of principal and of interest on the Mortgage Assets, and any
reinvestment income thereon, provide the capital to pay debt service on the CMOs
or make scheduled distributions on the multiclass pass-through securities. CMOs
may be issued by agencies or instrumentalities of the U.S. government or by
private originators of, or investors in, mortgage loans, including depositary
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
In
a CMO, a series of bonds or certificates is issued in multiple classes. Each
class of CMOs is issued at a specific fixed or floating coupon rate and has a
stated maturity or final distribution date. Principal prepayments on the
Mortgage Assets may cause the CMOs to be retired substantially earlier than
their stated maturities or final distribution dates. Interest is paid or accrued
on all classes of CMOs on a monthly, quarterly or semi-annual basis. The
principal of and interest on the Mortgage Assets may be allocated among the
several classes of a CMO series in a number of different ways. Generally, the
purpose of the allocation of the cash flow of a CMO to the various classes is to
obtain a more predictable cash flow to the individual class than exists with the
underlying collateral of the CMO. As a general rule, the more predictable the
cash flow to a particular CMO the lower the anticipated yield will be on that
class at the time of issuance relative to prevailing market yields on
MBS.
Certain
Portfolios may invest in CMOs, including but not limited to, 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 class. These simultaneous payments are taken into account in calculating the
stated maturity date or final distribution date of each class, 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 generally require
payments of a specified amount of principal on each payment date. PAC Bonds
always are parallel pay CMOs with the required principal payment on such
securities having the highest priority after interest has been paid to all
classes.
Asset-Backed
Securities.
Certain Portfolios may also invest in ABS, which are securities that represent
an interest in a pool of assets. These include secured debt instruments
collateralized by aircraft leases, automobile loans, credit card loans, home
equity loans, manufactured housing loans, syndicated bank loans, and other types
of debt providing the source of both principal and interest. On occasion, the
pool of assets may also include a swap obligation, which is used to change the
cash flows on the underlying assets. As an example, a swap may be used to allow
floating rate assets to back a fixed rate obligation. The credit quality of ABS
depends primarily on the quality of the underlying assets, the level of credit
support, if any, provided by the issuer, and the credit quality of the swap
counterparty, if any. ABS are subject to risks similar to those discussed above
with respect to MBS.
Automobile
Receivable Securities.
ABS may be backed by receivables from motor vehicle installment sales contracts
or installment loans secured by motor vehicles (“Automobile Receivable
Securities”). Since installment sales contracts for motor vehicles or
installment
loans related thereto (“Automobile Contracts”) typically have shorter durations
and lower incidences of prepayment, Automobile Receivable Securities generally
will exhibit a shorter average life and are less susceptible to prepayment
risk.
Most
entities that issue Automobile Receivable Securities create an enforceable
interest in their respective Automobile Contracts only by filing a financing
statement and by having the servicer of the Automobile Contracts, which is
usually the originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts were to sell the
same Automobile Contracts to another party, in violation of its obligation not
to do so, there is a risk that such party could acquire an interest in the
Automobile Contracts superior to that of the holders of Automobile Receivable
Securities. Although most Automobile Contracts grant a security interest in the
motor vehicle being financed, in most states the security interest in a motor
vehicle must be noted on the certificate of title to create an enforceable
security interest against competing claims of other parties. Due to the large
number of vehicles involved, however, the certificate of title to each vehicle
financed, pursuant to the Automobile Contracts underlying the Automobile
Receivable Security, usually is not amended to reflect the assignment of the
seller’s security interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that recoveries on
repossessed collateral may not, in some cases, be available to support payments
on the securities. In addition, various state and federal securities laws give
the motor vehicle owner the right to assert against the holder of the owner’s
Automobile Contract certain defenses such owner would have against the seller of
the motor vehicle. The assertion of such defenses could reduce payments on the
Automobile Receivable Securities.
Credit
Card Receivable Securities.
ABS may be backed by receivables from revolving credit card agreements (“Credit
Card Receivable Securities”). Credit balances on revolving credit card
agreements (“Accounts”) are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued publicly to date
have been pass-through certificates. In order to lengthen the maturity of Credit
Card Receivable Securities, most such securities provide for a fixed period
during which only interest payments on the underlying Accounts are passed
through to the security holder, and principal payments received on such Accounts
are used to fund the transfer to the pool of assets supporting the related
Credit Card Receivable Securities of additional credit card charges made on an
Account. The initial fixed period usually may be shortened upon the occurrence
of specified events which signal a potential deterioration in the quality of the
assets backing the security, such as the imposition of a cap on interest rates.
The ability of the issuer to extend the life of an issue of Credit Card
Receivable Securities thus depends upon the continued generation of additional
principal amounts in the underlying accounts during the initial period and the
non-occurrence of specified events. An acceleration in cardholders’ payment
rates or any other event that shortens the period during which additional credit
card charges on an Account may be transferred to the pool of assets supporting
the related Credit Card Receivable Security could shorten the weighted average
life and yield of the Credit Card Receivable Security.
Credit
cardholders are entitled to the protection of many state and federal consumer
credit laws, many of which give such holders the right to set off certain
amounts against balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other ABS, Accounts are unsecured
obligations of the cardholder.
Methods
of Allocating Cash Flows.
While many ABS are issued with only one class of security, many ABS are issued
in more than one class, each with different payment terms. Multiple class ABS
are issued for two main reasons. First, multiple classes may be used as a method
of providing credit support. This is accomplished typically through creation of
one or more classes whose right to payments on the ABS is made subordinate to
the right to such payments of the remaining class or classes (See “Types of
Credit Support”). Second, multiple classes may permit the issuance of securities
with payment terms, interest rates or other characteristics differing both from
those of each other and from those of the underlying assets. Examples include
so-called “strips” (ABS entitling the holder to disproportionate interests with
respect to the allocation of interest and principal of the assets backing the
security) and securities with a class or classes having characteristics which
mimic the characteristics of non-ABS, such as floating interest rates
(i.e.,
interest rates which adjust as a specified benchmark changes) or scheduled
amortization of principal.
ABS
in which the payment streams on the underlying assets are allocated in a manner
different than those described above may be issued in the future.
Types
of Credit Support.
ABS are often backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by obligors on
underlying assets to make payments, such securities may contain elements of
credit support. Such credit support falls into two classes: liquidity protection
and protection against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that scheduled payments on
the underlying pool are made in a timely fashion. Protection against ultimate
default ensures 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 from third parties, through
various means of structuring the transaction or through a combination of such
approaches. Examples of ABS with credit support arising out of the structure of
the transaction include “senior-subordinated securities” (multiple class ABS
with certain classes subordinate to other classes as to the payment of principal
thereon, with the result that defaults on the underlying assets are borne first
by the holders of the subordinated class) and ABS that have “reserve portfolios”
(where cash or investments, sometimes funded from a portion of the initial
payments on the underlying assets, are held in reserve against future losses) or
that have been “over collateralized” (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds that required
to make payment of the ABS and pay any servicing or other fees). The degree of
credit support provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such
payments. Delinquency or loss in excess of that anticipated could adversely
affect the return on an investment in an ABS. Additionally, if the letter of
credit is exhausted, holders of ABS may also experience delays in payments or
losses if the full amounts due on underlying sales contracts are not
realized.
Structured
Notes.
Certain Portfolios may invest in structured notes. Structured notes are debt
obligations that also contain an embedded derivative component with
characteristics that adjust the obligation’s risk/return profile. Generally, the
performance of a structured note will track that of the underlying debt
obligation and the derivative embedded within it. A Portfolio has the right to
receive periodic interest payments from the issuer of the structured notes at an
agreed-upon interest rate and a return of the principal at the maturity date.
Structured notes are typically privately negotiated transactions between two or
more parties. A Portfolio bears the risk that the issuer of the structured note
would default or become bankrupt which may result in the loss of principal
investment and periodic interest payments expected to be received for the
duration of its investment in the structured notes. If one of the underlying
corporate credit instruments defaults, a Portfolio may receive the security or
credit instrument that has defaulted, or alternatively a cash settlement may
occur, and the Portfolio’s principal investment in the structured note would be
reduced by the corresponding face value of the defaulted security. The market
for structured notes may be, or suddenly can become, illiquid. The other parties
to the transaction may be the only investors with sufficient understanding of
the derivative to be interested in bidding for it. Changes in liquidity may
result in significant, rapid, and unpredictable changes in the prices for
structured notes. In certain cases, a market price for a credit-linked security
may not be available.
Credit-Linked
Notes.
Certain Portfolios may invest in credit-linked notes. Credit-linked notes are a
type of structured note. The difference between a credit default swap and a
credit-linked note is that the seller of a credit-linked note receives the
principal payment from the buyer at the time the contract is originated. Through
the purchase of a credit-linked note, the buyer assumes the risk of the
reference asset and funds this exposure through the purchase of the note. The
buyer takes on the exposure to the seller to the full amount of the funding it
has provided. The seller has hedged its risk on the reference asset without
acquiring any additional credit exposure. A Portfolio has the right to receive
periodic interest payments from the issuer of the credit-linked note at an
agreed-upon interest rate and a return of principal at the maturity
date.
Credit-linked
notes are subject to the credit risk of the corporate credits referenced by the
note. If one of the underlying corporate credits defaults, a Portfolio may
receive the security that has defaulted, and the Portfolio’s principal
investment would be reduced by the difference between the original face value of
the reference security and the current value of the defaulted security.
Credit-linked notes are typically privately negotiated transactions between two
or more parties. A Portfolio bears the risk that the issuer of the credit-linked
note will default or become bankrupt. A Portfolio bears the risk of loss of its
principal investment, and the periodic interest payments expected to be received
for the duration of its investment in the credit-linked note.
Collateralized
Debt Obligations (“CDOs”).
Certain Portfolios may invest in CDOs. A CDO is an ABS whose underlying
collateral is typically a portfolio of bonds, bank loans, other structured
finance securities and/or synthetic instruments. Where the underlying collateral
is a portfolio of bonds, a CDO is referred to as a collateralized bond
obligation (“CBO”). Where the underlying collateral is a portfolio of bank
loans, a CDO is referred to as a collateralized loan obligation (“CLO”).
Investors in CDOs bear the credit risk of the underlying collateral. Multiple
tranches of securities are issued by the CDO, offering investors various
maturity and credit risk characteristics. Tranches are categorized as senior,
mezzanine, and subordinated/equity, according to their degree of risk. If there
are defaults or the CDO’s collateral otherwise underperforms, scheduled payments
to senior tranches take precedence over those of mezzanine tranches, and
scheduled payments to mezzanine tranches take precedence over those to
subordinated/equity tranches. CDOs are subject to the same risk of prepayment
described with respect to certain mortgage-related securities and ABS. The value
of CDOs may be affected by changes in the market’s perception of the
creditworthiness of the servicing agent for the pool or the
originator.
A
CLO is a trust or other special purpose entity that is comprised of or
collateralized by a pool of loans, including domestic and non-U.S. senior
secured loans, senior unsecured loans and subordinate corporate loans, including
loans that may be rated below investment grade or equivalent unrated loans. The
loans generate cash flow that is allocated among one or more classes of
securities (“tranches”) that vary in risk and yield. The most senior tranche has
the best credit quality and the lowest yield compared to the other tranches. The
equity tranche has the highest potential yield but also has the greatest risk,
as it bears the bulk of defaults from the underlying loans and helps to protect
the more senior tranches from risk of these defaults. However, despite the
protection from the equity and other more junior tranches, more senior tranches
can experience substantial losses due to actual defaults and decreased market
value due to collateral default and disappearance of protecting tranches, market
anticipation of defaults, as well as aversion to CLO securities as a
class.
Normally,
CLOs are privately offered and sold and are not registered under state or
federal securities laws. Therefore, investments in CLOs may be characterized as
illiquid securities; however, an active dealer market may exist for CLOs
allowing a CLO to qualify for transactions pursuant to Rule 144A under the 1933
Act. CLOs normally charge management fees and administrative expenses, which are
in addition to those of the Portfolio.
The
riskiness of investing in CLOs depends largely on the quality and type of the
collateral loans and the tranche of the CLO in which the Portfolio invests. In
addition to the normal risks associated with fixed-income securities (such as
interest rate risk and credit risk), CLOs carry risks including, but are not
limited to: (i) the possibility that distributions from the collateral will not
be adequate to make
interest
or other payments; (ii) the quality of the collateral may decline in value or
default; (iii) the Portfolio may invest in CLO tranches that are subordinate to
other tranches; and (iv) the complex structure of the CLO may not be fully
understood at the time of investment or may result in the quality of the
underlying collateral not being fully understood and may produce disputes with
the issuer or unexpected investment results. In addition, interest on certain
tranches of a CLO may be paid in-kind (meaning that unpaid interest is
effectively added to principal), which involves continued exposure to default
risk with respect to such payments. Certain CLOs may receive credit enhancement
in the form of a senior-subordinate structure, over-collateralization or bond
insurance, but such enhancement may not always be present and may fail to
protect the Portfolio against the risk of loss due to defaults on the
collateral. Certain CLOs may not hold loans directly, but rather, use
derivatives such as swaps to create “synthetic” exposure to the collateral pool
of loans. Such CLOs entail the risks of derivative instruments.
Corporate
Bonds.
Certain Portfolios may invest in corporate bonds. Corporate bonds are debt
obligations issued by corporations and other business entities. Corporate bonds
may be either secured or unsecured. Collateral used for secured debt includes
real property, machinery, equipment, accounts receivable, stocks, bonds or
notes. If a bond is unsecured, it is known as a debenture. Bondholders, as
creditors, have a prior legal claim over common and preferred stockholders as to
both income and assets of the corporation for the principal and interest due
them and may have a prior claim over other creditors if liens or mortgages are
involved. Interest on corporate bonds may be fixed or floating, or the bonds may
be zero coupons. Interest on corporate bonds is typically paid semi-annually and
is fully taxable to the bondholder. Corporate bonds contain elements of both
interest-rate risk and credit risk. The market value of a corporate bond
generally may be expected to rise and fall inversely with interest rates and may
also be affected by the credit rating of the corporation, the corporation’s
performance and perceptions of the corporation in the marketplace. Corporate
bonds usually yield more than government or agency bonds due to the presence of
credit risk.
The
market value of a corporate bond may be affected by factors directly related to
the issuer, such as investors’ perceptions of the creditworthiness of the
issuer, the issuer’s financial performance, perceptions of the issuer in the
market place, performance of management of the issuer, the issuer’s capital
structure and use of financial leverage and demand for the issuer’s goods and
services. There is a risk that the issuers of corporate bonds may not be able to
meet their obligations on interest or principal payments at the time called for
by an instrument. Corporate bonds of below investment grade quality are often
high risk and have speculative characteristics and may be particularly
susceptible to adverse issuer-specific developments.
Distressed
Company Risk.
Certain Portfolios may invest in securities of distressed companies that may be
subject to greater levels of credit, issuer and liquidity risk than a portfolio
that does not invest in such securities. Debt securities of distressed companies
are considered predominantly speculative with respect to the issuers’ continuing
ability to make principal and interest payments. Issuers of distressed company
securities may also be involved in restructurings or bankruptcy proceedings that
may not be successful. An economic downturn or period of rising interest rates
could adversely affect the market for these securities and reduce a Portfolio’s
ability to sell these securities (liquidity risk). If the issuer of a debt
security is in default with respect to interest or principal payments, it may
lose its entire investment.
U.S.
Government Obligations.
Each Portfolio may invest in U.S. government obligations. U.S. government
obligations are direct obligations of the U.S. government and are supported by
the full faith and credit of the U.S. government. U.S. government agency
securities are issued or guaranteed by U.S. government-sponsored enterprises and
federal agencies. Some of these securities are backed by the full faith and
credit of the U.S. government; others are backed by the agency’s right to borrow
a specified amount from the U.S. Treasury; and still others, while not
guaranteed directly or indirectly by the U.S. government, are backed with
collateral in the form of cash, Treasury securities or debt instruments that the
lending institution has acquired through its lending activities. Examples of the
types of U.S. government obligations which a Portfolio may hold include U.S.
Treasury bills, Treasury instruments and Treasury bonds and the obligations of
Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the
Federal Housing Administration, the Farmers Home Administration, the Export-
Import Bank of the United States, the Small Business Administration, FNMA, GNMA,
the General Services Administration, the Student Loan Marketing Association, the
Central Bank for Cooperatives, FHLMC, the Federal Intermediate Credit Banks, the
Maritime Administration, the International Bank of Reconstruction and
Development (the “World Bank”), the Asian-American Development Bank and the
Inter-American Development Bank.
Short-Term
Instruments.
When a Portfolio experiences large cash inflows through the sale of securities
and desirable equity securities that are consistent with the Portfolio’s
investment objectives are unavailable in sufficient quantities or at attractive
prices, the Portfolio may hold short-term investments for a limited time at the
discretion of the Subadvisers. Short-term instruments consist of: (1) short-term
obligations issued or guaranteed by the U.S. government or any of its agencies
or instrumentalities or by any of the states; (2) other short-term debt
securities; (3) commercial paper; (4) bank obligations, including negotiable
certificates of deposit, time deposits and bankers’ acceptances; and (5)
repurchase agreements.
Supranational
Organization Obligations.
Certain Portfolios may purchase debt securities of supranational organizations
such as the European Coal and Steel Community, the European Economic Community
and the World Bank, which are chartered to promote economic
development.
Municipal
Securities.
Certain Portfolios may invest in municipal securities issued by or on behalf of
states, territories and possessions of the U.S. and the District of Columbia and
their political subdivisions, agencies and instrumentalities, the payments from
which, in the opinion of bond counsel to the issuer, are excludable from gross
income for federal income tax purposes (“Municipal Bonds”).
Certain
Portfolios may also invest in Municipal Bonds that pay interest excludable from
gross income for purposes of state and local income taxes of the designated
state and/or allow a portion of a Portfolio’s distributions to be exempt from
state and local taxes of the designated state. Certain Portfolios may also
invest in securities not issued by or on behalf of a state or territory or by an
agency or instrumentality thereof that a Portfolio’s Subadviser believes such
securities to pay interest excludable from gross income for purposes of federal
income tax and state and local income taxes of the designated state and/or state
and local personal property taxes of the designated state (“Non-Municipal
Tax-Exempt Securities”). Non-Municipal Tax-Exempt Securities could include trust
certificates or other instruments evidencing interest in one or more long term
municipal securities. Non-Municipal Tax- Exempt Securities also may include
securities issued by other investment companies that invest in Municipal Bonds,
to the extent such investments are permitted by applicable law. Because each
Portfolio expects to invest less than 50% of its total assets in tax-exempt
municipal securities, the Portfolios do not expect to be eligible to pay
“exempt-interest dividends” to shareholders and interest on municipal securities
will be taxable for federal income tax purposes to shareholders when received as
a distribution from the Portfolio.
A
Portfolio cannot guarantee the accuracy of any opinion issued by bond counsel
regarding the tax-exempt status of a Municipal Bond. Furthermore, there can be
no guarantee that the Internal Revenue Service (“IRS”) will agree with such
counsel’s opinion. The value of Municipal Bonds may also be affected by
uncertainties in the municipal market related to legislation or litigation
involving the taxation of Municipal Bonds or the rights of Municipal Bond
holders in the event of a bankruptcy. From time to time, Congress has introduced
proposals to restrict or eliminate the federal income tax exemption for interest
on Municipal Bonds. State legislatures may also introduce proposals that would
affect the state tax treatment of a Portfolio’s distributions. If such proposals
were enacted, the availability of Municipal Bonds and the value of a Portfolio’s
holdings would be affected, and the investment objectives and policies of a
Portfolio would likely be re-evaluated.
Investments
in Municipal Bonds present certain risks, including credit, interest rate,
liquidity, and prepayment risks. Municipal Bonds may also be affected by local,
state, and regional factors, including erosion of the tax base and changes in
the economic climate. In addition, municipalities and municipal projects that
rely directly or indirectly on federal funding mechanisms may be negatively
affected by actions of the federal government including reductions in federal
spending, increases in federal tax rates, or changes in fiscal
policy.
The
marketability, valuation or liquidity of Municipal Bonds may be negatively
affected in the event that states, localities or their authorities default on
their debt obligations or other market events arise, which in turn may
negatively affect a Portfolio’s performance, sometimes substantially. A credit
rating downgrade relating to, default by, or insolvency or bankruptcy of, one or
several municipal issuers in a particular state, territory, or possession could
affect the market value or marketability of Municipal Bonds from any one or all
such states, territories, or possessions.
The
value of Municipal Bonds may also be affected by uncertainties with respect to
the rights of holders of Municipal Bonds in the event of bankruptcy. Municipal
bankruptcies have in the past been relatively rare, and certain provisions of
the U.S. Bankruptcy Code governing such bankruptcies are unclear and remain
untested. Further, the application of state law to municipal issuers could
produce varying results among the states or among Municipal Bond issuers within
a state. These legal uncertainties could affect the Municipal Bond market
generally, certain specific segments of the market, or the relative credit
quality of particular securities. Any of these effects could have a significant
impact on the prices of some or all of the Municipal Bonds held by a
Portfolio.
Certain
Portfolios may also invest in taxable municipal bonds that do not qualify for
federal support. Taxable municipal bonds are municipal bonds in which interest
paid to the bondholder does not qualify as tax-exempt for federal income tax
purposes because of the use to which the bond proceeds are put by the municipal
borrower. Although taxable municipal bonds are subject to federal taxation, they
may not be subject to taxation by the state in which the municipal issuer is
located.
Municipal
Bond Insurance.
Certain Portfolios may purchase a Municipal Bond that is covered by insurance
that guarantees the bond’s scheduled payment of interest and repayment of
principal. This type of insurance may be obtained by either: (i) the issuer at
the time the Municipal Bond is issued (primary market insurance); or (ii)
another party after the bond has been issued (secondary market insurance). Both
of these types of insurance seek to guarantee the timely and scheduled repayment
of all principal and payment of all interest on a Municipal Bond in the event of
default by the issuer, and cover a Municipal Bond to its maturity, typically
enhancing its credit quality and value.
Even
if a Municipal Bond is insured, it is still subject to market fluctuations,
which can result in fluctuations in a Portfolio’s share price. In addition, a
Municipal Bond insurance policy will not cover: (i) repayment of a Municipal
Bond before maturity (redemption); (ii) prepayment or payment of an acceleration
premium (except for a mandatory sinking fund redemption) or any other provision
of a bond indenture that advances the maturity of the bond; or (iii) nonpayment
of principal or interest caused by negligence or bankruptcy of the paying agent.
