STATEMENT
OF ADDITIONAL INFORMATION
Dated
February 28, 2024
AIM
Investment Funds (Invesco Investment Funds)
This Statement of
Additional Information (the SAI) relates to each portfolio (each a Fund,
collectively the Funds) of AIM Investment Funds (Invesco Investment Funds) (the
Trust) listed below. Each Fund offers separate classes of shares as
follows:
|
Fund |
A |
C |
R |
Y |
Investor |
Class
R5 |
Class
R6 |
Prospectus
Date |
|
Invesco
Balanced-Risk Allocation Fund |
ABRZX |
ABRCX |
ABRRX |
ABRYX |
N/A |
ABRIX |
ALLFX |
February
28, 2024 |
|
Invesco
Balanced-Risk Commodity Strategy Fund |
BRCAX |
BRCCX |
BRCRX |
BRCYX |
N/A |
BRCNX |
IBRFX |
February
28, 2024 |
|
Invesco
Core Bond Fund |
OPIGX |
OPBCX |
OPBNX |
OPBYX |
N/A |
TRTMX |
OPBIX |
February
28, 2024 |
|
Invesco
Developing Markets Fund |
ODMAX |
ODVCX |
ODVNX |
ODVYX |
N/A |
DVMFX |
ODVIX |
February
28, 2024 |
|
Invesco
Discovery Mid Cap Growth Fund |
OEGAX |
OEGCX |
OEGNX |
OEGYX |
N/A |
DMCFX |
OEGIX |
February
28, 2024 |
|
Invesco
Emerging Markets Local Debt Fund |
OEMAX |
OEMCX |
OEMNX |
OEMYX |
N/A |
EMLDX |
OEMIX |
February
28, 2024 |
|
Invesco
EQV Emerging Markets All Cap Fund |
GTDDX |
GTDCX |
N/A |
GTDYX |
N/A |
GTDIX |
GTDFX |
February
28, 2024 |
|
Invesco
Fundamental Alternatives Fund |
QVOPX |
QOPCX |
QOPNX |
QOPYX |
N/A |
FDATX |
QOPIX |
February
28, 2024 |
|
Invesco
Global Allocation Fund |
QVGIX |
QGRCX |
QGRNX |
QGRYX |
N/A |
GLALX |
QGRIX |
February
28, 2024 |
|
Invesco
Global Infrastructure Fund |
GIZAX |
GIZCX |
GIZRX |
GIZYX |
N/A |
GIZFX |
GIZSX |
February
28, 2024 |
|
Invesco
Global Strategic Income Fund |
OPSIX |
OSICX |
OSINX |
OSIYX |
N/A |
GLSSX |
OSIIX |
February
28, 2024 |
|
Invesco
Greater China Fund |
AACFX |
CACFX |
IGCRX |
AMCYX |
N/A |
IACFX |
CACSX |
February
28, 2024 |
|
Invesco
Health Care Fund |
GGHCX |
GTHCX |
N/A |
GGHYX |
GTHIX |
N/A |
GGHSX |
February
28, 2024 |
|
Invesco
International Bond Fund |
OIBAX |
OIBCX |
OIBNX |
OIBYX |
N/A |
INBQX |
OIBIX |
February
28, 2024 |
|
Invesco
Macro Allocation Strategy Fund |
GMSDX |
GMSEX |
GMSJX |
GMSHX |
N/A |
GMSKX |
GMSLX |
February
28, 2024 |
|
Invesco
Multi-Asset Income Fund |
PIAFX |
PICFX |
PIRFX |
PIYFX |
N/A |
IPNFX |
PIFFX |
February
28, 2024 |
This SAI is not a
Prospectus, and it should be read in conjunction with the Prospectuses for the
Funds listed above. Invesco Core Bond Fund, Invesco Developing Markets Fund,
Invesco Discovery Mid Cap Growth Fund, Invesco Emerging Markets Local Debt Fund,
Invesco Fundamental Alternatives Fund, Invesco Global Allocation Fund, Invesco
Global Strategic Income Fund and Invesco International Bond Fund were organized
on May 24, 2019, for the purpose of acquiring the assets and liabilities of
corresponding predecessor funds (as defined below). Portions of the each Fund’s
financial statements are incorporated into this SAI by reference to each Fund’s
most recent shareholder report for its fiscal year ended October
31, 2023.
You may obtain,
without charge, a copy of any Prospectus and/or shareholder report for any Fund
listed above from an authorized dealer or by writing to:
Invesco
Investment Services, Inc.
P.O. Box 219078
Kansas City, MO 64121-9078
P.O. Box 219078
Kansas City, MO 64121-9078
or by calling (800)
959-4246
or on the Internet:
http://www.invesco.com/us
The Trust has
established other funds which are offered by one or more separate prospectuses
and SAIs. Any reference to the term “Fund” or “Funds” throughout this SAI refers
to each Fund named above unless otherwise
indicated.
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ii
GENERAL
INFORMATION ABOUT THE TRUST
Fund
History
AIM
Investment Funds (Invesco Investment Funds) (the Trust) is a Delaware statutory
trust registered under the
Investment Company Act of 1940, as amended (the 1940 Act), as an open-end series
management investment company. The Trust was originally organized as a Maryland
corporation on October 29, 1987 and re-organized as a Delaware statutory trust
on May 7, 1998. Under the Trust's Agreement and Declaration of Trust, as amended
(the Trust Agreement), the Board of Trustees of the Trust (the Board) is
authorized to create new series of shares without the necessity of a vote of
shareholders of the Trust.
Prior
to April 30, 2010, the Trust was known as AIM Investment Funds.
The
following table shows each Fund’s current name and Fund history:
|
Fund
Name |
Fund
History |
|
Invesco
Balanced-Risk Allocation
Fund |
Prior
to April 30, 2010, Invesco Balanced-Risk Allocation Fund was known as
Invesco AIM
Balanced-Risk
Allocation Fund. |
|
|
|
|
Invesco
Balanced-Risk Commodity
Strategy
Fund |
No
prior history. |
|
|
|
|
Invesco
Core Bond Fund |
Prior
to September 30, 2020, Invesco Core Bond Fund was known as Invesco
Oppenheimer
Total
Return Bond Fund.
On
May 24, 2019, Invesco Oppenheimer Total Return Bond Fund assumed the
assets and
liabilities
of its predecessor fund Oppenheimer Total Return Bond
Fund. |
|
|
|
|
Invesco
Developing Markets Fund |
Prior
to September 30, 2020, Invesco Developing Markets Fund was known as
Invesco
Oppenheimer
Developing Markets Fund.
On
May 24, 2019, Invesco Oppenheimer Developing Markets Fund assumed the
assets and
liabilities
of its predecessor fund Oppenheimer Developing Markets
Fund. |
|
|
|
|
Invesco
Discovery Mid Cap Growth
Fund |
Prior
to September 30, 2020, Invesco Discovery Mid Cap Growth Fund was known as
Invesco
Oppenheimer
Discovery Mid Cap Growth Fund.
On
May 24, 2019, Invesco Oppenheimer Discovery Mid Cap Growth Fund assumed
the assets
and
liabilities of its predecessor fund Oppenheimer Discovery Mid Cap Growth
Fund. |
|
|
|
|
Invesco
Emerging Markets Local
Debt
Fund |
Prior
to September 30, 2020, Invesco Emerging Markets Local Debt Fund was known
as
Invesco
Oppenheimer Emerging Markets Local Debt Fund.
On
May 24, 2019, Invesco Oppenheimer Emerging Markets Local Debt Fund assumed
the
assets
and liabilities of its predecessor fund Oppenheimer Emerging Markets Local
Debt Fund. |
|
|
|
|
Invesco
EQV Emerging Markets All
Cap
Fund |
Prior
to February 28, 2022, Invesco EQV Emerging Markets All Cap Fund was known
as
Invesco
Emerging Markets All Cap Fund.
Prior
to September 30, 2020, Invesco Emerging Markets All Cap Fund was known as
Invesco
Developing
Markets Fund.
Prior
to April 30, 2010, Invesco Developing Markets Fund was known as AIM
Developing
Markets
Fund. |
|
|
|
|
Invesco
Fundamental Alternatives
Fund |
Prior
to September 30, 2020, Invesco Fundamental Alternatives Fund was known as
Invesco
Oppenheimer
Fundamental Alternatives Fund.
On
May 24, 2019, Invesco Oppenheimer Fundamental Alternatives Fund assumed
the assets
and
liabilities of its predecessor fund Oppenheimer Fundamental Alternatives
Fund. |
|
|
|
|
Invesco
Global Allocation Fund |
Prior
to September 30, 2020, Invesco Global Allocation Fund was known as Invesco
Oppenheimer
Global Allocation Fund.
On
May 24, 2019, Invesco Oppenheimer Global Allocation Fund assumed the
assets and
liabilities
of its predecessor fund Oppenheimer Global Allocation
Fund. |
|
|
|
1
|
Fund
Name |
Fund
History |
|
Invesco
Global Infrastructure Fund |
No
prior history. |
|
|
|
|
Invesco
Global Strategic Income
Fund |
Prior
to September 30, 2020, Invesco Global Strategic Income Fund was known as
Invesco
Oppenheimer
Global Strategic Income Fund.
On
May 24, 2019, Invesco Oppenheimer Global Strategic Income Fund assumed the
assets
and
liabilities of its predecessor fund Oppenheimer Global Strategic Income
Fund. |
|
|
|
|
Invesco
Greater China Fund |
Prior
to June 15, 2015, Invesco Greater China Fund was known as Invesco China
Fund.
Prior
to April 30, 2010, Invesco China Fund was known as AIM China Fund. On
April 23, 2021,
Invesco
Greater China Fund acquired the assets and liabilities of Invesco Pacific
Growth Fund. |
|
|
|
|
Invesco
Health Care Fund |
Prior
to April 30, 2018, Invesco Health Care Fund was known as Invesco Global
Health Care
Fund.
Prior
to April 30, 2010, Invesco Global Health Care Fund was known as AIM Global
Health Care
Fund. |
|
|
|
|
Invesco
International Bond Fund |
Prior
to September 30, 2020, Invesco International Bond Fund was known as
Invesco
Oppenheimer
International Bond Fund.
On
May 24, 2019, Invesco Oppenheimer International Bond Fund assumed the
assets and
liabilities
of its predecessor fund Oppenheimer International Bond
Fund. |
|
|
|
|
Invesco
Macro Allocation Strategy
Fund |
Prior
to July 27, 2016, Invesco Macro Allocation Strategy Fund was known as
Invesco Global
Markets
Strategy Fund. |
|
|
|
|
Invesco
Multi-Asset Income Fund |
Prior
to July 27, 2016, Invesco Multi-Asset Income Fund was known as Invesco
Premium
Income
Fund. |
Shares
of Beneficial Interest
Shares
of beneficial interest of the Trust are redeemable at their net asset value at
the option of the shareholder or at
the option of the Trust, in accordance with any applicable provisions of the
Trust Agreement and applicable law, subject in certain circumstances to a
contingent deferred sales charge, if applicable.
The
Trust allocates cash and property it receives from the issue or sale of shares,
together with all assets in which such
consideration is invested or reinvested, all income, earnings, profits and
proceeds thereof, to the appropriate Fund, as applicable, subject only to
the rights of creditors of that Fund. These assets constitute the assets
belonging to each Fund, are segregated on the Trust’s books, and are charged
with the liabilities and expenses of such Fund and its respective classes. The
Trust allocates any general liabilities and expenses of the Trust not readily
identifiable as belonging to a particular Fund primarily on the basis of
relative net assets or other relevant factors, subject to oversight by the
Board.
Each
share of each Fund represents an equal pro rata interest in that Fund with each
other share and is entitled to
dividends and other distributions with respect to the Fund, which may be from
income, capital gains, capital or distributions in kind, as declared by the
Board.
Each
class of shares of a Fund represents a proportionate undivided interest in the
net assets belonging to that Fund.
Differing sales charges and expenses will result in differing net asset values
and dividends and distributions. Upon any liquidation of the Trust,
shareholders of each class are entitled to share pro rata in the net assets
belonging to the applicable Fund allocable to such class available for
distribution after satisfaction of, or reasonable provision for, the outstanding
liabilities of the Fund allocable to such class.
The
Trust Agreement provides that each shareholder, by virtue of having become a
shareholder of the Trust, is bound by
terms of the Trust Agreement and the Trust’s Bylaws. Ownership of shares does
not make shareholders third party beneficiaries of any contract entered into by
the Trust.
The
Trust is not required to hold annual or regular meetings of shareholders.
Meetings of shareholders of a Fund or class
will be held for any purpose determined by the Board, including from time to
time to consider
2
matters
requiring a vote of such shareholders in accordance with the requirements of the
1940 Act, state law or the provisions
of the Trust Agreement. It is not expected that shareholder meetings will be
held annually.
The
Trust Agreement provides that the Board may authorize (i) a merger,
consolidation or sale of assets (including, but not
limited to, mergers, consolidations or sales of assets between two Funds, or
between a Fund and a series of any other registered investment company), and
(ii) the combination of two or more classes of shares of a Fund into a single
class, each without shareholder approval but subject to applicable requirements
under the 1940 Act and state law.
Each
share of a Fund generally has the same voting, dividend, liquidation and other
rights; however, each class of shares of
a Fund is subject to different sales loads, conversion features, exchange
privileges and class-specific expenses, as applicable.
Except
as specifically noted above, shareholders of each Fund are entitled to one vote
per share (with proportionate
voting for fractional shares), irrespective of the relative net asset value of
the shares of the Fund. However, on matters affecting an individual Fund or
class of shares, a separate vote of shareholders of that Fund or class is
required. Shareholders of a Fund or class are not entitled to vote on any matter
which does not affect that Fund or class but that requires a separate vote of
another Fund or class. An example of a matter that would be voted on separately
by shareholders of each Fund is the approval of the advisory agreement with
Invesco Advisers, Inc. (the Adviser or Invesco).
When
issued, shares of each Fund are fully paid and nonassessable, have no preemptive
or subscription rights, and are
freely transferable. Shares do not have cumulative voting rights in connection
with the election of Trustees or on any other matter.
Under
Delaware law, shareholders of a Delaware statutory trust shall be entitled to
the same limitation of personal liability
extended to shareholders of private for-profit corporations organized under
Delaware law. There is a remote possibility, however, that shareholders could,
under certain circumstances, be held liable for the obligations of the Trust to
the extent the courts of another state, which does not recognize such limited
liability, were to apply the laws of such state to a controversy involving such
obligations. The Trust Agreement disclaims shareholder personal liability for
the debts, liabilities, obligations and expenses of the Trust and requires that
every undertaking of the Trust or the Board relating to the Trust or any Fund
include a recitation limiting such obligation to the Trust and its assets or to
one or more of the Funds and the assets belonging thereto. The Trust Agreement
provides for indemnification out of the property of a Fund (or class, as
applicable) for all losses and expenses of any shareholder of such Fund held
personally liable solely on account of being or having been a
shareholder.
The
trustees and officers of the Trust will not be liable for any act, omission or
obligation of the Trust or any trustee or
officer; however, a trustee or officer is not protected against any liability to
the Trust or to the shareholders to which a trustee or officer would otherwise
be subject by reason of willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties involved in the conduct of his or her office
with the Trust or applicable Fund (Disabling Conduct). The Trust’s Bylaws
generally provide for indemnification by the Trust of the trustees, officers and
employees or agents of the Trust, provided that such persons have not engaged in
Disabling Conduct. Indemnification does not extend to judgments or amounts paid
in settlement in any actions by or in the right of the Trust. The Trust
Agreement also authorizes the purchase of liability insurance on behalf of
trustees and officers with Fund assets. The Trust’s Bylaws provide for the
advancement of payments of expenses to current and former trustees, officers and
employees or agents of the Trust, or anyone serving at their request, in
connection with the preparation and presentation of a defense to any claim,
action, suit or proceeding, for which such person would be entitled to
indemnification; provided that any advancement of expenses would be reimbursed
unless it is ultimately determined that such person is entitled to
indemnification for such expenses.
The
Trust Agreement provides that any Trustee who serves as chair of the Board, a
member or chair of a committee of the
Board, lead independent Trustee, or an expert on any topic or in any area
(including an audit committee financial expert), or in any other special
appointment will not be subject to any greater standard of care or liability
because of such position.
3
The
Trust Agreement provides a detailed process for the bringing of derivative
actions by shareholders. A shareholder may
only bring a derivative action on behalf of the Trust if certain conditions are
met. Among other things, such conditions: (i) require shareholder(s) to make a
pre-suit demand on the Trustees (unless such effort is not likely to succeed
because a majority of the Board or the committee established to consider the
merits of such action are not independent Trustees under Delaware law); (ii)
require 10% of the beneficial owners to join in the pre-suit demand, or if a
pre-suit demand is not required, require 10% of beneficial owners to join in the
demand for the Board to commence such action; and (iii) afford the Trustees a
reasonable amount of time to consider the request and investigate the basis of
the claims (including designating a committee to consider the demand and hiring
counsel or other advisers). These conditions generally are intended to provide
the Trustees with the ability to pursue a claim if they believe doing so would
be in the best interests of the Trust and its shareholders and to preclude the
pursuit of claims that the Trustees determine to be without merit or otherwise
not in the Trust’s best interest to pursue. Insofar as the federal securities
laws supersede state law, these provisions do not apply to shareholder
derivative claims that arise under the federal securities laws.
The
Trust Agreement also generally requires that actions by shareholders in
connection with or against the Trust or a Fund
be brought only in certain Delaware courts, provided that actions arising under
the U.S. federal securities laws are required to be brought in the United States
District Court for the Southern District of New York and that the right to jury
trial be waived to the fullest extent permitted by law. These provisions may
result in increased shareholder costs in pursuing a shareholder derivative claim
and/or may limit a shareholder's ability to bring a claim in a different
forum.
Share
Certificates
Shareholders
of the Funds do not have the right to demand or require the Trust to issue share
certificates and share
certificates are not issued. Any certificate previously issued with respect to
any shares is deemed to be cancelled without any requirement for surrender to
the Trust.
DESCRIPTION
OF THE FUNDS AND THEIR INVESTMENTS AND RISKS
Classification
The
Trust is an open-end management investment company. The following Funds are
classified as “diversified” for
purposes of the 1940 Act: Invesco Balanced-Risk Allocation Fund, Invesco
Balanced-Risk Commodity Strategy Fund, Invesco Core Bond Fund, Invesco
Developing Markets Fund, Invesco Discovery Mid Cap Growth Fund, Invesco EQV
Emerging Markets All Cap Fund, Invesco Fundamental Alternatives Fund, Invesco
Global Allocation Fund, Invesco Global Strategic Income Fund, Invesco Greater
China Fund, Invesco Health Care Fund, Invesco Macro Allocation Strategy
Fund
and
Invesco Multi-Asset
Income Fund. Invesco Emerging Markets Local Debt Fund, Invesco Global
Infrastructure Fund and Invesco International Bond Fund are classified as
“non-diversified” for purposes of the 1940 Act, which means the Funds can invest
a greater percentage of their assets in a small number of issuers or any one
issuer than a diversified fund can.
Investment
Strategies and Risks
Set
forth below are detailed descriptions of the various types of securities and
investment techniques that Invesco and/or the
Sub-Advisers (as defined herein) may use in managing the Funds, as well as the
risks associated with those types of securities and investment techniques. The
descriptions of the types of securities and investment techniques below
supplement the discussion of principal investment strategies and risks contained
in each Fund's Prospectus. Where a particular type of security or investment
technique is not discussed in a Fund's Prospectus, that security or investment
technique is not a principal investment strategy.
A
Fund may invest in all of the following types of investments (unless otherwise
indicated). A Fund might not invest in all
of these types of securities or use all of these techniques at any one time.
Invesco and/or the Sub-Advisers may invest in other types of securities and may
use other investment techniques in managing the Funds, including those described
below for Funds not specifically mentioned as investing in the security or
4
using
the investment technique, as well as securities and techniques not described. A
Fund's transactions in a particular type of
security or use of a particular technique is subject to limitations imposed by a
Fund's investment objective, policies and restrictions described in that Fund's
Prospectus and/or this SAI, as well as the federal securities laws.
Unless a Fund’s
prospectus or this
SAI states
that a
percentage limitation or fundamental or nonfundamental restriction applies on an
ongoing basis, it applies only at the time
a Fund
makes
an investment. That means a Fund
is not required to sell securities to meet the percentage limits or investment
restrictions if the value of the investment increases in proportion to the size
of a Fund. Percentage
limits
on borrowing and illiquid investments apply
on an
ongoing basis.
Invesco
Balanced-Risk Allocation Fund, Invesco Balanced-Risk Commodity Strategy Fund and
Invesco Macro Allocation
Strategy Fund will seek to gain exposure to the commodity market primarily
through investments in the Invesco Cayman Commodity Fund I Ltd., Invesco Cayman
Commodity Fund III Ltd. and Invesco Cayman Commodity Fund V Ltd., respectively,
wholly owned subsidiaries of Invesco Balanced-Risk Allocation Fund, Invesco
Balanced-Risk Commodity Strategy Fund and Invesco Macro Allocation Strategy
Fund, respectively, organized under the laws of the Cayman Islands (the
Subsidiaries). Invesco Balanced-Risk Allocation Fund, Invesco Balanced-Risk
Commodity Strategy Fund
and
Invesco Macro
Allocation Strategy Fund may invest up to 25% of its total assets in its
respective Subsidiaries.
Invesco
Global Allocation Fund and Invesco Fundamental Alternatives Fund will seek to
gain exposure to commodity-linked
derivatives (including commodity futures, financial futures, options and swap
contracts) and exchange-traded funds and other exchange-traded products related
to gold or other special minerals (“Gold ETFs”) through investments in
wholly-owned subsidiaries of the Funds organized under the laws of the Cayman
Islands (the Subsidiaries). Each Fund may invest up
to 25% of its total assets in its respective
Subsidiary.
Invesco
Global Strategic Income Fund and Invesco International Bond Fund will seek to
gain exposure to Regulation S
securities through investments in wholly-owned subsidiaries of the Funds
organized under the laws of the Cayman Islands (the Subsidiaries). Each Fund
may
invest up to 25% of its total assets in
its
respective
Subsidiary.
Incidental
to their other investment activities and unless otherwise indicated in a Fund’s
prospectus, Funds that have a
principal investment strategy of primarily investing in fixed income securities,
may acquire equity securities (including common stocks, preferred stocks,
convertible securities, warrants and rights) or other investments that the Fund
ordinarily would not purchase, in connection with a bankruptcy, restructuring,
workout or other extraordinary event concerning a particular portfolio
investment. To the extent a Fund acquires equity securities or investments as
described above, it may also purchase additional equity securities or
investments of those issuers.
The
Funds' investment objectives, policies, strategies and practices described below
are non-fundamental and may be changed
without approval of the holders of the Funds’ voting securities, unless
otherwise indicated.
Senior
Loans and Other Loans. Among other debt
securities described elsewhere in this SAI, the Fund may invest in loans, and in
particular, in floating rate loans (sometimes referred to as “adjustable” rate
loans that hold (or in the judgment of the Adviser, hold) a senior position in
the capital structure of U.S. and foreign corporations, parternerships or other
business entities that, under normal circumstances, allow them to have priority
of claim ahead of (or at least as high as) other obligations of a borrower in
the event liquidation. These investments are referred to as “Senior Loans” in
this SAI. Loans typically are arranged through private negotiations between a
borrower and one or more financial institutions (Lenders). Usually the Lenders
are represented by an agent (Agent), which usually is one of the Lenders. The
borrowers may use the proceeds of loans to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases, debt refinancings,
or for other purposes.
Senior
loans typically have higher recoveries than other debt obligations that rank
lower in the priority of payments for a
particular debtor, because in most instances they take preference over those
subordinated
5
debt
obligations, with respect to payment of interest and principal, and over stock.
However, the Fund is still subject to the risk
that the borrower under a loan will default on scheduled interest or principal
payments and that the assets of the borrower to which the Fund has recourse will
be insufficient to satisfy in full the payment obligations that the borrower has
to the Fund. The risk of default will increase in the event of an economic
downturn or, in the case of a floating rate loan, a substantial increase in
interest rates (because the cost of the borrower’s debt service will increase as
the interest rate on its loan is upwardly adjusted). The Fund may own a debt
obligation of a borrower that becomes, or is about to become, insolvent. The
Fund can also purchase debt obligations that are extended to a bankrupt entity
(so called debtor-in-possession or ‘DIP’ financing) or debt obligations that are
issued in connection with a restructuring of the borrower under bankruptcy
laws.
Agents
typically are commercial or investment banks that originate loans and invite
other parties to join the lending
syndicate. In larger transactions, it is common to have several Agents. However,
only one Agent usually has primary responsibility for documentation and
administration of the loan. Agents are normally paid fees by the borrower for
their services. While a Fund can serve as the Agent or co-agent for a loan, a
Fund currently does not intend to act as an Agent or co-Agent. Agents, acting on
behalf of the Lenders, generally are primarily responsible for negotiating the
loan agreement, which establishes the terms and conditions of the loan and the
rights of the borrower and the Lenders. A Fund will rely on Agents to collect
payments of principal and interest on a loan. A Fund also will rely in part on
Agents to monitor compliance by the borrower with the restrictive covenants in
the loan agreement and to notify a Fund (or the Lender from whom a Fund has
purchased a participation) of any adverse change in the borrower’s financial
condition.
Loans
may be secured or unsecured. Where a loan is secured, Agents usually monitor the
adequacy of assets that
collateralize loans. In reliance upon the opinions of their legal counsel,
Agents generally are also responsible for determining that the Lenders have
obtained a perfected security interest in the collateral securing loans, if
any.
