2024-01-08AMF-STAT-PRO_11422
|
| |
abrdn
Funds |
|
Statement
of Additional Information |
|
February
29, 2024 |
|
abrdn
Focused
U.S. Small Cap Equity Fund (formerly, abrdn U.S.
Sustainable Leaders Smaller Companies Fund)
Class
A - MLSAX ■
Class R - GLSRX ■
Institutional Class - GGUIX ■
Institutional Service Class - AELSX
abrdn
U.S. Small Cap Equity Fund
Class
A - GSXAX ■
Class C - GSXCX ■
Class R - GNSRX ■
Institutional Class - GSCIX ■
Institutional Service Class - GSXIX
abrdn
China A Share Equity Fund
Class
A - GOPAX ■
Class C - GOPCX ■
Class R - GOPRX ■
Institutional Class - GOPIX ■
Institutional Service Class - GOPSX
abrdn
Emerging Markets Sustainable Leaders Fund
Class
A - GIGAX ■
Class C - GIGCX ■
Class R - GIRRX ■
Institutional Class - GIGIX ■
Institutional Service Class - GIGSX
abrdn
Emerging Markets ex-China Fund
Class
A - GLLAX ■
Class C - GLLCX ■
Class R - GWLRX ■
Institutional Class - GWLIX ■
Institutional Service Class - GLLSX
abrdn
Emerging Markets Fund
Class
A - GEGAX ■
Class C - GEGCX ■
Class R - GEMRX ■
Institutional Class - ABEMX ■
Institutional Service Class - AEMSX
abrdn
Infrastructure
Debt Fund (formerly, abrdn Global
Absolute Return Strategies Fund)
Class
A - CUGAX ■
Institutional Class - AGCIX ■
Institutional Service Class - CGFIX
abrdn
International Small Cap Fund
Class
A – WVCCX ■
Class C – CPVCX ■
Class R – WPVAX ■
Institutional Class – ABNIX
abrdn
Intermediate Municipal Income Fund
Class
A – NTFAX ■
Class C – GTICX ■
Institutional Class – ABEIX ■
Institutional Service Class – ABESX
abrdn
U.S. Sustainable Leaders Fund
Class
A – GXXAX ■
Class C – GXXCX ■
Institutional Class – GGLIX ■
Institutional Service Class – GXXIX
abrdn
Dynamic Dividend Fund
Class
A – ADAVX ■
Institutional Class – ADVDX
abrdn
Global Infrastructure Fund
Class
A – AIAFX ■
Institutional Class – AIFRX
abrdn
Short Duration High Yield Municipal Fund
Class
A – AAHMX ■
Class C – ACHMX ■
Institutional Class – AHYMX
abrdn
Realty Income & Growth Fund
Class
A – AIAGX ■
Institutional Class – AIGYX
abrdn
Ultra Short Municipal Income Fund
Class
A – ATOAX ■
Class A1 – ATOBX ■
Institutional Class – ATOIX
abrdn
Emerging
Markets Dividend Fund (formerly, abrdn International
Sustainable Leaders Fund)
Class
A – BJBIX ■
Institutional Class – JIEIX
abrdn
Global Equity Impact Fund
Class
A – JETAX ■
Institutional Class – JETIX
abrdn
High
Income Opportunities Fund (formerly, abrdn Global
High Income Fund)
Class
A – BJBHX ■
Institutional Class – JHYIX
abrdn
Funds (the “Trust”) is a registered open-end investment company consisting of 19
series as of the date hereof. This Statement of Additional
Information (“SAI”) relates to the series of the Trust listed above (each, a
“Fund” and collectively, the “Funds”). This SAI is not a prospectus
but is incorporated by reference into the Prospectus for the Funds. It contains
information in addition to and more detailed than
that set forth in the Prospectus and should be read in conjunction with the
Prospectus for the Funds dated February 29,
2024, as amended.
Terms
not defined in this SAI have the meanings assigned to them in the Prospectus.
You can order copies of the Prospectus without charge
by writing to abrdn Funds, c/o SS&C GIDS, Inc. (”SS&C”)
at 430 W. 7th Street, Ste. 219534, Kansas City, MO 64105- 1407 or calling
(toll-free)
866-667-9231.
The
audited financial statements with respect to each of the Funds for the fiscal
year ended October 31, 2023,
and the related report of KPMG,
LLP (“KPMG”), independent registered public accounting firm for the Funds, which
are contained in the Funds’ October 31, 2023 Annual Report,
are incorporated herein by reference in the section “Financial Statements.” No
other parts of the Annual Report are incorporated
by reference herein. A copy of the Annual Report may be obtained upon request
and without charge by writing to abrdn Funds
at 430 W. 7th Street, Ste. 219534, Kansas City, MO 64105-1407 or by calling
866-667-9231.
General
Information
The
Trust is an open-end management investment company formed as a statutory trust
under the laws of the state of
Delaware by a Certificate of Trust filed on September 27, 2007. The Trust
currently consists of 19 separate series, each with
its own investment objective.
Certain
Funds in this SAI were formed to acquire the assets and liabilities of the
corresponding Fund of the Nationwide
Mutual Funds (the
“Nationwide Predecessor Funds”) as shown in the chart below.
| |
Fund
|
Corresponding
Predecessor Fund |
abrdn
Emerging Markets ex-China Fund (“Emerging Markets ex-China
Fund”) |
Nationwide
Worldwide Leaders Fund |
abrdn
China A Share Equity Fund (“China A Fund”) |
Nationwide
China Opportunities Fund |
abrdn
Emerging Markets Sustainable Leaders Fund (“Emerging Markets
Sustainable
Leaders Fund”) |
Nationwide
International Growth Fund |
abrdn
Focused U.S. Small Cap Equity Fund (formerly, abrdn U.S. Sustainable
Leaders
Smaller Companies Fund) (“Focused U.S. Small Cap Equity
Fund”) |
Nationwide
U.S. Growth Leaders Long-Short Fund |
abrdn
U.S. Small Cap Equity Fund (“U.S. Small Cap Equity
Fund”) |
Nationwide
Small Cap Fund |
abrdn
Intermediate Municipal Income Fund (“Intermediate Municipal Income
Fund”) |
Nationwide
Tax-Free Income Fund |
The
Nationwide Predecessor Funds, for purposes of the relevant reorganization, are
considered the accounting survivors
and accordingly, certain financial history of the Nationwide Predecessor Funds
is included in this SAI. Prior to February
28, 2022, the Intermediate Municipal Income Fund was known as the Aberdeen
Intermediate Municipal Income Fund.
Prior to February 28, 2019, the Intermediate Municipal Income Fund was known as
the Aberdeen Tax-Free Income Fund.
Prior to February 28, 2022, the China A Fund was known as the Aberdeen China A
Share Equity Fund. Prior
to June 13,
2019, the China A Fund was known as the Aberdeen China Opportunities
Fund.
Prior to February 29, 2024, the Focused
U.S. Small Cap Equity Fund was known as the abrdn U.S. Sustainable Leaders
Smaller Companies Fund. Prior
to February
28, 2022, the U.S. Sustainable Leaders Smaller Companies Fund was known as the
Aberdeen U.S. Sustainable Leaders
Smaller Companies Fund. Prior to December 1, 2020, the U.S. Sustainable Leaders
Smaller Companies Fund was known
as the Aberdeen Focused U.S. Equity Fund, and prior to November 15, 2017, the
Aberdeen Focused U.S. Equity Fund
was known as the Aberdeen Equity Long-Short Fund. Prior to February 28, 2022,
the Emerging Markets Sustainable Leaders
Fund was known as the Aberdeen Emerging Markets Sustainable Leaders Fund. Prior
to December 1, 2020, the Emerging
Markets Sustainable Leaders Fund was known as the Aberdeen International Equity
Fund. Prior to February 28, 2022,
the abrdn Emerging Markets ex-China Fund was known as the Aberdeen Global Equity
Fund.
Certain
Funds in this SAI were formed to acquire the assets and liabilities of the
corresponding Fund of the Credit Suisse
Funds (each a “Credit Suisse Predecessor Fund,” and collectively, the “Credit
Suisse Predecessor Funds”) as shown in
the chart below.
| |
Fund
|
Corresponding
Predecessor Fund |
abrdn
Infrastructure Debt Fund (formerly, abrdn Global Absolute Return
Strategies Fund)
(“Infrastructure Debt Fund”) |
Credit
Suisse Global Fixed Income Fund |
abrdn
International Small Cap Fund (“International Small Cap
Fund”) |
Credit
Suisse Global Small Cap Fund |
The
Credit Suisse Predecessor Funds, for purposes of the relevant reorganization,
are considered the accounting survivors
and accordingly, certain financial history of the Credit Suisse Predecessor
Funds is included in this SAI. Prior to August
18, 2023, the abrdn Infrastructure Debt Fund was known as the abrdn Global
Absolute Return Strategies Fund. Prior
to February
28, 2022, the abrdn
Global Absolute Return Strategies
Fund was known as the Aberdeen Global Absolute
Return Strategies Fund. Prior to November 15, 2019, the Aberdeen
Global Absolute Return Strategies
Fund was known
as the Aberdeen Global Unconstrained Fixed Income Fund, and prior to August 15,
2016, the Aberdeen Global Unconstrained
Fixed Income Fund was known as the Aberdeen Global Fixed Income Fund. Prior to
February 28, 2022, the International
Small Cap Fund was known as the Aberdeen International Small Cap
Fund.
Certain
Funds in this SAI acquired the assets and liabilities of the corresponding Fund
of the Pacific Capital Funds (each
a “Pacific Capital Predecessor Fund,” and collectively, the “Pacific Capital
Predecessor Funds”), as shown in the chart
below.
| |
Fund
|
Corresponding
Predecessor Fund |
U.S.
Small Cap Equity Fund |
Pacific
Capital Small Cap Fund |
Class
A Shares |
Class
A and B Shares |
Class
C Shares |
Class
C Shares |
Institutional
Class Shares |
Class
Y Shares |
Prior
to February 28, 2022, the abrdn Emerging Markets Fund (“Emerging Markets Fund”)
was known as the Aberdeen
Emerging Markets Fund. The Emerging Markets Fund was formed to acquire the
assets and liabilities of a former
Aberdeen Emerging Markets Fund, which was a series of The Advisors’ Inner Circle
Fund II (the “Emerging Markets Predecessor
Fund”). On May 21, 2012, the Emerging Markets Fund acquired the assets of the
Aberdeen Emerging Markets
Fund (the “Acquired Fund”), another series of the Trust, which had Class A, C
and R Shares. The Emerging Markets
Predecessor Fund, for purposes of the reorganization, is considered the
accounting survivor and accordingly, certain
financial history of the Emerging Markets Predecessor Fund is included in this
SAI.
Prior
to February 28, 2022, the abrdn U.S. Sustainable Leaders Fund (“Sustainable
Leaders Fund”) was known as the Aberdeen
U.S. Sustainable Leaders Fund, and prior to December 1, 2020, the U.S.
Sustainable Leaders Fund was known as the
Aberdeen U.S. Multi-Cap Equity Fund (“U.S. Multi-Cap Equity Fund”). Prior to
October 31, 2015, the U.S. Multi-Cap Equity
Fund was known as the Aberdeen U.S. Equity Fund. The Aberdeen U.S. Equity Fund
(“U.S. Equity Fund”) was created to
acquire the assets and liabilities of the Credit Suisse Large Cap Blend Fund,
Inc., a Maryland corporation, and a former series
of the Trust with a U.S. equity strategy (“Aberdeen U.S. Equity Predecessor
Fund”). The Aberdeen U.S. Equity Predecessor
Fund, for purposes of the reorganization, is considered the accounting survivor
and accordingly, certain financial
history of the Aberdeen U.S. Equity Predecessor Fund is included in this SAI. On
February 25, 2013, the U.S. Equity Fund
acquired the assets of the Aberdeen U.S. Equity II Fund, another series of the
Trust, which offered Class A, Class C, Class
R, Institutional Class and Institutional Service Class Shares. The U.S. Equity
Fund, for purposes of the reorganization, is
considered the accounting survivor.
Certain
Funds in this SAI were formed to acquire the assets and liabilities of certain
series of the Alpine Equity Trust, Alpine
Series Trust or Alpine Income Trust (each, an “Alpine Predecessor Fund,” and
collectively, the “Alpine Predecessor Funds”),
as shown in the chart below.
| |
Fund
|
Corresponding
Predecessor Fund |
abrdn
Dynamic Dividend Fund (“Dynamic Dividend Fund”) |
Alpine
Dynamic Dividend Fund, a series of Alpine Series
Trust |
abrdn
Global Infrastructure Fund (“Global Infrastructure
Fund”) |
Alpine
Global Infrastructure Fund, a series of Alpine
Equity Trust |
abrdn
Realty Income & Growth Fund (“Realty Income & Growth
Fund”) |
Alpine
Realty Income & Growth Fund, a series of Alpine
Equity Trust |
abrdn
Short Duration High Yield Municipal Fund (“Short Duration High Yield
Municipal
Fund”) |
Alpine
High Yield Managed Duration Municipal Fund,
a series of Alpine Income Trust |
abrdn
Ultra Short Municipal Income Fund (“Ultra Short Municipal Income
Fund”) |
Alpine
Ultra Short Municipal Income Fund, a series of
Alpine Income Trust |
The
Alpine Predecessor Funds, for purposes of the relevant reorganization, are
considered the accounting survivors and
accordingly, certain financial history of the Alpine Predecessor Funds is
included in this SAI.
