VICTORYSHARES
STATEMENT OF ADDITIONAL INFORMATION
STATEMENT OF ADDITIONAL INFORMATION
November
1, 2023
|
VictoryShares
Core Plus Intermediate Bond ETF (formerly, VictoryShares ESG Core Plus
Bond ETF) |
UBND |
|
VictoryShares
Corporate Bond ETF (formerly, VictoryShares ESG Corporate Bond
ETF) |
UCRD |
|
VictoryShares
THB Mid Cap ESG ETF
|
MDCP |
(each
a “Fund” and together, the “Funds”)
Each
Fund is a series of Victory Portfolios II (the “Trust”)
Listed
and traded on:
The Nasdaq Stock Market LLC
The Nasdaq Stock Market LLC
This
Statement of Additional Information (“SAI”) is not a prospectus and should be
read in conjunction with each Fund’s prospectus, dated
November 1, 2023, as it may be amended or supplemented from time to time (each,
a “Prospectus”). This SAI is incorporated by reference in its entirety into each
Prospectus. Copies of the Prospectus of each Fund can be obtained without charge
upon request made to Victory Funds, P.O. Box 182593, Columbus, OH 43218-2593, at
VictorySharesLiterature.com or by calling toll free 1-866-376-7890.
The
financial statements for each Fund and the Independent Registered Public
Accounting Firm's Report thereon for the fiscal year ended
June 30, 2023, are included in the respective Fund's annual report to
shareholders of that date and are incorporated herein by reference. The
annual report to shareholders is available, without charge, on the Fund’s
website at VictorySharesLiterature.com or by writing to the address or calling
the Trust at the above address or toll-free phone number.
The
Funds are each diversified series of the Trust (formerly named “Compass EMP
Funds Trust”), a Delaware statutory trust organized on April
11, 2012. The Trust is registered as an open-end management investment company.
The Trust currently consists of 26 series of beneficial interests (“shares”).
This SAI relates to the shares of three series of the Trust (each a "Fund," and
collectively, the "Funds").
Victory
Capital Management Inc. (the “Adviser” or “Victory Capital”) is the Funds’
investment adviser. Each Fund’s investment objective(s),
restrictions and policies are more fully described below and in the Fund’s
Prospectus. The Trust’s Board of Trustees (the “Board” or “Trustees”) may
organize and offer shares of a new fund or liquidate a Fund at any
time.
Much
of the information contained in this SAI expands on subjects discussed in each
Fund’s Prospectus. Capitalized terms not defined herein are
used as defined in the Prospectuses. No investment in shares of a Fund should be
made without first reading that Fund’s Prospectus.
For
purposes of this SAI, the VictoryShares Core Plus Intermediate Bond ETF
(formerly, VictoryShares ESG Core Plus Bond ETF until April 23,
2023) and VictoryShares Corporate Bond ETF (formerly, VictoryShares ESG
Corporate Bond ETF until April 23, 2023) are referred to as the “VictoryShares
Bond ETFs.”
The
Funds’ shares are offered at net asset value (“NAV”) only in aggregations of
25,000 shares (each a “Creation Unit”). The Funds will issue
and redeem Creation Units principally in exchange for a basket of securities
(the “Deposit Securities”), together with the deposit of a specified cash
payment (the “Cash Component”), plus a transaction fee. For the VictoryShares
Core Plus Intermediate Bond ETF and VictoryShares Corporate Bond ETF (“Bond
Funds”), each Bond Fund may issue and redeem Creation Units in exchange for a
specified all-cash payment (“Cash Deposit”).The Funds are approved for listing
on The Nasdaq Stock Market LLC (“Nasdaq” or the “Exchange”). Shares trade on the
Exchange at market prices that may be below, at, or above NAV. The Trust
reserves the right to adjust the prices of shares in the future to maintain
convenient trading ranges for investors. Any adjustments would be accomplished
through stock splits or reverse stock splits, which would have no effect on the
net assets of the applicable Fund.
The
Funds reserve the right to offer creations and redemptions of shares for cash.
In addition, shares may be issued in advance of receipt of Deposit
Securities subject to various conditions, including a requirement to maintain on
deposit with the Trust cash equal to at least 105% of the market value of the
missing Deposit Securities. In each instance of such cash creations or
redemptions, transaction fees may be imposed and may be higher than the
transaction fees associated with in-kind creations or redemptions. See “Purchase
and Redemption of Shares” below.
Shares of
each Fund are listed for trading and trade throughout the day on
Nasdaq.
In
order to provide additional information regarding the indicative value of shares
of the VictoryShares THB Mid Cap ESG ETF, the Exchange
or a market data vendor will disseminate every 15 seconds through the facilities
of the Consolidated Tape Association or other widely disseminated means an
updated “intraday indicative value” (“IIV”) for the Fund as calculated by an
information provider or market data vendor. The Trust is not involved in or
responsible for any aspect of the calculation or dissemination of the IIV and
makes no representation or warranty as to the accuracy of the IIV.
INVESTMENT
OBJECTIVES, POLICIES, AND LIMITATIONS
Investment
Objectives
Each
Fund’s investment objective is non-fundamental, meaning it may be changed by a
vote of the Trustees without a vote of the holders of
a majority of the Fund’s outstanding voting securities. There can be no
assurance that a Fund will achieve its investment objective.
Investment
Policies and Limitations of the Funds
Unless
a policy of a Fund is expressly deemed to be a fundamental policy, changeable
only by an affirmative vote of the holders of a majority
of that Fund’s outstanding voting securities, the Fund’s policies are
non-fundamental and may be changed without a shareholder vote.
A
Fund may, following notice to its shareholders, employ other investment
practices that presently are not contemplated for use by the Fund or
that currently are not available but that may be developed to the extent such
investment practices are both consistent with the Fund’s investment objective
and legally permissible for the Fund. Such investment practices, if they arise,
may involve risks that exceed those involved in the activities described in the
Fund’s Prospectus.
A
Fund’s classification and sub-classification is a matter of fundamental policy.
Each Fund is classified as an open-end investment company.
Each Fund is sub-classified as a diversified investment company, which under the
Investment Company Act of 1940, as
1
amended
(“1940 Act”) means that, with respect to 75% of a Fund’s total assets, the Fund
may not invest in securities of any issuer if, immediately
after such investment, (i) more than 5% of the total assets of the Fund (taken
at current value) would be invested in the securities of that issuer or (ii)
more than 10% of the outstanding voting securities of the issuer would be held
by the Fund (this limitation does not apply to obligations of the U.S.
government, its agencies or instrumentalities, and securities of other
investment companies). A diversified fund is not subject to this limitation with
respect to the remaining 25% of its total assets. In addition, each Fund has
elected to qualify as a “regulated investment company” under the United States
Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a
regulated investment company, the Funds must meet certain diversification
requirements as determined at the close of each quarter of each taxable year.
The Code’s diversification test is described in “TAXES.”
The
policies and limitations stated in this SAI supplement the Funds’ investment
policies set forth in each Fund’s Prospectus. Unless otherwise
noted, whenever an investment policy or limitation states a maximum percentage
of a Fund’s assets that may be invested in any security or other asset, or sets
forth a policy regarding quality standards, such standard or percentage
limitation will be determined immediately after and as a result of the Fund’s
acquisition of such security or other asset except in the case of borrowing (or
other activities that may be deemed to result in the issuance of a “senior
security” under the 1940 Act). Accordingly, any subsequent change in values, net
assets, or other circumstances will not be considered when determining whether
the investment complies with a Fund’s investment policies and limitations. If
the value of a Fund’s holdings of illiquid investments at any time exceeds the
percentage limitation applicable at the time of acquisition due to subsequent
fluctuations in value or other reasons, the Board will consider what actions, if
any, are appropriate to maintain adequate liquidity.
Fundamental
Investment Policies and Limitations of the Funds
The
following investment policies and limitations are fundamental and may not be
changed without the affirmative vote of the holders of a
majority of the Fund’s outstanding voting securities, as defined under the 1940
Act. Under the 1940 Act, the vote of a majority of the outstanding voting
securities of a Fund means the affirmative vote of the lesser of (a) 67% or more
of the shares of the Fund present at a meeting at which the holders of more than
50% of the outstanding shares of the Fund are represented in person or by proxy,
or (b) more than 50% of the outstanding shares of the Fund. Portions of the
Funds’ fundamental investment restrictions (e.g., references to “except as
permitted under the 1940 Act, and as interpreted or modified from time to time
by regulatory authorities having jurisdiction”) provide the Funds with
flexibility to change limitations in connection with changes in applicable law,
rules, regulations or exemptive relief. The language used in these restrictions
provides the necessary flexibility to allow the Board to respond efficiently to
these kinds of developments without the delay and expense of a shareholder
meeting.
Senior
Securities
None
of the Funds may issue senior securities, except as permitted under the 1940
Act, and as interpreted or modified from time to time by
regulatory authorities having jurisdiction.
This
limitation is not applicable to activities that may be deemed to involve the
issuance or sale of a senior security by the Fund, provided
that the Fund’s engagement in such activities is consistent with or permitted by
the 1940 Act the rules and regulations promulgated thereunder or interpretations
of the Securities and Exchange Commission (“SEC”) or its staff.
Rule
18f-4 under the 1940 Act permits a Fund to enter into Derivatives Transactions
(as defined below) and certain other transactions notwithstanding
the restrictions on the issuance of “senior securities” under Section 18 of the
1940 Act. Section 18 of the 1940 Act, among other things, prohibits open-end
funds, including the Funds, from issuing or selling any “senior security,” other
than borrowing from a bank (subject to a requirement to maintain 300% “asset
coverage”).
Under
Rule 18f-4, “Derivatives Transactions” include the following: (1) any swap,
security-based swap (including a contract for differences),
futures contract, forward contract, option (excluding purchased options), any
combination of the foregoing, or any similar instrument, under which the Fund is
or may be required to make any payment or delivery of cash or other assets
during the life of the instrument or at maturity or early termination, whether
as margin or settlement payment or otherwise; (2) any short sale borrowing; (3)
reverse repurchase agreements and similar financing transactions (e.g., recourse
and non-recourse tender option bonds, and borrowed bonds), if the Fund elects to
treat these transactions as Derivatives Transactions under Rule 18f-4; and (4)
when-issued or forward-settling securities (e.g., firm and standby commitments,
including to-be-announced (“TBA”) commitments, and dollar rolls) and
non-standard settlement cycle securities, unless a Fund intends to physically
settle the transaction and the transaction will settle within 35 days of its
trade date.
Unless
a Fund is relying on the Limited Derivatives User Exception (as defined below),
a Fund must comply with Rule 18f-4 with respect to
its Derivatives Transactions. Rule 18f-4, among other things, requires the Funds
to adopt and implement a comprehensive written derivatives risk management
program (“DRMP”) and comply with a relative or absolute limit on Fund leverage
risk calculated based on value-at-risk (“VaR”). The DRMP is administered by a
“derivatives risk manager,” who is appointed by the Board, including a majority
of Independent Trustees, and periodically reviews the DRMP and reports to the
Board.
2
Rule
18f-4 provides an exception from the DRMP, VaR limit and certain other
requirements if the Fund's “derivatives exposure” (as defined in
Rule 18f-4) is limited to 10% of its net assets (as calculated in accordance
with Rule 18f-4) and the Fund adopts and implements written policies and
procedures reasonably designed to manage its derivatives risks (the “Limited
Derivatives User Exception”). As of the date of this SAI, VictoryShares
Corporate Bond ETF and VictoryShares THB Mid Cap ESG ETF rely on the Limited
Derivatives User Exception.
Borrowing
None
of the Funds may borrow money, except as permitted under the 1940 Act, or by
order of the SEC and as interpreted or modified from time
to time by regulatory authorities having jurisdiction.
A
Fund’s ability to borrow money is limited by its investment policies and
limitations, by the 1940 Act, and by applicable exemptions, no action
letters, interpretations, and other pronouncements issued from time to time by
regulatory authorities, including the SEC and its staff. Under the 1940 Act, a
Fund is required to maintain continuous asset coverage (that is, total assets
including the proceeds of borrowings, less liabilities excluding borrowings) of
not less than 300% of the amount borrowed, with an exception for borrowings not
in excess of 5% of the fund’s total assets made for temporary purposes. Any
borrowings for temporary purposes in excess of 5% are subject to the minimum
300% asset coverage requirement. If the value of the assets set aside to meet
the 300 percent asset coverage were to decline below 300% due to market
fluctuations or other causes, a Fund may be required to sell some of its
portfolio holdings within three days (excluding Sundays and holidays) to reduce
the debt and comply with the 300% minimum asset coverage requirement, even in
circumstances where it is considered disadvantageous from an investment
perspective to sell securities at that time or at the prices then
available.
Underwriting,
Purchasing Securities on Margin, or Participating on a Joint Basis
None
of the Funds may underwrite securities issued by others, except to the extent
that a Fund may be considered an underwriter within the
meaning of the Securities Act of 1933 (the “1933 Act”), in the disposition of
restricted securities.
Real
Estate
None
of the Funds may purchase or sell real estate unless acquired as a result of
direct ownership of securities or other instruments. This
restriction shall not prevent any of these Funds from investing in the
following: (i) securities or other instruments backed by real estate; (ii)
securities of real estate operating companies; or (iii) securities of companies
engaged in the real estate business, including real estate investment trusts.
This restriction does not preclude any of these Funds from buying securities
backed by mortgages on real estate or securities of companies engaged in such
activities.
Concentration
None
of the Funds may concentrate its investments in a particular industry, as the
term “concentration” is used in the 1940 Act, and as
interpreted or modified from time to time by regulatory authorities having
jurisdiction. This restriction shall not prevent any Fund from investing all of
its assets in a “master” fund that has adopted similar investment objectives,
policies, and restrictions.
Concentration
means investing more than 25% of a Fund’s net assets in a particular industry or
a specified group of industries.
Commodities
None
of the Funds may purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments (but this
shall not prevent a Fund from purchasing or selling options and futures
contracts or from investing in securities or other instruments backed by
physical commodities).
Lending
None
of the Funds may make loans, except as permitted under the 1940 Act, and as
interpreted or modified from time to time by regulatory
authorities having jurisdiction. Generally, the 1940 Act prohibits loans if a
fund’s investment policies do not permit loans, and if the loans are made,
directly or indirectly, to persons deemed to control or to be under common
control with the registered investment company.
Non-Fundamental
Investment Policies and Limitations of the Funds
The
following investment policies restrictions are non-fundamental and may be
changed by a vote of a majority of the Trustees.
• Each Fund
has an investment policy that requires it to invest at least 80% of its assets
in the type of security suggested by its name. To the extent required by SEC
rules, each such policy may be changed only upon at least 60 days’ prior written
notice to the applicable Fund’s shareholders. The VictoryShares Core Plus
Intermediate Bond ETF, under normal circumstances,
3
invests
at least 80% of its assets in debt securities and in derivatives and other
instruments that have economic characteristics similar to
such securities. The VictoryShares Corporate Bond ETF, under normal
circumstances, invests at least 80% of its assets in corporate bonds, and in
related derivatives and other instruments that have economic characteristics
similar to corporate bonds. The VictoryShares THB Mid Cap ESG ETF, under normal
circumstances, invests at least 80% of its assets in equity securities of
mid-cap companies.
• No Fund
may purchase the securities of any registered open-end investment company or
registered unit investment trust in reliance on Section 12(d)(1)(F) or Section
12(d)(1)(G) of the 1940 Act, which permits operation as a “fund of funds.”
Except as provided in the next paragraph and below in “Securities of Other
Investment Companies,” none of the Funds may: (1) invest more than 5% of its
total assets in the securities of any one investment company; (2) own more than
3% of the securities of any one investment company; or (3) invest more than 10%
of its total assets in the securities of other investment
companies.
• Each Fund
may purchase and redeem shares issued by a money market fund without limit,
provided that either: (1) the acquiring Fund pays no “sales charge” or “service
fee” (as each of those terms is defined in the FINRA Conduct Rules); or (2) the
Adviser waives its advisory fee in an amount necessary to offset any such sales
charge or service fee. For purposes of this investment restriction, a “money
market fund” is either: (1) an open-end investment company registered under the
1940 Act and regulated as a money market fund in accordance with Rule 2a-7 under
the 1940 Act; or (2) a company that is exempt from registration as in investment
company under Sections 3(c)(1) or 3(c)(7) of the 1940 Act and that: (a) limits
its investments to those permitted under Rule 2a-7 under the 1940 Act; and (b)
undertakes to comply with all the other requirements of Rule 2a-7, except that,
if the company has no board of directors, the company’s investment adviser
performs the duties of the board of directors
• No Fund
may make short sales of securities, other than short sales “against the box,” or
purchase securities on margin except for short-term credits necessary for
clearance of portfolio transactions, provided that this restriction will not be
applied to limit the use of options, futures contracts and related options, in
the manner otherwise permitted by the investment restrictions, policies and
investment program of the Fund.
• No Fund
may invest more than 15% of its net assets in illiquid investments. Illiquid
investments are generally any investment that the Fund reasonably expects cannot
be sold or disposed of in current market conditions in seven calendar days or
less without the sale or disposition significantly changing the market value of
the investment. Such investments include, but are not limited to, time deposits
and repurchase agreements with maturities longer than seven days. Securities
that may be resold under Rule 144A, securities offered pursuant to Section
4(a)(2) of the 1933 Act, or securities otherwise subject to restrictions or
limitations on resale under the 1933 Act shall not be deemed illiquid solely by
reason of being unregistered. Victory Capital Management Inc. (the “Adviser”),
the Fund’s investment adviser, under oversight of the Board, determines whether
a particular investment is deemed to be liquid based on the trading markets for
the specific security and other factors.
INVESTMENT
PRACTICES, INSTRUMENTS, AND RISKS
In
addition to the principal investment strategies and the principal risks of the
Funds described in each Prospectus, each Fund may, but will not
necessarily, employ other investment practices and may be subject to additional
risks which are described further below. Because the following is a combined
description of investment strategies and risks for all of the Funds, certain
strategies and/or risks described below may not apply to every Fund. Unless a
strategy or policy described below is specifically prohibited with respect to a
particular Fund by the investment restrictions listed in the Prospectus, under
“Investment Objectives Policies and Limitations” in this SAI, or by applicable
law, a Fund may, but will not necessarily, engage in each of the practices
described below.
Adjustable-
Rate Securities
Each
Fund may invest in adjustable-rate securities. The interest on an
adjustable-rate security fluctuates periodically. Generally, the security’s
yield is based on a U.S. dollar-based interest-rate benchmark such as the
Federal Funds Rate, the 90-day U.S. Treasury bill rate, or the London Interbank
Offered Rate (“LIBOR”). The yields on these securities are reset on a periodic
basis (for example, daily, weekly, or quarterly) or upon a change in the
benchmark interest rate. The yields are closely correlated to changes in money
market interest rates.
Asset-Backed
Securities
Each
Fund may invest in asset-backed securities (“ABS”). ABS represent a
participation in, or are secured by and payable from, a stream of
payments generated by particular assets, such as credit card, motor vehicle, or
trade receivables. They may be pass-through certificates, which have
characteristics very similar to mortgage-backed securities, discussed below.
Such pass-through certificates may include equipment trust certificates (“ETC”)
secured by specific equipment, such as airplanes and railroad cars. ETC
securities also may be enhanced by letters of credit. An ABS may also be in the
form of asset-backed commercial paper, which is issued by a special purpose
entity, organized solely to issue the commercial paper and to purchase interests
in the assets.
4
The
credit quality of ABS depends primarily on the quality of the underlying assets,
the rights of recourse available against the underlying
assets and/or the issuer, the level of credit enhancement, if any, provided for
the securities, and the credit quality of the credit-support provider, if any.
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 administering the pool of assets, to ensure that the receipt of payments
on the underlying pool occurs in a timely fashion. Protection against losses
resulting from ultimate default ensures payment through insurance policies or
letters of credit obtained by the issuer or sponsor from third parties. 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 credit support or
failure of the credit support could adversely affect the return on an investment
in such a security. In addition, the risk of default by borrowers is greater
during times of rising interest rates and/or unemployment rates and generally is
higher in the case of asset pools that include subprime assets.
ABS
may be subject to interest rate risk and prepayment risk. In a period of
declining interest rates, borrowers may prepay the underlying
assets more quickly than anticipated, thereby reducing the yield to maturity and
the average life of the asset-backed securities. Moreover, when a Fund reinvests
the proceeds of a prepayment in these circumstances, it will likely receive a
rate of interest that is lower than the rate on the security that was prepaid.
In a period of rising interest rates, prepayments of the underlying assets may
occur at a slower than expected rate, creating maturity extension risk. This
particular risk may effectively change a security that was considered short- or
intermediate-term at the time of purchase into a longer-term security. Since the
value of longer-term securities generally fluctuates more widely in response to
changes in interest rates than does the value of shorter-term securities,
maturity extension risk could increase the volatility of a Fund. The weighted
average life of such securities is likely to be substantially shorter than their
stated final maturity as a result of scheduled principal payments and
unscheduled principal prepayments.
Bonds
Each
Fund may invest in bonds, which are fixed or variable-rate debt obligations,
including bills, notes, debentures, money market instruments
and similar instruments and securities. Mortgage- and asset-backed securities
are types of bonds, and certain types of income-producing, non-convertible
preferred stocks may be treated as bonds for investment purposes. Bonds
generally are used by corporations, governments, and other issuers to borrow
money from investors. The issuer pays the investor a fixed or variable rate of
interest and normally must repay the amount borrowed on or before maturity. Many
preferred stocks and some bonds are “perpetual” in that they have no maturity
date. Bonds are subject to interest rate risk and credit risk. Interest rate
risk generally is the risk that interest rates will rise and that, as a result,
bond prices will fall, lowering the value of a fund’s investments in bonds. In
general, bonds with longer durations are more sensitive to interest rate changes
than bonds with shorter durations. Credit risk, generally, is the risk that an
issuer may be unable or unwilling to pay interest and/or principal on the bond.
Credit risk can be affected by many factors, including adverse changes in the
issuer’s own financial condition or in economic conditions.
Calculation
of Dollar-Weighted Average Portfolio Maturity
Dollar-weighted
average portfolio maturity is derived by multiplying the value of each debt
instrument by the number of days remaining
to its maturity, adding these calculations, and then dividing the total by the
value of a Fund’s debt instruments. An obligation’s maturity is typically
determined on a stated final maturity basis, although there are some exceptions
to this rule.
With
respect to obligations held by a Fund, if it is probable that the issuer of an
instrument will take advantage of a maturity-shortening device,
such as a call, refunding, or redemption provision, the date on which the
instrument will probably be called, refunded, or redeemed may be considered to
be its maturity date. Also, the maturities of mortgage- backed securities, some
ABS, and securities subject to sinking fund arrangements are determined on a
weighted average life basis, which is the average time for principal to be
repaid. For mortgage-backed securities and some ABS, this average time is
calculated by assuming prepayment rates of the underlying loans. These
prepayment rates can vary depending upon the level and volatility of interest
rates. This, in turn, can affect the weighted average life of the security. The
weighted average lives of these securities will be shorter than their stated
final maturities. In addition, for purposes of a Fund’s investment policies, an
instrument will be treated as having a maturity earlier than its stated maturity
date if the instrument has technical features such as puts or demand features
that, in the judgment of the Adviser, will result in the instrument being valued
in the market as though it has the earlier maturity.
Finally,
for purposes of calculating the dollar-weighted average portfolio maturity of a
Fund, the maturity of a debt instrument with a periodic
interest reset date will be deemed to be the next reset date, rather than the
remaining stated maturity of the instrument if, in the judgment of the Adviser,
the periodic interest reset features will result in the instrument’s being
valued in the market as though it has the earlier maturity.
5
Certificates
of Deposit and Bankers’ Acceptances
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.
A
Fund may invest in insured bank obligations. The Federal Deposit Insurance
Corporation (“FDIC”) insures the deposits of federally insured
banks and savings and loan associations (collectively referred to as “banks”) up
to $250,000. A Fund may purchase bank obligations that are fully insured as to
principal by the FDIC. Currently, to remain fully insured as to principal, these
investments must be limited to $250,000 per bank; if the principal amount and
accrued interest together exceed $250,000, the excess principal and accrued
interest will not be insured. Insured bank obligations may have limited
marketability.
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.
Commercial
Paper
Each
Fund may invest in commercial paper. Commercial paper, which consists of
short-term (usually from one to 270 days) unsecured promissory
notes issued by corporations in order to finance their current operations. A
variable amount master demand note (which is a type of commercial paper)
represents a direct borrowing arrangement involving periodically- fluctuating
rates of interest under a letter agreement between a commercial paper issuer and
an institutional lender pursuant to which the lender may determine to invest
varying amounts.
Investments
in commercial paper are subject to the risk the issuer cannot issue enough new
commercial paper to satisfy its outstanding commercial
paper, also known as rollover risk. Commercial paper may become illiquid or may
suffer from reduced liquidity in certain circumstances. Like all fixed income
securities, commercial paper prices are susceptible to fluctuations in interest
rates. If interest rates rise, commercial paper prices will decline. The
short-term nature of a commercial paper investment makes it less susceptible to
interest rate risk than many other fixed income securities because interest rate
risk typically increases as maturity lengths increase.
Commercial
paper tends to yield smaller returns than longer-term corporate debt because
securities with shorter maturities typically have lower
effective yields than those with longer maturities. As with all fixed income
securities, there is a chance that the issuer will default on its commercial
paper obligation.
Commodity-Linked
Notes
Each
Fund may invest in commodity-linked notes, which are a type of structured note.
Commodity-linked notes are privately negotiated structured
debt securities indexed to the return of an index such as the Dow Jones-UBS
Commodity Index Total Return, which is representative of the commodities market.
They are available from a limited number of approved counterparties, and all
invested amounts are exposed to the dealer’s credit risk. Commodity- linked
notes may be leveraged. For example, if a Fund invests $100 in a three-times
leveraged commodity-linked note, it will exchange $100 principal with the dealer
to obtain $300 exposure to the commodities market. The value of the note will
change by a magnitude of three for every percentage point change (positive or
negative) in the value of the underlying index. This means a $100 note would be
worth $70 if the commodity index decreased by 10%. Structured notes also are
subject to counterparty risk.
Investments
linked to the prices of commodities, including commodity-linked notes, are
considered speculative. The values of commodity-linked
notes are affected by events that might have less impact on the values of stocks
and bonds. Prices of commodities and related contracts may fluctuate
significantly over short periods due to a variety of factors, including changes
in supply and demand relationships, weather, agriculture, fiscal, and exchange
control programs, disease, pestilence, and international economic, political,
military, and regulatory developments. In addition, the commodity markets may be
subject to temporary distortions and other disruptions due to, among other
factors, lack of liquidity, the participation of speculators, and government
regulation and other actions. These circumstances could adversely affect the
value of the commodity-linked notes and make commodity-linked notes more
volatile than other types of investments. Investments in commodity-linked notes
may have substantial risks, including risk of loss of a significant portion of
their principal value. They are also subject to tax risks because the income
therefrom is not “good” income for a regulated investment company. See the
section of the SAI entitled “Taxes.”