Financial
difficulties of Agents can pose a risk to a Fund. If an Agent for a particular
loan becomes insolvent, a Fund
could incur losses in connection with its investment in that loan. An Agent
could declare bankruptcy, and a regulatory authority could appoint a receiver or
conservator. Should this occur, the assets that the Agent holds under the loan
agreement, if any, should continue to be available to the Lenders, including a
Fund. A regulator or a court, however, might determine that any such assets are
subject to the claims of the Agent’s general or secured creditors. If that
occurs, a Fund might incur costs and delays in realizing final payment on a
loan, or a Fund might suffer a loss of principal or interest. A Fund may be
subject to similar risks when it buys a participation interest in a loan. Most
participations purchased by a Fund are structured to be “true sales” of the
underlying loan, in which case the loan should not be included in the bankruptcy
estate of the participation seller. However, a court might determine that the
participation was not in fact a “true sale”, in which case a Fund would be a
general unsecured creditor of the participation seller.
In
certain circumstances, loans may not be deemed to be securities, and in the
event of fraud or misrepresentation
by a borrower or an arranger, lenders will not have the protection of the
anti-fraud provisions of the federal securities laws, as would be the case for
bonds or stocks. Instead, in such cases, lenders generally rely on the
contractual provisions in the loan agreement itself, and common-law fraud
protections under applicable state law.
How
a Fund Invests in Loans. A Fund may invest
in loans in one or more of three ways: a Fund may invest directly in a loan by
acting as an original Lender; a Fund may invest directly in a loan by purchasing
a loan by an assignment (an “Assignment”) from the Agent or other Lender; or a
Fund may invest indirectly in a loan by purchasing a participation interest in a
loan (Participation Interest) from an Agent or other Lender. A Fund may also
gain exposure to loans indirectly using certain derivative instruments, which is
discussed elsewhere in this SAI.
•
Original
Lender. A Fund can invest
in loans, generally “at par” (a price for the loan equal approximately to 100%
of a funded principal amount of the loan, minus any original issue discount) as
an original lender. When a Fund is an original lender, it is entitled to receive
a return at the full interest rate for the loan. When a Fund is an original
lender, it will have a direct contractual
6
relationship with
the borrower and will have direct recourse against the borrower in the event the
borrower fails to pay scheduled principal or interest.
•
Assignments. A Fund may also
purchase a loan by assignment. When a Fund purchases a loan by assignment, it
typically succeeds to whatever rights and obligations the assigning lender had
under the loan agreement and becomes a “lender” under the loan agreement,
entitled to the same rights (including, but not limited to, enforcement or
set-off rights) that are available to lenders generally.
•
Participation
Interests. These investments
represent an undivided, indirect interest in a loan obligation of a borrower.
They are typically purchased from banks or dealers that have made the loan, or
are members of the loan syndicate. The participation seller remains as lender of
record, and continues to face the borrower, the agent, and the other parties to
the loan agreement, while a Fund generally acquires beneficial ownership of the
loan. Participation interests are subject to the ongoing counterparty risk of
the participation seller (and, in certain circumstances, such seller’s credit
risk) as well as the credit risk of the borrower.
While
a Fund expects to have access to financial and other information regarding the
borrower that has been made available
to the lenders under a loan, it may not have such information in connection with
participation interests and certain loan assignments. Additionally, the amount
of public information available with respect to loans generally will be less
extensive than what is available for exchange-listed or otherwise registered
securities.
Participation
interests involve risks for a Fund. Participation interests are primarily
dependent upon the creditworthiness of
the borrower, which is obligated to make payments of principal and interest on
the loan. In buying a participation interest, however, a Fund assumes both the
credit risk of the borrower and the counterparty risk of the Lender selling the
participation interest. As with an assignment or a loan originated by a Fund,
there is a risk that a borrower may have difficulty making payments. If a
borrower fails to pay scheduled interest or principal payments, a Fund’s income
may be reduced and the value of the investment in the participation interest
might also decline. Further, the seller of the participation interest will have
no obligation to a Fund other than to pay a Fund the proportionate amount of the
principal and interest payments it receives from the borrower. In addition, if
the seller of the participation interest fails to perform its obligations,
purchasers might incur costs and delays in realizing payment and suffer a loss
of principal and/or interest, including in cases where the borrower may have
performed its obligation to the Lender that issued the participation (e.g., if
the participation seller fails to pass along to a Fund payments received from
the borrower). Although most participation interests purchased by a Fund are
structured to cause a Fund to become beneficial owner of the relevant loans, and
therefore avoid this outcome, if a Lender that sells a Fund a participation
interest becomes insolvent, a Fund may be treated as a general creditor of the
Lender. As a general creditor, a Fund will have to share the proceeds of the
loan with any other creditors of the Lender. A Fund will acquire a participation
interest only if the investment adviser determines that the Lender (or other
intermediary Participant) selling the participation interest is
creditworthy.
A
Fund’s rights under a participation interest with respect to a particular loan
may be more limited than the rights of original
Lenders or of investors who acquire an assignment of that loan. A Fund has the
right to receive payments of principal, interest and any fees to which it is
entitled only from the Lender selling the participation interest and only when
the Lender receives the payments from the borrower. In purchasing participation
interests, a Fund will usually have a contractual relationship only with the
selling institution and not the underlying borrower. A Fund generally will have
no right directly to enforce compliance by the borrower with the terms of the
related loan agreement, nor will a Fund necessarily have the right to object to
certain changes to the loan agreement agreed to by the selling institution. If a
Fund buys a participation interest in a loan, a Fund may be subject to any
rights of set-off the borrower has against the selling institution (although
recourse to the selling institution may be available in the event of any such
set-off). In the event of bankruptcy or insolvency of the borrower, the
obligation of the borrower to repay the loan may be subject to certain defenses
that can be asserted by the borrower as a result of any improper conduct of the
Lender selling the participation (although recourse to the Lender may be
available). As a result, a Fund may be subject to delays, expenses and risks
that are greater than those that exist when a Fund is an original Lender or
7
assignee,
and therefore a participation may be relatively illiquid as compared to a direct
investment in a loan because of a
smaller universe of investors who are willing to assume these additional risks
present in a participation.
Fees. A Fund may be
required to pay and may receive various fees and commissions in connection with
purchasing, selling and holding interests in loans. Borrowers typically pay
three kinds of fees to Lenders: facility fees (which may be structured as
original issue discount) when a loan is originated; commitment fees on an
ongoing basis based on the unused portion of a loan commitment; and prepayment
penalties when a borrower prepays a loan.
A
Fund receives these fees directly from the borrower if a Fund is an original
Lender or, in the case of commitment fees and
prepayment penalties, if a Fund acquires an assignment. Whether a Fund receives
a facility fee in the case of an assignment or participation interest depends on
negotiations between a Fund and the Lender selling the interests.
When
a Fund buys an assignment or a participation, it may be required to pay a fee,
or cede a portion of the interest and
fees that accrued prior to settlement of the assignment, to the lender selling
the assignment or the participant. Occasionally, the selling lender pays a fee
to the assignee or the participant. If a Fund assigns a loan or sells a
participation, it may be required to pass along to a buyer a portion of any
interest and fees that a Fund would otherwise be entitled to. In addition, in
the case of an assignment, a Fund may be required to pay a transfer fee to the
lending agent. If a Fund sells a participation Interest, a Fund may be required
to pay a transfer fee to the Lender that holds the nominal interest in the
loan.
Highly
Leveraged Transactions and Insolvent Borrowers. A Fund can invest
in loans made in connection with highly leveraged transactions. These
transactions may include operating loans, leveraged buyout loans, leveraged
capitalization loans and other types of acquisition financing. Those loans are
subject to greater credit risks than other loans. Highly leveraged loans and
loans in default also may be less liquid than other loans. If a Fund voluntarily
or involuntarily sold those types of loans, it might not receive the full value
it expected.
A
Fund can also invest in loans of borrowers that are experiencing, or are likely
to experience, financial difficulty. In
addition, a Fund can invest in loans of borrowers that have filed for bankruptcy
protection or that have had involuntary bankruptcy petitions filed against them
by creditors. Various laws enacted for the protection of debtors may apply to
loans. A bankruptcy proceeding against a borrower could delay or limit the
ability of a Fund to collect the principal and interest payments on that
borrower’s loans. If a lawsuit is brought by creditors of a borrower under a
loan, a court or a trustee in bankruptcy could take certain actions that would
be adverse to a Fund. For example:
•
Other creditors
might convince the court to set aside a loan or the collateralization of the
loan as a “fraudulent conveyance” or “preferential transfer.” In that event, the
court could recover from a Fund the interest and principal payments that the
borrower made before becoming insolvent. There can be no assurance that a Fund
would be able to prevent that recapture.
•
A bankruptcy court
may restructure the payment obligations under the loan so as to reduce the
amount to which a Fund would be entitled.
•
The court might
discharge the amount of the loan that exceeds the value of the collateral or
assets to which the lenders have recourse.
•
The court could
subordinate a Fund’s rights to the rights of other creditors of the borrower
under applicable law.
Borrower
Covenants and Lender Rights. Loan agreements
historically have had contractual terms
designed to protect Lenders,
which often include
restrictive covenants that limit the activities of the borrower. A restrictive
covenant is a promise by the borrower not to take certain actions that might
impair the rights of Lenders. Those covenants typically require the scheduled
payment of interest and principal and may include restrictions on dividend
payments and other distributions to the borrower’s shareholders, provisions
requiring the borrower to maintain specific financial ratios or relationships
and limits on the borrower’s total debt. In
8
addition,
a covenant may require the borrower to prepay the loan or debt obligation with
any excess cash flow, proceeds of
asset sales or casualty insurance, or other available cash. Excess cash flow
generally includes net cash flow after scheduled debt service payments and
permitted capital expenditures, among other things, as well as the proceeds from
asset dispositions or sales of securities. A breach of a covenant (after the
expiration of any cure period) in a loan agreement that is not waived by the
Agent and the Lenders normally is an event of default, permitting acceleration
of the loan. This means that the Agent has the right to demand immediate
repayment in full of the outstanding loan. If a loan is not paid when due, or if
upon acceleration of a loan, the borrower fails to repay principal and accrued
(but unpaid) interest in full, this failure may result in a reduction in value
of the loan (and possibly a Fund’s net asset value).
Lenders
historically have had certain voting and
consent rights under a loan agreement. Action subject to a Lender vote or
consent generally requires the vote or consent of the holders of some specified
percentage of the outstanding principal amount of a loan. Certain decisions,
such as reducing the amount or increasing the time for payment of interest on or
repayment of principal of a loan, or releasing collateral for the loan,
frequently requires the unanimous vote or consent of all Lenders
affected.
If
a Fund is not a direct lender under the loan because it has invested via a
participation, derivative or other indirect
means, a Fund may not be entitled to exercise some or all of the Lender rights
described in this section.
Over
time, the customary terms of loans have evolved such that they are no longer
accompanied by the various restrictive
covenants that historically accompanied most loans and that were in favor of the
investor. Newly originated loans (including reissuances and restructured loans)
in which a Fund may invest have varied terms and conditions, but generally
contain few or no financial maintenance covenants. Financial maintenance
covenants are those that require a borrower to maintain certain financial
metrics during the life of the loan, such as maintaining certain levels of cash
flow or limiting leverage. In the event of financial deterioration on the part
of the borrower, these covenants are included to permit the lenders to
renegotiate the terms of the loan, such as increasing the borrowing costs to the
borrower, or to take other actions which would improve the position of the
lender. Accordingly, the Fund may experience difficulty or delays in enforcing
its rights on its holdings of loans, which may result in losses to the Fund,
especially during a downturn in the credit cycle. Although loans may contain few
or no financial maintenance covenants, information necessary to monitor a
borrower’s financial performance may be available without covenants to lenders
and the public alike, and can be used to detect such early warning signs as
deterioration of a borrower’s financial condition or results. When such
information is available, the Adviser or Sub-Adviser will seek to take
appropriate action without the help of covenants in the loans.
Delayed
Draw Loans. There may be
obligations under a loan agreement to make disbursements of loans after the
initial disbursement in certain circumstances, for example if the loan was
partially “unfunded” at the time the Fund invested or if there otherwise is an
ongoing commitment from the lenders to disburse further loans. The Fund will not
purchase a loan that would require the Fund to make additional loans unless it
reasonably believes, at the time it enters into such loan agreement, that it
will have sufficient cash and cash equivalents to meet its obligations with
respect to all of its unfunded commitments, in each case as they come
due.
Delayed
Settlement. Compared to
securities and to certain other types of financial assets, purchases and sales
of loans, including via participation, take relatively longer to settle. This is
partly due to the nature of loans, which require a written assignment agreement
and various ancillary documents for each transfer, and frequently require
discretionary consents from both the borrower and the administrative agent. In
addition, dealers frequently insist on matching their purchases and sales, which
can lead to delays in a Fund’s settlement of a purchase or sale in circumstances
where the dealer’s corresponding transaction with another party is delayed.
Dealers will also sometimes sell loans short, and hold their trades open for an
indefinite period while waiting for a price movement or looking for inventory to
purchase.
This
extended settlement process can (i) increase the counterparty credit risk borne
by a Fund; (ii) leave a Fund unable to
timely vote, or otherwise act with respect to, loans it has agreed to purchase;
(iii) delay a Fund from realizing the proceeds of a sale of a loan; (iv) inhibit
a Fund’s ability to re-sell a loan that it has
9
agreed
to purchase if conditions change (leaving a Fund more exposed to price
fluctuations); (v) prevent a Fund from timely
collecting principal and interest payments; and (vi) expose a Fund to adverse
tax or regulatory consequences.
The
Loan Syndications and Trading Association (the “LSTA”) has promulgated a “delay
compensation” provision in its
standard loan documentation that mitigates the direct risk of permanently losing
interest payments as a result of delayed settlement by causing interest to begin
to accrue for the buyer’s account after the seventh business day following the
trade date (for distressed trades, the twentieth business day). However, this
does not mitigate the other risks of delayed settlement. In addition, the
mechanism itself can result in opportunistic behavior: A seller, having locked
in its trade, might delay closing for seven business days in order to maximize
its interest collections, even if it could have closed earlier, while a buyer
may no longer feel any pressure to close at all, since interest is accruing for
its benefit, and may choose to use its cash elsewhere. The LSTA has further
attempted to put an outer limit on long, unjustified settlement delays by
promulgating “buy-in/sell-out” provisions that allow a party to enter into a
“cover” trade if the other party refuses to close. However, these provisions are
complicated, time-consuming, and little-used, and are in any event not triggered
until the fifteenth business day after the trade date (for distressed trades,
the fiftieth business day). To the extent the extended loan settlement process
gives rise to short-term liquidity needs, such as the need to satisfy redemption
requests, a Fund may hold cash, sell investments or temporarily borrow from
banks or other lenders.
Equity
Investments
Each
Fund may invest in all of the following types of equity
investments:
Common
Stock.
Common stock is issued by a company principally to raise cash for business
purposes and represents an equity or ownership interest in the issuing company.
Common stockholders are typically entitled to vote on important matters of the
issuing company, including the selection of directors, and may receive dividends
on their holdings. A Fund participates in the success or failure of any company
in which it holds common stock. In the event a company is liquidated or declares
bankruptcy, the claims of bondholders, other debt holders, owners of preferred
stock and general creditors take precedence over the claims of those who own
common stock.
The
prices of common stocks change in response to many factors including the
historical and prospective earnings of the
issuing company, the value of its assets, general economic conditions, interest
rates, investor perceptions and market liquidity.
Invesco
Developing Markets Fund has no limit on the
amount of its respective net
assets that may be invested in small, unseasoned companies.
Over-the-Counter
Securities. Securities of
small- and mid-capitalization issuers may be traded on securities exchanges or
in the over-the-counter market. The over-the-counter markets, both in the U.S.
and abroad, may have less liquidity than securities exchanges. That lack of
liquidity can affect the price the Fund is able to obtain when it wants to sell
a security, because if there are fewer buyers and less demand for a particular
security, the Fund might not be able to sell it at an acceptable price or might
have to reduce the price in writing in order to dispose of the security. There
are a number of over-the-counter markets in the U.S., as well as those abroad,
as long as a dealer is willing to make a market in a particular
security.
Preferred
Stock. Preferred stock,
unlike common stock, often offers a specified dividend rate payable from a
company’s earnings. Preferred stock also generally has a preference over common
stock on the distribution of a company’s assets in the event the company is
liquidated or declares bankruptcy; however, the rights of preferred stockholders
on the distribution of a company’s assets in the event of a liquidation or
bankruptcy are generally subordinate to the rights of the company’s debt holders
and general creditors. If interest rates rise, the fixed dividend on preferred
stocks may be less attractive, causing the price of preferred stocks to
decline.
Some
fixed rate preferred stock may have mandatory sinking fund provisions which
provide for the stock to be retired or
redeemed on a predetermined schedule, as well as call/redemption provisions
prior to
10
maturity,
which can limit the benefit of any decline in interest rates that might
positively affect the price of preferred stocks.
Preferred stock dividends 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 may be “participating,” which means that it may be
entitled to a dividend exceeding the stated dividend in certain cases. In some
cases an issuer may offer auction rate preferred stock, which means that the
interest to be paid is set by auction and will often be reset at stated
intervals.
Small-
and Mid-Capitalization Companies.
Small-capitalization (small-cap) companies may be either established or newer
companies, including “unseasoned” companies that have typically been in
operation for less than three years. Mid-capitalization (mid-cap) companies are
generally companies that have completed their initial start-up cycle, and in
many cases have established markets and developed seasoned market teams.
While smaller companies might offer greater opportunities for gain than larger
companies, they also involve greater risk of loss. They may be more sensitive to
changes in a company’s earnings expectations and may experience more abrupt and
erratic price movements. Small- and mid-cap companies’ securities often trade in
lower volumes and in many instances, are traded over-the-counter or on a
regional securities exchange, where the frequency and volume of trading is
substantially less than is typical for securities of larger companies traded on
national securities exchanges. Therefore, the securities of smaller companies
may be subject to wider price fluctuations and it might be harder for the Fund
to dispose of its holdings at an acceptable price when it wants to sell them.
Small- and mid-cap companies may not have established markets for their products
or services and may have fewer customers and product lines. They may have more
limited access to financial resources and may not have the financial strength to
sustain them through business downturns or adverse market conditions. Since
small- and mid-cap companies typically reinvest a high proportion of their
earnings in their business, they may not pay dividends for some time,
particularly if they are newer companies. Small- and mid-cap companies may have
unseasoned management or less depth in management skill than larger, more
established companies. They may be more reliant on the efforts of particular
members of their management team and management changes may pose a greater risk
to the success of the business. Securities of small, unseasoned companies may be
particularly volatile, especially in the short-term, and may have very limited
liquidity in a declining market. It may take a substantial period of time to
realize a gain on an investment in a small- or mid-cap company, if any gain is
realized at all.
When
the Fund invests in smaller company securities that might trade infrequently,
investors might seek to trade Fund
shares based on their knowledge or understanding of the value of those
securities (this is sometimes referred to as “price arbitrage”). If such price
arbitrage were successful, it might interfere with the efficient management of
the Fund’s portfolio and the Fund may be required to sell securities at
disadvantageous times or prices to satisfy the liquidity requirements created by
that activity. Successful price arbitrage might also dilute the value of fund
shares held by other shareholders.
Equity-Linked
Securities. Equity-linked
securities are instruments whose value is based upon the value of one or more
underlying equity securities, a reference rate or an index. Equity-linked
securities come in many forms and may include features, among others, such as
the following: (i) may be issued by the issuer of the underlying equity security
or by a company other than the one to which the instrument is linked (usually an
investment bank), (ii) may convert into equity securities, such as common stock,
within a stated period from the issue date or may be redeemed for cash or some
combination of cash and the linked security at a value based upon the value of
the underlying equity security within a stated period from the issue date, (iii)
may have various conversion features prior to maturity at the option of the
holder or the issuer or both, (iv) may limit the appreciation value with caps or
collars of the value of the underlying equity security and (v) may have fixed,
variable or no interest payments during the life of the security which reflect
the actual or a structured return relative to the underlying dividends of the
linked equity security. Investments in equity-linked securities may subject a
Fund to additional risks not ordinarily associated with investments in other
equity securities. Because equity-linked securities are sometimes issued by a
third party other than the issuer of the linked security, a Fund is subject to
risks if the underlying equity security, reference rate or index underperforms
or if the issuer defaults on the payment of the dividend or the common stock at
maturity. In addition, the trading market for particular equity-linked
securities may be less liquid, making it difficult for a Fund to dispose of a
11
particular
security when necessary and reduced liquidity in the secondary market for any
such securities may make it more
difficult to obtain market quotations for valuing the Fund’s
portfolio.
Convertible
Securities. Convertible
securities are generally bonds, debentures, notes, preferred stocks or other
securities or investments that may be converted or exchanged (by the holder or
by the issuer) into shares of the underlying common stock (or cash or securities
of equivalent value) at a stated exchange ratio or predetermined price (the
conversion price). A convertible security is designed to provide current income
and also the potential for capital appreciation through the conversion feature,
which enables the holder to benefit from increases in the market price of the
underlying common stock. A convertible security may be called for redemption or
conversion by the issuer after a particular date and under certain circumstances
(including a specified price) established upon issue. If a convertible security
held by a Fund is called for redemption or conversion, the Fund could be
required to tender it for redemption, convert it into the underlying common
stock, or sell it to a third party, which may have an adverse effect on the
Fund’s ability to achieve its investment objectives. Convertible securities have
general characteristics similar to both debt and equity securities.
A
convertible security generally entitles the holder to receive interest paid or
accrued until the convertible security matures or
is redeemed, converted or exchanged. Before conversion, convertible securities
have characteristics similar to non-convertible debt obligations and are
designed to provide for a stable stream of income with generally higher yields
than common stocks. However, there can be no assurance of current income because
the issuers of the convertible securities may default on their obligations.
Convertible securities rank senior to common stock in a corporation’s capital
structure and, therefore, generally entail less risk than the corporation’s
common stock. Convertible securities are subordinate in rank to any senior debt
obligations of the issuer, and, therefore, an issuer’s convertible securities
entail more risk than its debt obligations. Moreover, convertible securities are
often rated below investment grade or not rated because they fall below debt
obligations and just above common stock in order of preference or priority on an
issuer’s balance sheet. To the extent that a Fund invests in convertible
securities with credit ratings below investment grade, such securities may have
a higher likelihood of default, although this may be somewhat offset by the
convertibility feature.
Convertible
securities generally offer lower interest or dividend yields than
non-convertible debt securities of similar credit
quality because of the potential for capital appreciation. The common stock
underlying convertible securities may be issued by a different entity than the
issuer of the convertible securities.
The
value of convertible securities is influenced by both the yield of
non-convertible securities of comparable issuers
and by the value of the underlying common stock. The value of a convertible
security viewed without regard to its conversion feature (i.e., strictly on the
basis of its yield) is sometimes referred to as its “investment value.” The
investment value of the convertible security typically will fluctuate based on
the credit quality of the issuer and will fluctuate inversely with changes in
prevailing interest rates. However, at the same time, the convertible security
will be influenced by its “conversion value,” which is the market value of the
underlying common stock that would be obtained if the convertible security were
converted. Conversion value fluctuates directly with the price of the underlying
common stock, and will therefore be subject to risks relating to the activities
of the issuer and general market and economic conditions. Depending upon the
relationship of the conversion price to the market value of the underlying
security, a convertible security may trade more like an equity security than a
debt instrument.
If,
because of a low price of the common stock, the conversion value is
substantially below the investment value of the
convertible security, the price of the convertible security is governed
principally by its investment value. Generally, if the conversion value of a
convertible security increases to a point that approximates or exceeds its
investment value, the value of the security will be principally influenced by
its conversion value. A convertible security will sell at a premium over its
conversion value to the extent investors place value on the right to acquire the
underlying common stock while holding an income-producing security.
While
a Fund uses the same criteria to rate a convertible debt security that it uses
to rate a more conventional debt
security, a convertible preferred stock is treated like a preferred stock for
the Fund’s financial reporting, credit rating and investment limitation
purposes.
12
Contingent
Convertible Securities (CoCos). CoCos (also
referred to as contingent capital securities) are a form of hybrid fixed income
security typically issued by non-U.S. banks that may either convert into common
stock of the issuer or undergo a principal write-down by a predetermined
percentage upon the occurrence of a “trigger” event, such as if (a) the issuer’s
capital ratio falls below a specified level or (b) certain regulatory events,
such as a change in regulatory capital requirements, affect the issuer’s
continued viability. Unlike traditional convertible securities, the conversion
is not voluntary and the equity conversion or principal write-down features are
tailored to the issuing banking institution and its regulatory
requirements. In certain
circumstances, CoCos may be automatically written down to zero, thereby
cancelling the securities, and investors (including a Fund) could lose the
entire value of their investment even as the issuer remains in business. If such
an event occurs, an investor may not have any rights to repayment of the
principal amount of the securities that has not become due. Additionally, an
investor may not be able to collect interest payments or dividends on such
securities.
CoCos
are subject to credit, interest rate and market risks associated with fixed
income and equity securities
generally, along with risks typically applicable to convertible securities.
CoCos are also subject to loss absorption risk because coupon payments can
potentially be cancelled or deferred at the issuer’s discretion or at the
request of the relevant regulatory authority in order to help the bank absorb
losses. Additionally, certain call provisions permit an issuer to repurchase
CoCos if the regulatory environment or tax treatment of the security (e.g., tax
deductibility of interest payments) changes. This may result in a potential loss
to the Fund if the price at which the issuer calls or repurchases the CoCos is
lower than the initial purchase price by the Fund.
CoCos
are subordinate in rank to traditional convertible securities and other debt
obligations of an issuer in the issuer’s
capital structure, and therefore, CoCos entail more risk than an issuer’s other
debt obligations.
CoCos
are generally speculative and their market value may fluctuate based on a number
of unpredictable
factors, including, but not limited to, the creditworthiness of the issuer
and/or fluctuations in the issuer’s capital ratios, supply and demand for CoCos,
general market conditions and available liquidity, and economic, financial and
political events affecting the particular issuer or markets in
general.