Prior
to February 28, 2022, the Dynamic Dividend Fund was known as the Aberdeen
Dynamic Dividend Fund. Prior to February
28, 2022, the Global Infrastructure Fund was known as the Aberdeen Global
Infrastructure Fund. Prior to February
28, 2022, the Realty Income & Growth Fund was known as the Aberdeen Realty
Income & Growth Fund. Prior to February
28, 2022, the Short Duration High Yield Municipal Fund was known as the Aberdeen
Short Duration High Yield Municipal
Fund. Prior to February 28, 2019, the Short Duration High Yield Municipal Fund
was known as the Aberdeen High Yield
Managed Duration Municipal Fund. Prior to February 28, 2022, the Ultra Short
Fund was known as the Aberdeen Ultra
Short Municipal Income Fund.
Certain
Funds in this SAI were formed to acquire the assets and liabilities of certain
series of the corresponding Fund of
the Aberdeen Investment Funds (each, an “Aberdeen Investment Funds Predecessor
Fund,” and collectively, the “Aberdeen
Investment Funds Predecessor Funds”), as shown in the chart below.
| |
Fund
|
Corresponding
Aberdeen Investment Funds Predecessor Fund |
abrdn
Emerging Markets Dividend Fund (formerly, abrdn International Sustainable
Leaders
Fund) (“Emerging Markets Dividend Fund”) |
Aberdeen
International Sustainable Leaders Fund,
a series of Aberdeen Investment Funds |
abrdn
Global Equity Impact Fund (“Global Equity Impact
Fund”) |
Aberdeen
Global Equity Impact Fund, a series of Aberdeen
Investment Funds |
abrdn
High Income Opportunities Fund (formerly, abrdn Global High Income Fund)
(“High
Income Opportunities Fund”) |
Aberdeen
Global High Income Fund, a series of Aberdeen
Investment Funds |
The
Aberdeen Investment Funds Predecessor Funds, for purposes of the relevant
reorganization, are considered the accounting
survivors and accordingly, certain financial history of the Aberdeen Investment
Funds Predecessor Funds is included
in this SAI. Prior to February 29,
2024, the Emerging Markets Dividend Fund was known as the abrdn International
Sustainable
Leaders Fund. Prior to February 28,
2022, the Emerging
Markets Dividend
Fund was known as the Aberdeen International
Sustainable Leaders Fund. Prior to February 28, 2022, the Global Equity Impact
Fund was known as the
Aberdeen
Global Equity Impact Fund. Prior to August
18, 2023, the High Income Opportunities Fund was known as the abrdn
Global High Income Fund. Prior to February
28, 2022, the abrdn
Global
High Income Fund was known as the Aberdeen
Global High Income Fund.
Each
of the Funds, except the Realty Income & Growth Fund, is a diversified
open-end management investment company
as defined in the Investment Company Act of 1940, as amended (the “1940 Act”).
The Realty Income & Growth Fund
is a non-diversified open-end management investment company as defined in the
1940 Act.
Additional
Information on Portfolio Instruments and Investment Policies
The
Funds invest in a variety of securities and employ a number of investment
techniques that involve certain risks. The
Prospectus for the Funds highlights the principal investment strategies,
investment techniques and risks. This SAI contains
additional information regarding the principal investment strategies for the
Funds and information about non-principal
investment strategies of the Funds. The following tables set forth additional
information concerning permissible
investments and techniques for each of the Funds and risk factors. A
“●”
in the table indicates that the Fund may
invest in the corresponding instrument or technique or is subject to such risk
factor. An empty box indicates that the Fund
does not intend to invest in the corresponding instrument or follow the
corresponding technique or is not subject to such
risk factor.
Please
review the discussions in the Prospectus for further information regarding the
investment objective and policies
of each Fund.
References
to the “Adviser” in this section also include the Subadviser(s),
as applicable.
|
|
|
|
|
|
|
| |
Type
of Investment, Technique
or Risk Factor |
China
A Fund |
Emerging
Markets Dividend
Fund |
Emerging
Markets ex-China
Fund |
Emerging Markets
Fund |
Emerging
Markets Sustainable Leaders
Fund |
Focused
U.S. Small Cap
Equity Fund |
U.S.
Small Cap Equity
Fund |
U.S.
Sustainable Leaders
Fund |
Adjustable,
Floating and
Variable Rate Instruments
|
● |
|
● |
● |
● |
● |
● |
● |
Bank
Obligations |
|
● |
|
|
|
● |
● |
● |
Borrowing
|
● |
● |
● |
● |
● |
● |
● |
● |
Common
Stock |
● |
● |
● |
● |
● |
● |
● |
● |
Convertible
Securities |
● |
● |
|
|
|
● |
● |
● |
Currency
Transactions |
● |
● |
● |
● |
● |
● |
● |
● |
Custody/Sub-Custody
Risk
|
● |
● |
● |
● |
● |
● |
● |
● |
Cybersecurity
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Debt
Securities |
● |
|
|
|
|
● |
● |
● |
Depositary
Receipts |
● |
● |
● |
● |
● |
● |
● |
● |
Derivatives
|
● |
● |
|
|
|
● |
● |
● |
Dividend
Strategy Risk |
|
● |
|
|
|
|
|
|
Emerging
Markets Securities
|
● |
● |
● |
● |
● |
● |
● |
● |
Equity-Linked
Securities
|
● |
|
|
|
|
|
|
|
Event
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Exchange-Traded
Funds
|
● |
● |
● |
● |
● |
● |
● |
● |
Focus
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Foreign
Commercial Paper
|
|
● |
● |
● |
● |
|
|
|
Foreign
Currencies Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Foreign
Government Securities
|
● |
● |
● |
● |
● |
|
|
|
Foreign
Securities |
● |
● |
● |
● |
● |
● |
● |
● |
Frontier
Market Securities
|
● |
● |
● |
● |
● |
|
|
|
Futures
|
● |
● |
|
|
|
● |
● |
● |
Illiquid
Investments Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Impact
of Large Redemptions
and Purchases
of Fund Shares
|
● |
● |
● |
● |
● |
● |
● |
● |
Indexed
Securities |
● |
|
● |
● |
● |
● |
● |
● |
Inflation/Deflation
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
6 Additional
Information on Portfolio Instruments and Investment Policies
|
|
|
|
|
|
|
| |
Type
of Investment, Technique
or Risk Factor |
China
A Fund |
Emerging
Markets Dividend
Fund |
Emerging
Markets ex-China
Fund |
Emerging Markets
Fund |
Emerging
Markets Sustainable Leaders
Fund |
Focused
U.S. Small Cap
Equity Fund |
U.S.
Small Cap Equity
Fund |
U.S.
Sustainable Leaders
Fund |
Initial
Public Offerings |
● |
● |
● |
● |
● |
● |
● |
● |
Interests
in Publicly Traded
Limited Partnerships
|
● |
● |
● |
● |
● |
● |
● |
● |
Market
Events Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Medium
Company, Small
Company and Emerging
Growth Securities
|
● |
● |
● |
● |
● |
● |
● |
● |
Money
Market Instruments
|
● |
● |
● |
● |
● |
● |
● |
● |
Operational
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Options
|
● |
● |
|
|
|
● |
● |
● |
Preferred
Stock |
● |
● |
● |
● |
● |
● |
● |
● |
Private
Placements and
Other Restricted Securities
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Real
Estate Investment Trusts
|
● |
● |
● |
● |
● |
● |
● |
● |
Real
Estate Securities Risk
|
● |
● |
● |
● |
● |
● |
● |
● |
Regulation
of Commodity
Interests |
● |
● |
● |
● |
● |
● |
● |
● |
Repurchase
Agreements
|
● |
|
|
|
|
|
● |
● |
Reverse
Repurchase Agreements
|
● |
|
|
|
|
|
● |
● |
Rights
Issues and Warrants
|
● |
● |
● |
● |
● |
● |
● |
● |
Secondary
Offerings |
● |
|
● |
● |
● |
● |
● |
● |
Securities
Lending |
● |
|
● |
● |
● |
|
● |
|
Securities
of Investment
Companies
|
● |
● |
● |
● |
● |
● |
● |
● |
“Special
Situations” Companies
Risk |
● |
● |
● |
● |
● |
● |
● |
● |
Strategic
Transactions, Derivatives
and Synthetic
Investments |
● |
● |
● |
● |
● |
● |
● |
● |
Sustainable
Investing Risk
|
|
|
|
|
● |
|
|
● |
Tax
Reclaim Risk |
|
● |
|
|
● |
|
|
|
Temporary
Investments
|
● |
● |
● |
● |
● |
● |
● |
● |
U.S.
Government Securities
|
● |
● |
● |
● |
● |
● |
● |
● |
When-Issued
Securities
and Delayed-Delivery
|
● |
● |
● |
● |
● |
● |
● |
● |
|
|
|
|
| |
Type
of Investment, Technique or Risk
Factor |
Dynamic Dividend
Fund |
Global
Equity Impact
Fund |
Global Infrastructure Fund |
International Small
Cap Fund |
Realty
Income & Growth
Fund |
Adjustable,
Floating and Variable
Rate Instruments |
|
|
|
|
● |
Additional
Information on Portfolio Instruments and Investment Policies 7
|
|
|
|
| |
Type
of Investment, Technique or Risk
Factor |
Dynamic Dividend
Fund |
Global
Equity Impact
Fund |
Global Infrastructure Fund |
International Small
Cap Fund |
Realty
Income & Growth
Fund |
Asset-Backed
Securities |
|
|
|
|
● |
Borrowing
|
● |
● |
● |
● |
● |
Business
Development Companies (“BDCs”) |
● |
|
|
|
● |
Closed-end
Funds |
● |
|
● |
|
● |
Common
Stock |
● |
● |
● |
● |
● |
Convertible
Securities |
|
● |
|
● |
● |
Currency
Transactions |
● |
● |
● |
● |
|
Custody/Sub-Custody
Risk |
● |
● |
● |
● |
● |
Cybersecurity
Risk |
● |
● |
● |
● |
● |
Debt
Securities |
|
|
|
● |
● |
Depositary
Receipts |
● |
● |
● |
● |
● |
Derivatives
|
● |
● |
● |
● |
● |
Dividend
Strategy Risk |
● |
|
● |
|
● |
Emerging
Markets Securities |
● |
● |
● |
● |
|
Equity-Linked
Securities |
● |
|
● |
|
● |
Event
Risk |
● |
● |
● |
● |
● |
Exchange-Traded
Funds |
● |
● |
● |
● |
● |
Focus
Risk |
|
● |
● |
● |
|
Foreign
Commercial Paper |
|
● |
|
|
● |
Foreign
Currencies Risk |
● |
● |
● |
● |
● |
Foreign
Government Securities |
|
● |
|
|
|
Foreign
Securities |
● |
● |
● |
● |
● |
Frontier
Market Securities |
● |
● |
● |
● |
|
Futures
|
● |
● |
● |
|
|
Illiquid
Investments Risk |
● |
● |
● |
● |
● |
Impact
Investing Risk |
|
● |
|
|
|
Impact
of Large Redemptions and Purchases of Fund Shares |
● |
● |
● |
● |
● |
Indexed
Securities |
|
|
|
|
● |
Inflation/Deflation
Risk |
● |
● |
● |
● |
● |
Initial
Public Offerings |
● |
● |
● |
● |
● |
Interests
in Publicly Traded Limited Partnerships |
● |
● |
● |
● |
● |
Market
Events Risk |
● |
● |
● |
● |
● |
Medium
Company, Small Company and Emerging Growth Securities
|
● |
● |
● |
● |
● |
Money
Market Instruments |
● |
● |
● |
● |
● |
Mortgage-Related
Securities |
|
|
|
|
● |
Operational
Risk |
● |
● |
● |
● |
● |
Options
|
● |
● |
● |
|
|
Preferred
Stock |
● |
● |
● |
● |
● |
Private
Placements and Other Restricted Securities Risk |
● |
|
● |
● |
|
Real
Estate Investment Trusts |
● |
● |
● |
● |
● |
Real
Estate Related Securities Risk |
|
|
|
|
● |
Real
Estate Securities Risk |
● |
● |
● |
● |
● |
Regulation
of Commodity Interests |
● |
● |
● |
● |
● |
Rights
Issues and Warrants |
● |
● |
● |
● |
● |
Secondary
Offerings |
● |
|
● |
● |
● |
Securities
Lending |
|
|
● |
● |
● |
8 Additional
Information on Portfolio Instruments and Investment Policies
|
|
|
|
| |
Type
of Investment, Technique or Risk
Factor |
Dynamic Dividend
Fund |
Global
Equity Impact
Fund |
Global Infrastructure Fund |
International Small
Cap Fund |
Realty
Income & Growth
Fund |
Securities
of Investment Companies |
● |
● |
● |
● |
● |
“Special
Situations”Companies Risk |
● |
● |
● |
● |
|
Strategic
Transactions, Derivatives and Synthetic Investments
|
● |
● |
● |
|
|
Tax
Reclaim Risk |
● |
● |
|
|
|
Temporary
Investments |
● |
● |
● |
● |
● |
U.S.