A mandatory sinking fund redemption may be a provision of a Municipal Bond issue
whereby part of the Municipal Bond issue may be retired before
maturity.
Some
of the Municipal Bonds outstanding are insured by a small number of insurance
companies, not all of which have the highest credit rating. As a result, an
event involving one or more of these insurance companies could have a
significant adverse effect on the value of the securities insured by that
insurance company and on the municipal markets as a whole. If the Municipal Bond
is not otherwise rated, the ratings of insured bonds reflect the credit rating
of the insurer, based on the rating agency’s assessment of the creditworthiness
of the insurer and its ability to pay claims on its insurance policies at the
time of the assessment. While the obligation
of
a Municipal Bond insurance company to pay a claim extends over the life of an
insured bond, there is no assurance that Municipal Bond insurers will meet their
claims. A higher-than-anticipated default rate on Municipal Bonds (or other
insurance the insurer provides) could strain the insurer’s loss reserves and
adversely affect its ability to pay claims to bondholders.
Put
Bonds.
A put bond (also referred to as a tender option or third party bond) is a bond
created by coupling an intermediate or long-term fixed rate bond with an
agreement giving the holder the option of tendering the bond to receive its par
value. As consideration for providing this tender option, the sponsor of the
bond (usually a bank, broker-dealer or other financial intermediary) receives
periodic fees that equal the difference between the bond’s fixed coupon rate and
the rate (determined by a remarketing or similar agent) that would cause the
bond, coupled with the tender option, to trade at par. By paying the tender
offer fees, a Portfolio in effect holds a demand obligation that bears interest
at the prevailing short-term rate. In selecting put bonds, the Subadvisers, as
applicable, take into consideration the creditworthiness of the issuers of the
underlying bonds and the creditworthiness of the providers of the tender option
features. A sponsor may withdraw the tender option feature if the issuer of the
underlying bond defaults on interest or principal payments or the bond’s rating
is downgraded.
Put
bonds often pay a variable or floating rate of interest and therefore are
subject to many of the same risks associated with investing in floating rate
instruments, as described below under “Variable and Floating Rate
Instruments.”
Real
Estate Securities.
Certain Portfolios may invest in equity securities of real estate companies and
companies related to the real estate industry, including real estate investment
trusts (“REITs”) and companies with substantial real estate investments, and
therefore, a Portfolio may be subject to certain risks associated with direct
ownership of real estate and with the real estate industry in general. These
risks include, among others: possible declines in the value of real estate;
declines in rental income; possible lack of availability of mortgage funds;
extended vacancies of properties; risks related to national, state and local
economic conditions (such as the turmoil experienced during 2007 through 2009 in
the residential and commercial real estate market); overbuilding; increases in
competition, property taxes and operating expenses; changes in building,
environmental, zoning and other laws; costs resulting from the clean-up of, and
liability to third parties for damages resulting from, environmental problems;
casualty or condemnation losses; uninsured damages from floods, earthquakes,
terrorist acts or other natural disasters; limitations on and variations in
rents; and changes in interest rates. The value of real estate securities is
also subject to the management skill, insurance coverage, and creditworthiness
of their issuer. Because many real estate projects are dependent upon financing,
rising interest rates, which increase the costs of obtaining financing, may
cause the value of real estate securities to decline. Real estate income and
values may be greatly affected by demographic trends, such as population shirts
or changing tastes and values.
The
prices of real estate company securities may drop because of the failure of
borrowers to repay their loans, poor management, and the inability to obtain
financing either on favorable terms or at all. If the properties do not generate
sufficient income to meet operating expenses, including, where applicable, debt
service, ground lease payments, tenant improvements, third-party leasing
commissions and other capital expenditures, the income and ability of the real
estate company to make payments of interest and principal on their loans will be
adversely affected. Many real estate companies utilize leverage, which increases
investment risk and could adversely affect a company’s operations and market
value in periods of rising interest rates.
REITs.
REITs are pooled investment vehicles which invest primarily in income producing
real estate or real estate related loans or interests. REITs are generally
classified as equity REITs, mortgage REITs or hybrid REITs. Equity REITs invest
the majority of their assets directly in real property and derive income
primarily from the collection of rents. Equity REITs can also realize capital
gains by selling properties that have appreciated in value. Mortgage REITs
invest the majority of their assets in real estate mortgages and derive income
from the collection of interest payments. A hybrid REIT combines the
characteristics of equity REITs and mortgage REITs, generally by holding both
direct ownership interests and mortgage interests in real estate.
In
addition to the risks affecting real estate securities generally, REITs are also
subject to additional risks. REITs may invest in a limited number of properties,
a narrow geographic area or a single type of property, which may increase the
risk that a Portfolio could be adversely affected by the poor performance of a
single investment or type of investment. REITs have their own expenses, and as a
result, a Portfolio and its shareholders will indirectly bear its proportionate
share of expenses paid by each REIT in which it invests. Finally, certain REITs
may be self-liquidating in that a specific term of existence is provided for in
the trust document. Such trusts run the risk of liquidating at an economically
inopportune time.
REITs
are also subject to unique federal income tax requirements. A REIT that fails to
comply with federal income tax requirements affecting REITs may be subject to
federal income taxation, which may affect the value of the REIT and the
characterization of the REIT’s distributions, and a REIT that fails to comply
with the federal income tax requirement that a REIT distribute substantially all
of its net income to its shareholders may result in a REIT having insufficient
capital for future expenditures. The failure of a company to qualify as a REIT
could have adverse consequences for a Portfolio, including significantly
reducing return to the Portfolio on its investment in such company. In the event
of a default of an underlying borrower or lessee, a REIT could experience delays
in enforcing its rights as a mortgagee or lessor and may incur substantial costs
associated with protecting its investments. Investments in REIT equity
securities may require a Portfolio to accrue and distribute income not yet
received. In order to generate sufficient cash to make the requisite
distributions, the Portfolio may be required to sell securities in its portfolio
(including when it is not advantageous to do so) that it otherwise would have
continued to hold. A Portfolio’s investments in REIT equity securities may at
other times result in the Portfolio’s receipt of cash in excess of the REIT’s
earnings; if the Portfolio distributes such amounts, such distribution could
constitute
a return of capital to Portfolio shareholders for federal income tax purposes.
Dividends received by a Portfolio from a REIT generally will not constitute
qualified dividend income. REITs often do not provide complete tax information
to a Portfolio until after the calendar year-end. Consequently, because of the
delay, it may be necessary for a Portfolio to request permission to extend the
deadline for issuance of Forms 1099-DIV.
Impact
of Large Redemptions and Purchases of Portfolio Shares.
From time to time, shareholders of a Portfolio (which for all Portfolios except
the Wilshire 5000 IndexSM
Fund
may include affiliated registered investment companies that invest in a
Portfolio) may make relatively large redemptions or purchases of Portfolio
shares. These transactions may cause a Portfolio to have to sell securities or
invest additional cash, as the case may be. While it is impossible to predict
the overall impact of these transactions over time, there could be adverse
effects on a Portfolio’s performance to the extent that the Portfolio may be
required to sell securities or invest cash at times when it would not otherwise
do so. These transactions could also accelerate the recognition
of taxable income if sales of securities resulted in capital gains or other
income and could also increase transaction costs, which may impact a Portfolio’s
expense ratio and adversely affect a Portfolio’s performance.
Short
Sales.
Certain Portfolios may make short sales “against the box,” in which a Portfolio
enters into a short sale of a security it owns or has the right to obtain at no
additional cost. Certain Portfolios may also make short sales of securities the
Portfolio does not own. If a Portfolio makes a short sale, a Portfolio does not
immediately deliver from its own account the securities sold and does not
receive the proceeds from the sale. To complete the sale, a Portfolio must
borrow the security (generally from the broker through which the short sale is
made) to make delivery to the buyer. A Portfolios must replace the security
borrowed by purchasing it at the market price at the time of replacement or
delivering the security from its own portfolio. A Portfolio is said to have a
“short position” in securities sold until it delivers them to the broker at
which time it receives the proceeds of the sale.
Certain
Portfolios may make short sales that are not “against the box.” Short sales by a
Portfolio that are not made “against the box” create opportunities to increase
the Portfolio’s return but, at the same time, involve specific risk
considerations and may be considered a speculative technique. Since a Portfolio
in effect profits from a decline in the price of the securities sold short
without the need to invest the full purchase price of the securities on the date
of the short sale, the Portfolio’s NAV per share tends to increase more when the
securities it has sold short decrease in value, and to decrease more when the
securities it has sold short increase in value, than would otherwise be the case
if it had not engaged in such short sales. The amount of any gain will be
decreased, and the amount of any loss increased, by the amount of any premium,
dividends or interest a Portfolio may be required to pay in connection with the
short sale. Short sales theoretically involve unlimited loss potential, as the
market price of securities sold short may continually increase, although a
Portfolio may mitigate such losses by replacing the securities sold short before
the market price has increased significantly. Under adverse market conditions a
Portfolio might have difficulty purchasing securities to meet its short sale
delivery obligations and might have to sell portfolio securities to raise the
capital necessary to meet its short sale obligations at a time when fundamental
investment considerations would not favor such sales.
A
Portfolio’s decision to make a short sale “against the box” may be a technique
to hedge against market risks when the Subadvisers believe that the price of a
security may decline, causing a decline in the value of a security owned by a
Portfolio or a security convertible into or exchangeable for such security. In
such case, any future losses in a Portfolio’s long position would be reduced by
a gain in the short position. The extent to which such gains or losses in the
long position are reduced will depend upon the amount of securities sold short
relative to the amount of the securities a Portfolio owns, either directly or
indirectly, and, in the case where the Portfolio owns convertible securities,
changes in the investment values or conversion premiums of such securities. A
Portfolio can close out its short position by purchasing and delivering an equal
amount of the securities sold short, rather than by delivering securities
already held by the Portfolio, because the Portfolio might want to continue to
receive interest and dividend payments on securities in its portfolio that are
convertible into the securities sold short.
While
the short sale is outstanding, a Portfolio will be required to pledge a portion
of its assets to the broker as collateral for the obligation to deliver the
security to the broker at the close of the transaction. The broker will also
hold the proceeds of the short sale until the close of the transaction. A
Portfolio is often obligated to pay over interest and dividends on the borrowed
security to the broker.
In
the view of the SEC, a short sale involves the creation of a “senior security”
as such term is defined in the 1940 Act unless the sale is “against the box” and
the securities sold short (or securities convertible into or exchangeable for
such securities) are segregated or unless a Portfolio’s obligation to deliver
the securities sold short is “covered” by earmarking or segregating cash, U.S.
government securities or other liquid assets in an amount equal to the
difference between the market value of the securities sold short and any
collateral required to be deposited with a broker in connection with the sale
(not including the proceeds from the short sale), which difference is adjusted
daily for changes in the value of the securities sold short. The total value of
the short sale proceeds, cash, U.S. government securities or other liquid assets
deposited with the broker and earmarked or segregated on its books or with a
Portfolio’s custodian may not at any time be less than the market value of the
securities sold short. The Portfolios will comply with these requirements. The
Portfolios will incur transaction costs, including interest expense, in
connection with opening, maintaining and closing short sales.
Commercial
Paper.
The Income Fund may purchase commercial paper rated (at the time of purchase)
A-1 by S&P or Prime-1 by Moody’s or, when deemed advisable by the Income
Fund’s Adviser or Subadviser, “high quality” issues rated A-2 or Prime-2 by
S&P
or
Moody’s, respectively. These ratings are described in Appendix B. The Income
Fund may also purchase lower-rated, or unrated, commercial paper.
Commercial
paper purchasable by the Income Fund includes “Section 4(2) paper,” a term that
includes debt obligations issued in reliance on the “private placement”
exemption from registration afforded by Section 4(2) of the 1933 Act. Section
4(2) paper is restricted as to disposition under the federal securities laws,
and is frequently sold (and resold) to institutional investors such as the
Income Fund through or with the assistance of investment dealers who make a
market in the Section 4(2) paper, thereby providing liquidity. Certain
transactions in Section 4(2) paper may qualify for the registration exemption
provided in Rule 144A under the 1933 Act.
Commercial
Paper and Other Short-term Corporate Obligations.
Each Portfolio, except for the Income Fund which is described above, may invest
in commercial paper and other short-term corporate obligations. Commercial paper
is a short-term, unsecured promissory note issued to finance short-term credit
needs. The commercial paper purchased by a Portfolio will consist only of direct
obligations which, at the time of their purchase, are: (a) rated at least
Prime-1 by Moody’s, A-1 by S&P or F-1 by Fitch; (b) issued by companies
having an outstanding unsecured debt issue rated at least Aa3 by Moody’s or AA-
by S&P or Fitch; or (c) if unrated, determined by Wilshire or the
Subadvisers to be of comparable quality.
These
instruments include variable amount master demand notes, which are obligations
that permit a Portfolio to invest at varying rates of interest pursuant to
direct arrangements between a Portfolio, as lender, and the borrower. These
notes permit daily changes in the amounts borrowed. Because they are direct
lending arrangements between the lender and borrower, such instruments generally
will not be traded, and there generally is no established secondary market for
these obligations, although they are redeemable at face value, plus accrued
interest, at any time. If these obligations are not secured by letters of credit
or other credit support arrangements, a Portfolio’s right to redeem its
investment depends on the ability of the borrower to pay principal and interest
on demand. In connection with floating and variable rate demand obligations,
Wilshire and the Subadvisers will consider, on an ongoing basis, earning power,
cash flow and other liquidity ratios of the borrower, and the borrower’s ability
to pay principal and interest on demand. Such obligations frequently are not
rated by credit rating agencies, and a Portfolio may invest in them only if at
the time of an investment the borrower meets the criteria set forth above for
other commercial paper issuers.
Asset-Backed
Commercial Paper.
Certain Portfolios may purchase asset-backed commercial paper. Asset-backed
commercial paper is commercial paper collateralized by other financial assets.
These securities are exposed not only to the risks relating to commercial paper,
but also the risks relating to the collateral.
Investment
Grade Debt Obligations.
Certain Portfolios may invest in “investment grade securities,” which are
securities rated in the four highest rating categories of an NRSRO. It should be
noted that debt obligations rated in the lowest of the top four ratings
(i.e.,
Baa by Moody’s or BBB by S&P) are considered to have some speculative
characteristics and are more sensitive to economic change than higher rated
securities. See Appendix B to this SAI for a description of applicable
securities ratings.
When-Issued
Purchase and Forward Commitments.
Certain Portfolios may enter into “when-issued” and “forward” commitments,
including TBA purchase commitments, to purchase or sell securities at a fixed
price at a future date. When a Portfolio agrees to purchase securities on this
basis, liquid assets equal to the amount of the commitment will be set aside in
a separate account. Normally a Portfolio’s securities to satisfy a purchase
commitment will be set aside, and in such a case the Portfolio, may be required
subsequently to place additional assets in the separate account to ensure that
the value of the account remains equal to the amount of the Portfolio’s
commitments. It may be expected that the market value of a Portfolio’s net
assets will fluctuate to a greater degree when it sets aside fund securities to
cover such purchase commitments than when it sets aside cash.
If
deemed advisable as a matter of investment strategy, a Portfolio may dispose of
or renegotiate a commitment after it has been entered into and may sell
securities it has committed to purchase before those securities are delivered to
the fund on the settlement date. In these cases, a fund may recognize
a taxable capital gain or loss. When a Portfolio engages in when-issued, TBA or
forward commitment transactions, it relies on the other party to consummate the
trade. Failure of such party to do so may result in a fund incurring a loss or
missing an opportunity to obtain a price considered to be advantageous. The
market value of the securities underlying a commitment to purchase securities,
and any subsequent fluctuations in their market value, is taken into account
when determining the market value of a Portfolio starting on the day a Portfolio
agrees to purchase the securities. A Portfolio does not earn interest on the
securities it has committed to purchase until they are paid for and delivered on
the settlement date.
Investment
Companies.
Each Portfolio may invest in shares of other investment companies including
exchange-traded funds (“ETFs”), money market funds and other mutual funds, in
pursuit of its investment objective, subject to the limitations set forth in the
1940 Act. Each Fund may invest in money market mutual funds in connection with
its management of daily cash positions and for temporary defensive purposes. In
addition to the advisory and operational fees each Fund bears directly in
connection with its own operation, the Funds would also bear their pro rata
portion of each of the other investment company’s advisory and operational
expenses. Any investment by a Portfolio in shares of other investment companies
is subject to the 1940 Act and related rules thereunder.
Rule
12d1-1, under the 1940 Act, permits a fund to invest in a money market fund in
excess of the limits of Section 12(d)(1). As a shareholder in an investment
company, a Portfolio, would bear its pro rata portion of the investment
company’s expenses, including advisory fees, in addition to its own
expenses.
Rule
12d1-4 permits additional types of fund of fund arrangements without an
exemptive order. The rule imposes certain conditions, including limits on
control and voting of acquired funds’ shares, evaluations and findings by
investment advisers, fund investment agreements, and limits on most three-tier
fund structures.
Shares
of Other Investment Vehicles.
Subject to the requirements of the 1940 Act and a Portfolio’s investment
limitations, the Portfolio may invest in shares of other investment companies or
other investment vehicles, which may include, without limitation, among others,
mutual funds, closed-end funds and ETFs such as index-based investments and
private or foreign investment funds. A Portfolio may also invest in investment
vehicles that are not subject to regulation as registered investment companies.
Additionally, such other investment companies or other investment vehicles may
be managed by a Subadviser or its affiliate.
The
main risk of investing in index-based investment companies is the same as
investing in a portfolio of securities comprising the index. The market prices
of index-based investments will fluctuate in accordance with both changes in the
market value of their underlying portfolio securities and due to supply and
demand for the instruments on the exchanges on which they are traded.
Index-based investments may not replicate exactly the performance of their
specified index because of transaction costs and because of the temporary
unavailability of certain component securities of the index.
To
the extent a Portfolio invests in other investment companies, or other
investment vehicles, it will incur its pro rata share of the underlying
investment companies’ expenses (including, for example, investment advisory and
other management fees). In addition, a Portfolio will be subject to the effects
of business and regulatory developments that affect an underlying investment
company or the investment company industry generally.
Loans
Generally.
Certain Portfolios may invest in fixed and floating rate loans. Loans may
include syndicated bank loans, senior floating rate loans (“senior loans”),
secured and unsecured loans, second lien or more junior loans (“junior loans”),
bridge loans, unfunded commitments, payment-in-kind (“PIK”) and toggle loans,
and other floating rate loans. Loans are typically arranged through private
negotiations between borrowers in the U.S. or in foreign or emerging markets
which may be corporate issuers or issuers of sovereign debt obligations
(“borrowers”) and one or more financial institutions and other lenders
(“lenders”). A loan in which a Portfolio may invest typically is structured by
an agent bank acting on behalf of a group of lenders to whom the loan will be
syndicated. The syndicate of lenders often consists of commercial and investment
banks, thrift institutions, insurance companies, finance companies, mutual funds
and other institutional investment vehicles or other financial institutions.
Typically, the agent bank administers the loan on behalf of all the
lenders.
This
lender is referred to as the agent bank. The agent bank is primarily responsible
for negotiating on behalf of the original lenders the loan agreement which
establishes the terms and conditions of the syndicated bank loan and the rights
of the borrower and the lenders. The agent bank also is responsible for
monitoring collateral, distributing required reporting, and for exercising
remedies available to the lenders such as foreclosure upon collateral. In
addition, an institution, typically, but not always the agent bank, holds any
collateral on behalf of the lenders.
Generally,
a Portfolio may invest in a loan in one of two ways. It may purchase a
participation interest, or it may purchase an assignment. Participation
interests are interests issued by a lender, which represent a fractional
interest in a loan. A Portfolio may acquire participation interests from a
lender or other holders of participation interests. An assignment represents a
portion of a loan previously attributable to a different lender. Unlike a
participation interest, a Portfolio will generally become a lender for the
purposes of the relevant loan agreement by purchasing an assignment. If a
Portfolio purchases an assignment from a lender, the Portfolio will generally
have direct contractual rights against the borrower in favor of the lenders. On
the other hand, if a Portfolio purchases a participation interest either from a
lender or a participant, the Portfolio typically will have established a direct
contractual relationship with the seller/issuer of the participation interest,
but not with the borrower. Consequently, the Portfolio is subject to the credit
risk of the lender or participant who sold the participation interest to the
Portfolio, in addition to the usual credit risk of the borrower. Therefore, when
a Portfolio invests in syndicated bank loans through the purchase of
participation interests, the Subadviser must consider the creditworthiness of
the agent bank and any lenders and participants interposed between the Portfolio
and a borrower.
Purchases
of syndicated bank loans in the market may take place at, above, or below the
par value of a syndicated bank loan. Purchases above par will effectively reduce
the amount of interest being received by a Portfolio through the amortization of
the purchase price premium, whereas purchases below par will effectively
increase the amount of interest being received by the Portfolio through the
amortization of the purchase price discount. A Portfolio may be able to invest
in syndicated bank loans only through participation interests or assignments at
certain times when reduced direct investment opportunities in syndicated bank
loans may exist.
A
loan may be secured by collateral that, at the time of origination, has a fair
market value at least equal to the amount of such loan. The Subadviser generally
will determine the value of the collateral by customary valuation techniques
that it considers appropriate. However, the value of the collateral may decline
following a Portfolio’s investment. Also, collateral may be difficult to sell,
and there are other risks which may cause the collateral to be insufficient in
the event of a default. Consequently, a Portfolio might not receive payments to
which it is entitled. The collateral may consist of various types of assets or
interests including working capital assets or intangible assets. The borrower’s
owners may provide additional collateral, typically by pledging their ownership
interest in the borrower as collateral for the loan.
In
the process of buying, selling and holding loans, a Portfolio may receive and/or
pay certain fees. These fees are in addition to the interest payments received
and may include facility fees, commitment fees and commissions. When a Portfolio
buys or sells a loan it may pay a fee.