Enhanced
Convertible Securities. “Enhanced”
convertible securities are equity-linked hybrid securities that automatically
convert to equity securities on a specified date. Enhanced convertibles have
been designed with a variety of payoff structures, and are known by a variety of
different names. Three features common to enhanced convertible securities are
(i) conversion to equity securities at the maturity of the convertible (as
opposed to conversion at the option of the security holder in the case of
ordinary convertibles); (ii) capped or limited appreciation potential relative
to the underlying common stock; and (iii) dividend yields that are typically
higher than that on the underlying common stock. Thus, enhanced convertible
securities offer holders the opportunity to obtain higher current income than
would be available from a traditional equity security issued by the same company
in return for reduced participation in the appreciation potential of the
underlying common stock. Other forms of enhanced convertible securities may
involve arrangements with no interest or dividend payments made until maturity
of the security or an enhanced principal amount received at maturity based on
the yield and value of the underlying equity security during the security’s term
or at maturity.
Synthetic
Convertible Securities. A synthetic
convertible security is a derivative position composed of two or more distinct
securities whose investment characteristics, taken together, resemble those of
traditional convertible securities, i.e., fixed income and the right to acquire
the underlying equity security. For example, a Fund may purchase a
non-convertible debt security and a warrant or option, which enables a Fund to
have a convertible-like position with respect to a security or
index.
Synthetic
convertibles are typically offered by financial institutions in private
placement transactions and are typically sold
back to the offering institution. Upon conversion, the holder generally receives
from the offering institution an amount in cash equal to the difference between
the conversion price and the then-current value of the underlying security.
Synthetic convertible securities differ from true convertible securities in
several respects. The value of a synthetic convertible is the sum of the values
of its fixed-income component and its convertibility component. Thus, the values
of a synthetic convertible and a true convertible security will respond
differently to market fluctuations. Purchasing a synthetic convertible security
may provide
13
greater
flexibility than purchasing a traditional convertible security, including the
ability to combine components
representing distinct issuers, or to combine a fixed income security with a call
option on a stock index, when the Adviser determines that such a combination
would better further a Fund’s investment goals. In addition, the component parts
of a synthetic convertible security may be purchased simultaneously or
separately.
The
holder of a synthetic convertible faces the risk that the price of the stock or
the level of the market index underlying
the convertibility component will decline. In addition, in purchasing a
synthetic convertible security, a Fund may have counterparty risk with respect
to the financial institution or investment bank that offers the
instrument.
Alternative
Entity Securities. Alternative entity
securities are the securities of entities that are formed as limited
partnerships, limited liability companies, business trusts or other
non-corporate entities that are similar to common or preferred stock of
corporations.
Special
Purpose Acquisition Companies. Special purpose
acquisition companies (“SPACs”) are investment entities, acquired through
stocks, warrants and other securities, that pool funds to seek potential
acquisition or merger opportunities. A SPAC is a publicly traded company that
raises funds through an initial public offering (“IPO”) for the purpose of
acquiring or merging with another company to be identified subsequent to the
SPAC’s IPO. The securities of a SPAC are often issued in “units” that include
one share of common stock and one right or warrant (or partial right or warrant)
conveying the right to purchase additional common shares or partial shares of
the SPAC. In some cases, the rights and warrants may be separated from the
common stock at the election of the holder, after which they may become freely
tradeable. If a Fund purchases shares of a SPAC in an IPO it will generally bear
a sales commission, which may be significant.
Unless
and until a business combination transaction is completed, a SPAC generally
invests its assets (which are
constituted solely by the proceeds of the IPO), less a portion retained to cover
expenses, in U.S. government securities, money market funds and similar
investments whose returns or yields may be significantly lower than those of a
Fund’s other investments. If an acquisition or merger that meets the
requirements for the SPAC is not completed within a pre-established period of
time, the invested funds are returned to the SPAC’s shareholders, less certain
permitted expenses, and any rights or warrants issued by the SPAC will expire
worthless. Under any circumstances in which a Fund receives a refund of all or a
portion of its original investment in a SPAC, the returns on that investment may
be negligible, and a Fund may be subject to opportunity costs to the extent that
alternative investments would have produced higher returns. Further, a Fund may
be delayed in receiving any redemption or liquidation proceeds from a SPAC to
which it is entitled.
Because
SPACs are in essence “blank check” companies without operating histories or
ongoing business operations (other
than identifying and pursuing acquisition or merger opportunities), the
potential for the long term capital appreciation of their securities is
dependent on the ability of the SPAC’s sponsor to identify and complete a
profitable business combination. There is no guarantee that the SPACs in which a
Fund invests will complete a business combination or that any transaction
completed by the SPACs in which a Fund invests will be profitable. Even if a
SPAC in which a Fund has invested identifies a desirable acquisition or merger
target and reaches agreement with that company as to the terms of the business
combination, there can be no guarantee that the transaction will ultimately be
consummated because, among other conditions that must be satisfied, a requisite
number of shareholders of the SPAC or of the target company do not vote in favor
of the transaction. The values of investments in SPACs may be highly volatile
and may depreciate significantly over time. Some SPACs may pursue acquisitions
or mergers only within certain industries or regions, which may ultimately lead
to an increase in the volatility of their prices following completion of a
business combination. In addition, some of these securities may be considered
illiquid and/or subject to restrictions on resale, leaving a Fund unable to sell
its interest in a SPAC or able to sell its interest only at a price below what
that Fund believes is the SPAC interest’s intrinsic value. Additionally, an
investment in a SPAC may be diluted by additional later offerings of interests
in the SPAC or by other investors exercising their warrants to purchase shares
of the SPAC.
14
Due
to the risk of the loss of sponsors’ and other initial investors’ capital if an
acquisition or merger is not consummated,
sponsors of SPACs may be incentivized to consummate business combinations at
less attractive valuations at the expense of SPAC shareholders. In addition, as
the number of SPACs grows, there is greater competition among SPACs and
traditional purchasers of companies, which further increases the likelihood that
SPAC sponsors may be incentivized to consummate acquisitions or mergers at less
attractive valuations, as well as the risk that SPACs cannot successfully
complete business combinations. In addition,
recent regulations promulgated by the SEC impose additional disclosure
obligations and other requirements on SPACs and may impact the ability of a SPAC
to conduct its operations.
Equity-Linked
Notes (ELNs). ELNs are hybrid
derivative-type instruments, in a single note form, that are specially designed
to combine the characteristics of one or more reference securities (such as a
single stock, exchange-traded fund, exchange-traded note, or an index or basket
of securities (underlying securities)) and a related equity derivative, such as
a put or call option. Generally, when purchasing an ELN, a Fund pays the
counterparty the current value of the underlying securities plus a commission.
Upon the maturity of the note, the Fund generally receives the par value of the
note plus a return based on the appreciation of the underlying securities. A
Fund may or may not hold an ELN until its maturity. If the underlying securities
have depreciated in value or if their price fluctuates outside of a preset
range, depending on the type of ELN, the Fund may receive only the principal
amount of the note, or may lose the entire principal invested in the ELN. ELNs
are available with an assortment of features, including periodic coupon
payments; limitations on participation in the appreciation of the underlying
securities; and different protection levels on the Fund’s principal investment.
A Fund will only invest in ELNs for which the underlying security is a
permissible investment for the Fund in accordance with its investment policies
and restrictions. ELNs are generally in two types: (1) those that provide for
protection of a Fund’s principal in exchange for limited participation in the
appreciation of the underlying securities, and (2) those that do not provide for
such protection and subject a Fund to the risk of loss of its principal
investment.
Investments
in ELNs possess the risks associated with the underlying securities, such as
management risk, market risk
and, as applicable, foreign securities and currency risks. In addition, as a
note, ELNs are also subject to certain debt securities risks, such as interest
rate and credit risk. An investment in an ELN also bears the risk that the ELN
issuer will default or become bankrupt. In such an event, the Fund may have
difficulty being repaid, or fail to be repaid, the principal amount of, or
income from, its investment. ELNs may be structured to be subordinated or
unsubordinated to other classes of debt holders' right of payment. A downgrade
or impairment to the credit rating of the issuer may also negatively impact the
price of the ELN. The Fund may also experience liquidity issues when investing
in ELNs, as ELN transactions generally take place in the over-the-counter
institutional investment market as well as in privately negotiated transactions
with ELN issuers. The secondary market for ELNs may be limited, and the lack of
liquidity may make ELNs difficult to sell at a desirable time and price and
value. ELNs may be subject
to resale restrictions such as those contained in Rule 144A promulgated under
the Securities Act of 1933, as amended (the 1933 Act). The price of an
ELN may not correlate with the price of the underlying securities or a
fixed-income investment. As the holder of an ELN, the Fund generally has no
rights to the underlying securities, including no voting rights or rights to
receive dividends. The Adviser’s ability to accurately forecast movements in the
underlying securities will determine the success of the Fund’s ELNs investments.
Should the prices of the underlying securities move in an unexpected manner, the
Fund may not achieve the anticipated benefits of its ELN investments, and it may
realize losses, which could be significant and could include the Fund’s entire
principal investment.
Foreign
Investments
Foreign
Securities. Each Fund may
invest in foreign securities. Invesco Balanced-Risk Allocation Fund, Invesco
Developing Markets Fund, Invesco Greater
China
Fund, Invesco Macro Allocation Strategy Fund, and Invesco Multi-Asset Income
Fund may invest up to 100% of their net assets in foreign securities. Invesco
Health Care Fund may invest substantially all of its assets in foreign
securities. Foreign securities are equity or debt securities issued by issuers
outside the United States, and include securities in the form of American
Depositary Receipts (ADRs), European Depositary Receipts (EDRs), Global
Depositary Receipts (GDRs) or
15
other
securities representing underlying securities of foreign issuers (foreign
securities). ADRs are receipts, issued by U.S.
banks, for the shares of foreign corporations, held by the bank issuing the
receipt. ADRs are typically issued in registered form, denominated in U.S.
dollars and designed for use in the U.S. securities markets. GDRs are bank
certificates issued in more than one country for shares in a foreign company.
The shares are held by a foreign branch of an international bank. GDRs trade as
domestic shares but are offered for sale globally through the various bank
branches. GDRs are typically used by private markets to raise capital and are
denominated in either U.S. dollars or foreign currencies. EDRs are similar to
ADRs and GDRs, except they are typically issued by European banks or trust
companies, denominated in foreign currencies and designed for use outside the
U.S. securities markets. ADRs, EDRs and GDRs entitle the holder to all dividends
and capital gains on the underlying foreign securities, less any fees paid to
the bank. Purchasing ADRs, EDRs or GDRs gives a Fund the ability to purchase the
functional equivalent of foreign securities without going to the foreign
securities markets to do so. ADRs, EDRs or GDRs that are “sponsored” are those
where the foreign corporation whose shares are represented by the ADR, EDR or
GDR is actively involved in the issuance of the ADR, EDR or GDR and generally
provides material information about the corporation to the U.S. market. An
“unsponsored” ADR, EDR or GDR program is one where the foreign corporation whose
shares are held by the bank is not obligated to disclose material information in
the United States, and, therefore, the market value of the ADR, EDR or GDR may
not reflect important facts known only to the foreign company.
Foreign
debt securities include corporate debt securities of foreign issuers, certain
foreign bank obligations (see
“Bank Instruments”) and U.S. dollar or foreign currency denominated obligations
of foreign governments or their subdivisions, agencies and instrumentalities
(see “Foreign Government Obligations”), international agencies and supranational
entities.
The
Funds consider various factors when determining whether a company is in a
particular country or in a particular
region/continent, including whether (1) it is organized under the laws of a
country or in a country in a particular region/continent; (2) it has a principal
office in a country or in a country in a particular region/continent; (3) it
derives 50% or more of its total revenues from businesses in a country or in a
country in a particular region/continent; (4) its securities are traded
principally on a security exchange, or in an over-the-counter (OTC) market, in a
particular country or in a country in a particular region/continent; and/or (5)
its “country of risk" as determined by a third party service provider such as
Bloomberg. The issuer's “country of risk” is determined based on a number of
criteria, including its country of domicile, the primary stock exchange on which
it trades, the location from which the majority of its revenue comes, and its
reporting currency.
Investments
by a Fund in foreign securities, including ADRs, EDRs and GDRs, whether
denominated in U.S. dollars or
foreign currencies, may entail all of the risks set forth below in addition to
those accompanying an investment in issuers in the United States.
Currency
Risk.
The value in U.S. dollars of a Fund’s non-dollar-denominated foreign investments
will be affected by changes in currency exchange rates. The U.S. dollar value of
a foreign security decreases when the value of the U.S. dollar rises against the
foreign currency in which the security is denominated and increases when the
value of the U.S. dollar falls against such currency.
Political
and Economic Risk. The economies of
many countries may not be as developed as that of the United States’ economy and
may be subject to significantly different forces. Political, economic or social
instability and development, expropriation or confiscatory taxation, and
limitations on the removal of funds or other assets could also adversely affect
the value of portfolio investments. Certain foreign companies may be subject to
sanctions, embargoes, or other governmental actions that may impair or otherwise
limit the ability to invest in, receive, hold or sell the securities of such
companies. These factors may affect the value of investments in those companies.
Certain
companies may
operate in, or have dealings with, countries that the U.S. government has
identified as state sponsors of terrorism. As a result, such companies may be
subject to specific constraints or regulations under U.S. law and, additionally,
may be subject to negative investor perception, either of which could adversely
affect such companies' performance. Further, war and
military conflict between countries or in a region, for example the current
conflicts in the Ukraine and Middle East, may have an impact on the value of
portfolio investments.
16
Regulatory
Risk.
Foreign companies may not be registered with the SEC and are generally not
subject to the regulatory controls and disclosure requirements imposed on U.S.
issuers and, as a consequence, there is generally less publicly available
information about foreign securities than is available about domestic
securities. Foreign companies may not be subject to uniform accounting, auditing
and financial reporting standards, corporate governance practices and
requirements comparable to those applicable to domestic companies. Therefore,
financial information about foreign companies may be incomplete, or may not be
comparable to the information available on U.S. companies. Income from foreign
securities owned by the Funds may be reduced by a withholding tax at the source,
which tax would reduce dividend income payable to Fund shareholders.
There
is generally less government supervision and regulation of securities exchanges,
brokers, dealers, and listed
companies in foreign countries than in the U.S., thus increasing the risk of
delayed settlements of portfolio transactions or loss of certificates for
portfolio securities. Foreign markets may also have different clearance and
settlement procedures. If a Fund experiences settlement problems, it may result
in temporary periods when a portion of that Fund’s assets are uninvested and
could cause it to miss attractive investment opportunities or create a potential
liability to that Fund arising out of its inability to fulfill a contract to
sell such securities.
Market
Risk.
Investing in foreign markets generally involves certain risks not typically
associated with investing in the United States. The securities markets in many
foreign countries will have substantially lower trading volume than the U.S.
markets. As a result, the securities of some foreign companies may be less
liquid and experience more price volatility than comparable domestic securities.
Obtaining and/or enforcing judgments in foreign countries may be more difficult,
and there is generally less government regulation and supervision of foreign
stock exchanges, brokers and issuers, each of which may make it more difficult
to enforce contractual obligations. Increased custodian costs as well as
administrative costs (such as the need to use foreign custodians) may also be
associated with the maintenance of assets in foreign jurisdictions. In addition,
transaction costs in foreign securities markets are likely to be higher, since
brokerage commission rates in foreign countries are likely to be higher than in
the United States.
Invesco
Developing Markets Fund
and
Invesco Discovery
Mid Cap Growth Fund will hold foreign currency only in connection with the
purchase or sale of foreign securities.
Risks
of Developing/Emerging Market Countries. The Funds may
invest in securities of companies located in developing and emerging market
countries, subject to any
limits included in the Fund's prospectus. Each of Invesco
Developing
Markets Fund and Invesco
Greater
China
Fund may invest up to 100% of its net assets in securities of companies located
in developing and emerging market countries. Invesco Global Infrastructure Fund
may invest up to 25% of its respective net assets in securities of companies
located in developing and emerging market countries. Unless a Fund’s prospectus
includes a different definition, the Fund considers developing and emerging
market countries to be those countries that are (i) generally recognized to be
an emerging market country by the international financial community, including
the World Bank, (ii) determined by the Adviser to be an emerging market country
or (iii) its “country of risk” is an emerging market country as determined by a
third party service provider such as Bloomberg. As of the date of this SAI, the
Adviser considers “emerging market countries” to generally include every country
in the world except those countries included in the MSCI World Index. The
Adviser has broad discretion to identify countries that it considers to be
emerging market countries and may consider various factors in determining
whether to classify a country as an emerging market country, including a
country’s relative interest rates, inflation rates, exchange rates, monetary and
fiscal policies, trade and current account balances, legal and political
developments and any other specific factors the Adviser believes to be relevant.
Because emerging market equity and emerging market debt are distinct asset
classes, a country may be deemed an emerging market country with respect to its
equity only, its debt only, both its equity and debt, or neither.
Investments
in developing and emerging market countries present risks in addition to, or
greater than, those presented by
investments in foreign issuers generally, and may include the following
risks:
i. Restriction, to
varying degrees, on foreign investment in stocks;
17
ii. Repatriation of
investment income, capital, and the proceeds of sales in foreign countries may
require foreign governmental registration and/or approval;
iii. Greater risk
of fluctuation in the value of foreign investments due to changes in currency
exchange rates, currency control regulations or currency devaluation. In
addition, there may be higher rates of inflation and more rapid and extreme
fluctuations in inflation rates and greater sensitivity to interest rate
changes;
iv. Inflation and
rapid fluctuations in inflation rates may have negative effects on the economies
and securities markets of certain developing and emerging market
countries;
v. Many of the
developing and emerging market countries’ securities markets are relatively
small or less diverse, have low trading volumes, suffer periods of relative
illiquidity, and are characterized by significant price volatility;
vi. There is a risk
in developing and emerging market countries that a future economic or political
crisis could lead to price controls, forced mergers of companies, expropriation
or confiscatory taxation, seizure, nationalization, or creation of government
monopolies;
vii. Investments in
such securities markets may be subject to unexpected market
closures;
viii. The taxation
systems at the federal, regional and local levels in developing or emerging
market countries may be less transparent and inconsistently enforced, and
subject to sudden change. Developing or emerging market countries may also have
a higher degree of corruption and fraud than developed market countries, as well
as counterparties and financial institutions with less financial sophistication,
creditworthiness and/or resources;
ix. Less developed
legal systems allowing for enforcement of private property rights and/or redress
for injuries to private property, such as bankruptcy. The ability to bring and
enforce actions in developing or emerging market countries, or to obtain
information needed to pursue or enforce such actions, may be limited and
shareholder claims may be difficult or impossible to pursue; and
x. Less stringent
regulatory, disclosure, financial reporting, accounting, auditing and
recordkeeping standards than companies in more developed countries and, as a
result, the nature and quality of such information may vary. Information about
such companies may be less available and reliable and, therefore, the ability to
conduct adequate due diligence in developing or emerging markets may be limited
which can impede the Fund's ability to evaluate such companies. In addition,
certain developing or emerging market countries may impose material limitations
on Public Company Accounting Oversight Board (“PCAOB”) inspection, investigation
and enforcement capabilities which can hinder the PCAOB’s ability to engage in
independent oversight or inspection of accounting firms located in or operating
in certain developing or emerging markets. There is no guarantee that the
quality of financial reporting or the audits conducted by audit firms of
developing or emerging market issuers meet PCAOB standards.
Frontier
Markets. The risks
associated with investments in frontier market countries include all the risks
associated with investments in developing and emerging markets. These risks are
magnified for frontier market countries because frontier markets countries
generally have smaller economies, even less developed capital markets, and are
traditionally less accessible than traditional emerging and developing markets.
As a result, investments in companies in frontier markets countries are
generally subject to a higher risk of loss than investments in companies in
traditional emerging and developing market countries due to less developed
securities markets, different settlement procedures, greater price volatility,
less developed governments and economies, more government restrictions, and the
limited ability of foreign entities to participate in certain privatization
programs. Investments in companies operating in frontier market countries are
highly speculative in nature.
Investment
in the Private Fund. The Invesco
Developing Markets Fund may invest up to 10% of its net assets in a private
investment vehicle organized under Delaware law (the “Private Fund”). The
Private Fund seeks long term capital appreciation by investing primarily in
companies established or operating in the People’s Republic of China. It is
expected that the Private Fund will invest a significant portion of its assets
in
18
class
A-shares of Chinese companies (“China A Shares”) and other securities available
to investors holding a Qualified Foreign
Institutional Investor (“QFII”) license in order to be classified and regulated
as an “open-end Private Fund” for purposes of Chinese regulations. The Private
Fund may also invest in shares or other financial instruments listed, quoted or
traded on any China or Hong Kong stock exchange which have a significant
proportion of their ownership, assets or other interests in China, or other
investments. Such other financial instruments may include, without limitation,
class B-shares of Chinese companies listed in China and shares of Hong
Kong-listed companies with a Chinese parent. In addition, although it is not
currently expected to do so, the Private Fund may invest a portion of its assets
in certain exchanged-traded and over-the-counter financial instruments from
countries other than China.
Because
the Invesco Developing Markets Fund may invest a portion of its assets in the
Private Fund, which may hold
certain of the investments described in the Fund’s prospectus and this SAI, the
Fund may be considered to be investing indirectly in those investments through
the Private Fund. Therefore, references in each Fund’s prospectus and in this
SAI to investments by the Fund also may be deemed to include the Fund’s indirect
investments through the Private Fund.
The
Private Fund is not registered under the 1940 Act and is not subject to its
investor protections, except as noted in each
Fund’s prospectus or this SAI. The Fund, as a shareholder of the Private Fund,
does not have all of the protections offered by the 1940 Act. However, the
Private Fund is controlled by Invesco Developing Markets Fund and managed by its
managing member (the “Managing Member”), OppenheimerFunds, Inc. Therefore,
Invesco Developing Markets Fund’s ownership of the Private Fund make it unlikely
that the Private Fund would take action contrary to the interests of the Fund or
its shareholders.
The
Fund’s Board has oversight responsibility for the investment activities of the
Fund, including its expected investment
in the Private Fund, and the Fund’s role as a shareholder of the Private Fund.
The Fund applies its investment restrictions and compliance policies and
procedures on a look-through basis to the Private Fund, including, without
limitation, those restrictions, policies and procedures relating to portfolio
leverage, liquidity, brokerage, and the timing and method of the valuation of
the Private Fund’s portfolio investments and interests in the Private
Fund.
Investing
in securities of Chinese companies involves certain risks and considerations not
typically associated with
investing in securities of U.S. issuers. The heavy concentration of market
capitalization and trading volume in a small number of Chinese companies
representing a limited number of industries may result in fewer investment
opportunities. The small size of the market for Chinese securities and a low
volume of trading for certain issues could also result in a lack of liquidity
and in price volatility. Investments in Chinese securities are subject to
currency devaluations and other currency exchange rate fluctuations, and there
may be an insufficient market to engage in hedging transactions to minimize
renminbi foreign exchange risk. The nature and extent of intervention by the
Chinese government in the Chinese securities markets may have an adverse impact
on investments in Chinese securities. Further, limitations on the use of
brokers, higher rates of inflation, greater political, economic and social
uncertainty, governmental restrictions on potential investment opportunities,
custody requirements, and investment and repatriation restrictions may pose
risks to investments in Chinese securities. In addition, accounting, auditing
and financial reporting standards in China are different from U.S. standards
and, therefore, disclosure of certain material information may not be made. Less
information may be available to the Fund and other investors than would be the
case if the Fund’s investments were restricted to securities of U.S. issuers.
There is also generally less governmental regulation of the securities industry
in China, and less enforcement of regulatory provisions relating thereto, than
in the United States. Moreover, it may be more difficult to obtain a judgment in
a court outside the United States. Investments in Chinese securities may be
subject to withholding taxes, as well as currency repatriation restrictions
imposed by the government of China from time to time. The Chinese system of
taxation is not as well settled as that of non-emerging market countries and
changes in the Chinese tax system may have retroactive effects. See “Investing in
Greater China Risk,” herein.
Further,
the Private Fund may invest substantially all of its assets in a limited number
of issuers or a single issuer. To
the extent that it does so, the value of its investments may be affected to a
greater extent by adverse conditions affecting such
issuers.
19
Investing
in Greater China Risk. Investments in
companies located or operating in Greater China involve risks not associated
with investments in Western nations, such as nationalization, expropriation, or
confiscation of property; lack of willingness
or ability of the Chinese government to support the economies and markets of the
Greater China region; difficulty in
obtaining and/or enforcing judgments; lack of publicly
available information; alteration or
discontinuation of economic reforms; military conflicts and the risk of
war,
either internal or with other countries; public health
emergencies resulting in market closures, travel restrictions, quarantines or
other interventions; inflation,
currency fluctuations and fluctuations in inflation and interest rates that may
have negative effects on the economy and securities markets of Greater China;
and Greater China’s dependency on the economies of other Asian countries, many
of which are developing countries. Events in any one country within Greater
China may impact the other countries in the region or Greater China as a whole.
For example, changes to their political and economic relationships with the
mainland China could adversely impact the Fund’s investments in Taiwan and Hong
Kong.
Certain
securities issued by companies located or operating in Greater China, such as
China A-shares, are subject to
trading restrictions, quota limitations, and clearing and settlement risks.
Significant portions of the Chinese securities markets may become rapidly
illiquid, as Chinese issuers have the ability to suspend the trading of their
equity securities, and have shown a willingness to exercise that option in
response to market volatility and other events. The liquidity of Chinese
securities may shrink or disappear suddenly and without warning as a result of
adverse economic, market or political events, or adverse investor perceptions,
whether or not accurate.