6
Common
Stock
Common
stock represents an equity (ownership) interest in a company, and usually
possesses voting rights and earns dividends. Dividends
on common stock are not fixed but are declared at the discretion of the issuer.
Common stock generally represents the riskiest investment in a company. In
addition, common stock generally has the greatest appreciation and depreciation
potential because increases and decreases in earnings are usually reflected in a
company’s stock price. A company’s common stock also may decline significantly
in price over a short period of time due to factors specific to that company,
including decisions made by its management or lower demand for the company’s
products or services.
Convertible
Securities
Each
Fund may invest in convertible securities, which are bonds, preferred stocks,
and other securities that pay interest or dividends and offer
the buyer the ability to convert the security into common stock. The value of
convertible securities depends partially on interest rate changes and the credit
quality of the issuer. Because a convertible security affords an investor the
opportunity, through its conversion feature, to participate in the capital
appreciation of the underlying common stock, the value of convertible securities
also depends on the price of the underlying common stock.
A
convertible security entitles the holder to receive interest paid or accrued on
debt or the dividend paid on preferred stock until the convertible
security matures or is redeemed, converted or exchanged. Before conversion,
convertible securities have characteristics similar to nonconvertible income
securities in that they ordinarily provide a stable stream of income with
generally higher yields than those of common stocks of the same or similar
issuers, but lower yields than comparable nonconvertible securities. The value
of a convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as interest
rates decline. The credit standing of the issuer and other factors also may have
an effect on the convertible security’s investment value. Convertible securities
are subordinate in rank to any senior debt obligations of the same issuer and,
therefore, an issuer’s convertible securities entail more risk than its debt
obligations.
The
convertible securities in which the Funds will invest may be rated below
investment grade as determined by Moody’s or S&P, or unrated
but judged by the Adviser to be of comparable quality (commonly called “junk”
bonds). Ratings represent a rating agency’s opinion regarding the quality of the
security and are not a guarantee of quality. In addition, rating agencies may
fail to make timely changes to credit ratings in response to subsequent events
and a rating may become stale in that it fails to reflect changes in an issuer’s
financial condition. For a more complete description of debt ratings, see
Appendix A. Such securities are deemed to be speculative and involve greater
risk of default due to changes in interest rates, economic conditions, and the
issuer’s creditworthiness. As a result, their market prices tend to fluctuate
more than those of higher-quality securities. During periods of general economic
downturns or rising interest rates, issuers of such securities may experience
financial difficulties, which could affect their ability to make timely interest
and principal payments. The Fund’s ability to timely and accurately value and
dispose of lower-quality securities also may be affected by the absence or
periodic discontinuance of liquid trading markets.
Cover
Transactions
using certain derivative instruments, other than purchased options, expose a
Fund to an obligation to another party. A Fund will not
enter into any such transactions unless it owns either (1) an offsetting
(“covered”) position in securities, currencies or other options, futures
contracts, or forward contracts, or (2) cash or liquid assets with a value,
marked-to-market daily, sufficient to cover its potential obligations to the
extent not covered as provided in (1) above.
For more
information about these practices, see the “Derivatives” section.
Depositary
Receipts
A
Fund may invest in sponsored and unsponsored depositary receipts, such as
American Depositary Receipts (“ADRs”), which are receipts
issued by an American bank or trust company evidencing ownership of underlying
securities issued by a foreign issuer. ADRs, in registered form, are designed
for use in U.S. securities markets. Unsponsored ADRs may be created without the
participation of the foreign issuer. Holders of these ADRs generally bear all
the costs of the ADR facility, whereas foreign issuers typically bear certain
costs in a sponsored ADR. The bank or trust company depositary of an unsponsored
ADR may be under no obligation to distribute shareholder communications received
from the foreign issuer or to pass through voting rights. Many of the risks
described below regarding foreign securities apply to investments in ADRs.
Without limitation, a Fund may also invest in European Depositary Receipts
(“EDRs”) and Global Depositary Receipts (“GDRs”). EDRs are receipts issued in
Europe that evidence a similar ownership arrangement. GDRs are receipts issued
throughout the world that evidence a similar arrangement.
Investments
in depositary receipts may be less liquid and more volatile than the underlying
securities in their primary trading market. If a
depositary receipt is denominated in a different currency than its underlying
securities, a Fund will be subject to the currency risk of both the investment
in the depositary receipt and the underlying security. The values of depositary
receipts may decline for a number
7
of
reasons relating to the issuers or sponsors of the depositary receipts,
including, but not limited to, insolvency of the issuer or sponsor. Holders of
depositary receipts may have limited or no rights to take action with respect to
the underlying securities or to compel the issuer of the receipts to take
action. The prices of depositary receipts may differ from the prices of
securities upon which they are based.
A
Fund may invest in unsponsored depositary receipts, which are issued by one or
more depositaries without a formal agreement with the
company that issues the underlying securities. Holders of unsponsored depositary
receipts generally bear all the costs thereof, and the depositaries of
unsponsored depositary receipts frequently are under no obligation to distribute
shareholder communications received from the issuers of the underlying
securities or to pass through voting rights with respect to the underlying
securities. In addition, the issuers of the securities underlying unsponsored
depositary receipts are not obligated to disclose material information to the
market and, therefore, there may be less information available regarding such
issuers and there may not be a correlation between such information and the
market value of the depositary receipts.
Derivatives
The
use of derivatives is a highly specialized activity that can involve investment
techniques and risks different from, and in some respects
greater than, those associated with investing in more traditional investments
such as stocks and bonds. Derivatives may have varying degrees of volatility at
different times, or under different market conditions, and may perform in
unanticipated ways. New regulation of derivatives may make them more costly, or
may otherwise adversely affect their liquidity, value, or
performance.
Rule
18f-4 regulates the use of derivatives for certain funds registered under the
1940 Act. Unless the Fund qualifies as a “limited derivatives
user,” Rule 18f-4 requires, among other things, that the Fund establishes a
comprehensive derivatives risk management program, to comply with certain
value-at-risk based leverage limits, to appoint a derivatives risk manager and
to provide additional disclosure both publicly and to the SEC regarding its
derivatives positions. Rule 18f-4 also has eliminated the general asset
segregation requirement in connection with certain derivatives transactions, in
light of Rule 18f-4’s requirements for funds to establish and maintain
derivatives risk management programs that comply with certain risk-based limits.
For funds that qualify as limited derivatives users, Rule 18f-4 requires
policies and procedures to manage aggregate derivatives risk. These requirements
could have an impact on the Fund, including a potential increase in cost to
enter into derivatives transactions. The full impact of Rule 18f-4 on the Fund,
however, remains uncertain.
Under
circumstances in which such instruments are expected by the Adviser to aid in
achieving each Fund’s investment objective, each Fund may
buy and sell certain types of derivatives. Derivatives are instruments that
derive their value from the value of one or more underlying assets, reference
rates or indices, and may include futures contracts, options on futures
contracts, swaps, options on currencies, securities, and securities indices.
Derivatives also may possess the characteristics of both futures and securities
(e.g., debt instruments with interest and principal payments determined by
reference to the value of a commodity or a currency at a future time) and
therefore, possess the risks of both futures and securities
investments.
Permissible
derivative instruments include “market access products,” which offer synthetic
exposure to an underlying local foreign stock.
They include, for example, equity-linked notes, warrants, zero strike options,
and total return swaps. Market access products are subject to the same risks as
direct investments in securities of foreign issuers. If the underlying stock
decreases in value, the market access product will decrease commensurately. In
addition, market access products are subject to counterparty risk due to the
fact that the security is issued by a broker. If the broker suffers a
significant credit event and cannot perform under the terms of an agreement, a
market access product may lose value regardless of the strength of the
underlying stock.
Derivatives,
such as futures contracts; options on currencies, securities, and securities
indexes; options on futures contracts; and swaps enable a
Fund to take both “short” positions (positions which anticipate a decline in the
market value of a particular asset or index) and “long” positions (positions
which anticipate an increase in the market value of a particular asset or
index). Each Fund also may use strategies that involve simultaneous short and
long positions in response to specific market conditions, such as where the
Adviser anticipates unusually high or low market volatility.
The
Adviser may enter into derivative positions for a Fund for either hedging or
non-hedging purposes. The term “hedging” is applied to
defensive strategies designed to protect a Fund from an expected decline in the
market value of an asset or group of assets that a Fund owns (in the case of a
short hedge) or to protect a Fund from an expected rise in the market value of
an asset or group of assets which it intends to acquire in the future (in the
case of a long or “anticipatory” hedge). Non-hedging strategies include
strategies designed to produce incremental income (such as the option writing
strategy described below) or “speculative” strategies, which are undertaken to
equitize the cash or cash- equivalent portion of a Fund’s portfolio or to profit
from (i) an expected decline in the market value of an asset or group of assets
which a Fund does not own or (ii) expected increases in the market value of an
asset which it does not plan to acquire. Information about specific types of
instruments is provided below.
8
Equity
Securities
Each
Fund may invest in equity securities listed on any domestic or foreign
securities exchange or traded in the over- the-counter market, as
well as certain restricted or unlisted securities. As used herein, “equity
securities” are defined as common stock, preferred stock, trust or limited
partnership interests, rights and warrants to subscribe to or purchase such
securities, sponsored or unsponsored American depositary receipts (“ADRs”),
European depositary receipts (“EDRs”), global depositary receipts (“GDRs”), and
convertible securities, consisting of debt securities or preferred stock that
may be converted into common stock or that carry the right to purchase common
stock. Common stocks, the most familiar type, represent an equity (ownership)
interest in a corporation. They may or may not pay dividends or carry voting
rights. Common stock occupies the most junior position in a company’s capital
structure. Although equity securities have a history of long-term growth in
value, their prices fluctuate based on changes in a company’s financial
condition and on overall market and economic conditions. Smaller companies are
especially sensitive to these factors. Equity securities generally have greater
volatility than debt securities.
Equity-Linked
Structured Notes
Equity-linked
structured notes are derivative securities that are specifically designed to
combine the characteristics of one or more underlying
securities and their equity derivatives in a single note form. The return and/or
yield or income component may be based on the performance of the underlying
equity securities, an equity index, and/or option positions. Equity-linked
structured notes are typically offered in limited transactions by financial
institutions in either registered or non-registered form. An investment in
equity-linked notes creates exposure to the credit risk of the issuing financial
institution, as well as to the market risk of the underlying securities. There
is no guaranteed return of principal with these securities and the appreciation
potential of these securities may be limited by a maximum payment or call right.
In certain cases, equity-linked notes may be more volatile and less liquid than
less-complex securities or other types of fixed income securities. Such
securities may exhibit price behavior that does not correlate with other fixed
income securities.
Eurodollar
and Yankee Obligations
Each
Fund may invest in Eurodollar obligations or Yankee obligations. Eurodollar
obligations are dollar-denominated instruments that have been
issued outside the U.S. capital markets by foreign corporations and financial
institutions and by foreign branches of U.S. corporations and financial
institutions. Yankee obligations are dollar-denominated instruments that have
been issued by foreign issuers in the U.S. capital markets.
Eurodollar
and Yankee obligations are subject to the same risks that pertain to domestic
issues, notably credit risk, market risk, and liquidity
risk. Additionally, Eurodollar (and to a limited extent, Yankee) obligations are
subject to certain sovereign risks. One such risk is the possibility that a
sovereign country might prevent capital, in the form of dollars, from leaving
the country. Other risks include: adverse political and economic developments;
the extent and quality of government regulation of financial markets and
institutions; the imposition of foreign withholding taxes; and expropriation or
nationalization of foreign issuers. However, Eurodollar and Yankee obligations
will undergo the same type of credit analysis as domestic issues in which the
Fund invests, and will have at least the same financial strength as the domestic
issuers approved for the Fund.
European
Securities
The
EU Economic and Monetary Union (“EMU”) requires member countries to comply with
restrictions on interest rates, deficits, debt levels,
and inflation rates, and other factors, each of which may significantly impact
every European country. The economies of EU member countries and their trading
partners may be affected adversely by changes in the euro’s exchange rate,
changes in EU or governmental regulations on trade, and the threat of default or
default by an EU member country on its sovereign debt, which could negatively
impact a Fund’s investments and cause it to lose money. Recently, the European
financial markets have been impacted negatively by rising government debt
levels; possible default on or restructuring of sovereign debt in several
European countries, including Greece, Ireland, Italy, Portugal and Spain; and
economic downturns. A European country’s default or debt restructuring would
adversely affect the holders of the country’s debt and sellers of credit default
swaps linked to the country’s creditworthiness and could negatively impact
global markets more generally. Recent events in Europe have adversely affected
the euro’s exchange rate and value and may continue to impact the economies of
every European country. See “Brexit.”
Exchange-Traded
Funds (“ETFs”)
Each
Fund may invest in ETFs, which are, with a few exceptions, open-end investment
companies that trade throughout the day. ETFs trade on
stock exchanges. Because they trade like a stock, they offer trading flexibility
desired by both individuals and institutions. The value of the underlying
securities held by an ETF is a major factor in determining an ETF’s price.
However, ETFs do not necessarily trade at their NAV. The price of an ETF also is
determined by supply and demand and, as a result, the share price of an ETF may
trade at a premium or discount to its NAV.
9
To
the extent a Fund invests in ETFs, it will be exposed to the same risks of the
ETFs’ holdings as the ETFs themselves in direct proportion
to the allocation of the Fund’s assets among those ETFs. You also will
indirectly bear fees and expenses charged by the ETFs in which the Fund invests
in addition to the Fund’s direct fees and expenses. In addition, the ETFs that
the Funds invest in are typically “passive investors” that invest in the
securities and sectors contained in the indexes they seek to track without
regard for or analysis of the prospects of such securities or sectors (“Passive
ETFs”). A Passive ETF may invest in all of the securities in such index or in a
representative sample of such securities.
Passive
ETFs generally do not attempt to take defensive positions in volatile or
declining markets or under other conditions. Furthermore,
Passive ETFs usually are not able to duplicate exactly the performance of the
underlying indexes they track. The difference in performance between a Passive
ETF and the index it seeks to track can be due to, among other factors, the
expenses that the Passive ETF pays, regulatory constraints, investment
strategies, techniques undertaken by the Passive ETF and changes to an
underlying index. There also may be a lack of correlation between the securities
in an index and those actually held by a Passive ETF. The performance of a fund
that invests in such an ETF could be adversely impacted. In addition, although
ETFs (both active and passive) are generally listed on securities exchanges,
there can be no assurances that an active trading market for such ETFs will be
maintained. Secondary market trading in the ETFs also may be halted by a
national securities exchange because of market conditions or for other reasons.
There can be no assurances that the requirement necessary to maintain the
listing of the ETFs will continue to be met or will remain
unchanged.
Exchange-Traded
Notes (“ETNs”)
Each
Fund may invest in ETNs, which are a type of unsecured, unsubordinated debt
security, usually issued by large financial institutions.
This type of debt security differs from other types of bonds and notes because
ETN returns are based upon the performance of a market index minus applicable
fees, no period coupon payments are distributed, and no principal protections
exist. The purpose of ETNs is to create a type of security that combines the
aspects of both bonds and ETFs. Similar to ETFs, ETNs are traded on a major
exchange (i.e., NYSE) during normal trading hours. However, investors can also
hold the debt security until maturity. At that time, the issuer will give the
investor a cash amount that would be equal to the principal amount (subject to
the day’s index factor). One factor that affects the ETN’s value is the credit
rating of the issuer. The value of an ETN also may be influenced by time to
maturity, level of supply and demand for the ETN, volatility and lack of
liquidity in underlying commodities or securities markets, changes in the
applicable interest rates, changes in the issuer’s credit rating and economic,
legal, political, or geographic events that affect the referenced commodity or
security. A Fund’s decision to sell its ETN holdings may be limited by the
availability of a secondary market. If a Fund must sell some or all of its ETN
holdings and the secondary market is weak, it may have to sell such holdings at
a discount. There may be restrictions on a Fund’s right to redeem its investment
in an ETN, which are generally meant to be held until maturity. ETNs are subject
to counterparty credit risk and fixed income risk. ETNs also are subject to tax
risk. No assurance can be given that the Internal Revenue Service (“IRS”) will
accept, or a court will uphold, how a Fund characterizes and treats ETNs for
federal income tax purposes. Further, the IRS and Congress are considering
proposals that would change the timing of recognition and tax character of
income and gains from ETNs.
Foreign
Securities
A
Fund may invest in foreign securities. Investing in foreign securities poses
unique risks: currency exchange rate fluctuations; foreign market
illiquidity; emerging markets risk; increased price volatility; exchange control
regulations; foreign ownership limits; different accounting, reporting, and
disclosure requirements; political or social instability, including policies of
foreign governments which may affect their respective equity markets; foreign
taxation requirements, including withholding taxes; prohibitions or restrictions
by certain foreign governments on foreign investing in their capital markets or
in certain industries, or limitations on the removal of funds or assets; and
difficulties in obtaining legal judgments. In the past, equity and debt
instruments of foreign markets have been more volatile than equity and debt
instruments of U.S. securities markets.
Investing
in the securities of companies located in emerging market companies generally
involve greater risk than investing in the securities
of companies located in countries with developed markets. The People’s Republic
of China (“PRC”) currently exercises sovereignty over Hong Kong; however, Hong
Kong retains significant economic and political autonomy under the Basic Law, a
“quasi-constitution” that has been in place since Hong Kong reverted to PRC
sovereignty in 1997. The Basic Law is anticipated to remain in place until 2047.
Investments in emerging market countries may present market, credit, currency,
liquidity, legal, political, technical, and other risks different from, or
greater than, the risks of investing in developed countries. For instance, these
countries may be more likely than developed countries to experience rapid and
significant developments in their political or economic structures. Some
emerging market countries restrict foreign investments, impose withholding or
other taxes on foreign investments, or may nationalize or expropriate the assets
of private companies. Therefore, a Fund may be limited in its ability to make
direct or additional investments in an emerging markets country. Such
restrictions also may have negative impacts on transaction costs, market price,
investment returns and the legal rights and remedies of a Fund. In addition, the
securities markets of emerging markets countries generally are smaller, less
liquid, and more volatile than those of developed countries. Emerging market
countries often have less uniformity in accounting and reporting requirements
and less reliable settlement, registration, and custodial procedures. Emerging
10
market
countries also may be subject to high inflation and rapid currency devaluations
and may be heavily dependent on international trade,
which can materially affect their securities markets. The risks associated with
investing in a narrowly defined geographic area also, generally, are more
pronounced with respect to investments in emerging market
countries.
Any
investments in foreign securities will be made in compliance with U.S. and
foreign currency restrictions, tax laws, and laws limiting
the amount and types of foreign investments. Pursuit of the Funds’ investment
objectives will involve currencies of the United States and of foreign
countries. Consequently, changes in exchange rates, currency convertibility, and
repatriation requirements may favorably or adversely affect the
Funds.
Special
Risk Considerations of Investing in China.
Investing in securities of Chinese issuers involves certain risks and
considerations not typically associated with investing in securities of U.S.
issuers, including, among others, more frequent trading suspensions and
government interventions (including by nationalization of assets), currency
exchange rate fluctuations or blockages, limits on the use of brokers and on
foreign ownership, different financial reporting standards, higher dependence on
exports and international trade, potential for increased trade tariffs,
sanctions, embargoes and other trade limitations, custody risks, and potential
adverse tax consequences. U.S. sanctions or other investment restrictions could
preclude a Fund from investing in certain Chinese issuers or cause a Fund to
sell investments at a disadvantageous time. Significant portions of the Chinese
securities markets may become rapidly illiquid, as Chinese issuers have the
ability to suspend the trading of their equity securities, and have shown a
willingness to exercise that option in response to market volatility and other
events.
The
government of the PRC provided new guidance to and placed restrictions on
China-based companies raising capital offshore, including
through associated offshore shell companies. These developments include
government-led cybersecurity reviews of certain companies raising capital
through offshore entities. In a number of sectors in China in which a Fund may
invest, companies are not allowed to have foreign ownership and cannot directly
list on exchanges outside of China. To raise money on such exchanges, many
China-based operating companies are structured as Variable Interest Entities
(“VIEs”). In such an arrangement, a China-based operating company often
establishes an offshore shell company in another jurisdiction to issue stock to
public shareholders. That shell company enters into service and other contracts
with the China-based operating company, then issues shares on a foreign
exchange, such as the NYSE. While the shell company has no equity ownership in
the China-based operating company, for accounting purposes the shell company is
able to consolidate the operating company into its financial statements. For an
investor such as a Fund, this arrangement creates “exposure” to the China-based
operating company, though only through a series of service contracts and other
contracts.
Uncertainty
about future actions by the government of the PRC could significantly affect the
operating company’s financial performance
and the enforceability of the contractual arrangements. The government of the
PRC could determine at any time and without notice that the underlying
contractual arrangements on which control of the VIE is based violate Chinese
law. In addition, if either the China-based company (or its officers, directors,
or Chinese equity owners) breach those contracts with the U.S.-listed shell
company, or Chinese law changes in a way that affects the enforceability of
these arrangements, or those contracts are otherwise not enforceable under
Chinese law, investors, such as a Fund, may suffer significant losses with
little or no recourse available. Moreover, if the parties to these contracts do
not meet their obligations as intended or there are effects on the
enforceability of these arrangements from changes in Chinese law or practice,
the U.S.-listed company may lose control over the China-based company, and
investments in its securities may suffer significant economic losses. Additional
risks, among others, could entail that a breach of the contractual agreements
between the U.S.-listed company and the China-based VIE (or its officers,
directors, or Chinese equity owners) will likely be subject to Chinese law and
jurisdiction, and investments in the U.S.-listed company may be affected by
conflicts of interest and duties between the legal owners of the China-based VIE
and the stockholders of the U.S.-listed company.
Forward
Currency Contracts
Each
Fund may enter into forward currency contracts. A forward currency contract
involves an agreement to purchase or sell a specific currency
at a specified future date or over a specified time period at a price set at the
time of the contract. Forward currency contracts seek to protect against
uncertainty in the level of future foreign exchange rates. These contracts are
usually traded directly between currency traders (usually large commercial
banks) and their customers. A forward contract generally has no deposit
requirements, and no commissions are charged.
A
Fund may enter into forward currency contracts under two circumstances. First,
when a Fund enters into a contract for the purchase or sale of
a security denominated in a foreign currency, it may desire to “lock in” the
U.S. dollar price of the security until settlement. By entering into such a
contract, a Fund will be able to protect itself against a possible loss
resulting from an adverse change in the relationship between the U.S. dollar and
the foreign currency from the date the security is purchased or sold to the date
on which payment is made or received. Second, when management of a Fund believes
that the currency of a specific country may deteriorate relative to the U.S.
dollar, it may enter into a forward currency contract to sell that currency. A
Fund may not hedge with respect to a particular currency for an amount greater
than the aggregate market value (determined at the time of making any sale of
forward currency) of the securities held in its portfolio denominated or quoted
in, or bearing a substantial correlation to, such currency.
11
The
use of forward currency contracts involves certain risks. The precise matching
of contract amounts and the value of securities involved
generally will not be possible since the future value of such securities in
currencies will more than likely change between the date the contract is entered
into and the date it matures. The projection of short-term currency market
movements is extremely difficult and successful execution of a short-term
hedging strategy is uncertain. Under normal circumstances, consideration of the
prospect for currency parities will be incorporated into the longer-term
investment strategies. The Adviser believes it is important, however, to have
the flexibility to enter into such contracts when it determines it is in the
best interest of the Funds to do so. It is impossible to forecast what the
market value of portfolio securities will be at the expiration of a contract.
Accordingly, it may be necessary for a Fund to purchase additional currency (and
bear the expense of such purchase) if the market value of the security is less
than the amount of currency a Fund is obligated to deliver, and if a decision is
made to sell the security and make delivery of the currency. Conversely, it may
be necessary to sell some of the foreign currency received on the sale of the
portfolio security if its market value exceeds the amount of currency a Fund is
obligated to deliver. A Fund is not required to enter into such transactions and
will not do so unless deemed appropriate by the Adviser.
Although
the Funds value their assets each business day in terms of U.S. dollars, they do
not intend to convert their foreign currencies into U.S.
dollars on a daily basis. They will do so from time to time, and shareholders
should be aware of currency conversion costs. Although foreign exchange dealers
do not charge a fee for conversion, they do realize a profit based on the
difference (spread) between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to a
Fund at one rate, while offering a lesser rate of exchange should a Fund desire
to resell that currency to the dealer.
Forward
currency contracts in which a Fund may engage include foreign exchange forwards.
The consummation of a foreign exchange forward
requires the actual exchange of the principal amounts of the two currencies in
the contract (i.e., settlement on a physical basis). Because foreign exchange
forwards are physically settled through an exchange of currencies, they are
traded in the interbank market directly between currency traders (usually large
commercial banks) and their customers. A foreign exchange forward generally has
no deposit requirement, and no commissions are charged at any stage for trades;
foreign exchange dealers realize a profit based on the difference (the spread)
between the prices at which they are buying and the prices at which they are
selling various currencies. When a Fund enters into a foreign exchange forward,
it relies on the counterparty to make or take delivery of the underlying
currency at the maturity of the contract. Failure by the counterparty to do so
would result in the loss of any expected benefit of the transaction. A Fund may
be required to obtain the currency that it must deliver under the foreign
exchange forward through the sale of portfolio securities denominated in such
currency or through conversion of other assets of a Fund into such
currency.
Forward
currency contracts in which a Fund may engage also include non-deliverable
forwards (“NDFs”). NDFs are cash-settled, short-term
forward currency contracts on foreign currencies (each a “Reference Currency”)
that are non- convertible and that may be thinly traded or illiquid. NDFs
involve an obligation to pay an amount (the “Settlement Amount”) equal to the
difference between the prevailing market exchange rate for the Reference
Currency and the agreed-upon exchange rate (the “NDF Rate”), with respect to an
agreed notional amount. NDFs have a fixing date and a settlement (delivery)
date. The fixing date is the date and time at which the difference between the
prevailing market exchange rate and the agreed-upon exchange rate is calculated.
The settlement (delivery) date is the date by which the payment of the
Settlement Amount is due to the party receiving payment.
Although
NDFs are similar to foreign exchange forwards, NDFs do not require physical
delivery of the Reference Currency on the settlement
date. Rather, on the settlement date, the only transfer between the
counterparties is the monetary settlement amount representing the difference
between the NDF Rate and the prevailing market exchange rate. NDFs typically may
have terms from one month up to two years and are settled in U.S.
dollars.
NDFs
are subject to many of the risks associated with derivatives in general and
forward currency transactions, including risks associated
with fluctuations in foreign currency and the risk that the counterparty will
fail to fulfill its obligations. Although NDFs historically have been traded
over-the-counter, in the future, pursuant to the Dodd-Frank Wall Street Reform
and Consumer Protection Act (“Dodd-Frank Act”), they may be exchange-traded.