Loans
are subject to the risks associated with other debt obligations, including:
interest rate risk, credit risk, market risk, liquidity risk, counterparty risk
and risks associated with high yield securities. Many loans in which a Portfolio
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. The amount of public information with respect to loans will
generally be less extensive than that available for registered or
exchange-listed securities. A Portfolio will make an investment in a loan only
after the Subadviser determines that the investment is suitable for the
Portfolio based on an independent credit analysis. Generally, this means that
the Subadviser has determined that the likelihood that the borrower will meet
its obligations is acceptable.
Additional
Information About Senior Bank Loans (“Senior Loans”).
Certain Portfolios may invest in Senior Loans. The risks associated with Senior
Loans of below-investment grade quality are similar to the risks of other lower
grade income securities, although Senior Loans are typically senior and secured
in contrast to subordinated and unsecured income securities. Senior Loans’
higher standing has historically resulted in generally higher recoveries in the
event of a corporate reorganization. In addition, because their interest
payments are adjusted for changes in short-term interest rates, investments in
Senior Loans generally have less interest rate risk than other lower grade
income securities, which may have fixed interest rates.
Economic
and other events (whether real or perceived) can reduce the demand for certain
Senior Loans or Senior Loans generally, which may reduce market prices and cause
a Portfolio’s NAV per share to fall. The frequency and magnitude of such changes
cannot be predicted.
Loans
and other debt instruments are also subject to the risk of price declines due to
increases in prevailing interest rates, although floating-rate debt instruments
are substantially less exposed to this risk than fixed-rate debt instruments.
Interest rate changes may also increase prepayments of debt obligations and
require a Portfolio to invest assets at lower yields. No active trading market
may exist for certain Senior Loans, which may impair the ability of a Portfolio
to realize full value in the event of the need to liquidate such assets. Adverse
market conditions may impair the liquidity of some actively traded Senior
Loans.
Additional
Information About Second Lien Loans.
Certain Portfolios may invest in second lien loans. Second lien loans are
subject to the same risks associated with investment in Senior Loans and other
lower grade Income Securities. However, second lien loans are second in right of
payment to Senior Loans and therefore are subject to the additional risk that
the cash flow of the borrower and any property securing the loan may be
insufficient to meet scheduled payments after giving effect to the senior
secured obligations of the borrower. Second lien loans are expected to have
greater price volatility and exposure to losses upon default than Senior Loans
and may be less liquid. There is also a possibility that originators will not be
able to sell participations in second lien loans, which would create greater
credit risk exposure.
Additional
Information About Subordinated Secured Loans.
Certain Portfolios may invest in subordinated secured loans. Subordinated
secured loans generally are subject to similar risks as those associated with
investment in Senior Loans, Second Lien Loans and below investment grade
securities. However, such loans may rank lower in right of payment than any
outstanding Senior Loans, Second Lien Loans or other debt instruments with
higher priority of the borrower and therefore are subject to additional risk
that the cash flow of the borrower and any property securing the loan may be
insufficient to meet scheduled payments and repayment of principal in the event
of default or bankruptcy after giving effect to the higher ranking secured
obligations of the borrower. Subordinated secured loans are expected to have
greater price volatility than Senior Loans and second lien loans and may be less
liquid.
Additional
Information About Unsecured Loans.
Certain Portfolios may invest in unsecured loans. Unsecured loans generally are
subject to similar risks as those associated with investment in Senior Loans,
second lien loans, subordinated secured loans and below investment grade
securities. However, because unsecured loans have lower priority in right of
payment to any higher-ranking obligations of the borrower and are not backed by
a security interest in any specific collateral, they are subject to additional
risk that the cash flow of the borrower and available assets may be insufficient
to meet scheduled payments and repayment of principal after giving effect to any
higher ranking obligations of the borrower. Unsecured loans are expected to have
greater price volatility than Senior Loans, second lien loans and subordinated
secured loans and may be less liquid.
Debtor-in-Possession
(“DIP”) Loan Risks.
DIP financings are subject to additional risks. DIP financings are arranged when
an entity seeks the protections of the bankruptcy court under Chapter 11 of the
U.S. Bankruptcy Code and must be approved by the bankruptcy court. These
financings allow the entity to continue its business operations while
reorganizing under Chapter 11. DIP financings are typically fully secured by a
lien on the debtor’s otherwise unencumbered assets or secured by a junior lien
on the debtor’s encumbered assets (so long as the loan is fully secured based on
the most recent current valuation or appraisal report of the debtor). DIP
financings are often required to close with certainty and in a rapid manner in
order to satisfy existing creditors and to enable the issuer to emerge from
bankruptcy or to avoid a bankruptcy proceeding. There is a risk that the
borrower will not emerge from Chapter 11 bankruptcy proceedings and be forced to
liquidate its assets under Chapter 7 of the U.S. Bankruptcy Code. In the event
of liquidation, a Portfolio’s only recourse will be against the property
securing the DIP financing.
Mortgage
Backed Securities Risks.
Certain Portfolios may invest in MBS. MBS represent an interest in a pool of
mortgages. MBS are subject to certain risks: credit risk associated with the
performance of the underlying mortgage properties and of the borrowers owning
these properties; risks associated with their structure and execution (including
the collateral, the process by which principal and interest payments are
allocated and distributed to investors and how credit losses affect the return
to investors in such MBS); risks associated with the servicer of the underlying
mortgages; adverse changes in economic conditions and circumstances, which are
more likely to have an adverse impact on MBS secured by loans on certain types
of commercial properties than on those secured by loans on residential
properties; prepayment risk, which can lead to significant fluctuations in the
value of the MBS; loss of all or part of the premium, if any, paid; and decline
in the market value of the security, whether resulting from changes in interest
rates, prepayments on the underlying mortgage collateral or perceptions of the
credit risk associated with the underlying mortgage collateral. In addition, a
Portfolio’s level of investment in MBS of a particular type or in MBS issued or
guaranteed by affiliated obligors, serviced by the same servicer or backed by
underlying collateral located in a specific geographic region, may subject the
Portfolio to additional risk.
When
market interest rates decline, more mortgages are refinanced and the securities
are paid off earlier than expected. Prepayments may also occur on a scheduled
basis or due to foreclosure. When market interest rates increase, the market
values of MBS decline. At the same time, however, mortgage refinancings, and
prepayments slow, which lengthens the effective maturities of these securities.
As a result, the negative effect of the rate increase on the market value of MBS
is usually more pronounced than it is for other types of debt securities.
Certain Portfolios may invest in sub-prime mortgages or MBS that are backed by
sub-prime mortgages. Moreover, the relationship between prepayments and interest
rates may give some high-yielding MBS less potential for growth in value than
conventional bonds with comparable maturities. During periods of falling
interest rates, the reinvestment of prepayment proceeds by a Portfolio will
generally be at lower rates than the rates that were carried by the obligations
that have been prepaid. Because of these and other reasons, MBS’s total return
and maturity may be difficult to predict precisely. To the extent that a
Portfolio purchases MBS at a premium, prepayments (which may be made without
penalty) may result in loss of the Portfolio’s principal investment to the
extent of premium paid. MBS generally are classified as either commercial
mortgage-backed securities (“CMBS”) or residential mortgage-backed securities
(“RMBS”), each of which are subject to certain specific risks.
Commercial
Mortgage-Backed Securities Risk.
The market for CMBS developed more recently and, in terms of total outstanding
principal amount of issues, is relatively small compared to the market for
residential single family MBS. CMBS are subject to particular risks. CMBS lack
of standardized terms, have shorter maturities than residential mortgage loans
and provide for payment of all or substantially all of the principal only at
maturity rather than regular amortization of principal. In addition, commercial
lending generally is viewed as exposing the lender to a greater risk of loss
than residential lending. Commercial lending typically involves larger loans to
single borrowers or groups of related borrowers than residential mortgage loans.
In addition, the repayment of loans secured by income producing properties
typically is dependent upon the successful operation of the related real estate
project and the cash flow generated therefrom. Net operating income of an
income-producing property can be affected by, among other things: tenant mix,
success of tenant businesses, property management decisions, property location
and condition, competition from comparable types of properties, changes in laws
that increase operating expense or limit rents that may be charged, any need to
address environmental contamination at the property, the occurrence of any
uninsured casualty at the property, changes in national, regional or local
economic conditions and/or specific industry segments, declines in regional or
local real estate values, declines in regional or local rental or occupancy
rates, increases in interest rates, real estate tax rates and other operating
expenses, change in governmental rules, regulations and fiscal policies,
including environmental legislation, acts of God, terrorism, social unrest and
civil disturbances. Consequently, adverse changes in economic conditions and
circumstances are more likely to have an adverse impact on MBS secured by loans
on commercial properties than on those secured by loans on residential
properties. Additional risks may be presented by the type and use of a
particular commercial property. Special risks are presented by hospitals,
nursing homes, hospitality properties and certain other property types.
Commercial property values and net operating income are subject to volatility,
which may result in net operating income becoming insufficient to cover debt
service on the related mortgage loan. The exercise of remedies and successful
realization of liquidation proceeds relating to CMBS may be highly dependent on
the performance of the servicer or special servicer. There may be a limited
number of special servicers available, particularly those that do not have
conflicts of interest.
Residential
Mortgage-Backed Securities Risk.
Credit-related risk on RMBS arises from losses due to delinquencies and defaults
by the borrowers in payments on the underlying mortgage loans and breaches by
originators and servicers of their obligations under the underlying
documentation pursuant to which the RMBS are issued. The rate of delinquencies
and defaults on residential mortgage loans and the aggregate amount of the
resulting losses will be affected by a number of factors, including general
economic conditions, particularly those in the area where the related mortgaged
property is located, the level of the borrower’s equity in the mortgaged
property and the individual financial circumstances of the borrower. If a
residential mortgage loan is in default, foreclosure on the related residential
property may be a lengthy and difficult process involving significant legal and
other expenses. The net proceeds obtained by the holder on a residential
mortgage loan following the foreclosure on the related property may be less than
the total amount that remains due on the loan. The prospect of incurring a loss
upon the foreclosure of the related property may lead the holder of the
residential mortgage loan to restructure the residential mortgage loan or
otherwise delay the foreclosure process.
Stripped
MBS Risk.
Stripped MBS may be subject to additional risks. One type of stripped MBS pays
to one class all of the interest from the mortgage assets (the interest only or
IO class), while the other class will receive all of the principal (the
principal only or PO class). The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
underlying mortgage assets, and a rapid rate of principal payments may have a
material adverse effect on a Portfolio’s yield to
maturity
from these securities. If the assets underlying the IO class experience greater
than anticipated prepayments of principal, a Portfolio may fail to recoup fully,
or at all, its initial investment in these securities. Conversely, PO class
securities tend to decline in value if prepayments are slower than
anticipated.
Sub-Prime
Mortgage Market Risk.
The residential mortgage market in the United States has experienced
difficulties that may adversely affect the performance and market value of
certain mortgages and MBS. Borrowers with adjustable rate mortgage loans are
more sensitive to changes in interest rates, which affect their monthly mortgage
payments, and may be unable to secure replacement mortgages at comparably low
interest rates. Reduced investor demand for mortgage loans and MBS and increased
investor yield requirements can limit liquidity in the secondary market for
certain MBS, which can adversely affect the market value of MBS.
A
rise in interest rates will generally cause the value of debt securities to
decrease. Actions by governments and central banking authorities may result in
increases in interest rates. Conversely, a decrease in interest rates will
generally cause the value of debt securities to increase. Interest rate declines
may also increase prepayments of debt obligations. Consequently, changes in
interest rates may have a significant effect on a Portfolio, especially if the
Portfolio is holding a significant portion of its assets in debt securities that
are particularly sensitive to interest rate fluctuations, such as debt
securities with longer maturities, zero coupon bonds, and debentures. A
Portfolio may be subject to greater risk of rising interest rates due to the
current period of historically low interest rates. Interest rate changes may
have different effects on the values of mortgage-related securities held by a
Portfolio because of prepayment and extension risks.
Moreover,
with respect to hybrid mortgage loans after their initial fixed rate period,
interest-only products or products having a lower rate, and with respect to
mortgage loans with a negative amortization feature which reach their negative
amortization cap, borrowers may experience a substantial increase in their
monthly payment even without an increase in prevailing market interest rates.
Increases in payments for borrowers may result in increased rates of
delinquencies and defaults on residential mortgage loans underlying the
RMBS.
Cyber
Security Risk.
Investment companies such as each Portfolio and its service providers may be
prone to operational and information security risks resulting from
cyber-attacks. Cyber-attacks include, among other behaviors, stealing or
corrupting data maintained online or digitally, denial of service attacks on
websites, the unauthorized release of confidential information or various other
forms of cyber security breaches. Cyber security attacks affecting a Portfolio
or its Adviser, Subadvisers, custodian, transfer agent and other third party
service providers may adversely impact a Portfolio. For instance, cyber-attacks
may interfere with the processing of shareholder transactions, impact a
Portfolio’s ability to calculate its NAV, cause the release of private
shareholder information or confidential company information, impede trading,
subject the Portfolio to regulatory fines or financial losses, and cause
reputational damage. A Portfolio may also incur additional costs for cyber
security risk management purposes. Similar types of cyber security risks are
also present for issuers of securities in which the Portfolio may invest, which
could result in materials adverse consequences for such issuers, and may cause a
Portfolio’s investment in such portfolio companies to lose value.
Legislation
and Regulation Risk.
As a result of the dislocation of the credit markets during the 2008 recession,
the securitization industry has become subject to additional and changing
regulation. For example, pursuant to the Dodd-Frank Act, which went into effect
on July 21, 2010, various federal agencies have promulgated, or are in the
process of promulgating, regulations, and rules on various issues that affect
securitizations, including: rule requiring that sponsors in securitizations
retain 5% of the credit risk associated with securities they issue; requirements
for additional disclosure; requirements for additional review and reporting;
rules for swaps (including those used by securitizations); and certain
restrictions designed to prohibit conflicts of interest. Other regulations have
been and may ultimately be adopted. The risk retention rule (as it relates to
CMBS) took effect in December 2016 and requires retention of at least 5% of the
fair value of all securities issued in connection with a securitization. The
risk (with respect to CMBS) must be retained by a sponsor (generally an issuer
or certain mortgage loan originators) or, upon satisfaction of certain
requirements, up to two third-party purchasers of interests in the
securitization. The risk retention rules and other rules and regulations that
have been adopted or may be adopted may alter the structure of securitizations,
reduce or eliminate economic benefits of participation in securitizations, and
could discourage traditional issuers, underwriters or other participants from
participating in future securitization. Any of these outcomes could reduce the
market for CMBS in which a Portfolio seeks suitable investments or otherwise
adversely affect a Portfolio’s ability to achieve its investment
objective.
Zero
Coupon and Payment-In-Kind Securities.
Each Portfolio, except the Index Fund, may invest in zero coupon U.S. Treasury
securities. Each such Portfolio also may invest in zero coupon securities issued
by corporations and financial institutions which constitute a proportionate
ownership of the issuer’s pool of underlying U.S. Treasury securities. Zero
coupon securities pay no interest to holders prior to maturity, and
payment-in-kind securities pay interest in the form of additional securities.
The market value of a zero-coupon or payment-in-kind security, which usually
trades at a deep discount from its face or par value, is generally more volatile
than the market value of, and is more sensitive to changes in interest rates and
credit quality than, other fixed income securities with similar maturities and
credit quality that pay interest in cash periodically. Zero coupon and
payment-in-kind securities also may be less liquid than other fixed-income
securities with similar maturities and credit quality that pay interest in cash
periodically. In addition, zero coupon and payment-in-kind securities may be
more difficult to value than other fixed income securities with similar
maturities and credit quality that pay interest in cash
periodically.
When
held to maturity, the entire income from zero coupon securities, which consists
of accretion of discount, comes from the difference between the issue price and
their value at maturity. Zero coupon securities, which are convertible into
common stock, offer the opportunity for capital appreciation as increases (or
decreases) in market value of such securities closely follows the movements in
the market value of the underlying common stock. Zero coupon convertible
securities generally are expected to be less volatile than the underlying common
stocks, as they usually are issued with maturities of 15 years or less and are
issued with options and/or redemption features exercisable by the holder of the
obligation entitling the holder to redeem the obligation and receive a defined
cash payment.
Zero
coupon securities include securities issued directly by the U.S. Treasury and
U.S. Treasury bonds or notes and their un-accrued interest coupons and receipts
for their underlying principal (“coupons”) which have been separated by their
holder, typically a custodian bank or investment brokerage firm. A holder will
separate the interest coupons from the underlying principal (the “corpus”) of
the U.S. Treasury security. A number of securities firms and banks have stripped
the interest coupons and receipts and then resold them in custodial receipt
programs with a number of different names, including “Treasury Income Growth
Receipts” (TIGRSTM) and Certificate of Accrual on Treasuries (CATSTM). The
underlying U.S. Treasury bonds and notes themselves are held in book-entry form
at the Federal Reserve Bank or, in the case of bearer securities (i.e.,
unregistered securities which are owned ostensibly by the bearer or holder
thereof), in trust on behalf of the owners thereof. Counsel to the underwriters
of these certificates or other evidences of ownership of the U.S. Treasury
securities have stated that, for federal tax and securities purposes, in their
opinion purchasers of such certificates, such as a Portfolio, most likely will
be deemed the beneficial holder of the underlying U.S. government
securities.
The
U.S. Treasury has facilitated transfers of ownership of zero coupon securities
by accounting separately for the beneficial ownership of particular interest
coupon and corpus payments on Treasury securities through the Federal Reserve
book-entry recordkeeping system. The Federal Reserve program as established by
the Treasury Department is known as “STRIPS” or “Separate Trading of Registered
Interest and Principal of Securities.” Under the STRIPS program, a Portfolio
will be able to have its beneficial ownership of zero coupon securities recorded
directly in the book-entry recordkeeping system in lieu of having to hold
certificates or other evidences of ownership of the underlying U.S. Treasury
securities. When U.S. Treasury obligations have been stripped of their unmatured
interest coupons by the holder, the principal or corpus is sold at a deep
discount because the buyer receives only the right to receive a future fixed
payment in the security and does not receive any rights to periodic interest
(cash) payments. Once stripped or separated, the corpus and coupons may be sold
separately. Typically, the coupons are sold separately or grouped with other
coupons with like maturity dates and sold bundled in such form. Purchasers of
stripped obligations acquire, in effect, discount obligations that are
economically identical to the zero-coupon securities that the U.S. Treasury
sells itself.
A
portion of the original issue discount on zero coupon securities and the
“interest” on payment-in-kind securities will be included in a Portfolio’s
income. Accordingly, for a Portfolio to qualify for federal income tax treatment
as a regulated investment company and to avoid certain taxes, the Portfolio will
generally be required to distribute to its shareholders an amount that is
greater than the total amount of cash it actually receives with respect to these
securities. These distributions must be made from a Portfolio’s cash assets or,
if necessary, from the proceeds of sales of portfolio securities. A Portfolio
will not be able to purchase additional income-producing securities with cash
used to make any such distributions, and its current income ultimately may be
reduced as a result.
PORTFOLIO
TURNOVER
A
Portfolio’s portfolio turnover rate is calculated by dividing the lesser of
long-term purchases or sales of portfolio securities for the fiscal year by the
monthly average of the value of the portfolio securities owned by the Portfolio
during the fiscal year. Although a Portfolio’s annual portfolio turnover rate
cannot be accurately predicted, the Adviser anticipates that each Portfolio’s
portfolio turnover rate normally will be below 100%. A 100% turnover rate would
occur if all of the Portfolio’s portfolio securities were replaced once within a
one year period. High turnover involves correspondingly greater commission
expenses and transaction costs, which will be borne directly by a Portfolio, and
may result in the Portfolio recognizing greater amounts of income and capital
gains, which would increase the amount of income and capital gains which the
Portfolio must distribute to shareholders to maintain its status as a regulated
investment company and to avoid the imposition of federal income or excise taxes
(see “Dividends, Distributions and Federal Income Taxes”).
The
Portfolios do not intend to use short-term trading as a primary means of
achieving their respective investment objectives. Generally, the Portfolios
intend to invest for long-term purposes. However, the rate of portfolio turnover
will depend upon market and other conditions, and it will not be a limiting
factor when the Adviser or Subadvisers believe that portfolio changes are
appropriate.
The
portfolio turnover rates for the Portfolios for the two most recent fiscal years
ended December 31, are detailed in the table below.
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Name
of Portfolio |
2023 |
2022 |
Large
Company Growth Portfolio |
66% |
75% |
Large
Company Value Portfolio |
50% |
38% |
Small
Company Growth Portfolio |
81% |
57% |
Small
Company Value Portfolio |
65% |
52% |
Index
Fund |
5% |
21% |
International
Fund |
55% |
48% |
Income
Fund |
66% |
78% |
DISCLOSURE
OF PORTFOLIO HOLDINGS
The
Board has adopted a Dissemination of Portfolio Information Policy (the “Policy”)
regarding the disclosure by Wilshire and the Subadvisers of information about
the portfolio holdings and characteristics of each Portfolio. Pursuant to the
Policy, such information may be made available to the general public by posting
on the Company’s website on the first business day following the 20th calendar
day after each month end. Other than such disclosure, no portfolio holdings
information may be disclosed to any third party except for the following
disclosures: (a) to the Company’s administrator, custodian, legal counsel,
independent registered public accounting firm and other service providers to
enable them to fulfill their responsibilities to the Company; (b) to the Board;
(c) to third parties (e.g.,
broker-dealers) for the purpose of analyzing or trading portfolio securities;
(d) to rating agencies and companies that collect and maintain information about
mutual funds, subject to confidentiality requirements; (e) as required by law,
including in regulatory filings with the SEC; (f) to shareholders of the Company
and others, provided such information is publicly available (e.g.,
posted on the Company’s internet website or included in a regulatory filing);
(g) to third parties for purposes of effecting in-kind redemptions of securities
to facilitate orderly redemption of Portfolio assets and to minimize impact on
remaining Portfolio shareholders; or (h) as approved by the Chief Compliance
Officer of the Company (the “CCO”). Any disclosure made pursuant to item (h)
above will be reported to the Board at its next quarterly meeting.