Export
growth continues to be a major driver of China’s rapid economic growth. As a
result, a reduction in spending on Chinese
products and services, the institution of tariffs,
sanctions, capital
controls, embargoes, trade wars, or other trade
barriers, or a downturn in any of the economies of China’s key trading partners
may have an adverse impact on the Chinese economy. The current political climate
has intensified concerns about a potential trade war between China and the
United States, as each country has recently imposed tariffs on the other
country’s products. These actions may trigger a significant reduction in
international trade, the oversupply of certain manufactured goods, substantial
price reductions of goods and possible failure of individual companies and/or
large segments of China’s export industry, which could have a negative impact on
the Fund’s performance. Events such as these and their consequences are
difficult to predict and it is unclear whether further tariffs may be imposed or
other escalating actions may be taken in the future. In addition,
actions by the U.S. government, such as delisting of certain Chinese companies
from U.S. securities exchanges or otherwise restricting their operations in the
U.S., may negatively impact the value of such securities held by the Fund.
Further, from time to time, certain companies in which the Fund invests may
operate in, or have dealings with, countries subject to sanctions or embargoes
imposed by the U.S. government and the United Nations and/or in countries the
U.S. government identified as state sponsors of terrorism. One or more of these
companies may be subject to constraints under U.S. law or regulations that could
negatively affect the company’s performance.
Additionally,
developing countries, such as those in Greater China, may subject the Fund’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 Fund, directly or indirectly, including by reducing the
after-tax profits of companies in China in which the Fund invests. Chinese taxes
that may apply to the Fund’s investments include income tax or withholding tax
on dividends, interest or gains earned by the Fund, business tax and stamp duty.
Uncertainties in Chinese tax rules could result in unexpected tax liabilities
for the Fund. Additionally, any difficulties of the PCAOB to inspect audit work
papers and practices of PCAOB-registered accounting firms in China with respect
to their audit work of U.S. reporting companies may impose significant
additional risks associated with investments in China.
Risks
of Investing in Chinese Variable Interest Entities. Many Chinese
companies have created a special structure, which is based in China, known as a
variable interest entity (“VIE”) as a means to circumvent limits on direct
foreign ownership of equity in Chinese operating companies in certain sectors,
such as internet, media, education and telecommunications, imposed by the
Chinese government. Typically in such an
20
arrangement,
a China-based operating company establishes an offshore “holding” company in
another jurisdiction that
likely does not have the same disclosure, reporting, and governance requirements
as the United States. The holding company issues shares, i.e., is “listed”, on a
foreign exchange such as the New York Stock Exchange or the Hong Kong Stock
Exchange. The listed holding company enters into service and other contracts
with the China-based operating company, typically through the China-based VIE.
The VIE must be owned by Chinese nationals (and/or other Chinese companies),
which often are the VIE’s founders, in order to obtain the licenses and/or
assets required to operate in the restricted or prohibited sector in China. The
operations and financial position of the VIE are included in consolidated
financial statements of the listed holding company. Foreign investors, including
mutual funds and ETFs (such as the Fund), hold stock in the listed holding
company rather than directly in the China-based operating company.
The
VIE structure allows foreign shareholders to exert a degree of control and
obtain economic benefits arising from the
operating company but without formal legal ownership because the listed holding
company’s control over the operating company is predicated entirely on contracts
with the VIE. The listed holding company is distinct from the underlying
operating company, and an investment in the listed holding company represents
exposure to a company that maintains service contracts with the operating
company, not equity ownership.
Investments
in companies that use VIEs may pose additional risks because the investment is
made through the listed
holding company’s service and other contractual arrangements with the underlying
Chinese operating company. As a result, such investment may limit the rights of
an investor with respect to the underlying Chinese operating company. The
contractual arrangements between the VIE and the operating company may not be as
effective in providing operational control as direct equity ownership. The
Chinese government could determine at any time and without notice that the
underlying contractual arrangements on which control of the VIE is based violate
Chinese law. While VIEs are a longstanding industry practice, well known to
Chinese officials and regulators, VIEs historically have not been formally
recognized under Chinese law. The owners of the VIE could decide to breach the
contractual arrangements with the listed holding company and it is uncertain
whether the contractual arrangements, which may be subject to conflicts of
interest between the legal owners of the VIE and foreign investors, would be
enforced by Chinese courts or arbitration bodies. Prohibitions of these
structures by the Chinese government, or the inability to enforce such
contracts, from which the shell company derives its value, would likely cause
the VIE-structured holding(s) to suffer significant, detrimental, and possibly
permanent loss, and in turn, adversely affect the Fund’s returns and net asset
value.
The
Chinese government previously placed restrictions on China-based companies
raising capital offshore in certain
sectors, including through VIEs, and investors face uncertainty about future
actions by the Chinese government that could significantly affect the operating
company’s financial performance and the enforceability of the contractual
arrangements underlying the VIE structure. It is uncertain whether Chinese
officials or regulators will withdraw their acceptance of the VIE structure,
generally, or with respect to
certain industries, or whether any new
laws, rules or regulations relating to VIE structures will be adopted and what
impact such laws may have on foreign investors. There is a risk that China might
prohibit the existence of VIEs or sever their ability to transmit economic and
governance rights to foreign individuals and entities; if so, the market value
of any associated portfolio holdings would likely suffer substantial,
detrimental, and possibly permanent loss.
Chinese
companies, including those listed on U.S. exchanges, are generally not subject
to the same degree of
regulatory requirements, accounting standards or auditor oversight as companies
in more developed countries. As a result, information about VIEs may be less
reliable or complete. Foreign companies with securities listed on U.S.
exchanges, including those that utilize VIEs, may be delisted if they do not
meet the requirements of the listing exchange, the Public Company Accounting
Oversight Board (“PCAOB”) and the U.S. government, which could significantly
decrease the liquidity and value of such securities. Actions by the U.S.
government, such as delisting of certain Chinese companies from U.S. securities
exchanges or otherwise restricting their operations in the U.S., may negatively
impact the liquidity and value of such securities.
21
Risks
of Investments in China A-shares through the Stock Connect Program. The Shanghai-Hong
Kong Stock Connect program and the Shenzhen-Hong Kong Stock Connect program
(both programs collectively referred to as the Stock Connect Program)
are securities trading and clearing programs through which the Funds can trade
eligible listed China A-shares. The Stock Connect Program is
subject to quota limitations, which may restrict or preclude a
fund's
ability to invest in Stock Connect
securities.
Foreign
investors,
individually and in
the aggregate,
are
subject to ownership
limitations from
Shanghai or Shenzhen listed companies,
including those
purchased through the Stock Connect
Program.
Once
the daily quota is reached, orders to purchase
additional China A-shares
through the Stock
Connect Program will be rejected. Only certain
China A-shares are eligible to be accessed through the Stock Connect Program.
Such securities may lose their eligibility at any time, in which case they could
be sold but could no longer be purchased through the Stock Connect Program.
Because the Stock Connect Program is
still relatively in its early stages, the actual effect on the market for
trading China A-shares with the introduction of large numbers of foreign
investors is currently unknown. The Stock Connect Program is
subject to regulations promulgated by regulatory authorities for the Shanghai
Stock Exchange, the Stock Exchange of Hong Kong Limited, and the Shenzhen Stock
Exchange, and further regulations or restrictions, such as limitations on
redemptions or suspension of trading, may adversely impact the Stock Connect Program, if
the authorities believe it necessary to assure orderly markets or for other
reasons. There is no guarantee that all three exchanges will continue to support
the Stock Connect Program in
the future and no assurance that further regulations will not adversely affect
the availability of securities under Stock Connect or other operational
arrangements.
Investments
in China A-shares may not be covered by the securities investor protection
programs of the exchanges and,
without the protection of such programs, will be subject to the risk of default
by the broker. In the event that the depository of the Shanghai Stock Exchange
and the Shenzhen Stock Exchange defaulted, a Fund may not be able to recover
fully its losses from the depository or may be delayed in receiving proceeds as
part of any recovery process. In addition, because all trades on the
Stock
Connect Program in
respect of eligible China A-shares must be settled in Renminbi (RMB), the
Chinese currency, the Funds investing through the Stock Connect Program
must have timely access to a reliable supply of offshore RMB, which cannot be
guaranteed. The existence of a liquid trading market for China A-shares may
depend on whether there is supply of, and demand for, such China A-shares.
Market volatility and settlement difficulties in the China A-shares markets may
also result in significant fluctuations in the prices of the securities traded
on such markets.
China
A-shares purchased through the Stock Connect Program are
held in nominee name and not the Fund’s name as the beneficial owner. It is
possible, therefore, that a Fund’s ability to exercise its rights as a
shareholder and to pursue claims against the issuer of China A-shares may be
limited because the nominee structure has not been tested in Chinese courts, as
Chinese courts generally have limited experience in applying the concept of
beneficial ownership and the law in that area continues to evolve. In addition,
a Fund may not be able to participate in corporate actions affecting China
A-shares held through the Stock Connect Program due
to time constraints or for other operational reasons.
Trades
on the Stock Connect Program are
subject to certain requirements prior to trading. If these requirements are not
completed prior to the market opening, a Fund cannot sell the shares on that
trading day. In addition, these requirements may limit the number of brokers
that a Fund may use to execute trades. Additionally, there are foreign
ownership limitations that may result in limitations on investment
or the
return of profits if a fund purchases and sells shares of an issuer in which it
owns above a certain threshold determined by China's securities
rules.
As a
result, a Fund may not be
able to execute
trading freely in
accordance with its investment strategy and the profits that the Fund derives
from such
investments
may be
limited.
Risks
of Investments in the China Interbank Bond Market through the Bond Connect
Program.
Certain Funds may
invest in China onshore bonds traded on the China Interbank Bond Market (“CIBM”)
through the China – Hong Kong Bond Connect Program (“Bond Connect”). In China,
the Hong Kong Monetary Authority Central Moneymarkets Unit holds Bond Connect
securities on behalf of ultimate investors (such as the Funds) in accounts
maintained with a China-based custodian (either the China Central Depository
& Clearing Co. or the Shanghai Clearing House). This recordkeeping system
subjects a Fund to various risks, including the risks of settlement delays and
counterparty default of the China custodian and
22
Hong
Kong custody agent. In addition, the Fund may have a limited ability to enforce
rights as a bondholder because enforcing
the ownership rights of a beneficial holder of Bond Connect securities is
untested and courts in China have limited experience in applying the concept of
beneficial ownership.
Bond
Connect uses the trading infrastructure of both Hong Kong and China and is not
available on trading holidays in
Hong Kong. As a result, prices of securities purchased through Bond Connect may
fluctuate at times when the Fund is unable to add to or exit its position.
Securities offered through Bond Connect may lose their eligibility for trading
through Bond Connect at any time. If Bond Connect securities lose their
eligibility for trading through Bond Connect, they may be sold but can no longer
be purchased through Bond Connect.
Because
Bond Connect trades are settled in RMB, the Funds investing through Bond Connect
must have timely access to a
reliable supply of offshore RMB, which cannot be guaranteed.
Market
volatility and potential lack of liquidity due to low trading volume of certain
bonds on the CIBM may result in prices of
such bonds fluctuating significantly, exposing a Fund to liquidity and
volatility risks. The bid-ask spreads of the prices of such securities may be
large, and a Fund may therefore incur significant costs and may suffer losses
when selling such investments. Bonds traded on the CIBM may be difficult or
impossible to sell, which may impact a Fund’s ability to acquire or dispose of
such securities at their expected prices.
Bond
Connect is relatively new and its effects on the Chinese interbank bond market
are uncertain. Trading through
Bond Connect is performed through newly developed trading platforms and
operational systems, and in the event of systems malfunctions or extreme market
conditions, trading via Bond Connect could be disrupted. There can be no
assurance as to Bond Connect’s continued existence or whether future
developments regarding Bond Connect (including further interpretation and
guidance provided by regulators in Hong Kong and China) may restrict or
adversely affect the Fund’s investments or returns. Finally, uncertainties in
China tax rules governing taxation of income and gains from investments via Bond
Connect could result in unexpected tax liabilities for a
Fund.
Foreign
Government Obligations. Debt securities
issued by foreign governments are often, but not always, supported by the full
faith and credit of the foreign governments, or their subdivisions, agencies or
instrumentalities, that issue them. These securities involve the risks discussed
above under “Foreign Securities”. Additionally, the issuer of the debt or the
governmental authorities that control repayment of the debt may be unwilling or
unable to pay interest or repay principal when due. Political or economic
changes or the balance of trade may affect a country’s willingness or ability to
service its debt obligations. Periods of economic uncertainty may result in the
volatility of market prices of sovereign debt obligations, especially debt
obligations issued by the governments of developing countries. Foreign
government obligations of developing countries, and some structures of emerging
market debt securities, both of which are generally below investment grade, are
sometimes referred to as “Brady Bonds.” The failure of a sovereign debtor to
implement economic reforms, achieve specified levels of economic performance, or
repay principal or interest when due may result in the cancellation of
third-party commitments to lend funds to the sovereign debtor, which may impair
the debtor’s ability or willingness to service its debts.
Passive
Foreign Investment Companies. Under U.S. tax
laws, passive foreign investment companies (PFICs) are those foreign
corporations which generate primarily “passive” income. Passive income is
defined as any income that is considered foreign personal holding company income
under the Internal Revenue Code of 1986, as amended (Code). For federal tax
purposes, a foreign corporation is deemed to be a PFIC if 75% or more of its
gross income during a taxable year is passive income or if 50% or more of its
assets during a taxable year are assets that produce, or are held to produce,
passive income.
Foreign
mutual funds are generally deemed to be PFICs, since nearly all of the income of
a mutual fund is passive income.
Foreign mutual funds investments may be used to gain exposure to the securities
of companies in countries that limit or prohibit direct foreign investment;
however, investments in foreign mutual funds by a Fund are subject to limits
under the Investment Company Act.
23
Other
types of foreign corporations may also be considered PFICs if their percentage
of passive income or passive assets
exceeds the limits described above. A determination as to whether a foreign
corporation is considered a PFIC is based on an interpretation of complex
provisions of the tax law. Accordingly, there can be no assurance that a
conclusion regarding a corporation's status as a PFIC will not be challenged by
the Internal Revenue Service (IRS) and conclusions as to a corporation's PFIC
status may vary depending on who is doing the analysis. Unless a Fund makes an
election with respect to its investment in a PFIC, which election may not always
be possible, income from the disposition of a PFIC investment and from certain
PFIC distributions may be subject to adverse tax treatment. The application of
the PFIC rules may affect, among other things, the character of gains, the
amount of gain or loss and the timing of the recognition of income with respect
to PFIC shares, and may subject a Fund to tax on certain income from PFIC
shares. Federal tax laws impose severe tax penalties for failure to properly
report investment income from PFICs. Although every effort is made to ensure
compliance with federal tax reporting requirements for these investments,
foreign corporations that are PFICs for federal tax purposes may not always be
recognized as such or may not provide a Fund with all information required to
report, or make an election with respect to, such investment.
A
foreign issuer will not be treated as a PFIC with respect to a shareholder if
such issuer is a controlled foreign corporation
for U.S. federal income tax purposes (CFC) and the shareholder holds (directly,
indirectly, or constructively) 10% or more of the voting interests in or total
value of such issuer. In such a case, the shareholder generally would be
required to include in gross income each year, as ordinary income, its share of
certain amounts of a CFC’s income, whether or not the CFC distributes such
shareholder’s share of such amounts to it. Under proposed regulations, such
income will be considered “qualifying income” for purposes of a shareholder’s
qualification as a regulated investment company only to the extent such income
is timely distributed to that shareholder.
Additional
risks of investing in other investment companies are described under “Other
Investment Companies.”
Foreign
Exchange Transactions. Certain Funds may
invest in foreign currency-denominated securities and have the authority to
purchase and sell put and call options on foreign currencies (foreign currency
options), foreign currency futures contracts and related options, and
currency-related swaps, and may engage in foreign currency transactions either
on a spot (i.e., for prompt delivery and settlement) basis at the rate
prevailing in the currency exchange market at the time or through forward
foreign currency contracts (see “Forward Foreign Currency Contracts”). The use
of these instruments may result in a loss to a Fund if the counterparty to the
transaction (particularly with respect to OTC derivatives, as discussed further
below) does not perform as promised, including because of such counterparty’s
bankruptcy or insolvency.
The
Funds will incur costs in converting assets from one currency to another.
Foreign exchange dealers may charge a fee
for conversion. In addition, dealers may realize a profit based on the
difference between the prices at which they buy and sell various currencies in
the spot and forward markets.
A
Fund will generally engage in these foreign exchange transactions in order to
complete a purchase or sale of foreign
currency denominated securities. The Funds may also use foreign currency
options, forward foreign currency contracts, foreign currency futures contracts
and currency-related swap contracts to increase or reduce exposure to a foreign
currency, to shift exposure from one foreign currency to another in a cross
currency hedge or to enhance returns. These transactions are intended to
minimize the risk of loss due to a decline in the value of the hedged
currencies; however, at the same time, they tend to limit any potential gain
which might result should the value of such currencies increase.
A
Fund may purchase and sell foreign currency futures contracts and purchase and
write foreign currency options to increase
or decrease its exposure to different foreign currencies. A Fund may also
purchase and write foreign currency options in connection with foreign currency
futures contracts or forward foreign currency contracts. Foreign currency
futures contracts are traded on exchanges and have standard contract sizes and
delivery dates. Most foreign currency futures contracts call for payment or
delivery in U.S. dollars. The uses and risks of foreign currency futures
contracts are similar to those of futures contracts relating to securities or
indices (see “Futures Contracts”). Foreign currency futures contracts’ values
can be expected to correlate with exchange rates but may not reflect other
factors that affect the value of the Fund’s investments.
24
Whether
or not any hedging strategy will be successful is highly uncertain, and use of
hedging strategies may leave a Fund in
a less advantageous position than if a hedge had not been established. Moreover,
it is impossible to forecast with precision the market value of portfolio
securities at the expiration of a forward foreign currency contract.
Accordingly, a Fund may be required to buy or sell additional currency on the
spot market (and bear the expense of such transaction) if Invesco’s or the
Sub-Advisers’ predictions regarding the movement of foreign currency or
securities markets prove inaccurate.
Certain
Funds may hold a portion of their assets in bank deposits denominated in foreign
currencies, so as to facilitate
investment in foreign securities as well as protect against currency
fluctuations and the need to convert such assets into U.S. dollars (thereby also
reducing transaction costs). To the extent these monies are converted back into
U.S. dollars, the value of the assets so maintained will be affected favorably
or unfavorably by changes in foreign currency exchange rates and exchange
control regulations. Foreign exchange transactions may involve some of the risks
of investments in foreign securities. For a discussion of tax considerations
relating to foreign currency transactions, see “Dividends, Distributions and Tax
Matters — Tax Matters — Tax Treatment of Portfolio Transactions — Foreign
currency transactions.”
Under
definitions adopted by the Commodity Futures Trading Commission (CFTC) and the
U.S. Securities and
Exchange Commission (SEC), non-deliverable foreign exchange forwards and OTC
foreign exchange options are considered “swaps.” These instruments are therefore
included in the definition of “commodity interests” for purposes of determining
whether fund service providers qualify for certain exemptions and exclusions
from regulation by the CFTC. Although non-deliverable forward foreign currency
contracts have historically been traded in the OTC market, as swaps they may in
the future be regulated to be centrally cleared and traded on public execution
facilities. For more information, see “Forward Foreign Currency Contracts” and
“Swaps.”
Floating
Rate Corporate Loans and Corporate Debt Securities of Non-U.S.
Borrowers. The Funds may
invest in floating rate loans that are made to and floating rate debt securities
that are issued by non-U.S. borrowers, provided that the loans are U.S.
dollar-denominated or otherwise provide for payment in U.S. dollars, and any
such borrower meets the credit quality standards established by Invesco and the
Sub-Advisers for U.S. borrowers. The Fund similarly may invest in floating rate
loans and floating rate debt securities made to and issued by U.S. borrowers
with significant non-U.S. dollar denominated revenue, provided that the loans
are U.S. dollar-denominated or otherwise provide for payment to the Fund in U.S.
dollars.In cases where the floating rate loans or floating rate debt securities
are not denominated in U.S. dollars, provisions will be made for payments to the
lenders, including the Funds, in U.S. dollars pursuant to foreign currency
swaps or the currency risk of the transaction will be hedged using forward
foreign currency contracts.
Foreign
Bank Obligations. Foreign bank
obligations include certificates of deposit, banker’s acceptances and fixed time
deposits and other obligations (a) denominated in U.S. dollars and issued by a
foreign branch of a domestic bank (Eurodollar Obligations), (b) denominated in
U.S. dollars and issued by a domestic branch of a foreign bank (Yankee Dollar
Obligations), or (c) issued by foreign branches of foreign banks. Foreign banks
are not generally subject to examination by any U.S. government agency or
instrumentality.
Eurozone
Investment Risks. The European Union
(EU) is an economic and political union of most western European countries and a
growing number of eastern European countries, collectively known as “member
states.” One of the key mandates of the EU is the establishment and
administration of a common single market, consisting of, among other things, a
single currency and a common trade policy. In order to pursue this goal, member
states established the Economic and Monetary Union (EMU), which sets out
different stages and commitments that member states need to follow to achieve
greater economic and monetary policy coordination, including the adoption of a
single currency, the euro. Many member states have adopted the euro as their
currency and, as a result, are subject to the monetary policies of the European
Central Bank (ECB).
The
global economic crisis that began in 2008 has caused severe financial
difficulties for many EU member states,
pushing some to the brink of insolvency and causing others to experience
recession, large
25
public
debt, restructuring of government debt, credit rating downgrades and an overall
weakening of banking and financial
sectors. Recovery from the crisis has been challenged by high unemployment and
budget deficits as well as by weaknesses in sovereign debt issued by Greece,
Spain, Portugal, the Republic of Ireland, Italy and other EU member states. The
sovereign debt of several of these countries was downgraded in 2012 and many
remain subject to further downgrades, which may have a negative effect on
European and non-European banks that have significant exposure to sovereign
debt. Since 2010, several countries, including Greece, Italy, Spain, the
Republic of Ireland and Portugal, agreed to multi-year bailout loans from the
ECB, the International Monetary Fund (IMF), and other institutions. To address
budget deficits and public debt concerns, a number of European countries have
imposed strict austerity measures and comprehensive financial and labor market
reforms.
Some
EU member states may continue to be dependent on assistance from the ECB, the
IMF, or other governments and
institutions. Such assistance could depend on a country’s implementation of
reforms or attainment of a certain level of performance. Failure by one or more
EU member states to reach those objectives or an insufficient level of
assistance could result in a deeper or prolonged economic downturn, which could
have a significant adverse effect on the value of investments in European
countries. By adopting the euro, a member state relinquishes control of its own
monetary policies. As a result, EU member states are significantly affected by
fiscal and monetary controls implemented by the EMU and may be limited to some
degree from implementing their own economic policies. The euro may not fully
reflect the strengths and weaknesses of the various economies that comprise the
EMU and Europe generally.
Additionally,
it is possible that EMU member states could voluntarily abandon the euro or
involuntarily be forced out of the
euro, including by way of a partial or complete dissolution of the EMU. The
effects of such outcomes on the rest of the Eurozone and global markets as a
whole are unpredictable, but are likely to be negative, including adversely
impacted market values of Eurozone and various other securities and currencies,
redenomination of certain securities into less valuable local currencies, and
more volatile and illiquid markets. Under such circumstances, investments
denominated in euros or replacement currencies may be difficult to value, the
ability to operate an investment strategy in connection with euro-denominated
securities may be significantly impaired and the value of euro-denominated
investments may decline significantly and unpredictably. Furthermore, the United
Kingdom’s (“UK”) departure from the EU, known as “Brexit,” may have significant
political and financial consequences for Eurozone markets, including greater
market volatility and illiquidity, currency fluctuations, deterioration in
economic activity, a decrease in business confidence and an increased likelihood
of a recession in the UK. Uncertainty relating to the withdrawal procedures and
timeline may have adverse effects on asset valuations and the renegotiation of
current trade agreements, as well as an increase in financial regulation of UK
banks. While the full impact of Brexit is unknown, market disruption in the EU
and globally may have a negative effect on the value of the Fund’s investments.
Additionally, the risks related to Brexit could be more pronounced if one or
more additional EU member states seek to leave the EU.
Risks
Related to Armed Conflict. As a result of
increasingly interconnected global economies and financial markets, armed
conflict between countries or in a geographic region, for example the current
conflicts between Russia and Ukraine in Europe and Hamas and Israel in the
Middle East, has the potential to adversely impact Fund investments. Such
conflicts, and other corresponding events, have had, and could continue to have,
severe negative effects on regional and global economic and financial markets,
including increased volatility, reduced liquidity, and overall uncertainty. The
negative impacts may be particularly acute in certain sectors The timing and
duration of such conflicts, resulting sanctions, related events and other
implications cannot be predicted. The foregoing may result in a negative impact
on Fund performance and the value of an investment in the Fund, even beyond any
direct investment exposure the Fund may have to issuers located in or with
significant exposure to an impacted country or geographic region.
Risks
Related to Russian Invasion of Ukraine. In late February
2022, Russian military forces invaded Ukraine, significantly amplifying already
existing geopolitical tensions among Russia, Ukraine, Europe, the North Atlantic
Treaty Organization (NATO), and the West. Russia’s invasion, the responses of
countries and political bodies to Russia’s actions, and the potential for wider
conflict may increase
26
financial market
volatility and could have severe adverse effects on regional and global economic
markets, including the markets for certain securities and commodities such as
oil and natural gas.