Under such circumstances, they will be centrally cleared and a secondary market
for them will exist. With respect to NDFs that are centrally cleared, an
investor could lose margin payments it has deposited with the clearing
organization as well as the net amount of gains not yet paid by the clearing
organization if the clearing organization breaches its obligations under the
NDF, becomes insolvent or goes into bankruptcy. In the event of bankruptcy of
the clearing organization, the investor may be entitled to the net amount of
gains the investor is entitled to receive plus the return of margin owed to it
only in proportion to the amount received by the clearing organization’s other
customers, potentially resulting in losses to the investor. Even if some NDFs
remain traded over the counter (“OTC”), they will be subject to margin
requirements for uncleared swaps and counterparty risk common to other
swaps.
Futures
Contracts
Each
Fund may use futures contracts to implement its investment strategy. Futures
contracts are publicly traded contracts to buy or sell an
underlying asset or group of assets, such as a currency, interest rate, or an
index of securities, at a future time at a specified price. A contract to buy
establishes a long position while a contract to sell establishes a short
position.
12
The
purchase of a futures contract on a security or an index of securities normally
enables a buyer to participate in the market movement of the
underlying asset or index after paying a transaction charge and posting margin
in an amount equal to a small percentage of the value of the underlying asset or
index. A Fund will initially be required to deposit with the Trust’s custodian
or the futures commission merchant (“FCM”), effecting the futures transaction,
an amount of “initial margin” in cash or securities, as permitted under
applicable regulatory policies.
Initial
margin in futures transactions is different from margin in securities
transactions in that the former does not involve the borrowing of funds
by the customer to finance the transaction. Rather, the initial margin is like a
performance bond or good faith deposit on the contract. Subsequent payments
(called “maintenance margin” or “variation margin”) to and from the broker will
be made on a daily basis as the price of the underlying asset fluctuates. This
process is known as “marking to market.” For example, when a Fund has taken a
long position in a futures contract and the value of the underlying asset has
risen, that position will have increased in value and a Fund will receive from
the broker a maintenance margin payment equal to the increase in value of the
underlying asset. Conversely, when a Fund has taken a long position in a futures
contract and the value of the underlying instrument has declined, the position
would be less valuable, and a Fund would be required to make a maintenance
margin payment to the broker.
At
any time prior to expiration of the futures contract, a Fund may elect to close
the position by taking an opposite position that will terminate
a Fund’s position in the futures contract. A final determination of maintenance
margin is then made, additional cash is required to be paid by or released to a
Fund, and a Fund realizes a loss or a gain.
While
futures contracts with respect to securities do provide for the delivery and
acceptance of such securities, such delivery and acceptance
are seldom made.
The
risk of loss in trading futures contracts can be substantial because of the low
margin deposits required and the high degree of leveraging
involved in futures pricing. As a result, a relatively small price movement in a
futures contract may cause an immediate and substantial loss or gain. The
primary risks associated with the use of futures contracts are: (i) imperfect
correlation between the change in market value of the stocks held by a Fund and
the prices of futures contracts; and (ii) possible lack of a liquid secondary
market for a futures contract and the resulting inability to close a futures
position prior to its maturity date. The degree of imperfection of correlation
depends on circumstances such as variations in speculative market demand for
futures on securities, including technical influences in futures trading, and
differences between the financial instruments being hedged and the instruments
underlying the standard contracts available for trading in such respects as
interest rate levels, maturities, and creditworthiness of issuers.
Initial
Public Offerings (“IPOs”)
Each
Fund may invest in IPOs, which subject a Fund to the risk that the market value
of IPO shares will fluctuate considerably due to factors
such as the absence of a prior public market, unseasoned trading, a potentially
small number of shares available for trading, and limited information about the
issuer. The purchase of IPO shares may involve high transaction costs. IPO
shares are subject to market risk and liquidity risk. When a Fund’s asset base
is small, a significant portion of the Fund’s performance could be attributable
to investments in IPOs, because such investments would have a magnified impact
on the Fund. As the Fund’s assets grow, the effect of the Fund’s investments in
IPOs on the Fund’s performance probably will decline, which could reduce the
Fund’s performance.
Lending
of Portfolio Securities
A
Fund may, from time to time, lend securities from their portfolios to
broker-dealers, banks, financial institutions, and institutional borrowers
of securities and receive collateral in the form of cash or U.S. government
obligations. Under the Fund’s current practices (which are subject to change), a
Fund must receive initial collateral at least equal to the maintenance
requirements (e.g., 102% for U.S. equity securities and 105% for non-U.S.
securities). This collateral must be valued daily and should the market value of
the loaned securities increase, the borrower must furnish additional collateral
to a Fund sufficient to maintain the value of the collateral equal to at least
100% of the value of the loaned securities. The lending agent receives a
pre-negotiated percentage of the net earnings on the investment of the
collateral. A Fund will not lend portfolio securities to: (a) any “affiliated
person” (as that term is defined in the 1940 Act) of any Fund; (b) any
affiliated person of the Adviser; or (c) any affiliated person of such an
affiliated person. During the time portfolio securities are on loan, the
borrower will pay the Fund any dividends or interest paid on such securities
plus any fee negotiated between the parties to the lending agreement. Loans will
be subject to termination by the Funds or the borrower at any time. While a Fund
will not have the right to vote securities on loan, they intend to terminate
loans and regain the right to vote if that is considered important with respect
to the investment. A Fund will enter into loan arrangements only with
broker-dealers, banks, or other institutions that either the Adviser or the
lending agent has determined are creditworthy under guidelines established by
the Board. Although these loans are fully collateralized, there are risks
associated with securities lending. A Fund’s performance could be hurt if a
borrower defaults or becomes insolvent, or if the Fund wishes to sell a security
before its return can be arranged. The return on invested cash collateral will
result in gains and losses for the Funds. Each Fund will limit its securities
lending to 33-1/3% of its total assets.
13
Limitations
and Risks of Options and Futures Activity
Each
Fund may engage in both hedging and non-hedging strategies. Although effective
hedging can generally capture the bulk of a desired
risk adjustment, no hedge is completely effective. A Fund’s ability to hedge
effectively through transactions in futures and options depends on the degree to
which price movements in the hedged asset correlate with price movements of the
futures and options.
Non-hedging
strategies typically involve special risks. The profitability of a Fund’s
non-hedging strategies will depend on the ability of the
Adviser to analyze both the applicable derivatives market and the market for the
underlying asset or group of assets. Derivatives markets are often more volatile
than corresponding securities markets and a relatively small change in the price
of the underlying asset or group of assets can have a magnified effect upon the
price of a related derivative instrument.
Derivatives
markets also are often less liquid than the market for the underlying asset or
group of assets. Some positions in futures and options
may be closed out only on an exchange that provides a secondary market. There
can be no assurance that a liquid secondary market will exist for any particular
futures contract or option at any specific time. Thus, it may not be possible to
close such an option or futures position prior to maturity. The inability to
close options and futures positions also could have an adverse impact on a
fund’s ability to effectively carry out its derivative strategies and might, in
some cases, require the fund to deposit cash to meet applicable margin
requirements.
Under
certain circumstances, futures exchanges may establish daily limits on the
amount that the price of a futures contract or an option on a
futures contract can vary from the previous day’s settlement price; once that
limit is reached, no trades may be made that day at a price beyond the limit.
Daily price limits do not limit potential losses because prices could move to
the daily limit for several consecutive days with little or no trading, thereby
preventing liquidation of unfavorable positions.
If
a Fund were unable to liquidate a futures contract or an option on a futures
position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In addition,
except in the case of purchased options, the Fund would continue to be required
to make daily variation margin payments and might be required to maintain the
position being hedged by the future or option or to maintain cash or securities
in a segregated account.
Historically,
advisers of registered investment companies trading commodity interests (such as
futures contracts, options on futures contracts,
and swaps), including the Funds, have been excluded from regulation as Commodity
Pool Operators (“CPOs”) pursuant to Commodity Futures Trading Commission
(“CFTC”) Regulation 4.5. In February 2012, the CFTC announced substantial
amendments to the permissible exclusions, and to the conditions for reliance on
the permissible exclusions, from registration as a CPO. To qualify for an
exclusion under these amendments to CFTC Regulation 4.5, if a Fund uses
commodity interests (such as futures contracts, options on futures contracts,
and swaps) other than for bona fide hedging purposes (as defined by the CFTC),
the aggregate initial margin and premiums required to establish these positions,
determined at the time the most recent position was established, may not exceed
5% of the fund’s NAV (after taking into account unrealized profits and
unrealized losses on any such positions and excluding the amount by which
options that are “in-the-money” at the time of purchase are “in-the-money”) or,
alternatively, the aggregate net notional value of those positions, determined
at the time the most recent position was established, may not exceed 100% of the
fund’s NAV (after taking into account unrealized profits and unrealized losses
on any such positions). In addition, to qualify for an exclusion, a Fund must
satisfy a marketing test, which requires, among other things, that a fund not
hold itself out as a vehicle for trading commodity interests. The amendments to
CFTC Regulation 4.5 became effective on April 24, 2012. The regulatory
requirements could change at any time and additional regulations could also be
adopted, which may adversely affect the Funds.
The
Adviser currently claims an exclusion (under CFTC Regulation 4.5) from
registration as a CPO with respect to the Funds and, in its
management of the Funds, intends to comply with one of the two alternative
trading limitations described above and the marketing limitation. Complying with
the trading limitations may restrict the Adviser’s ability to use derivatives as
part of the Funds’ investment strategies. Although the Adviser expects to be
able to execute the Funds’ investment strategies within the limitations, a
Fund’s performance could be adversely affected. In addition, new rules may limit
the availability of certain derivatives, may make the use of derivatives by
portfolios more costly and may otherwise adversely impact the performance and
value of derivatives.
Liquidity
Determinations
A
Fund may invest up to 15% of its net assets in illiquid investments. Rule 22e-4
under the 1940 Act defines illiquid investments as investments
that the Fund reasonably expects cannot be sold or disposed of in current market
conditions in seven calendar days or less without the sale or disposition
significantly changing the market value of the investment.
Illiquid
investments include investments subject to contractual or legal restrictions on
resale (e.g., because they have not been registered under the
1933 Act and securities that are otherwise not readily marketable (e.g., because
trading in the investments is suspended or because market makers do not exist or
will not entertain bids or offers). Investments that have not been registered
under the 1933 Act
14
are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Foreign
securities that are freely tradable in their principal markets are not
considered to be illiquid.
Restricted
and other illiquid investments may be subject to the potential for delays on
resale and uncertainty in valuation. A Fund might be unable
to dispose of illiquid investments promptly or at reasonable prices and might
thereby experience difficulty in satisfying redemption requests from
shareholders. A Fund might have to register restricted investments in order to
dispose of them, resulting in additional expense and delay. Adverse market
conditions could impede such a public offering of investments.
A
large institutional market exists for certain securities that are not registered
under the 1933 Act, including foreign securities. The fact that there
are contractual or legal restrictions on resale to the general public or to
certain institutions may not be indicative of the liquidity of such investments.
Rule 144A under the 1933 Act allows such a broader institutional trading market
for securities otherwise subject to restrictions on resale to the general
public.
Rule
144A establishes a “safe harbor” from the registration requirements of the 1933
Act for resale of certain securities to qualified institutional
buyers. Rule 144A has produced enhanced liquidity for many restricted
securities, and market liquidity for such securities may continue to expand as a
result of this regulation and the consequent existence of the PORTAL system,
which is an automated system for the trading, clearance, and settlement of
unregistered securities of domestic and foreign issuers sponsored by the
Financial Industry Regulatory Authority, Inc. (“FINRA”).
Under
guidelines adopted by the Trust’s Board, the Adviser may determine that
particular Rule 144A securities, and commercial paper issued in
reliance on the private placement exemption from registration afforded by
Section 4(a)(2) of the 1933 Act, are liquid even though they are not registered.
A determination of whether such a security is liquid or not is a question of
fact. In making this determination, the Adviser will consider, as it deems
appropriate under the circumstances and among other factors: (1) the frequency
of trades and quotes for the security; (2) the number of dealers willing to
purchase or sell the security; (3) the number of other potential purchasers of
the security; (4) dealer undertakings to make a market in the security; (5) the
nature of the security (e.g., debt or equity, date of maturity, terms of
dividend or interest payments, and other material terms) and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers, and the mechanics of transfer); and (6) the rating of the
security and the financial condition and prospects of the issuer. In the case of
commercial paper, the Adviser will also determine that the paper (1) is not
traded flat or in default as to principal and interest and (2) is rated in one
of the two highest rating categories by at least two National Statistical Rating
Organizations (“NRSROs”) or, if only one NRSRO rates the security, by that
NRSRO, or, if the security is unrated, the Adviser determines that it is of
equivalent quality.
Rule
144A securities and Section 4(a)(2) commercial paper that have been deemed
liquid as described above will continue to be monitored
by the Adviser to determine if the security is no longer liquid as the result of
changed conditions. Investing in Rule 144A securities or Section 4(a)(2)
commercial paper could have the effect of increasing the amount of a Fund’s
assets invested in illiquid investments if institutional buyers are unwilling to
purchase such securities.
The
Funds have adopted a liquidity risk management program designed to meet the
requirements of the rules under the 1940 Act related to
liquidity.
Loan
Interests and Direct Debt Instruments (“Bank Loans”)
Each
Fund may invest in loan interests and direct debt instruments, which are
interests in amounts owed by a corporate, governmental, or other
borrower to lenders or lending syndicates (in the case of loans and loan
participations), to suppliers of goods or services (in the case of trade claims
or other receivables) or to other parties. These investments involve a risk of
loss in case of the default, insolvency, or bankruptcy of the
borrower.
Loans
normally are not registered with the SEC or any state securities commission or
listed on any securities exchange. As a result, there is
typically less public information available about a specific loan than there
would be if the loan were registered or traded on exchange. Loans also may not
be considered “securities,” and purchasers, such as the Funds, may not be
entitled to rely on the anti-fraud protections of the federal securities laws
with respect to any loans they own in the event of fraud or misrepresentation by
a borrower.
A
Fund may come into possession of material non-public information about a
borrower as a result of its ownership of a loan or other debt
instrument of such borrower. Because of prohibitions on trading in securities of
issuers while possessing such information, a Fund might be unable to enter into
a transaction in a publicly traded security of that borrower when it would
otherwise be advantageous to do so.
Purchasers
of loans and other forms of direct indebtedness depend primarily upon the
creditworthiness of the borrower for payment of
interest and repayment of principal. If scheduled interest or principal payments
are not made, or are not made in a timely manner, the value of the instrument
may be adversely affected. Loans that are fully secured provide more protections
than unsecured loans in the event of failure to make scheduled interest or
principal payments. However, there is no assurance that the liquidation of
collateral
15
from
a secured loan would satisfy the borrower’s obligation, or that the collateral
could be liquidated. Indebtedness of borrowers whose creditworthiness
is poor involves substantially greater risks and may be highly speculative.
Borrowers that are in bankruptcy or restructuring may never pay off their
indebtedness, or may only pay a small fraction of the amount owed. Direct
indebtedness of developing countries also involves a risk that the governmental
entities responsible for the repayment of the debt may be unable, or unwilling,
to pay interest and repay principal when due.
Investments
in loans through direct assignment of a financial institution’s interests with
respect to a loan may involve additional risks, such as a
loan foreclosure and costs and liabilities associated with owning and disposing
of the collateral. In addition, it is possible that a purchaser could be held
liable as a co-lender. Direct debt instruments also may involve a risk of
insolvency of the lending bank or other intermediary.
A
loan is often administered by a bank or other financial institution that acts as
agent for all holders. The agent administers the terms of the
loan, as specified in the loan agreement. Unless the purchaser has direct
recourse against the borrower, the purchaser may have to rely on the agent to
apply appropriate credit remedies against a borrower under the terms of the loan
or other indebtedness. If assets held by the agent for the benefit of a
purchaser were determined to be subject to the claims of the agent’s general
creditors, the purchaser might incur certain costs and delays in realizing
payment on the loan or loan participation and could suffer a loss of principal
or interest.
Direct
indebtedness may include letters of credit, revolving credit facilities, or
other standby financing commitments that obligate purchasers
to make additional cash payments on demand. These commitments may have the
effect of requiring a purchaser to increase its investment in a borrower at a
time when it would not otherwise have done so, even if the borrower’s condition
makes it unlikely that the amount will ever be repaid.
For
purposes of Fund investment limitations, a Fund generally will treat the
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
financial intermediary between a fund and the borrower, if the participation
does not shift to the Fund the direct debtor-creditor relationship with the
borrower, SEC interpretations require the Fund, in some circumstances, to treat
both the lending bank or other lending institution and the borrower as “issuers”
for purposes of the Fund’s investment policies. 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
may have extended settlement periods. Accordingly, the proceeds from the sale of
a loan may not be available to make additional investments
or to meet redemption obligations until potentially a substantial period after
the sale of the loan. The extended trade settlement periods could force a Fund
to liquidate other securities to meet redemptions and may present a risk that
the Fund may incur losses in order to timely honor redemptions.
Certain
of the debt obligations (including municipal securities, certificates of
participation, commercial paper, and other short-term obligations)
that the Funds may purchase may be backed by an unconditional and irrevocable
letter of credit of a bank, savings and loan association, or insurance company
which assumes the obligation for payment of principal and interest in the event
of default by the issuer. Only banks, savings and loan associations and
insurance companies which, in the opinion of the Adviser, are of comparable
quality to issuers of other permitted investments of a Fund, may be used for
letter of credit-backed investments.
Master
Demand Notes
Each
Fund may invest in master demand notes, which are obligations that permit the
investment of fluctuating amounts by each Fund, at varying
rates of interest using direct arrangements between the Fund, as lender, and the
borrower. These notes permit daily changes in the amounts borrowed. Each Fund
has the right to increase the amount under the note at any time up to the full
amount provided by the note agreement, or to decrease the amount, and the
borrower may repay up to the full amount of the note without penalty.
Frequently, such obligations are secured by letters of credit or other credit
support arrangements provided by banks. Because master demand notes are direct
lending arrangements between the lender and borrower, these instruments
generally will not be traded, and there, generally, is no secondary market for
these notes, although they are redeemable (and immediately repayable by the
borrower) at face value, plus accrued interest, at any time. The Adviser will
invest a Fund’s assets in master demand notes only if the Board or its delegate
has determined that they are of credit quality comparable to the debt securities
in which the Fund generally may invest.
Mortgage-Backed
Securities
Each
Fund may invest in mortgage-backed securities. Mortgage-backed securities
include, but are not limited to, securities issued by the
Government National Mortgage Association (“Ginnie Mae,” also known as “GNMA”),
Federal National Mortgage Association (“Fannie Mae”), and Federal Home Loan
Mortgage Corporation (“Freddie Mac”). These securities represent ownership in a
pool of mortgage loans. They differ from conventional bonds in that principal is
paid back to the investor as payments are made on the underlying mortgages in
the pool. Accordingly, a Fund receives monthly scheduled payments of principal
and interest along with any
16
unscheduled
principal prepayments on the underlying mortgages. Because these scheduled and
unscheduled principal payments must be
reinvested at prevailing interest rates, mortgage-backed securities do not
provide an effective means of locking in long-term interest rates for the
investor. Like other fixed income securities, when interest rates rise, the
value of mortgage-backed securities with prepayment features will generally
decline. In addition, when interest rates are declining, the value of
mortgage-backed securities with prepayment features may not increase as much as
other fixed income securities. The weighted average life of such securities is
likely to be substantially shorter than the stated final maturity as a result of
scheduled principal payments and unscheduled principal prepayments.
Ginnie
Mae is a government-owned corporation that is an agency of the U.S. Department
of Housing and Urban Development. It guarantees,
with the full faith and credit of the United States, full and timely payment of
all monthly principal and interest on its mortgage-backed securities. Until
recently, Fannie Mae and Freddie Mac were government-sponsored corporations
owned entirely by private stockholders. Both issue mortgage-related securities
that contain guarantees as to timely payment of interest and principal but that
are not backed by the full faith and credit of the U.S. government. The value of
the companies’ securities fell sharply in 2008 due to concerns that the firms
did not have sufficient capital to offset losses. The U.S. Treasury has
historically had the authority to purchase obligations of Fannie Mae and Freddie
Mac. In addition, in 2008, due to capitalization concerns, Congress provided the
U.S. Treasury with additional authority to lend Fannie Mae and Freddie Mac
emergency funds and to purchase the companies’ stock, as described below. In
September 2008, the U.S. Treasury and the Federal Housing Finance Agency
(“FHFA”) announced that Fannie Mae and Freddie Mac had been placed in
conservatorship.
Since
that time, Fannie Mae and Freddie Mac have received significant capital support
through U.S. Treasury preferred stock purchases and
Federal Reserve (“Fed”) purchases of their mortgage-backed securities. While the
Fed’s purchases have terminated, the U.S. Treasury announced in December 2009
that it would continue its support for the entities’ capital as necessary to
prevent a negative net worth. From the time Fannie Mae and Freddie Mac were
placed into conservatorship through the fourth quarter of 2017, Fannie Mae and
Freddie Mac have required U.S. Treasury support of approximately $187.5 billion
through draws under the preferred stock purchase agreements. Fannie Mae and
Freddie Mac also have paid the U.S. Treasury approximately $278.8 billion in
aggregate cash dividends. However, such payments do not constitute a repayment
of the draws Fannie Mae and Freddie Mac received from the U.S. Treasury. In the
first quarter of 2018, Fannie Mae and Freddie Mac each reported that the passage
of the Tax Cuts and Jobs Act in December 2017 had resulted in a decrease in the
value of their deferred tax assets. As a result, Fannie Mae and Freddie Mac
reported net losses during the fourth quarter of 2017, and indicated that they
would request draws from the U.S. Treasury in the amount of $3.7 billion and
$0.3 billion, respectively. Accordingly, no assurance can be given that the Fed,
U.S. Treasury or FHFA initiatives will ensure that Fannie Mae or Freddie Mac
will remain successful in meeting their obligations with respect to the debt and
mortgage-backed securities they issue. Moreover, there remains significant
uncertainty as to whether (or when) Fannie Mae and Freddie Mac will emerge from
conservatorship, which has no specified termination date. Fannie Mae and Freddie
Mac also are the subject of several continuing class action lawsuits and
investigations by federal regulators, which (along with any resulting financial
restatements) may adversely affect the guaranteeing entities. The future of
Fannie Mae and Freddie Mac is in question as Congress is considering several
pieces of legislation that would reform Fannie Mae and Freddie Mac, proposing to
address their structure, mission, portfolio limits and guarantee fees, among
other issues. The potential impact of these developments is unclear, but could
cause a Fund to lose money.
Each
Fund also may invest in mortgage-backed securities that include collateralized
mortgage obligations (“CMOs”), commercial mortgage-backed
securities (“CMBSs”), stripped mortgage-backed securities (“SMBSs”),
interest-only commercial mortgage-backed securities (“CMBS IOs”), and mortgage
dollar rolls.
CMOs
are obligations fully collateralized by a portfolio of mortgages or
mortgage-related securities. CMOs are divided into pieces (tranches)
with varying maturities. The cash flow from the underlying mortgages is used to
pay off each tranche separately. CMOs are designed to provide investors with
more predictable cash flows than regular mortgage securities, but such cash
flows can be difficult to predict because of the effect of prepayments. Failure
to accurately predict prepayments can adversely affect a Fund’s return on these
investments. CMOs also may be less marketable than other
securities.
CMBSs
include securities that reflect an interest in, and are secured by, mortgage
loans on commercial real property, such as industrial and
warehouse properties, office buildings, retail space and shopping malls,
apartments, hotels and motels, nursing homes, hospitals, and senior living
centers. Many of the risks of investing in commercial mortgage- backed
securities reflect the risks of investing in the real estate securing the
underlying mortgage loans. These risks reflect the effects of local and other
economic conditions on real estate markets, the ability of tenants to make loan
payments, and the ability of a property to attract and retain tenants. In
addition, commercial properties, particularly industrial and warehouse
properties, are subject to environmental risks and the burdens and costs of
compliance with environmental laws and regulations. CMBSs may be less liquid and
exhibit greater price volatility than other types of mortgage-backed
securities.
SMBSs
are derivative multi-class mortgage securities. SMBSs may be issued by agencies
or instrumentalities of the U.S. government, or by
private originators of, or investors in, mortgage loans, including savings and
loan associations, mortgage banks, commercial
17
banks,
investment banks, and special purpose entities of the foregoing. SMBSs are
usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the interest-only or
“IO” class), while the other class will receive all of the principal (the
principal-only or “PO” class). The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on a Fund’s yield to maturity from these
securities. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, a Fund may fail to recoup some or all of
its initial investment in these securities even if the security is in one of the
highest rating categories. Although SMBSs are purchased and sold by
institutional investors through several investment banking firms acting as
brokers or dealers, established trading markets for these types of securities
are not as developed and, accordingly, these securities may be deemed “illiquid”
and subject to a Fund’s limitations on illiquid investments. CMBS IOs are
similar to the SMBSs described above, but are contrasted by being backed by
loans that have various forms of prepayment protection, which include lock-out
provisions, yield maintenance provisions, and prepayment penalties. Therefore,
they generally have less prepayment risk than SMBSs, and also are less sensitive
to interest rate changes. CMBS IOs are subject to default-related prepayments
that may have a negative impact on yield.
In
mortgage dollar roll transactions, a Fund sells mortgage-backed securities for
delivery in the current month and simultaneously contracts
to purchase substantially similar securities on a specified future date. While
the Fund would forego principal and interest paid on the mortgage-backed
securities during the roll period, the Fund would be compensated by the
difference between the current sales price and the lower price for the future
purchase as well as by any interest earned on the proceeds of the initial sale.
At the time a Fund enters into a mortgage dollar roll, it designates on its
books and records cash or liquid securities to secure its obligation for the
forward commitment to buy mortgage-backed securities. Mortgage dollar roll
transactions may be considered a borrowing by a Fund. The mortgage dollar rolls
entered into by a Fund may be used as arbitrage transactions in which the Fund
will maintain an offsetting position in investment grade debt obligations or
repurchase agreements that mature on or before the settlement date on the
related mortgage dollar roll. Because a Fund will receive interest on the
securities or repurchase agreements in which it invests the transaction
proceeds, such transactions may involve leverage.
Municipal
Lease Obligations
Each
Fund may invest in municipal lease obligations, installment purchase contract
obligations and certificates of participation in such obligations
(collectively, “lease obligations”). Lease obligations do not constitute general
obligations of the municipality for which the municipality’s taxing power is
pledged, although lease obligations are ordinarily backed by a municipality’s
covenant to budget for the payments due under the lease obligation.
Certain
lease obligations contain “non-appropriation” clauses, which provide that the
municipality has no obligation to make lease obligation
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although “non-appropriation” lease obligations are secured by the
leased property, disposition of the property in the event of foreclosure might
prove difficult. In evaluating a potential investment in such a lease
obligation, the Adviser will consider: (1) the credit quality of the obligor;
(2) whether the underlying property is essential to a governmental function; and
(3) whether the lease obligation contains covenants prohibiting the obligor from
substituting similar property if the obligor fails to make appropriations for
the lease obligation.