The
Company, Wilshire and/or the Subadvisers have ongoing business arrangements with
the following entities which involve making portfolio holdings information
available to such entities as an incidental part of the services they provide to
the Company: (i) the Company’s administrator and custodian pursuant to fund
accounting and custody agreements, respectively, under which the Company’s
portfolio holdings information is provided daily on a real-time basis; (ii) MSCI
Institutional Shareholder Services and Investor Responsibility Research Center,
Inc., pursuant to proxy voting agreements under which the portfolio holdings
information of certain Portfolios is provided daily, on a real-time basis; and
(iii) the Company’s independent registered public accounting firm and legal
counsel to whom the Company provides portfolio holdings information as needed
with no lag time.
The
release of information is subject to confidentiality requirements. None of the
Company, Wilshire, the Subadvisers or any other person receives compensation or
any other consideration in connection with such arrangements (other than the
compensation paid by the Company to such entities for the services provided by
them to the Company). In the event of a conflict between the interests of
Portfolio shareholders and those of the Company, Wilshire, the Company’s
principal underwriter, or any of their affiliated persons, the CCO will
determine in the best interests of the Company’s shareholders, and will report
such determination to the Board at the end of the quarter in which such
determination was made.
INVESTMENT
RESTRICTIONS
The
investment restrictions described below are fundamental policies of each of the
Large Company Value Portfolio, the Small Company Growth Portfolio, the Small
Company Value Portfolio, the International Fund, and the Index Fund and cannot
be changed without the approval of a majority of the Portfolio’s outstanding
voting shares (as defined by the 1940 Act). In addition the investment
objectives of the International Fund and Index Fund are fundamental policies and
cannot be changed without the approval of a majority of the Portfolio’s
outstanding voting shares (as defined by the 1940 Act). All percentage
limitations apply only at the time of the transaction. Subsequent changes in
value or in a Portfolio’s total assets will not result in a violation of the
percentage limitations, except for the limitation on borrowing. The Large
Company Value Portfolio, the Small Company Growth Portfolio, the Small Company
Value Portfolio, the International Fund, and the Index Fund may
not:
1.Invest
in commodities, except that a Portfolio may purchase and sell options, forward
contracts, and futures contracts, including those relating to indices, and
options on futures contracts or indices.
2.Purchase,
hold or deal in real estate or oil, gas or other mineral leases or exploration
or development programs, but a Portfolio may purchase and sell securities that
are secured by real estate or issued by companies that invest or deal in real
estate.
3.Borrow
money, except for temporary or emergency (not leveraging) purposes in an amount
up to 33⅓% of the value of a Portfolio’s total assets (including the amount
borrowed) based on the lesser of cost or market, less liabilities (not including
the
amount borrowed) at the time the borrowing is made. When borrowings exceed 5% of
the value of a Portfolio’s total assets, the Portfolio will not make any
additional investments. For purposes of this investment restriction, the entry
into options, forward contracts, or futures contracts, including those relating
to indices and options on futures contracts or indices, will not constitute
borrowing.
4.Make
loans to others, except through the purchase of debt obligations and entry into
repurchase agreements. However, each Portfolio may lend its portfolio securities
in an amount not to exceed 33⅓% of the value of its total assets, including
collateral received for such loans. Any loans of portfolio securities will be
made according to guidelines established by the SEC and the Board.
5.Act
as an underwriter of securities of other issuers, except to the extent a
Portfolio may be deemed an underwriter under the Securities Act of 1933, as
amended, by virtue of disposing of portfolio securities.
6.Invest
more than 25% of its assets in the securities of issuers in any single industry,
provided there will be no limitation on the purchase of obligations issued or
guaranteed by the U.S. government, its agencies or
instrumentalities.
7.Invest
more than 5% of its assets in the obligations of any single issuer, except that
up to 25% of the value of a Portfolio’s total assets may be invested, and
securities issued or guaranteed by the U.S. government, or its agencies or
instrumentalities may be purchased, without regard to any such
limitation.
8.With
respect to 75% of a Portfolio’s assets, hold more than 10% of the outstanding
voting securities of any single issuer.
9.Issue
any senior security (as defined in Section 18(f) of the 1940 Act), except to the
extent that the activities permitted in investment restrictions No. 1 and 3 may
be deemed to give rise to a senior security.
With
respect to the investment restriction on borrowing, in the event that asset
coverage falls below 33⅓% of its total assets, a Portfolio, except for the
Income Fund, shall, within three days thereafter (not including Sundays and
holidays), reduce the amount of its borrowings to an extent that the asset
coverage of such borrowings shall be at least 33⅓% of its total
assets.
All
swap agreements and other derivative instruments that were not classified as
commodities or commodity contracts prior to July 21, 2010 are not deemed to be
commodities or commodity contracts for purposes of restriction No. 1
above.
The
following investment restrictions are non-fundamental and may be changed by a
vote of a majority of the Company’s Board. Each of the Large Company Growth
Portfolio, the Large Company Value Portfolio, the Small Company Growth
Portfolio, the Small Company Value Portfolio, the International Fund, and the
Index Fund may not:
1.Invest
in the securities of a company for the purpose of exercising management or
control, but a Portfolio will vote the securities it owns in its portfolio as a
shareholder in accordance with its views.
2.Enter
into repurchase agreements providing for settlement in more than seven days
after notice or purchase securities which are illiquid, if, in the aggregate,
more than 15% of the value of a Portfolio’s net assets would be so
invested.
3.Purchase
securities of other investment companies, except to the extent permitted under
the 1940 Act or those received as part of a merger or
consolidation.
In
addition, as a non-fundamental policy of each Portfolio, a Portfolio may not
invest in the securities of other registered open-end investment companies or in
registered trusts in reliance on Sections 12(d)(1)(F) and 12(d)(1)(G) of the
1940 Act but may otherwise invest in the securities of other investment
companies to the extent permitted under the 1940 Act or the rules and
regulations thereunder or by guidance regarding, interpretations of, or
exemptive orders under, the 1940 Act or the rules and regulations thereunder
published by appropriate regulatory authorities.
The
investment restrictions described below are fundamental policies of the Income
Fund and cannot be changed without the approval of a majority of the Income
Fund’s outstanding voting shares (as defined by the 1940 Act). All percentage
limitations apply only at the time of the transaction. Subsequent changes in
value or in the Income Fund’s total assets will not result in a violation of the
percentage limitations, except for the limitation on borrowing. The Income
Fund:
1.may
not purchase securities other than the securities in which the Income Fund is
authorized to invest;
2.may
issue senior securities to the extent permitted under the 1940 Act and other
applicable laws, rules and regulations, as interpreted, modified, or applied by
regulatory authority having jurisdiction from time to time;
3.may
borrow money to the extent permitted under the 1940 Act and other applicable
laws, rules and regulations, as interpreted, modified, or applied by regulatory
authority having jurisdiction from time to time;
4.may
not “concentrate” its investments in a particular industry, except to the extent
permitted under the 1940 Act and other applicable laws, rules and regulations,
as interpreted, modified, or applied by regulatory authority having jurisdiction
from time to time;
5.may
purchase real estate or any interest therein (such as securities or instruments
backed by or related to real estate) to the extent permitted under the 1940 Act
and other applicable laws, rules and regulations, as interpreted, modified, or
applied by regulatory authority having jurisdiction from time to time;
6.may
purchase or sell commodities, including physical commodities, or contracts,
instruments and interests relating to commodities to the extent permitted under
the 1940 Act and other applicable laws, rules and regulations, as interpreted,
modified, or applied by regulatory authority having jurisdiction from time to
time;
7.may
make loans to the extent permitted under the 1940 Act and other applicable laws,
rules and regulations, as interpreted, modified, or applied by regulatory
authority having jurisdiction from time to time;
8.may
not act as an underwriter of securities issued by others, except to the extent
it could be considered an underwriter in the acquisition and disposition of
restricted securities; and
9.shall
be a “diversified company,” as that term is defined in the 1940 Act, as
interpreted, modified, or applied by regulatory authority having jurisdiction
from time to time.
The
investment restrictions described below are fundamental policies of the Large
Company Growth Portfolio and cannot be changed without the approval of a
majority of the Large Company Growth Portfolio’s outstanding voting shares (as
defined by the 1940 Act). All percentage limitations apply only at the time of
the transaction. Subsequent changes in value or in the Large Company Growth
Portfolio’s total assets will not result in a violation of the percentage
limitations, except for the limitation on borrowing. The Large Company Growth
Portfolio may not:
1.Invest
in commodities, except that a Portfolio may purchase and sell options, forward
contracts, and futures contracts, including those relating to indices, and
options on futures contracts or indices.
2.Purchase,
hold or deal in real estate or oil, gas or other mineral leases or exploration
or development programs, but a Portfolio may purchase and sell securities that
are secured by real estate or issued by companies that invest or deal in real
estate.
3.Borrow
money, except for temporary or emergency (not leveraging) purposes in an amount
up to 33⅓% of the value of a Portfolio’s total assets (including the amount
borrowed) based on the lesser of cost or market, less liabilities (not including
the amount borrowed) at the time the borrowing is made. When borrowings exceed
5% of the value of a Portfolio’s total assets, the Portfolio will not make any
additional investments. For purposes of this investment restriction, the entry
into options, forward contracts, or futures contracts, including those relating
to indices and options on futures contracts or indices, will not constitute
borrowing.
4.Make
loans to others, except through the purchase of debt obligations and entry into
repurchase agreements. However, each Portfolio may lend its portfolio securities
in an amount not to exceed 33⅓% of the value of its total assets, including
collateral received for such loans. Any loans of portfolio securities will be
made according to guidelines established by the SEC and the Board.
5.Act
as an underwriter of securities of other issuers, except to the extent a
Portfolio may be deemed an underwriter under the Securities Act of 1933, as
amended, by virtue of disposing of portfolio securities.
6.Invest
more than 25% of its assets in the securities of issuers in any single industry,
provided there will be no limitation on the purchase of obligations issued or
guaranteed by the U.S. government, its agencies or
instrumentalities.
7.Issue
any senior security (as defined in Section 18(f) of the 1940 Act), except to the
extent that the activities permitted in investment restrictions No. 1 and 3 may
be deemed to give rise to a senior security.
8.The
Large Company Growth Portfolio shall be a “diversified company,” as that term is
defined in the 1940 Act, as interpreted, modified, or applied by regulatory
authority having jurisdiction from time to time.
Each
Portfolio may borrow from a line of credit to meet redemption requests or for
other temporary purposes. The use of borrowing a Portfolio involves special risk
considerations that may not be associated with other funds having similar
policies. The interest which a Portfolio must pay on borrowed money, together
with any additional fees to maintain a line of credit or any minimum average
balances required to be maintained, are additional costs which will reduce or
eliminate any net investment income and may also offset any potential capital
gains.
DIRECTORS
AND OFFICERS
The
Board of Directors, four of whom are not considered “interested persons” of the
Company within the meaning of the 1940 Act (the “Independent Directors”), has
responsibility for the overall management and operations of the Company. The
Board establishes the Company’s policies and meets regularly to review the
activities of the officers, who are responsible for day-to-day operations of the
Company.
Set
forth below are the names of the Directors and executive officers of the
Company, their ages, business addresses, positions and terms of office, their
principal occupations during the past five years, and other directorships held
by them, including directorships in public companies. The address of each
Director and officer is 1299 Ocean Avenue, Suite 600,
Santa Monica, CA 90401.
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Name
and Age as of April 30, 2023 |
Position
Held with the Company |
Term
of Office(1)
and Length of Time Served |
Principal
Occupations During the Past Five Years |
Number
of Funds/ Funds in Complex Overseen by Director |
Other
Directorships Held by Director Over the Past Five Years |
NON-INTERESTED
DIRECTORS |
Matt
Forstenhausler, 65 |
Director |
Since
2023 |
Retired;
formerly Partner, Ernst Young LLP (1981 to 2019) |
8 |
Wilshire
Variable Insurance Trust
(1
Fund); Sierra Income Fund (2020-2022) |
Edward
Gubman,
74 |
Director |
Since
2011 |
Retired;
formerly Founder and Principal, Strategic Talent Solutions (2004 to 2009);
Consultant, Gubman Consulting (2001 to 2003); Account Manager and Global
Practice Leader, Hewitt Associates (1983 to 2000) |
8 |
Wilshire
Variable Insurance Trust
(1
Fund) |
Elizabeth
A. Levy-Navarro, 61 |
Director |
Since
2019 |
Independent
Corporate Advisor, Summit Strategy (2018 to 2023); Chief Executive
Officer, Orrington Strategies (2002 to 2017); Partner, Practice Leader,
and Operating Committee Member for a division of Nielsen Holdings (1993 to
2002). |
8 |
Wilshire
Variable Insurance Trust
(1
Fund) |
George
J. Zock,
74 |
Director,
Chairperson of the Board |
Since
2006 |
Independent
Consultant; Consultant, Horace Mann Service Corporation (2004 to 2005);
Executive Vice President, Horace Mann Life Insurance Company and Horace
Mann Service Corporation (1997 to 2003) |
8 |
Wilshire
Variable Insurance Trust
(1
Fund);
Armed
Forces Insurance Exchange |
INTERESTED
DIRECTOR and PRESIDENT |
Jason
Schwarz,(2)
50 |
Director
and President |
Director
since 2018/ President since 2012 |
President,
Wilshire Advisors LLC (since 2021); Chief Operating Officer, Wilshire
Advisors LLC (2020 to March 2022); President, Wilshire Funds Management
(2014 to 2020); President, Wilshire Analytics (2017 to 2020); Managing
Director, Head of Wilshire Funds Management’s Client Service, Sales,
Marketing and Distribution functions (2005 to 2014) |
8 |
Wilshire
Variable Insurance Trust
(1
Fund) |
OFFICERS |
Sandy
Choi,
50 |
Chief
Compliance Officer and Secretary |
Since
2023 |
General
Counsel and Head of Compliance, Wilshire Advisors LLC (Since 2023);
General Counsel, Cercano Management LLC (2022 to
2023);
Sr. Managing Director, Guggenheim Investments
(2013
to 2022) |
N/A |
N/A |
Nathan
R. Palmer,
48 |
Vice
President |
Since
2011 |
Managing
Director, Wilshire Advisors LLC (since 2011); Senior Investment Management
Associate, Convergent Wealth Advisors (2009 to 2010); Director of Public
Markets, Investment Office, California Institute of Technology (2008 to
2009). Treasury Manager, Retirement Investments, Intel Corporation (2004
to 2008) |
N/A |
N/A |
Michael
Wauters,
58 |
Treasurer |
Since
2009 |
Managing
Director - Finance, Wilshire Advisors LLC (since 2021); Chief Financial
Officer (2013 to 2021), Controller, (2009 to 2012) |
N/A |
N/A |
Josh
Emanuel,
44 |
Vice
President |
Since
2015 |
Managing
Director, Wilshire Advisors LLC (since 2015); Chief Investment Officer,
Wilshire Advisors LLC (since 2015); Chief Investment Officer, The Elements
Financial Group, LLC (2010 to 2015) |
N/A |
N/A |
Suehyun
Kim,
47 |
Vice
President |
Since
2018 |
Senior
Vice President, Wilshire Advisors LLC (since 2023); Vice President,
Wilshire Advisors LLC (2018 to 2022); Director, Cetera Financial Group
(2011 to 2018) |
N/A |
N/A |
(1)Each
Director serves until the next shareholders’ meeting (and until the election and
qualification of a successor), or until death, resignation, removal or
retirement which takes effect no later than May 1 following his or her 75th
birthday. Officers are elected by the Board on an annual basis to serve until
their successors have been elected and qualified.
(2)Mr.
Schwarz is considered an Interested Director because he is an officer of
Wilshire.
Board
of Directors
Under
the Company’s Articles of Incorporation and the laws of the State of Maryland,
the Board is responsible for overseeing the Company’s business and affairs. The
Board is currently comprised of five
Directors,
four of
whom are classified under the 1940 Act as “non-interested” persons of the
Company and are often referred to as “independent directors.”
Qualifications
and Experience
The
following is a summary of the experience, qualifications, attributes and skills
of each Director that support the conclusion, as of the date of this SAI, that
each Director should serve as a Director in light of the Company’s business and
structure. Each Director also has considerable familiarity with the Wilshire
family of investment companies (by service on the Board of the Company and
Wilshire Variable Insurance Trust (the “Trust”)), the Adviser and distributor,
and their operations, as well as the special regulatory requirements governing
regulated investment companies and the special responsibilities of investment
company directors as a result of his or her substantial prior service as a
Director of the Company. References to the qualifications, attributes and skills
of Directors are pursuant to requirements of the SEC, do not constitute holding
out of the Board or any Director as having any special expertise and shall not
impose any greater responsibility or liability on any such person or on the
Board by reason thereof.
Edward
Gubman, PhD.
Mr. Gubman has served as a Director of the Company since 2011 and chairperson of
the Investment Committee since 2020. He has also served as a board member of
other funds in the Wilshire funds complex since 2011. Mr. Gubman was a founding
partner of Strategic Talent Solutions, a consulting firm that helps executives
with leadership development, talent management and employee engagement, and he
was a principal of that firm from 2004 to 2009. Prior to founding Strategic
Talent Solutions in 2004, Mr. Gubman served as a consultant with his own firm,
Gubman Consulting, from 2001 to 2003 where he consulted with clients on
leadership and talent management. Mr. Gubman worked at Hewitt Associates from
1983 to 2000 in Account Management and as Global Practice Leader where he
specialized in talent management and organizational effectiveness. Mr. Gubman is
the author of The Talent Solution: Aligning Strategy and People to Create
Extraordinary Business Results and The Engaging Leader: Winning with Today’s
“Free Agent” Workforce. He is also the Executive Editor of People &
Strategy, The Journal of the Human Resource Planning Society since 2008 and is a
lecturer in executive education, MBA, MILR and physician leadership programs at
The University of Chicago, Cornell University, The University of Dayton, Indiana
University, Northwestern University, the University of Minnesota and the
University of Wisconsin. From 2009 to the present, Mr. Gubman has served as a
Board member, Assistant Treasurer and Chair of the Personnel Committee of the
Jewish Family Service of the Desert, and in 2008 served as Advisor to the
Presidential Transition Team on the Social Security Administration and as a
committee member, National Policy Committee on Retirement Security from 2007 to
2008. Mr. Gubman has served as Chair of the Publications Committee, of The Human
Resource Planning Society since 2008, and as a Board member of The Human
Resource Planning Society from 2005 to 2008.
Elizabeth
A. Levy-Navarro.
Ms. Levy-Navarro has served as Director of the Company since 2019 and
chairperson of the Valuation Committee since 2020. She has also served as a
board member of other funds in the Wilshire Funds complex since 2019 and
was
on the board of Eastside Distilling Company. Ms. Levy-Navarro co-founded and was
Chief Executive Officer of Orrington Strategies, a management consulting firm,
helping investment management, insurance, and consumer products executives grow
their businesses and brands, from 2002 to 2017. From
2018 to 2023,
she has been a corporate advisor with Summit Strategy Advisors. Ms. Levy-Navarro
was a fiduciary for Orrington Strategies’ 401k, profit sharing, and defined
benefits plans. From 1993 to 2002, Ms. Levy-Navarro served as Practice Leader
and Operating Committee Member for The Cambridge Group. Ms. Levy-Navarro led her
practice helping corporate executives develop and implement demand-driven
business strategies. Ms. Levy-Navarro serves on two privately-held company
boards. Ms. Levy-Navarro earned her MBA in finance from The Wharton School,
University of Pennsylvania, and holds a BBA in marketing from University of
Michigan.
Matt
Forestenhausler.
Mr. Forstenhausler has served as Director of the Company since March
2023
and is chairperson of the Audit Committee. He
has also served as a board member of the other funds in the Wilshire funds
complex since 2023. Mr. Forstenhausler served as a director of the Sierra Income
Fund from 2020 to 2022. Mr. Forstenhausler spent his career at Ernst & Young
LLP from July 1981 to July 2019, retiring as a partner and the Americas Leader
of its Registered Funds Practice. Mr. Forstenhausler has also served on the
boards of a number of charitable, religious and social organizations. The Board
has determined that Mr. Forstenhausler is an “audit committee financial expert”
as defined by the SEC.
Jason
Schwarz.
Mr. Schwarz has served as Director of the Company since 2018. He has served as
President of the Company since 2012. Mr. Schwarz is the President of Wilshire
Advisors LLC and was formerly the Chief Operating Officer of Wilshire Advisors
LLC. Mr. Schwarz joined Wilshire in 2005 and has served as President of the
firm’s investment and analytics business practices. Mr. Schwarz earned his AB in
government from Hamilton College and holds an MBA from the Marshall School of
Business, University of Southern California.
George
J. Zock.
Mr. Zock has served as Director of the Company and chairperson of the Board
since 2006. He is chairperson of the Nominating Committee. Mr. Zock also has
served as a board member of other funds in the Wilshire funds complex since 1996
and was a board member of the predecessor funds to those funds from 1995 to
1996. Mr. Zock, a certified public accountant, is currently an independent
consultant and is a member of the Illinois CPA Society. Mr. Zock has held senior
executive positions with the Horace Mann Life Insurance Company and Horace Mann
Service Corporation, serving as Executive Vice President from 1997 to 2003. Mr.
Zock has served as a Director for Armed Forces Insurance Exchange from 2013 to
present.
Leadership
Structure
The
Company’s Board manages the business affairs of the Company. The Directors
establish policies and review and approve contracts and their continuance. The
Directors regularly request and/or receive reports from the Adviser, the
Company’s other service providers and the Company’s CCO. The Board is comprised
of five
Directors, four
of whom (including the chairperson) are independent Directors. The independent
chairperson, who serves as a spokesperson for the Board, is primarily
responsible for facilitating communication among the Directors and between the
Board and the officers and service providers of the Company and presides at
meetings of the Board. In conjunction with the officers and legal counsel, the
independent chairperson develops agendas for Board meetings that are designed to
be relevant, prioritized, and responsive to Board concerns. The Board has four
standing committees - an Audit Committee, a Nominating Committee, an Investment
Committee, and a Valuation Committee. The Audit Committee is responsible for
monitoring the Portfolio’s accounting policies, financial reporting and internal
control system; monitoring the work of the Portfolio’s independent accountants
and providing an open avenue of communication among the independent accountants,
management and the Board. The Nominating Committee is primarily responsible for
the identification and recommendation of individuals for Board membership and
for overseeing the administration of the Company’s Governance Guidelines and
Procedures. The Valuation Committee oversees the activities of the Adviser in
the Adviser’s capacity as the Company’s Valuation Designee. The Investment
Committee monitors performance of the Portfolios and the performance of the
Adviser and Subadvisers. The Company’s day-to-day operations are managed by the
Adviser and other service providers. The Board and the committees meet
periodically throughout the year to review the Company’s activities, including,
among others, Portfolio performance, valuation matters and compliance with
regulatory requirements, and to review contractual arrangements with service
providers. The Board has determined that the Company’s leadership structure is
appropriate given the number, size and nature of the Portfolios in the fund
complex.