Following
Russia’s actions, various countries, including the U.S., Canada, the United
Kingdom, Germany, and
France, among others, as well as the European Union, issued broad-ranging
economic sanctions against Russia. The sanctions freeze certain Russian assets
and prohibit trading by individuals and entities in certain Russian securities,
engaging in certain private transactions, and doing business with certain
Russian corporate entities, large financial institutions, officials and
oligarchs. The sanctions include a commitment by certain countries and the
European Union to remove selected Russian banks from the Society for Worldwide
Interbank Financial Telecommunications, commonly called “SWIFT,” the electronic
network that connects banks globally, and imposed restrictive measures to
prevent the Russian Central Bank from undermining the impact of the sanctions. A
number of large corporations have since withdrawn from Russia or suspended or
curtailed their Russia-based operations.
The
imposition of these current sanctions (and the potential for further sanctions
in response to Russia’s continued
military activity) and other actions undertaken by countries and businesses may
adversely impact various sectors of the Russian economy, including, but not
limited to, the financials, energy, metals and mining, engineering, and defense
and defense-related materials sectors. Such actions also may result in the
decline of the value and liquidity of Russian securities, a weakening of the
ruble, and could impair the ability of a Fund to buy, sell, receive, or deliver
those securities. Moreover, the measures could adversely affect global financial
and energy markets and thereby negatively affect the value of a Fund’s
investments beyond any direct exposure to Russian issuers or those of adjoining
geographic regions.
In
response to sanctions, the Russian Central Bank raised its interest rates and
banned sales of local securities by
foreigners. Russia also prevented the export of certain goods and payments to
foreign shareholders of Russian securities. Russia may take additional
countermeasures or retaliatory actions, which may further impair the value and
liquidity of Russian securities and Fund investments. Such actions could, for
example, include restricting gas exports to other countries, the seizure of U.S.
and European residents’ assets, or undertaking or provoking other military
conflict elsewhere in Europe, any of which could exacerbate negative
consequences on global financial markets and the economy. The actions discussed
above could have a negative effect on the performance of Funds that have
exposure to Russia. While diplomatic efforts have been ongoing, the conflict
between Russia and Ukraine is unpredictable and has the potential to result in
broader military actions. The duration of the ongoing conflict and corresponding
sanctions and related events cannot be predicted and may result in a negative
impact on Fund performance and the value of Fund investments, particularly as it
relates to Russian exposure.
Exchange-Traded
Funds
Exchange-Traded
Funds (ETFs). Each Fund may
purchase shares of ETFs. Most ETFs are registered under the 1940 Act as
investment companies, although others may not be registered as investment
companies and are registered as commodity pools. Therefore, a Fund’s purchase of
shares of an ETF may be subject to the restrictions on investments in other
investment companies discussed under “Other Investment Companies.” ETFs have
management fees, which increase their cost. The Fund may invest in ETFs advised
by unaffiliated advisers as well as ETFs advised by Invesco Capital Management
LLC (Invesco Capital). Invesco, the Sub-Advisers and Invesco Capital are
affiliates of each other as they are all indirect wholly-owned subsidiaries of
Invesco Ltd.
Generally,
ETFs hold portfolios of securities, commodities and/or currencies that are
designed to replicate, as
closely as possible before expenses, the performance of a specified market
index. The performance results of ETFs will not replicate exactly the
performance of the pertinent index due to transaction and other expenses,
including fees to service providers, borne by ETFs. Furthermore, there can be no
assurance that the portfolio of securities, commodities and/or currencies
purchased by an ETF will
27
replicate
a particular index. Some ETFs are actively managed and instead of replicating a
particular index they seek to
outperform it, or outperform a basket of securities or price of a commodity or
currency.
Only
Authorized Participants (APs) may engage in creation or redemption transactions
directly with ETFs. ETF shares are sold
to and redeemed by APs at net asset value only in large blocks called creation
units and redemption units, respectively. Such market makers have no obligation
to submit creation or redemption orders; consequently, there is no assurance
that market makers will establish or maintain an active trading market for ETF
shares. In addition, to the extent that APs exit the business or are unable to
proceed with creation and/or redemption orders with respect to an ETF and no
other AP is able to step forward to create or redeem units of an ETF, an ETF’s
shares may be more likely to trade at a premium or discount to net asset value
and possibly face trading halts and/or delisting. ETF shares may be purchased
and sold by all other investors in secondary market trading on national
securities exchanges, which allows investors to purchase and sell ETF shares at
their market price throughout the day.
Investments
in ETFs generally present the same primary risks as an investment in a
conventional mutual fund that has the
same investment objective, strategy and policies. Investments in ETFs further
involve the same risks associated with a direct investment in the types of
securities, commodities and/or currencies included in the indices the ETFs are
designed to replicate. In addition, shares of an ETF may trade at a market price
that is higher or lower than their net asset value and an active trading market
in such shares may not develop or continue. Moreover, trading of an ETF’s shares
may be halted if the listing exchange’s officials deem such action to be
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.
Exchange-Traded
Notes
Exchange-Traded
Notes (ETNs). ETNs are senior,
unsecured, unsubordinated debt securities whose returns are linked to the
performance of a particular market benchmark or strategy, minus applicable fees.
ETNs are traded on an exchange (e.g., the New York Stock Exchange) during normal
trading hours; however, investors can also hold the ETN until maturity. At
maturity, the issuer pays to the investor a cash amount equal to the principal
amount, subject to the day’s market benchmark or strategy factor. ETNs do not
make periodic coupon payments or provide principal protection. ETNs are subject
to credit risk, including the credit risk of the issuer, and the value of the
ETN may drop due to a downgrade in the issuer’s credit rating, despite the
underlying market benchmark or strategy remaining unchanged. The value of an ETN
may also be influenced by time to maturity, level of supply and demand for the
ETN, volatility and lack of liquidity in underlying assets, changes in the
applicable interest rates, changes in the issuer’s credit rating, and economic,
legal, political, or geographic events that affect the referenced underlying
asset. When a Fund invests in ETNs it will bear its proportionate share of any
fees and expenses borne by the ETN. A decision to sell ETN holdings may be
limited by the availability of a secondary market. In addition, although an ETN
may be listed on an exchange, the issuer may not be required to maintain the
listing, and there can be no assurance that a secondary market will exist for an
ETN.
ETNs
are also subject to tax risk. No assurance can be given that the Internal
Revenue Service (IRS) will accept, or a court
will uphold, how ETNs are characterized or treated for tax purposes. Further,
the IRS and Congress are considering proposals that would change the timing and
character of income and gains from ETNs.
An
ETN that is tied to a specific market benchmark or strategy may not be able to
replicate and maintain exactly the
composition and relative weighting of securities, commodities or other
components in the applicable market benchmark or strategy. Some ETNs that use
leverage can, at times, be relatively illiquid, and thus they may be difficult
to purchase or sell at a fair price. Leveraged ETNs are subject to the same risk
as other instruments that use leverage in any form.
The
market value of ETNs may differ from their market benchmark or strategy. This
difference in price may be due to the
fact that the supply and demand in the market for ETNs at any point in time is
not always identical to the supply and demand in the market for the securities,
commodities or other components
28
underlying
the market benchmark or strategy that the ETN seeks to track. As a result, there
may be times when an ETN trades
at a premium or discount to its market benchmark or strategy.
Debt
Investments
U.S.
Government Obligations. U.S. government
obligations are obligations issued or guaranteed by the U.S. government, its
agencies and instrumentalities, including bills, notes and bonds issued by the
U.S. Treasury, as well as "stripped" or "zero coupon" U.S. Treasury
obligations.
U.S.
government obligations may be, (i) supported by the full faith and credit of the
U.S. Treasury, (ii) supported by the
right of the issuer to borrow from the U.S. Treasury, (iii) supported by the
discretionary authority of the U.S. government to purchase the agency’s
obligations, or (iv) supported only by the credit of the instrumentality. There
is a risk that the U.S. government may choose not to provide financial support
to U.S. government-sponsored agencies or instrumentalities if it is not legally
obligated to do so. In that case, if the issuer were to default, a Fund holding
securities of such issuer might not be able to recover its investment from the
U.S. government. For example, while the U.S. government has provided financial
support to Federal National Mortgage Association (FNMA) and Federal Home Loan
Mortgage Corporation (FHLMC), no assurance can be given that the U.S. government
will always do so, since the U.S. government is not so obligated by law. There
also is no guarantee that the government would support Federal Home Loan Banks.
Accordingly, securities of FNMA, FHLMC and Federal Home Loan Banks, and other
agencies, may involve a risk of non-payment of principal and interest. Any
downgrade of the credit rating of the securities issued by the U.S. government
may result in a downgrade of securities issued by its agencies or
instrumentalities, including government-sponsored entities. Additionally, from
time to time uncertainty regarding the status of negotiations in the U.S.
government to increase the statutory debt limit, commonly called the “debt
ceiling,” could increase the risk that the U.S. government may default on
payments on certain U.S. government securities, cause the credit rating of the
U.S. government to be downgraded, increase volatility in the stock and bond
markets, result in higher interest rates, reduce prices of U.S. Treasury
securities, and/or increase the costs of various kinds of debt. If a U.S.
government-sponsored entity is negatively impacted by legislative or regulatory
action, is unable to meet its obligations, or its creditworthiness declines, the
performance of a Fund that holds securities of that entity will be adversely
impacted.
Event-Linked
Bonds.
Investments may be made in “event-linked” bonds or interests in trusts and other
pooled entities that invest primarily or exclusively in event-linked bonds,
including entities sponsored and/or advised by Invesco or its affiliates.
Event-linked
bonds may be issued by government agencies, insurance companies, reinsurers, and
financial
institutions, among other issuers, or special purpose vehicles associated with
the foregoing. Often event-links bonds provide for extensions of maturity in
order to process and audit loss claims in those cases when a trigger event has
occurred or is likely to have occurred. An extension of maturity may increase a
bond’s volatility.
29
Event-linked
bonds may expose a Fund to certain other risks, including issuer default,
adverse regulatory or jurisdictional
interpretations, liquidity risk and adverse tax consequences. Lack of a liquid
market may result in higher transaction costs and the possibility that a Fund
may be forced to liquidate positions when it would not be advantageous to do so.
Event-linked bonds are typically rated by one or more nationally recognized
statistical rating organizations and a Fund will only invest in event-linked
bonds that meet the credit quality requirements for the Fund.
The
issuers of the event-linked bonds in which a Fund will invest are generally
treated as PFICs for U.S. income tax
purposes. For more information about PFICs, see “Passive Foreign Investment
Companies.”
Inflation-Indexed
Bonds.
Inflation-indexed bonds are fixed income securities whose principal value is
periodically adjusted according to the rate of inflation. Two structures are
common. The U.S. Treasury and some other issuers use a structure that accrues
inflation into the principal value of the bond. Most other issuers pay out the
Consumer Price Index (CPI) accruals as part of a semiannual coupon.
Inflation-indexed
securities issued by the U.S. Treasury have maturities of five, ten or thirty
years, although it is
possible that securities with other maturities will be issued in the future. The
U.S. Treasury securities pay interest on a semi-annual basis, equal to a fixed
percentage of the inflation-adjusted principal amount. For example, if a fund
purchased an inflation-indexed bond with a par value of $1,000 and a 3% real
rate of return coupon (payable 1.5% semi-annually), and inflation over the first
six months was 1%, the mid-year par value of the bond would be $1,010 and the
first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If
inflation during the second half of the year resulted in the whole years’
inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and
the second semiannual interest payment would be $15.45 ($1,030 times
1.5%).
If
the periodic adjustment rate measuring inflation falls, the principal value of
inflation-indexed bonds will be adjusted
downward, and consequently the interest payable on these securities (calculated
with respect to a smaller principal amount) will be reduced. Repayment of the
original bond principal upon maturity (as adjusted for inflation) is guaranteed
in the case of U.S. Treasury inflation-indexed bonds, even during a period of
deflation. However, the current market value of the bonds is not guaranteed, and
will fluctuate. The Fund may also invest in other inflation related bonds which
may or may not provide a similar guarantee. If a guarantee of principal is not
provided, the adjusted principal value of the bond repaid at maturity may be
less than the original principal.
The
value of inflation-indexed bonds is expected to change in response to changes in
real interest rates. Real interest rates
in turn are tied to the relationship between nominal interest rates and the rate
of inflation. Therefore, if inflation were to rise at a faster rate than nominal
interest rates, real interest rates might decline, leading to an increase in
value of inflation-indexed bonds. In contrast, if nominal interest rates
increased at a faster rate than inflation, real interest rates might rise,
leading to a decrease in value of inflation-indexed bonds.
While
these securities are expected to be protected from long-term inflationary
trends, short-term increases in
inflation may lead to a decline in value. If interest rates rise due to reasons
other than inflation (for example, due to changes in currency exchange rates),
investors in these securities may not be protected to the extent that the
increase is not reflected in the bond’s inflation measure.
The
periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer
Price Index for Urban Consumers (CPI-U),
which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI-U is
a measurement of changes in the cost of living, made up of components such as
housing, food, transportation and energy. Inflation-indexed bonds issued by a
foreign government are generally adjusted to reflect a comparable inflation
index, calculated by that government. There can be no assurance that the CPI-U
or any foreign inflation index will accurately measure the real rate of
inflation in the prices of goods and services. Moreover, there can be no
assurance that the rate of inflation in a foreign country will be correlated to
the rate of inflation in the United States.
Any
increase in the principal amount of an inflation-indexed bond will be considered
taxable ordinary income, even though
investors do not receive their principal until
maturity.
30
Temporary
Investments. Each Fund may
invest a portion of its assets in affiliated money market funds or in other
types of money market instruments in which those funds would invest or other
short-term U.S. government securities for cash management purposes. Each Fund
may invest up to 100% of its assets in investments that may be inconsistent with
the Fund’s principal investment strategies for temporary defensive purposes in
anticipation of or in response to adverse market, economic, political or other
conditions, or atypical circumstances such as unusually large cash inflows or
redemptions. As a result, the Fund may not achieve its investment
objective.
Changing
Interest Rates. In a low or
negative interest rate environment, debt securities may trade at, or be issued
with, negative yields, which means the purchaser of the security may receive at
maturity less than the total amount invested. In addition, in a negative
interest rate environment, if a bank charges negative interest, instead of
receiving interest on deposits, a depositor must pay the bank fees to keep money
with the bank. To the extent a Fund holds a negatively-yielding debt security or
has a bank deposit with a negative interest rate, the Fund would generate a
negative return on that investment. Cash positions may also subject a Fund to
increased counterparty risk to the Fund's bank. Debt market conditions are
highly unpredictable and some parts of the market are subject to dislocations.
In the past, the U.S. government and certain foreign central banks have taken
steps to stabilize markets by, among other things, reducing interest rates. To
the extent such actions are pursued, they present heightened risks to debt
securities, and such risks could be even further heightened if these actions are
unexpectedly or suddenly reversed or are ineffective in achieving their desired
outcomes. In recent years, the U.S. government began implementing increases to
the federal funds interest rate and there may be further rate increases. As
interest rates rise, there is risk that rates across the financial system also
may rise. To the extent rates increase substantially and/or rapidly, the Funds
may be subject to significant losses.
In
a low or negative interest rate environment, some investors may seek to
reallocate assets to other income-producing
assets. This may cause the price of such higher yielding instruments to rise,
could further reduce the value of instruments with a negative yield, and may
limit a Fund's ability to locate fixed income instruments containing the desired
risk/return profile. Changing interest rates, including, rates that fall below
zero, could have unpredictable effects on the markets and may expose fixed
income markets to heightened volatility, increased redemptions, and potential
illiquidity.
With
respect to a money market fund, which seeks to maintain a stable $1.00 price per
share, a low or negative interest
rate environment could impact the money market fund’s ability to maintain a
stable $1.00 share price. During a negative interest rate
environment causing a money
market fund to have a negative gross yield, the money market fund
may reduce the number of shares outstanding on a pro rata basis through reverse
distribution
mechanisms
or
other mechanisms to seek to maintain a stable $1.00 price per share,
subject
to
approval of the
Board and to the extent permissible
by applicable law and its organizational documents. A money market fund
that implements share cancellation would continue to maintain a stable $1.00
share price by use of the amortized cost method of valuation and/or penny
rounding method but the value of an investor’s investment would decline if the
fund reduces the number of shares held by the investor.
Alternatively, the
money market fund may discontinue using the amortized cost method of valuation
to maintain a stable $1.00 price per share and establish a fluctuating NAV per
share rounded to four decimal places by using available market quotations or
equivalents. A money market
fund that floats its NAV would no longer maintain a stable $1.00 share price and
instead have a share price that fluctuates. An investor in a money market fund
that floats its NAV would lose money if the investor sells their shares when
they are worth less than what the investor originally paid for
them.
Mortgage-Backed
and Asset-Backed Securities. Mortgage-backed
and asset-backed securities include commercial mortgage-backed securities (CMBS)
and residential mortgage-backed securities (RMBS). Mortgage-backed
securities are mortgage-related securities issued or guaranteed by the U.S.
government, its agencies and instrumentalities, or issued by non-government
entities, such as commercial banks and other private lenders. Mortgage-related
securities represent ownership in pools of mortgage loans assembled for sale to
investors by various government agencies such as the Government National
Mortgage Association (GNMA) and government-related organizations such as the
FNMA and the FHLMC, as well as by non-government issuers such as commercial
banks, savings and loan institutions, mortgage bankers and private
31
mortgage
insurance companies. Although certain mortgage-related securities are guaranteed
by a third party or otherwise
similarly secured, the market value of the security, which may fluctuate, is not
so secured. These securities differ from conventional bonds in that the
principal is paid back to the investor as payments are made on the underlying
mortgages in the pool. Accordingly, a Fund receives monthly scheduled payments
of principal and interest along with any unscheduled principal prepayments on
the underlying mortgages. Because these scheduled and unscheduled principal
payments must be reinvested at prevailing interest rates, mortgage-backed
securities do not provide an effective means of locking in long-term interest
rates for the investor.
In
addition, there are a number of important differences among the agencies and
instrumentalities of the U.S. government
that issue mortgage-related securities and among the securities they issue.
Mortgage-related securities issued by GNMA include GNMA Mortgage Pass-Through
Certificates (also known as Ginnie Maes) which are guaranteed as to the timely
payment of principal and interest. That guarantee is backed by the full faith
and credit of the U.S. Treasury. GNMA is a corporation wholly-owned by the U.S.
government within the Department of Housing and Urban Development.
Mortgage-related securities issued by FNMA include FNMA Guaranteed Mortgage
Pass-Through Certificates (also known as Fannie Maes) and are guaranteed as to
payment of principal and interest by FNMA itself and backed by a line of credit
with the U.S. Treasury. FNMA is a government-sponsored entity (GSE) wholly-owned
by public stockholders. Mortgage-related securities issued by FHLMC include
FHLMC Mortgage Participation Certificates (also known as Freddie Macs) and are
guaranteed as to payment of principal and interest by FHLMC itself and backed by
a line of credit with the U.S. Treasury. FHLMC is a GSE wholly-owned by public
stockholders.
Another
type of mortgage-related security issued by GSEs, such as FNMA and FHLMC, is
credit risk transfer
securities. GSE credit risk transfer securities are unguaranteed and unsecured
fixed or floating rate general obligations issued by GSEs, which are typically
issued at par and have stated final maturities. In addition, GSE credit risk
transfer securities are structured so that: (i) interest is paid directly by the
issuing GSE; and (ii) principal is paid by the issuing GSE in accordance with
the principal payments and default performance of a pool of residential mortgage
loans acquired by the GSE. The issuing GSE selects the pool of mortgage loans
based on that GSE’s eligibility criteria, and the performance of the credit risk
transfer securities will be directly affected by the selection of such
underlying mortgage loans.
GSE
credit risk transfer securities are not directly linked to or backed by the
underlying mortgage loans. Thus, although the
payment of principal and interest on such securities is tied to the performance
of the pool of underlying mortgage loans, in no circumstances will the actual
cash flow from the underlying mortgage loans be paid or otherwise made available
to the holders of the securities and the holders of the securities will have no
interest in the underlying mortgage loans. As a result, in the event that a GSE
fails to pay principal or interest on its credit risk transfer securities or
goes through a bankruptcy, insolvency or similar proceeding, holders of such
credit risk transfer securities will have no direct recourse to the underlying
mortgage loans. Such holders will receive recovery on par with other unsecured
note holders (agency debentures) in such a scenario.
GSE
credit risk transfer securities are issued in multiple tranches, which are
allocated certain principal repayments and
credit losses corresponding to the seniority of the particular tranche. Each
tranche will have credit exposure to the underlying mortgage loans and the yield
to maturity will be directly related to the amount and timing of certain defined
credit events on the underlying mortgage loans, any prepayments by borrowers and
any removals of a mortgage loan from the pool. Because credit risk exposure is
allocated in accordance with the seniority of the particular tranche, principal
losses will be first allocated to the most junior or subordinate tranches, thus
making the most subordinate tranches subject to increased sensitivity to
dramatic housing downturns. In addition, many credit risk transfer securities
have collateral performance triggers (such as those based on credit enhancement,
delinquencies or defaults) that could shut off principal payments to subordinate
tranches.
The
risks associated with an investment in GSE credit risk transfer securities will
be different than the risks associated
with an investment in mortgage-backed securities issued by GSEs, because some or
all of the mortgage default or credit risk associated with the underlying
mortgage loans in credit risk transfer
32
securities
is transferred to investors, such as the Fund. As a result, investors in GSE
credit risk transfer securities could
lose some or all of their investment in these securities if the underlying
mortgage loans default.
The
Funds may also invest in credit risk transfer securities issued by private
entities, such as banks or other financial
institutions. Credit risk transfer securities issued by private entities are
structured similarly to those issued by GSEs, and are generally subject to the
same types of risks, including credit, prepayment, extension, interest rate and
market risks.
On
September 7, 2008, FNMA and FHLMC were placed under the conservatorship of the
Federal Housing Finance
Agency (FHFA) to provide stability in the financial markets, mortgage
availability and taxpayer protection by preserving FNMA and FHLMC’s assets and
property and putting FNMA and FHLMC in a sound and solvent position. Under the
conservatorship, the management of FNMA and FHLMC was replaced.
Since
2009, both FNMA and FHLMC have received significant capital support through U.S.
Treasury preferred stock
purchases and Federal Reserve purchases of the entities’ mortgage-backed
securities.
In
February 2011, the Obama Administration produced a report to Congress outlining
proposals to wind down FNMA and FHLMC
and reduce the government’s role in the mortgage market. In December 2011,
Congress enacted the Temporary Payroll Tax Cut Continuation Act of 2011 which,
among other provisions, requires that FNMA and FHLMC increase their
single-family guaranty fees by at least 10 basis points and remit this increase
to Treasury with respect to all loans acquired by FNMA or FHLMC on or after
April 1, 2012 and before January 1, 2022. Discussions among policymakers
continue, however, as to whether FNMA and FHLMC should be nationalized,
privatized, restructured, or eliminated altogether. FNMA reported in the third
quarter of 2016 that it expected "continued significant uncertainty" regarding
its future and the housing finance system, including how long FNMA will continue
to exist in its current form, the extent of its role in the market, how long it
will be in conservatorship, what form it will have and what ownership interest,
if any, current common and preferred stockholders will hold after the
conservatorship is terminated, and whether FNMA will continue to exist following
conservatorship. FHLMC faces similar uncertainty about its future role. If FNMA
and FHLMC are taken out of conservatorship, it is unclear how the capital
structure of FNMA and FHLMC would be constructed and what effects, if any, there
may be on FNMA’s and FHLMC’s creditworthiness and guarantees of certain
mortgage-backed securities. It is also unclear whether the U.S. Treasury would
continue to enforce its rights or perform its obligations related to senior
preferred stock. Should FNMA’s and FHLMC’s conservatorship end, there could be
an adverse impact on the value of their securities, which could cause Fund
losses. FNMA and FHLMC also are the subject of several continuing legal actions
and investigations over certain accounting, disclosure or corporate governance
matters, which (along with any resulting financial restatements) may continue to
have an adverse effect on the guaranteeing entities. Importantly, the future of
the entities is in question as the U.S. government considers multiple options
regarding the future of FNMA and FHLMC.
Under
the direction of the FHFA, FNMA and FHLMC have entered into a joint initiative
to develop a common
securitization platform for the issuance of a uniform mortgage-backed security
(the “Single Security Initiative”) that aligns the characteristics of FNMA and
FHLMC certificates. The Single Security Initiative seeks to support the overall
liquidity of the TBA market. FNMA and FHLMC began issuing uniform
mortgage-backed security in June 2019, and while the initial effects of the
issuance of uniform mortgage-backed securities on the market for
mortgage-related securities have been relatively minimal, the long-term effects
are still uncertain.
Asset-backed
securities are structured like mortgage-backed securities, but instead of
mortgage loans or interests in
mortgage loans, the underlying assets may include such items as motor vehicle
installment sales contracts or installment loan contracts, leases of various
types of real and personal property, and receivables from credit card agreements
and from sales of personal property. Regular payments received on
asset-backed securities include both interest and principal. Asset-backed
securities typically have no U.S. Government backing. Additionally, the
ability of an issuer of asset-backed securities to enforce its security interest
in the underlying assets may be limited.
33
If
a Fund purchases a mortgage-backed or other asset-backed security at a premium,
the premium may be lost if there is
a decline in the market value of the security whether resulting from changes in
interest rates or prepayments in the underlying collateral. As with other
interest-bearing securities, the prices of such securities are inversely
affected by changes in interest rates. Although the value of a mortgage-backed
or other asset-backed security may decline when interest rates rise, the
converse is not necessarily true, since in periods of declining interest rates
the mortgages and loans underlying the securities are prone to prepayment,
thereby shortening the average life of the security and shortening the period of
time over which income at the higher rate is received. When interest rates are
rising, the rate of prepayment tends to decrease, thereby lengthening the period
of time over which income at the lower rate is received. For these and other
reasons, a mortgage-backed or other asset-backed security’s average maturity may
be shortened or lengthened as a result of interest rate fluctuations and,
therefore, it is not possible to predict accurately the security’s return. In
addition, while the trading market for short-term mortgages and asset-backed
securities is ordinarily quite liquid, in times of financial stress the trading
market for these securities may become restricted.