Government Securities |
|
● |
|
● |
● |
When-Issued
Securities and Delayed-Delivery |
● |
● |
● |
● |
● |
|
|
|
|
| |
Type
of Investment, Technique
or Risk Factor |
Infrastructure
Debt
Fund |
High
Income Opportunities
Fund |
Intermediate Municipal Income
Fund |
Short
Duration High
Yield Municipal
Fund |
Ultra
Short Municipal Income
Fund |
Adjustable,
Floating and Variable Rate Instruments |
● |
● |
● |
● |
● |
Asset-Backed
Securities |
● |
● |
● |
● |
● |
Bank
Loans |
|
● |
|
|
|
Bank
Obligations |
● |
● |
● |
● |
● |
Bonds
with Warrants Attached |
● |
● |
|
|
|
Borrowing
|
● |
● |
● |
● |
● |
Bridge
Loans |
● |
● |
|
|
|
Catastrophe
Bond |
● |
● |
● |
● |
● |
Common
Stock |
● |
● |
|
|
|
Convertible
Securities |
● |
● |
|
|
|
Corporate
Obligations |
● |
● |
● |
● |
● |
Credit
Linked Notes |
● |
● |
|
|
|
Currency
Transactions |
● |
● |
|
|
|
Custody/Sub-Custody
Risk |
● |
● |
|
|
|
Cybersecurity
Risk |
● |
● |
● |
● |
● |
Debt
Securities |
● |
● |
● |
● |
● |
Derivatives
|
● |
● |
|
|
|
Direct
Debt Instruments |
|
● |
|
|
|
Distressed
Securities |
|
● |
● |
● |
|
Emerging
Markets Securities |
● |
● |
|
|
|
Equity-Linked
Securities |
● |
● |
|
|
|
Eurodollar
Instruments |
● |
● |
|
|
|
European
Sovereign Debt Risk |
● |
● |
|
|
|
Event
Risk |
● |
● |
|
|
|
Exchange-Traded
Funds |
● |
● |
● |
● |
● |
Foreign
Commercial Paper |
● |
● |
|
|
|
Foreign
Currencies |
● |
● |
|
|
|
Foreign
Fixed Income Securities |
● |
● |
|
|
|
Foreign
Government Securities |
● |
● |
|
|
|
Foreign
Securities |
● |
● |
|
|
|
Frontier
Market Securities |
● |
● |
|
|
|
Futures
|
● |
● |
|
|
|
Illiquid
Investments Risk |
● |
● |
● |
● |
● |
Impact
of Large Redemptions and Purchases of Fund Shares |
● |
● |
● |
● |
● |
Income
Deposit Securities |
|
● |
|
|
|
Indexed
Securities |
● |
● |
|
|
|
Inflation/Deflation
Risk |
● |
● |
● |
● |
● |
Additional
Information on Portfolio Instruments and Investment Policies 9
|
|
|
|
| |
Type
of Investment, Technique
or Risk Factor |
Infrastructure
Debt
Fund |
High
Income Opportunities
Fund |
Intermediate Municipal Income
Fund |
Short
Duration High
Yield Municipal
Fund |
Ultra
Short Municipal Income
Fund |
Inverse
Floating Rate Instruments |
● |
● |
● |
● |
● |
LIBOR
and Replacement Rates Risk |
● |
● |
|
|
|
Loans
|
● |
● |
● |
● |
● |
Market
Events Risk |
● |
● |
● |
● |
● |
Medium
Company, Small Company and Emerging Growth Securities
|
● |
● |
|
|
|
Money
Market Instruments |
● |
● |
● |
● |
● |
Mortgage-Related
Securities |
● |
● |
|
|
|
Municipal
Securities |
● |
● |
● |
● |
● |
Non-Deliverable
Forwards |
● |
● |
|
|
|
Operational
Risk |
● |
● |
● |
● |
● |
Options
|
● |
● |
|
|
|
Pay-In-Kind
Bonds and Deferred Payment Securities |
● |
● |
|
|
|
Preferred
Stock |
● |
● |
|
|
|
Private
Placements and Other Restricted Securities |
● |
● |
● |
● |
● |
Put
Bonds |
● |
● |
● |
● |
● |
Real
Estate Investment Trusts |
● |
● |
|
|
|
Real
Estate Securities Risk |
● |
● |
|
|
|
Regulation
of Commodity Interests |
● |
● |
● |
● |
● |
Repurchase
Agreements |
● |
● |
|
|
|
Reverse
Repurchase Agreements |
● |
● |
|
|
|
Rights
Issues and Warrants |
● |
● |
● |
● |
● |
Securities
Backed by Guarantees |
● |
● |
● |
● |
● |
Securities
Lending |
● |
● |
● |
● |
● |
Securities
of Investment Companies |
● |
● |
● |
● |
● |
Short
Sales |
|
● |
|
|
|
“Special
Situations” Companies Risk |
● |
● |
|
|
|
Standby
Commitment Agreements |
● |
● |
● |
● |
● |
Strategic
Transactions, Derivatives and Synthetic Investments
|
● |
● |
|
|
|
Structured
Notes |
● |
● |
|
|
|
Structured
Securities |
● |
● |
● |
● |
● |
Supranational
Entities |
● |
● |
|
|
|
Swaps,
Caps, Floors and Collars |
● |
● |
|
|
|
Temporary
Investments |
● |
● |
● |
● |
● |
Transactions
Leverage Risk |
● |
● |
|
|
|
Trust
Preferred Securities |
● |
● |
|
|
|
U.S.
Government Securities |
● |
● |
● |
● |
● |
When-Issued
Securities and Delayed-Delivery |
● |
● |
● |
● |
● |
Zero
Coupon, Discount and Payment-In-Kind Securities |
● |
● |
● |
● |
● |
General
Information about the Fund’s Portfolio Instruments and Investment
Policies
The
following is a description of various types of securities, instruments and
techniques that may be purchased and/or used by
the Funds as well as certain risks to which the Funds are
subject.
Adjustable, Floating and Variable Rate
Instruments.
Floating, adjustable rate or variable rate obligations bear interest
at
rates that are not fixed, but vary with changes in specified market rates or
indices, such as the prime rate, or at specified
intervals. The interest rate on floating-rate securities varies with changes in
the underlying index (such as the Treasury
bill rate), while the interest rate on variable or adjustable rate securities
changes at preset times based upon an underlying
index. Certain of the floating or variable rate obligations that may be
purchased by a Fund may carry a demand
feature that would permit the holder to tender them back to the issuer of the
instrument or to a third-party at par
value prior to maturity.
10 Additional
Information on Portfolio Instruments and Investment Policies
The
interest rates paid on the adjustable rate securities in which a Fund may invest
generally are readjusted at intervals
of one year or less to an increment over some predetermined interest rate index.
There are three main categories
of indices: those based on U.S. Treasury securities, those derived from a
calculated measure such as a cost of funds
index and those based on a moving average of mortgage rates. Commonly used
indices include the one-year, three-year
and five-year constant maturity Treasury rates, the three-month Treasury bill
rate, the 180-day Treasury bill rate,
rates on longer-term Treasury securities, the 11th District Federal Home Loan
Bank Cost of Funds, and the National Median
Cost of Funds. Some
indices, such as the one-year constant maturity Treasury rate, closely mirror
changes in market
interest rate levels. Others, such as the 11th Federal District Home Loan Bank
Cost of Funds index, tend to lag behind
changes in market rate levels and tend to be somewhat less
volatile.
Auction
rate securities are variable rate bonds whose interest rates are reset at
specified intervals through a “Dutch” auction
process. A “Dutch” auction is a competitive bidding process designed to
determine a single uniform clearing rate that
enables purchases and sales of the auction rate securities to take place at par.
All accepted bids and holders of the auction
rate securities receive the same rate. Auction rate securities holders rely on
the liquidity generated by the auction.
There is a risk that an auction will fail due to insufficient demand for the
securities. If an auction fails, an auction rate
security may become illiquid until a subsequent successful auction is conducted,
the issuer redeems the issue, or a secondary
market develops. See “Municipal Securities” below for more information about
auction rate securities.
Demand
Instruments.
Demand instruments usually have a stated maturity of more than one year but
contain a demand
feature (or “put”) that enables the holder to redeem the investment.
Variable-rate demand instruments provide for
automatic establishment of a new interest rate on set dates. Floating-rate
demand instruments provide for automatic adjustment
of interest rates whenever a specified interest rate (e.g., the prime rate)
changes. These floating and variable rate
instruments are payable upon a specified period of notice which may range from
one day up to one year. The terms of
the instruments provide that interest rates are adjustable at intervals ranging
from daily to up to one year and the adjustments
are based upon the prime rate of a bank or other appropriate interest rate
adjustment index as provided in the
respective instruments. Variable rate instruments include participation
interests in variable- or fixed-rate municipal obligations
owned by a bank, insurance company or other financial institution or affiliated
organizations. Although the rate
of the underlying municipal obligations may be fixed, the terms of the
participation interest may result in a fund receiving
a variable rate on its investment.
Because
of the variable rate nature of the instruments, when prevailing interest rates
decline the yield on these instruments
will generally decline. On the other hand, during periods when prevailing
interest rates increase, the yield on these
instruments will generally increase and the instruments will have less risk of
capital depreciation than instruments bearing
a fixed rate of return.
Some
of the demand instruments purchased by a Fund may not be traded in a secondary
market and derive their liquidity
solely from the ability of the holder to demand repayment from the issuer or
third-party providing credit support. If
a demand instrument is not traded in a secondary market, a Fund will nonetheless
treat the instrument as “readily marketable”
for the purposes of its investment restriction limiting investments in illiquid
securities unless the demand feature
has a notice period of more than seven days in which case the instrument will be
characterized as “not readily marketable”
and therefore illiquid. Such obligations include variable rate master demand
notes, which are unsecured instruments
issued pursuant to an agreement between the issuer and the holder that permit
the indebtedness thereunder
to vary and to provide for periodic adjustments in the interest rate. A Fund
will limit its purchases of floating and
variable rate obligations to those of the same quality as it is otherwise
allowed to purchase. abrdn Inc. (“abrdn Inc.” or the
“Adviser”) will monitor on an ongoing basis the ability of an issuer of a demand
instrument to pay principal and interest on
demand. A Fund’s right to obtain payment at par on a demand instrument could be
affected by events occurring between
the date the Fund elects to demand payment and the date payment is due that may
affect the ability of the issuer
of the instrument or third-party providing credit support to make payment when
due, except when such demand instruments
permit same day settlement. To facilitate settlement, these same day demand
instruments may be held in book
entry form at a bank other than a Fund’s custodian subject to a sub-custodian
agreement approved by the Fund between
that bank and the Fund’s custodian.
Asset-Backed
Securities.
Asset-backed securities, issued by trusts and special purpose corporations, are
pass-through
securities, meaning that principal and interest payments, net of expenses, made
by the borrower on the underlying
asset (such as credit card or automobile loan receivables) are passed to a Fund.
Asset-backed securities may include
pools of loans, receivables or other assets. Payment of principal and interest
may be largely dependent upon the cash
flows generated by the assets backing the securities. Asset-backed securities
present certain risks that are not presented
by mortgage-backed securities. Primarily, these securities may not have the
benefit of any security interest in the
related assets. Credit card receivables are generally unsecured and the debtors
are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts owed
on the credit cards, thereby reducing the balance due. There is the possibility
that recoveries on repossessed collateral
may not, in some cases, be available to support payments on these securities.
Asset-backed securities are often
backed by a pool of assets representing the obligations of a number of different
parties. To lessen the effect of failures
by obligors on underlying assets to make payments, the securities may contain
elements of credit support which fall
into two categories: (i) liquidity protection, and (ii) protection against
losses resulting from ultimate default by an obligor
on the underlying assets. Liquidity protection refers to the provision of
advances, generally by the entity
Additional
Information on Portfolio Instruments and Investment Policies 11
administering
the pool of assets, to ensure that the receipt of payments on the underlying
pool occurs in a timely fashion. Protection
against losses results from payment of the insurance obligations on at least a
portion of the assets in the pool. This
protection may be provided through guarantees, policies or letters of credit
obtained by the issuer or sponsor from third
parties, through various means of structuring the transaction or through a
combination of such approaches. A Fund will
not pay any additional or separate fees for credit support. The degree of credit
support provided for each issue is generally
based on historical information respecting the level of credit risk associated
with the underlying assets.
Delinquency
or loss in excess of that anticipated or failure of the credit support could
adversely affect the return on an
investment in such a security. The availability of asset-backed securities may
be affected by legislative or regulatory developments.
It is possible that such developments may require the Fund to dispose of any
then-existing holdings of such
securities. Additionally, the risk of default by borrowers is greater during
periods of rising interest rates and/or unemployment
rates. In addition, instability in the markets for asset-backed securities may
affect the liquidity of such securities,
which means a Fund may be unable to sell such securities at an advantageous time
and price. As a result, the value
of such securities may decrease and a Fund may incur greater losses on the sale
of such securities than under more
stable market conditions. Furthermore, instability and illiquidity in the market
for lower-rated asset-backed securities
may affect the overall market for such securities thereby impacting the
liquidity and value of higher-rated securities.
Several
types of asset-backed securities have been offered to investors, including
Certificates of Automobile ReceivablesSM
(“CARSSM”).
CARSSM
represent undivided fractional interests in a trust whose assets consist of a
pool of motor
vehicle retail installment sales contracts and security interests in the
vehicles securing the contracts. Payments of principal
and interest on CARSSM
are passed through monthly to certificate holders, and are guaranteed up to
certain amounts
and for a certain time period by a letter of credit issued by a financial
institution unaffiliated with the trustee or originator
of the trust. An investor’s return on CARSSM
may be affected by early prepayment of principal on the underlying vehicle
sales contracts. If the letter of credit is exhausted, the trust may be
prevented from realizing the full amount due on
a sales contract because of state law requirements and restrictions relating to
foreclosure sales of vehicles and the obtaining
of deficiency judgments following such sales or because of depreciation, damage
or loss of a vehicle, the application
of federal and state bankruptcy and insolvency laws, or other factors. As a
result, certificate holders may experience
delays in payments or losses if the letter of credit is exhausted.
A
Fund may also invest in residual interests in asset-backed securities. In the
case of asset-backed securities issued in
a pass-through structure, the cash flow generated by the underlying assets is
applied to make required payments on the
securities and to pay related administrative expenses. The residual in an
asset-backed security pass-through structure
represents the interest in any excess cash flow remaining after making the
foregoing payments. The amount of residual
cash flow resulting from a particular issue of asset-backed securities will
depend on, among other things, the characteristics
of the underlying assets, the coupon rates on the securities, prevailing
interest rates, the amount of administrative
expenses and the actual prepayment experience on the underlying assets.
Asset-backed security residuals
not registered under the Securities Act of 1933, as amended (the “Securities
Act”) may be subject to certain restrictions
on transferability. In addition, there may be no liquid market for such
securities.