Risk
Oversight
Consistent
with its responsibility for oversight of the Company and its Portfolios, the
Board, among other things, oversees risk management of each Portfolio’s
investment program and business affairs directly and through the committee
structure that it has established. Risks to the Portfolios include, among
others, investment risk, credit risk, liquidity risk, valuation risk and
operational risk, as well as the overall business risk relating to the
Portfolios. The Board has adopted, and periodically reviews, policies and
procedures designed to address these risks. Under the overall supervision of the
Board, the Adviser and other services providers to the Portfolios also have
implemented a variety of processes, procedures and controls to address these
risks. Different processes, procedures and controls are employed with respect to
different types of risks. These processes include those that are embedded in the
conduct of regular business by the Board and in the responsibilities of officers
of the Company and other service providers.
The
Board requires senior officers of the Company, including the President,
Treasurer and CCO, to report to the full Board on a variety of matters at
regular and special meetings of the Board and its committees, as applicable,
including matters relating to risk management. The Treasurer also reports
regularly to the Audit Committee on the Company’s internal controls and
accounting and financial reporting policies and practices. The Audit Committee
also receives reports from the Company’s independent registered public
accounting firm on internal control and financial reporting matters. On at least
a quarterly basis, the Board meets with the Company’s CCO, including separate
meetings with the independent Directors in executive session, to discuss issues
related to portfolio compliance and, on at least an annual basis, receives a
report from the CCO regarding the effectiveness of the Company’s compliance
program. In addition, the Investment Committee receives reports from the Adviser
on the performance of the Portfolios and the Valuation Committee receives
valuation reports from the Adviser as the Company’s Valuation Designee. The
Board also receives reports from the Company’s primary service providers on a
periodic or regular basis, including the Adviser and Subadvisers to the
Portfolios as well as the Company’s custodian, administrator/fund accounting
agent, distributor and transfer agent. The Board also requires the Adviser to
report to the Board on other matters relating to risk management on a regular
and as-needed basis.
Committees
The
Audit Committee held two meetings in 2023. The current members of the Audit
Committee, all of whom are Independent Directors, include Messrs. Forstenhausler
(chairperson), Gubman, and Zock and Ms. Levy-Navarro.
The
Nominating Committee held four meetings in 2023. The current members of the
Nominating Committee, all of whom are Independent Directors, include Messrs.
Zock (chairperson), Gubman, and Forstenhausler and Ms. Levy-Navarro. Pursuant to
the Company’s Governance Procedures, shareholders may submit suggestions for
Board candidates to the Nominating Committee, which will evaluate candidates for
Board membership by forwarding their correspondence by U.S. mail or courier
service to the Company’s Secretary for the attention of the Chairperson of the
Nominating Committee.
The
Investment Committee held four meetings in 2023. The current members of the
Investment Committee, all of whom are Independent Directors, include Messrs.
Gubman (chairperson), Forstenhausler, and Zock and Ms.
Levy-Navarro.
The
Valuation Committee held four meetings in 2023. The current members of the
Valuation Committee, one of whom is an interested Director, include Ms.
Levy-Navarro (chairperson) and Messrs. Gubman, Forstenhausler, Schwarz, and
Zock.
Directors’
Holdings of Portfolio Shares
The
following table sets forth the dollar range of equity securities beneficially
owned by each Director in each Portfolio as of December 31,
2023,
as well as the aggregate dollar range in all registered investment companies
overseen by the Director within the family of investment companies.
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Dollar
Range of Equity Securities in |
Name
of Director |
Large
Company Growth Portfolio |
Large
Company Value Portfolio |
Small
Company Growth Portfolio |
Small
Company Value Portfolio |
Index
Fund |
International
Fund |
Income
Fund |
All
Portfolios Overseen by Director within Fund Complex(1) |
Independent
Directors |
Matt
Forstenhausler |
None |
None |
None |
None |
$10,001
- $50,000 |
None |
None |
$10,001
- $50,000 |
Edward
Gubman |
None |
None |
None |
None |
None |
None |
None |
None |
Elizabeth
A. Levy-Navarro |
None |
None |
None |
None |
None |
None |
None |
None |
George
J. Zock |
None |
None |
None |
None |
None |
None |
None |
None |
Interested
Director |
Jason
Schwarz |
None |
None |
None |
None |
None |
None |
None |
None |
(1)“Fund
Complex” means two or more registered investment companies that hold themselves
out as related companies for purposes of investment and investor services, or
have a common investment adviser or are advised by affiliated investment
advisers. The Fund Complex includes the Portfolios and the Wilshire Variable
Insurance Trust.
As
of April
1, 2024,
the Directors and officers of the Company did not hold in the aggregate,
directly and beneficially, more than 1% of the outstanding shares of any class
of any Portfolio.
As
of April
1, 2024,
the Independent Directors did not have any ownership of the Adviser or the
Distributor.
Compensation
The
Company and the Trust together pay each Independent Director an annual retainer
of $56,000, pay to the Independent Board Chair an annual additional retainer of
$12,000 and pay to each Committee Chair an annual additional retainer of
$12,000. In addition, each Independent Director is compensated for Board and
Committee meeting attendance in accordance with the following schedule: a
quarterly Board or special in-person meeting fee of $6,000 for Independent
Directors and $7,000 for the Board Chair, a virtual special Board meeting fee of
$3,000 for Independent Directors and $3,500 for the Board Chair, and a virtual
Committee meeting fee of $1,500.
The
table below sets forth the compensation paid to the Independent Directors of the
Company for the 12 months ended December 31,
2023.
The Company does not compensate any of the officers. The Company does not have
any pension or retirement plans for the Directors.
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Director |
Aggregate
Compensation From the Company(1) |
Pension
Retirement Benefits Accrued as Part of Company Expenses |
Estimated
Annual Benefits Upon Retirement |
Total
Compensation from the Company and the Fund Complex(2) |
Matt
Forstenhausler |
$60,806 |
N/A |
N/A |
$86,000 |
Edward
Gubman |
$69,295 |
N/A |
N/A |
$98,000 |
Elizabeth
A. Levy-Navarro |
$69,295 |
N/A |
N/A |
$98,000 |
George
J. Zock |
$81,316 |
N/A |
N/A |
$115,000 |
(1) The
allocation of aggregate compensation paid from the Company for each Director is
estimated based upon the Company’s ratio of average net assets for the year
ended December 31, 2023. For the year ended December 31, 2023, the
Company paid total Director compensation for retainers and meeting fees in the
amount of $350,007 (of this amount the Large Company Growth Portfolio paid
$70,009, the Large Company Value Portfolio paid $52,986, the Small Company
Growth Portfolio paid $8,406, the Small Company Value Portfolio paid $8,406, the
Index Fund paid $28,250, the International Fund paid $28,945, and the Income
Fund paid $69,347).
(2) This
is the total amount compensated to the Director for his or her service on the
Board and the board of any other investment company in the fund complex. The
Fund Complex includes the Portfolios and the Wilshire Variable Insurance
Trust.
PRINCIPAL
HOLDERS OF SECURITIES
Listed
below are the names and addresses of those shareholders who owned beneficially
or of record 5% or more of the outstanding Investment Class Shares or
Institutional Class Shares of a Portfolio as of April
1, 2024 (a
“Principal Shareholder”). Shareholders who have the power to vote a large
percentage of shares of a particular Portfolio may be in a position to control a
Portfolio and determine the outcome of a shareholder meeting. A shareholder who
owns, directly or indirectly, 25% or more of a Portfolio’s voting securities may
be deemed to be a “control person,” as defined by the 1940 Act.
The
following table lists the Principal Shareholders of each Class:
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Portfolio/Class |
|
Shareholders |
|
Percentage
Owned |
Large
Company Growth Portfolio – Investment Class |
|
| Charles
Schwab & Co. Mutual Funds Reinvest Account 101 Montgomery
Street San Francisco, CA 94101-4151 |
| 71.39% |
|
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| |
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|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 11.30% |
Large
Company Growth Portfolio – Institutional Class |
|
|
Capinco
c/o US Bank, NA
1555
N Rivercenter Drive, Suite 302
Milwaukee,
WI 53212-3958 |
| 44.30% |
|
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| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 20.08% |
|
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| |
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|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 17.97% |
|
|
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| |
|
|
Charles
Schwab & Co.
Mutual
Funds Dept.
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 8.54% |
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| |
Portfolio/Class |
|
Shareholders |
|
Percentage
Owned |
Large
Company Value Portfolio – Investment Class |
|
|
Charles
Schwab & Co.
Mutual
Funds Dept.
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 25.50% |
|
|
|
| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 10.84% |
|
|
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| |
|
|
Jonathan
C. Gaffney
150
Powers Road
Binghamton,
NY 13903-6504 |
| 10.37% |
|
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| |
|
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Ameriprise
Financial Services Inc.
Attn:
RPCS
70911
Ameriprise Financial Center
Minneapolis,
MN 55474-0001 |
| 10.32% |
|
|
|
| |
|
| Morgan
Stanley Smith Barney LLC 201 Plaza Two Fl 3 Jersey City, NJ
07311-0000 |
| 7.66% |
|
|
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| |
|
|
US
Bank NA Custody
A/C
Francis G. Chase SEP IRA
16
Cordis Street
Wakefield,
MA 01880-1710 |
| 6.26% |
Large
Company Value Portfolio – Institutional Class |
|
|
Capinco
c/o US Bank, NA
1555
N Rivercenter Drive, Suite 302
Milwaukee,
WI 53212-3958 |
| 48.53% |
|
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| |
|
|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 18.03% |
|
|
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| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 17.52% |
|
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| |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 12.33% |
Small
Company Growth Portfolio – Investment Class |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 28.64% |
|
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| |
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Steven
S. Andrews
1020
NE 90th Street
Seattle,
WA 98115-3025 |
| 17.63% |
|
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| |
|
|
Patrick
B. Moran
8585
Via Mallorca Unit 34
La
Jolla, CA 92037-2592 |
| 13.04% |
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| |
Portfolio/Class |
|
Shareholders |
|
Percentage
Owned |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 8.60% |
Small
Company Growth Portfolio – Institutional Class |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 38.48% |
|
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| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 22.53% |
|
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| |
|
|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 22.31% |
|
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| |
|
|
Charles
Schwab & Company Inc.
Attn
Mutual Funds SF215FMT-05
211
Main Street
San
Francisco, CA 94105-1901 |
| 13.16% |
Small
Company Value Portfolio – Investment Class |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 61.86% |
|
|
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| |
|
|
Rachel
K. Sion
17
Brampton Lane
Great
Neck, NY 11023-1303 |
| 6.86% |
|
|
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| |
|
| Peter
James Reynolds 1024 Edinborough Drive Durham, NC
27703-8489 |
| 5.66% |
|
|
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| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 5.65% |
Small
Company Value Portfolio – Institutional Class |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 36.76% |
|
|
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| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 24.08% |
|
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| |
|
|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 21.46% |
|
|
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| |
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|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 13.68% |
Wilshire
5000 IndexSM
Fund – Investment Class |
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| |
Portfolio/Class |
|
Shareholders |
|
Percentage
Owned |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 40.74% |
|
|
|
| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 21.73% |
|
|
|
| |
|
|
Morgan
Stanley Smith Barney LLC
201
Plaza Two Fl 3
Jersey
City, NJ 07311-0000 |
| 8.75% |
|
|
|
| |
|
|
Wells
Fargo Clearing Services LLC
1
North Jefferson Avenue MSC MO3970
St.
Louis, MO 63103-2254 |
| 5.54% |
Wilshire
5000 IndexSM
Fund – Institutional Class |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 58.92% |
|
|
|
| |
|
|
Charles
Schwab & Co. Inc.
Special
Custody A/C FBO Customers
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 22.06% |
|
|
|
| |
|
|
Vanguard
Brokerage Services
PO
Box 1170
Valley
Forge, PA 19482-1170 |
| 7.42% |
Wilshire
International Equity Fund – Investment Class |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 47.79% |
|
|
|
| |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 25.39% |
|
|
|
| |
|
|
US
Bank, N.A.
Francis
G. Chase Roth IRA
16
Cordis Street
Wakefield,
MA 01880-1710 |
| 11.20% |
|
|
|
| |
|
|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 7.65% |
Wilshire
International Equity Fund – Institutional Class |
|
| Capinco
c/o US Bank, N.A. 1555 N Rivercenter Drive, Suite 302 Milwaukee, WI
53212-3958 |
| 51.26% |
|
|
|
| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 19.03% |
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Portfolio/Class |
|
Shareholders |
|
Percentage
Owned |
|
|
Pershing
LLC
1
Pershing Plaza
Jersey
City, NJ 07399-0002 |
| 16.03% |
|
|
|
| |
|
|
Charles
Schwab & Co.
Attn
Mutual Funds
Reinvest
Account
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 10.71% |
Wilshire
Income Opportunities Fund – Investment Class |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 62.17% |
|
|
|
| |
|
|
Charles
Schwab & Co. Inc.
Special
Custody A/C FBO Customers
211
Main Street
San
Francisco, CA 94105-1901 |
| 28.85% |
|
|
|
| |
|
|
US
Bank, N.A.
Sidney
Krimson Mason Roth IRA
4801
Eagleroost Court
Wake
Forest , NC 27587-9653 |
| 6.11% |
Wilshire
Income Opportunities Fund – Institutional Class |
|
| Capinco
c/o US Bank, N.A. 1555 N Rivercenter Drive, Suite 302 Milwaukee, WI
53212-3958 |
| 49.58% |
|
|
|
| |
|
| Pershing
LLC 1 Pershing Plaza Jersey City, NJ 07399-0002 |
| 18.74% |
|
|
|
| |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 16.61% |
|
|
|
| |
|
|
Charles
Schwab & Co. Inc.
Attn
Mutual Fund OPS
211
Main Street
San
Francisco, CA 94105-1901 |
| 11.88% |
The
following table lists the control persons of each Portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Portfolio |
|
Shareholders |
|
Percentage
Owned |
Large
Company Growth Portfolio |
|
|
Charles
Schwab & Co. Inc.
Special
Custody A/C FBO Customers
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 25.71% |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 30.33% |
Large
Company Value Portfolio |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 47.40% |
Small
Company Growth Portfolio |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 28.35% |
Small
Company Value Portfolio |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 28.78% |
Wilshire
5000 IndexSM
Fund |
|
|
Charles
Schwab & Co. Inc.
Special
Custody A/C FBO Customers
Attn:
Mutual Funds
101
Montgomery Street
San
Francisco, CA 94104-4151 |
| 36.89% |
|
|
National
Financial Services, LLC
499
Washington Boulevard, Floor 4
Jersey
City, NJ 07310-1995 |
| 29.38% |
Wilshire
International Equity Fund |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 51.11% |
Wilshire
Income Opportunities Fund |
|
|
Capinco
c/o US Bank, N.A. 1555 North Rivercenter Drive, Suite 302 Milwaukee,
WI 53212-3958 |
| 49.53% |
INVESTMENT
ADVISORY AND OTHER SERVICES
Investment
Adviser and Subadvisers
Wilshire
Advisors LLC (“Wilshire”) is the investment adviser to the Portfolios pursuant
to an Investment Advisory Agreement dated January 8, 2021 (the “Advisory
Agreement”). Wilshire is owned by Monica HoldCo (US), Inc. Monica HoldCo (US),
Inc. is controlled by CC Capital Partners, LLC and Motive Capital Management,
LLC. Wilshire manages the portion of each of the Large Company Growth Portfolio,
Large Company Value Portfolio, and the Wilshire International Equity Fund (the
“International Fund”) that is invested in the Swaps Strategy (as defined in each
Portfolio’s prospectus).
Pursuant
to subadvisory agreements with Wilshire, each dated as indicated below, the
following subadvisers each manage a portion of the Portfolio(s) as
indicated:
|
|
|
|
|
|
|
| |
Subadviser |
Portfolio(s) |
Agreement
Date |
Alger
Management |
Large
Company Growth Portfolio |
1/8/2021
as amended 5/13/2021 |
AllianceBernstein |
Large
Company Growth Portfolio |
12/1/2021 |
Diamond
Hill |
Small
Company Value Portfolio |
1/8/2021 |
DoubleLine |
Income
Fund |
1/8/2021 |
Granahan |
Small
Company Growth Portfolio |
11/3/2021 |
Hotchkis
& Wiley |
Large
Company Value Portfolio |
1/3/2021
as amended 11/3/2021 |
| Small
Company Value Portfolio |
1/3/2021
as amended 11/3/2021 |
Lazard |
International
Fund |
1/8/2021 |
Los
Angeles Capital |
Large
Company Growth Portfolio |
1/8/2021 |
Large
Company Value Portfolio |
1/8/2021 |
Small
Company Growth Portfolio |
1/8/2021 |
Small
Company Value Portfolio |
1/8/2021 |
Index
Fund |
1/8/2021 |
International
Fund |
1/8/2021 |
Manulife |
Income
Fund |
1/8/2021 |
MFS |
Large
Company Value Portfolio |
1/20/2021 |
Pzena |
International
Fund |
1/8/2021 |
Ranger |
Small
Company Growth Portfolio |
1/8/2021 |
Voya |
Large
Company Growth Portfolio |
1/8/2021 |
Large
Company Value Portfolio |
1/8/2021 |
International
Fund |
1/8/2021 |
Income
Fund |
1/8/2021 |
WCM |
International
Fund |
1/8/2021 |
Investment
Advisory Agreements and Fees
For
the three most recent fiscal years ended December 31, the advisory fees for each
Portfolio payable to Wilshire, the reductions attributable to fee waivers, the
net fees paid with respect to the Portfolios, and the corresponding percentages
of average net assets (net of waivers), were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Portfolio |
| Advisory
Fee Expense |
| Reduction
in Fee |
| Recouped
Fees |
| Net
Fee Paid |
| %
of Average Net Assets |
Large
Company Growth Portfolio |
|
|
|
|
|
|
|
|
| |
2021 |
| $2,109,576 |
| $1,620 |
| $5,090 |
| $2,113,046 |
| 0.75% |
2022 |
| $1,740,703 |
| $10,446 |
| $2,542 |
| $1,732,799 |
| 0.75% |
2023 |
| $1,647,717 |
| $37,477 |
| $5,724 |
| $1,615,964 |
| 0.74% |
Large
Company Value Portfolio |
|
|
|
|
|
|
|
|
| |
2021 |
| $1,673,301 |
| $0 |
| $0 |
| $1,673,301 |
| 0.75% |
2022 |
| $1,415,178 |
| $30,491 |
| $0 |
| $1,384,687 |
| 0.73% |
2023 |
| $1,220,041 |
| $78,058 |
| $0 |
| $1,141,983 |
| 0.70% |
Small
Company Growth Portfolio |
|
|
|
|
|
|
|
|
| |
2021 |
| $353,298 |
| $112,600 |
| $0 |
| $240,698 |
| 0.58% |
2022 |
| $235,093 |
| $154,221 |
| $0 |
| $80,872 |
| 0.29% |
2023 |
| $221,387 |
| $134,112 |
| $8,749 |
| $96,024 |
| 0.37% |
Small
Company Value Portfolio |
|
|
|
|
|
|
|
|
| |
2021 |
| $314,627 |
| $133,921 |
| $0 |
| $180,706 |
| 0.49% |
2022 |
| $248,526 |
| $148,103 |
| $0 |
| $100,423 |
| 0.34% |
2023 |
| $220,418 |
| $159,538 |
| $0 |
| $60,880 |
| 0.23% |
Index
Fund |
|
|
|
|
|
|
|
|
| |
2021 |
| $238,721 |
| $0 |
| $0 |
| $238,721 |
| 0.10% |
2022 |
| $225,120 |
| $0 |
| $0 |
| $225,120 |
| 0.10% |
2023 |
| $220,016 |
| $0 |
| $0 |
| $220,016 |
| 0.10% |
International
Fund |
|
|
|
|
|
|
|
|
| |
2021 |
| $3,067,786 |
| $372,589 |
| $0 |
| $2,695,197 |
| 0.88% |
2022 |
| $2,422,095 |
| $359,553 |
| $0 |
| $2,062,542 |
| 0.85% |
2023 |
| $2,202,717 |
| $381,711 |
| $0 |
| $1,821,006 |
| 0.83% |
Income
Fund |
|
|
|
|
|
|
|
|
| |
2021 |
| $1,822,226 |
| $77,038 |
| $0 |
| $1,745,188 |
| 0.57% |
2022 |
| $1,570,012 |
| $159,407 |
| $0 |
| $1,410,605 |
| 0.54% |
2023 |
| $1,254,940 |
| $307,680 |
| $0 |
| $947,260 |
| 0.45% |
Wilshire
has entered into contractual expense limitation agreements to waive a portion of
its management fee or reimburse expenses to limit expenses of the Large Company
Growth Portfolio and Large Company Value Portfolio (excluding taxes, brokerage
expenses, dividend expenses on short securities, and extraordinary expenses) to
1.30% and 1.00% of average daily net assets for Investment Class Shares and
Institutional Class Shares, respectively.
Wilshire
has entered into a contractual expense limitation agreement to waive a portion
of its management fee or reimburse expenses to limit expenses of the Small
Company Growth Portfolio and Small Company Value Portfolio (excluding taxes,
brokerage expenses, dividend expenses on short securities, and extraordinary
expenses) to 1.35% and 1.10% of average daily net assets for Investment Class
Shares and Institutional Class Shares, respectively.
Wilshire
has entered into a contractual expense limitation agreement to waive a portion
of its management fee or reimburse expenses to limit expenses of the
International Fund (excluding taxes, brokerage expenses, dividend expenses on
short securities, acquired fund fees and expenses, and extraordinary expenses)
to 1.50% and 1.25% of average daily net assets for Investment Class Shares and
Institutional Class Shares, respectively.