CMBS
and RMBS generally offer a higher rate of interest than government and
government-related mortgage-backed
securities because there are no direct or indirect government or government
agency guarantees of payment. The risk of loss due to default on CMBS and RMBS
is historically higher because neither the U.S. government nor an agency or
instrumentality have guaranteed them. CMBS and RMBS whose underlying assets are
neither U.S. government securities nor U.S. government insured mortgages, to the
extent that real properties securing such assets may be located in the same
geographical region, may also be subject to a greater risk of default than other
comparable securities in the event of adverse economic, political or business
developments that may affect such region and, ultimately, the ability of
property owners to make payments of principal and interest on the underlying
mortgages. Non-government mortgage-backed securities are generally subject to
greater price volatility than those issued, guaranteed or sponsored by
government entities because of the greater risk of default in adverse market
conditions. Where a guarantee is provided by a private guarantor, the Fund is
subject to the credit risk of such guarantor, especially when the guarantor
doubles as the originator.
Collateralized
Mortgage Obligations (CMOs). A CMO is a hybrid
between a mortgage-backed bond and a mortgage pass-through security. A CMO is a
type of mortgage-backed security that creates separate classes with varying
maturities and interest rates, called tranches. Similar to a bond, interest and
prepaid principal is paid, in most cases, semiannually. CMOs may be
collateralized by whole mortgage loans, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs
are structured into multiple classes, each bearing a different fixed or floating
interest rate and stated maturity.
Actual maturity and average life will depend upon the prepayment experience of
the collateral. CMOs provide for a modified form of call protection through a de
facto breakdown of the underlying pool of mortgages according to how quickly the
loans are repaid. Monthly payment of principal received from the pool of
underlying mortgages, including prepayments, is first returned to investors
holding the shortest maturity class. Investors holding the longer maturity
classes receive principal only after the first class has been retired. An
investor is partially guarded against a sooner than desired return of principal
because of the sequential payments.
In
a typical CMO transaction, a corporation (issuer) issues multiple series (i.e.,
Series A, B, C and Z) of CMO bonds (Bonds).
Proceeds of the Bond offering are used to purchase mortgages or mortgage
pass-through certificates (Collateral). The Collateral is pledged to a third
party trustee as security for the Bonds. Principal and interest payments from
the Collateral are used to pay principal on the Bonds in the following order:
Series A, B, C and Z. The Series A, B, and C Bonds all bear current interest.
Interest on a Series Z Bond is accrued and added to principal and a like amount
is paid as principal on the Series A, B, or C Bond is currently being paid off.
Only after the Series A, B, and C Bonds are paid in full does the Series Z Bond
begin to receive payment. With some CMOs, the issuer serves as a conduit to
allow loan originators (primarily builders or savings and loan associations) to
borrow against their loan portfolios.
34
CMOs
that are issued or guaranteed by the U.S. government or by any of its agencies
or instrumentalities will be considered
U.S. government securities by the Funds, while other CMOs, even if
collateralized by U.S. government securities, will have the same status as other
privately issued securities for purposes of applying the Funds' diversification
tests.
FHLMC
CMOs are debt obligations of FHLMC issued in multiple classes having different
maturity dates which are secured
by the pledge of a pool of conventional mortgage loans purchased by FHLMC.
Payments of principal and interest on the FHLMC CMOs are made semiannually. The
amount of principal payable on each semiannual payment date is determined in
accordance with FHLMC’s mandatory sinking fund schedule, which, in turn, is
equal to approximately 100% of FHA prepayment experience applied to the mortgage
collateral pool. All sinking fund payments in the FHLMC CMOs are allocated to
the retirement of the individual classes of bonds in the order of their stated
maturities. Payment of principal on the mortgage loans in the collateral pool in
excess of the amount of FHLMC’s minimum sinking fund obligation for any payment
date are paid to the holders of the FHLMC CMOs as additional sinking fund
payments. Because of the “pass-through” nature of all principal payments
received on the collateral pool in excess of FHLMC’s minimum sinking fund
requirement, the rate at which principal of the FHLMC CMOs is actually repaid is
likely to be such that each class of bonds will be retired in advance of its
scheduled maturity date. If collection of principal (including prepayments) on
the mortgage loans during any semiannual payment period is not sufficient to
meet the FHLMC CMO’s minimum sinking fund obligation on the next sinking fund
payment date, FHLMC agrees to make up the deficiency from its general
funds.
Classes
of CMOs may also include interest only securities (IOs) and principal only
securities (POs). IOs and POs are
stripped mortgage-backed securities representing interests in a pool of
mortgages the cash flow from which has been separated into interest and
principal components. IOs receive the interest portion of the cash flow while
POs receive the principal portion. IOs and POs can be extremely volatile in
response to changes in interest rates. As interest rates rise and fall, the
value of IOs tends to move in the same direction as interest rates. POs perform
best when prepayments on the underlying mortgages rise since this increases the
rate at which the investment is returned and the yield to maturity on the PO.
When payments on mortgages underlying a PO are slow, the life of the PO is
lengthened and the yield to maturity is reduced.
CMOs
are generally subject to the same risks as mortgage-backed securities. In
addition, CMOs may be subject to credit
risk because the issuer or credit enhancer has defaulted on its obligations and
a Fund may not receive all or part of its principal. Obligations issued by U.S.
government-related entities are guaranteed as to the payment of principal and
interest, but are not backed by the full faith and credit of the U.S.
government. The performance of private label mortgage-backed securities, issued
by private institutions, is based on the financial health of those institutions.
Although GNMA guarantees timely payment of GNMA certificates even if homeowners
delay or default, tracking the “pass-through” payments may, at times, be
difficult.
Real
Estate Mortgage Investment Conduits (REMICs). REMICs are pools
of mortgage loans in which the interest and principal payments from mortgages
are structured into separately traded securities. REMICs meet certain
qualifications under the Internal Revenue Code that allow them to be exempt from
taxation at the entity level, although the income from a REMIC is taxable to
investors. REMICs may invest only in “qualified mortgages” and “permitted
investments.” Qualified mortgages include single family or multifamily
mortgages, commercial mortgages, second mortgages, second mortgages, mortgage
participations, and federal agency pass-through securities. Permitted
investments include cash flow investments, qualified reserve assets, and
foreclosure property. If a REMIC loses its exempt tax status, it is permanently
lost.
REMICs
issue pass-through certificates, multiclass bonds or other securities to
investors. The different classes of
interests in a REMIC may have different maturities and different risks. REMIC
interests are structured in classes of “regular interests” and a single
“residual interest” class. REMICs may have any number of classes of regular
interests with different servicing priorities and varying maturity dates. The
different classes are assigned a coupon (fixed, floating, or zero interest rate)
and include other terms regarding payments to the investors.
35
REMICs
are subject to the market risks of mortgage related securities. In addition, the
allowable activities for REMICs are
generally limited to holding a fixed pool of mortgages and distributing payments
currently to investors and transactions that are considered to be prohibited
activities are subject to a penalty tax of 100%. REMICs have no minimum equity
requirements and REMICs may sell all of their assets without retaining any to
meet collateralization requirements.
Collateralized
Debt Obligations (CDOs). A CDO is a
security backed by a pool of bonds, loans and other debt obligations. CDOs are
not limited to investing in one type of debt and accordingly, a CDO may own
corporate bonds, commercial loans, asset-backed securities, residential
mortgage-backed securities, commercial mortgage-backed securities, and emerging
market debt. The CDO’s securities are typically divided into several classes, or
bond tranches, that have differing levels of investment grade or credit
tolerances. Most CDO issues are structured in a way that enables the senior bond
classes and mezzanine classes to receive investment-grade credit ratings. Credit
risk is shifted to the most junior class of securities. If any defaults occur in
the assets backing a CDO, the senior bond classes are first in line to receive
principal and interest payments, followed by the mezzanine classes and finally
by the lowest rated (or non-rated) class, which is known as the equity tranche.
Similar in structure to a collateralized mortgage obligation (described above)
CDOs are unique in that they represent different types of debt and credit
risk.
Collateralized
Loan Obligations (CLOs). CLOs are debt
instruments backed solely by a pool of other debt securities. The risks of an
investment in a CLO depend largely on the type of the collateral securities and
the class of the CLO in which a Fund invests. Some CLOs have credit ratings, but
are typically issued in various classes with various priorities. Normally, CLOs
are privately offered and sold (that is, they are not registered under the
securities laws) and may be characterized by a Fund as illiquid investments;
however, an active dealer market may exist for CLOs that qualify for Rule 144A
transactions. In addition to the normal interest rate, default and other risks
of fixed income securities, CLOs carry additional risks, including the
possibility that distributions from collateral securities will not be adequate
to make interest or other payments, the quality of the collateral may decline in
value or default a Fund may invest in CLOs that are subordinate to other
classes, values may be volatile, and disputes with the issuer may produce
unexpected investment results.
Credit
Linked Notes (CLNs). A CLN is a
security structured and issued by an issuer, which may be a bank, broker or
special purpose vehicle. If a CLN is issued by a special purpose vehicle, the
special purpose vehicle will typically be collateralized by AAA-rated
securities, but some CLNs are not collateralized. The performance and payment of
principal and interest is tied to that of a reference obligation which may be a
particular security, basket of securities, credit default swap, basket of credit
default swaps, or index. The reference obligation may be denominated in foreign
currencies. Risks of CLNs include those risks associated with the underlying
reference obligation including, but not limited to, market risk, interest rate
risk, credit risk, default risk and foreign currency risk. In the case of a CLN
created with credit default swaps, the structure will be “funded” such that the
par amount of the security will represent the maximum loss that could be
incurred on the investment and no leverage is introduced. An investor in a CLN
also bears counterparty risk or the risk that the issuer of the CLN will default
or become bankrupt and not make timely payments of principal and interest on the
structured security. Should the issuer default or declare bankruptcy, the CLN
holder may not receive any compensation. In return for these risks, the CLN
holder receives a higher yield. As with most derivative instruments, valuation
of a CLN may be difficult due to the complexity of the
security.
Bank
Instruments. Bank instruments
are unsecured interest bearing bank deposits. Bank instruments include, but are
not limited to, certificates of deposit, time deposits, and banker’s acceptances
from U.S. or foreign banks, as well as Eurodollar certificates of deposit
(Eurodollar CDs) and Eurodollar time deposits of foreign branches of domestic
banks. Some certificates of deposit are negotiable interest-bearing instruments
with a specific maturity issued by banks and savings and loan institutions in
exchange for the deposit of funds, and can typically be traded in the secondary
market prior to maturity. Other certificates of deposit, like time deposits, are
non-negotiable receipts issued by a bank in exchange for the deposit of funds
which earns a specified rate of interest over a definite period of time;
however, it cannot be traded in the secondary market. A banker’s acceptance is a
bill of exchange or time draft drawn on and accepted by a commercial
bank.
36
An
investment in Eurodollar CDs or Eurodollar time deposits may involve some of the
same risks that are described for
Foreign Securities.
Commercial
Instruments. Commercial
instruments include commercial paper, master notes and other short-term
corporate instruments, that are denominated in U.S. dollars or foreign
currencies.
Commercial
instruments are a type of instrument issued by large banks and corporations to
raise money to meet their
short-term debt obligations, and are only backed by the issuing bank or
corporation’s promise to pay the face amount on the maturity date specified on
the note. Commercial paper consists of short-term promissory notes issued by
corporations. Commercial paper may be traded in the secondary market after its
issuance. Master notes are demand notes that permit the investment of
fluctuating amounts of money at varying rates of interest pursuant to
arrangements with issuers who meet certain credit quality criteria. The interest
rate on a master note may fluctuate based on changes in specified interest rates
or may be reset periodically according to a prescribed formula or may be a set
rate. Although there is no secondary market in master notes, if such notes have
a demand feature, the payee may demand payment of the principal amount of the
note upon relatively short notice. Master notes are generally illiquid and
therefore typically subject to the Funds' percentage limitations for investments
in illiquid investments. Commercial instruments may not be registered with the
SEC.
Invesco
Fundamental
Alternatives Fund and Invesco
Global
Allocation Fund do not
currently intend to invest more than 5% of its total assets in master notes. The
Funds have no limitations on the type of issuer from whom these notes will be
purchased.
Commercial
Paper.
Commercial paper is short-term unsecured, promissory notes of domestic or
foreign companies that is rated in the three top rating categories of a
nationally recognized statistical rating organization.
Synthetic
Municipal Instruments. Synthetic
municipal instruments are instruments, the value of and return on which are
derived from underlying securities. Synthetic municipal instruments in
which the Funds may invest include tender option bonds, and fixed or variable
rate trust certificates. These types of instruments involve the deposit into a
trust or custodial account of one or more long-term tax-exempt bonds or notes
(Underlying Bonds), and the sale of certificates evidencing interests in the
trust or custodial account to investors such as the Funds. The trustee or
custodian receives the long-term fixed rate interest payments on the Underlying
Bonds, and pays certificate holders fixed rates or short-term floating or
variable interest rates which are reset periodically. A “tender option bond”
provides a certificate holder with the conditional right to sell its certificate
to the sponsor or some designated third party at specified intervals and receive
the par value of the certificate plus accrued interest (a demand feature). A
"fixed rate trust certificate" evidences an interest in a trust entitling a
certificate holder to fixed future interest and/or principal payments on the
Underlying Bonds. A “variable rate trust certificate” evidences an interest in a
trust entitling the certificate holder to receive variable rate interest based
on prevailing short-term interest rates and also typically provides the
certificate holder with the conditional demand feature (the right to tender its
certificate at par value plus accrued interest under certain
conditions).
All
synthetic municipal instruments must meet the minimum quality standards for the
Funds' investments and must present
minimal credit risks. In selecting synthetic municipal instruments for the
Funds, Invesco considers the creditworthiness of the issuer of the Underlying
Bond, the sponsor and the party providing certificate holders with a conditional
right to sell their certificates at stated times and prices (a demand
feature).
Typically,
a certificate holder cannot exercise the demand feature until the occurrence of
certain conditions, such as
where the issuer of the Underlying Bond defaults on interest payments. Moreover,
because synthetic municipal instruments involve a trust or custodial account and
a third party conditional demand feature, they involve complexities and
potential risks that may not be present where a municipal security is owned
directly.
The
tax-exempt character of the interest paid to certificate holders is based on the
assumption that the holders have an
ownership interest in the Underlying Bonds; however, the IRS has not issued a
ruling
37
addressing
this issue. In the event the IRS issues an adverse ruling or successfully
litigates this issue, it is possible that the
interest paid to the Funds on certain synthetic municipal instruments would be
deemed to be taxable. The Funds rely on opinions of special tax counsel on this
ownership question and opinions of bond counsel regarding the tax-exempt
character of interest paid on the Underlying Bonds.
Municipal
Securities. Municipal
Securities are typically debt obligations of states, territories or possessions
of the United States and the District of Columbia and their political
subdivisions, agencies and instrumentalities, the interest on which, in the
opinion of bond counsel or other counsel to the issuers of such securities, is,
at the time of issuance, exempt from federal income tax. The issuers of
municipal securities obtain funds for various public purposes, including the
construction of a wide range of public facilities such as airports, highways,
bridges, schools, hospitals, housing, mass transportation, streets and water and
sewer works. Other public purposes for which municipal securities may be issued
include refunding outstanding obligations, obtaining funds for general operating
expenses and obtaining funds to lend to other public institutions and
facilities.
Certain
types of municipal securities are issued to obtain funding for privately
operated facilities. The credit and quality
of private activity debt securities are dependent on the private facility or
user, who is responsible for the interest payment and principal
repayment.
The
two major classifications of Municipal Securities are bonds and notes. Municipal
bonds are municipal debt obligations in
which the issuer is obligated to repay the original (or “principal”) payment
amount on a certain maturity date along with interest. A municipal bond’s
maturity date (the date when the issuer of the bond repays the principal) may be
years in the future. Short-term bonds mature in one to three years, while
long-term bonds usually do not mature for more than a decade. Notes are
short-term instruments which usually mature in less than two years. Most notes
are general obligations of the issuing municipalities or agencies and are sold
in anticipation of a bond sale, collection of taxes or receipt of other
revenues. Municipal notes also include tax, revenue notes and revenue and bond
anticipation notes (discussed more fully below) of short maturity, generally
less than three years, which are issued to obtain temporary funds for various
public purposes.
Municipal
debt securities may also be classified as general obligation or revenue
obligations (or "special delegation
securities"). General obligation securities are secured by the issuer's pledge
of its faith, credit and taxing power for the payment of principal and
interest.
Revenue
debt obligations, such as revenue bonds and revenue notes, are usually payable
only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue source but not from
the general taxing power. The principal and interest payments for industrial
development bonds or pollution control bonds are often the sole responsibility
of the industrial user and therefore may not be backed by the taxing power of
the issuing municipality. The interest paid on such bonds may be exempt from
federal income tax, although current federal tax laws place substantial
limitations on the purposes and size of such issues. Such obligations are
considered to be Municipal Securities provided that the interest paid thereon,
in the opinion of bond counsel, qualifies as exempt from federal income tax.
However, interest on municipal securities may give rise to a federal alternative
minimum tax (AMT) liability for noncorporate taxpayers and may have other
collateral federal income tax consequences. There is a risk that some or all of
the interest received by the Fund from tax-exempt municipal securities might
become taxable as a result of tax law changes or determinations of the
IRS.
Another
type of revenue obligations is pre-refunded bonds, which are typically issued to
refinance debt. In other words,
pre-refunded bonds result from the advance refunding of bonds that are not
currently redeemable. The proceeds from the issue of the lower yield and/or
longer maturing pre-refunding bond will usually be used to purchase U.S.
government obligations, such as U.S. Treasury securities, which are held in an
escrow account and used to pay interest and principal payments until the
scheduled call date of the original bond issue occurs. Like other fixed income
securities, pre-refunded bonds are subject to interest rate, market, credit, and
reinvestment risks. However, because pre-refunded bonds are generally
collateralized with
38
U.S.
government obligations, such pre-refunded bonds have essentially the same risks
of default as an AAA-rated security. The Fund
will treat such pre-refunded securities as investment-grade securities,
notwithstanding the fact that the issuer of such securities may have a lower
rating (such as a below-investment-grade rating) from one or more rating
agencies.
Within
these principal classifications of municipal securities, there are a variety of
types of municipal securities,
including but not limited to, fixed and variable rate securities, variable rate
demand notes, municipal leases, custodial receipts, participation certificates,
inverse floating rate securities, and derivative municipal
securities.
After
purchase by a Fund, an issue of Municipal Securities may cease to be rated by
Moody's Investors Service, Inc.
(Moody's) or S&P Global Ratings Services (S&P), or another nationally
recognized statistical rating organization (NRSRO), or the rating of such a
security may be reduced below the minimum credit quality rating required for
purchase by the Fund. Neither event would require a Fund to dispose of the
security. To the extent that the ratings applied by Moody’s, S&P or another
NRSRO to Municipal Securities may change as a result of changes in these rating
systems, a Fund will attempt to use comparable credit quality ratings as
standards for its investments in Municipal Securities.
The
yields on Municipal Securities are dependent on a variety of factors, including
general economic and monetary
conditions, money market factors, conditions of the Municipal Securities market,
size of a particular offering, and maturity and rating of the obligation.
Because many Municipal Securities are issued to finance similar projects,
especially those related to education, health care, transportation and various
utilities, conditions in those sectors and the financial condition of an
individual municipal issuer can affect the overall municipal market. The market
values of the Municipal Securities held by a Fund will be affected by changes in
the yields available on similar securities. If yields increase following the
purchase of a Municipal Security, the market value of such Municipal Security
will generally decrease. Conversely, if yields decrease, the market value of a
Municipal Security will generally increase. The ratings of S&P and Moody’s
represent their opinions of the quality of the municipal securities they
undertake to rate. It should be emphasized, however, that ratings are general
and are not absolute standards of quality. Consequently, municipal securities
with the same maturity, coupon and rating may have different yields while
municipal securities of the same maturity and coupon with different ratings may
have the same yield.
Certain
of the municipal securities in which the Funds may invest represent relatively
recent innovations in the municipal
securities markets and the markets for such securities may be less developed
than the market for conventional fixed rate municipal securities.
Under
normal market conditions, longer-term municipal securities generally provide a
higher yield than shorter-term
municipal securities. The Funds have no limitation as to the maturity of
municipal securities in which they may invest. The Adviser may adjust the
average maturity of a Fund’s portfolio from time to time depending on its
assessment of the relative yields available on securities of different
maturities and its expectations of future changes in interest rates.
The
net asset value of a Fund will change with changes in the value of its portfolio
securities. With fixed income municipal
securities, the net asset value of a Fund can be expected to change as general
levels of interest rates fluctuate. When interest rates decline, the value of a
portfolio invested in fixed income securities generally can be expected to rise.
Conversely, when interest rates rise, the value of a portfolio invested in fixed
income securities generally can be expected to decline. The prices of longer
term municipal securities generally are more volatile with respect to changes in
interest rates than the prices of shorter term municipal securities. Volatility
may be greater during periods of general economic uncertainty.
Municipal
Securities, like other debt obligations, are subject to the credit risk of
nonpayment. The ability of issuers of
municipal securities to make timely payments of interest and principal may be
adversely impacted in general economic downturns and as relative governmental
cost burdens are allocated and reallocated among federal, state and local
governmental units. Such nonpayment would result in a reduction of income to a
Fund, and could result in a reduction in the value of the municipal securities
experiencing nonpayment and
39
a
potential decrease in the net asset value of the Fund. In addition, a Fund may
incur expenses to work out or restructure a
distressed or defaulted security.
The
Funds may invest in Municipal Securities with credit enhancements such as
letters of credit and municipal bond
insurance. The Funds may invest in Municipal Securities that are insured by
financial insurance companies. Since a limited number of entities provide such
insurance, a Fund may invest more than 25% of its assets in securities insured
by the same insurance company. If a Fund invests in Municipal Securities backed
by insurance companies and other financial institutions, changes in the
financial condition of these institutions could cause losses to the Fund and
affect share price. Letters of credit are issued by a third party, usually a
bank, to enhance liquidity and ensure repayment of principal and any accrued
interest if the underlying Municipal Bond should default. These credit
enhancements do not guarantee payments or repayments on the Municipal Securities
and a downgrade in the credit enhancer could affect the value of the Municipal
Security.
If
the IRS determines that an issuer of a Municipal Security has not complied with
applicable tax requirements,
interest from the security could be treated as taxable, which could result in a
decline in the security’s value. In addition, there could be changes in
applicable tax laws or tax treatments that reduce or eliminate the current
federal income tax exemption on Municipal Securities or otherwise adversely
affect the current federal or state tax status of Municipal Securities. For
example, 2017 legislation commonly known as the Tax Cuts and Jobs Act repeals
the exclusion from gross income for interest on pre-refunded municipal
securities effective for such bonds issued after December 31, 2017.
Taxable
municipal securities are debt securities issued by or on behalf of states and
their political subdivisions, the
District of Columbia, and possessions of the United States, the interest on
which is not exempt from federal income tax. Taxable investments include, for
example, hedging instruments, repurchase agreements, and many of the types of
securities the Fund would buy for temporary defensive purposes.
At
times, in connection with the restructuring of a municipal bond issuer either
outside of bankruptcy court in a negotiated
workout or in the context of bankruptcy proceedings, the Fund may determine or
be required to accept equity or taxable debt securities, or the underlying
collateral (which may include real estate or loans) from the issuer in exchange
for all or a portion of the Fund’s holdings in the municipal security. Although
the Adviser will attempt to sell those assets as soon as reasonably practicable
in most cases, depending upon, among other things, the Adviser’s valuation of
the potential value of such assets in relation to the price that could be
obtained by the Fund at any given time upon sale thereof, the Fund may determine
to hold such securities or assets in its portfolio for limited period of time in
order to liquidate the assets in a manner that maximizes their value to the
Fund.
Municipal
Securities also include,
but
are not limited to, the following
securities:
•
Bond Anticipation
Notes usually are general obligations of state and local governmental issuers
which are sold to obtain interim financing for projects that will eventually be
funded through the sale of long-term debt obligations or bonds.
•
Revenue
Anticipation Debt Securities, including bonds, notes, and certificates, are
issued by governments or governmental bodies with the expectation that future
revenues from a designated source will be used to repay the securities. In
general, they also constitute general obligations of the issuer.
•
Tax Anticipation
Notes are issued by state and local governments to finance the current
operations of such governments. Repayment is generally to be derived from
specific future tax revenues.
•
Tax-Exempt
Commercial Paper (Municipal Paper) is similar to taxable commercial paper,
except that tax-exempt commercial paper is issued by states, municipalities and
their agencies.
•
Tax-Exempt
Mandatory Paydown Securities (TEMPS) are fixed rate term bonds carrying a
short-term maturity, usually three to four years beyond the expected redemption.
TEMPS are structured as bullet repayments, with required optional redemptions as
entrance fees are collected.
40
•
Zero Coupon and
Pay-in-Kind Securities do not immediately produce cash income. These securities
are issued at an original issue discount, with the full value, including accrued
interest, paid at maturity. Interest income may be reportable annually, even
though no annual payments are made. Market prices of zero coupon bonds tend to
be more volatile than bonds that pay interest regularly. Pay-in-kind securities
are securities that have interest payable by delivery of additional securities.
Upon maturity, the holder is entitled to receive the aggregate par value of the
securities. Zero coupon and pay-in-kind securities may be subject to greater
fluctuation in value and less liquidity in the event of adverse market
conditions than comparably rated securities paying cash interest at regular
interest payment periods. Prices on non-cash-paying instruments may be more
sensitive to changes in the issuer’s financial condition, fluctuation in
interest rates and market demand/supply imbalances than cash-paying securities
with similar credit ratings, and thus may be more speculative. Special tax
considerations are associated with investing in certain lower-grade securities,
such as zero coupon or pay-in-kind securities.