Asset-backed
securities present certain risks. For instance, in the case of credit card
receivables, these securities may
not have the benefit of any security interest in the related collateral. Credit
card receivables are generally unsecured and
the debtors are entitled to the protection of a number of state and federal
consumer credit laws, many of which give such
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the balance due. Most issuers
of automobile receivables permit the servicers to retain possession of the
underlying obligations. If the servicer were
to sell these obligations to another party, there is a risk that the purchaser
would acquire an interest superior to that of
the holders of the related automobile receivables. In addition, because of the
large number of vehicles involved in a typical
issuance and technical requirements under state laws, the trustee for the
holders of the automobile receivables may
not have a proper security interest in all of the obligations backing such
receivables. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be available to
support payments on these securities. The
underlying assets (e.g., loans) are also subject to prepayments, which shorten
the securities’ weighted average life and
may lower their return.
Bank Loans.
Bank loans include floating and fixed-rate debt obligations. Floating rate loans
are debt obligations issued
by companies or other entities with floating interest rates that reset
periodically. Bank loans may include, but are not
limited to, term loans, delayed funding loans, bridge loans and revolving credit
facilities. Loan interests will primarily take
the form of assignments purchased in the primary or secondary market, but may
include participations. Floating rate
loans are secured by specific collateral of the borrower and are senior to most
other securities of the borrower (e.g., common
stock or debt instruments) in the event of bankruptcy. Floating rate loans are
often issued in connection with recapitalizations,
acquisitions, leveraged buyouts, and refinancings. Floating rate loans are
typically structured and administered
by a financial institution that acts as the agent of the lenders participating
in the floating rate loan. Floating rate
loans may be acquired directly through the agent, as an assignment from another
lender who holds a direct interest in
the floating rate loan, or as a participation interest in another lender’s
portion of the floating rate loan.
A
Fund generally invests in floating rate loans directly through an agent, by
assignment from another holder of the loan,
or as a participation interest in another holder’s portion of the loan.
Assignments and participations involve credit, interest
rate, and liquidity risk. Interest rates on floating rate loans adjust
periodically and are tied to a benchmark lending
12 Additional
Information on Portfolio Instruments and Investment Policies
rate
such as the Secured
Overnight Financing Rate (“SOFR”) or another rate based on the SOFR.
The
lending rate could also
be tied to the prime rate offered by one or more major U.S. banks or the rate
paid on large certificates of deposit traded
in the secondary markets. If the benchmark lending rate changes, the rate
payable to lenders under the loan will change
at the next scheduled adjustment date specified in the loan agreement. Investing
in floating rate loans with longer
interest rate reset periods may increase fluctuations in a Fund’s net asset
value (“NAV”) as a result of changes in interest
rates.
When
a Fund purchases an assignment, it generally assumes all the rights and
obligations under the loan agreement
and will generally become a “lender” for purposes of the particular loan
agreement. The rights and obligations
acquired by a Fund under an assignment may be different, and be more limited,
than those held by an assigning
lender. Subject to the terms of a loan agreement, the Fund may enforce
compliance by a borrower with the terms
of the loan agreement and may have rights with respect to any funds acquired by
other lenders through set-off. If a
loan is foreclosed, the Fund may become part owner of any collateral securing
the loan, and may bear the costs and liabilities
associated with owning and disposing of any collateral. The Fund could be held
liable as a co-lender. In addition, there
is no assurance that the liquidation of any collateral from a secured loan would
satisfy a borrower’s obligations or that
any collateral could be liquidated.
If
a Fund purchases a participation interest, it typically will have a contractual
relationship with the lender and not with
the borrower. The Fund may only be able to enforce its rights through the lender
and may assume the credit risk of both
the borrower and the lender, or any other intermediate participant. The Fund may
have the right to receive payments
of principal, interest, and any fees to which it is entitled only from the
lender and only upon receipt by the lender
of the payments from the borrower. The failure by the Fund to receive scheduled
interest or principal payments may
adversely affect the income of the Fund and may likely reduce the value of its
assets, which would be reflected by a reduction
in the Fund’s NAV.
In
the cases of a Fund’s investments in floating rate loans through participation
interests, it may be more susceptible to
the risks of the financial services industries. The Fund may also be subject to
greater risks and delays than if the Fund could
assert its rights directly against the borrower. In the event of the insolvency
of an intermediate participant who sells a
participation interest to a Fund, it may be subject to loss of income and/or
principal. Additionally, a Fund may not have any
right to vote on whether to waive any covenants breached by a borrower and may
not benefit from any collateral securing
a loan. Parties through which the Fund may have to enforce its rights may not
have the same interests as the Fund.
The
borrower of a loan in which a Fund holds an assignment or participation interest
may, either at its own election or
pursuant to the terms of the loan documentation, prepay amounts of the loan from
time to time. There is no assurance that
the Fund will be able to reinvest the proceeds of any loan prepayment at the
same interest rate or on the same terms
as those of the original loan participation. This may result in a Fund realizing
less income on a particular investment and
replacing the loan with a less attractive security, which may provide less
return to the Fund.
The
secondary market on which floating rate loans are traded may be less liquid than
the market for investment grade
securities or other types of income producing securities. Therefore, a Fund may
have difficulty trading assignments
and participations to third parties. There is also a potential that there is no
active market to trade floating rate
loans. There may be restrictions on transfer and only limited opportunities may
exist to sell such securities in secondary
markets. As a result, the Fund may be unable to sell assignments or
participations at the desired time or only at
a price less than fair market value. The secondary market may also be subject to
irregular trading activity, wide price spreads,
and extended trade settlement periods. The lack of a liquid secondary market may
have an adverse impact on the
market price of the security.
Assignments
and participations of bank loans also may be less liquid at times because of
potential delays in the settlement
process. Bank loans may settle on a delayed basis, resulting in the proceeds
from the sale of such loans not being
readily available to make additional investments or to meet a Fund’s redemption
obligations. To the extent the extended
settlement process gives rise to short-term liquidity needs, a Fund may hold
additional cash, sell investments or temporarily
borrow from banks or other lenders. Settlement risk is heightened for bank loans
in certain foreign markets, which
differ significantly and may be less established from those in the United
States. Foreign settlement procedures and trade
regulations also may involve certain risks (such as delays in payment for or
delivery of securities) not typically generated
by the settlement of U.S. loans and other debt securities. Communications
between the United States and emerging
market countries may be unreliable, increasing the risk of delayed settlements.
If a Fund cannot settle or there is
a delay in settling a purchase of a loan or other security, that Fund may miss
attractive investment opportunities and certain
assets may be uninvested with no return earned thereon for some period. In
addition, that Fund may lose money if
the value of the security then declines or, if there is a contract to sell the
security to another party, the Fund could be liable
to that party for any losses incurred. Furthermore, some foreign markets in
which a Fund may invest in loans may not
operate with the concept of delayed compensation, or a pricing adjustment
payable by the parties to a secondary loan
trade that settles after an established time intended to assure that neither
party derives an economic advantage from
the delay (established in the U.S. as T+7 and T+20 for par/near par trades and
distressed trades, respectively). Where
there is no delayed compensation, one party will typically bear the risk of the
other’s delaying settlement for economic
gain.
Additional
Information on Portfolio Instruments and Investment Policies 13
In
certain circumstances, loans may not be deemed to be securities, and in the
event of fraud or misrepresentation by
a borrower, lenders and purchasers of interests in loans, such as a Fund, 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.
Loan Participations and
Assignments.
A participation in commercial loans may be secured or unsecured. Loan
participations
typically represent direct participation in a loan to a corporate borrower, and
generally are offered by banks
or other financial institutions or lending syndicates. A Fund may participate in
such syndications, or can buy part of a
loan, becoming a part lender. Participations and assignments involve credit
risk, interest rate risk, liquidity risk, and the risk
of being a lender.
When
purchasing loan participations, a Fund assumes the credit risk associated with
the corporate borrower and may
assume the credit risk associated with an interposed bank or other financial
intermediary; however, the Fund may only
be able to enforce its rights through the lender. The participation interests in
which a Fund invests may not be rated by
any nationally recognized statistical rating organization
(“NRSRO”).
A
loan is often administered by an agent bank acting as agent for all holders. The
agent bank administers the terms of
the loan, as specified in the loan agreement. In addition, the agent bank is
normally responsible for the collection of principal
and interest payments from the corporate borrower and the apportionment of these
payments to the credit of all
institutions which are parties to the loan agreement. Unless, under the terms of
the loan or other indebtedness, a Fund has
direct recourse against the corporate borrower, the Fund may have to rely on the
agent bank or other financial intermediary
to apply appropriate credit remedies against a corporate borrower.
A
financial institution’s employment as agent bank might be terminated in the
event that it fails to observe a requisite standard
of care or becomes insolvent. A successor agent bank would generally be
appointed to replace the terminated agent
bank, and assets held by the agent bank under the loan agreement should remain
available to holders of such indebtedness.
However, if assets held by the agent bank for the benefit of a Fund were
determined to be subject to the claims
of the agent bank’s general creditors, the Fund might incur certain costs and
delays in realizing payment on a loan or
loan participation and could suffer a loss of principal and/or interest. In
situations involving other interposed financial institutions
(e.g., an insurance company or governmental agency) similar risks may
arise.
Purchasers
of loans and other forms of direct indebtedness depend primarily upon the
creditworthiness of the corporate
borrower for payment of principal and interest. If a Fund does not receive
scheduled interest or principal payments
on such indebtedness, the Fund’s share price and yield could be adversely
affected. Loans that are fully secured
offer a Fund more protection than an unsecured loan in the event of non-payment
of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral from a secured
loan would satisfy the corporate borrower’s
obligation, or that the collateral can be liquidated.
A
Fund may invest in loan participations with credit quality comparable to that of
issuers of its securities investments. Indebtedness
of companies whose creditworthiness is poor involves substantially greater risks
and may be highly speculative.
Some companies may never pay off their indebtedness, or may pay only a small
fraction of the amount owed.
Consequently, when investing in indebtedness of companies with poor credit, a
Fund bears a substantial risk of losing
the entire amount invested.
For
purposes of a Fund’s concentration limits, a Fund generally will treat the
corporate borrower as the “issuer” of indebtedness
held by the Fund. In the case of loan participations where a bank or other
lending institution serves as a financial
intermediary between a Fund and the corporate borrower, if the participation
does not shift to the Fund the direct
debtor-creditor relationship with the corporate borrower, SEC interpretations
require the Fund to treat both the lending
bank or other lending institution and the corporate borrower as “issuers.”
Treating a financial intermediary as an issuer
of indebtedness may restrict a Fund’s ability to invest in indebtedness related
to a single financial intermediary, or a group
of intermediaries engaged in the same industry, even if the underlying borrowers
represent many different companies
and industries.
Loans
and other types of direct indebtedness may not be readily marketable and may be
subject to restrictions on resale.
In some cases, negotiations involved in disposing of indebtedness may require
weeks to complete. Consequently, some
indebtedness may be difficult or impossible to dispose of readily at what the
Adviser believes to be a fair price. In addition,
valuation of illiquid indebtedness involves a greater degree of judgment in
determining a Fund’s NAV than if that value
were based on available market quotations, and could result in significant
variations in a Fund’s daily share price. At the
same time, some loan interests are traded among certain financial institutions
and accordingly may be deemed liquid.
As the market for different types of indebtedness develops, the liquidity of
these instruments is expected to improve.
In addition, each Fund currently intends to treat indebtedness for which there
is no readily available market as illiquid
for purposes of a Fund’s limitation on illiquid investments. Investments in loan
participations are considered to be debt
obligations for purposes of the Trust’s investment restriction relating to the
lending of funds or assets by a Fund.
Investments
in loans through a direct assignment of the financial institution’s interests
with respect to the loan may involve
additional risks to a Fund. For example, if a loan is foreclosed, a Fund could
become part owner of any collateral, and
would bear the costs and liabilities associated with owning and disposing of the
collateral. In addition, it is
14 Additional
Information on Portfolio Instruments and Investment Policies
conceivable
that under emerging legal theories of lender liability, a Fund could be held
liable as co-lender. It is unclear whether
loans and other forms of direct indebtedness offer securities law protections
against fraud and misrepresentation.
In the absence of definitive regulatory guidance, a Fund relies on the Adviser’s
research in an attempt to
avoid situations where fraud or misrepresentation could adversely affect the
Fund.
A
Fund may also enter into, or acquire participations in, delayed funding loans
and revolving credit facilities. Delayed funding
loans and revolving credit facilities are borrowing arrangements in which the
lender agrees to make loans up to a maximum
amount upon demand by the borrower during a specified term. A revolving credit
facility differs from a delayed
funding loan in that as the borrower repays the loan, an amount equal to the
repayment may be borrowed again
during the term of the revolving credit facility. Delayed funding loans and
revolving credit facilities usually provide for
floating or variable rates of interest. These commitments may have the effect of
requiring a Fund to increase its investment
in a company at a time when it might not otherwise decide to do so (including at
a time when the company’s financial
condition makes it unlikely that such amounts will be repaid). In accordance
with current federal securities laws, rules,
and staff positions, to the extent that a Fund is committed to advance
additional funds, it will at all times segregate or
“earmark” assets, determined to be liquid by the Adviser in accordance with
procedures established by the board of trustees
of the Trust (the “Board of Trustees”), in an amount sufficient to meet such
commitments.
A
Fund may invest in delayed funding loans and revolving credit facilities with
credit quality comparable to that of issuers
of its securities investments. Delayed funding loans and revolving credit
facilities may be subject to restrictions on transfer,
and only limited opportunities may exist to resell such instruments. As a
result, a Fund may be unable to sell such investments
at an opportune time or may have to resell them at less than fair market value.