Wilshire
has entered into a contractual expense limitation agreement with the Company, on
behalf of the Income Fund, to waive a portion of its management fee or reimburse
expenses to limit expenses of the Income Fund (excluding taxes, brokerage
expenses, dividend expenses on short securities, acquired fund fees and
expenses, and extraordinary expenses) to 1.15% and 0.90% of average daily net
assets for Investment Class Shares and Institutional Class Shares,
respectively.
These
agreements to limit expenses continue through at least April 30,
2025
or upon the termination of the Advisory Agreement. To the extent that a
Portfolio’s expenses are less than the expense limitation, Wilshire may recoup
the amount of any management fee waived or expenses reimbursed within three
years after the date on which Wilshire incurred the expense, if the recoupment
does not exceed the existing expense limitation as well as the expense
limitation that was in place at the time of the fee waiver or expense
reimbursement.
The
Advisory Agreement provides that Wilshire will act as the investment adviser to
each Portfolio, and may recommend to the Board one or more subadvisers to manage
one or more Portfolios or portions thereof. Upon appointment of a subadviser,
Wilshire will review, monitor and report to the Board regarding the performance
and investment procedures of the subadviser, and assist and consult the
subadviser in connection with the investment program of the relevant
Portfolio.
The
Advisory Agreement provides that Wilshire shall exercise its best judgment in
rendering the services to be provided to the Portfolios under the Advisory
Agreement. Wilshire is not liable under the Advisory Agreement for any error of
judgment or mistake of law or for any loss suffered by the Portfolios. Wilshire
is not protected, however, against any liability to the Portfolios or its
shareholders to which Wilshire would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence in the performance of its duties
under the Advisory Agreement, or by reason of Wilshire’s reckless disregard of
its obligations and duties under the Advisory Agreement.
The
Advisory Agreement will continue in force unless sooner terminated as provided
in certain provisions contained in the Advisory Agreement. It is terminable with
respect to any Portfolio without penalty on 60 days’ notice by the Board, by
vote of a majority of a Portfolio’s outstanding shares (as defined in the 1940
Act), or on at least 90 days’ notice by Wilshire. The Advisory Agreement
terminates in the event of its assignment (as defined in the 1940
Act).
Investment
Subadvisory Agreements and Fees
Pursuant
to the subadvisory agreements with each of the Subadvisers (the “Subadvisory
Agreements”), the fees payable to a Subadviser with respect to a Portfolio are
paid exclusively by Wilshire and not directly by the stockholders of the
Portfolio. The Subadvisers are independent contractors, and may act as
investment advisers to other clients. Wilshire may retain one or more other
Subadvisers with respect to any portion of the assets of any Portfolio other
than the portions to be managed by the respective Subadvisers.
No
Subadviser will be liable to Wilshire, the Company or any stockholder of the
Company for any error of judgment, mistake of law, or loss arising out of any
investment, or for any other act or omission in the performance by the
Subadviser of its duties, except for liability resulting from willful
misfeasance, bad faith, negligence (gross negligence, in the case of DoubleLine,
MFS, and Pzena) or reckless disregard of its obligations. Each Subadviser will
indemnify and defend Wilshire, the Company, and their representative officers,
directors, employees and any person who controls Wilshire for any loss or
expense arising out of or in connection with any claim, demand, action, suit or
proceeding relating to any material misstatement or omission in the Company’s
registration statement, any proxy statement, or any communication to current or
prospective investors in any Portfolio, if such misstatement or omission was
made in reliance upon and in conformity with written information furnished by
the Subadviser to Wilshire or the Portfolios.
Following
an initial two-year period, each Subadvisory Agreement will continue in force
from year to year with respect to a Portfolio so long as it is specifically
approved for a Portfolio at least annually in the manner required by the 1940
Act. The Subadvisory Agreements with each Subadviser were approved for the
period ending August
31, 2024.
For
the fiscal years ended December 31, 2021,
2022, and 2023,
the aggregate subadvisory fees paid by Wilshire with respect to each Portfolio,
and the corresponding percentage of net average assets, were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Portfolio |
| Aggregate
Subadvisory Fees Paid |
| %
of Average Net Assets |
Large
Company Growth Portfolio |
|
|
| |
2021(1) |
| $725,046 |
| 0.26% |
2022 |
| $548,207 |
| 0.24% |
2023 |
| $508,509 |
| 0.23% |
Large
Company Value Portfolio |
|
|
| |
2021(2) |
| $562,001 |
| 0.25% |
2022 |
| $400,044 |
| 0.21% |
2023 |
| $343,481 |
| 0.21% |
Small
Company Growth Portfolio |
|
|
| |
2021 |
| $171,379 |
| 0.41% |
2022 |
| $118,428 |
| 0.43% |
2023 |
| $111,701 |
| 0.43% |
Small
Company Value Portfolio |
|
|
| |
2021 |
| $145,784 |
| 0.39% |
2022 |
| $116,791 |
| 0.40% |
2023 |
| $101,815 |
| 0.39% |
Index
Fund |
|
|
| |
2021 |
| $95,488 |
| 0.04% |
2022 |
| $90,048 |
| 0.04% |
2023 |
| $88,006 |
| 0.04% |
International
Fund |
|
|
| |
2021 |
| $1,125,460 |
| 0.37% |
2022 |
| $908,540 |
| 0.37% |
2023 |
| $799,450 |
| 0.36% |
Income
Fund |
|
|
| |
2021 |
| $1,035,387 |
| 0.34% |
2022 |
| $888,205 |
| 0.34% |
2023 |
| $711,309 |
| 0.34% |
(1)Prior
to December 14, 2021, Loomis, Sayles & Company, L.P. served as sub-adviser
to the Portfolio. Amounts paid include fees paid to the Portfolio’s previous
sub-adviser.
(2)Prior
to December 17, 2021, Pzena Investment Management, LLC served as sub-adviser to
the Portfolio. Amounts paid include fees paid to the Portfolio’s previous
sub-adviser.
Portfolio
Managers
The
following paragraphs provide certain information with respect to the portfolio
managers of each Portfolio as identified in the prospectus and the material
conflicts of interest that may arise in connection with their management of the
investments of a Portfolio, on the one hand, and the investments of other client
accounts for which they may have primary responsibility. Certain other potential
conflicts of interest with respect to use of affiliated brokers, personal
trading and proxy voting are discussed below under “Portfolio Transactions,”
“Code of Ethics” and “Proxy Voting Policy and Procedures.”
Alger
Management
Ankur
Crawford and Patrick Kelly manage Alger Management’s portion of the Large
Company Growth Portfolio. The table below includes details regarding the number
of registered investment companies, other pooled investment vehicles and other
accounts managed by each of the portfolio managers, as well as total assets
under management for each type of account, and total assets in each type of
account with performance-based advisory fees, as of December 31,
2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (billions) |
#
of Accounts Managed with Performance-Based Advisory Fee |
Total
Assets with Performance-Based Advisory Fee (millions) |
Ankur
Crawford, Ph.D. and Patrick Kelly, CFA |
Registered
Investment Companies |
6 |
$8.6 |
0 |
$0 |
Other
Pooled Investment Vehicles |
7 |
$1.2 |
0 |
$0 |
Other
Accounts |
42 |
$2.4 |
1 |
$262.6 |
|
|
|
| |
Conflicts
of Interest
Summary
Alger
Management and Fred Alger & Company, LLC (“Alger LLC”), an affiliated
registered broker-dealer and a member of the New York Stock Exchange, are owned
by Alger Group Holdings, LLC, which is wholly-owned by Alger Associates, Inc.
(“Alger Associates”). Additionally, Alger Management is under common ownership
with Weatherbie Capital, LLC, a registered investment adviser based in Boston,
Massachusetts. Alger LLC serves as a broker-dealer for securities trades placed
on behalf of Alger Management clients and accounts. Alger LLC does not conduct
public brokerage business and substantially all of its transactions are for
clients of Alger Management if their investment guidelines and relevant
regulations that govern their accounts allow it. Neither Alger Management nor
any of its management personnel is registered or plans to register as a futures
commission merchant, commodity pool operator, commodity trading advisor, or an
associated person of these entities. From time to time, Alger LLC, Alger
Management, Alger Group Holdings, LLC, or Alger Associates, or other affiliated
persons (“Alger Affiliates”) may hold controlling positions in certain pooled
investment vehicles, such that they are considered affiliates.
In
addition to serving as a subadviser to the Large Company Growth Portfolio, Alger
Management serves as the investment adviser of the mutual funds in the Alger
Family of Funds and the investment adviser to Alger Dynamic Return Fund LLC, a
Delaware limited liability company, as well as to Alger SICAV, a publicly
offered pooled investment vehicle registered in Luxembourg. Alger Management
also serves as a sub-adviser to third-party registered investment companies, as
well as bank collective investment trusts. From time to time, Alger Affiliates
may own significant stakes in one or more of the above.
Alger
Management may recommend to clients that they purchase interests in investment
partnerships or funds for which Alger Management serves as investment adviser or
sub-adviser and in which Alger Management and related persons have a financial
interest. Alger Management and such related persons will fully disclose such
financial interests to all clients to which such recommendations are
given.
Alger
Affiliates also have other direct and indirect interests in the equity markets,
directly or through investments in pooled products, in which the Portfolio
directly and indirectly invests. Investors should be aware that this may cause
Alger Affiliates to have conflicts that could disadvantage the Portfolio.
As
a registered investment adviser under the Investment Advisers Act of 1940, as
amended, Alger Management is required to file and maintain a registration
statement on Form ADV with the SEC. Form ADV contains information about assets
under management, types of fee arrangements, types of investments, conflicts and
potential conflicts of interest, and other relevant information regarding Alger
Management.
Conflicts
as a Result of Alger Management’s Other Affiliates
Selection
of Administrative and Other Service Providers.
Alger Management may choose to (and currently does) have Alger Affiliates
provide administrative services, shareholder services, brokerage and other
account services to the funds it manages. While any such engagement would be on
market terms, it will nevertheless result in greater benefit to Alger Management
than hiring a similarly qualified unaffiliated service provider.
In
connection with these services and subject to applicable law, Alger Affiliates,
including the Alger Management, may from time to time, and without notice to
investors or clients, in-source or outsource certain processes or functions that
it provides in its administrative or other capacities. Such in-sourcing or
outsourcing may give rise to additional conflicts of interest, including which
processes or functions to in-source or outsource, which entity to outsource to,
and the fees charged by the Alger Affiliates or the third party. Alger
Management maintains policies designed to mitigate the conflicts described
herein; however, such policies may not fully address situations described above.
Information
the Investment Adviser May Receive.
Alger Management and its affiliates may have or be deemed to have access to the
current status of certain markets, investments and funds because of Alger
Affiliates’ brokerage and other activities. Alger Affiliates may therefore
possess information which, if known to Alger Management, might cause Alger
Management to seek to dispose of, retain or increase interests in investments
held by the Large Company Growth Portfolio, or acquire certain positions on
behalf of the portion of the Portfolio it manages. Moreover, Alger Management
and its affiliates may come into possession of material, non-public information
that would prohibit or otherwise limit its ability to trade on behalf of the
Portfolio. A fund not subadvised by Alger Management would not be subject to
these restrictions. Alger Management maintains policies designed to prevent the
disclosure of such information; however, such policies may not fully address
situations described above.
Allocation
Issues
As
Alger Management manages multiple accounts or funds managed, advised, or
subadvised by Alger Affiliates (including Alger Management) or in which Alger
Affiliates (including Alger Management) or its personnel have interests
(collectively, the “client/Alger Affiliates accounts”), issues can and do arise
as a result of how Alger Management allocates investment opportunities. In an
effort to treat all clients/Alger Affiliates reasonably in light of all factors
relevant to managing an account, aggregated trades will generally be allocated
pro rata among the Portfolio and client/Alger Affiliates accounts whenever
possible. There are exceptions to this practice, however, as described below:
Unusual
Market Conditions. During
periods of unusual market conditions, Alger Management may deviate from its
normal trade allocation practices. During such periods, Alger Management will
seek to exercise a disciplined process for determining its actions to
appropriately balance the interests of all accounts, including the Portfolio, as
it determines in its sole discretion.
Availability
of Investments. The
availability of certain investments such as initial public offerings or private
placements may be limited. In such cases, all client/Alger Affiliates accounts
(including the Large Company Growth Portfolio) may not receive an allocation. As
a result, the amount, timing, structuring or terms of an investment by the
Portfolio may differ from, and performance may be lower than, investments and
performance of other client/Alger Affiliates accounts.
Alger
Management, as a general practice, allocates initial public offering shares and
other limited availability investments pro rata among the eligible client/Alger
Affiliates accounts (including the Portfolio) where the portfolio manager seeks
allocation. An account or accounts may not receive an allocation because it
lacks available cash, is restricted from making certain investments, the account
pays a performance fee, the account is so large that the allocation is
determined to be de minimis, or due to co-investment by Alger Affiliates. When a
pro rata allocation of limited availability investments is not possible or is
not appropriate, Alger Management considers numerous other factors to determine
an appropriate allocation. These factors include (i) Alger Management’s good
faith assessment of the best use of such limited opportunities relative to the
account’s investment objectives, investment limitations and requirements of the
accounts; (ii) suitability requirements and the nature of the investment
opportunity, including relative attractiveness of a security to different
accounts; (iii) relative size of applicable accounts; (iv) impact on overall
performance and allocation of such securities may have on accounts; (v) cash and
liquidity considerations, including without limitation, availability of cash for
investment; (vi) minimum denomination, minimum increments, de minimus threshold
and round lot consideration; (vii) account investment horizons, investment
objectives and guidelines; (viii) an account’s risk tolerance and/or risk
parameters; (ix) tax sensitivity of accounts; (x) concentration of positions in
an account; (xi) appropriateness of a security for the account given the
benchmark and benchmark sensitivity of an account; (xii) use of the opportunity
as a replacement for another security Alger Management believes to be attractive
for an account of the availability of other appropriate investment
opportunities; (xiii) considerations related to giving a subset of accounts
exposure to an industry; and/or (xiv) account turnover guidelines.
In
some circumstances, it is possible that the application of these factors may
result in certain client/Alger Affiliates accounts receiving an allocation when
other accounts do not. Moreover, Alger Affiliates, or accounts in which Alger
Affiliates and/or employees have interests, may receive an allocation or an
opportunity not allocated to other accounts or the Portfolio.
Portfolio
managers who manage multiple strategies exercise investment discretion over each
strategy on an individualized basis and therefore may allocate investments
(including IPOs and secondary offerings) in a different manner for each
strategy. Considerations for such different allocations, include, but are not
limited to, when an allocation to a particular strategy results in a de minimis
investment, different investment policies and objectives of one strategy versus
another; as well as the implementation of strategy objectives such as sector or
industry weightings. As a result of such allocations, there will be instances
when funds within a strategy managed by the same portfolio manager do not
participate in an investment that is allocated among funds invested in another
strategy managed by the same portfolio manager. For example, it is generally the
case that investment strategies with larger AUM do not participate in
allocations of IPOs and secondary offerings as the allocation of limited shares
will result in the strategy receiving de minimis amounts of shares to allocate
across strategies. Such investment decisions may result in a loss of investment
opportunity for funds that may otherwise have been suited to invest in such
offerings.
Differing
Guidelines, Objectives and Time Horizons. Because
client/Alger Affiliates accounts (including the Portfolio) are managed according
to different strategies and individual client guidelines, certain accounts may
not be able to participate in a transaction or strategy employed by Alger
Management.
Actions
taken by one account could affect others. For example, in the event that
withdrawals of capital result in one account selling securities, this could
result in securities of the same issuer falling in value, which could have a
material adverse effect on the performance of other accounts (including the
Portfolio) that do not sell such positions.
Alger
Affiliates may also develop and implement new strategies, which may not be
employed in all accounts or pro rata among the accounts where they are employed,
even if the strategy is consistent with the objectives of all accounts. Alger
Affiliates may make decisions based on such factors as strategic fit and other
portfolio management considerations, including an account’s capacity for such
strategy, the liquidity of the strategy and its underlying instruments, the
account’s liquidity, the business risk of the strategy relative to the account’s
overall portfolio make-up, the lack of efficacy of, or return expectations from,
the strategy for the account, and any such other factors as Alger Affiliates
deem relevant in their sole discretion. For example, such a determination may,
but will not necessarily, include consideration of the fact that a particular
strategy will not have a meaningful impact on an account given the overall size
of the account, the limited availability of opportunities in the strategy and
the availability of other strategies for the account.
Investing
in Different Classes of the Same Issuer. Conflicts
also arise when one or more client/Alger Affiliates accounts (including the
Portfolio) invests in different classes of securities of the same issuer. As a
result, one or more client/Alger Affiliates accounts may pursue or enforce
rights with respect to a particular issuer in which the Portfolio has invested,
and those activities may have an adverse effect on the Portfolio. For example,
if a client/Alger Affiliates account holds debt securities of an issuer and the
Portfolio holds equity securities of the same issuer, if the issuer experiences
financial or operational challenges, the client/Alger Affiliates account which
holds the debt securities may seek a liquidation of the issuer, whereas the
Portfolio which holds the equity securities may prefer a reorganization of the
issuer. In addition, Alger Management may also, in certain circumstances, pursue
or enforce rights with respect to a particular issuer jointly on behalf of one
or more client/Alger Affiliates accounts, the Portfolio, or Alger Affiliates.
The Portfolio may be negatively impacted by Alger Affiliates’ and other
client/Alger Affiliates accounts’ activities, and transactions for the Portfolio
may be impaired or effected at prices or terms that may be less favorable than
would otherwise have been the case had Alger Affiliates and other client/Alger
Affiliates accounts not pursued a particular course of action with respect to
the issuer of the securities.
Conflicts
Related to Timing of Transactions. When
Alger or a client/Alger Affiliates account implements a portfolio decision or
strategy ahead of, or contemporaneously with, similar portfolio decisions or
strategies for the Portfolio (whether or not the portfolio decisions emanate
from the same research analysis or other information), market impact, liquidity
constraints, or other factors could result in the Portfolio receiving less
favorable trading results. In addition, the costs of implementing such portfolio
decisions or strategies could be increased or the Portfolio could otherwise be
disadvantaged. Alger Affiliates may, in certain cases, implement internal
policies and procedures designed to limit such consequences to client/Alger
Affiliates accounts, which may cause the Portfolio to be unable to engage in
certain activities, including purchasing or disposing of securities, when it
might otherwise be desirable for it to do so.
Moreover,
each client/Alger Affiliates account is managed independently of other accounts.
Given the independence in the implementation of advice to these accounts, there
can be no warranty that such investment advice will be implemented
simultaneously. Neither Alger Management nor its affiliates will always know
when advice issued has been executed and, if so, to what extent. Alger
Management and its affiliates will use reasonable efforts to procure timely
execution. It is possible that prior execution for or on behalf of an account
could adversely affect the prices and availability of the securities and
instruments in which the Portfolio invests. In other words, an account, by
trading first, may increase the price or decrease the availability of a security
to the Portfolio.
In
some instances, Alger Management is retained through programs sponsored by
unaffiliated financial intermediaries, advisers or planners in which Alger
Management serves as an investment adviser (“wrap programs”). Alger Management
offers advisory services through single contract programs, dual contract
programs and model portfolio programs. Given the structure of the wrap programs
and the fact that payments to Alger Management are paid directly by the wrap
sponsor, Alger Management does not believe it receives any direct compensation
from clients who participate in the wrap programs. Because wrap clients
generally pay the wrap sponsor to effect transactions for their accounts, Alger
Management does not aggregate transactions on behalf of wrap program accounts
with other accounts or funds it advises. Because of the distinct trading process
Alger Management follows for wrap accounts and the portfolio limitations of the
wrap programs, the timing of trades for wrap accounts may differ from other
accounts and will generally be made later in time than for other accounts
managed by Alger Management.
In
some instances, internal policies designed to facilitate trade aggregation may
result in delays in placing trades, which may adversely affect trade execution.
For example, a purchase for a particular account may be held while other
portfolio managers are considering whether to make the same transaction for
other accounts. Differences in allocations will affect the performance of the
Portfolio.
Cross
Transactions. From
time to time and for a variety of reasons, certain client/Alger Affiliates
accounts may buy or sell positions in a particular security while the Portfolio
is undertaking the opposite strategy. Trading in the opposite manner could
disadvantage the Portfolio. Moreover, Alger Affiliates may have a potentially
conflicting division of loyalties and responsibilities to both parties in such a
case. For example, Alger Management will represent both the Portfolio on one
side of a transaction and another account on the other side of the trade
(including an account in which Alger Affiliates may have a proprietary interest)
in connection with the purchase of a security by such Portfolio. In an effort to
reduce this negative impact, and when permitted by applicable law, the accounts
may enter into “cross transactions.”
A
cross transaction, or cross trade, occurs when Alger Management causes the
Portfolio to buy securities from, or sell a security to, another client of Alger
Management or Alger Affiliates. Alger Management will ensure that any such cross
transactions are effected on commercially reasonable market terms and in
accordance with applicable law, including but not limited to Alger Management’s
fiduciary duties to all accounts.
Valuation
of Assets. Alger
Affiliates may have a conflict of interest in valuing the securities and other
assets in which the Portfolio may invest. Alger Management is generally paid an
advisory fee based on the value of the assets under management, so more valuable
securities will result in a higher advisory fee. Alger Management may also
benefit from showing better performance or higher account values on periodic
statements.
Certain
securities and other assets in which the Portfolio may invest may not have a
readily ascertainable market value and will be valued by Alger Management in
accordance with the valuation guidelines described in the valuation procedures
adopted by the Portfolio. Such securities and other assets may constitute a
substantial portion of the Portfolio’s investments. Alger Management’s risk of
misstating the value of securities is greater with respect to illiquid
securities like those just described.
Alger
Affiliates may hold proprietary positions in the Portfolio. One consequence of
such proprietary positions is that Alger Management may be incented to misstate
the value of illiquid securities.
Regulatory
Conflicts.
From time to time, the activities of the Portfolio may be restricted because of
regulatory or other requirements applicable to Alger Affiliates and/or their
internal policies designed to comply with, limit the applicability of, or
otherwise relate to such requirements. As a result, Alger Affiliates may
implement internal restrictions that delay or prevent trades for the Portfolio,
which could result in less favorable execution of trades and may impact the
performance of the Portfolio.