•
Capital
Appreciation Bonds are municipal securities in which the investment return on
the initial principal payment is reinvested at a compounded rate until the bond
matures. The principal and interest are due on maturity. Thus, like zero coupon
securities, investors must wait until maturity to receive interest and
principal, which increases the interest rate and credit risks.
•
Payments in lieu of
taxes (also known as PILOTs) are voluntary payments by, for instance the U.S.
government or nonprofits, to local governments that help offset losses in or
otherwise serve as a substitute for property taxes.
•
Converted Auction
Rate Securities (CARS) are a structure that combines the debt service deferral
feature of Capital Appreciation Bonds (CABS) with Auction Rate Securities. The
CARS pay no debt service until a specific date, then they incrementally convert
to conventional Auction Rate Securities. At each conversion date the issuer has
the ability to call and pay down any amount of the CARS.
Some
bonds may be “callable,” allowing the issuer to redeem them before their
maturity date. To protect
bondholders, callable bonds may be issued with provisions that prevent them from
being called for a period of time. Typically, that is 5 to 10 years from the
issuance date. When interest rates decline, if the call protection on a bond has
expired, it is more likely that the issuer may call the bond. If that occurs,
the Fund might have to reinvest the proceeds of the called bond in investments
that pay a lower rate of return, which could reduce the Fund’s
yield.
Inverse
Floating Rate Interests. Inverse floating
rate interests
(Inverse
Floaters)
are
issued in connection with municipal tender option
bond (TOB) financing
transactions to generate leverage for the Fund. Such instruments
are created by a special purpose trust (a TOB Trust) that
holds long-term fixed rate bonds
sold
to it by the Fund (the underlying
security), and issues two classes of
beneficial interests: short-term floating rate interests
(Floaters),
which
are sold to other investors, and Inverse
Floaters, which are
purchased by the Fund. The Floaters have
first priority on the cash flow from the underlying security held by the TOB
Trust, have a tender option feature that allows holders to tender the Floaters
back to the TOB Trust for their par amount and accrued
interest at specified
intervals and bear interest at prevailing short-term interest rates.
Tendered Floaters
are remarketed for sale to other investors for their par amount and accrued
interest by a remarketing agent to the TOB Trust and are ultimately supported by
a liquidity facility provided by a bank, upon which the TOB Trust can draw funds
to pay such amount to holders of Tendered Floaters that cannot be remarketed.
The Fund,
as
holder of the Inverse
Floaters, is paid the
residual cash flow from the underlying
security. Accordingly, the Inverse
Floaters provide the Fund
with leveraged exposure to the underlying security. When short-term
interest rates rise or fall, the interest payable
on
the
Floaters issued by a TOB Trust will, respectively, rise or
fall,
leaving less or
more, respectively,
residual interest
cash flow from the underlying security available for payment on the Inverse
Floaters. Thus,
as
short-term interest rates
rise,
Inverse Floaters
produce less income for the Fund,
and as
short-term interest rates
decline,
Inverse Floaters
produce more income for the Fund.
The
price of Inverse
Floaters is
expected to decline when interest rates rise and increase when interest rates
decline,
in
either case generally more so than the price of a bond with a similar maturity,
because of the effect of leverage. As a result, the price of Inverse Floaters is
typically more volatile
41
than
the price of bonds with similar maturities, especially if the relevant TOB Trust
is structured to provide the holder of the
Inverse Floaters relatively greater leveraged exposure to the underlying
security (e.g., if the par amount of the Floaters, as a percentage of the par
amount of the underlying security, is relatively greater). Upon the occurrence
of certain adverse events (including a credit ratings downgrade of the
underlying security or a substantial decrease in the market value of the
underlying security), a TOB Trust may be collapsed by the remarketing agent or
liquidity provider and the underlying security liquidated, and the Fund could
lose the entire amount of its investment in the Inverse Floater and may, in some
cases, be contractually required to pay the shortfall, if any, between the
liquidation value of the underlying security and the principal amount of the
Floaters. Consequently, in a rising
interest rate environment, the Fund’s
investments in Inverse Floaters could negatively impact the Fund’s performance
and yield, especially when those Inverse Floaters provide the Fund with
relatively greater
leveraged exposure
to the underlying securities held by the relevant TOB Trusts.
Final
rules implementing section 619 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Volcker Rule)
prohibit banking entities and their affiliates
from sponsoring and/or providing certain services to TOB Trusts, which
constitute “covered
funds” under the Volcker
Rule. As a result of the
Volcker Rule, the Fund, as holder of
Inverse
Floaters, is required
to
perform certain duties in connection with
TOB financing transactions previously
performed by banking entities. These duties may alternatively be performed by a
non-bank third-party service provider. A Fund’s expanded role in TOB financing
transactions as a result of the Volcker Rule may increase its
operational and regulatory risk.
Further,
the SEC and various banking agencies have adopted rules implementing credit risk
retention requirements for
asset-backed securities (the Risk Retention Rules), which apply to TOB
financing
transactions and TOB Trusts. The Risk
Retention Rules require the sponsor of a TOB Trust, which is deemed to be the
Fund (as holder of the
related Inverse Floaters), to retain at
least 5% of the credit risk of the underlying security held by the TOB Trust. As
applicable, the Fund
has
adopted policies and procedures
intended to comply
with the Risk Retention Rules. The Risk Retention Rules may adversely affect the
Fund’s
ability to engage
in TOB financing transactions or
increase the costs of such transactions in certain circumstances.
There
can be no assurances that TOB financing
transactions will continue to
be a viable or cost-effective
form
of leverage. The
unavailability of
TOB financing transactions or an increase in the cost of financing
provided by TOB
transactions may adversely affect
the Fund’s net asset value, distribution rate and ability to achieve its
investment objective.
Municipal
Lease Obligations. Municipal lease
obligations are issued by state and local governments or authorities to finance
the acquisition of land, equipment and facilities, such as state and municipal
vehicles, telecommunications and computer equipment, and other capital
assets. Municipal lease obligations, another type of Municipal Security,
may take the form of a lease, an installment purchase contract or a conditional
sales contract. Interest payments on qualifying municipal lease obligations are
generally exempt from federal income taxes.
Municipal
lease obligations are generally subject to greater risks than general obligation
or revenue bonds. State laws
set forth requirements that states or municipalities must meet in order to issue
municipal obligations, and such obligations may contain a covenant by the issuer
to budget for, appropriate, and make payments due under the obligation. However,
certain municipal lease obligations may contain "non-appropriation" clauses
which provide that the issuer is not obligated to make payments on the
obligation in future years unless funds have been appropriated for this purpose
each year. If not enough money is appropriated to make the lease payments, the
leased property may be repossessed as security for holders of the municipal
lease obligation. In such an event, there is no assurance that the property's
private sector or re-leasing value will be enough to make all outstanding
payments on the municipal lease obligation or that the payments will continue to
be tax-free. Additionally, it may be difficult to dispose of the underlying
capital asset in the event of non-appropriation or other default. Direct
investments by the Fund in municipal lease obligations may be deemed illiquid
and therefore subject to the Funds' percentage limitations for illiquid
investments and the risks of holding illiquid
investments.
42
Municipal
Forward Contracts. A municipal
forward contract is an agreement by a Fund to purchase a Municipal Security on a
when-issued basis with a longer-than-standard settlement period, in some cases
with the settlement date taking place up to five years from the date of
purchase. Municipal forward contracts typically carry a substantial yield
premium to compensate the buyer for the risks associated with a long when-issued
period, including shifts in market interest rates that could materially impact
the principal value of the bond, deterioration in the credit quality of the
issuer, loss of alternative investment options during the when-issued period and
failure of the issuer to complete various steps required to issue the
bonds.
Municipal
Market Data Rate Locks. A Municipal Market
Data Rate Lock (MMD Rate Lock) permits a Fund to lock in a specified municipal
interest rate for a portion of its portfolio to preserve a return on a
particular investment or a portion of its portfolio as a duration management
technique or to protect against any increase in the price of securities to be
purchased at a later date. MMD Rate Locks may be used for hedging purposes. An
MMD Rate Lock is an agreement between two parties, a Fund and an MMD Rate Lock
provider, pursuant to which the parties agree to make payments to each other on
a notional amount, contingent upon whether the Municipal Market Data AAA General
Obligation Scale is above or below a specified level on the expiration date of
the contract.
MMD
Rate Locks involve the risk that municipal yields will move in the direction
opposite than the direction
anticipated by a Fund. The risk of loss with respect to MMD Rate Locks is
limited to the amount of payments a Fund is contractually obligated to make. If
the other party to an MMD Rate Lock defaults, a Fund's risk of loss consists of
the amount of payments that the Fund contractually is entitled to receive. If
there is a default by the counterparty, a Fund may have contractual remedies
pursuant to the agreements related to the transaction, but they could be
difficult to enforce.
Investment
Grade Debt Obligations. Each Fund may
invest in U.S. dollar-denominated debt obligations issued or guaranteed by U.S.
corporations or U.S. commercial banks, U.S. dollar-denominated obligations of
foreign issuers or debt obligations of foreign issuers denominated in foreign
currencies. Debt obligations include, among others, bonds, notes, debentures and
variable rate demand notes. They may be U.S. dollar-denominated debt obligations
issued or guaranteed by U.S. corporations or U.S. commercial banks, U.S.
dollar-denominated obligations of foreign issuers or debt obligations of foreign
issuers denominated in foreign currencies.
The
Adviser considers investment grade securities to include: (i) securities rated
BBB- or higher by S&P or Baa3 or higher
by Moody’s or an equivalent rating by another NRSRO, (ii) short-term securities
with comparable NRSRO ratings, or (iii) unrated securities determined by the
Adviser to be of comparable quality, each at the time of purchase. The
Adviser may rely to
some extent on credit ratings by NRSROs in evaluating the credit risk of
securities selected for the Fund’s portfolio. Credit ratings evaluate the
expectation that scheduled interest and principal payments will be made in a
timely manner. They do not reflect any judgment of market risk. Ratings and
market value may change from time to time, positively or negatively, to reflect
new developments regarding the issuer. Rating organizations might not change
their credit rating of an issuer in a timely manner to reflect events that could
affect the issuer’s ability to make timely payments on its obligations. The
Fund’s Adviser internally assigns ratings to unrated securities, after assessing
their credit quality and other factors, in investment-grade or
below-investment-grade categories similar to those of NRSROs. There can be no
assurance, nor is it intended, that the Fund’s Adviser’s credit analysis process
is consistent or comparable with the credit analysis process used by a NRSRO.
The descriptions of
debt securities ratings are found in Appendix A.
In
choosing corporate debt securities on behalf of a Fund, portfolio managers may
consider:
i.
general economic
and financial conditions;
ii.
the specific
issuer’s (a) business and management, (b) cash flow, (c) earnings coverage of
interest and dividends, (d) ability to operate under adverse economic
conditions, (e) fair market value of assets, and (f) in the case of foreign
issuers, unique political, economic or social conditions applicable to such
issuer’s country; and,
iii.
other
considerations deemed appropriate.
43
Debt
securities are subject to a variety of risks, such as interest rate risk, income
risk, prepayment risk, inflation risk,
credit risk, currency risk and default risk.
Non-Investment
Grade Debt Obligations (Junk Bonds). Each Fund, other
than Invesco Balanced-Risk Allocation Fund, Invesco Balanced-Risk Commodity
Strategy Fund
and
Invesco Macro Allocation Strategy Fund, may invest in lower-rated or
non-rated debt securities commonly known as junk bonds. Invesco Developing
Markets Fund and Invesco Health Care Fund may invest up to 5% of their total
assets in junk bonds, including junk bonds of companies located in developing
countries. Bonds rated below or determined to be below investment grade (as
defined above in “Investment Grade Debt Obligations”) are commonly referred to
as “junk bonds.” Analysis of the creditworthiness of junk bond issuers is more
complex than that of investment-grade issuers and the success of the
Adviser in managing these
decisions is more dependent upon its own credit analysis than is the case with
investment-grade bonds. Descriptions of
debt securities ratings are found in Appendix A.
The
capacity of junk bonds to pay interest and repay principal is considered
speculative. While junk bonds may provide an
opportunity for greater income and gains, they are subject to greater risks than
higher-rated debt securities. The prices of and yields on junk bonds may
fluctuate to a greater extent than those of higher-rated debt securities. Junk
bonds are generally more sensitive to individual issuer developments, economic
conditions and regulatory changes than higher-rated bonds. Issuers of junk bonds
are often smaller, less-seasoned companies or companies that are highly
leveraged with more traditional methods of financing unavailable to them. Junk
bonds are generally at a higher risk of default because such issues are often
unsecured or otherwise subordinated to claims of the issuer’s other creditors.
If a junk bond issuer defaults, a Fund may incur additional expenses to seek
recovery. The secondary markets in which junk bonds are traded may be thin and
less liquid than the market for higher-rated debt securities and a Fund may have
difficulty selling certain junk bonds at the desired time and price. Less
liquidity in secondary trading markets could adversely affect the price at which
a Fund could sell a particular junk bond, and could cause large fluctuations in
the net asset value of that Fund’s shares. The lack of a liquid secondary market
may also make it more difficult for a Fund to obtain accurate market quotations
in valuing junk bond assets and elements of judgment may play a greater role in
the valuation.
Interest
Rate Benchmarks for Floating Rate Loans. Interest rates on
floating rate loans adjust periodically based on a benchmark rate plus a premium
or spread over the benchmark rate. The benchmark rate usually is the Prime Rate,
LIBOR, the Federal Reserve federal funds rate, or other base lending rates used
by commercial lenders (each as defined in the applicable loan agreement). See
“LIBOR Transition Risk” for more information regarding LIBOR.
•
The Prime Rate
quoted by a major U.S. bank is generally the interest rate at which that bank is
willing to lend U.S. dollars to its most creditworthy borrowers, although it may
not be the bank’s lowest available rate.
•
LIBOR usually is an
average of the interest rates quoted by several designated banks as the rates at
which they pay interest to major depositors in the London interbank market on
deposits in a particular currency. For U.S. dollar-denominated senior loans, any
applicable LIBOR rate for senior loans would be in respect of U.S. dollar
deposits. The market views changes in short-term LIBOR rates as closely related
to changes in the Federal Reserve federal funds rate, although the two are not
officially related.
•
The Federal Reserve
Bank of New York has identified the Secured Overnight Financing Rate (“SOFR”) as
the intended replacement to USD LIBOR and foreign regulators have proposed other
interbank offered rates, such as the Sterling Overnight Index Average (“SONIA”)
and other replacement rates, which could also be adopted.
•
The Federal Reserve
federal funds rate is the rate that the Federal Reserve Bank charges member
banks for borrowing money.
The
interest rate on Prime Rate-based loans floats daily as the Prime Rate changes,
while the interest rate on LIBOR based
loans is reset periodically, typically between 30 days and one year. Quarterly
interest
44
periods
are most common for floating rate loans in which a Fund invests. Certain
floating or variable rate loans may permit
the borrower to select an interest rate reset period of up to one year (although
interest periods longer than six months will often require lender consent).
Investing in loans with longer interest rate reset periods or fixed interest
rates may increase fluctuations in a Fund’s net asset value as a result of
changes in market interest rates: falling short-term floating interest rates
tend to decrease the income payable to a Fund on its floating rate loan
investments, and rising short-term floating interest rates tend to increase that
income. However, a Fund may attempt to hedge its fixed rate loans against
interest rate fluctuations by entering into interest rate swaps or total return
swap transactions. Nevertheless, changes in interest rates can affect the value
of a Fund’s floating rate loans, especially if rates change sharply in a short
period, because the resets of the interest rates on the underlying portfolio of
floating rate loans occur periodically and will not all happen simultaneously
with changes in prevailing rates.
Floating
rate loans are generally structured so that borrowers pay higher margins when
they elect LIBOR-based borrower options.
This permits lenders to obtain generally consistent yields on floating rate
loans, regardless of whether borrowers select the LIBOR-based options or the
Prime-based option. In market conditions where the differential between the
lower LIBOR base rates and the higher Prime Rate base rates prevailing in the
commercial bank markets has widened to the point that the higher margins paid by
borrowers for LIBOR based pricing options do not compensate for the differential
between the Prime Rate and the LIBOR base rates, borrowers may select the
LIBOR-based pricing option, resulting in a yield on floating rate loans that is
consistently lower than the yield available from the Prime Rate-based pricing
option. In sustained periods of such market conditions, this tendency will
significantly limit the ability of a Fund to achieve a net return to
shareholders that consistently approximates the average published Prime Rate of
leading U.S. banks. The Advisor or
Sub-Adviser cannot
predict the occurrence of these conditions nor their duration in the event they
do occur.
In
addition, in market conditions where short term interest rates are particularly
low, certain floating rate loans may be issued
with a feature that prevents the relevant benchmark rate from adjusting below a
specified minimum level. This is achieved by defining a “floor” to the benchmark
rate, so that if downward market movements of the benchmark rate would, absent
this feature, cause the benchmark rate to fall below the floor, with this
feature, the benchmark rates of these floating rate loans become fixed at the
applicable minimum floor level until short term interest rates (and therefore
the benchmark rate) rise above that level. Although this feature is intended to
result in these floating rate loans yielding more than they otherwise would when
short term interest rates are low, the feature might also result in the
secondary market prices of these floating rate loans becoming more sensitive to
changes in interest rates should short term interest rates rise.
A
Fund may invest in loans having a fixed rate of interest, however it is unlikely
to do so given fixed rate loans are uncommon
in the loan market generally.
Prepayment
Risk and Loans. Loans typically
have mandatory and optional prepayment provisions. Because of prepayments, the
actual remaining maturity of a loan may be considerably less than its stated
maturity. The reinvestment by a Fund of the proceeds of prepaid loans could
result in a reduction of income to a Fund in falling interest rate environments.
Prepayment penalty fees that may be assessed in some cases may help offset the
loss of income to a Fund in those cases.
Subordination. Senior loans
generally hold the most senior position in a borrower’s capital structure.
Borrowers generally are required contractually to pay the holders of senior
loans before they pay the holders of corporate bonds or subordinated debt and
preferred or common stockholders. Lenders obtain priority liens that typically
provide the first right to cash flows or proceeds from the sale of a borrower’s
collateral, if any, if the borrower becomes insolvent. That right is subject to
the limitations of bankruptcy law, which may provide higher priority to certain
other claims such as, for example, employee salaries, employee pensions and
taxes. Senior loans are subject to the risk that a court could subordinate a
senior loan to presently existing or future indebtedness or take other action
detrimental to the holders of senior loans.
Lien
Position. Loans that are
collateralized may have multiple lenders or other creditors that take different
lien positions. This means that if the borrower defaults on its obligations
under the loan and the loan creditors enforce their security interest or if the
borrower becomes bankrupt, the secured claims of the
45
creditors
in the first lien position will be satisfied prior to the secured claims of the
creditors in the second lien position. If the
cash flow and assets of the borrower are insufficient to satisfy both the first
lien loans and the second lien loans in full, the creditors in the second lien
position may not be satisfied in full. Intercreditor arrangements that are often
present where a loan has first and second lien positions typically include
‘standstill’ provisions whereby the enforcement rights of second lien creditors
are restricted in favor of the first lien creditors’ rights and give the first
lien creditors the right to accept or reject any restructuring plans in the
event of the default or insolvency of the borrower. If a loan has first and
second lien positions, typically a Fund will invest in the first lien position;
however, it may invest in the second lien position. Second lien positions
generally pay a higher margin than first lien positions to compensate second
lien creditors for the greater risk they assume.
Collateral. Loans, like other
debt obligations, are subject to the risk of the borrower’s non-payment of
scheduled interest and/or principal. While certain of a Fund’s investments in
loans may be secured by collateral that the investment adviser believes to be
equal to or in excess of the principal amount of the loan at the time of
investment, there can be no assurance that the liquidation of such collateral,
if any, would satisfy the borrower’s obligations in the event of non-payment of
scheduled interest or principal payments, or that the collateral could be
readily liquidated. In the event of a borrower’s bankruptcy, a Fund could
experience delays or limitations in its ability to realize the benefits of
collateral securing a loan.
For
the loans in which a Fund invests that are secured by collateral, that
collateral may include the borrower’s tangible
assets, such as cash, accounts receivable, inventory, real estate, buildings and
equipment, common and/or preferred stock of subsidiaries, and intangible assets
including trademarks, copyrights, patent rights and franchise value. A Fund may
also receive guarantees or other credit support as a form of security. A loan
agreement may or may not require the borrower to pledge additional collateral to
secure a loan if the value of the initial collateral declines, or if additional
assets are acquired by the borrower. Collateral may consist of assets that may
not be readily liquidated, and there is no assurance that the liquidation of
those assets would satisfy in full a borrower’s obligations under a loan. If the
collateral consists of stock of the borrower or its subsidiaries or affiliates,
the stock may lose all of its value in the event of a bankruptcy, which would
leave a Fund exposed to greater potential loss.
Generally,
the Agent for a particular loan is responsible for monitoring collateral and for
exercising remedies available
to the Lenders such as foreclosure upon collateral in the event of the
borrower’s default. However, the Agent will usually only be liable for its gross
negligence or willful misconduct, and not for ordinary negligence. In certain
circumstances, the loan agreement may authorize the Agent to liquidate the
collateral and to distribute the liquidation proceeds pro rata among the
lenders. A Fund may also invest in loans that are not secured by collateral.
Unsecured loans involve additional risk because the lenders are general
unsecured creditors of the borrower and any secured creditors may have prior
rights of recourse to the assets of the borrower, and the assets of the borrower
may be insufficient to satisfy in full all obligations owed to its
creditors.
Loans,
Loan Participations and Assignments. Loans and loan
participations are interests in amounts owed by a corporate, governmental or
other borrowers to another party. They may represent amounts owed to lenders or
lending syndicates, to suppliers of goods or services, or to other parties. A
Fund will have the right to receive payments of principal, interest and any fees
to which it is entitled only from the lender selling the participation and only
upon receipt by the lender of the payments from the borrower. In connection with
purchasing participations, a Fund generally will have no right to enforce
compliance by the borrower with the terms of the loan agreement relating to the
loan, nor any rights of set-off against the borrower, and a Fund may not
directly benefit from any collateral supporting the loan in which it has
purchased the participation. In addition, the Fund's rights to consent to
modifications of the loan are limited and it is dependent upon the participating
lender to enforce the Fund's rights upon a default. As a result, the Fund will
be subject to the credit risk of the borrower, the lender, and the agent who is
responsible for collection of principal and interest and fee payments from the
borrower and apportioning those payments to all lenders who are parties to the
loan agreement. In the event of the insolvency of the lender selling a
participation, the Fund may be treated as a general creditor of the lender and
may not benefit from any set-off between the lender and the borrower. Credit
risks relating to the agent may include delay in receiving payments of principal
and interest paid by the
46
borrower
to the agent. In the event of the borrower's bankruptcy, the borrower's
obligation to repay the loan may be subject to
defenses that the borrower can assert as a result of improper conduct by the
agent.
When
a Fund purchases assignments from lenders, it acquires direct rights against the
borrower on the loan. However,
because assignments are arranged through private negotiations between potential
assignees and potential assignors, the rights and obligations acquired by a Fund
as the purchaser of an assignment may differ from, and be more limited than,
those held by the assigning lender. In addition, if the loan is foreclosed, a
Fund could be part owner of any collateral and could bear the costs and
liabilities of owning and disposing of the collateral.
Investments
in loans, loan participations and assignments present the possibility that a
Fund could be held liable as a
co-lender under emerging legal theories of lender liability. The Fund
anticipates that loans, loan participations and assignments could be sold only
to a limited number of institutional investors. If there is no active secondary
market for a loan, it may be more difficult to sell the interests in such a loan
at a price that is acceptable or to even obtain pricing information. In
addition, some loans, loan participations and assignments may not be rated by
major rating agencies. Loans held by a Fund might not be considered securities
for purposes of the 1933 Act, or the
Securities
Exchange
Act of
1934, as amended (the
Exchange
Act),
and therefore a risk exists that purchasers, such as the Fund, may not be
entitled to rely on the anti-fraud provisions of those Acts.
The
secondary market for certain floating rate loans may be subject to irregular
trading activity, wide bid/ask spreads and
extended trade settlement periods (in some cases, longer than seven
days).
Floating
Rate Corporate Loans and Corporate Debt Securities. Floating rate
loans consist generally of obligations of companies and other entities
(collectively, borrowers) incurred for the purpose of reorganizing the assets
and liabilities of a borrower; acquiring another company; taking over control of
a company (leveraged buyout); temporary refinancing; or financing internal
growth or other general business purposes. Floating rate loans are often
obligations of borrowers who have incurred a significant percentage of debt
compared to equity issued and thus are highly leveraged.
Floating
rate loans may include both term loans, which are generally fully funded at the
time of a Fund’s investment, and
revolving loans, which may require a Fund to make additional investments in the
loans as required under the terms of the loan agreement. A revolving credit loan
agreement may require a Fund to increase its investment in a loan at a time when
a Fund might not otherwise have done so, even if the borrower’s condition makes
it unlikely that the loan will be repaid.
A
floating rate loan is generally offered as part of a lending syndicate to banks
and other financial institutions and is
administered in accordance with the terms of the loan agreement by an agent bank
who is responsible for collection of principal and interest and fee payments
from the borrower and apportioning those payments to all lenders who are parties
to the agreement. Typically, the agent is given broad discretion to enforce the
loan agreement and is compensated by the borrower for its services.