The Funds currently intend to treat
delayed funding loans and revolving credit facilities for which there is no
readily available market as illiquid for purposes
of a Fund’s limitation on illiquid investments. Participation interests in
revolving credit facilities will be subject to the
limitations discussed above. Delayed funding loans and revolving credit
facilities are considered to be debt obligations
for purposes of the Trust’s investment restriction relating to the lending of
funds or assets by a Fund.
Delayed Funding Loans and Revolving Credit
Facilities.
Delayed funding loans and revolving credit facilities are borrowings
in which the Fund agrees to make loans up to a maximum amount upon demand by the
borrowing issuer for a
specified term. A revolving credit facility differs from a delayed funding loan
in that as the borrowing issuer repays the loan,
an amount equal to the repayment is again made available to the borrowing issuer
under the facility. The borrowing issuer
may at any time borrow and repay amounts so long as, in the aggregate, at any
given time the amount borrowed does
not exceed the maximum amount established by the loan agreement. Delayed funding
loans and revolving credit facilities
usually provide for floating or variable rates of interest.
There
are a number of risks associated with an investment in delayed funding loans and
revolving credit facilities including,
credit, interest rate and liquidity risk and the risks of being a lender. There
may be circumstances under which the
borrowing issuer’s credit risk may be deteriorating and yet a Fund may be
obligated to make loans to the borrowing issuer
as the borrowing issuer’s credit continues to deteriorate, including at a time
when the borrowing issuer’s financial condition
makes it unlikely that such amounts will be repaid.
Delayed
funding loans and revolving credit facilities may be subject to restrictions on
transfer, and only limited opportunities
may exist to resell such instruments. As a result, a Fund may be unable to sell
such investments at an opportune
time or may have to resell them at less than fair market value. These risks
could cause a Fund to lose money on
its investment, which in turn could affect a Fund’s returns. A Fund may treat
delayed funding loans and revolving credit facilities
for which there is no readily available market as illiquid for purposes of the
Fund’s limitation on illiquid investments.
Bank
Obligations.
Bank obligations are obligations issued or guaranteed by U.S. or foreign banks.
Bank obligations, including
without limitation, time deposits, bankers’ acceptances and certificates of
deposit, may be general obligations of
the parent bank or may be limited to the issuing branch by the terms of the
specific obligations or by government regulations.
Banks are subject to extensive but different governmental regulations which may
limit both the amount and types
of loans which may be made and interest rates which may be charged. General
economic conditions as well as exposure
to credit losses arising from possible financial difficulties of borrowers play
an important part in the operation of the
banking industry.
Certificates
of deposit are receipts issued by a depository institution in exchange for the
deposit of funds. The issuer agrees
to pay the amount deposited plus interest to the bearer of the receipt on the
date specified on the certificate. The certificate
usually can be traded in the secondary market prior to maturity. Bankers’
acceptances typically arise from short-term
credit arrangements designed to enable businesses to obtain funds to finance
commercial transactions. Generally,
an acceptance is a time draft drawn on a bank by an exporter or an importer to
obtain a stated amount of funds
to pay for specific merchandise. The draft is then “accepted” by a bank that, in
effect, unconditionally guarantees to
pay the face value of the instrument on its maturity date. The acceptance may
then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities
for acceptances can be as long as 270 days, most acceptances have maturities of
six months or less.
A
Fund may also invest in certificates of deposit issued by banks and savings and
loan institutions which had, at the time
of their most recent annual financial statements, total assets of less than $1
billion, provided that (i) the principal amounts
of such certificates of deposit are insured by an agency of the U.S. Government,
(ii) at no time will a Fund hold
Additional
Information on Portfolio Instruments and Investment Policies 15
more
than $100,000 principal amount of certificates of deposit of any one such bank,
and (iii) at the time of acquisition, no
more than 10% of a Fund’s assets (taken at current value) are invested in
certificates of deposit of such banks having total
assets not in excess of $1 billion.
Bankers’
acceptances are credit instruments evidencing the obligations of a bank to pay a
draft drawn on it by a customer.
These instruments reflect the obligation both of the bank and of the drawer to
pay the face amount of the instrument
upon maturity.
Time
deposits are non-negotiable deposits maintained in a banking institution for a
specified period of time at a stated
interest rate. Time deposits which may be held by a Fund will not benefit from
insurance from the Bank Insurance Fund
or the Savings Association Insurance Fund administered by the Federal Deposit
Insurance Corporation. Fixed time deposits
may be withdrawn on demand by the investor, but may be subject to early
withdrawal penalties that vary with market
conditions and the remaining maturity of the obligation. Fixed time deposits
subject to withdrawal penalties maturing
in more than seven calendar days are subject to a Fund’s limitation on
investments in illiquid securities.
Bonds with Warrants
Attached.
Bonds with warrants attached are bonds issued as a unit with warrants. A Fund
may dispose
of the common stock received upon conversion of a convertible security or
exercise of a warrant as promptly as it
can and in a manner that it believes reduces the risk to the Fund of a loss in
connection with the sale. A Fund does not intend
to retain in its portfolio any warrant acquired as a unit with bonds if the
warrant begins to trade separately from the related
bond.
Borrowing.
Each Fund, to the extent permitted by its fundamental investment restrictions,
may borrow money from banks.
Each Fund will limit borrowings to amounts not in excess of 33⅓% of the value of
the Fund’s total assets less liabilities
(other than borrowings), unless a Fund’s fundamental investment restrictions set
forth a lower limit. Any borrowings
that exceed this amount will be reduced within three days (not including Sundays
and holidays) to the extent necessary
to comply with the 33⅓% limitation or fundamental investment restriction. Each
Fund may borrow money as a temporary
measure for defensive or emergency purposes in order to meet redemption requests
without immediately selling
any portfolio securities. Investments in mortgage dollar roll and reverse
repurchase agreements are not considered
a form of borrowing where the Fund covers its exposure by segregating or
earmarking liquid assets. Rule 18f-4
under the 1940 Act (“Rule 18f-4”) permits the Funds to treat reverse repurchase
transactions either as borrowings or
as “derivative transactions” subject to the risk-based limits of the rule, and
does not require a Fund to maintain in a segregated
account assets to meet its asset coverage requirements.
Certain
types of borrowings by a Fund may result in the Fund being subject to covenants
in credit agreements relating
to asset coverage, portfolio composition requirements and other matters. It is
not anticipated that observance of such
covenants would impede the Adviser from managing the Fund’s portfolio in
accordance with the Fund’s investment objective(s)
and policies. However, a breach of any such covenants not cured within the
specified cure period may result in
acceleration of outstanding indebtedness and require a Fund to dispose of
portfolio investments at a time when it may be
disadvantageous to do so.
Bridge Loans.
Bridge loans or bridge facilities are short-term loan arrangements (e.g., 12 to
18 months) typically made
by a borrower in anticipation of intermediate-term or long-term permanent
financing. Most bridge loans are structured
as floating-rate debt with step-up provisions under which the interest rate on
the bridge loan rises the longer the
loan remains outstanding. In addition, bridge loans commonly contain a
conversion feature that allows the bridge loan
investor to convert its loan interest into senior exchange notes if the loan has
not been prepaid in full on or prior to its maturity
date. Bridge loans may be subordinate to other debt and may be secured or
unsecured. Like any loan, bridge loans
involve credit risk. Bridge loans are generally made with the expectation that
the borrower will be able to obtain permanent
financing in the near future. Any delay in obtaining permanent financing
subjects the bridge loan investor to increased
risk. A borrower’s use of bridge loans also involves the risk that the borrower
may be unable to locate permanent
financing to replace the bridge loan, which may impair the borrower’s perceived
creditworthiness. From time to
time, a Fund may make a commitment to participate in a bridge loan facility,
obligating itself to participate in the facility
if it funds. In return for this commitment, a Fund receives a fee.
Business Development Companies
(“BDCs”).
BDCs are typically publicly-held, closed-end investment funds that are
regulated
by the 1940 Act. BDCs primarily lend to or invest in private or thinly-traded
companies. They also offer managerial
assistance to the companies in which they invest. BDCs must adhere to various
substantive regulatory requirements
under the 1940 Act. For example, the 1940 Act restricts the types of assets in
which a BDC may invest (i.e., at
least 70% of the BDC’s total assets must be “qualifying assets,” as defined in
the 1940 Act). The 1940 Act also regulates how
BDCs employ “leverage” (i.e., how BDCs use borrowed funds to make investments).
Because the 1940 Act applies unique
“coverage ratio” tests to BDCs, BDCs may incur more debt than other regulated
closed-end investment companies.
Specifically, on one hand, the total assets of a closed-end investment company
(other than a BDC) must exceed
the fund’s outstanding debt by at least 300%. On the other hand, the total
assets of a BDC must exceed the BDC’s outstanding
debt by only 200%, thereby allowing a BDC to employ more leverage than other
regulated closed-end investment
companies. Leverage magnifies the potential for gain and loss on amounts
invested and, as a result, increases the
risks associated with the securities of leveraged companies.
16 Additional
Information on Portfolio Instruments and Investment Policies
Privately-held
and thinly-traded companies are generally considered to be below investment
grade, and the debt securities
of those companies, in turn, are often referred to as “high-yield” or “junk.”
The revenues, income (or losses) and valuations
of these companies can, and often do, fluctuate suddenly and dramatically, and
they face considerable risk of loss.
In addition, the fair value of a BDC’s investments in privately-held or
thinly-traded companies often is not readily determinable.
Although each BDC’s board of directors is responsible for determining the fair
value of these securities, the uncertainty
regarding fair value may adversely affect the determination of the BDC’s NAV.
This could cause a Fund’s investments
in a BDC to be inaccurately valued. BDCs often borrow funds to make investments
and, as a result, are exposed
to the risks of leverage. Leverage magnifies the potential loss on amounts
invested and therefore increases the risks
associated with an investment in a leveraged BDC’s securities. Leverage is
generally considered a speculative investment
technique. Moreover, BDCs’ management fees, which are generally higher than the
management fees charged
to other funds, are normally payable on gross assets, including those assets
acquired through the use of leverage.
This may give a BDC’s investment adviser a financial incentive to incur
leverage.
Catastrophe
Bond.
A catastrophe bond (“cat bond”) is a high-yield debt instrument that is usually
insurance linked and
meant to raise money in case of a catastrophe such as a hurricane or earthquake.
If an “issuer,” such as an insurance company
or reinsurance company (a company that insures insurance companies), wants to
transfer some or all of the risk
it assumes in insuring a catastrophe, it can set up a separate legal
structure—commonly known as a special purpose vehicle
(“SPV”). Foreign governments and private companies also have sponsored cat bonds
as a hedge against natural disasters.
The
SPV issues cat bonds and typically invests the proceeds from the bond issuance
in low-risk securities, such as in investment
grade money market or treasury funds, which are those rated Aaa by Moody’s
Investors Service Inc. (“Moody’s”)
or AAA by Fitch, Inc. (“Fitch”) or a comparable rating by another NRSRO (the
collateral). The earnings on these
low-risk securities, as well as insurance premiums paid to the issuer, are used
to make periodic, variable rate interest
payments to investors.
As
long as the natural disaster covered by the bond does not occur during the time
investors own the bond, investors will
receive their interest payments and, when the bond matures, their principal back
from the collateral. Most cat bonds generally
mature in three years, although terms range from one to five years, depending on
the bond.
If
the event does occur, however, the issuer’s right to the collateral is
“triggered.” This means the issuer receives the collateral,
instead of investors receiving it when the bond matures, causing investors to
lose most—or all—of their principal and
unpaid interest payments. You may hear this described as a “credit cliff.” When
this happens, the SPV might also have the
right to extend the maturity of the bonds to verify that the trigger did occur
or to process and audit insurance claims. Depending
on the bond, the extension can last anywhere from three months to two years or
more. In some cases, cat bonds
cover multiple events to reduce the chances that investors will lose all of
their principal.
Each
cat bond has its own triggering event(s), which is(are) spelled out in the
bond’s offering documents. These documents
typically are only available to purchasers or potential purchasers, however,
because cat bonds are not subject
to the Securities and Exchange Commission’s (“SEC”) registration and disclosure
requirements. A number of different
types of triggers have developed. The question of whether a triggering event
occurred—or the true meaning of a
triggering event—can be complex and could wind up being litigated and require a
ruling from a court. This in turn may add
additional uncertainty to the way these securities perform.
Because
cat bond holders face potentially huge losses, cat bonds are typically rated BB,
or “non-investment grade” by
credit rating agencies such as Fitch, Moody’s and Standard & Poor’s Global
Ratings (“Standard & Poor’s”). Non-investment
grade bonds are also known as “high yield” or “junk” bonds. These ratings
agencies, as well as sponsors and
underwriters of cat bonds, rely heavily on a handful of firms that specialize in
modeling natural disasters. These “risk modeling”
firms employ meteorologists, seismologists, statisticians, and other experts who
use large databases of historical
or simulated data to estimate the probabilities and potential financial damage
of natural disasters.
The
potential advantages of cat bonds are that they are not closely linked with the
stock market or economic conditions
and offer significant attractions to investors. For example, for the same level
of risk, investors can usually obtain a
higher yield with cat bonds relative to alternative investments. Another
potential benefit is that the insurance risk securitization
of cat bonds shows no correlation with equities or corporate bonds, meaning they
may provide a good diversification
of risks.
As
with any financial instrument, cat bonds also present risks, which include the
following:
Credit
Cliff:
A cat bond can cause the investor rapidly to lose most or all of his or her
principal and any unpaid interest
if a triggering event occurs. The high yield will not make investors whole if
the triggering event actually occurs.
Modeling
Risk:
Prices, yields and ratings of cat bonds rely almost exclusively on complex
computer modeling techniques,
which in turn are extremely sensitive to the data used in the models. The
quality and quantity of data vary depending
on the catastrophe.