Certain
activities and actions may be considered to result in reputational risk or
disadvantage for the management of the Portfolio and Alger Management as well as
for other Alger Affiliates. Such situations could arise if Alger Affiliates
serve as directors of companies the securities of which the Portfolio wishes to
purchase or sell or is representing or providing financing to another potential
purchaser. The larger Alger Management’s investment advisory business and Alger
Affiliates’ businesses, the larger the potential that these restricted list
policies will impact the performance of the Portfolio.
Other
Potential Conflicts Relating to the Management of the Large Company Growth
Portfolio by Alger Management
Potential
Conflicts Relating to Alger Affiliates’ Proprietary Activities and Activities On
Behalf of Other Accounts. Alger
Management may purchase or sell, for itself or Alger Affiliates, mutual funds or
other pooled investment vehicles, commercial paper or fixed-income securities
that it recommends to its clients. The results achieved by Alger Affiliates
proprietary accounts may differ from those achieved for other accounts. Alger
Management will manage the Portfolio and its other client/Alger Affiliates
accounts in accordance with their respective investment objectives and
guidelines. However, Alger Management may give advice, and take action, with
respect to any current or future client/Alger Affiliates accounts that may
compete or conflict with the advice Alger Management may give to the Portfolio
including with respect to the return of the investment, the timing or nature of
action relating to the investment or method of exiting the investment.
The
directors, officers and employees of Alger Affiliates, including Alger
Management, may buy and sell securities or other investments for their own
accounts (including through investment funds managed by Alger Affiliates,
including Alger Management). As a result of differing trading and investment
strategies or constraints, positions may be taken by directors, officers and
employees that are the same, different from or made at different times than
positions taken for the Portfolio. To reduce the possibility that the Portfolio
will be materially adversely affected by the personal trading described above,
Alger Management has established policies and procedures that restrict
securities trading in the personal accounts of investment professionals and
others who normally come into possession of information regarding the
Portfolio’s portfolio transactions. Alger Management has adopted a code of
ethics (the “Code of Ethics”) and monitoring procedures relating to certain
personal securities transactions by personnel of Alger Management which Alger
Management deems to involve potential conflicts involving such personnel,
client/Alger Affiliates accounts managed by Alger Management and the Portfolio.
The Code of Ethics requires that personnel of Alger Management comply with all
applicable federal securities laws and with the fiduciary duties and anti-fraud
rules to which Alger Management is subject.
Potential
Conflicts in Connection With Proxy Voting
Alger
Management has adopted policies and procedures designed to prevent conflicts of
interest from influencing proxy voting decisions that it makes on behalf of
clients, including the Portfolio, and to help ensure that such decisions are
made in accordance with Alger Management’s fiduciary obligations to its clients.
Notwithstanding such proxy voting policies and procedures, actual proxy voting
decisions of Alger Management may have the effect of favoring the interests of
other clients or Alger Affiliates provided that Alger Management believes such
voting decisions to be in accordance with its fiduciary obligations. In other
words, regardless of what Alger Management’s conflict of interest is, the
importance placed on exercising a client’s right to vote dictates that Alger
Management will cast the vote in accordance with its voting guidelines even if
Alger Management, its affiliate, or its client, somehow, indirectly, benefits
from that vote. For a more detailed discussion of these policies and procedures,
see “Appendix A – Proxy Voting Policies” to the SAI.
Potential
Conflicts in Connection with Brokerage Transactions
Trade
Aggregation. If
Alger Management believes that the purchase or sale of a security is in the best
interest of more than one client/Alger Affiliates account (including the
Portfolio), it may (but is not obligated to) aggregate the orders to be sold or
purchased to seek favorable execution or lower brokerage commissions, to the
extent permitted by applicable laws and regulations. As a general practice,
Alger Management may delay an order for one account to allow portfolio managers
of other strategies to participate in the same trade being recommended by a
portfolio manager who also serves as an analyst to a specific sector or industry
(e.g.
health care). Aggregation of trades under this circumstance may, on average,
decrease the costs of execution. In the event Alger Management aggregates a
trade for participating accounts, the method of allocation will generally be
determined prior to the trade execution. Although no specific method of
allocation of trades is expected to be used, allocations are generally pro rata
and if not, will be designed so as not to systematically and consciously favor
or disfavor any account in the allocation of investment opportunities. The
accounts aggregated may include registered and unregistered investment
companies, Alger Affiliates Accounts (including the Portfolio), and separate
accounts. Transaction costs will be shared by participants on a pro-rata basis
according to their allocations.
When
orders are aggregated for execution, it is possible that Alger Affiliates will
benefit from such trades, even in limited capacity situations. Alger Management
maintains policies and procedures that it believes are reasonably designed to
deal equitably with conflicts of interest that may arise when purchase or sale
orders for an account are aggregated for execution with orders for Alger
Affiliates Accounts. For example, Alger Management may aggregate trades for its
clients and affiliates in private placements pursuant to internally developed
procedures. In such cases, Alger Management will only negotiate the price of
such investments, and no other material terms of the offering, and will prepare
a written allocation statement reflecting the allocation of the securities.
Orders
to purchase or sell the same security need not be aggregated if there is a
reasonable distinction between or among the orders. For example, orders that are
not price specific need not be aggregated with orders that are to be executed at
a specific price. Also, certain short sale trades may not be aggregated due to
settlement issues and may not trade sequentially in order to maintain the
average trade price.
Alger
Management is not required to bunch or aggregate trades if portfolio management
decisions for different accounts are made separately, or if it determines that
bunching or aggregating is not practicable, or with respect to client directed
accounts.
Even
when trades are aggregated, prevailing trading activity frequently may make
impossible the receipt of the same price or execution on the entire volume of
securities purchased or sold. When this occurs, the various prices may be
averaged, and the Portfolio will be charged or credited with the average price.
Thus, the effect of the aggregation may operate on some occasions to the
disadvantage of the Portfolio.
Soft
Dollars. Alger
Management relies primarily on its own internal research to provide primary
research in connection with buy and sell recommendations. However, Alger
Management does acquire research services provided by a third party vendor,
which is pays for with brokerage fees and commissions, sometimes referred to as
“soft dollars.” The services that Alger Management may receive include:
management meetings; conferences; research on specific industries; research on
specific companies; macroeconomic analyses; analyses of national and
international events and trends; evaluations of thinly traded securities;
computerized trading screening techniques and securities ranking services;
general research services (i.e.,
Bloomberg, FactSet).
Alger
Management may pay higher commissions for receipt of brokerage and research
services in connection with securities trades that are consistent with the “safe
harbor” provisions of Section 28(e) of the Securities Exchange Act of 1934, as
amended (the “Securities Exchange Act”). This benefits Alger Management because
it does not have to pay for the research, products, or services. Such benefit
gives Alger Management an incentive to select a broker-dealer based on its
interest in receiving the research, products, or services rather than on its
clients’ interest in receiving the most favorable execution.
Research
or other services obtained in this manner may be used in servicing any or all of
the Portfolio and other client/Alger Affiliates accounts. This includes accounts
other than those that pay commissions to the broker providing soft dollar
benefits. Therefore, such products and services may disproportionately benefit
certain client/Alger Affiliates accounts, including the Portfolio, to the extent
that the commissions from such accounts are not used to purchase such services.
Neither
the research services nor the amount of brokerage given to a particular
broker-dealer are made through an arrangement or commitment that obligates Alger
Management to pay selected broker-dealers for the services provided.
Alger
Management has entered into certain commission sharing arrangements. A
commission sharing arrangement allows Alger Management to aggregate commissions
at a particular broker-dealer and to direct that particular broker-dealer to pay
various other broker-dealers from this pool of aggregate commissions for
research and research services the broker-dealers have provided to Alger
Management. These arrangements allow Alger Management to limit the
broker-dealers it trades with, while maintaining valuable research
relationships.
Additionally,
Alger Management receives a credit for routing orders through a fixed connection
with a national securities exchange, which is applied to the costs of research
services.
In
certain cases, a research service may serve additional functions that are not
related to the making of investment decisions (such as accounting, record
keeping or other administrative matters). Where a product obtained with
commissions has such a mixed use, Alger
Management
will make a good faith allocation of the cost of the product according to its
use. Alger Management will not use soft dollars to pay for services that provide
only administrative or other non-research assistance.
Compensation
An
Alger Management portfolio manager’s compensation generally consists of salary
and an annual bonus. In addition, portfolio managers are eligible for health and
retirement benefits available to all Alger Management employees, including a
401(k) plan sponsored by Alger Management. A portfolio manager’s base salary is
typically a function of the portfolio manager’s experience (with consideration
given to type, investment style and size of investment portfolios previously
managed), performance of his or her job responsibilities, and financial services
industry peer comparisons. Base salary is generally a fixed amount that is
subject to an annual review. The annual bonus is variable from year to year, and
considers various factors, including:
•the
firm’s overall financial results and profitability;
•the
firm’s overall investment management performance;
•current
year’s and prior years’ pre-tax investment performance (both relative and
absolute) of the portfolios for which the individual is responsible, based on
the benchmark of each such portfolio;
•qualitative
assessment of an individual’s performance with respect to the firm’s investment
process and standards; and
•the
individual’s leadership contribution within the firm.
While
the benchmarks and peer groups used in determining a portfolio manager’s
compensation may change from time to time, Alger Management may refer to
benchmarks, such as those provided by Russell Investments and S&P’s Global
Ratings, and peer groups, such as those provided by Lipper Inc. and Morningstar
Inc., that are widely-recognized by the investment industry. Alger Management
has implemented a long-term deferred compensation program (“LTDC”) which gives
key personnel the opportunity to have equity-like participation in the long-term
growth and profitability of the firm. There is broad participation in the LTDC
program amongst the investment professionals. The LTDC reinforces the portfolio
managers’ commitment to generating superior investment performance for the
firm’s clients.
The
awards are invested in Alger mutual funds and have a four year vesting schedule.
The total award earned can increase or decrease with the firm’s investment and
earnings results over the four year period.
Additionally,
the Alger Partners Plan provides key investment executives with phantom equity
that allows participants pro-rata rights to growth in the firm’s book value,
dividend payments and participation in any significant corporate transactions
(e.g.,
partial sale, initial public offering, merger, etc.). The firm does not have a
limit on the overall percentage of the firm’s value it will convey through this
program. Further, participation in this program will be determined
annually.
As
of December 31,
2023,
the Dr. Crawford and Mr. Kelly did not own any shares of the Large Company
Growth Portfolio.
AllianceBernstein
John
H. Fogarty, CFA and Vinay Thapar, CFA manage AllianceBernstein’s portion of the
Large Company Growth Portfolio. In addition to their portion of the Portfolio,
the portfolio managers managed the following other accounts as of December 31,
2023,
none of which were subject to a performance-based fee.
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (billions) |
John
H. Fogarty, CFA |
| |
Registered
Investment Companies |
15 |
$32.8 |
Other
Pooled Investment Vehicles |
6 |
$42.2 |
Other
Accounts |
3,032 |
$10.9 |
Vinay
Thapar, CFA |
| |
Registered
Investment Companies |
14 |
$32.8 |
Other
Pooled Investment Vehicles |
26 |
$42.2 |
Other
Accounts |
3,032 |
$10.9 |
|
| |
Conflicts
of Interest
As
an investment adviser and fiduciary, AllianceBernstein owes its clients and
shareholders an undivided duty of loyalty. AllianceBernstein recognizes that
conflicts of interest are inherent in its business and accordingly has developed
policies and procedures (including oversight monitoring) reasonably designed to
detect, manage and mitigate the effects of actual or potential conflicts of
interest in the area of employee personal trading, managing multiple accounts
for multiple clients, and allocating investment opportunities. Investment
professionals, including portfolio managers and research analysts, are subject
to the above-mentioned policies and oversight monitoring to ensure that all
clients are treated equitably. AllianceBernstein places the interests of its
clients first and expects all of its employees to meet their fiduciary
duties.
Employee
Personal Trading
AllianceBernstein
has adopted a Code of Business Conduct and Ethics that is designed to detect and
prevent conflicts of interest when investment professionals and other personnel
of AllianceBernstein own, buy or sell securities which may be owned by, or
bought or sold for, clients. Personal securities transactions by an employee may
raise a potential conflict of interest when an employee owns or trades in a
security that is owned or considered for purchase or sale by a client, or
recommended for purchase or sale by an employee to a client. Subject to the
reporting requirements and other limitations of its Code of Business Conduct and
Ethics, AllianceBernstein permits its employees to engage in personal securities
transactions, and also allows them to acquire investments in the
AllianceBernstein Mutual Funds. AllianceBernstein’s Code of Business Conduct and
Ethics requires disclosure of all personal accounts and maintenance of brokerage
accounts with designated broker-dealers approved by AllianceBernstein. The Code
of Business Conduct and Ethics also requires preclearance of all securities
transactions (except transactions in U.S. Treasuries and open-end mutual funds)
and imposes a 60-day holding period for securities purchased by employees to
discourage short-term trading.
Managing
Multiple Accounts for Multiple Clients
AllianceBernstein
has compliance policies and oversight monitoring in place to address conflicts
of interest relating to the management of multiple accounts for multiple
clients. Conflicts of interest may arise when an investment professional has
responsibilities for the investments of more than one account because the
investment professional may be unable to devote equal time and attention to each
account. The investment professional or investment professional teams for each
client may have responsibilities for managing all or a portion of the
investments of multiple accounts with a common investment strategy, including
other registered investment companies, unregistered investment vehicles, such as
hedge funds, pension plans, separate accounts, collective trusts and charitable
foundations. Among other things, AllianceBernstein’s policies and procedures
provide for the prompt dissemination to investment professionals of initial or
changed investment recommendations by analysts so that investment professionals
are better able to develop investment strategies for all accounts they manage.
In addition, investment decisions by investment professionals are reviewed for
the purpose of maintaining uniformity among similar accounts and ensuring that
accounts are treated equitably. Investment professional compensation reflects a
broad contribution in multiple dimensions to long-term investment success for
our clients and is generally not tied specifically to the performance of any
particular client’s account, nor is it generally tied directly to the level or
change in level of assets under management.
Allocating
Investment Opportunities
The
investment professionals at AllianceBernstein routinely are required to select
and allocate investment opportunities among accounts. AllianceBernstein has
policies and procedures intended to address conflicts of interest relating to
the allocation of investment opportunities. These policies and procedures are
designed to ensure that information relevant to investment decisions is
disseminated promptly within its portfolio management teams and investment
opportunities are allocated equitably among different clients.
AllianceBernstein’s policies and procedures require, among other things,
objective allocation for limited investment opportunities (e.g., on a rotational
basis) and documentation and review of justifications for any decisions to make
investments only for select accounts or in a manner disproportionate to the size
of the account. Portfolio holdings, position sizes, and industry and sector
exposures tend to be similar across similar accounts which minimizes the
potential for conflicts of interest relating to the allocation of investment
opportunities. Nevertheless, access to portfolio funds or other investment
opportunities may be allocated differently among accounts due to the particular
characteristics of an account, such as size of the account, cash position, tax
status, risk tolerance and investment restrictions or for other
reasons.
AllianceBernstein’s
procedures are also designed to address potential conflicts of interest that may
arise when AllianceBernstein has a particular financial incentive, such as a
performance-based management fee, relating to an account. An investment
professional may perceive that he or she has an incentive to devote more time to
developing and analyzing investment strategies and opportunities or allocating
securities preferentially to accounts for which AllianceBernstein could share in
investment gains.
Compensation
AllianceBernstein’s
compensation program for portfolio managers, analysts and traders is designed
attract and retain the highest-caliber employees. We incorporate multiple
sources of industry benchmarking data to ensure our compensation is highly
competitive and fully reflects the individual’s contributions in achieving
client objectives.
Incentive
Compensation Significant Component: Portfolio managers, analysts and traders
receive base compensation, incentive compensation and retirement contributions.
While both overall compensation levels and the splits between base and incentive
compensation vary from year to year, incentive compensation is a significant
part of overall compensation. For example, for our portfolio managers, the bonus
component for portfolio managers averages approximately 60-80% of their total
compensation each year. Part of each professional’s annual incentive
compensation across all asset classes is normally paid through an award under
the firm’s Incentive Compensation Award Plan (ICAP). The ICAP awards vest over a
four-year period. We believe this helps our investment professionals focus
appropriately on long-term client objectives and results.
Determined
by Both Quantitative and Qualitative Factors: Total compensation for our
investment professionals is determined by quantitative and qualitative factors.
For portfolio managers, the most significant quantitative component focuses on
measures of absolute and relative investment performance in client portfolios.
Relative returns are evaluated using both the Strategy’s primary benchmark and
peers over one-, three- and five-year periods, with more weight given to longer
time periods. We also assess the risk pattern of performance, both absolute and
relative to peers. The qualitative component for portfolio managers incorporates
the manager’s broader contributions to overall investment processes and our
clients’ success. Among the important aspects are: thought leadership,
collaboration with other investment professionals at the firm, contributions to
risk-adjusted returns in other portfolios, building a strong talent pool,
mentoring newer investment professionals, being a good corporate citizen, and
achievement of personal goals. Personal goals include objectives related to ESG
and Diversity and Inclusion. Other factors that can play a part in determining
portfolio managers’ compensation include complexity of investment strategies
managed.
Research
Analysts: Research professionals have compensation and career opportunities that
reflect a stature equivalent to their portfolio manager peers. Compensation for
our research analysts is also heavily incentive-based and aligned with results
generated for client portfolios. Criteria used include how well the analyst’s
research recommendations performed, the breadth and depth of his or her research
knowledge, the level of attentiveness to forecasts and market movements, and the
analyst’s willingness to collaborate and contribute to the overall intellectual
capital of the firm.
Traders:
Traders are critically important to generating results in client accounts. As
such, compensation for our traders is highly competitive and heavily
incentive-based. Our portfolio managers and Heads of Trading evaluate traders on
their ability to achieve best execution and add value to client portfolios
through trading. We also incentivize our fixed income traders to continually
innovate for clients, encouraging them to continue developing and refining new
trading technologies to enable AllianceBernstein to effectively address
liquidity conditions in the fixed income markets for our clients.
Assessments
of all investment professionals are formalized in a year-end review process that
includes 360-degree feedback from other professionals from across the investment
teams and firm.
As
of December 31,
2023,
Mr. Fogarty and Mr. Thapar did not own any shares of the Large Company Growth
Portfolio.
Diamond
Hill
Aaron
Monroe manages Diamond Hill’s portion of the Small Company Value Portfolio. The
table below includes details regarding the number of registered investment
companies, other pooled investment vehicles and other accounts managed by the
portfolio manager, as well as total assets under management for each type of
account, and total assets in each type of account with performance-based
advisory fees, as of December 31,
2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (millions) |
#
of Accounts Managed with Performance-Based Advisory Fee |
Total
Assets with Performance-Based Advisory Fee (millions) |
Aaron
Monroe, CFA |
|
|
| |
Registered
Investment Companies |
1 |
$230 |
0 |
$0 |
Other
Pooled Investment Vehicles |
2 |
$25 |
1 |
$20 |
Other
Accounts |
1 |
$10 |
0 |
$0 |
|
|
|
| |
Conflicts
of Interest
Aaron
Monroe (a “Portfolio Manager”) is also responsible for managing other account
portfolios in addition to the portion of the Small Company Value Portfolio (the
“Portfolio”) which he manages. Management of other accounts, in addition to the
Portfolio, can present certain conflicts of interest, including those
associated with different fee structures, various trading practices, and the
amount of time a Portfolio Manager may spend on other accounts versus the
respective funds he manages. Diamond Hill has implemented specific policies and
procedures to address any potential conflicts. Below are material conflicts of
interest that have been identified and mitigated when managing other account
portfolios as well as the Portfolio.
Performance
Based Fees
Diamond
Hill manages certain accounts for which part of its fee is based on the
performance of the account (“Performance Fee Accounts”). As a result of the
performance-based fee component, Diamond Hill may receive additional revenue
related to the Performance Fee Accounts. None of the Portfolio Managers receive
any direct incentive compensation related to their management of the Performance
Fee Accounts; however, revenues from Performance Fee Accounts management will
impact the resources available to compensate Portfolio Managers and all
staff.
Trade
Allocation
Diamond
Hill manages numerous accounts in addition to the portion of the Portfolio it
manages. When the Portfolio and another of Diamond Hill’s clients seek to
purchase or sell the same security at or about the same time, Diamond Hill may
execute the transactions with the same broker on a combined or “blocked” basis.
Blocked transactions can produce better execution for a fund because of
increased volume of the transaction. However, when another of Diamond Hill’s
clients specifies that trades be executed with a specific broker (“Directed
Brokerage Accounts”), a potential conflict of interest exists related to the
order in which those trades are executed and allocated. As a result, Diamond
Hill has adopted a trade allocation policy in which all trade orders occurring
simultaneously among the Portfolio and one or more other accounts where Diamond
Hill has the discretion to choose the execution broker are blocked and executed
first. After the blocked trades have been completed, the remaining trades for
the Directed Brokerage Accounts are then executed in random order, through
Diamond Hill’s portfolio management software. When a trade is partially filled,
the number of filled shares is allocated on a pro-rata basis to the appropriate
client accounts. Trades are not segmented by investment product.
Personal
Security Trading by the Portfolio Managers
Diamond
Hill has adopted a Code of Ethics designed to: (1) demonstrate Diamond Hill’s
duty at all times to place the interest of clients first; (2) align the
interests of the Portfolio Managers with clients, and (3) mitigate inherent
conflicts of interest associated with personal securities transactions. The Code
of Ethics prohibits all employees of Diamond Hill, including the Portfolio
Managers, from purchasing any individual equity or fixed income securities that
are eligible to be purchased in a client account. The Code of Ethics also
prohibits the purchase of third party mutual funds in the primary Morningstar
categories with which Diamond Hill competes. As a result, each of the Portfolio
Managers are significant owners in the Diamond Hill strategies, thus aligning
their interest with clients.
Best
Execution and Research Services
Diamond
Hill has controls in place for monitoring trade execution in client accounts,
including reviewing trades for best execution. Certain broker-dealers that
Diamond Hill uses to execute client trades are also clients of Diamond Hill
and/or refer clients to Diamond Hill creating a conflict of interest. To
mitigate this conflict, Diamond Hill adopted a policy that prohibits considering
any factor other than best execution when a client trade is placed with a
broker-dealer.