Floating
rate loans may be acquired by direct investment as a lender at the inception of
the loan or by assignment of a
portion of a floating rate loan previously made to a different lender or by
purchase of a participation interest. If a Fund makes a direct investment in a
loan as one of the lenders, it generally acquires the loan at par. This means a
Fund receives a return at the full interest rate for the loan. If a Fund
acquires its interest in loans in the secondary market or acquires a
participation interest, the loans may be purchased or sold above, at, or below
par, which can result in a yield that is below, equal to, or above the stated
interest rate of the loan. At times, a Fund may be able to invest in floating
rate loans only through assignments or participations.
A
participation interest represents a fractional interest in a floating rate loan
held by the lender selling a Fund the
participation interest. In the case of participations, a Fund will not have any
direct contractual relationship with the borrower, a Fund’s rights to consent to
modifications of the loan are limited and it is dependent upon the participating
lender to enforce each Fund’s rights upon a default.
47
A
Fund may be subject to the credit of both the agent and the lender from whom the
Fund acquires a participation
interest. These credit risks may include delay in receiving payments of
principal and interest paid by the borrower to the agent or, in the case of a
participation, offsets by the lender's regulator against payments received from
the borrower. In the event of the borrower's bankruptcy, the borrower's
obligation to repay the floating rate loan may be subject to defenses that the
borrower can assert as a result of improper conduct by the agent.
Historically,
floating rate loans have not been registered with the SEC or any state
securities commission or listed on any
securities exchange. As a result, the amount of public information available
about a specific floating rate loan has been historically less extensive than if
the floating rate loan were registered or exchange
traded.
Floating
rate debt securities are typically in the form of notes or bonds issued in
public or private placements in the
securities markets. Floating rate debt securities will typically have
substantially similar terms to floating rate loans, but will not be in the form
of participations or assignments.
The
floating rate loans and debt securities in which a Fund invests will, in most
instances, be secured and senior to other
indebtedness of the borrower. Each floating rate loan and debt security will
generally be secured by collateral such as accounts receivable, inventory,
equipment, real estate, intangible assets such as trademarks, copyrights and
patents, and securities of subsidiaries or affiliates. The value of the
collateral generally will be determined by reference to financial statements of
the borrower, by an independent appraisal, by obtaining the market value of such
collateral, in the case of cash or securities if readily ascertainable, or by
other customary valuation techniques considered appropriate by Invesco and/or
the Sub-Advisers. The value of collateral may decline after a Fund’s investment,
and collateral may be difficult to sell in the event of default. Consequently,
the Fund may not receive all the payments to which it is entitled. A Fund’s
assets may be invested in unsecured floating rate loans and debt securities or
subordinated floating rate loans and debt securities, which may or may not be
secured. If the borrower defaults on an unsecured loan or security, there is no
specific collateral on which the lender can foreclose. If the borrower defaults
on a subordinated loan or security, the collateral may not be sufficient to
cover both the senior and subordinated loans and securities.
Most
borrowers pay their debts from cash flow generated by their businesses. If a
borrower’s cash flow is insufficient to pay
its debts, it may attempt to restructure its debts rather than sell collateral.
Borrowers may try to restructure their debts by filing for protection under the
federal bankruptcy laws or negotiating a work-out. If a borrower becomes
involved in a bankruptcy proceeding, access to collateral may be limited by
bankruptcy and other laws. If a court decides that access to collateral is
limited or voidable, a Fund may not recover the full amount of principal and
interest that is due.
A
borrower must comply with certain restrictive covenants contained in the loan
agreement or indenture (in the case of
floating rate debt securities). In addition to requiring the scheduled payment
of principal and interest, these covenants may include restrictions on the
payment of dividends and other distributions to the borrower’s shareholders,
provisions requiring compliance with specific financial ratios, and limits on
total indebtedness. The agreement may also require the prepayment of the
floating rate loans or debt securities from excess cash flow. A breach of a
covenant that is not waived by the agent (or lenders directly) is normally an
event of default, which provides the agent and lenders the right to call for
repayment of the outstanding floating rate loan or debt security.
Over
time, the customary terms of loans have evolved such that they are no longer
accompanied by the various restrictive
covenants that historically accompanied most loans and that were in favor of the
investor. Newly originated loans (including reissuances and restructured loans)
in which a Fund may invest have varied terms and conditions, but generally
contain few or no financial maintenance covenants. Financial maintenance
covenants are those that require a borrower to maintain certain financial
metrics during the life of the loan, such as maintaining certain levels of cash
flow or limiting leverage. In the event of financial deterioration on the part
of the borrower, these covenants are included to permit the lenders to
renegotiate the terms of the loan, such as increasing the borrowing costs to the
borrower, or to take other actions which would improve the position of the
lender. Accordingly, the Fund may experience difficulty or delays in
48
enforcing
its rights on its holdings of loans, which may result in losses to the Fund,
especially during a downturn in the
credit cycle. Although loans may contain few or no financial maintenance
covenants, information necessary to monitor a borrower’s financial performance
may be available without covenants to lenders and the public alike and can be
used to detect such early warning signs as deterioration of a borrower’s
financial condition or results. When such information is available, the Adviser
or Sub-Adviser will seek to take appropriate action without the help of
covenants in the loans.
Purchasers
of floating rate loans may receive and/or pay certain fees. These fees are in
addition to interest payments
and may include commitment fees, facility fees, and prepayment penalty fees.
When a Fund buys a floating rate loan, it may receive a facility fee, and when
it sells a floating rate loan, it may pay an assignment fee.
In
general,
floating rate loans
and debt securities typically have stated
maturities of three to ten years. However, because floating rate loans and debt
securities are frequently prepaid, it is generally
expected that the
average maturity will be less. The degree to
which borrowers prepay floating rate loans and debt securities, whether as a
contractual requirement or at the borrower’s election, may be affected by
general business conditions, the borrower’s financial condition and competitive
conditions among lenders. Prepayments cannot be predicted with accuracy.
Prepayments may result in a Fund’s investing in floating rate loans and debt
securities with lower yields.
Companies
involved in significant restructuring tend to be subject to increased litigation
risk, including for investors in these
companies, such as the Funds. Expenses of asserting, or defending against,
claims in connection with such restructurings are generally directly or
indirectly borne by the Funds. See also “Litigation Risk.” herein.
Investments
in loans, loan participations and assignments present the possibility that a
Fund could be held liable as a
co-lender under emerging legal theories of lender liability. Each Fund
anticipates that loans, loan participations and assignments could be sold only
to a limited number of institutional investors. If there is no active secondary
market for a loan, it may be more difficult to sell the interests in such a loan
at a price that is acceptable or to even obtain pricing information. In
addition, some loans, loan participations and assignments may not be rated by
major rating agencies. Loans held by the Funds might not be considered
securities for the purposes of the 1933
Act or
the Securities Exchange Act of 1934, as amended (the Exchange Act), and
therefore a risk exists that purchasers, such as the Funds may not be entitled
to rely on the anti-fraud provisions of those Acts.
Public
Bank Loans. Public bank loans
are privately negotiated loans for which information about the issuer has been
made publicly available. Public loans are made by banks or other financial
institutions, and may be rated investment grade (as defined above in “Investment
Grade Debt Obligations”) or below investment grade. However, public bank loans
are not registered under the 1933 Act and are not publicly traded. They usually
are second lien loans normally lower in priority of payment to senior loans, but
have seniority in a company’s capital structure to other claims, such as
subordinated corporate bonds or publicly-issued equity so that in the event of
bankruptcy or liquidation, the company is required to pay down these second lien
loans prior to such other lower-ranked claims on their assets. Bank loans
normally pay floating rates that reset frequently, and as a result, protect
investors from increases in interest rates.
Bank
loans generally are negotiated between a borrower and several financial
institutional lenders represented by one
or more lenders acting as agent of all the lenders. The agent is responsible for
negotiating the loan agreement that establishes the terms and conditions of the
loan and the rights of the borrower and the lenders, monitoring any collateral,
and collecting principal and interest on the loan. By investing in a loan, a
Fund becomes a member of a syndicate of lenders. Certain bank loans are
illiquid, meaning the Fund may not be able to sell them quickly at a fair price.
Illiquid investments are also difficult to value. To the extent a bank loan has
been deemed illiquid, it will be subject to a Fund’s restrictions on illiquid
investments. The secondary market for bank loans may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement
periods.
49
Bank
loans are subject to the risk of default. Default in the payment of interest or
principal on a loan will result in a
reduction of income to a Fund, a reduction in the value of the loan, and a
potential decrease in the Fund’s net asset value. The risk of default will
increase in the event of an economic downturn or a substantial increase in
interest rates. Bank loans are subject to the risk that the cash flow of the
borrower and property securing the loan or debt, if any, may be insufficient to
meet scheduled payments. As discussed above, however, because bank loans reside
higher in the capital structure than high yield bonds, default losses have been
historically lower in the bank loan market. Bank loans that are rated below
investment grade share the same risks of other below investment grade
securities.
Investments
in Pooled Investment Entities that Invest in Loans. A Fund can buy
interests in trusts and other pooled entities (including other investment
companies) that invest primarily or exclusively in loan obligations, including
entities sponsored or advised by the Adviser or an affiliate. The loans
underlying these investments may include loans to foreign or U.S. borrowers, may
be collateralized or uncollateralized and may be rated investment-grade or
below, or may be unrated. These investments are subject to risks applicable to
loan investments, including the risk of default by the borrower, interest rate
and prepayment risk. The Fund will be subject to the pooled entity’s credit
risks as well as the credit risks of the underlying loans. There is a risk that
a borrower of the underlying loan may have difficulty making payments. If a
borrower fails to pay scheduled interest or principal payments, the Fund’s
income may be reduced and the value of the investment in the pooled entity might
also decline.
Structured
Notes and Indexed Securities. Structured notes
are derivative debt instruments, the interest rate or principal of which is
linked to currencies, interest rates, commodities, indices or other financial
indicators (reference instruments). Indexed securities may include structured
notes and other securities wherein the interest rate or principal is determined
by a reference instrument.
Most
structured notes and indexed securities are fixed income securities that have
maturities of three years or less. The
interest rate or the principal amount payable at maturity of an indexed security
may vary based on changes in one or more specified reference instruments, such
as a floating interest rate compared with a fixed interest rate. The reference
instrument need not be related to the terms of the indexed security. Structured
notes and indexed securities may be positively or negatively indexed (i.e.,
their principal value or interest rates may increase or decrease if the
underlying reference instrument appreciates), and may have return
characteristics similar to direct investments in the underlying reference
instrument or to one or more options on the underlying reference
instrument.
Structured
notes and indexed securities may entail a greater degree of market risk than
other types of debt securities
because the investor bears the risk of the reference instrument. Structured
notes or indexed securities also may be more volatile, less liquid, and more
difficult to accurately price than less complex securities and instruments or
more traditional debt securities. In addition to the credit risk of the
structured note or indexed security’s issuer and the normal risks of price
changes in response to changes in interest rates, the principal amount of
structured notes or indexed securities may decrease as a result of changes in
the value of the underlying reference instruments. Further, in the case of
certain structured notes or indexed securities in which the interest rate, or
exchange rate in the case of currency, is linked to a reference instrument, the
rate may be increased or decreased or the terms may provide that, under certain
circumstances, the principal amount payable on maturity may be reduced to zero
resulting in a loss to the Fund.
Qualifying
Hybrid Instruments. “Qualifying hybrid
instruments” are commodity-linked notes that are excluded from regulation under
the Commodity Exchange Act and the rules thereunder.
Distressed
Debt Securities. A Fund may invest
in securities, including loans purchased in the secondary market, that are the
subject of bankruptcy proceedings or otherwise in default or in risk of being in
default as to the repayment of principal and/or interest at the time of
acquisition by a Fund or that are rated in the lower rating categories by one or
more nationally recognized statistical rating organizations (for example, Ca or
lower by Moody’s and CC or lower by S&P or Fitch) or, if unrated, are in the
judgment of the Adviser or Sub-Adviser of equivalent quality (“Distressed
Securities”). Investment in Distressed Securities is speculative and involves
significant risks.
50
A
Fund will generally make such investments only when the Adviser or Sub-Adviser
believes it is reasonably likely
that the issuer of the Distressed Securities will make an exchange offer or will
be the subject of a plan of reorganization pursuant to which a Fund will receive
new securities in return for the Distressed Securities. However, there can be no
assurance that such an exchange offer will be made or that such a plan of
reorganization will be adopted. Additionally, a significant period of time may
pass between the time at which a Fund makes its investment in Distressed
Securities and the time that any such exchange offer or plan of reorganization
is completed, if at all. During this period, it is unlikely that a Fund would
receive any interest payments on the Distressed Securities, a Fund will be
subject to significant uncertainty as to whether or not the exchange offer or
plan of reorganization will be completed and a Fund may be required to bear
certain extraordinary expenses to protect and recover its investment. Therefore,
a Fund’s ability to achieve current income for its shareholders may be
diminished. Each Fund also will be subject to significant uncertainty as to when
and in what manner and for what value the obligations evidenced by the
distressed securities will eventually be satisfied (e.g., through a liquidation
of the obligor’s assets, an exchange offer or plan of reorganization involving
the distressed securities or a payment of some amount in satisfaction of the
obligation). Even if an exchange offer is made or plan of reorganization is
adopted with respect to Distressed Securities held by a Fund, there can be no
assurance that the securities or other assets received by the Fund in connection
with such exchange offer or plan of reorganization will not have a lower value
or income potential than may have been anticipated when the investment was made
or no value. Moreover, any securities received by a Fund upon completion of an
exchange offer or plan of reorganization may be restricted as to resale.
Similarly, if a Fund participates in negotiations with respect to any exchange
offer or plan of reorganization with respect to an issuer of Distressed
Securities, a Fund may be restricted from disposing of such securities. To the
extent that a Fund becomes involved in such proceedings, the Fund may have a
more active participation in the affairs of the issuer than that assumed
generally by an investor. Each Fund, however, will not make investments for the
purpose of exercising day-to-day management of any issuer’s
affairs.
U.S.
Corporate Debt Obligations. Corporate debt
obligations are debt obligations issued or guaranteed by corporations that are
denominated in U.S. dollars. Such investments may include, among others,
commercial paper, bonds, notes, debentures, variable rate demand notes, master
notes, funding agreements and other short-term corporate instruments. Commercial
paper consists of short-term promissory notes issued by corporations. Commercial
paper may be traded in the secondary market after its issuance. Variable rate
demand notes are securities with a variable interest which is readjusted on
pre-established dates. Variable rate demand notes are subject to payment of
principal and accrued interest (usually within seven days) on a Fund’s demand.
Master notes are negotiated notes that permit the investment of fluctuating
amounts of money at varying rates of interest pursuant to arrangements with
issuers who meet the credit quality criteria of the Fund. The interest rate on a
master note may fluctuate based upon changes in specified interest rates or be
reset periodically according to a prescribed formula or may be a set rate.
Although there is no secondary market in master notes, if such notes have a
demand feature, the payee may demand payment of the principal amount of the note
upon relatively short notice. Funding agreements are agreements between an
insurance company and a Fund covering underlying demand notes. Although there is
no secondary market in funding agreements, if the underlying notes have a demand
feature, the payee may demand payment of the principal amount of the note upon
relatively short notice. Master notes and funding agreements are generally
illiquid and therefore subject to the Funds' percentage limitation for illiquid
investments.
Investments
in Wholly-Owned Subsidiary. Invesco
Balanced-Risk Allocation Fund, Invesco Balanced-Risk Commodity Strategy Fund and
Invesco Macro Allocation Strategy Fund may invest up to 25% of their total
assets, each, in their respective wholly-owned and controlled Subsidiary which
is expected to invest primarily in commodity swaps and futures and option
contracts, as well as fixed income securities and other investments intended to
serve as margin or collateral for each Subsidiary’s derivative positions. As a
result, the Funds may be considered to be investing indirectly in these
investments through their respective Subsidiary.
Each
of Invesco Fundamental Alternatives Fund and Invesco Global Allocation Fund may
invest up to 25% of their total
assets in their respective wholly-owned and controlled Subsidiary which is
expected to
51
invest
commodity-linked derivatives (including commodity futures, financial futures,
options and swap contracts) and Gold
ETFs, as well as fixed income securities and other investments intended to serve
as margin or collateral for each Subsidiary’s derivative positions. As a result,
the Fund may be considered to be investing indirectly in these investments
through their respective Subsidiary.
The
Subsidiaries will not be registered under the 1940 Act, and except otherwise
noted in the Funds’ prospectuses, are
not subject to the investor protections of that 1940 Act. The Funds, as sole
shareholders of their respective Subsidiary, will not have all of the
protections offered to investors in registered investment companies. However,
since the Funds wholly-own and control their respective Subsidiary, and the Fund
and their respective Subsidiaries are managed by the Adviser, it is unlikely
that the Subsidiaries will take action contrary to the interests of the Funds or
their shareholders. The Funds’ Trustees have oversight responsibility for the
investment activities of the Funds, including its investments in their
respective Subsidiary, and the Funds’ role as sole shareholder of their
respective Subsidiary. Also, in managing their respective Subsidiary’s
portfolio, the Adviser will be subject to the same operational guidelines that
apply to the management of the Funds.
Changes
in the laws of the United States and/or the Cayman Islands, under which the
Funds and their respective
Subsidiaries are organized, could result in the inability of the Funds or their
respective Subsidiary to operate as described in this SAI and could negatively
affect the Funds and their shareholders. For example, the government of the
Cayman Islands does not currently impose any income, corporate or capital gains
tax, estate duty, inheritance tax, gift tax or withholding tax on the
Subsidiaries. If Cayman Islands law changes such that the Subsidiaries must pay
Cayman Islands taxes, the Funds’ shareholders would likely suffer decreased
investment returns.
Regulation
S Securities. Regulation S
securities of U.S. and non-U.S. issuers are offered through private offerings
without registration with the SEC pursuant to Regulation S of the 1933 Act.
Offerings of Regulation S securities may be conducted outside of the United
States, and Regulation S securities may be relatively less liquid as a result of
legal or contractual restrictions on resale. Although Regulation S securities
may be resold in privately negotiated transactions, the price realized from
these sales could be less than that originally paid by a Fund. Further,
companies whose securities are not publicly traded may not be subject to the
disclosure and other investor protection requirements that would be applicable
if their securities were publicly traded. Accordingly, Regulation S securities
may involve a high degree of business and financial risk and may result in
substantial losses.
Other
Investments
Real
Estate Investment Trusts (REITs). The Funds may
invest in equity and/or debt obligations issued by REITs. Invesco EQV Emerging
Markets All Cap Fund and Invesco Health Care Fund may invest up to 15% of their
total assets in equity and/or debt obligations issued by REITs. Invesco Greater
China Fund may invest up to 20% of its total assets in equity and/or debt
securities issued by REITs. REITs are trusts that sell equity or debt securities
to investors and use the proceeds to invest in real estate or interest therein.
A REIT may focus on particular projects, such as apartment complexes, or
geographic regions, such as the southeastern United States or both. 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 property that has appreciated in value. Mortgage REITs invest
the majority of their assets in real estate mortgages and derive income from the
collection of interest payments.
Investments
in REITs may be subject to many of the same risks as direct investments in real
estate. These risks include
difficulties in valuing and trading real estate, declines in the value of real
estate, risks related to general and local economic conditions, adverse changes
in the climate for real estate, environmental liability risks, increases in
property taxes and operating expenses, changes in zoning laws, casualty or
condemnation losses, limitations on rents, changes in neighborhood values, the
appeal of properties to tenants, heavy cash flow dependency and increases in
interest rates. To the extent that a Fund invests in REITs, the Fund could
conceivably acquire real estate directly as a result of a default on the REIT
interests or obligations it owns.
52
In
addition to the risks of direct real estate investment described above, equity
REITs may be affected by any changes in the
value of the underlying property owned by the trusts, while mortgage REITs may
be affected by the quality of any credit extended. REITs are also subject to the
following risks: they are dependent upon management skill and on cash flows; are
not diversified; are subject to defaults by borrowers, self-liquidation, and the
possibility of failing to maintain an exemption from the 1940 Act; and are
subject to interest rate risk. A Fund that invests in REITs will bear a
proportionate share of the expenses of the REITs.
Furthermore,
for tax reasons, a REIT may impose limits on how much of its securities any one
investor may own. These
ownership limitations (also called “excess share provisions”) may be based on
ownership of securities by multiple funds and accounts managed by the same
investment adviser and typically result in adverse consequences (such as
automatic divesture of voting and dividend rights for shares that exceed the
excess share provision) to investors who exceed the limit. A REIT’s excess share
provision may result in a Fund being unable to purchase (or otherwise obtain
economic exposure to) the desired amounts of certain REITs. In some
circumstances, a Fund may seek and obtain a waiver from a REIT to exceed the
REIT’s ownership limitations without being subject to the adverse consequences
of exceeding such limit were a waiver not obtained, provided that the Fund
complies with the provisions of the waiver.
Master
Limited Partnerships (MLPs). MLPs generally are
limited partnerships (or limited liability companies), the common units of which
are listed and traded on a national securities exchange or over-the-counter.
MLPs generally have two classes of partners, the general partner and the limited
partners. The general partner normally controls the MLP through an equity
interest plus units that are subordinated to the common (publicly traded) units
for an initial period and then only converting to common if certain financial
tests are met. The general partner also generally receives a larger portion of
the net income as incentive. As cash flow grows, the general partner receives a
greater interest in the incremental income compared to the interest of limited
partners.
MLP
common units represent an equity ownership interest in a partnership, providing
limited voting rights and entitling the
holder to a share of the company’s success through distributions and/or capital
appreciation. Unlike shareholders of a corporation, common unit holders do not
elect directors annually and generally have the right to vote only on certain
significant events, such as mergers, a sale of substantially all of the assets,
removal of the general partner or material amendments to the partnership
agreement. MLPs are required by their partnership agreements to distribute a
large percentage of their current operating earnings. Common unit holders
generally have first right to a minimum quarterly distribution (MQD) prior to
distributions to the convertible subordinated unit holders or the general
partner (including incentive distributions). Common unit holders typically have
arrearage rights if the MQD is not met. In the event of liquidation, MLP common
unit holders have first right to the partnership’s remaining assets after
bondholders, other debt holders, and preferred unit holders have been paid in
full.
The
general partner or managing member interest in an MLP is typically retained by
the original sponsors of an MLP, such as
its founders, corporate partners and entities that sell assets to the MLP. The
holder of the general partner or managing member interest can be liable in
certain circumstances for amounts greater than the amount of the holder’s
investment in the general partner or managing member. General partner or
managing member interests often confer direct board participation rights in, and
in many cases control over the operations of, the MLP. General partner or
managing member interests can be privately held or owned by publicly traded
entities. General partner or managing member interests receive cash
distributions, typically in an amount of up to 2% of available cash, which is
contractually defined in the partnership or limited liability company agreement.
In addition, holders of general partner or managing member interests typically
receive incentive distribution rights (IDRs), which provide them with an
increasing share of the entity’s aggregate cash distributions upon the payment
of per common unit distributions that exceed specified threshold levels above
the MQD. Incentive distributions to a general partner are designed to encourage
the general partner, who controls and operates the partnership, to maximize the
partnership’s cash flow and increase distributions to the limited partners. Due
to the IDRs, general partners of MLPs have higher distribution growth prospects
than their underlying MLPs, but quarterly incentive distribution payments would
also decline at a greater rate than the decline rate in quarterly distributions
to common and subordinated unit holders in the event of a
53
reduction
in the MLP’s quarterly distribution. The ability of the limited partners or
members to remove the general partner or
managing member without cause is typically very limited. In addition, some MLPs
permit the holder of IDRs to reset, under specified circumstances, the incentive
distribution levels and receive compensation in exchange for the distribution
rights given up in the reset.
Some
companies in which a Fund may invest have been organized as limited liability
companies (MLP LLCs). Such MLP
LLCs generally are treated in the same manner as MLPs for federal income tax
purposes (i.e., generally taxed as partnerships). MLP LLC common units trade on
a national securities exchange or OTC. In contrast to MLPs, MLP LLCs have no
general partner and there are generally no incentives that entitle management or
other unitholders to increased percentages of cash distributions as
distributions reach higher target levels. In addition, MLP LLC common
unitholders typically have voting rights with respect to the MLP LLC, whereas
MLP common units have limited voting rights.
Investments
in securities of an MLP involve risks that differ from investments in common
stock, including risks related to
limited control and limited rights to vote on matters affecting the MLP, risks
related to potential conflicts of interest between the MLP and the MLP’s general
partner, cash flow risks, dilution risks and risks related to the general
partner’s right to require unit-holders to sell their common units at an
undesirable time or price. Certain MLP securities may trade in lower volumes due
to their smaller capitalizations, and may be subject to more abrupt or erratic
price movements and lower market liquidity. MLPs are generally considered
interest-rate sensitive investments. During periods of interest rate volatility,
these investments may not provide attractive returns.
There
are also certain tax risks undertaken by the Fund when it invests in MLPs. MLPs
are generally treated as
partnerships for U.S. federal income tax purposes. Partnerships do not pay U.S.
federal income tax at the partnership level, subject to the application of
certain partnership audit rules. Rather, each partner is allocated a share of
the partnership’s income, gains, losses, deductions and expenses. A change in
current tax law or a change in the underlying business mix of a given MLP could
result in an MLP being treated as a corporation for U.S. federal income tax
purposes, which would result in the MLP being required to pay U.S. federal
income tax (as well as state and local income taxes) on its taxable income. This
would have the effect of reducing the amount of cash available for distribution
by the MLP and could result in a reduction in the value of the Fund’s investment
in the MLP and lower income to the Fund. Also, to the extent a distribution
received by a Fund from an MLP is treated as a return of capital, the Fund’s
adjusted tax basis in the interests of the MLP will be reduced, which may
increase the Fund’s tax liability upon the sale of the interests in the MLP or
upon subsequent distributions in respect of such interests.
MLP
Debt Securities. Debt securities
issued by MLPs may include those rated below investment grade or that are
unrated but judged to be below investment gra