Non-Investment-Grade
Securities or “Junk Bonds”
A
Fund may invest directly or indirectly in or hold “junk bonds” or
non-investment-grade securities. Non-investment-grade securities (i.e., BB
or lower by S&P or Fitch, or Ba or lower by Moody’s or, if unrated, deemed
to be of comparable quality by the Adviser) are speculative in nature, involve
greater risk of default by the issuing entity, and may be subject to greater
market fluctuations than higher rated fixed income securities. Non-investment
grade bonds, sometimes referred to as “junk bonds,” are usually issued by
companies without long track records of sales and earnings, or by those
companies with questionable credit strength. The retail secondary market for
these “junk bonds” may be less liquid than that of higher-rated securities and
adverse conditions could make it difficult at times to sell certain securities
or could result in lower prices than those used in calculating a Fund’s NAV.
Also, there may be significant disparities in the prices quoted for “junk bonds”
by various dealers. Under such conditions, a Fund may find it difficult to value
its “junk bonds” accurately. A Fund’s investments in “junk bonds” may also be
subject to greater credit risk because it may invest in debt securities issued
in connection with corporate restructuring by highly- leveraged issuers or in
debt securities not current in the payment of interest or principal or in
default. If the issuer of a security is in default with respect to interest or
principal payments, a Fund may lose its entire investment. Because of the risks
involved in investing in below investment grade securities, an investment in a
Fund that invests substantially in such securities should be considered
speculative. “Junk bonds” may contain redemption or call provisions. If an
issuer exercises these provisions in a declining interest rate market, a Fund
would have to replace the security with a lower-yielding security, resulting in
a decreased return. Conversely, a “junk bond’s” value will decrease in a rising
interest rate market, as will the value of a Fund’s assets. The credit rating of
a below investment grade security does not necessarily address its market value
risk and may not reflect its actual credit risk. Ratings and market value may
change from time to time, positively or negatively, to reflect new
18
developments
regarding the issuer. If a Fund that invests in “junk bonds” experiences
unexpected net redemptions, this may force it to sell
its non-investment grade securities, without regard to their investment merits,
thereby decreasing the asset base upon which a Fund’s expenses can be spread and
possibly reducing the Fund’s rate of return.
Ratings
represent a rating agency’s opinion regarding the quality of the security and
are not a guarantee of quality. In addition, rating agencies
may fail to make timely changes to credit ratings in response to subsequent
events and a rating may become stale in that it fails to reflect changes in an
issuer’s financial condition. For a more complete description of debt ratings,
see Appendix B.
Options
on Futures Contracts
Each
Fund may invest in options on futures contracts to implement its investment
strategy. An option on a futures contract gives the purchaser
the right, in return for the premium paid, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the period of
the option.
The
trading of options on futures contracts entails the risk that changes in the
value of the underlying futures contract will not be fully reflected
in the value of the option. The risk of imperfect correlation, however,
generally tends to diminish as the maturity date of the futures contract or
expiration date of the option approaches. In addition, a Fund utilizing options
on futures contracts is subject to the risk of market movements between the time
that the option is exercised and the time of performance thereunder. This could
increase the extent of any loss suffered by a Fund in connection with such
transactions.
Each
Fund may also purchase and write options on futures contracts with respect to
each of their respective Index. The purchase of a call
option on an index futures contract is similar in some respects to the purchase
of a call option on such an index. For example, when a Fund is not fully
invested, it may purchase a call option on an index futures contract to hedge
against a market advance.
Options
on Securities and Securities Indexes
Each
Fund may purchase and sell options on securities or securities indexes to
implement its investment strategy. There are two basic types of
options: “puts” and “calls.” Each type of option can be used to establish either
a long or a short position, depending upon whether a Fund is the purchaser or a
writer of the option. A call option on a security, for example, gives the
purchaser of the option the right to buy, and the writer of the option the
obligation to sell, the underlying asset at the exercise price during the option
period. Conversely, a put option on a security gives the purchaser the right to
sell, and the writer of the option the obligation to buy, the underlying asset
at the exercise price during the option period.
Purchased
options have limited risk equal to the amount of the premium paid for the
option. Such options afford the opportunity for gain
corresponding to the increase or decrease in the value of the optioned asset. In
general, a purchased put increases in value as the value of the underlying
security falls and a purchased call increases in value as the value of the
underlying security rises.
The
principal reason to write options is to generate extra income (the premium paid
by the buyer). Written options have varying degrees of risk.
An uncovered written call option theoretically carries unlimited risk, as the
market price of the underlying asset could rise far above the exercise price
before its expiration. This risk is tempered when the call option is covered;
that is, when the option writer owns the underlying asset. In this case, the
writer runs the risk of the lost opportunity to participate in the appreciation
in value of the asset rather than the risk of an out-of-pocket loss. A written
put option has defined risk; that is, the difference between the agreed-upon
price that a Fund must pay to the buyer upon exercise of the put and the value,
which could be zero, of the asset at the time of exercise.
The
obligation of the writer of an option continues until the writer effects a
closing purchase transaction or until the option expires. To secure
its obligation to deliver the underlying asset in the case of a call option, or
to pay for the underlying asset in the case of a put option, a covered writer is
required to deposit in escrow the underlying security or other assets in
accordance with the rules of the applicable clearing corporation and
exchanges.
Among
the options that a Fund may purchase or sell are options on a securities index.
In general, options on an index of securities are similar to
options on the securities themselves, except that delivery requirements are
different. For example, a put option on an index of securities does not give the
holder the right to make actual delivery of a basket of securities, but instead
gives the holder the right to receive an amount of cash upon exercise of the
option if the value of the underlying index has fallen below the exercise price.
The amount of cash received will be equal to the difference between the closing
price of the index and the exercise price of the option expressed in dollars
times a specified multiple. As with options on equity securities, or futures
contracts, a Fund may offset its position in index options prior to expiration
by entering into a closing transaction on an exchange or it may let the option
expire unexercised.
A
securities index assigns relative values to the securities included in the index
and the index options are based on a broad market index. In
connection with the use of such options, a Fund may cover its position by
identifying assets having a value equal to the aggregate face value of the
option position taken.
19
Indexed
securities are instruments whose prices are indexed to the prices of other
securities, securities indices, commodities indices, currencies,
precious metals or other commodities, or other financial indicators. Indexed
securities typically, but not always, are debt securities or deposits whose
value at maturity or coupon rate is determined by reference to a specific
instrument or statistic.
Inflation-protected
securities, for example, can be indexed to a measure of inflation, such as the
Consumer Price Index (“CPI”).
Commodity-indexed
securities, for example, can be indexed to a commodities index such as the Dow
Jones-UBS Commodity Index Total
Return.
The
performance of indexed securities depends to a great extent on the performance
of the security, currency, commodity, or other instrument
or measure to which they are indexed, and also may be influenced by interest
rate changes in the United States and abroad. Indexed securities may be more
volatile than the underlying instruments or measures. Indexed securities also
are subject to the credit risks associated with the issuer of the security, and
their values may decline substantially if the issuer’s creditworthiness
deteriorates. Recent issuers of indexed securities have included banks,
corporations, the U.S. Treasury and certain other U.S. government agencies. In
calculating a Fund’s dividends, index-based adjustments may be considered
income.
Periodic
Auction Reset Bonds
Each
Fund may invest in periodic auction reset bonds, which are bonds whose interest
rates are reset periodically through an auction mechanism.
For purposes of calculating the portfolio weighted average maturity of each
Fund, the maturity of periodic auction reset bonds will be deemed to be the next
interest reset date, rather than the remaining stated maturity of the
instrument.
Periodic
auction reset bonds, similar to short-term debt instruments, are generally
subject to less interest rate risk than long-term fixed rate debt
instruments because the interest rate will be periodically reset in a market
auction. Periodic auction reset bonds with a long remaining stated maturity
(i.e., ten years or more), however, could have greater market risk than fixed
short-term debt instruments, arising from the possibility of auction failure or
insufficient demand at an auction, resulting in greater price volatility of such
instruments compared to fixed short-term bonds.
Preferred
Stocks
Each
Fund may invest in preferred stocks, which represent a class of capital stock.
Generally, preferred stock has a specified dividend and ranks
after bonds and before common stocks in its claim on income for dividend
payments and on assets should the company be liquidated. Preferred stockholders
do not ordinarily enjoy any of the voting rights of common stockholders. Most
preferred stock is cumulative, meaning that if dividends are passed (not paid
for any reason), they accumulate and must be paid before common dividends.
Typically, a preferred stock pays a fixed dividend that does not fluctuate,
although the company does not have to pay this dividend if it lacks the
financial ability to do so. However, an adjustable-rate preferred stock pays a
dividend that is adjustable, usually quarterly, based on changes in the U.S.
Treasury bill rate or other money market rates. A convertible preferred stock is
exchangeable for a given number of common shares and thus tends to be more
volatile than nonconvertible preferred, which behaves more like a fixed income
bond. The main benefit to owning preferred stock is that the investor has a
greater claim on the company’s assets than common stockholders. Preferred
stockholders always receive their dividends, and in the event the company goes
bankrupt, are paid off before common stockholders. The Fund may purchase
preferred stock where the issuer has omitted, or is in danger of omitting,
payment of its dividend. Such investments would be made primarily for their
capital appreciation potential.
Private
Placements
Each
Fund may invest in securities that are not registered under the 1933 Act
(“restricted securities”). Restricted securities may be sold in private
placement transactions between issuers and their purchasers and may be neither
listed on an exchange nor traded in other established markets. In many cases,
privately placed securities may not be freely transferable under the laws of the
applicable jurisdiction or due to contractual restrictions on resale. As a
result of the absence of a public trading market, privately placed securities
may be less liquid and more difficult to value than publicly traded securities.
To the extent that privately-placed securities may be resold in
privately-negotiated transactions, the prices realized from the sales, due to
illiquidity, could be less than those originally paid by the Fund or less than
their fair market value. In addition, issuers whose securities are not
publicly-traded may not be subject to the disclosure and other investor
protection requirements that may be applicable if their securities were publicly
traded. Certain of the Fund’s investments in private placements may consist of
direct investments and may include investments in smaller, less seasoned
issuers, which may involve greater risks. These issuers may have limited product
lines, markets or financial resources, or they may be dependent on a limited
management group. In making investments in such securities, a Fund may obtain
access to material nonpublic information, which may restrict the Fund’s ability
to conduct portfolio transactions in such securities.
Some
of these securities are new and complex, and trade only among institutions; the
markets for these securities are still developing, and may
not function as efficiently as established markets. Because there may not be an
established market price for these securities, the Fund may have to estimate
their value. Transactions in restricted or illiquid investments may entail
registration expense and other
20
transaction
costs that are higher than those for transactions in unrestricted or liquid
securities. Where registration is required for restricted
or illiquid investments, a considerable time period may elapse between the time
the Fund decides to sell the security and the time it is actually permitted to
sell the security under an effective registration statement. If during such
period, adverse market conditions were to develop, the Fund might obtain
less-favorable pricing terms that when it decided to sell the
security.
Put
Bonds
Each
Fund may invest in securities, the interest on which is excludable from gross
income for federal income tax purposes (tax exempt securities)
(including securities with variable interest rates) that may be redeemed or sold
back (“put”) to the issuer of the security or a third party prior to stated
maturity (“put bonds”). Such securities will normally trade as if maturity is
the earlier put date, even though stated maturity is longer. Under a Fund’s
portfolio allocation procedure, maturity for put bonds is deemed to be the date
on which the put becomes exercisable.
Recent
Market Conditions and Events
Global
economies and financial markets are increasingly interconnected, which increases
the possibilities that conditions in one country or region
might adversely affect issuers in another country or region. Geopolitical and
other risks, including war, terrorism, trade disputes, political or economic
dysfunction within some nations, public health crises and related geopolitical
events, as well as environmental disasters such as earthquakes, fires, and
floods, may add to instability in world economies and markets generally. Changes
in trade policies and international trade agreements could affect the economies
of many countries in unpredictable ways. Likewise, systemic market dislocations
of the kind that occurred during the financial crisis that began in 2008, if
repeated, would be highly disruptive to economies and markets, adversely
affecting individual companies and industries, securities markets, interest
rates, credit ratings, inflation, investor sentiment, and other factors
affecting the value of a Fund’s investments.
Political
and diplomatic events within the United States, including a contentious domestic
political environment, changes in political party
control of one or more branches of the U.S. government, the U.S. government's
inability at times to agree on a long-term budget and deficit reduction plan,
the threat of a U.S. government shutdown, and disagreements over, or threats not
to increase, the U.S. government's borrowing limit (or “debt ceiling”), as well
as political and diplomatic events abroad, may affect investor and consumer
confidence and may adversely impact financial markets and the broader economy,
perhaps suddenly and to a significant degree. A downgrade of the ratings of U.S.
government debt obligations, or concerns about the U.S. government's credit
quality in general, could have a substantial negative effect on the U.S. and
global economies. Moreover, although the U.S. government has honored its credit
obligations, there remains a possibility that the United States could default on
its obligations. The consequences of such an unprecedented event are impossible
to predict, but it is likely that a default by the United States would be highly
disruptive to the U.S. and global securities markets and could significantly
impair the value of the Funds’ investments.
Certain
illnesses spread rapidly and have the potential to significantly and adversely
affect the global economy and the value of a Fund’s investments.
Outbreaks of illnesses and diseases, such as severe acute respiratory syndrome
(SARS), influenza of various types and, most recently, COVID-19, or other
similarly infectious diseases, may have material adverse impacts on a Fund and
its performance. Epidemics and/or pandemics, such as COVID-19, have and may
further result in, among other things, border closings and other significant
travel restrictions and disruptions, significant disruptions to business
operations, supply chains and customer activity, significant challenges to
healthcare service preparation and delivery, and quarantines and stay-at-home
orders, as well as general concern and uncertainty that has negatively affected
the economic environment. These impacts have caused significant volatility and
declines in global financial markets, which have caused losses for investors.
The impact of COVID-19, and other epidemics and/or pandemics that may arise in
the future, and may affect the economies of many nations, individual companies
and the global securities and commodities markets, including their liquidity, in
ways that cannot necessarily be foreseen at the present time. Historical
patterns of correlation among asset classes may break down in unanticipated ways
during times of high volatility, disrupting investment programs and potentially
causing losses. The impact of public health crises, including COVID-19, may
continue to last for an extended period of time.
The
U.S. government and certain foreign central banks have taken a variety of
unprecedented actions to stabilize the economy and calm the
financial markets and may continue to do so, but the ultimate impact of these
efforts and interventions is uncertain. In the future, the U.S. government or
other governments may take actions that could affect the overall economy as well
as the securities in which a Fund invests, the markets in which they trade, or
the issuers of such securities, in ways that cannot necessarily be foreseen at
the present time. Governmental and quasi-governmental authorities and regulators
throughout the world, such as the U.S. Federal Reserve (the “Fed”), have in the
past responded to major economic disruptions with a variety of significant
fiscal and monetary policy changes, including but not limited to, direct capital
infusions into companies, new monetary programs, and changes to interest rates.
Certain of those policy changes, for example, were implemented in response to
the COVID-19 pandemic. The Fed has spent hundreds of billions of dollars to keep
credit flowing through short-term money markets since mid-September 2019 when a
shortage of liquidity caused a spike in overnight borrowing rates, and again in
2020 with large stimulus initiatives intended to respond to economic stresses
stemming from the COVID-19 pandemic. The impact of infectious diseases in
developing and emerging market countries, however, may be
21
greater
due to less established health care systems and fewer government resources to
bolster their economies. Public health crises may exacerbate
other pre-existing political, social, and economic risks in certain
countries.
Instability
in the global capital markets may result in disruptions in liquidity in the debt
capital markets, significant write-offs in the financial
services sector (including banking), the repricing of credit risk in credit
markets and the failure of domestic and international financial institutions.
Precise interest rate predictions are difficult to make, and interest rates may
change unexpectedly and dramatically in response to extreme changes in market or
economic conditions. As a result, the value of fixed income securities may vary
widely under certain market conditions and may result in heightened market
volatility and a decline in the value of a Fund’s portfolio. Changes in
government policies or central banks could negatively affect the value and
liquidity of a Fund’s investments and cause it to lose money. The markets could
react strongly to expectations for changes in government policies, which could
increase volatility, especially if the market’s expectations are not borne out.
There can be no assurance that the initiatives undertaken by governments and
central banks will be successful.
COVID-19,
and future epidemics or pandemics, could also impair the information technology
and other operational systems upon which a
Fund’s service providers rely, and could otherwise disrupt the ability of a
Fund’s service providers to perform essential tasks. These could impair a Fund’s
ability to maintain operational standards (such as with respect to satisfying
redemption requests), disrupt the operations of a Fund’s service providers, and
negatively impact a Fund’s performance. In certain cases, an exchange or market
may close or issue trading halts on either specific securities or even the
entire market, which may result in a Fund being, among other things, unable to
buy or sell certain securities or financial instruments or accurately value its
investments.
Markets
generally and the energy sector specifically, including MLPs and energy
companies in which a Fund may invest, may also be adversely
impacted by reduced demand for oil and other energy commodities as a result of a
slowdown in economic activity and by price competition among key oil producing
countries. In the recent past, global oil prices have declined significantly and
experienced significant volatility, including a period where an oil-price
futures contract fell into negative territory for the first time in history, as
demand for oil has slowed and oil storage facilities reach their storage
capacities. Although the Organization of Petroleum Exporting Countries (OPEC)
and other oil-producing countries responded, oil price volatility may adversely
impact MLPs and energy infrastructure companies. Such companies’ growth
prospects and ability to pay dividends may be negatively impacted, which could
adversely impact a Fund's performance. Additionally, an extended period of
reduced oil prices may significantly lengthen the time the energy sector would
need to recover after a stabilization of prices.
Some
countries, including the United States, are adopting more protectionist trade
policies and are moving away from the tighter financial
industry regulations that followed the 2008 financial crisis. The United States
may also be considering significant new investments in infrastructure and
national defense which, coupled with potentially lower federal taxes, could lead
to sharply increased government borrowing and higher interest rates. The exact
shape of these policies is still being considered through the political process,
but the equity and debt markets may react strongly to expectations, which could
increase volatility, especially if the market’s expectations for changes in
government policies are not borne out.
High
public debt in the United States and other countries creates ongoing systemic
and market risks and policymaking uncertainty. There may
be additional increases in the amount of debt due to the economic effects of the
COVID-19 pandemic. Because there is little precedent for this situation, it is
difficult to predict the impact on various markets. Over the longer term, rising
interest rates may present a greater risk than has historically been the case
due to the recent period of historically low rates, the effect of government
fiscal and monetary policy initiatives, and potential market reactions to those
initiatives.
Some
countries where economic conditions are still recovering from the 2008 crisis
are perceived as still fragile. The crisis caused strains
among countries in the euro-zone that have not been fully resolved, and it is
not yet clear what measures, if any, European Union (“EU”) or individual country
officials may take in response. Withdrawal of government support, failure of
efforts in response to the strains, or investor perception that such efforts are
not succeeding could adversely impact the value and liquidity of certain
securities and currencies.
In
addition, global climate change may have an adverse effect on property and
security values. A rise in sea levels, an increase in powerful
windstorms and/or a storm-driven increase in flooding could cause coastal
properties to lose value or become unmarketable altogether. Large wildfires
driven by high winds and prolonged drought may devastate entire communities and
may be very costly to any business found to be responsible for the fire or
conducting operations in affected areas. These losses could adversely affect
corporate borrowers and mortgage lenders, the value of mortgage-backed
securities, the bonds of municipalities that depend on tax revenues and tourist
dollars generated by such properties, and insurers of the property and/or of
corporate, municipal, or mortgage-backed securities. Since property and security
values are driven largely by buyers’ perceptions, it is difficult to know the
time period over which these effects might unfold. Economists warn that, unlike
previous declines in the real estate market, properties in affected coastal
zones may never recover their value. Regulatory changes and divestment movements
tied to concerns about climate change could adversely affect the value of
certain land and the viability of industries whose activities or products are
seen as accelerative to climate change.
22
Some
market participants have expressed concern that passively managed index funds
and other indexed products inflate the value of their
component securities. If the component securities in such indices decline in
value for this and other reasons, the value of a Fund’s investments in these
securities will also decline.
Russia’s
invasion of Ukraine, and corresponding events in late February 2022, have had,
and could continue to have, severe adverse effects on
regional and global economic markets for securities and commodities. Following
Russia’s actions, various governments, including the United States, have issued
broad-ranging economic sanctions against Russia, including, among other actions,
a prohibition on doing business with certain Russian companies, large financial
institutions, officials and oligarchs; the removal by certain countries and the
EU of selected Russian banks from the Society for Worldwide Interbank Financial
Telecommunications (SWIFT), the electronic banking network that connects banks
globally; and restrictive measures to prevent the Russian Central Bank from
undermining the impact of the sanctions. The current events, including sanctions
and the potential for future sanctions, including any impacting Russia’s energy
sector, and other actions, and Russia’s retaliatory responses to those sanctions
and actions, may continue to adversely impact the Russian and Ukrainian
economies and may result in the further decline of the value and liquidity of
Russian and Ukrainian securities, a continued weakening of the ruble and hryvnia
and continued exchange closures, and may have other adverse consequences on the
Russian and Ukrainian economies that could impact the value of these investments
and impair the ability of the Fund to buy, sell, receive or deliver those
securities. Moreover, those events have, and could continue to have, an adverse
effect on global markets performance and liquidity, thereby negatively affecting
the value of a Fund’s investments beyond any direct exposure to Russian and
Ukrainian issuers. The duration of ongoing hostilities and the vast array of
sanctions and related events cannot be predicted. Those events present material
uncertainty and risk with respect to markets globally and the performance of the
Funds and their investments or operations could be negatively
impacted.
Risks
Related to Cybersecurity. The Funds
and their service providers have administrative and technical safeguards in
place with respect to information security. Nevertheless, the Funds and their
service providers are potentially susceptible to operational and information
security risks resulting from a cyber-attack as the Funds are highly dependent
upon the effective operation of their computer systems and those of their
business partners. These risks include, among other things, the theft, misuse,
corruption and destruction of data maintained online or digitally, denial of
service on websites and other operational disruption and unauthorized release of
confidential customer information. Cyber-attacks affecting the Adviser, Victory
Capital Services, Inc. (the “Distributor,”), the Funds, the custodian, the
transfer agent, financial intermediaries and other affiliated or third-party
service providers may adversely affect the Funds and their shareholders. For
instance, cyber-attacks may interfere with the processing of Fund transactions,
including the processing of orders, impact a Fund’s ability to calculate net
asset values, cause the release and possible destruction of confidential
customer or business information, impede trading, subject a Fund and/or its
service providers and intermediaries to regulatory fines and financial losses
and/or cause reputational damage. Cybersecurity risks may also affect the
issuers of securities in which a Fund invests, which may cause a Fund’s
investments to lose value. A Fund may also incur additional costs for
cybersecurity risk management in the future. Although the Funds and their
service providers have adopted security procedures to minimize the risk of a
cyber-attack, there can be no assurance that the Funds or their service
providers will avoid losses affecting the Funds due to cyber-attacks or
information security breaches in the future.
Responsible
Investing Risk. A Fund may
incorporate specific responsible, environmental, social and governance (“ESG”),
impact or sustainability considerations into its investment objectives,
strategies, and/or processes, as described in the applicable Fund's Prospectus.
These considerations will vary depending on a Fund's particular investment
strategy and the investment process followed by the particular investment team
that manages the Fund. A team may include consideration of third-party research
as well as consideration of proprietary research across the ESG risks and
opportunities regarding an issuer. The investment team considers those ESG
characteristics it deems relevant or additive when making investment decisions
for a Fund. The ESG characteristics utilized in a Fund's investment process are
anticipated to evolve over time and one or more characteristics may not be
relevant with respect to all issuers that are eligible for
investment.
ESG
characteristics are not the sole considerations when making investment decisions
for a Fund. Further, investors can differ in their views of
what constitutes positive or negative ESG characteristics. As a result, a Fund
may invest in issuers that do not reflect the beliefs and values with respect to
ESG of any particular investor. ESG considerations may affect a Fund's exposure
to certain companies or industries and a Fund may forego certain investment
opportunities. While the Adviser views ESG considerations as having the
potential to contribute to a Fund's long-term performance, there is no guarantee
that such results will be achieved.
Brexit.
The United
Kingdom (“UK”) ceased to be a member of the EU on January 31, 2020 (“Brexit”).
During a prescribed period (the “Transition Period”), certain transitional
arrangements were in effect, such that the UK continued to be treated, in most
respects, as if it were still a member of the EU, and generally remained subject
to EU law. The Transition Period ended on December 31, 2020. On December 24,
2020, the EU and the UK reached an agreement in principle on the terms of
certain agreements and declarations governing the ongoing relationship between
the EU and the UK, including the EU-UK Trade and Cooperation Agreement (the
“Agreement”). The Agreement entered into force on May 1, 2021. The Agreement is
limited in its scope primarily to the trade of goods, transport, energy links
and fishing, and uncertainties remain relating to certain aspects of the UK’s
future economic, trading, and legal relationships with the EU and with other
countries. The actual or potential consequences of Brexit, and the associated
uncertainty, could
23
adversely
affect economic and market conditions in the UK, in the EU and its member states
and elsewhere, and could contribute to instability
in global financial markets.
The
impact of such events on the Funds is difficult to predict but they may
adversely affect the return on the Funds and their investments.
There may be detrimental implications for the value of a Fund’s investments, its
ability to enter into transactions or to value or realize such investments or
otherwise to implement its investment program. It is possible that a Fund’s
investments may need to be restructured to enable a Fund's objectives to be
pursued fully. This may increase costs or make it more difficult for a Fund to
pursue its investment objective.
The
London Interbank Offered Rate (“LIBOR”). LIBOR has
historically been the principal floating rate benchmark in the financial
markets. However, LIBOR was discontinued as a floating rate benchmark after June
30, 2023. Then-existing LIBOR obligations have been transitioned or will
transition to another benchmark, depending on the LIBOR currency and tenor. For
some existing LIBOR-based obligations, the contractual consequences of the
discontinuation of LIBOR may not be clear.
Non-LIBOR
floating rate obligations, including obligations based on the Secured Overnight
Financing Rate (“SOFR”), may have returns
and values that fluctuate more than those of floating rate debt obligations that
are based on LIBOR or other rates. Also, because SOFR and some alternative
floating rates are relatively new market indexes, markets for certain non-LIBOR
obligations may never develop or may not be liquid. Market terms for non-LIBOR
floating rate obligations, such as the spread over the index reflected in
interest rate provisions, may evolve over time, and prices of non-LIBOR floating
rate obligations may be different depending on when they are issued and changing
views about correct spread levels.
Various
SOFR-based rates, including SOFR-based term rates, and various non-SOFR-based
rates have developed in response to the discontinuation
of U.S. dollar LIBOR, which may create various risks for the Funds and the
financial markets more generally. There are non- LIBOR forward-looking floating
rates that are not based on SOFR and that may be considered by participants in
the financial markets as LIBOR alternatives. Unlike forward-looking SOFR-based
term rates, such rates are intended reflect a bank credit spread
component.