Additional
Information on Portfolio Instruments and Investment Policies 17
Liquidity
Risk:
Secondary trading for cat bonds is very limited, so in a pinch an investor may
not be able to sell. In addition,
the secondary transactions that do occur are privately negotiated, so pricing
information is not generally available
to the public. In addition, as noted, the maturity of some cat bonds can be
extended during the worst possible time—when
a trigger may have occurred, which can cause the bonds’ value to plummet,
potentially making them even harder
to sell.
Unregistered
Investments:
Most cat bonds are issued in offerings pursuant to Rule 144A under the
Securities Act (“Rule
144A”), which are available only to large institutional investors and are not
subject to the SEC’s registration and disclosure
requirements. As a result, many of the normal investor protections that are
common to most traditional registered
investments are missing. For example, issuers of cat bonds are not required to
file a registration statement or periodic
reports with the SEC, unlike issuers of registered bonds. While general
prohibitions against securities fraud apply to
Rule 144A offerings, the lack of public disclosure may make it difficult to
obtain and evaluate the information used to price
and structure cat bonds.
Closed-end
Funds.
The value of the shares of a closed-end fund may be higher or lower than the
value of the portfolio
securities held by the closed-end fund. Closed-end investment funds may trade
infrequently and with small volume,
which may make it difficult for a Fund to buy and sell shares. Also, the market
price of closed-end investment companies
tends to rise more in response to buying demand and fall more in response to
selling pressure than is the case with
larger capitalization companies.
Common Stock.
Common stock is issued by companies to raise cash for business purposes and
represents a proportionate
interest in the issuing companies. Therefore, a Fund participates in the success
or failure of any company in which
it holds stock. The market value of common stock can fluctuate significantly,
reflecting the business performance of
the issuing company, investor perception,
general economic or financial market movements,
or the occurrence of political,
geopolitical, social or economic events affecting issuers.
Smaller companies are especially sensitive to these factors
and may even become valueless. Despite the risk of price volatility, however,
common stocks also offer a greater potential
for gain on investment, compared to other classes of financial assets such as
bonds or cash equivalents. A Fund may
also receive common stock as proceeds from a defaulted debt security held by the
Fund or from a convertible bond converting
to common stock. In such situations, a Fund will hold the common stock at the
Adviser’s discretion.
Convertible
Securities.
Convertible securities are bonds, notes, debentures, preferred stocks and other
securities which
are convertible into common stock. Investments in convertible securities can
provide an opportunity for capital appreciation
and/or income through interest and dividend payments by virtue of their
conversion or exchange features.
The
convertible securities in which a Fund may invest are either fixed income or
zero coupon debt securities which may
be converted or exchanged at a stated or determinable exchange ratio into
underlying shares of common stock. The
exchange ratio for any particular convertible security may be adjusted from time
to time due to stock splits, dividends,
spin-offs, other corporate distributions or scheduled changes in the exchange
ratio. Convertible debt securities
and convertible preferred stocks, until converted, have general characteristics
similar to both debt and equity securities.
Although to a lesser extent than with debt securities generally, the market
value of convertible securities tends to
decline as interest rates increase and, conversely, tends to increase as
interest rates decline. In addition, because of the conversion
or exchange feature, the market value of convertible securities typically
changes as the market value of the underlying
common stock changes, and, therefore, also tends to follow movements in the
general market for equity securities.
A unique feature of convertible securities is that as the market price of the
underlying common stock declines, convertible
securities tend to trade increasingly on a yield basis, and so may not
experience market value declines to the same
extent as the underlying common stock. When the market price of the underlying
common stock increases, the prices
of the convertible securities tend to rise as a reflection of the value of the
underlying common stock, although typically
not as much as the underlying common stock. While no securities investments are
without risk, investments in convertible
securities generally entail less risk than investments in common stock of the
same issuer.
As
debt securities, convertible securities are investments which provide for a
stream of income (or in the case of zero coupon
securities, accretion of income) with generally higher yields than common
stocks. Convertible securities generally
offer lower yields than non-convertible securities of similar quality because of
their conversion or exchange features.
Like
all debt securities, there can be no assurance of income or principal payments
because the issuers of the convertible
securities may default on their obligations.
Convertible
securities generally are subordinated to other similar but non-convertible
securities of the same issuer, although
convertible bonds, as corporate debt obligations, enjoy seniority in right of
payment to all equity securities, and convertible
preferred stock is senior to common stock, of the same issuer. However, because
of the subordination feature,
convertible bonds and convertible preferred stock typically have lower ratings
than similar non-convertible securities.
Convertible securities may be issued as fixed income obligations that pay
current income or as zero coupon notes
and bonds, including Liquid Yield Option Notes (“LYONs”™).
Zero
coupon convertible securities are debt securities which are issued at a discount
to their face amount and do not
entitle the holder to any periodic payments of interest prior to maturity.
Rather, interest earned on zero coupon convertible
securities accretes at a stated yield until the security reaches its face amount
at maturity. Zero coupon
18 Additional
Information on Portfolio Instruments and Investment Policies
convertible
securities are convertible into a specific number of shares of the issuer’s
common stock. In addition, zero coupon
convertible securities usually have put features that provide the holder with
the opportunity to sell the securities back
to the issuer at a stated price before maturity. Generally, the prices of zero
coupon convertible securities may be more
sensitive to market interest rate fluctuations than conventional convertible
securities.
Contingent Convertible
Securities.
Certain Funds may invest in contingent convertible securities, or “CoCos”. These
securities
are usually deeply subordinated instruments with long maturities that contain a
conversion mechanism that is governed
by the issuer’s ability to meet certain minimum financial and accounting ratios
as promulgated by statutory regulatory
authorities such as banking regulators or macro prudential regulatory
authorities. If the issuer triggers the CoCo’s
conversion mechanism, the contingent convertible security’s principal may be (1)
permanently written off in total,
(2) temporarily written off in total or in part with principal reinstatement
contingent upon the issuer re-attaining compliance
with statutorily required financial and accounting ratios, or (3) converted into
common equity or into a security
ranking junior to the contingent convertible security. In any or all of these
circumstances, the CoCo’s value may be
partially or completely impaired either temporarily or permanently.
Many,
but not all, contingent convertible securities are rated as speculative or ‘High
Yield’ by NRSROs. Like many other
fixed income securities, the contingent convertible security’s market value
tends to decline as interest rates rise and tends
to rise as interest rates fall. Because of the CoCo’s subordinated status within
the issuer’s capital structure, market value
fluctuations may be greater than for other more senior securities issued by the
issuer. Also the contingent convertible
security’s value may fluctuate more closely with the issuer’s equity than with
its debt given the CoCo’s subordination
and given the embedded conversion mechanism. Because most CoCo conversion
mechanisms are triggered
by the issuer failing to meet minimum financial and accounting thresholds due to
financial stress, unforeseen economic
conditions, or unforeseen regulatory changes (among others), there is risk that
the contingent convertible security
will lose most if not all of its value upon conversion.
In
addition, some such instruments have a set stock conversion rate that would
cause an automatic write-down of capital
if the price of the stock is below the conversion price on the conversion date.
In another version of a security with loss
absorption characteristics, the liquidation value of the security may be
adjusted downward to below the original par value
under certain circumstances similar to those that would trigger a CoCo. The
write down of the par value would occur
automatically and would not entitle the holders to seek bankruptcy of the
company. In certain versions of the instruments,
the notes will write down to zero under certain circumstances and investors
could lose everything, even as the
issuer remains in business.
Corporate
Obligations.
Investment in corporate debt obligations involves credit and interest rate risk.
The value of fixed
income investments will fluctuate with changes in interest rates and bond market
conditions, tending to rise as interest
rates decline and to decline as interest rates rise. Corporate debt obligations
generally offer less current yield than
securities of lower quality, but lower-quality securities generally have less
liquidity, greater credit and market risk, and
as a result, more price volatility. Longer term bonds are, however, generally
more volatile than bonds with shorter maturities.
Credit Linked
Notes.
Credit linked securities are generally issued by a limited purpose trust or
other vehicle that, in turn,
invests in a derivative instrument or basket of derivative instruments, such as
credit default swaps, interest rate swaps
and other securities, in order to provide exposure to certain fixed income
markets. For instance, credit linked securities
may be used as a cash management tool in order to gain exposure to a certain
market and/or to remain fully invested
when more traditional income producing securities are not
available.
Like
an investment in a bond, investments in credit linked securities generally
represent the right to receive periodic income
payments (in the form of distributions) and payment of principal at the end of
the term of the security. However, these
payments are conditioned on the issuer’s receipt of payments from, and the
issuer’s potential obligations to, the counterparties
to the derivative instruments and other securities in which the issuer invests.
For instance, the issuer may sell
one or more credit default swaps, under which the issuer would receive a stream
of payments over the term of the swap
agreements provided that no event of default has occurred with respect to the
referenced debt obligation upon which
the swap is based. If a default occurs, the stream of payments may stop and the
issuer would be obligated to pay the
counterparty the par value (or other agreed upon value) of the referenced debt
obligation. This, in turn, would reduce the
amount of income and principal that a Fund would receive. The Fund’s investments
in these instruments are indirectly subject
to the risks associated with derivative instruments, including, among others,
credit risk, default or similar event risk, counterparty
risk, interest rate risk, leverage risk and management risk. It is also expected
that the securities will be exempt
from registration under the Securities Act. Accordingly, there may be no
established trading market for the securities
and they may constitute illiquid investments.
Currency
Transactions.
A Fund may engage in currency transactions as described in the prospectus or
this SAI. Generally,
except as provided otherwise, a Fund may engage with counterparties primarily in
order to hedge, or manage the
risk of the value of portfolio holdings denominated in particular currencies
against fluctuations in relative value. Currency
transactions include forward currency contracts, exchange listed currency
futures, exchange listed and over-the-counter (“OTC”) options
on currencies, and currency swaps. A Fund may enter into currency transactions
with creditworthy counterparties
that have been approved by the Adviser’s Counterparty Credit Risk Department in
accordance with its Credit
Risk Management Policy.
Additional
Information on Portfolio Instruments and Investment Policies 19
Forward Currency
Contracts.
A forward currency contract involves an obligation to purchase or sell a
specific currency
at a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties,
at a price set at the time of the contract. These contracts are entered into in
the interbank market conducted directly
between currency traders (usually large commercial banks) and their
customers.
At
or before the maturity of a forward currency contract, a Fund may either sell a
portfolio security and make delivery
of the currency, or retain the security and fully or partially offset its
contractual obligation to deliver the currency by
purchasing a second contract. If a Fund retains the portfolio security and
engages in an offsetting transaction, the Fund,
at the time of execution of the offsetting transaction, will incur a gain or a
loss to the extent that movement has occurred
in forward currency contract prices.
The
precise matching of forward currency contract amounts and the value of the
securities involved generally will not
be possible because the value of such securities, measured in the foreign
currency, will change after the foreign currency
contract has been established. Thus, a Fund might need to purchase or sell
foreign currencies in the spot (cash) market
to the extent such foreign currencies are not covered by forward currency
contracts. The projection of short-term
currency market movements is extremely difficult, and the successful execution
of a short-term hedging strategy
is highly uncertain.
In
general, in accordance with current federal securities laws, rules, and staff
positions, the Funds cover their daily obligation
requirements for outstanding forward foreign currency contracts by earmarking or
segregating liquid portfolio securities.
To the extent that a Fund is not able to cover its forward currency positions
with underlying portfolio securities, the
Fund segregates cash. If the value of the securities used to cover a position or
the value of segregated assets declines,
a Fund will find alternative cover or segregate additional cash or other liquid
assets on a daily basis so that the value
of the ear-marked or segregated assets will be equal to the amount of such
Fund’s commitments with respect to such
contracts.
Transaction
hedging is entering into a currency transaction with respect to specific assets
or liabilities of a Fund, which
will generally arise in connection with the purchase or sale of its portfolio
securities or the receipt of income therefrom.
Position hedging is entering into a currency transaction with respect to
portfolio security positions denominated
or generally quoted in that currency.
Cross Hedge.
If a particular currency is expected to decrease against another currency, a
Fund may sell the currency
expected to decrease and purchase a currency which is expected to increase
against the currency sold in an amount
approximately equal to the lesser of some or all of the Fund’s portfolio
holdings denominated in or exposed to the
currency sold.
Proxy-Hedge.
A Fund may also enter into a position hedge transaction in a currency other than
the currency being hedged
(a “proxy hedge”). A Fund may enter into a proxy hedge if the Adviser believes
there is a correlation between the currency
being hedged and the currency in which the proxy hedge is denominated. Proxy
hedging is often used when the
currency to which a Fund’s portfolio is exposed is difficult to hedge or to
hedge against the dollar. This type of hedging entails
an additional risk beyond a direct position hedge because it is dependent on a
stable relationship between two currencies
paired as proxies. Overall risk to a Fund may increase or decrease as a
consequence of the use of proxy hedges.
Currency
Hedging.
While the value of forward currency contracts, currency options, currency
futures and options on futures
may be expected to correlate with exchange rates, they will not reflect other
factors that may affect the value of a
Fund’s investments. A currency hedge, for example, should protect a
yen-denominated bond against a decline in the yen,
but will not protect a Fund against price decline if the issuer’s
creditworthiness deteriorates. Because the value of a Fund’s
investments denominated in foreign currency will change in response to many
factors other than exchange rates, a
currency hedge may not be entirely successful in mitigating changes in the value
of the Fund’s investments denominated
in that currency over time.
A
decline in the dollar value of a foreign currency in which a Fund’s securities
are denominated will reduce the dollar value
of the securities, even if their value in the foreign currency remains constant.