Receipt
of research from brokers who execute client trades involves conflicts of
interest. Since Diamond Hill uses client brokerage commissions to obtain
research, it receives a benefit because it does not have to produce or pay for
the research, products, or services itself. Consequently, Diamond Hill has an
incentive to select or recommend a broker based on its desire to receive
research, products, or services rather than a desire to obtain the most
favorable execution. Diamond Hill attempts to mitigate these potential conflicts
through oversight of the use of commissions by its Best Execution
Committee.
Compensation
Aaron
Monroe is paid by Diamond
Hill a competitive base salary based on experience, external market comparisons
to similar positions, and other business factors. To align their interests with
those of shareholders, all portfolio managers also participate in an annual cash
and equity incentive compensation program that is based on:
•The
long-term pre-tax investment performance of the Fund(s) that they
manage,
•The
Adviser’s assessment of the investment contribution they make to Funds they do
not manage,
•The
Adviser’s assessment of each portfolio manager’s overall contribution to the
development of the investment team through ongoing discussion, interaction,
feedback and collaboration, and
•The
Adviser’s assessment of each portfolio manager’s contribution to client service,
marketing to prospective clients and investment communication
activities.
Long-term
performance is defined as the trailing five years (performance of less than five
years is judged on a subjective basis). Incentive compensation is paid annually
from an incentive pool that is determined based on several factors including
investment results in client portfolios, revenues, employee performance, and
industry operating margins. Portfolio Manager compensation is not directly tied
to product asset growth or revenue, however, both of these factors influence the
size of the incentive pool and therefore indirectly contribute to portfolio
manager compensation. Incentive compensation is subject to review and oversight
by the compensation committee of the Adviser’s parent firm, Diamond Hill
Investment Group, Inc. The compensation committee is comprised of independent
outside members of the board of directors. The portfolio managers are also
eligible to participate in the Diamond Hill Investment Group, Inc. 401(k) plan
and related company match. The Adviser also offers a Deferred Compensation Plan,
whereby
each portfolio manager may voluntarily elect to defer a portion of their
incentive compensation. Any deferral of incentive compensation must be invested
in Diamond Hill Funds for the entire duration of the deferral.
As
of
December 31, 2023, Mr. Monroe did
not own any shares of the Small Company Value Portfolio.
DoubleLine
Jeffrey
E. Gundlach, Chief Executive Officer, and Jeffrey Sherman are the portfolio
managers for the Income Fund. The table below includes details regarding the
number of registered investment companies, other pooled investment vehicles, and
other accounts managed by Messrs. Gundach and Sherman, total assets under
management for each type of account, and total assets in each type of account
with performance-based advisory fees, as of December 31,
2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Accounts |
Total
# of Accounts Managed |
Total
Assets (billions) |
#
of Accounts Managed With Performance Based Advisory Fee |
Total
Assets With Performance-Based Advisory Fee (billions) |
Jeffrey
E. Gundlach |
|
|
| |
Registered
Investment Companies |
31 |
$67.3 |
0 |
$0 |
Other
Pooled Investment Vehicles |
21 |
$6.8 |
2 |
$908
million |
Other
Accounts |
72 |
$45.6 |
3 |
$1.3 |
Jeffrey
Sherman |
|
|
| |
Registered
Investment Companies |
23 |
$34.0 |
0 |
$0 |
Other
Pooled Investment Vehicles |
13 |
$3.0 |
0 |
$0 |
Other
Accounts |
19 |
$3.9 |
0 |
$0 |
|
|
|
| |
Conflicts
of Interest
From
time to time, potential and actual conflicts of interest may arise between the
portfolio manager’s management of the investments of the Income Fund, on the one
hand, and the management of other accounts, on the other. Potential and actual
conflicts of interest also may result because of DoubleLine’s other business
activities. Other accounts managed by the portfolio manager might have similar
investment objectives or strategies as the Income Fund, be managed (benchmarked)
against the same index the Income Fund tracks, or otherwise hold, purchase, or
sell securities that are eligible to be held, purchased or sold by the Income
Fund. The other accounts might also have different investment objectives or
strategies than the Income Fund.
Knowledge
and Timing of Fund Trades.
A potential conflict of interest may arise as a result of the portfolio
manager’s management of the Income Fund. Because of his position as portfolio
manager, the portfolio manager knows the size, timing and possible market impact
of the Income Fund’s trades. It is theoretically possible that the portfolio
manager could use this information to the advantage of other accounts under
management, and also theoretically possible that actions could be taken (or not
taken) to the detriment of the Income Fund.
Investment
Opportunities.
A potential conflict of interest may arise as a result of the portfolio
manager’s management of a number of accounts with varying investment guidelines.
Often, an investment opportunity may be suitable for both the Income Fund and
other accounts managed by the portfolio manager, but securities may not be
available in sufficient quantities for both the Income Fund and the other
accounts to participate fully. Similarly, there may be limited opportunity to
sell an investment held by the Income Fund and another account. DoubleLine has
adopted policies and procedures reasonably designed to allocate investment
opportunities on a fair and equitable basis over time.
Under
DoubleLine’s allocation procedures, investment opportunities are allocated among
various investment strategies based on individual account investment guidelines,
DoubleLine’s investment outlook, cash availability and a series of other
factors. DoubleLine has also adopted additional internal practices to complement
the general trade allocation policy that are designed to address potential
conflicts of interest due to the side-by-side management of the Income Fund and
certain pooled investment vehicles, including investment opportunity allocation
issues.
Conflicts
potentially limiting the Income Fund’s investment opportunities may also arise
when the Income Fund and other clients of DoubleLine invest in, or even conduct
research relating to, different parts of an issuer’s capital structure, such as
when the Income Fund owns senior debt obligations of an issuer and other clients
own junior tranches of the same issuer. In such circumstances, decisions over
whether to trigger an event of default, over the terms of any workout, or how to
exit an investment may result in conflicts of interest. In order to minimize
such conflicts, the portfolio manager may avoid certain investment opportunities
that would potentially give rise to conflicts with other clients of DoubleLine
or result in DoubleLine receiving material, non-public information, or
DoubleLine may enact internal procedures designed to minimize such conflicts,
which could have the effect of limiting the Income Fund’s investment
opportunities. Additionally, if DoubleLine acquires material non-public
confidential information in connection with its business activities for other
clients, the portfolio manager or other investment personnel may be restricted
from purchasing
securities
or selling certain securities for the Fund or other clients. When making
investment decisions where a conflict of interest may arise, DoubleLine will
endeavor to act in a fair and equitable manner between the Income Fund and other
clients; however, in certain instances the resolution of the conflict may result
in DoubleLine acting on behalf of another client in a manner that may not be in
the best interest, or may be opposed to the best interest, of the Income
Fund.
Investors
in the Income Fund may also be advisory clients of DoubleLine or the Fund may
invest in a product managed or sponsored or otherwise affiliated with
DoubleLine. Accordingly, DoubleLine may in the course of its business provide
advice to advisory clients whose interests may conflict with those of the Income
Fund, may render advice to the Income Fund that provides a direct or indirect
benefit to DoubleLine an affiliate of DoubleLine or may manage or advise a
product in which the Fund is invested in such a way that would not be beneficial
to the Income Fund. For example, DoubleLine may advise a client who has invested
in the Income Fund to redeem its investment in the Fund, which may cause the
Fund to incur transaction costs and/or have to sell assets at a time when it
would not otherwise do so.
DoubleLine
could also, for example, make decisions with respect to a structured product
managed or sponsored by DoubleLine in a manner that could have adverse effects
on investors in the product, including, potentially, the Income Fund. DoubleLine
currently provides asset allocation investment advice, including recommending
the purchase and/or sale of shares of the Income Fund, to another investment
advisor which itself makes that advice available to a number of unaffiliated
registered representatives, who then may provide identical or similar
recommendations to their clients.
Affiliates
of DoubleLine may invest in the Income Fund. DoubleLine could face a conflict if
an account it advises is invested in the Income Fund and that account’s
interests diverge from those of the Income Fund. The timing of a redemption by
an affiliate could benefit the affiliate. For example, the affiliate may choose
to redeem its shares at a time when the Income Fund’s portfolio is more liquid
than at times when other investors may wish to redeem all or part of their
interests. In addition, a consequence of any redemption of a significant amount,
including by an affiliate, is that investors remaining in the Income Fund will
bear a proportionately higher share of Fund expenses following the
redemption.
Broad
and Wide-Ranging Activities.
The portfolio manager, DoubleLine and its affiliates engage in a broad spectrum
of activities. In the ordinary course of their business activities, the
portfolio manager, DoubleLine and its affiliates may engage in activities where
the interests of certain divisions of DoubleLine and its affiliates or the
interests of their clients may conflict with the interests of the shareholders
of the Income Fund.
Possible
Future Activities.
DoubleLine and its affiliates may expand the range of services that it provides
over time. Except as provided herein, DoubleLine and its affiliates will not be
restricted in the scope of its business or in the performance of any such
services (whether now offered or undertaken in the future) even if such
activities could give rise to conflicts of interest, and whether or not such
conflicts are described herein. DoubleLine and its affiliates have, and will
continue to develop, relationships with a significant number of companies,
financial sponsors and their senior managers, including relationships with
clients who may hold or may have held investments similar to those intended to
be made by the Income Fund. These clients may themselves represent appropriate
investment opportunities for the Income Fund or may compete with the Income Fund
for investment opportunities.
Performance
Fees and Personal Investments.
The portfolio manager may advise certain accounts with respect to which the
advisory fee is based entirely or partially on performance or in respect of
which the portfolio manager may have made a significant personal investment.
Such circumstances may create a conflict of interest for the portfolio manager
in that the portfolio manager may have an incentive to allocate the investment
opportunities that he believes might be the most profitable to such other
accounts instead of allocating them to the Income Fund. DoubleLine has adopted
policies and procedures reasonably designed to allocate investment opportunities
between the Income Fund and performance fee based accounts on a fair and
equitable basis over time.
Compensation
The
overall objective of the compensation program for the portfolio managers
employed by DoubleLine is for DoubleLine to attract competent and expert
investment professionals and to retain them over the long-term. Compensation is
comprised of several components which, in the aggregate, are designed to achieve
these objectives and to reward DoubleLine’s portfolio managers for their
contribution to the success of the clients and DoubleLine. The DoubleLine
portfolio managers are compensated through a combination of base salary,
discretionary bonus and, in some cases, equity participation in
DoubleLine.
Salary.
Salary is agreed to with managers at time of employment and is reviewed from
time to time. It does not change significantly and often does not constitute a
significant part of a portfolio managers’ compensation.
Discretionary
Bonus/Guaranteed Minimums.
Portfolio managers receive discretionary bonuses. However, in some cases,
pursuant to contractual arrangements, some portfolio managers may be entitled to
a mandatory minimum bonus if the sum of their salary and profit sharing does not
reach certain levels.
Equity
Incentives.
Some portfolio managers participate in equity incentives based on overall firm
performance of DoubleLine, through direct ownership interests in DoubleLine.
These ownership interests or participation interests provide eligible portfolio
managers the opportunity to participate in the financial performance of
DoubleLine. Participation is generally determined in the discretion of
DoubleLine, taking into account factors relevant to the portfolio manager’s
contribution to the success of DoubleLine.
Other
Plans and Compensation Vehicles.
Portfolio managers may elect to participate in DoubleLine’s 401(k) plan, to
which they may contribute a portion of their pre- and post-tax compensation to
the plan for investment on a tax-deferred basis. DoubleLine may also choose,
from time to time, to offer certain other compensation plans and vehicles, such
as a deferred compensation plan, to portfolio managers.
Summary.
As described above, an investment professional’s total compensation is
determined through a subjective process that evaluates numerous quantitative and
qualitative factors, including the contribution made to the overall investment
process. Not all factors apply to each employee and there is no particular
weighting or formula for considering certain factors. Among the factors
considered are: relative investment performance of portfolios (although there
are no specific benchmarks or periods of time used in measuring performance);
complexity of investment strategies; participation in the investment team’s
dialogue; contribution to business results and overall business strategy;
success of marketing/business development efforts and client servicing;
seniority/length of service with the firm; management and supervisory
responsibilities; and fulfillment of DoubleLine’s leadership
criteria.
As
of December 31,
2023,
Messrs. Gundlach and Sherman did not own any shares of the Income
Fund.
Granahan
Jeffrey
Harrison manages Granahan’s portion of the Small Company Growth Portfolio. In
addition to Granahan’s portion of the Portfolio, the portfolio managers managed
the following other accounts as of December 31,
2023,
none of which were subject to a performance-based fee.
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (millions) |
Jeffrey
Harrison |
| |
Registered
Investment Companies |
4 |
$503.7 |
Other
Pooled Investment Vehicles |
3 |
$453 |
Other
Accounts |
16 |
$585.5 |
|
| |
Conflicts
of Interest
The
portfolio management team responsible for managing the Fund has similar
responsibilities to other clients of Granahan. The firm has established policies
and procedures to address the potential conflicts of interest inherent in
managing portfolios for multiple clients. These policies and procedures are
designed to prevent and detect favorable treatment of one account over another,
and include policies for allocating trades equitably across multiple accounts,
monitoring the composition of client portfolios to ensure that each reflects the
investment profile of that client, and reviewing the performance of accounts of
similar styles. Additionally, each employee of Granahan is bound by its Code of
Ethics, which establishes policies and procedures designed to ensure that
clients’ interests are placed before those of an individual or the
firm.
Compensation
Mr.
Harrison is compensated with a base salary plus an annual bonus and profit
sharing. Bonuses are based on an objective formula and have the potential to
double, or more, a portfolio manager’s salary. The bonus formula accounts for
individual contribution, with emphasis on three-year rolling performance against
the applicable benchmark(s). Granahan believes that the formula promotes
accountability and teamwork and aligns Granahan employees’ interests with those
of its clients. Other things that are considered when determining total
compensation is a portfolio manager’s overall responsibilities, experience
level, and tenure at Granahan. The compensation of Mr. Harrison is not directly
based upon the performance of the Small Company Growth Portfolio or other
accounts that the portfolio manager manages. Employee shareholders of Granahan
are also compensated through their equity in the firm, in the form of dividends.
As
of December 31,
2023,
Mr. Harrison did not own any shares of the Small Company Growth
Portfolio.
Hotchkis
& Wiley
George
Davis, Jr., Scott McBride, and Judd Peters manage Hotchkis & Wiley’s portion
of the Large Company Value Portfolio. Judd Peters and Ryan Thomes manage
Hotchkis & Wiley’s portion of the Small Company Value Portfolio.
The
table below includes details regarding the number of registered investment
companies, other pooled investment vehicles and other accounts managed by each
of the portfolio managers, as well as total assets under management for each
type of account, and total assets in each type of account with performance-based
advisory fees, as of December 31,
2023.
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (billions) |
#
of Accounts Managed with Performance-Based Advisory Fee |
Total
Assets with Performance-Based Advisory Fee |
George
Davis, Jr., Scott McBride, CFA, Judd Peters, CFA, and Ryan
Thomes |
|
Registered
Investment Companies |
24* |
$21.3 |
1 |
$12.4B |
Other
Pooled Investment Vehicles |
11 |
$2.3 |
1 |
$46.2M |
Other
Accounts |
52 |
$6.3 |
4 |
$791M |
|
|
|
| |
*Excludes
Wilshire Large Company Value Portfolio
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (billions) |
#
of Accounts Managed with Performance-Based Advisory Fee |
Total
Assets with Performance-Based Advisory Fee |
Judd
Peters, CFA |
|
Registered
Investment Companies |
23* |
$21.3 |
1 |
$12.4B |
Other
Pooled Investment Vehicles |
11 |
$2.3 |
1 |
$46.2M |
Other
Accounts |
52 |
$6.3 |
4 |
$791M |
|
|
|
| |
*Excludes
Wilshire Small Company Value Portfolio & Wilshire Large Company Value
Portfolio
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Type
of Account |
Total
# of Accounts Managed |
Total
Assets (billions) |
#
of Accounts Managed with Performance-Based Advisory Fee |
Total
Assets with Performance-Based Advisory Fee |
Ryan
Thomes |
|
Registered
Investment Companies |
24* |
$21.4 |
1 |
$12.4B |
Other
Pooled Investment Vehicles |
11 |
$2.3 |
1 |
$46.2M |
Other
Accounts |
52 |
$6.3 |
4 |
$791M |
|
|
|
| |
*Excludes
Wilshire Large Company Value Portfolio
Conflicts
of Interest
Portions
of the Large Company Value Portfolio and Small Company Value Portfolio are
managed by Hotchkis & Wiley’s investment team (Investment Team). The
Investment Team also manages institutional accounts and other mutual funds in
several different investment strategies. The portfolios within an investment
strategy are managed using a target portfolio; however, each portfolio may have
different restrictions, cash flows, tax and other relevant considerations which
may preclude a portfolio from participating in certain transactions for that
investment strategy. Consequently, the performance of portfolios may vary due to
these different considerations. The Investment Team may place transactions for
one investment strategy that are directly or indirectly contrary to investment
decisions made on behalf of another investment strategy. Hotchkis & Wiley
also provides model portfolio investment recommendations to sponsors without
execution or additional services. The recommendations are provided either
contemporaneously with the communication to its trading desk for discretionary
client accounts or after Hotchkis & Wiley completes all corresponding trades
for discretionary client accounts based on each contractual
arrangement.
Hotchkis
& Wiley may be restricted from purchasing more than a limited percentage of
the outstanding shares of a company or otherwise restricted from trading in a
company’s securities due to other regulatory limitations. If a company is a
viable investment for more than one investment strategy, Hotchkis & Wiley
has adopted policies and procedures reasonably designed to ensure that all of
its clients are treated fairly and equitably. Additionally, potential and actual
conflicts of interest may also arise as a result of Hotchkis & Wiley’s other
business activities and Hotchkis & Wiley’s possession of material non-public
information about an issuer, which may have an adverse impact on one group of
clients while benefiting another group. In certain situations, Hotchkis &
Wiley will purchase different classes of securities of the same company (e.g.
senior debt, subordinated debt, and or equity) in different investment
strategies which can give rise to conflicts where Hotchkis & Wiley may
advocate for the benefit of one class of security which may be adverse to
another security that is held by clients of a different strategy. Hotchkis &
Wiley seeks to mitigate the impact of these conflicts on a case by case
basis.
Hotchkis
& Wiley utilizes soft dollars to obtain brokerage and research services,
which may create a conflict of interest in allocating clients’ brokerage
business. Research services may benefit certain accounts more than others.
Certain accounts may also pay a less proportionate amount of commissions for
research services. If a research product provides both a research and a non-
research function, Hotchkis & Wiley will make a reasonable allocation of the
use and pay for the non-research portion with hard dollars. Hotchkis & Wiley
will make decisions involving soft dollars in a manner that satisfies the
requirements of Section 28(e) of the Securities Exchange Act of
1934.
Different
types of accounts and investment strategies may have different fee structures.
Additionally, certain accounts pay Hotchkis & Wiley performance-based fees,
which may vary depending on how well the account performs compared to a
benchmark. Because such fee arrangements have the potential to create an
incentive for Hotchkis & Wiley to favor such accounts in making investment
decisions and allocations, Hotchkis & Wiley has adopted policies and
procedures reasonably designed to ensure that all of its clients are treated
fairly and equitably, including in respect of allocation decisions, such as
initial public offerings.
Since
accounts are managed to a target portfolio by the Investment Team, adequate time
and resources are consistently applied to all accounts in the same investment
strategy. Investment personnel of the firm or its affiliates may be permitted to
be commercially or professionally involved with an issuer of securities. Any
potential conflicts of interest from such involvement would be monitored for
compliance with the firm’s Code of Conduct.
Compensation
The
Investment Team, including portfolio managers, is compensated in various forms,
which may include one or more of the following: (i) a base salary, (ii) bonus,
(iii) profit sharing and (iv) equity ownership. Compensation is used to reward,
attract and retain high quality investment professionals.
The
Investment Team is evaluated and accountable at three levels. The first level is
individual contribution to the research and decision-making process, including
the quality and quantity of work achieved. The second level is teamwork,
generally evaluated through contribution within sector teams. The third level
pertains to overall portfolio and firm performance.
Fixed
salaries and discretionary bonuses for investment professionals are determined
by the Chief Executive Officer of Hotchkis & Wiley using tools which may
include annual evaluations, compensation surveys, feedback from other employees
and advice from members of the firm’s Executive and Compensation Committees. The
amount of the bonus is determined by the total amount of the firm’s bonus pool
available for the year, which is generally a function of revenues. No investment
professional receives a bonus that is a pre-determined percentage of revenues or
net income. Compensation is thus subjective rather than formulaic.
Messrs.
Peters, McBride, Davis, and Thomes own equity in Hotchkis & Wiley. Hotchkis
& Wiley believes that the employee ownership structure of the firm will be a
significant factor in ensuring a motivated and stable employee base going
forward. Hotchkis & Wiley believes that the combination of competitive
compensation levels and equity ownership provides Hotchkis & Wiley with a
demonstrable advantage in the retention and motivation of employees. Portfolio
managers who own equity in Hotchkis & Wiley receive their pro rata share of
Hotchkis & Wiley’s profits. Investment professionals may also receive
contributions under Hotchkis & Wiley’s profit sharing/401(k)
plan.
Hotchkis
& Wiley maintains a bank of unallocated equity to be used for those
individuals whose contributions to the firm grow over time. If any owner should
retire or leave the firm, Hotchkis & Wiley has the right to repurchase their
ownership thereby increasing the equity bank. This should provide for smooth
succession through the gradual rotation of the firm’s ownership from one
generation to the next.
Hotchkis
& Wiley believes that its compensation structure/levels are more attractive
than the industry norm, which is illustrated by the firm’s
lower-than-industry-norm investment personnel turnover.
As
of December 31,
2023,
Mr. Peters and Mr. Thomes did not own any shares of the Small Company Value
Portfolio and Mr. Davis, Mr. McBride, and Mr. Peters did not own any shares of
the Large Company Value Portfolio.
Lazard
Paul
Moghtader, Taras Ivanenko, Alex Lai, Kurt
Livermore,
Ciprian Marin, Craig Scholl, Peter Kashanek, and Susanne Willumsen manage
Lazard’s portion of the International Fund. The table below includes details
regarding the number of registered investment companies, other pooled investment
vehicles and other accounts managed by each of the portfolio managers, as well
as total assets under management for each type of account, and total assets in
each type of account with performance-based advisory fees, as of December 31,
2023.