It
is not clear how replacement rates for LIBOR--including SOFR-based rates and
non-SOFR-based rates--will continue to develop and to what
extent they will be used. There is no assurance that these replacement rates
will be suitable substitutes for LIBOR, and thus the substitution of such rates
for LIBOR could have an adverse effect on the Funds and the financial markets
more generally. Concerns about market depth and stability could affect the
development of non-SOFR-based term rates, and such rates may create various
risks, which may or may not be similar to the risks relating to
SOFR.
Repurchase
Agreements
A
Fund may enter into repurchase agreements. In a repurchase agreement, an
investor (such as the Fund) purchases a security (known as the
“underlying security”) from a securities dealer or bank. Any such dealer or bank
must be deemed creditworthy by the Adviser. At that time, the bank or securities
dealer agrees to repurchase the underlying security at a mutually agreed upon
price on a designated future date. The repurchase price may be higher than the
purchase price, the difference being income to the Fund, or the purchase and
repurchase prices may be the same, with interest at an agreed upon rate due to
the Fund on repurchase. In either case, the income to the Fund generally will be
unrelated to the interest rate on the underlying securities. Repurchase
agreements must be “fully collateralized,” in that the market value of the
underlying securities (including accrued interest) must at all times be equal to
or greater than the repurchase price. Therefore, a repurchase agreement can be
considered a loan collateralized by the underlying securities.
Repurchase
agreements are generally for a short period of time, often less than a week, and
will generally be used by a Fund to invest excess
cash or as part of a temporary defensive strategy. Repurchase agreements that do
not provide for payment within seven days will be treated as illiquid
investments. In the event of a bankruptcy or other default by the seller of a
repurchase agreement, the Fund could experience both delays in liquidating the
underlying security and losses. These losses could result from: (a) possible
decline in the value of the underlying security while the Fund is seeking to
enforce its rights under the repurchase agreement; (b) possible reduced levels
of income or lack of access to income during this period; and (c) expenses of
enforcing its rights.
Regulation
as a Commodity Pool Operator
The
Funds have filed with the National Futures Association (“NFA”), a notice
claiming an exclusion from the definition of the term “commodity
pool operator” under the Commodity Exchange Act, as amended, and the rules of
the Commodity Futures Trading Commission promulgated thereunder, with respect to
the Funds’ operations. Accordingly, the Funds will not be subject to
registration or regulation as a commodity pool.
24
Securities
of Other Investment Companies
General. Except
as described in the following paragraphs, each Fund currently intends to limit
its investments in securities issued by other investment companies so that, as
determined immediately after a purchase of such securities is made: (1) not more
than 5% of the value of a Fund’s total assets will be invested in the securities
of any one investment company; (2) not more than 10% of the value of its total
assets will be invested in the aggregate in securities of investment companies
as a group; and (3) not more than 3% of the outstanding voting stock of any one
investment company will be owned by a Fund.
A
Fund may also purchase and redeem shares issued by a money market fund without
limit, provided that either: (1) the Fund pays no “sales
charge” or “service fee” (as each of those terms is defined in the FINRA Conduct
Rules); or (2) the Adviser waives its advisory fee in an amount necessary to
offset any such sales charge or service fee.
Rule
12d1-4 under the 1940 Act permits a Fund, absent any other investment
restrictions to the contrary and subject to the conditions of Rule
12d1-4, to invest in registered investment companies in excess of the limits set
forth in Section 12(d) of the 1940 Act.
As
a shareholder of an investment company, a Fund indirectly will bear its
proportionate share of any management fees and other expenses
paid by such investment company in addition to the fees and expenses a Fund
bears directly in connection with its own operations. These securities represent
interests in professionally managed portfolios that may invest in various types
of instruments pursuant to a wide range of investment styles. A Fund would also
bear the risk of all of the underlying investments held by the other investment
company. An investment company may not achieve its investment
objective.
Exchange-Traded
Funds. (“ETFs”)
are investment companies, many of which pursue investment objectives to achieve
the same rate of return as a particular market index or commodity while trading
throughout the day on an exchange. Certain ETFs are actively managed portfolios
rather than being based upon an underlying index. ETF shares are sold initially
in the primary market in units, often consisting of 50,000 or more shares
(“creation units”). A creation unit represents a bundle of securities or
commodities that replicates, or is a representative sample of, a particular
index or commodity and that is deposited with the ETF. Once owned, the
individual shares comprising each creation unit are traded on an exchange in
secondary market transactions for cash. The secondary market for ETF shares
allows them to be readily converted into cash, like commonly traded stocks. The
combination of primary and secondary markets permits ETF shares to be traded
throughout the day close to the value of the ETF’s underlying portfolio
securities. A Fund would purchase and sell individual shares of ETFs in the
secondary market. These secondary market transactions require the payment of
commissions.
Unit
Investment Trusts. (“UITs”)
are investment companies that hold a fixed portfolio of securities until the
fixed maturity date of the UIT. A Fund would generally only purchase UITs in the
secondary market for cash, which would result in the payment of commissions.
Risk
Factors Associated with Investments in ETFs and UITs. ETF and
UIT shares are subject to the same risk of price fluctuation due to supply and
demand as any other stock traded on an exchange, which means that a Fund could
receive less from the sale of shares of an ETF or UIT it holds than it paid at
the time it purchased those shares. Furthermore, there may be times when the
exchange halts trading, in which case a Fund owning ETF or UIT shares would be
unable to sell them until trading is resumed. There can be no assurance that an
ETF or UIT will continue to meet the listing requirements of the exchange or
that an active secondary market will develop for shares. In addition, because
ETFs and UITs invest in a portfolio of common stocks or other instruments or
commodities, the value of an ETF or UIT could decline if prices of those
instruments or commodities decline. An overall decline of those instruments or
commodities comprising an ETF’s or UIT’s benchmark index could have a greater
impact on the ETF or UIT and investors than might be the case in an investment
company with a more widely diversified portfolio. Losses could also occur if the
ETF or UIT is unable to replicate the performance of the chosen benchmark index.
There may be times when the market price for an ETF or UIT and its NAV vary
significantly and a Fund may pay more than (premium) or less than (discount) NAV
when buying shares on the secondary market. The market price of an ETF’s or
UIT’s shares includes a “bid-ask spread” charged by the exchange specialists,
market makers or other participants that trade the particular security. In times
of severe market disruption, the bid-ask spread often increases significantly.
This means that the shares may trade at a discount to NAV and the discount is
likely to be greatest when the price of shares is falling fastest.
Other
risks associated with ETFs and UITs include the possibility that: (i) an ETF’s
or UIT’s distributions may decline if the issuers of the
ETF’s or UIT’s portfolio securities fail to continue to pay dividends; and (ii)
under certain circumstances, an ETF or UIT could be terminated. Should
termination occur, the ETF or UIT could have to liquidate its portfolio
securities when the prices for those securities are falling. In addition,
inadequate or irregularly provided information about an ETF or UIT or its
investments, because ETFs and UITs are generally passively managed, could expose
investors in ETFs and UITs to unknown risks. Actively managed ETFs are also
subject to the risk of underperformance relative to their chosen
benchmark.
25
Time
Deposits and Variable Rate Notes
A
Fund may invest in fixed time deposits, whether or not subject to withdrawal
penalties. The commercial paper obligations, which the Fund
may buy are unsecured and may include variable rate notes. The nature and terms
of a variable rate note (i.e., a “Master Note”) permit the Fund to invest
fluctuating amounts at varying rates of interest pursuant to a direct
arrangement between the Fund as Lender, and the issuer, as borrower. It permits
daily changes in the amounts borrowed. A Fund has the right at any time to
increase, up to the full amount stated in the note agreement, or to decrease the
amount outstanding under the note. The issuer may prepay at any time and without
penalty any part of or the full amount of the note. The note may or may not be
backed by one or more bank letters of credit. Because these notes are direct
lending arrangements between the Fund and the issuer, it is not generally
contemplated that they will be traded; moreover, there is currently no secondary
market for them. Except as specifically provided in the Prospectus, there is no
limitation on the type of issuer from whom these notes may be purchased;
however, in connection with such purchase and on an ongoing basis, the Adviser
will consider the earning power, cash flow and other liquidity ratios of the
issuer, and its ability to pay principal and interest on demand, including a
situation in which all holders of such notes made demand simultaneously.
Variable rate notes are subject to the Fund’s investment restriction on illiquid
investments unless such notes can be put back to the issuer on demand within
seven days.
U.S.
Government Obligations
These
consist of various types of marketable securities issued by the U.S. Treasury
e.g., bills, notes and bonds. Such securities are direct obligations
of the U.S. government and differ mainly in the length of their maturity.
Treasury bills, the most frequently issued marketable government security, have
a maturity of up to one year and are issued on a discount basis. A Fund may also
invest in Treasury Inflation-Protected Securities (“TIPS”). TIPS are special
types of treasury bonds that were created in order to offer bond investors
protection from inflation. The values of the TIPS are automatically adjusted to
the inflation rate as measured by the Consumer Price Index (“CPI”). If the CPI
goes up by half a percent, the value of the bond (the TIPS) would also go up by
half a percent. If the CPI falls, the value of the bond does not fall because
the government guarantees that the original investment will stay the same. TIPS
decline in value when real interest rates rise. However, in certain interest
rate environments, such as when real interest rates are rising faster than
nominal interest rates, TIPS may experience greater losses than other fixed
income securities with similar duration.
Obligations
of U.S. government agencies and instrumentalities are not necessarily backed by
the full faith and credit of the U.S.
Treasury, but rather of the government agency or instrumentality itself (see
“U.S. Government Agency Obligations,” below.) Although a Fund may hold
securities that carry U.S. government guarantees, these guarantees do not extend
to shares of the Fund itself and do not guarantee the market prices of the
securities. In recent periods, the values of U.S. government securities have
been affected substantially by increased demand for them in the global markets.
Increases or decreases in the demand for U.S. government securities may occur at
any time and may result in increased volatility in the values of those
securities.
Warrants
A
Fund may invest in warrants. Warrants are options to purchase common stock at a
specific price (usually at a premium above the market
value of the optioned common stock at issuance) valid for a specific period of
time. Warrants may have a life ranging from less than one year to twenty years,
or they may be perpetual. However, most warrants have expiration dates after
which they are worthless. In addition, a warrant is worthless if the market
price of the common stock does not exceed the warrant’s exercise price during
the life of the warrant. Warrants have no voting rights, pay no dividends, and
have no rights with respect to the assets of the corporation issuing them. The
percentage increase or decrease in the market price of the warrant may tend to
be greater than the percentage increase or decrease in the market price of the
optioned common stock. Warrants can provide a greater potential for profit or
loss than an equivalent investment in the underlying security. Prices of
warrants do not necessarily move in tandem with the prices of the underlying
securities and therefore are highly volatile and speculative investments. If a
warrant held by a Fund is not exercised by the date of its expiration, the Fund
would lose the entire purchase price of the warrant.
INVESTMENTS
IN THE FUNDS BY OTHER REGISTERED INVESTMENT COMPANIES
Section
12(d)(1) of the 1940 Act restricts investments by registered investment
companies in the securities of other investment companies,
including shares of a Fund. Other registered investment companies (typically
structured as a “fund of funds”) are not permitted to invest in a Fund beyond
the limits set forth in Section 12(d)(1) except as permitted by any rules and
regulations adopted under applicable law, including that such investment
companies enter into an agreement with the Trust on behalf of the
Fund.
DETERMINING
NET ASSET VALUE (“NAV”) AND VALUING PORTFOLIO SECURITIES
Each
Fund’s NAV is determined, and the shares of each Fund are priced normally as of
the valuation time(s) indicated in the Prospectus on each
Business Day. A “Business Day” is a day on which the NYSE is open. The NYSE
generally is closed in observance of the following holidays: New Year’s Day, Dr.
Martin Luther King, Jr. Day, Presidents’ Day, Good Friday, Memorial Day,
Juneteenth,
26
Independence
Day, Labor Day, Thanksgiving, and Christmas Day. In addition to closing in
observance of the same holidays as the NYSE, the
Federal Reserve Bank of Cleveland is also closed on Columbus Day and Veterans
Day.
In
the event of an emergency or other disruption in trading on the NYSE, a Fund’s
share price normally will be determined based upon the close
of the NYSE.
The
Funds generally value their investments based upon their last reported sale
prices, market quotations, or estimates of value provided by an
independent pricing service as of the time as of which the Fund’s share price is
calculated. The Board has designated the Adviser as the “valuation designee” in
accordance with Rule 2a-5 under the 1940 Act.
Investment
Company Securities
Shares
of another open-end investment company (mutual fund) held by a Fund are valued
at the latest closing NAV of such mutual fund.
Shares of any ETFs held by a Fund are valued in the manner described below under
“Equity Securities.”
Fixed
Income Securities
Fixed
income securities held by a Fund are valued on the basis of security valuations
provided by an independent pricing service, approved
by the Board, that determines value by using, among other things, information
with respect to transactions of a security, quotations from dealers, market
transactions in comparable securities and various relationships between
securities. Specific investment securities that are not priced by the approved
pricing service will be valued according to quotations obtained from dealers who
are market makers in those securities. Investment securities with less than 60
days to maturity when purchased are valued at amortized cost that approximates
market value. Investment securities not having readily available market
quotations will be priced at fair value using a methodology approved in good
faith by the Board or its designee in accordance with applicable Rules under the
1940 Act subject to Board oversight.
Convertible
Fixed Income Securities
Convertible
fixed income securities are valued in the same manner as any fixed income
security. Non-convertible fixed income securities
are valued on the basis of prices provided by independent pricing services.
Prices provided by the pricing service may be determined without exclusive
reliance on quoted prices and may reflect appropriate factors such as
institution-sized trading in similar groups of securities, developments related
to special securities, yield, quality, coupon rate, maturity, type of issue,
individual trading characteristics, and other market data. Securities for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the supervision of the Trust’s officers in
a manner specially authorized by the Board or its designee in accordance with
applicable Rules under the 1940 Act, subject to Board oversight. Short-term
obligations having 60 days or less to maturity are valued on the basis of
amortized cost, except for convertible fixed income securities.
Equity
Securities
Each
equity security (including ETFs) held by a Fund is valued at the closing price
on the exchange where the security is principally traded.
Each security traded in the over-the-counter market (but not including
securities the trading activity of which is reported on Nasdaq’s Automated
Confirmation Transaction (“ACT”) System) is valued at the bid based upon quotes
furnished by market makers for such securities. Each security the trading
activity of which is reported on Nasdaq’s ACT System is valued at the Nasdaq
Official Closing Price.
Futures
and Options Contracts
For
purposes of determining NAV, futures and options contracts generally will be
valued 15 minutes after the close of trading of the NYSE.
Fair
Value Pricing
If
market quotations are not readily available, or (in the Adviser’s judgment) do
not accurately reflect the fair value of a security, or if after
the close of the principal market on which a security held by a Fund is traded
and before the time as of which the Funds’ net asset value is calculated that
day, an event occurs that the Adviser learns of and believes in the exercise of
its judgment will cause a material change in the value of that security from the
closing price of the security on the principal market on which it is traded,
that security may be valued by another method that the Board or its designee in
accordance with applicable Rules under the 1940 Act subject to Board oversight
believes would more accurately reflect the security’s fair value.
The
Funds’ use of fair value pricing procedures involves subjective judgments and it
is possible that the fair value determined for a security
may be materially different from the value that could be realized upon the sale
of that security. Accordingly, there can be no
27
assurance
that a Fund will obtain the fair value assigned to a security if it were to sell
the security at approximately the same time at which the
Fund determines its NAV per share.
Other
Valuation Information
Under
the 1940 Act, the Funds are required to act in good faith in determining the
fair value of portfolio securities. The SEC has recognized
that a security’s valuation may differ depending on the method used for
determining value. The fair value ascertained for a security is an estimate and
there is no assurance, given the limited information available at the time of
fair valuation, that a security’s fair value will be the same as or close to the
subsequent opening market price for that security.
The
Board has adopted valuation procedures for the Funds and has delegated the
day-to-day responsibility for fair valuation determinations
to the Adviser and the Adviser’s Pricing Committee. Those determinations may
include consideration of recent transactions in comparable securities,
information relating to a specific security, developments in and performance of
foreign securities markets, current valuations of foreign or U.S. indices, and
adjustment co-efficients based on fair value models developed by independent
service providers. The Adviser may, for example, adjust the value of portfolio
securities based on fair value models supplied by the service provider when the
Adviser believes that the adjustments better reflect actual prices as of the
close of the NYSE.
Generally,
trading in foreign securities, corporate bonds, U.S. government securities and
money market instruments is substantially completed
each day at various times prior to the close of the NYSE. The values of such
securities used in computing the NAV of each Fund’s shares generally are
determined at such times. Foreign currency exchange rates are also generally
determined prior the close of the NYSE. Occasionally, events affecting the
values of such securities and such exchange rates may occur between the times at
which such values are determined and the close of the NYSE. If events affecting
the value of securities occur during such a period, and a Fund’s NAV is
materially affected by such changes in the value of the securities, then these
securities will be valued at their fair value as determined in good faith by the
Adviser in accordance with applicable law. Other securities and assets for which
market quotations are not readily available or for which valuation cannot be
provided are valued as determined in good faith of the Adviser in accordance
with applicable law.
When
the NYSE is closed, or when trading is restricted for any reason other than its
customary weekend or holiday closings, or under emergency
circumstances as determined by the SEC to warrant such action, the Funds may not
be able to accept purchase or redemption requests. A Fund’s NAV may be affected
to the extent that its securities are traded on days that are not Business Days.
Each Fund reserves the right to reject any purchase order in whole or in
part.
PURCHASE
AND REDEMPTION OF SHARES
Creation
Units
Each
Fund issues and redeems Shares in Creation Units on a continuous basis through
the Distributor (as defined below), without a sales
load, at the NAV next determined after receipt of an order in proper form on any
Business Day. A “Business Day” is any day on which the NYSE is open for
business.
Currently,
a Creation Unit is an aggregation of 25,000 shares. In its discretion, the Trust
reserves the right to increase or decrease the number of
the Fund’s shares that constitute a Creation Unit. The Board reserves the right
to declare a split or a consolidation in the number of shares outstanding of the
Fund, and to make changes in the number of shares constituting a Creation Unit,
including in the event that the per share price in the secondary market rises
(or declines) to an amount that falls outside the range deemed desirable by the
Board.
Authorized
Participants
To
purchase or redeem any Creation Units, you must be, or transact through, an
Authorized Participant. In order to be an Authorized Participant,
you must be either a broker-dealer or other participant (“Participating Party”)
in the Continuous Net Settlement System (“Clearing Process”) of the National
Securities Clearing Corporation (“NSCC”) or a participant in DTC with access to
the DTC system (“DTC Participant”), and you must execute an agreement
(“Participant Agreement”) with the Distributor that governs transactions in each
Fund’s Creation Units.
Investors
who are not Authorized Participants but want to transact in Creation Units may
contact the Distributor for the names of Authorized
Participants. An Authorized Participant may require investors to enter into a
separate agreement to transact through it for Creation Units and may require
orders for purchases of shares placed with it to be in a particular form.
Investors transacting through a broker that is not itself an Authorized
Participant and, therefore, must still transact through an Authorized
Participant, may incur additional charges. There are expected to be a limited
number of Authorized Participants at any one time.
28
Investors
who are not Authorized Participants may purchase and sell shares of the Fund
through an Authorized Participant or on the secondary
market.
Orders
must be transmitted by an Authorized Participant by telephone or other
transmission method acceptable to the Distributor. Market
disruptions and telephone or other communication failures may impede the
transmission of orders.
Transaction
Fees
A
fixed fee payable to the Custodian (as defined below) is imposed on each
creation and redemption transaction regardless of the number of
Creation Units involved in the transaction (“Fixed Fee”). Purchases and
redemptions of Creation Units for cash or involving cash-in-lieu (as defined
below) are required to pay an additional variable charge to compensate each Fund
and its ongoing shareholders for brokerage and market impact expenses relating
to Creation Unit transactions (“Variable Charge,” and together with the Fixed
Fee, the “Transaction Fees”). With the approval of the Board, the Adviser may
waive or adjust the Transaction Fees, including the Fixed Fee and/or Variable
Charge (shown in the table below), from time to time. In such cases, the
Authorized Participant will reimburse each Fund for, among other things, any
difference between the market value at which the securities and/or financial
instruments were purchased by each Fund and the cash-in-lieu amount, applicable
registration fees, brokerage commissions and certain taxes and other costs and
expenses related to the execution of trades resulting from such transaction (up
to the maximum amount shown below). In addition, purchasers of Creation Units
are responsible for the costs of transferring the Deposit Securities to the
account of each Fund (as defined below). Investors who use the services of a
broker, or other such intermediary, may be charged a fee for such
services.
The
following table sets forth each Fund’s standard Transaction Fees and maximum
additional charge (as described above):
|
|
Fee
for In-Kind and
Cash
Purchases and
Redemptions |
Maximum
Additional
Variable
Charge
for Cash
Purchases
and
Redemptions* |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$100 |
2.00% |
|
VictoryShares
Corporate Bond ETF |
$100 |
2.00% |
|
VictoryShares
THB Mid Cap ESG ETF |
$250 |
2.00% |
*
As a
percentage of the amount invested.
The
Clearing Process
Transactions
by an Authorized Participant that is a Participating Party using the NSCC system
are referred to as transactions “through the
Clearing Process.” Transactions by an Authorized Participant that is a DTC
Participant using the DTC system are referred to as transactions “outside the
Clearing Process.” The Clearing Process is an enhanced clearing process that is
available only for certain securities and only to DTC participants that are also
participants in the Continuous Net Settlement System of the NSCC. In-kind
(portions of) purchase orders not subject to the Clearing Process will go
through a manual clearing process run by DTC. Portfolio Deposits that include
government securities must be delivered through the Federal Reserve Bank wire
transfer system (“Federal Reserve System”). Fund Deposits that include cash may
be delivered through the Clearing Process or the Federal Reserve System. In-kind
deposits of securities for orders outside the Clearing Process must be delivered
through the Federal Reserve System (for government securities) or through DTC
(for corporate securities).
Foreign
Securities
Because
the portfolio securities of each Fund may trade on days that the Exchange is
closed or are otherwise not Business Days for each Fund,
shareholders may not be able to redeem their shares of each Fund, or to purchase
or sell shares of each Fund on the Exchange, on days when the NAV of each Fund
could be significantly affected by events in the relevant foreign
markets.
Purchasing
Creation Units
Portfolio
Deposits
The
consideration for a Creation Unit generally consists of the in-kind deposit of
designated securities (“Deposit Securities”) and an amount of
cash in U.S. dollars (“Cash Component”). Together, the Deposit Securities and
the Cash Component constitute the “Portfolio Deposit.” The Cash Component serves
the function of compensating for any differences between the net asset value per
Creation Unit and the Deposit Securities. Thus, the Cash Component is equal to
the difference between (x) the net asset value per Creation Unit of each Fund
and (y) the market value of the Deposit Securities. If (x) is more than (y), the
Authorized Participant will pay the Cash Component to each Fund. If (x) is less
than (y), the Authorized Participant will receive the Cash Component from each
Fund.
29
On
each Business Day, prior to the opening of business on the Exchange (currently
9:30 a.m., Eastern Time), the Adviser through the Custodian
makes available through NSCC the name and amount of each Deposit Security in the
current Portfolio Deposit (based on information at the end of the previous
Business Day) for each Fund and the (estimated) Cash Component, effective
through and including the previous Business Day, per Creation Unit. The Deposit
Securities announced are applicable, subject to any adjustments as described
below, to purchases of Creation Units until the next announcement of Deposit
Securities.
The
Deposit Securities may change, for example, as rebalancing adjustments and
corporate action events are reflected from time to time by the
Adviser in each Fund’s portfolio. These adjustments will reflect changes known
to the Adviser on the date of announcement to be in effect by the time of
delivery of the Portfolio Deposit.
Payment
of any stamp duty or the like shall be the sole responsibility of the Authorized
Participant purchasing a Creation Unit. The Authorized
Participant must ensure that all Deposit Securities properly denote change in
beneficial ownership.
Custom
Orders and Cash-in-lieu
Each
Fund may, in its sole discretion, permit or require the substitution of an
amount of cash (“cash-in-lieu”) to be added to the Cash Component
to replace any Deposit Security. Each Fund may permit or require cash-in-lieu
when, for example, a Deposit Security may not be available in sufficient
quantity for delivery or may not be eligible for transfer through the systems of
DTC or the Clearing Process. Similarly, each Fund may permit or require cash in
lieu of Deposit Securities when, for example, the Authorized Participant or its
underlying investor is restricted under U.S. or local securities laws or
policies from transacting in one or more Deposit Securities. Each Fund will
comply with the federal securities laws in accepting Deposit Securities
including that the Deposit Securities are sold in transactions that would be
exempt from registration under the 1933 Act. All orders involving cash-in-lieu
are considered to be “Custom Orders.”
Purchase
Orders
To order a
Creation Unit, an Authorized Participant must submit an irrevocable purchase
order to the Distributor.
Timing
of Submission of Purchase Orders
All
orders to purchase shares directly from a Fund must be placed for one or more
Creation Units and in the manner and by 4:00 p.m. Eastern
time (2:00 p.m. Eastern time for the purchase of the Bond Funds) or such earlier
time that the Exchange or bond market closes (the “Cut-off Time”) in order to
receive the NAV calculated on the Transmittal Date. The “Transmittal Date” is
the date on which such an order to purchase Creation Units (or an order to
redeem Creation Units, as set forth below).
Intermediary
Deadlines
Persons
placing or effectuating custom orders and/or orders involving cash should be
mindful of time deadlines imposed by intermediaries,
such as DTC and/or the Federal Reserve Bank wire system, which may impact the
successful processing of such orders to ensure that cash and securities are
transferred by the “Settlement Date,” which is generally the Business Day
immediately following the Transmittal Date (“T+1”) for cash and the second
Business Day following the Transmittal Date for domestic securities
(“T+2”).
Orders
Using the Clearing Process
If
available, (portions of) orders may be settled through the Clearing Process. In
connection with such orders, the Distributor or its agent transmits,
on behalf of the Authorized Participant, such trade instructions as are
necessary to effect the creation order. Pursuant to such trade instructions, the
Authorized Participant agrees to deliver the requisite Portfolio Deposit to each
Fund, together with such additional information as may be required by the
Distributor . Cash Components will be delivered using either the Clearing
Process or the Federal Reserve System.
Orders
Outside the Clearing Process
If
the Clearing Process is not available for (portions of) an order, Portfolio
Deposits will be made outside the Clearing Process. Orders outside
the Clearing Process must state that the DTC Participant is not using the
Clearing Process and that the creation of Creation Units will be effected
through DTC. The Portfolio Deposit transfer must be ordered by the DTC
Participant on the Transmittal Date in a timely fashion so as to ensure the
delivery of Deposit Securities (whether standard or custom) through DTC to each
Fund account by 11:00 a.m., Eastern time, on T+1. The Cash Component, along with
any cash-in-lieu and Transaction Fee, must be transferred directly to the
Custodian through the Federal Reserve System in a timely manner so as to be
received by the Custodian no later than 12:00 p.m., Eastern Time, on T+1. If the
Custodian does not receive both the Deposit Securities and the cash by the
appointed time, the order may be canceled. A canceled order may be resubmitted
the following Business Day but must conform to that Business Day’s Portfolio
Deposit. Authorized Participants that submit a canceled order will be liable to
each Fund for any losses incurred by each Fund in connection
therewith.