The use of currency hedges does not eliminate
fluctuations in the underlying prices of the securities, but it does establish a
rate of exchange that can be achieved
in the future. In order to protect against such diminutions in the value of
securities it holds, a Fund may purchase put
options on the foreign currency. If the value of the currency does decline, a
Fund will have the right to sell the currency for
a fixed amount in dollars and will thereby offset, in whole or in part, the
adverse effect on its securities that otherwise would
have resulted. Conversely, if a rise in the dollar value of a currency in which
securities to be acquired are denominated
is projected, thereby potentially increasing the cost of the securities, a Fund
may purchase call options on the
particular currency. The purchase of these options could offset, at least
partially, the effects of the adverse movements
in exchange rates. Although currency hedges limit the risk of loss due to a
decline in the value of a hedged currency,
at the same time, they also limit any potential gain that might result should
the value of the currency increase.
A
Fund may enter into foreign currency exchange transactions to hedge its currency
exposure in specific transactions
or portfolio positions. Transaction hedging is the purchase or sale of forward
currency contracts with respect
to specific receivables or payables of a Fund generally accruing in connection
with the purchase or sale of its portfolio
securities. Position hedging is the sale of forward currency contracts with
respect to portfolio security positions.
20 Additional
Information on Portfolio Instruments and Investment Policies
The
currencies of certain emerging market countries have experienced devaluations
relative to the U.S. Dollar, and future
devaluations may adversely affect the value of assets denominated in such
currencies. In addition, currency hedging
techniques may be unavailable in certain emerging market countries. Many
emerging market countries have experienced
substantial, and in some periods extremely high, rates of inflation or deflation
for many years, and future inflation
may adversely affect the economies and securities markets of such
countries.
Position Hedge.
A Fund may hedge some or all of its investments denominated in a foreign
currency or exposed to foreign
currency fluctuations against a decline in the value of that currency relative
to the U.S. Dollar by entering into forward
foreign currency contracts to sell an amount of that currency approximating the
value of some or all of its portfolio
securities denominated in or exposed to that currency and buying U.S. Dollars or
by participating in options or future
contracts with respect to the currency. Such transactions do not eliminate
fluctuations caused by changes in the local
currency prices of security investments, but rather, establish an exchange rate
at a future date. Although such contracts
are intended to minimize the risk of loss due to a decline in the value of the
hedged currencies, at the same time
they tend to limit any potential gain which might result should the value of
such currencies increase. The Adviser may
from time to time seek to reduce foreign currency risk by hedging some or all of
a Fund’s foreign currency exposure back
into the U.S. Dollar.
Currency
Futures.
A Fund may also seek to enhance returns or hedge against the decline in the
value of a currency through
use of currency futures or options thereon. Currency futures are similar to
forward foreign exchange transactions
except that futures are standardized, exchange-traded contracts while forward
foreign exchange transactions
are traded in the OTC market. Currency futures involve currency risk equivalent
to currency forwards.
Currency
Options.
A Fund that invests in foreign currency-denominated securities may buy or sell
put and call options
on foreign currencies either on exchanges or in the OTC market. A put option on
a foreign currency gives the purchaser
of the option the right to sell a foreign currency at the exercise price until
the option expires. A call option on a foreign
currency gives the purchaser of the option the right to purchase the currency at
the exercise price until the option expires.
A Fund may also write covered options on foreign currencies. For example, to
hedge against a potential decline in the
U.S. Dollar value of foreign currency denominated securities due to adverse
fluctuations in exchange rates, a Fund could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option
will most likely not be exercised and the decline in value of portfolio
securities will be offset by the amount of the premium
received. Currency options traded on U.S. or other exchanges may be subject to
position limits which may limit the
ability of a Fund to reduce foreign currency risk using such options. OTC
options differ from exchange traded options in
that they are two-party contracts with price and other terms negotiated between
buyer and seller, and generally do not
have as much market liquidity as exchange-traded options.
Under
definitions adopted by the Commodity
Futures Trading Commission (“CFTC”) and U.S. Securities and Exchange
Commission (“SEC”),
many foreign currency options are considered swaps for certain purposes,
including determination
of whether such instruments need to be exchange-traded and centrally
cleared.
Currency
hedging involves some of the same risks and considerations as other transactions
with similar instruments. Currency
transactions can result in losses to a Fund if the currency being hedged
fluctuates in value to a degree or in a direction
that is not anticipated. Further, there is the risk that the perceived
correlation between various currencies may not
be present or may not be present during the particular time that a Fund is
engaging in proxy hedging.
Risks of Currency
Transactions.
Currency transactions are subject to risks different from those of other
portfolio transactions.
Because currency control is of great importance to the issuing governments and
influences economic planning
and policy, purchases and sales of currency and related instruments can be
negatively affected by government exchange
controls, blockages, and manipulations or exchange restrictions imposed by
governments. These can result in losses
to a Fund if it is unable to deliver or receive currency or funds in settlement
of obligations and could also cause hedges
it has entered into to be rendered useless, resulting in full currency exposure
as well as incurring transaction costs. Buyers
and sellers of currency futures are subject to the same risks that apply to the
use of futures generally. Further, settlement
of a currency futures contract for the purchase of most currencies must occur at
a bank based in the issuing nation.
Trading options on currency futures is relatively new, and the ability to
establish and close out positions on such options
is subject to the maintenance of a liquid market which may not always be
available. Currency exchange rates may
fluctuate based on factors extrinsic to that country’s economy.
Risk Factors in Hedging Foreign Currency
Risks.
Hedging transactions involving currency instruments involve substantial
risks, including correlation risk. While an objective of a Fund’s use of
currency instruments to effect hedging strategies
is intended to reduce the volatility of the NAV of the Fund’s shares, the NAV of
the Fund’s shares will fluctuate. Moreover,
although currency instruments will be used with the intention of hedging against
adverse currency movements,
transactions in currency instruments involve the risk that such currency
movements may not occur and that the
Fund’s hedging strategies may be ineffective. To the extent that a Fund hedges
against anticipated currency movements
that do not occur, the Fund may realize losses and decrease its total return as
the result of its hedging transactions.
Furthermore, a Fund will only engage in hedging activities from time to time and
may not be engaging in hedging
activities when movements in currency exchange rates occur.
Additional
Information on Portfolio Instruments and Investment Policies 21
In
connection with its trading in forward foreign currency contracts, a Fund will
contract with a foreign or domestic bank,
or foreign or domestic securities dealer, to make or take future delivery of a
specified amount of a particular currency.
There are no limitations on daily price moves in such forward contracts, and
banks and dealers are not required to
continue to make markets in such contracts. There have been periods during which
certain banks or dealers have refused
to quote prices for such forward contracts or have quoted prices with an
unusually wide spread between the price
at which the bank or dealer is prepared to buy and that at which it is prepared
to sell. Governmental imposition of credit
controls might limit any such forward contract trading. With respect to its
trading of forward contracts, if any, a Fund
may be subject to the risk of bank or dealer failure and the inability of, or
refusal by, a bank or dealer to perform with respect
to such contracts. Any such default would deprive the Fund of any profit
potential or force the Fund to cover its commitments
for resale, if any, at the then market price and could result in a loss to the
Fund. It may not be possible for a Fund
to hedge against currency exchange rate movements, even if correctly
anticipated, in the event that (i) the currency
exchange rate movement is so generally anticipated that the Fund is not able to
enter into a hedging transaction
at an effective price, or (ii) the currency exchange rate movement relates to a
market with respect to which currency
instruments are not available and it is not possible to engage in effective
foreign currency hedging. The cost to a Fund
of engaging in foreign currency transactions varies with such factors as the
currencies involved, the length of the contract
period and the market conditions then prevailing. In addition, a Fund may not
always be able to enter into forward
contracts at attractive prices and may be limited in its ability to use these
contracts to hedge Fund assets. Since transactions
in foreign currency exchanges usually are conducted on a principal basis, no
fees or commissions are involved.
New
regulations governing certain OTC derivatives may also increase the costs of
using these types of instruments or
make them less effective, as described under “Strategic Transactions,
Derivatives and Synthetic Investments – Risks of Strategic
Transactions Inside the U.S.”
See
“Regulation of Commodity Interests” for additional information about the Funds’
use of derivatives in connection with
CFTC exclusions.
Custody/Sub-Custody
Risk.
To the extent that a Fund invests in markets where custodial and/or settlement
systems are
not fully developed, the Fund is subject to foreign custody/sub-custody risk.
Foreign custody risk refers to the risks inherent
in the process of clearing and settling trades and to the holding of securities,
cash and other assets by banks, agents
and depositories in securities markets that are less developed than those in the
United States. Low trading volumes
and volatile prices in less developed markets make trades harder to complete and
settle, and governments or trade
groups may compel non-U.S. agents to hold securities in designated depositories
that may not be subject to independent
evaluation. The laws of certain countries may place limitations on the ability
to recover assets if a non-U.S. bank,
agent or depository becomes insolvent or enters bankruptcy. Non-U.S. agents are
held only to the standards of care
of their local markets, and thus may be subject to limited or no government
oversight. In general, the less developed a
country’s securities market is, or the more difficult communication is with that
location, the greater the likelihood of custody
problems.
Cybersecurity
Risk.
With the increased use of technologies such as mobile devices and Web-based or
“cloud” applications,
and the dependence on the Internet and computer systems to conduct business, the
Funds are susceptible to
operational, information security and related risks. In general, cybersecurity
incidents can result from deliberate attacks
or unintentional events (arising from external or internal sources) that may
cause a Fund to lose proprietary information,
suffer data corruption, physical damage to a computer or network system or lose
operational capacity. Cybersecurity
attacks include, but are not limited to, artificial
intelligence spoofing, infection
by malicious software, such as
malware or computer viruses or gaining unauthorized access to digital systems,
networks or devices that are used to service
a Fund’s operations (e.g., through “hacking,” “phishing” or malicious software
coding) or other means for purposes of
misappropriating assets or sensitive information, corrupting data, or causing
operational disruption. Cybersecurity attacks
may also be carried out in a manner that does not require gaining unauthorized
access, such as causing denial-of-service
attacks on a Fund’s websites (i.e., efforts to make network services unavailable
to intended users). In addition,
authorized persons could inadvertently or intentionally release confidential or
proprietary information stored on a
Fund’s systems.
The use of cloud-based service providers could heighten or change these
risks.
Cybersecurity
incidents affecting the Funds’ Adviser, other service providers to a Fund or its
shareholders (including, but
not limited to, fund accountants, custodians, sub-custodians, transfer agents
and financial intermediaries) have the ability
to cause disruptions and impact business operations, potentially resulting in
financial losses to both a Fund and shareholders,
interference with a Fund’s ability to calculate its NAV, impediments to trading,
the inability of Fund shareholders
to transact business and of a Fund to process transactions (including
fulfillment of Fund share purchases and
redemptions), violations of applicable privacy and other laws (including the
release of private shareholder information)
and attendant breach notification and credit monitoring costs, regulatory fines,
penalties, litigation costs, reputational
damage, reimbursement or other compensation costs, forensic investigation and
remediation costs, and/ or additional
compliance costs. Similar adverse consequences could result from cybersecurity
incidents affecting issuers of securities
in which a Fund invests, counterparties with which a Fund engages in
transactions, governmental and other regulatory
authorities, exchange and other financial market operators, banks, brokers,
dealers, insurance companies and
other financial institutions (including financial intermediaries and other
service providers) and other parties. In addition,
substantial costs may be incurred in order to safeguard against and reduce the
risk of any cybersecurity
22 Additional
Information on Portfolio Instruments and Investment Policies
incidents
in the future. In addition to administrative, technological and procedural
safeguards, the Adviser has established business
continuity plans in the event of such cybersecurity incidents. However, there
are inherent limitations in such plans
and systems, including the possibility that certain risks have not been
identified, as well as the rapid development of new
threats. Furthermore, a Fund cannot control the cybersecurity plans and systems
put in place by its service providers or
any other third parties whose operations may affect a Fund or its shareholders.
A Fund and its shareholders could be negatively
impacted as a result. In addition, work-from-home arrangements by the Funds, the
Adviser or their service providers
could increase all of the above risks, create additional data and information
accessibility concerns, and make the
Funds, the Adviser or their service providers susceptible to operational
disruptions, any of which could adversely impact
their operations. Furthermore, the Funds may be an appealing target for
cybersecurity threats such as hackers and
malware.
Debt
Securities.
Debt
Securities Generally.
The
principal risks involved with investments in debt securities include interest
rate risk, credit risk and pre-payment risk.
Interest rate risk refers to the likely decline in the value of bonds as
interest rates rise. Generally, longer-term securities are
more susceptible to changes in value as a result of interest-rate changes than
are shorter-term securities. Changing interest
rate environments (whether downward or upward) impact the various sectors if the
economy in different ways. During
periods when interest rates are low (or negative), a Fund’s yield (or total
return) may also be low and fall below zero.
A Fund may be subject to heightened levels of interest rate risk because the
U.S. Federal Reserve (“the Fed”) has sharply
raised interest rates from relatively low levels and has signaled an intention
to continue to do so until current inflation
levels re-align with the Fed’s long-term inflation target. To the extent the Fed
continues to raise interest rates, there
is a risk that rates across the financial system may rise. Credit risk refers to
the risk that an issuer of a bond may default
with respect to the payment of principal and interest. The lower a bond is
rated, the more it is considered to be a speculative
or risky investment. Pre-payment risk is commonly associated with pooled debt
securities, such as mortgage-backed
securities and asset-backed securities, but may affect other debt securities as
well. When the underlying
debt obligations are prepaid ahead of schedule, the return on the security will
be lower than expected. Pre-payment
rates usually increase when interest rates are falling.
Lower-rated
securities are more likely to react to developments affecting these risks than
are more highly rated securities,
which react primarily to movements in the general level of interest rates.
Although the fluctuation in the price of debt
securities is normally less than that of common stocks, in the past there have
been extended periods of cyclical increases
in interest rates that have caused significant declines in the price of debt
securities in general and have caused the
effective maturity of securities with prepayment features to be extended, thus
effectively converting short or intermediate
term securities (which tend to be less volatile in price) into long term
securities (which tend to be more volatile
in price).