30
Orders
involving foreign Deposit Securities are expected to be settled outside the
Clearing Process. Thus, upon receipt of an irrevocable purchase
order, the Distributor will notify the Adviser and the Custodian of such order.
The Custodian, who will have caused the appropriate local sub-custodian(s) of
each Fund to maintain an account into which an Authorized Participant may
deliver Deposit Securities (or cash -in-lieu), with adjustments determined by
each Fund, will then provide information of the order to such local
sub-custodian(s). The ordering Authorized Participant will then deliver the
Deposit Securities (and any cash-in-lieu) to each Fund’s account at the
applicable local sub-custodian. The Authorized Participant must also make
available on or before the contractual settlement date, by means satisfactory to
each Fund, immediately available or same day funds in U.S. dollars estimated by
each Fund to be sufficient to pay the Cash Component and Transaction Fee. When a
relevant local market is closed due to local market holidays, the local market
settlement process will not commence until the end of the local holiday period.
Settlement must occur by 2:00 p.m., Eastern Time, on the contractual settlement
date.
Acceptance
of Purchase Order
All
questions as to the number of shares of each security in the Deposit Securities
and the validity, form, eligibility, and acceptance for
deposit of any securities to be delivered shall be determined by each Fund. Each
Fund’s determination shall be final and binding.
Each
Fund reserves the right to reject or revoke acceptance of a purchase order
transmitted to it by the Distributor, provided that such action
does not result in a suspension of sales of Creation Units in contravention of
Rule 6c-11 under the 1940 Act and the SEC’s positions thereunder. For example, a
Fund may reject or revoke acceptance of a creation order including, but not
limited to, when (a) the order is not in proper form; (b) the investor(s), upon
obtaining the shares ordered, would own 80% or more of the currently outstanding
shares of each Fund; (c) the Deposit Securities delivered do not conform to the
Deposit Securities for the applicable date; (d) the acceptance of the Portfolio
Deposit would, in the opinion of counsel, be unlawful; or (e) in the event that
circumstances outside the control of the Trust, the Distributor and the Adviser
make it for all practical purposes impossible to process purchase orders.
Examples of such circumstances include acts of God; public service or utility
problems resulting in telephone, telecopy, or computer failures; fires, floods,
or extreme weather conditions; market conditions or activities causing trading
halts; systems failures involving computer or other informational systems
affecting the Trust, the Distributor, DTC, NSCC, the Adviser, each Fund’s
Custodian, a sub-custodian, or any other participant in the creation process;
and similar extraordinary events. The Distributor shall notify an Authorized
Participant of its rejection of the order. Each Fund, the Custodian, any
sub-custodian, and the Distributor are under no duty, however, to give
notification of any defects or irregularities in the delivery of Portfolio
Deposits, and they shall not incur any liability for the failure to give any
such notification.
Issuance
of a Creation Unit
Once
a Fund has accepted an order, upon next determination of the Fund’s NAV, the
Fund will confirm the issuance of a Creation Unit against
receipt of payment, at such NAV. The Distributor will transmit a confirmation of
acceptance to the Authorized Participant that placed the order.
Except
as provided below, a Creation Unit will not be issued until a Fund obtains good
title to the Deposit Securities, along with any cash-in-lieu
and Transaction Fee. The delivery of Creation Units will generally occur no
later than T+2.
In
certain cases, Authorized Participants will create and redeem Creation Units on
the same trade date. In these instances, the Trust reserves
the right to settle these transactions on a net basis.
With
respect to orders involving foreign Deposit Securities, when a local
sub-custodian has confirmed to the Custodian that the Deposit Securities
(or cash-in-lieu) have been delivered to a Fund’s account with the
sub-custodian, the Fund will issue and deliver the Creation Unit. As stated
above, Creation Units are generally delivered on T+2. However, a Fund may settle
Creation Unit transactions on a basis other than T+2 in order to accommodate
foreign market holiday schedules, to account for different treatment among
foreign and U.S. markets of dividend record dates and ex-dividend dates (that is
the last day the holder of a security can sell the security and still receive
dividends payable on the security), and in certain other
circumstances.
A
Fund may issue a Creation Unit prior to receiving good title to the Deposit
Securities under the following circumstances if, pursuant to the
applicable Participant Agreement, the relevant Authorized Participant provides
an undertaking to deliver the missing Deposit Securities as soon as possible,
which undertaking is secured by such Authorized Participant’s delivery of cash
in U.S. Dollars to the Custodian having a value equal to at least 105% of the
value of the missing Deposit Securities (“Collateral”) as adjusted by time to
time by the Adviser. The Collateral will have a value greater than the NAV of
the Creation Unit on the date the order is placed and must be delivered no later
than 2:00 p.m., Eastern Time, on T+1. The value of the missing Deposit
Securities is marked to market daily and the amount of Collateral is adjusted to
make sure the Collateral value is at least 105% of the marked value. At any
time, a Fund may use the Collateral to purchase the missing Deposit Securities,
and the Authorized Participant will be liable to the Fund for any costs incurred
thereby or losses resulting therefrom, whether or not they exceed the amount of
the Collateral, including any Transaction Fee, any amount by which the purchase
price of the missing Deposit Securities exceeds the market value of such
securities on the
31
Transmittal
Date, brokerage, and other transaction costs. The Trust will return any unused
Collateral once all of the missing Deposit Securities
have been received by a Fund. More information regarding a Fund’s current
procedures for collateralization is available from the Funds.
Cash
Purchase Method
When
cash purchases of Creation Units are available or specified for a Fund, they
will be effected in essentially the same manner as in-kind
purchases. In the case of a cash purchase, the investor must pay the cash
equivalent of the Portfolio Deposit. In addition, cash purchases will be subject
to Transaction Fees, as described above.
The
Funds reserve the right to offer purchases of Creation Units solely in cash if,
on a given Business Day, a Fund announces before the open
of trading that all purchases on that day will be made entirely in cash. A Fund
may also, on a given Business Day, require all Authorized Participants
purchasing Creation Units on that day to deposit cash in lieu of some or all of
the Deposit Securities because: (i) such securities are not eligible for
transfer either through the NSCC or DTC or (ii) in the case of Foreign Funds
holding non-U.S. investments, such securities are not eligible for trading due
to local trading restrictions, local restrictions on securities transfers or
other similar circumstances.
A
Fund also may permit an Authorized Participant to deposit cash in lieu of some
or all of the Deposit Securities because: (i) such securities
are not available in sufficient quantity or (ii) such securities are not
eligible for trading by an Authorized Participant or the investor on whose
behalf the Authorized Participant is acting.
Redeeming
a Creation Unit
Shares
of a Fund may be redeemed only in Creation Units at their NAV next determined
after receipt of a redemption request made in proper
form by the Distributor on any Business Day. A Fund will not redeem shares in
amounts less than Creation Units.
Redemption
Basket
The
consideration received in connection with the redemption of a Creation Unit
generally consists of an in-kind basket of designated securities
(“Redemption Securities”) and an amount of cash in U.S. dollars (“Cash
Component”). Together, the Redemption Securities and the Cash Component
constitute the “Redemption Basket.”
There
can be no assurance that there will be sufficient liquidity in shares in the
secondary market to permit assembly of a Creation Unit. In
addition, investors may incur brokerage and other costs in connection with
assembling a Creation Unit.
The
Cash Component serves the function of compensating for any differences between
the net asset value per Creation Unit and the Redemption
Securities. Thus, the Cash Component is equal to the difference between (x) the
net asset value per Creation Unit of the Fund and (y) the market value of the
Redemption Securities. If (x) is more than (y), the Authorized Participant will
receive the Cash Component from the Fund. If (x) is less than (y), the
Authorized Participant will pay the Cash Component to the Fund.
If
the Redemption Securities on a Business Day are different from the Deposit
Securities, prior to the opening of business on the Exchange
(currently 9:30 a.m., Eastern Time), the Adviser through the Custodian makes
available through NSCC the name and amount of each Redemption Security in the
current Redemption Basket (based on information at the end of the previous
Business Day) for a Fund and the (estimated) Cash Component, effective through
and including the previous Business Day, per Creation Unit. If the Redemption
Securities on a Business Day are different from the Deposit Securities, all
redemption requests that day will be processed outside the Clearing
Process.
The
Redemption Securities may change as rebalancing adjustments and corporate action
events are reflected from time to time by the Adviser in
the Fund’s portfolio. These adjustments will reflect changes known to the
Adviser on the date of announcement to be in effect by the time of delivery of
the Redemption Basket.
The
right of redemption may be suspended or the date of payment postponed: (i) for
any period during which the NYSE is closed (other than
customary weekend and holiday closings); (ii) for any period during which
trading on the NYSE is suspended or restricted; (iii) for any period during
which an emergency exists as a result of which disposal of the shares or
determination of the ETF’s NAV is not reasonably practicable; or (iv) in such
other circumstances as permitted by the SEC, including as described
below.
32
Custom
Redemptions and Cash-in-lieu
A
Fund may, in its sole discretion, permit or require the substitution of an
amount of cash (“cash-in-lieu”) to be added to the Cash Component
to replace any Redemption Security. The Fund may permit or require cash-in-lieu
when, for example, a Redemption Security may not be available in sufficient
quantity for delivery or may not be eligible for transfer through the systems of
DTC or the Clearing Process. Similarly, a Fund may permit or require
cash-in-lieu of Redemption Securities when, for example, the Authorized
Participant or its underlying investor is restricted under U.S. or local
securities law or policies from transacting in one or more Redemption
Securities. Each Fund will comply with the federal securities laws in satisfying
redemptions with Redemption Securities, including that the Redemption Securities
are sold in transactions that would be exempt from registration under the 1933
Act. All redemption requests involving cash-in-lieu are considered to be “Custom
Redemptions.”
Redemption
Requests
To
redeem a Creation Unit, an Authorized Participant must submit an irrevocable
redemption request to the Distributor. An Authorized Participant
will represent to the Fund that it will not attempt to place a redemption order
for the purpose of redeeming any Creation Units, unless it first ascertains or
has reasonable grounds to believe that as of the time of the settlement date:
(i) it, or its customer, as the case may be, will own outright (or have full
legal authority and legal beneficial right to tender) the requisite number of
Fund shares for redemption, and (ii) all of the shares that are in the Creation
Unit to be redeemed have not been loaned or pledged to another party and are not
the subject of a repurchase agreement, securities lending agreement or such
other arrangement that would preclude the delivery of such shares to a Fund on
the settlement date. Each Fund reserves the absolute right, in its sole
discretion, to verify these representations, but will typically require
verification in connection with higher levels of redemption activity and /or
short interest in a Fund. If the Authorized Participant, upon receipt of a
verification request, does not provide sufficient verification of the requested
representations, the redemption request will not be considered to be in proper
form and may be rejected by a Fund.
Timing
of Submission of Redemption Requests
All
orders to redeem shares directly from any Fund must be placed for one or more
Creation Units by the Cut-off Time in order to receive
the NAV calculated on the Transmittal Date.
Intermediary
Deadlines
A
redemption request is deemed received if (i) such order is received by the
Distributor by the Cut-off Time on such day and (ii) all other
procedures set forth in the Participant Agreement are properly followed. Persons
placing or effectuating Custom Redemptions and/or orders involving cash should
be mindful of time deadlines imposed by intermediaries, such as DTC and/or the
Federal Reserve System, which may impact the successful processing of such
orders to ensure that cash and securities are transferred by the Settlement
Date, as defined above.
Requests
Using the Clearing Process
If
available, (portions of) redemption requests may be settled through the Clearing
Process. In connection with such orders, the Distributor
transmits on behalf of the Authorized Participant, such trade instructions as
are necessary to effect the redemption. Pursuant to such trade instructions, the
Authorized Participant agrees to deliver the requisite Creation Unit(s) to a
Fund, together with such additional information as may be required by the
Distributor. Cash Components will be delivered using either the Clearing Process
or the Federal Reserve System, as described above.
Requests
Outside the Clearing Process
If
the Clearing Process is not available for (portions of) an order, Redemption
Baskets will be delivered outside the Clearing Process. Orders
outside the Clearing Process must state that the DTC Participant is not using
the Clearing Process and that the redemption will be effected through DTC. The
Authorized Participant must transfer or cause to be transferred the Creation
Unit(s) of shares being redeemed through the book-entry system of DTC so as to
be delivered through DTC to the Custodian by 10:00 a.m., Eastern Time, on
received T+1. In addition, the Cash Component must be received by the Custodian
by 12:00 p.m., Eastern Time, on T+1. If the Custodian does not receive the
Creation Unit(s) and Cash Component by the appointed times on T+1, the
redemption will be rejected, except in the circumstances described below. A
rejected redemption request may be resubmitted the following Business
Day.
Orders
involving foreign Redemption Securities are expected to be settled outside the
Clearing Process. Thus, upon receipt of an irrevocable
redemption request, the Distributor will notify the Adviser and the Custodian.
The Custodian will then provide information of the redemption to the Fund’s
local sub-custodian(s). The redeeming Authorized Participant, or the investor on
whose behalf is acting, will have established appropriate arrangements with a
broker-dealer, bank or other custody provider in each jurisdiction in which the
Redemption Securities are customarily traded and to which such Redemption
Securities (and any cash-in-lieu) can be delivered from the Fund’s accounts at
the applicable local sub-custodian(s).
33
Acceptance
of Redemption Requests
All
questions as to the number of shares of each security in the Deposit Securities
and the validity, form, eligibility, and acceptance for
deposit of any securities to be delivered shall be determined by the Trust. The
Trust’s determination shall be final and binding.
The
Fund reserves the right to reject a redemption order if the order is not in
proper form. In addition, the right of redemption may be
suspended or the date of payment postponed with respect to the Fund (i) for any
period during which the NYSE is closed (other than customary weekend and holiday
closings), (ii) for any period during which trading on the NYSE is suspended or
restricted, (iii) for any period during which an emergency exists as a result of
which disposal of the shares of the Fund's portfolio securities or determination
of its NAV is not reasonably practicable; or (iv) in such other circumstance as
is permitted by the SEC. The Fund or Distributor will notify the Authorized
Participant of such rejection, but the Fund, Custodian, sub-custodian, and
Distributor shall not be liable for any failure to give such
notification.
Delivery
of Redemption Basket
Once
a Fund has accepted a redemption request, upon next determination of the Fund’s
NAV, the Fund will confirm the issuance of a
Redemption Basket, against receipt of the Creation Unit(s) at such NAV, any
cash-in-lieu and Transaction Fee. A Creation Unit tendered for redemption and
the payment of the Cash Component, any cash-in-lieu and Transaction Fee will be
effected through DTC. The Authorized Participant, or the investor on whose
behalf it is acting, will be recorded on the book-entry system of
DTC.
The
Redemption Basket will generally be delivered to the redeeming Authorized
Participant within T+2. Except under the circumstances
described below; however, a Redemption Basket generally will not be issued until
the Creation Unit(s) are delivered to a Fund, along with the Cash Component, any
cash-in-lieu and Transaction Fee.
In
certain cases, Authorized Participants will create and redeem Creation Units on
the same trade date. In these instances, the Trust reserves
the right to settle these transactions on a net basis.
With
respect to orders involving foreign Redemption Securities, a Fund may settle
Creation Unit transactions on a basis other than T+2 in order
to accommodate foreign market holiday schedules, to account for different
treatment among foreign and U.S. markets of dividend record dates and
ex-dividend dates (that is the last day the holder of a security can sell the
security and still receive dividends payable on the security), and in certain
other circumstances. When a relevant local market is closed due to local market
holidays, the local market settlement process will not commence until the end of
the local holiday period.
Cash
Redemption Method. The Funds
reserve the right to redeem Creation Units solely in cash if, on a given
Business Day, a Fund announces before the open of trading that all redemptions
on that day will be made entirely in cash. A Fund may also on a given Business
Day, requires all Authorized Participants redeeming Creation Units on that day
to receive cash in lieu of some or all of the Deposit Securities because: (i)
such securities are not eligible for transfer either through the NSCC or DTC or
(ii) in the case of a Fund that invests a significant amount of its assets in
foreign securities holding non-U.S. investments, such securities are not
eligible for trading due to local trading restrictions, local restrictions on
securities transfers or other similar circumstances. The Funds may also permit
an Authorized Participant to receive cash in lieu of some or all of the Deposit
Securities because: (i) such securities are not available in sufficient
quantity, (ii) such securities are not eligible for trading by an Authorized
Participant or the investor on whose behalf the Authorized Participant is
acting, or (iii) a holder of shares of a Fund holding non-U.S. investments would
be subject to unfavorable income tax treatment if the holder receives redemption
proceeds in kind. When cash redemptions of Creation Units are available or
specified for a Fund, they will be effected in essentially the same manner as
in-kind redemptions. In the case of a cash redemption, the investor will receive
the cash equivalent of the Redemption Basket minus any Transaction Fees, as
described above.
MANAGEMENT
OF THE TRUST
Board
Leadership Structure
The
Trust is governed by the Board, which is comprised of nine Trustees, eight of
whom are not “interested persons” of the Trust within the
meaning of that term under the 1940 Act (the “Independent Trustees”). The Chair
of the Board is an Independent Trustee, who functions as the lead Trustee. The
Chair serves as liaison between the Board and its Committees, the Adviser and
other service providers. The Chair is actively involved in setting the Board
meeting agenda, and participates on certain Board Committees.
Board
Role in Risk Oversight
In
considering risks related to the Funds, the Board consults and receives reports
from officers of the Funds and personnel of the Adviser,
who are charged with the day-to-day risk oversight function. Matters regularly
reported to the Board or a designated committee include certain risks involving,
among other things, the Funds’ investment portfolios, trading practices,
operational matters, financial and accounting controls, and legal and regulatory
compliance. The Board has delegated to each of the Compliance Committee and
34
Audit
and Risk Oversight Committee certain responsibilities for reviewing reports
relating to compliance and enterprise risk, including operational
risk, liquidity, and personnel. The Board relies on the Investment Committee to
review reports relating to investment risks, that is, risks to the Funds
resulting from pursuing the Funds’ investment strategies (e.g., credit risk and
market risk).
Trustees,
Advisory Trustee, and Officers
The
following tables list the Trustees, the Advisory Trustee, and Officers, their
dates of birth, position with the Trust, length of time served,
principal occupations during the past five years and, where applicable, any
directorships of other investment companies or companies whose securities are
registered under the Securities Exchange Act of 1934, as amended (“1934 Act”),
or who file reports under the 1934 Act. There is no defined term of office and
each Trustee and Advisory Trustee serves until the earlier of his or her
resignation, retirement, removal, death, or the election of a qualified
successor. Each Trustee’s, Advisory Trustee’s, and Officer’s address is c/o
Victory Funds, 4900 Tiedeman Road, 4th Floor, Brooklyn, Ohio 44144.
Independent
Trustees
|
Name
and
Date
of Birth |
Position
Held
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
Number
of Portfolios
in
Fund Complex
Overseen
by Trustee |
Other
Directorships
Held
During
the
Past
5 Years |
|
David
Brooks
Adcock,
Born
October
1951 |
Trustee |
May
2015 |
Consultant
(since 2006) |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
None |
|
Nigel
D.T.
Andrews,
Born
April 1947 |
Trustee |
May
2015 |
Retired |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
Director,
Carlyle
Secured
Lending,
Inc.
(formerly
TCG
BDC
I, Inc.)
(since
2012);
Director,
Carlyle
Credit
Solutions,
Inc.
(formerly
TCG
BDC
II, Inc.)
(since
2017);
Trustee,
Carlyle
Secured
Lending
III
(since
2021) |
|
E.
Lee Beard*,
Born
August
1951 |
Trustee |
May
2015 |
Retired |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
None |
|
Dennis
M.
Bushe,
Born
January
1944 |
Trustee |
July
2016 |
Retired |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
None |
35
|
Name
and
Date
of Birth |
Position
Held
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
Number
of Portfolios
in
Fund Complex
Overseen
by Trustee |
Other
Directorships
Held
During
the
Past
5 Years |
|
John
L. Kelly,
Born
April 1953 |
Chair
and
Trustee |
May
2015 |
Managing
Partner,
Active
Capital
Partners
LLC, a
strategic
consultant
(since
October 2017) |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
Director,
Caledonia
Mining
Corporation
(since
May
2012) |
|
David
L. Meyer,
Born
April 1957 |
Trustee |
May
2015 |
Retired |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
None |
|
Gloria
S.
Nelund,
Born
May 1961 |
Trustee |
July
2016 |
Chair,
CEO, and
Co-Founder
of TriLinc
Global,
LLC, an
investment
firm |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
TriLinc
Global
Impact
Fund,
LLC
(since
2012) |
|
Leigh
A. Wilson,
Born
December
1944 |
Trustee |
May
2015 |
Private
Investor |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
Chair
(since
2013),
Caledonia
Mining
Corporation |
Advisory
Trustee
|
Name
and
Date
of Birth |
Position
Held
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
Number
of Portfolios
in
Fund Complex
Overseen
by Trustee |
Other
Directorships
Held
During
the
Past
5 Years |
|
Timothy
Pettee,
Born
April 1958 |
Advisory
Trustee |
January
2023 |
Chief
Investment
Officer,
Hoya Capital
Real
Estate LLC (since
February
2022); Chief
Investment
Officer, Sun
America
Asset
Management
Corp.
(January
2003-July
2021) |
69
portfolios comprised
of
26 portfolios in the
Trust,
37 portfolios in
Victory
Portfolios, and 6
portfolios
in Victory
Variable
Insurance
Funds |
None |
36
Interested
Trustee
|
Name
and
Date
of Birth |
Position
Held
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
Number
of Portfolios
in
Fund Complex
Overseen
by Trustee |
Other
Directorships
Held
During
the
Past
5 Years |
|
David
C.
Brown**,
Born
May 1972 |
Trustee |
May
2015 |
Chief
Executive Officer
and
Chairman
(2013-present),
Victory
Capital
Management
Inc.; Chief
Executive
Officer and
Chairman
(2013-present),
Victory
Capital
Holdings, Inc.;
Director,
Victory Capital
Services,
Inc. (2013-
present);
Director,
Victory
Capital Transfer
Agency,
Inc. (2019-
present) |
114
portfolios
comprised
of 26
portfolios
in the Trust,
37
portfolios in Victory
Portfolios,
6 portfolios
in
Victory Variable
Insurance
Funds, and 45
portfolios
in Victory
Portfolios
III. |
Trustee,
Victory
Portfolios
III;
Board
Member,
Victory
Capital
Services,
Inc. |
*
The Board
has designated Ms. Beard as its Audit Committee Financial
Expert.
**
Mr. Brown
is an “Interested Person” by reason of his relationship with the
Adviser.
Trustee
and Advisory Trustee Qualifications
The
following summarizes the experience and qualifications of the Trustees and
Advisory Trustee.
• David
Brooks Adcock. Mr.
Adcock served for many years as general counsel to Duke University and Duke
University Health System, where he provided oversight to complex business
transactions such as mergers and acquisitions and dispositions. He has served
for more than 20 years as a public interest arbitrator for, among others, the
New York Stock Exchange, the American Stock Exchange, the National Futures
Association, FINRA, and the American Arbitration Association. The Board believes
that Mr. Adcock’s knowledge of complex business transactions and the securities
industry combined with his previous service on the boards of other mutual funds
qualifies him to serve on the Board.
• Nigel
D.T. Andrews. Mr.
Andrews served for many years as a management consultant for a nationally
recognized consulting company and as a senior executive at GE, including Vice
President of Corporate Business Development, reporting to the Chairman, and as
Executive Vice President of GE Capital. He also served as a Director and member
of the Audit and Risk Committee of Old Mutual plc, a large publicly traded
company whose shares are traded on the London Stock Exchange. Mr. Andrews also
formerly served as the non-executive chairman of Old Mutual’s U.S. asset
management business, where he also served on the audit and risk committee. Mr.
Andrews also served as a Governor of the London Business School. He serves as a
director of Carlyle Secured Lending, Inc. (formerly TCG BDC I, Inc.) and Carlyle
Credit Solutions, Inc., (formerly TCG BDC II, Inc.), and as a Trustee for
Carlyle Secured Lending III, each a business development company. The Board
believes that his experience in these positions, particularly with respect to
oversight of risk and the audit function of public companies, as well as his
previous service on the boards of other mutual funds qualifies him to serve as a
Trustee.
• E.
Lee Beard. Ms.
Beard, a certified public accountant, has served as the president, chief
executive officer and director, and as a chief financial officer, of public,
federally insured depository institutions. As such, Ms. Beard is familiar with
issues relating to audits of financial institutions. The Board believes that Ms.
Beard’s experience as the chief executive officer of a depository institution,
her service on the boards of other mutual funds and her knowledge of audit and
accounting matters qualifies her to serve as a Trustee.
• David
C. Brown. Mr. Brown
serves as the Chairman and Chief Executive Officer (since 2013) of the Adviser
and, as such, is an “interested person” of the Trust. Previously, he served as
Co-Chief Executive Officer (2011 - 2013), and President — Investments and
Operations (2010 - 2011) and Chief Operating Officer (2004 - 2011) of the
Adviser. The Board believes that his position and experience with the Adviser
and his previous experience in the investment management business qualifies him
to serve as a Trustee.
37
• Dennis
M. Bushe. Mr.
Bushe has experience in fixed income investment management and research. He is a
former chief investment risk officer of a large investment management firm. Mr.
Bushe previously served as a Trustee of the boards of the RS Investment Trust
and RS Variable Products Trust. The Board believes that Mr. Bushe’s experience
qualifies him to serve as a Trustee.
• John
L. Kelly. Mr. Kelly
has more than 35 years of experience and leadership roles in the financial
services industry including institutional electronic trading, capital markets,
corporate and investment banking, retail brokerage, private equity, asset/wealth
management, institutional services, mutual funds, and related technology enabled
services. He previously served as an Independent Trustee of Victory Portfolios,
Victory Institutional Funds, and Victory Variable Insurance Funds from 2008 to
2011. The Board believes that this experience qualifies him to serve as a
Trustee.
• David
L. Meyer. For six
years, Mr. Meyer served as chief operating officer, Investment Wealth Management
Division, of Mercantile Bankshares Corp (now PNC Financial Services Corp.) and
has served as an officer or on the boards of other mutual funds for many years.
The Board believes that his experience, particularly as it related to the
operation of registered investment companies, qualifies him to serve as a
Trustee.
• Gloria
S. Nelund. Ms.
Nelund has executive and investment management industry experience, including
service as chief executive officer of two investment advisory firms. Ms. Nelund
also has experience as a co-founder and chief executive officer of an investment
firm. Ms. Nelund previously served as the Chairman and Trustee of the boards of
the RS Investment Trust and RS Variable Products Trust. The Board believes that
this experience qualifies her to serve as a Trustee.
• Timothy
Pettee. Mr.
Pettee served for many years as Chief Investment Officer and Lead Portfolio
Manager (Rules Based Funds) of SunAmerica Asset Management Corp., where he was
responsible for investment oversight, portfolio management, and securities
selection. At SunAmerica, Mr. Pettee also was Chair of the Portfolio Policy and
Brokerage and Soft Dollar Committees, and a member of the Proxy and Executive
Committees. The Board believes that Mr. Pettee's experience with other mutual
funds and his knowledge qualifies him to serve as an Advisory
Trustee.
• Leigh
A. Wilson. Mr.
Wilson was Chair of the Victory Funds through 2021. He served for many years as
Chief Executive Officer of Paribas North America and as such has extensive
experience in the financial sector. He serves as an Independent Non-Executive
Director and Chairman of the Board of Caledonia Mining Corporation, a Canadian
mining company listed on the Toronto Stock Exchange. As a former director of the
Mutual Fund Directors Forum (“MFDF”), he is familiar with the operation and
regulation of registered investment companies. He served on a MFDF steering
committee created at the request of then-SEC Chairman William Donaldson to
recommend best practices to independent mutual fund directors. He received the
Small Fund Trustee of the Year award from Institutional Investor Magazine in
2006. The Board believes that this experience and his previous service on the
boards of other mutual funds qualifies him to serve as a Trustee.
Committees
of the Board
The
following standing Committees of the Board are currently in operation: Audit and
Risk Oversight, Compliance, Continuing Education,
Investment, Service Provider, Board Governance and Nominating, and Agenda. In
addition to these standing Committees, the Board may form temporary Sub- or
Special Committees to address particular areas of concern. A Committee may form
a Sub-Committee to address particular areas of concern to that
Committee.
• The
members of the Audit and Risk Oversight Committee, all of whom are Independent
Trustees, are Ms. Beard (Chair), Mr. Andrews, Mr. Kelly, Ms. Nelund, and Mr.
Wilson. The primary purpose of this Committee is to oversee the Trust’s
accounting and financial reporting policies, practices, and internal controls,
as required by the statutes and regulations administered by the SEC, including
the 1940 Act. The Committee also has overall responsibility for reviewing
periodic reports with respect to compliance and enterprise risk, including
operational risk and personnel. The Board has designated Mr. Meyer and Ms. Beard
as its Audit Committee Financial Experts.
• The
members of the Compliance Committee are Mr. Adcock (Chair), Mr. Andrews, Ms.
Beard, Mr. Kelly, Ms. Nelund, and Mr. Wilson. The Compliance Committee oversees
matters related to the Funds’ compliance program and compliance with applicable
laws, rules and regulations and meets regularly with the Trust’s Chief
Compliance Officer.
• The
members of the Continuing Education Committee are Mr. Meyer (Chair), Mr. Adcock,
Mr. Andrews, Ms. Beard, Mr. Bushe, Mr. Kelly, and Ms. Nelund. The function of
this Committee is to develop programs to educate the Trustees to enhance their
effectiveness as a Board and individually.
• The
members of the Investment Committee are Mr. Bushe (Chair), Mr. Adcock, Mr.
Kelly, and Mr. Meyer. The function of this Committee is to oversee the Fund’s
compliance with investment objectives, policies, and restrictions, including
those imposed by law or regulation, and assist the Board in its annual review of
the Funds’ investment advisory agreements.
38
• The
members of the Service Provider Committee are Ms. Nelund (Chair), Mr. Andrews,
Ms. Beard, Mr. Kelly, and Mr. Wilson. This Committee oversees the negotiation of
the terms of the written agreements with the Funds’ service providers, evaluates
the quality of periodic reports from the service providers (including reports
submitted by sub-service providers) and assists the Board in its review of each
Fund’s service providers, other than the investment adviser and independent
auditors.
• The Board
Governance and Nominating Committee consists of all of the Independent Trustees.
Mr. Andrews currently serves as the Chair of this Committee. The functions of
this Committee are: to oversee Fund governance, including the nomination and
selection of Trustees; to evaluate and recommend to the Board the compensation
and expense reimbursement policies applicable to Trustees; and periodically, to
coordinate and facilitate an evaluation of the performance of the
Board.
• The Board
Governance and Nominating Committee will consider nominee recommendations from
Fund shareholders, in accordance with procedures established by the Committee. A
Fund shareholder should submit a nominee recommendation in writing to the
attention of the Chair of the Trust, 4900 Tiedeman Road, Brooklyn, Ohio 44144.
The Committee (or a designated sub-committee) will screen shareholder
recommendations in the same manner as it screens nominations received from other
sources, such as current Trustees, management of the Fund or other individuals,
including professional recruiters. The Committee need not consider any
recommendations when no vacancy on the Board exists, but the Committee will
consider any such recommendation if a vacancy occurs within six months after
receipt of the recommendation. In administering the shareholder recommendation
process, the Chair, in the Chair’s sole discretion, may retain the services of
counsel to the Trust or to the Independent Trustees, management of the Fund or
any third party. The Committee will communicate the results of the evaluation of
any shareholder recommendation to the shareholder who made the
recommendation.
• The
Agenda Committee consists of the Chair of the Board and the Chair of each other
Committee.
During
the fiscal year ended June 30, 2023, the Board held eight meetings. The Audit
and Risk Oversight Committee held four meetings;
the Compliance Committee held four meetings; the Investment Committee held four
meetings; the Service Provider Committee held four meetings; and the Board
Governance and Nominating Committee held four meetings. The Continuing Education
Committee met informally during the fiscal year.
Officers
of the Trust
The
officers of the Trust are elected by the Board to actively supervise the Trust’s
day-to-day operations. The officers of the Trust, their dates of
birth, the length of time served, and their principal occupations during the
past five years, are detailed in the following table. Each individual holds the
same position with the other registered investment companies in the Victory Fund
Complex, and each officer serves until the earlier of his or her resignation,
removal, retirement, death, or the election of a successor. The mailing address
of each officer of the Trust is 4900 Tiedeman Road, Brooklyn, Ohio 44144. The
officers of the Trust receive no compensation directly from the Trust for
performing the duties of their offices.
|
Name
and
Date
of Birth |
Position
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
|
James
K. De Vries
Born
April 1969 |
President |
May
2023 |
Head
of Fund Administration (5/1/23-present);Vice
President,
Victory Capital Transfer Agency, Inc.
(4/20/23-present);
Executive Director, the Adviser
(7/1/19-4/30/23
present); Executive Director, Investment
and
Financial Administration, USAA (2012-6/30/19);
Treasurer,
USAA Mutual Funds Trust (2018-4/30/23).
Mr.
De Vries also serves as the Principal Executive
Officer
for the Funds, Victory Portfolios, Victory
Portfolios
III, and Victory Variable Insurance Funds. |
|
Scott
A. Stahorsky,
Born
July 1969 |
Vice
President |
May
2015 |
Director,
Third-Party Dealer Services & Reg
Administration,
Fund Administration, the Adviser
(5/1/2023-present);
Vice President, Victory Capital
Transfer
Agency, Inc. (4/20/23-present); Manager, Fund
Administration,
the Adviser (4/30/23- 2015). Mr.
Stahorsky
also serves as Vice President of Victory
Portfolios,
Victory Portfolios III, and Victory Variable
Insurance
Funds. |
39
|
Name
and
Date
of Birth |
Position
with
the
Trust |
Date
Commenced
Service |
Principal
Occupation
During
Past 5 Years |
|
Thomas
Dusenberry,
Born
July 1977 |
Secretary |
May
2022 |
Director,
Fund Administration, the Adviser; Treasurer
and
Principal Financial Officer (May 2023-present);
Manager,
Fund Administration, the Adviser; Treasurer
and
Principal Financial Officer (2020-2022), Assistant
Treasurer
(2019), Salient MF Trust, Salient Midstream,
MLP
Fund and Forward Funds; Principal Financial
Officer
(2018-2021) and Treasurer (2020-2021), Salient
Private
Access Funds and Endowment PMF Funds;
Senior
Vice President of Fund Accounting and
Operations,
Salient Partners (2020-2022); Director of
Fund
Operations, Salient Partners (2016-2019). Mr.
Dusenberry
also serves as Secretary of Victory
Portfolios,
Victory Portfolios III, and Victory Variable
Insurance
Funds. |
|
Allan
Shaer,
Born
March 1965 |
Treasurer |
December
2017 |
Senior
Vice President, Financial Administration, Citi
Fund
Services Ohio, Inc. (since 2016); Vice President,
Mutual
Fund Administration, JP Morgan Chase
(2011-2016).
Mr. Shaer also serves as Treasurer of
Victory
Portfolios, Victory Portfolios III, and Victory
Variable
Insurance Funds. |
|
Christopher
Ponte,
Born
March 1984 |
Assistant
Treasurer |
May
2015 |
Director,
Fund and Broker Dealer Finance, Fund
Administration,
(5/1/23-present); Victory Capital
Transfer
Agency, Inc. (May 2023-present); Manager,
Fund
Administration, the Adviser (2017-2023); Chief
Financial
Officer, Victory Capital Services, Inc. (since
2018).
Mr. Ponte also serves as Assistant Treasurer of
Victory
Portfolios, Victory Portfolios III, and Victory
Variable
Insurance Funds. |
|
Carol
D. Trevino
Born
October 1965 |
Assistant
Treasurer |
February
2023 |
Director,
Financial Reporting, Fund Administration
(5/1/23-present);
Director, Accounting and Finance, the
Adviser
(7/1/19-4/30/23); Accounting/ Financial
Director,
USAA (12/13-6/30/19). Ms. Trevino also
serves
as Assistant Treasurer of Victory Portfolios,
Victory
Portfolios III, and Victory Variable Insurance
Funds. |
|
Sean
Fox,
Born
September
1976 |
Chief
Compliance
Officer |
June
2022 |
Sr.
Compliance Officer, the Adviser (2019-Present);
Compliance
Officer, the Adviser (2015-2019). Mr. Fox
also
serves as Chief Compliance Officer for Victory
Portfolios,
Victory Portfolios III, and Victory Variable
Insurance
Funds. |
|
Michael
Bryan,
Born
December
1962 |
Anti-Money
Laundering
Compliance
Officer
and
Identity
Theft
Officer |
May
2023 |
Vice
President, CCO Compliance Support Services, Citi
Fund
Services Ohio, Inc. (2008-present). Mr. Bryan
also
serves as the Anti-Money Laundering Compliance
Officer
and Identity Theft Officer for Victory
Portfolios,
Victory Portfolios III, and Victory Variable
Insurance
Funds. |
|
Jay
G. Baris,
Born
January 1954 |
Assistant
Secretary |
May
2015 |
Partner,
Sidley Austin LLP (since 2020); Partner,
Shearman
& Sterling LLP
(2018-2020). |
Fund
Ownership
The
following tables show the dollar ranges of Fund shares (and of shares of all
series of the Victory Fund Complex) beneficially owned by each
Trustee and Advisory Trustee as of December 31, 2022. No Independent Trustee or
Advisory Trustee (or any immediate family member) owns beneficially or of record
an interest in the Adviser or the Distributor or in any person directly or
indirectly controlling, controlled by, or under common control with the Adviser
or the Distributor (other than Funds in the Victory Funds Complex). As of
December 31, 2022, the Trustees, Advisory Trustee, and officers as a group owned
beneficially less than 1% of each class of outstanding shares of those series of
the Trust. No information is provided for the Advisory Trustee, Timothy Pettee,
because he was not appointed an Advisory Trustee until January 1,
2023.
40
Independent
Trustees
|
Trustee |
Dollar
Range of Beneficial
Ownership
of Fund Shares |
Aggregate
Dollar
Range
of Ownership
of
Shares of
All
Series of the
Victory
Fund Complex |
|
Mr.
Adcock |
None |
Over
$100,000 |
|
Mr.
Andrews |
None |
Over
$100,000 |
|
Ms.
Beard |
None |
Over
$100,000 |
|
Mr.
Bushe |
None |
Over
$100,000 |
|
Mr.
Kelly |
None |
Over
$100,000 |
|
Mr.
Meyer |
None |
Over
$100,000 |
|
Ms.
Nelund |
None |
Over
$100,000 |
|
Mr.
Wilson |
None |
None |
Advisory
Trustee
|
Trustee |
Dollar
Range of Beneficial
Ownership
of Fund Shares |
Aggregate
Dollar
Range
of Ownership
of
Shares of
All
Series of the
Victory
Fund Complex |
|
Mr.
Pettee |
None |
None |
Interested
Trustee
|
Trustee |
Dollar
Range of Beneficial
Ownership
of Fund Shares |
Aggregate
Dollar
Range
of Ownership
of
Shares of
All
Series of the
Victory
Fund Complex |
|
Mr.
Brown* |
None |
Over
$100,000 |
* Mr. Brown
is an “Interested Person” by reason of his relationship with the
Adviser.
Compensation
The
Victory Fund Complex pays each Independent Trustee and Advisory Trustee $344,000
per year for his or her services to the Complex.
The Board Chair is paid an additional retainer of $150,000 per year. While the
Board reserves the right to award reasonable compensation to any Interested
Trustee, as of the date of this SAI no Interested Trustee receives compensation
for services as a Trustee.
The
following tables indicate the compensation received by each Trustee and Advisory
Trustee from the Funds covered in this SAI and from the
Victory Fund Complex for the fiscal year ended June 30, 2023. As of June 30,
2023, there were 69 funds in the Victory Fund Complex for which the Trustees or
Advisory Trustee listed below were compensated. The Trust does not maintain a
retirement plan for its Trustees or Advisory Trustee.
Independent
Trustees
|
Trustee |
Aggregate
Compensation
from
the Funds |
Total
Compensation from the
Victory
Fund Complex |
|
Mr.
Adcock |
$2,157 |
$344,000 |
|
Mr.
Andrews* |
$2,157 |
$344,000 |
|
Ms.
Beard |
$2,157 |
$344,000 |
|
Mr.
Bushe |
$2,157 |
$344,000 |
|
Mr.
Kelly |
$3,097 |
$494,000 |
|
Mr.
Meyer |
$2,157 |
$344,000 |
|
Ms.
Nelund |
$2,157 |
$344,000 |
|
Mr.
Wilson |
$2,157 |
$344,000 |
41
* Mr.
Andrews no longer elects to receive a portion of his compensation as deferred
compensation. As of June 30, 2023, the value of Mr. Andrews' deferred
compensation account was $575,153.02.
Advisory
Trustee
|
Trustee |
Aggregate
Compensation
from
the Funds |
Total
Compensation from the
Victory
Fund Complex |
|
Mr.
Pettee* |
$1,072 |
$172,000 |
* Appointed
effective January 2023.
Interested
Trustee
|
Trustee |
Aggregate
Compensation
from
the Funds |
Total
Compensation from the
Victory
Fund Complex |
|
Mr.
Brown* |
None |
None |
*
Mr. Brown
is an “Interested Person” by reason of his relationship with the
Adviser.
Deferred
Compensation
Each
Trustee may elect to defer a portion of his or her compensation from the Victory
Fund Complex in accordance with a Deferred Compensation
Plan adopted by the Board (the “Plan”). Such amounts are invested in one or more
Funds in the Victory Fund Complex offered under the Plan or a money market fund,
as selected by the Trustee.
As
of the most recent fiscal year ended June 30, 2023, the following current
Trustees have elected to defer a portion of his or her compensation
from the Victory Fund Complex.
|
Trustee |
Aggregate
Compensation
from
the Funds |
Total
Compensation from the
Victory
Fund Complex |
|
Mr.
Adcock* |
$323 |
$51,600 |
|
Ms.
Beard** |
$291 |
$46,440 |
|
Mr.
Bushe*** |
$1,078 |
$172,000 |
* As
of June 30, 2023, the value of Mr. Adcock's deferred compensation account
was $259,115.
** As of June 30, 2023, the value of Ms. Beard’s deferred compensation account was $65,015.
*** As of June 30, 2023, the value of Mr. Busche's deferred compensation account was $1,583,968.
** As of June 30, 2023, the value of Ms. Beard’s deferred compensation account was $65,015.
*** As of June 30, 2023, the value of Mr. Busche's deferred compensation account was $1,583,968.
.
CONTROL
PERSONS AND PRINCIPAL SHAREHOLDERS
As
of September 30, 2023, the following shareholders owned 5% or more of the
indicated Funds. Each shareholder that beneficially owns more
than 25% of the voting securities of a class of a Fund may be deemed a control
person of the Fund’s outstanding shares and, thereby, may influence the outcome
of matters on which shareholders are entitled to vote. Since the economic
benefit of investing in a Fund and related voting authority is passed through to
the underlying investors of the record owners, it is expected that these record
owners generally will not be considered the beneficial owners of the Fund’s
shares or control persons of the Fund.
The
names and addresses of the record holders and the percentage of the outstanding
shares held by such holders are set forth in the following
table.
|
Fund
- Class |
Name
and Address of Owner |
Percentage
Owned
of
Record |
|
VictoryShares
Core Plus Intermediate Bond ETF |
CITIBANK,
NATIONAL ASSOCIATION
399
Park Avenue
New
York NY 10022 |
94.60% |
|
VictoryShares
Corporate Bond ETF |
CITIBANK,
NATIONAL ASSOCIATION
399
Park Avenue
New
York NY 10022 |
99.70% |
42
|
Fund
- Class |
Name
and Address of Owner |
Percentage
Owned
of
Record |
|
VictoryShares
THB Mid Cap ESG ETF |
MERRILL
LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
4800
E Deer Lake Drive
Jacksonville
FL 32246 |
82.60% |
|
|
TD
AMERITRADE CLEARING, INC.
200
South 108th Avenue
Omaha
NE 68154 |
23.90% |
|
|
CHARLES
SCHWAB & CO., INC.
101
Montgomery Street
San
Franciso CA 94101 |
9.70% |
INVESTMENT
ADVISER AND OTHER SERVICE PROVIDERS
Investment
Adviser
Victory
Capital, a New York corporation registered as an investment adviser with the
SEC, serves as investment adviser to the Funds. Victory
Capital’s principal business address is 15935 La Cantera Parkway, San Antonio,
TX 78256. Subject to the authority of the Board, the Adviser is responsible for
the overall management and administration of the Funds’ business affairs. Each
of the Adviser’s multiple investment teams, referred to separately as investment
franchises utilizes its own independent approach to investing. The Adviser is
responsible for selecting each Fund’s investments according to its investment
objective, policies, and restrictions. The Adviser is an indirect wholly owned
subsidiary of Victory Capital Holdings, Inc. (“VCH”), a publicly traded Delaware
corporation. As of September 30, 2023, the Adviser managed assets totaling in
excess of $153.5 billion for numerous clients including large corporate and
public retirement plans, Taft-Hartley plans, foundations and endowments, high
net worth individuals and mutual funds.
The
Adviser is a diversified global asset manager comprised of multiple investment
teams, referred to as investment franchises, each of which
utilizes an independent approach to investing.
The
Advisory Agreement
The
Adviser serves as the Funds’ investment adviser pursuant to an advisory
agreement dated as of May 1, 2015 (the “Advisory Agreement”).
Unless sooner terminated, the Advisory Agreement between the Adviser and the
Trust, on behalf of the Funds, provides that it will continue in effect as to
the Funds for two years and for consecutive one-year terms thereafter, provided
that such renewal is approved at least annually by the Trustees or by vote of
the majority of the outstanding shares of each such Fund (as defined under
“Miscellaneous” below) and, in either case, by a majority of the Trustees who
are not parties to the Advisory Agreement or “interested persons” (as defined in
the 1940 Act) of any party to the Advisory Agreement, by votes cast in person at
a meeting called for such purpose. The Advisory Agreement is terminable as to
any particular Fund at any time on 60 days’ written notice without penalty by a
vote of the majority of the outstanding shares of a Fund, by vote of the
Trustees, or as to all applicable Funds by the Adviser. The Advisory Agreement
also terminates automatically in the event of any assignment, as defined by the
1940 Act.
The
Advisory Agreement provides that the Adviser shall not be liable for any error
of judgment or mistake of law or for any loss suffered
by the Funds in connection with the performance of the services pursuant
thereto, except a loss resulting from a breach of fiduciary duty with respect to
the receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith, gross negligence on the part of the Adviser in the
performance of its duties, or from reckless disregard by the Adviser of its
duties and obligations thereunder.
Under
the Advisory Agreement, the Adviser may delegate a portion of its
responsibilities to a sub-adviser. In addition, the agreements provide
that the Adviser may render services through its own employees or the employees
of one or more affiliated companies that are qualified to act as an investment
adviser of the Fund provided all such persons are functioning as part of an
organized group of persons, managed by authorized officers of the
Adviser.
The
following schedule lists the advisory fees for each Fund, as an annual
percentage of its average daily net assets.
|
Fund |
Advisory
Fee |
|
VictoryShares
Core Plus Intermediate Bond ETF |
0.35% |
|
VictoryShares
Corporate Bond ETF |
0.35% |
|
VictoryShares
THB Mid Cap ESG ETF |
0.50% |
43
Advisory
fees paid by the Funds to the Adviser for the fiscal year ended June 30, 2023,
and the fiscal period ended June 30, 2022, are shown in
the table below. The Funds commenced investment operations on October 5,
2021.
|
Fund |
2023 |
2022 |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$749,057 |
$493,664 |
|
VictoryShares
Corporate Bond ETF |
$363,930 |
$274,535 |
|
VictoryShares
THB Mid Cap ESG ETF |
$11,263 |
$8,872 |
Management
Fee Waiver/Expense Reimbursement
The
Adviser has contractually agreed to waive its management fee and/or reimburse
Fund expenses so that the total annual operating expenses
(excluding any acquired fund fees and expenses and certain other items such as
interest, taxes, dividend and interest expenses on short sales and brokerage
commissions) of a Fund (by share class) do not exceed a certain percentage for a
predetermined amount of time. In these instances, the fee and expense table in
the Fund’s Prospectus provides more details about this arrangement and shows the
impact it will have on the Fund’s total annual fund operating expenses. Under
its contractual agreement with the Funds, the Adviser is permitted to recoup
advisory fees waived and expenses reimbursed for up to three years after the
date of the waiver or reimbursement, subject to the lesser of any operating
expense limits in effect at the time of: (a) the original waiver or expense
reimbursement; or (b) the recoupment, after giving effect to the recoupment
amount. This agreement may only be terminated by the Board. From time to time,
the Adviser may also voluntarily waive its management fee and/or reimburse
expenses for a Fund. These voluntary reductions are not reflected in the fee and
expense table in the Fund’s Prospectus.
From
time to time, the Manager may, without prior notice to shareholders, waive all
or any portion of fees or agree to reimburse expenses
incurred by a Fund. As a result of the Funds’ expense limitation agreement, for
the fiscal year ended June 30, 2023, and the fiscal period ended June 30, 2022,
Victory Capital waived its management fee and/or reimbursed the Funds the amount
listed in the table below. The Funds commenced investment operations on October
5, 2021.
|
Fund |
2023 |
2022 |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$107,433 |
$138,029 |
|
VictoryShares
Corporate Bond ETF |
$60,286 |
$103,382 |
|
VictoryShares
THB Mid Cap ESG ETF |
$42,025 |
$34,457 |
Compliance
Services
The
Trust and the Adviser are parties to the Agreement to Provide Compliance
Services (the “Compliance Agreement”) pursuant to which the
Adviser furnishes its compliance personnel, including the services of the CCO,
and other resources reasonably necessary to provide the Trust with compliance
oversight services related to the design, administration, and oversight of a
compliance program for the Trust in accordance with Rule 38a-1 under 1940 Act.
The funds in the Victory Fund Complex, in the aggregate, compensate the Adviser
for these services.
For
the fiscal year ended June 30, 2023, and the fiscal period ended June 30, 2022,
the Funds paid the Adviser the following fees under the terms
of the Compliance Agreement. The Funds commenced investment operations on
October 5, 2021.
|
Fund |
2023 |
2022 |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$1,931 |
$875 |
|
VictoryShares
Corporate Bond ETF |
$938 |
$497 |
|
VictoryShares
THB Mid Cap ESG ETF |
$20 |
$11 |
Administrator
and Fund Accountant
Victory
Capital serves as the administrator and fund accountant to the Trust pursuant to
an agreement dated July 1, 2006, as amended (the
“Administration and Fund Accounting Agreement”). Citi Fund Services Ohio, Inc.
(“Citi”) serves as sub-administrator and sub-fund accountant to the Trust
pursuant to an agreement with Victory Capital dated October 1, 2015, as amended
(the “Sub-Administration and Sub-Fund Accounting Agreement”). As administrator,
Victory Capital supervises the Trust’s operations, including the services that
Citi provides to the Funds as sub-administrator and sub-fund accountant, but
excluding those that Victory Capital supervises as investment adviser, subject
to the supervision of the Board.
Under
the Administration and Fund Accounting Agreement, for the administration and
fund accounting services that Victory Capital renders to
the Funds, the Trust, Victory Portfolios ("VP") and Victory Variable Insurance
Funds (“VVIF”) pay Victory Capital an annual fee, accrued daily and paid
monthly, at the following annual rates based on the aggregate average daily net
assets of the Trust, VP and VVIF: 0.08% of the first $15 billion in aggregate
Trust, VP and VVIF net assets, plus 0.05% of aggregate Trust, VP and VVIF net
assets in excess of $15 billion to $30 billion, plus 0.04% of aggregate Trust,
VP and VVIF net assets in excess of $30 billion. Victory Capital
44
may
periodically waive all or a portion of the amount of its fee that is allocated
to any Fund in order to increase the Fund’s net income available
for distribution to shareholders. In addition, the Trust, VP and VVIF reimburse
Victory Capital for all of its reasonable out-of-pocket expenses incurred as a
result of providing the services under the Administration and Fund Accounting
Agreement, including costs associated with implementing new reports required by
the new RIC Modernization rules adopted by the SEC under the 1940
Act.
Except
as otherwise provided in the Administration and Fund Accounting Agreement,
Victory Capital pays all expenses that it incurs in
performing its services and duties as administrator. Unless sooner terminated,
the Administration and Fund Accounting Agreement continues in effect for a
period of three years and for consecutive one-year terms thereafter, provided
that such continuance is approved by the Board or by vote of a majority of the
outstanding shares of each Fund and, in either case, by a majority of the
Independent Trustees. The Administration and Fund Accounting Agreement provides
that Victory Capital shall not be liable for any error of judgment or mistake of
law or any loss suffered by the Trust in connection with the matters to which
the Agreement relates, except a loss resulting from bad faith, willful
misfeasance, negligence or reckless disregard of its obligations and duties
under the Agreement.
Under
the Administration and Fund Accounting Agreement, Victory Capital, among other
things, coordinates the preparation, filing and distribution
of amendments to the Trust’s registration statement on Form N-1A, supplements to
prospectuses and SAIs, and proxy materials in connection with shareholder
meetings; drafts shareholder communications, including annual and semi-annual
reports; administers the Trust’s other service provider contracts; monitors
compliance with investment restrictions imposed by the 1940 Act, each Fund’s
investment objective, defined investment policies, and restrictions, tax
diversification, and distribution and income requirements; coordinates the
Funds’ service arrangements with financial institutions that make the Funds’
shares available to their customers; assists with regulatory compliance;
supplies individuals to serve as Trust officers; prepares Board meeting
materials; and annually determines whether the services that it provides (or the
services that Citi provides as sub-administrator) are adequate and
complete.