Ratings as Investment
Criteria.
High-quality, medium-quality and non-investment grade debt obligations are
characterized
as such based on their ratings by NRSROs, such as Standard & Poor’s or
Moody’s. In general, the ratings of NRSROs
represent the opinions of these agencies as to the quality of securities that
they rate. Such ratings, however, are relative
and subjective, and are not absolute standards of quality and do not evaluate
the market value risk of the securities.
These ratings are used by a Fund as initial criteria for the selection of
portfolio securities, but a Fund also relies upon
the independent advice of the Adviser to evaluate potential investments. This is
particularly important for lower-quality
securities. Among the factors that will be considered is the long-term ability
of the issuer to pay principal and
interest and general economic trends, as well as an issuer’s capital structure,
existing debt and earnings history. Appendix
B to this SAI contains further information about the rating categories of NRSROs
and their significance.
Subsequent
to its purchase by a Fund, an issuer of securities may cease to be rated or its
rating may be reduced below
the minimum required for purchase by such Fund. In addition, it is possible that
an NRSRO might not change its rating
of a particular issuer to reflect subsequent events. None of these events
generally will require sale of such securities,
but the Adviser will consider such events in its determination of whether the
Fund should continue to hold the securities.
In addition, to the extent that the ratings change as a result of changes in an
NRSRO or its rating systems, or due
to a corporate reorganization, a Fund will attempt to use comparable ratings as
standards for its investments in accordance
with its investment objective and policies.
Investment Grade Debt
Securities.
The Funds may purchase “investment grade” bonds, which are those rated Aaa,
Aa,
A or Baa by Moody’s or AAA, AA, A or BBB by Standard & Poor’s or Fitch or a
comparable rating by another NRSRO; or, if
unrated, judged to be of equivalent quality as determined by the Adviser. For
the avoidance of doubt, bonds rated Baa3 by
Moody’s or BBB- by Standard & Poor’s or BBB- by Fitch are considered to be
investment grade. In general, but not always,
investments in securities rated in the BBB category tend to have more risk than
securities in the A, AA or AAA categories
due to greater exposure to, among other things: adverse economic conditions;
higher levels of debt; or more volatile
industry performance. Securities within the BBB category can also experience
greater market value fluctuations over
time. To the extent that a Fund invests in higher-grade securities, the Fund may
not be able to avail itself of opportunities
for higher income that may be available at lower grades.
Additional
Information on Portfolio Instruments and Investment Policies 23
Lower Quality (High-Risk) Debt
Securities.
Non-investment grade debt or lower quality/rated securities, commonly
known
as junk bonds or high yield securities (hereinafter referred to as
“lower-quality securities”) include (i) bonds rated below
Baa3 by Moody’s or below BBB- by Standard & Poor’s or Fitch, (ii) commercial
paper rated at or below C by Standard
& Poor’s, Not Prime by Moody’s or Fitch 4 by Fitch; and (iii) unrated debt
securities of comparable quality as determined
by the Adviser. The lower the ratings of such lower-quality securities, the more
their risks render them like equity
securities. Securities rated D may be in default with respect to payment of
principal or interest. Lower-quality securities,
while generally offering higher yields than investment grade securities with
similar maturities, involve greater risks,
including a higher possibility of default or bankruptcy. There is more risk
associated with these investments because of
reduced creditworthiness and increased risk of default. Lower-quality securities
generally involve greater volatility of price
and risk to principal and income, and may be less liquid, than securities in the
higher rating categories. Under NRSRO
guidelines, lower-quality securities and comparable unrated securities will
likely have some quality and protective characteristics
that are outweighed by large uncertainties or major risk exposures to adverse
conditions.
Lower-quality
securities are also considered to be at risk of, among other things: failing to
attain improved credit quality
and NRSRO investment grade rating status; having a current identifiable
vulnerability to default or to be in default; not
having the capacity to make required interest payments and repay principal when
due in the event of adverse business,
financial or economic conditions; or, being in default or not current in the
payment of interest or principal. They are
regarded as predominantly speculative with respect to the issuer’s capacity to
pay interest and repay principal.
Issuers
of lower-quality securities often are highly leveraged and may not have
available to them more traditional methods
of financing. Therefore, the risk associated with acquiring the securities of
such issuers generally is greater than is
the case with higher rated securities. For example, during an economic downturn
or a sustained period of rising interest rates,
highly leveraged issuers of lower-quality securities may experience financial
stress. During such periods, such issuers
may not have sufficient revenues to meet their interest payment obligations. The
issuer’s ability to service its debt obligations
may also be adversely affected by specific corporate developments, or the
issuer’s inability to meet specific projected
business forecasts, or the unavailability of additional financing. The risk of
loss from default by the issuer is significantly
greater for the holders of high yield securities because such securities are
generally unsecured and are often subordinated
to other creditors of the issuer. Prices and yields of high yield securities
will fluctuate over time and, during periods
of economic uncertainty, volatility of high yield securities may adversely
affect a Fund’s NAV. In addition, investments
in high yield zero coupon or pay-in-kind bonds, rather than income-bearing high
yield securities, may be more
speculative and may be subject to greater fluctuations in value due to changes
in interest rates.
A
Fund may have difficulty disposing of certain lower-quality securities because
they may have a thin trading market.
Because not all dealers maintain markets in all high yield securities, a Fund
anticipates that such securities could be
sold only to a limited number of dealers or institutional investors. The lack of
a liquid secondary market may have an adverse
effect on the market price and a Fund’s ability to dispose of particular issues
and may also make it more difficult for
the Fund to obtain accurate market quotations for purposes of valuing the Fund’s
assets. Market quotations generally are
available on many lower-quality issues only from a limited number of dealers and
may not necessarily represent firm bids
of such dealers or prices for actual sales. Adverse publicity and investor
perceptions may decrease the values and liquidity
of high-yield securities. These securities may also involve special registration
responsibilities, liabilities and costs, and
liquidity and valuation difficulties.
Credit
quality (or perceived credit quality) in the lower-quality securities market can
change suddenly and unexpectedly,
and even recently-issued credit ratings may not fully reflect the actual risks
posed by a particular high-yield
security. For these reasons, it is generally the policy of the Adviser not to
rely exclusively on ratings issued by established
credit rating agencies, but to supplement such ratings with its own independent
and on-going review of credit
quality. The achievement of a Fund’s investment objective by investment in such
securities may be more dependent
on the Adviser’s credit analysis than is the case for higher quality bonds.
Should the rating of a portfolio security
be downgraded, the Adviser will determine whether it is in the best interests of
a Fund to retain or dispose of such security.
Prices
for lower-quality securities may be affected by legislative and regulatory
developments. Also, Congress has from
time to time considered legislation which would restrict or eliminate the
corporate tax deduction for interest payments
on these securities and regulate corporate restructurings. Such legislation may
significantly depress the prices of
outstanding securities of this type.
A
portion of the lower-quality securities acquired by a Fund may be purchased upon
issuance, which may involve special
risks because the securities so acquired are new issues. In such instances, a
Fund may be a substantial purchaser of
the issue and therefore have the opportunity to participate in structuring the
terms of the offering. Although this may enable
a Fund to seek to protect itself against certain of such risks, the
considerations discussed herein would nevertheless
remain applicable.
Information Concerning
Duration.
Duration is a risk measure that describes how much the price of a fixed income
security
changes given a change in the level of interest rates. Duration was developed as
a more precise alternative to the
concepts of “term to maturity” or “average dollar weighted maturity”, which had
been used historically in the market as
rough measures of “volatility” or “risk” associated with changes in interest
rates. Duration incorporates a security’s yield, coupon
interest payments, final maturity and call features into one
measure.
24 Additional
Information on Portfolio Instruments and Investment Policies
Most
debt obligations provide interest (“coupon”) payments in addition to final
(“par”) payment at maturity. Some obligations
also have call provisions. Depending on the relative magnitude of these payments
and the nature of the call provisions,
the market values of debt obligations may respond differently to changes in
interest rates.
Traditionally,
a debt security’s “term-to-maturity” has been used as a measure of the
sensitivity of the security’s price to
changes in interest rates (which is the “interest rate risk” or “volatility” of
the security). However, “term-to-maturity” measures
only the time until a debt security provides its final payment, taking no
account of the pattern of the security’s payments
prior to maturity. Average dollar weighted maturity is calculated by averaging
the terms of maturity of each debt
security held with each maturity “weighted” according to the percentage of
assets that it represents. Duration is a measure
of the expected life of a debt security on a present value basis and reflects
both principal and interest payments.
Duration takes the length of the time intervals between the present time and the
time that the interest and principal
payments are scheduled or, in the case of a callable security, expected to be
received, and weights them by the present
values of the cash to be received at each future point in time. For any debt
security with interest payments occurring
prior to the payment of principal, duration is ordinarily less than maturity. In
general, all other factors being the same,
the lower the stated or coupon rate of interest of a debt security, the longer
the duration of the security; conversely,
the higher the stated or coupon rate of interest of a debt security, the shorter
the duration of the security.
There
are some situations where the standard duration calculation does not properly
reflect the interest rate exposure
of a security. For example, floating and variable rate securities often have
final maturities of ten or more years; however,
their interest rate exposure corresponds to the frequency of the coupon reset.
Another example where the interest
rate exposure is not properly captured by duration is the case of mortgage
pass-through securities. The stated final
maturity of such securities is generally 30 years, but current prepayment rates
are more critical in determining the securities’
interest rate exposure. In these and other similar situations, the Funds’ will
use more sophisticated analytical techniques
to project the economic life of a security and estimate its interest rate
exposure. Since the computation of duration
is based on predictions of future events rather than known factors, there can be
no assurance that a Fund will at all
times achieve its targeted portfolio duration.
The
change in market value of U.S. Government fixed income securities is largely a
function of changes in the prevailing
level of interest rates. When interest rates are falling, a portfolio with a
shorter duration generally will not generate
as high a level of total return as a portfolio with a longer duration. When
interest rates are stable, shorter duration
portfolios generally will not generate as high a level of total return as longer
duration portfolios (assuming that long-term
interest rates are higher than short-term rates, which is commonly the case).
When interest rates are rising, a portfolio
with a shorter duration will generally outperform longer duration portfolios.
With respect to the composition of a fixed
income portfolio, the longer the duration of the portfolio, generally, the
greater the anticipated potential for total return,
with, however, greater attendant interest rate risk and price volatility than
for a portfolio with a shorter duration.
Newly Issued Debt
Securities.
New issues of certain debt instruments are often offered on a when-issued or
firm-commitment
basis; that is, the payment obligation and the interest rate are fixed at the
time the buyer enters into the
commitment, but delivery and payment for the securities normally take place
after the customary settlement time. The
value of when-issued securities or securities purchased on a firm-commitment
basis may vary prior to and after delivery
depending on market conditions and changes in interest rate levels. However, a
Fund will not accrue any income on
these securities prior to delivery. Rule 18f-4 under the 1940 Act provides that
funds may invest in securities on a when-issued
or forward-settling basis, or with a non-standard settlement cycle. These
transactions will not be deemed to
involve a senior security, and thus generally will not require the Fund to
maintain a “segregated account” when engaging
in these types of transactions, subject to certain conditions and any other
restrictions that the Fund has adopted.
Depositary
Receipts.
Depositary receipts include American Depositary Receipts (“ADRs”), European
Depositary Receipts
(“EDRs”) and Global Depositary Receipts (“GDRs”) or other securities convertible
into securities of issuers based in
foreign countries. These securities may not necessarily be denominated in the
same currency as the securities into which
they may be converted. Generally, ADRs, in registered form, are denominated in
U.S. Dollars and are designed for use
in the U.S. securities markets, GDRs, in bearer form, are issued and designed
for use outside the United States and EDRs
(also referred to as Continental Depositary Receipts (“CDRs”)), in bearer form,
may be denominated in other currencies
and are designed for use in European securities markets. ADRs are receipts
typically issued by a U.S. bank or trust
company evidencing ownership of the underlying securities. EDRs are European
receipts evidencing a similar arrangement.
GDRs are receipts typically issued by non-U.S. banks and trust companies that
evidence ownership of either
foreign or domestic securities. For purposes of a Fund’s investment policies,
ADRs, GDRs and EDRs are deemed to have
the same classification as the underlying securities they represent. Thus, an
ADR, GDR or EDR representing ownership
of common stock will be treated as common stock.
A
Fund may invest in depositary receipts through “sponsored” or “unsponsored”
facilities. While ADRs issued under these
two types of facilities are in some respects similar, there are distinctions
between them relating to the rights and obligations
of ADR holders and the practices of market participants.
A
depositary may establish an unsponsored facility without participation by (or
even necessarily the acquiescence of)
the issuer of the deposited securities, although typically the depositary
requests a letter of non-objection from such issuer
prior to the establishment of the facility. Holders of unsponsored ADRs
generally bear all the costs of such facilities.
Additional
Information on Portfolio Instruments and Investment Policies 25
The
depositary usually charges fees upon the deposit and withdrawal of the deposited
securities, the conversion of dividends
into U.S. Dollars, the disposition of non-cash distributions, and the
performance of other services. The depositary
of an unsponsored facility frequently is under no obligation to pass through
voting rights to ADR holders in respect
of the deposited securities. In addition, an unsponsored facility is generally
not obligated to distribute communications
received from the issuer of the deposited securities or to disclose material
information about such issuer
in the U.S. and thus there may not be a correlation between such information and
the market value of the depositary
receipts. Unsponsored ADRs tend to be less liquid than sponsored
ADRs.
Sponsored
ADR facilities are created in generally the same manner as unsponsored
facilities, except that the issuer of
the deposited securities enters into a deposit agreement with the depositary.
The deposit agreement sets out the