Victory
Capital also performs fund accounting services for each Fund, excluding those
services that Citi performs as sub-fund accountant.
The fund accountant calculates each Fund’s NAV, its dividend and capital gain
distribution, if any, and its yield. The fund accountant also provides a current
security position report, a summary report of transactions and pending
maturities, a current cash position report, and maintains the general ledger
accounting records for the Funds. The fees that Citi receives for
sub-administration and sub-fund accounting services are described in the SAI
section entitled “Sub-Administrator and Sub-Fund Accountant.”
For
the fiscal year ended June 30, 2023, and the fiscal period ended June 30, 2022,
the Funds accrued the following amounts in administrative,
fund accountant fees. The Funds commenced investment operations on October 5,
2021.
|
Fund |
2023
Fees
Paid |
2022
Fees
Paid |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$117,848 |
$76,218 |
|
VictoryShares
Corporate Bond ETF |
$57,258 |
$42,396 |
|
VictoryShares
THB Mid Cap ESG ETF |
$1,241 |
$959 |
Sub-Administrator
and Sub-Fund Accountant
Citi
serves as sub-administrator and sub-fund accountant to the Funds pursuant to the
Sub-Administration and Sub-Fund Accounting Agreement
dated October 1, 2015, as amended, by and between Victory Capital and Citi (the
"Sub-Administration and Sub-Fund Accounting Agreement.”) Citi assists in
supervising all operations of the Funds (other than those performed by Victory
Capital either as investment adviser or administrator), subject to the
supervision of the Board.
Unless
sooner terminated, the Sub-Administration and Sub-Fund Accounting Agreement
continues in effect as to each Fund for a period of three
years and for consecutive one-year terms thereafter. The Sub-Administration and
Sub-Fund Accounting Agreement provides that Citi shall not be liable for any
error of judgment or mistake of law or any loss suffered by the Trust in
connection with the matters to which the Agreement relates, except a loss
resulting from bad faith, willful misfeasance, negligence, or reckless disregard
of its obligations and duties under the Agreement.
Under
the Sub-Administration and Sub-Fund Accounting Agreement, Citi calculates Trust
expenses and make disbursements; calculates
capital gain and distribution information; registers the Funds’ shares with the
states; prepares shareholder reports and reports to the SEC on Forms N-CEN and
N-PORT; coordinates dividend payments; calculates the Funds’ performance
information; files the Trust’s tax returns; supplies individuals to serve as
Trust officers; monitors the Funds’ status as regulated investment companies
under the Code; assists in developing portfolio compliance procedures; reports
to the Board amounts paid under shareholder service agreements; assists with
regulatory compliance; obtains, maintains and files fidelity bonds and trustees’
and officers’/errors and omissions insurance policies for the Trust; assists
with liquidity and derivatives risk management services; and assists in the
annual audit of the Funds, among other services.
45
Transfer
Agent
Citibank,
N.A. (“Citibank” or the “Custodian”), 388 Greenwich St., New York, New York
10013, serves as transfer agent for the Funds pursuant
to a Transfer Agency Services Agreement. Under its agreement with the Funds,
Citibank has agreed, among other things, to (1) perform and facilitate the
performance of purchases and redemptions of Creation Units by Authorized
Participants; (2) record and calculate the number of outstanding Fund shares;
(3) maintain shareholder accounts; (4) perform duties relating to anti-money
laundering and identity theft prevention; and (5) make periodic reports to the
Board and regulators regarding its operations.
Custodian
General. Citibank,
388 Greenwich St., New York, New York 10013, ("Citibank" or the "Custodian")
serves as the custodian of the assets of each Fund pursuant to the Global
Custodial Services Agreement dated August 5, 2008, as amended (the “Custody
Agreement”). The Custodian’s responsibilities include safeguarding and
controlling each Fund’s cash and securities, handling the receipt and delivery
of securities, and collecting interest and dividends on the Fund’s investments.
Pursuant to the Custody Agreement, the Custodian also maintains original entry
documents and books of record and general ledgers; posts cash receipts and
disbursements; and records purchases and sales based upon communications from
the Adviser. The Custodian may, with the approval of a Fund and at its own
expense, open and maintain a sub-custody account or accounts on behalf of a
Fund, provided that it shall remain liable for the performance of all of its
duties under the Custody Agreement.
Foreign
Custody. Rule
17f-5 under the 1940 Act, which governs the custody of investment company assets
outside the United States, allows a mutual fund’s board of directors to delegate
to a “Foreign Custody Manager” the selection and monitoring of foreign
sub-custodian arrangements for the Trust’s assets. Accordingly, the Board
delegated these responsibilities to the Custodian pursuant to the Custody
Agreement. As Foreign Custody Manager, the Custodian must (a) determine that the
assets of the Funds held by a foreign sub-custodian will be subject to
reasonable care, based on the standards applicable to custodians in the relevant
market; (b) determine that the Trust’s foreign custody arrangements are governed
by written contracts in compliance with Rule 17f-5 (or, in the case of a
compulsory depository, by such a contract and/or established practices or
procedures); and (c) monitor the appropriateness of these arrangements and any
material change in the relevant contract, practices or procedures. In
determining appropriateness, the Custodian will not evaluate a particular
country’s investment risks, such as (a) the use of compulsory depositories, (b)
such country’s financial infrastructure, (c) such country’s prevailing custody
and settlement practices, (d) nationalization, expropriation or other
governmental actions, (e) regulation of the banking or securities industry, (f)
currency controls, restrictions, devaluations or fluctuations, and (g) market
conditions that affect the orderly execution of securities transactions or
affect the value of securities. The Custodian will provide to the Board
quarterly written reports regarding the Trust’s foreign custody
arrangements.
Line
of Credit. Each
Fund, along with other funds managed by the Adviser, participates in a 364-day
committed credit facility and a 364-day uncommitted, demand credit facility with
Citibank. Each such credit facility may be renewed if so agreed by the parties.
Under the current agreement with Citibank, the Funds may borrow up to $600
million, of which $300 million is committed and $300 million is uncommitted. Of
this amount, $40 million of the committed line of credit and $60 million of the
uncommitted line of credit are reserved for use by the Victory Floating Rate
Fund (a series of Victory Portfolios), with that Fund paying the related
commitment fees for that amount. The purpose of each agreement is to meet
temporary or emergency cash needs. For the committed credit facility, Citibank
received an annual commitment fee of 0.15%. Each Fund pays a pro-rata portion
(adjusted for the amount of credit reserved for the Victory Floating Rate Fund)
of these fees and pays the interest on any amount that it borrows. Each Fund
paid a pro-rata portion of the renewal fee.
Securities
Lending
The
Funds, through a Securities Lending Agreement with Citibank, N.A. (“Citibank”),
may lend its securities to qualified financial institutions,
such as certain broker-dealers and banks, to earn additional income, net of
income retained by Citibank. Borrowers are required to initially secure their
loans for collateral in the amount of at least 102% of the value of U.S.
securities loaned or at least 105% of the value of non-U.S. securities loaned,
marked-to-market daily. Any collateral shortfalls associated with increases in
the valuation of the securities loaned generally are cured the next business
day. The collateral can be received in the form of cash collateral and/or
non-cash collateral. Non-cash collateral can include U.S. government securities
and other securities as permitted by SEC guidelines. The cash collateral is
invested in short-term instruments or cash equivalents, primarily open-end
investment companies. The Funds effectively do not have control of the non-cash
collateral. Collateral requirements are determined daily based on the value of a
Fund’s securities on loan as of the end of the prior business day. During the
time portfolio securities are on loan, the borrower will pay the Fund any
dividends or interest paid on such securities plus any fee negotiated between
the parties to the lending agreement. A Fund also earns a return from the
collateral. A Fund pays Citibank various fees in connection with the investment
of cash collateral and fees based on the investment income received from
securities lending activities. Loans are terminable upon demand and the borrower
must return the loaned securities within the lesser of one standard settlement
period or five business days. Although risk is mitigated by the collateral, a
Fund could experience a delay in recovering its securities and possible loss of
income or value if the borrower fails to return
46
them.
In addition, there is a risk that the value of the short-term investments will
be less than the amount of cash collateral required to be
returned to the borrower.
The
Funds’ agreement with Citibank does not include master netting provisions.
Non-cash collateral received by a Fund may not be sold or
repledged, except to satisfy borrower default.
The Funds
did not participate in Securities Lending during the fiscal year ended June 30
last completed fiscal year.
Distributor
Foreside
Fund Services, LLC serves as the distributor of Creation Units (the
“Distributor”) for the Funds on an agency basis. Under the ETF
Distribution Agreement most recently entered into as of December 6, 2022, as may
be amended (“Distribution Agreement”), the Distributor receives orders from
Authorized Participants to create and redeem shares in Creation Unit
aggregations and transmits such orders to the Trust's Custodian and transfer
agent. The Distributor’s principal address is Three Canal Plaza, Portland, Maine
04101. The Distributor is a broker-dealer registered under the 1934 Act and a
member of the Financial Industry Regulatory Authority, Inc. (“FINRA”). Shares
will be continuously offered for sale only in Creation Units. Shares in less
than a Creation Unit are not distributed by the Distributor. The Distributor has
no role in determining the investment policies of the Funds or which securities
are to be purchased or sold by the Funds. No compensation is payable by the
Trust to the Distributor for such distribution services. However, the Adviser
has entered into an agreement with the Distributor under which it makes payments
to the Distributor in consideration for its services under the Distribution
Agreement. The payments made by the Adviser to the Distributor do not represent
an additional expense to the Trust or its shareholders.
Under
the Distribution Agreement, the Distributor, as agent for the Trust, will
solicit orders for the purchase of shares, provided that any
subscriptions and orders will not be binding on the Trust until accepted by the
Trust. The Distributor will deliver Prospectuses and, upon request, SAIs to
persons purchasing Creation Units. The Distributor is a broker-dealer registered
under the Exchange Act and a member of FINRA.
The
Distributor may also enter into agreements with securities dealers (“Soliciting
Dealers”) who will solicit purchases of Creation Units of
shares. Such Soliciting Dealers may also be Authorized Participants (as
discussed in “Procedures for Creation of Creation Units” below) or DTC
participants (as defined below).
The
Distribution Agreement will continue for two years from its effective date and
is renewable thereafter. The continuance of the Distribution
Agreement must be specifically approved at least annually (i) by the vote of the
Trustees or by a vote of the shareholders of the Fund and (ii) by the vote of a
majority of the Trustees who are not “interested persons” of the Trust and have
no direct or indirect financial interest in the operations of the Distribution
Agreement or any related agreement, cast in person at a meeting called for the
purpose of voting on such approval. The Distribution Agreement is terminable,
without penalty, by the Trust on 60 days’ written notice when authorized either
by majority vote of its outstanding voting shares or by a vote of a majority of
its Board (including a majority of the Independent Trustees), or by the
Distributor on 60 days’ written notice, and will automatically terminate in the
event of its assignment. The Distribution Agreement provides that in the absence
of willful misfeasance, bad faith or gross negligence on the part of the
Distributor, or reckless disregard by it of its obligations thereunder, the
Distributor shall not be liable for any action or failure to act in accordance
with its duties thereunder.
47
PORTFOLIO
MANAGERS
This
section includes information about the Funds’ portfolio managers, including
information concerning other accounts they manage, the dollar
range of Fund shares they own and how they are compensated.
Other
Accounts
The
following table lists the number and types of accounts managed by the portfolio
managers and assets under management in those accounts
as of the end of the last completed fiscal year:
|
|
Registered
Investment
Company
Accounts |
Pooled
Investment
Vehicle
Accounts |
Other
Accounts | |||
|
Assets
Managed
(In
Millions |
Number
of
Accounts |
Assets
Managed
(In
Millions) |
Number
of
Accounts |
Assets
Managed
(In
Millions) |
Number
of
Accounts | |
|
Victory
Income Investors Team | ||||||
|
Kurt
Daum |
$13,755.23 |
8 |
$— |
0 |
$— |
0 |
|
John
Spear |
$13,755.23 |
8 |
$— |
0 |
$— |
0 |
|
James
F. Jackson Jr. |
$19,267.3 |
14 |
$— |
0 |
$— |
0 |
|
R.
Neal Graves |
$19,267.3 |
14 |
$— |
0 |
$— |
0 |
|
Michael
Duncan* |
$— |
1 |
$— |
0 |
$— |
0 |
|
VictoryShares
THB Mid Cap ESG ETF Team | ||||||
|
Christopher
N. Cuesta |
$571.05 |
5 |
$161.45 |
4 |
$93.13 |
22 |
|
Manish
Maheshwari |
$571.05 |
5 |
$161.45 |
4 |
$93.13 |
22 |
*Mr. Duncan
commenced as a portfolio manager of the VictoryShares Corporate Bond ETF
effective November 1, 2023.
The
following table sets forth performance-based accounts for which the Funds’
portfolio managers were primarily responsible for the day-to-day
portfolio management as of the end of the last completed fiscal
year:
|
|
Registered
Investment
Company
Accounts |
Pooled
Investment
Vehicle
Accounts |
Other
Accounts | |||
|
Assets
Managed
(In
Millions) |
Number
of
Accounts |
Assets
Managed
(In
Millions) |
Number
of
Accounts |
Assets
Managed
(In
Millions) |
Number
of
Accounts | |
|
Victory
Income Investors Team | ||||||
|
Kurt
Daum |
$11,454.59 |
4 |
$— |
0 |
$— |
0 |
|
John
Spear |
$11,454.59 |
4 |
$— |
0 |
$— |
0 |
|
James
F. Jackson Jr. |
$12,714.3 |
6 |
$— |
0 |
$— |
0 |
|
R.
Neal Graves |
$12,714.3 |
6 |
$— |
0 |
$— |
0 |
|
Michael
Duncan* |
$— |
0 |
$— |
0 |
$— |
0 |
|
VictoryShares
THB Mid Cap ESG ETF Team | ||||||
|
Christopher
N. Cuesta |
$549.49 |
3 |
$— |
0 |
$— |
0 |
|
Manish
Maheshwari |
$549.49 |
3 |
$— |
0 |
$— |
0 |
*Mr. Duncan
commenced as a portfolio manager of the VictoryShares Corporate Bond ETF
effective November 1, 2023.
48
Fund
Ownership
As
of the most recent fiscal year end, the dollar range of shares beneficially
owned by the portfolio managers of the Funds are set forth below:
|
Portfolio
Manager |
Fund |
Dollar
Range
of
Shares
Beneficially
Owned
as of
June
30, 2023 |
|
VictoryShares
THB Mid Cap
ESG
ETF Team |
|
|
|
Mr.
Cuesta |
VictoryShares
THB Mid Cap ESG ETF |
None |
|
Mr.
Maheshwari |
VictoryShares
THB Mid Cap ESG ETF |
None |
|
Victory
Income Investors
Team |
|
|
|
Mr.
Daum |
VictoryShares
Core Plus Intermediate Bond ETF
VictoryShares
Corporate Bond ETF |
$10,001-$50,000
None |
|
Mr.
Spear |
VictoryShares
Core Plus Intermediate Bond ETF
VictoryShares
Corporate Bond ETF |
None
None |
|
Mr.
Jackson Jr. |
VictoryShares
Core Plus Intermediate Bond ETF
VictoryShares
Corporate Bond ETF |
$1-$10,000
$1-$10,000 |
|
Mr.
Graves |
VictoryShares
Core Plus Intermediate Bond ETF
VictoryShares
Corporate Bond ETF |
None
None |
|
Mr.
Duncan* |
VictoryShares
Corporate Bond ETF |
None |
*Mr. Duncan
commenced as a portfolio manager of the VictoryShares Corporate Bond ETF
effective November 1, 2023.
Portfolio
Manager Compensation
The
Adviser has designed the structure of its portfolio managers’ compensation to
(1) align portfolio managers’ interests with those of the
Adviser’s clients with an emphasis on long-term, risk-adjusted investment
performance, (2) help the Adviser attract and retain high-quality investment
professionals, and (3) contribute to the Adviser’s overall financial success.
Each of the portfolio managers receives a base salary plus an annual incentive
bonus for managing a Fund, separate accounts, other investment companies, other
pooled investment vehicles and other accounts (including any accounts for which
the Adviser receives a performance fee) (together, “Accounts”). A portfolio
manager’s base salary is dependent on the manager’s level of experience and
expertise. The Adviser monitors each manager’s base salary relative to salaries
paid for similar positions with peer firms by reviewing data provided by various
independent third-party consultants that specialize in competitive salary
information. Such data, however, is not considered to be a definitive
benchmark.
Each
of the Adviser’s investment franchises may earn incentive compensation based on
a percentage of the Adviser’s revenue attributable
to fees paid by Accounts managed by the team. The chief investment officer or a
senior member of each team, in coordination with the Adviser, determines the
allocation of the incentive compensation earned by the team among the team’s
portfolio managers by establishing a “target” incentive for each portfolio
manager based on the manager’s level of experience and expertise in the
manager’s investment style. Individual performance is based on objectives
established annually using performance metrics such as portfolio structure and
positioning, research, stock selection, asset growth, client retention,
presentation skills, marketing to prospective clients and contribution to the
Adviser’s philosophy and values, such as leadership, risk management and
teamwork. The annual incentive bonus also factors in individual investment
performance of each portfolio manager’s portfolio or Fund relative to a selected
peer group(s). The overall performance results for a manager are based on the
composite performance of all Accounts managed by that manager on a combination
of one-, three-, and five-year rolling performance periods as compared to the
performance information of a peer group of similarly managed
competitors.
The
Adviser’s portfolio managers may participate in the equity ownership plan of the
Adviser’s parent company. There is an ongoing annual
equity pool granted to certain employees based on their contribution to the
firm. Eligibility for participation in these incentive programs depends on the
manager’s performance and seniority.
Conflicts
of Interest
The
Adviser’s portfolio managers are often responsible for managing one or more
Funds as well as other accounts, such as separate accounts,
and other pooled investment vehicles, such as collective trust funds or
unregistered hedge funds. A portfolio manager may manage other accounts which
have materially higher fee arrangements than a Fund and may, in the future,
manage other accounts which
49
have
a performance-based fee. A portfolio manager also may make personal investments
in accounts he or she manages or supports. The
side-by-side management of the Funds along with other accounts may raise
potential conflicts of interest by incenting a portfolio manager to direct a
disproportionate amount of: (1) their attention; (2) limited investment
opportunities, such as less-liquid securities or initial public offering; and/or
(3) desirable trade allocations, to such other accounts. In addition, certain
trading practices, such as cross-trading between Funds or between a Fund and
another account, raise conflict of interest issues. The Adviser has adopted
numerous compliance policies and procedures, including a Code of Ethics, and
brokerage and trade allocation policies and procedures, which seek to address
the conflicts associated with managing multiple accounts for multiple clients.
In addition, the Adviser has a designated Chief Compliance Officer (selected in
accordance with the federal securities laws) and compliance staff whose
activities are focused on monitoring the activities of the Adviser’s investment
franchises and employees in order to detect and address potential and actual
conflicts of interest. However, there can be no assurance that the Adviser’s
compliance program will achieve its intended result.
DISTRIBUTION
AND SERVICE PLAN
The
Trust has adopted a Distribution Plan pursuant to Rule 12b-1 under the 1940 Act
(“Rule 12b-1 Plan” or “Plan”). In accordance with its
Plan, the Funds are authorized to pay an amount up to 0.25% of its average daily
net assets each year for certain distribution-related activities. In addition,
if the payment of management fees by the Fund is deemed to be indirect financing
by the Funds of the distribution of its shares, such payment is authorized by
the Rule 12b-1 Plan. The Plan specifically recognizes that the Adviser and other
persons may use management fee revenue, as well as past profits or other
resources, to pay for expenses incurred in connection with providing services
intended to result in the sale of shares. The Adviser and such other persons, as
well as their affiliates, may pay amounts to third parties for distribution or
marketing services on behalf of the Funds. The making of the types of payments
described in this paragraph could create a conflict of interest for the party
receiving such payments.
The
Rule 12b-1 Plan was adopted in order to permit the implementation of the Funds’
method of distribution. No fees are currently paid by
the Funds under the Plan, and there are no current plans to impose such fees. In
the event such fees were to be charged, over time they would increase the cost
of an investment in the Funds.
The
Distributor is required to provide a written report, at least quarterly to the
Board, specifying in reasonable detail the amounts (if any)
expended pursuant to the Rule 12b-1 Plan and the purposes for which such
expenditures were made. Further, the Distributor will inform the Board of any
Rule 12b-1 fees to be paid by the Distributor to Recipients. From time to time,
the Adviser, at its expense, may provide additional compensation to dealers that
sell or arrange for the sale of shares of a Fund. Such compensation provided by
the Adviser may include financial assistance to dealers that enable the Adviser
to participate in and/or present at conferences or seminars, sales or training
programs for invited registered representatives and other employees, client and
investor events and other dealer-sponsored events. Other compensation may be
offered to the extent not prohibited by state laws or any self-regulatory
agency, such as FINRA. The Adviser may make payments for events it deems
appropriate, subject to applicable law. These payments may vary depending upon
the nature of the event.
The
Rule 12b-1 Plan may not be amended to increase materially the amount of the
Distributor’s compensation to be paid by the Fund, unless
such amendment is approved by the vote of a majority of the outstanding voting
securities of the affected Fund (as defined in the 1940 Act). All material
amendments must be approved by a majority of the Board and a majority of the
Rule 12b-1 Trustees by votes cast in person at a meeting called for the purpose
of voting on a Rule 12b-1 Plan. During the term of the Rule 12b-1 Plan, the
selection and nomination of non-interested Trustees of the Trust will be
committed to the discretion of current non-interested Trustees. The Distributor
will preserve copies of the Rule 12b-1 Plan, any related agreements, and all
reports, for a period of not less than six years from the date of such document
and for at least the first two years in an easily accessible place.
Any
agreement related to the Rule 12b-1 Plan will be in writing and provide that:
(a) it may be terminated by the Trust or the applicable Fund at
any time upon sixty days’ written notice, without the payment of any penalty, by
vote of a majority of the respective Rule 12b-1 Trustees, or by vote of a
majority of the outstanding voting securities of the Trust or the Fund; (b) it
will automatically terminate in the event of its assignment (as defined in the
1940 Act); and (c) it will continue in effect for a period of more than one year
from the date of its execution or adoption only so long as such continuance is
specifically approved at least annually by a majority of the Board and a
majority of the Rule 12b-1 Trustees by votes cast in person at a meeting called
for the purpose of voting on such agreements.
CODE
OF ETHICS
The
Trust and the Adviser each have adopted a Code of Ethics in accordance with Rule
17j-1 under the 1940 Act. The Adviser’s Code of Ethics
applies to all of the Adviser’s directors and officers and employees with
investment advisory duties (“Access Personnel”) and all of the Adviser’s
directors, officers and employees (“Supervised Personnel”). Each Code of Ethics
provides that Access Personnel must refrain from certain trading practices. Each
Code also requires all Access Personnel (and, in the Adviser Code, all
Supervised
50
Personnel)
to report certain personal investment activities, including, but not limited to,
purchases or sales of securities that may be purchased
or held by a Fund. Violations of any Code of Ethics can result in penalties,
suspension, or termination of employment.
PROXY
VOTING POLICIES AND PROCEDURES
In
accordance with the 1940 Act, the Trust has adopted policies and procedures for
voting proxies related to equity securities held by the Funds
(the “Proxy Voting Policy”). The Trust’s Proxy Voting Policy is designed to: (i)
ensure that proxies are voted in the best interests of shareholders of the Funds
with a view toward maximizing the value of their investments; (ii) address
conflicts of interests between these shareholders, on the one hand, and
affiliates of the Fund, the Adviser or the Distributor, on the other, that may
arise regarding the voting of proxies; and (iii) provide for the disclosure of
the Funds’ proxy voting records and the Proxy Voting Policy.
The
Proxy Voting Policy delegates to the Adviser the obligation to vote the Funds’
proxies in the best interests of the Funds and their shareholders,
subject to oversight by the Board.
To
assist the Adviser in making proxy-voting decisions, the Adviser has adopted a
Proxy Voting Policy (“Policy”) that establishes voting
guidelines (“Proxy Voting Guidelines”) with respect to certain recurring issues.
The Policy is reviewed on an annual basis by the Adviser’s Proxy Committee
(“Proxy Committee”) and revised when the Committee determines that a change is
appropriate. The Board annually reviews the Trust’s Proxy Voting Policy and the
Adviser’s Policy and determines whether amendments are necessary or advisable.
Voting under the Adviser’s Policy may be executed through administrative
screening per established guidelines with oversight by the Proxy Committee or
upon vote by a quorum of the Proxy Committee. The Adviser delegates to
Institutional Shareholder Services (“ISS”), an independent service provider, the
non-discretionary administration of proxy voting for the Trust, subject to
oversight by the Adviser’s Proxy Committee. In no circumstances shall ISS have
the authority to vote proxies except in accordance with standing or specific
instructions given to it by the Adviser.
The
Adviser votes proxies in the best interests of the Funds and their shareholders.
This entails voting client proxies with the objective of
increasing the long-term economic value of Fund assets. The Adviser’s Proxy
Committee determines how proxies are voted by following established guidelines,
which are intended to assist in voting proxies and are not considered to be
rigid rules. The Proxy Committee is directed to apply the guidelines as
appropriate. On occasion, however, a contrary vote may be warranted when such
action is in the best interests of the Funds or if required by the Board or the
Funds’ Proxy Voting Policy. In such cases, the Adviser may consider, among other
things:
• the
effect of the proposal on the underlying value of the securities
• the
effect on marketability of the securities
• the
effect of the proposal on future prospects of the issuer
• the
composition and effectiveness of the issuer’s board of directors
• the
issuer’s corporate governance practices
• the
quality of communications from the issuer to its shareholders
The
Adviser may also take into account independent third-party, general industry
guidance or other corporate governance review sources
when making decisions. It may additionally seek guidance from other senior
internal sources with special expertise on a given topic where it is
appropriate. The Adviser generally votes on a case-by-case basis, taking into
consideration whether implementation of an Environmental, Social, and Governance
(“ESG”)-related proposal is likely to enhance or protect shareholder value. The
investment team’s opinion concerning the management and prospects of the issuer
may be taken into account in determining whether a vote for or against a
proposal is in a Fund’s best interests. Insufficient information, onerous
requests or vague, ambiguous wording may indicate that a vote against a proposal
is appropriate, even when the general principal appears to be
reasonable.
The
following examples illustrate the Adviser’s policy with respect to some common
proxy votes. This summary is not an exhaustive list of
all the issues that may arise or of all matters addressed in the Guidelines, and
whether the Adviser supports or opposes a proposal will depend upon the specific
facts and circumstances described in the proxy statement and other available
information.
Directors
• The
Adviser generally supports the election of directors in uncontested elections,
except when there are issues of accountability, responsiveness, composition,
and/or independence.
• The
Adviser generally supports proposals for an independent chair taking into
account factors such as the current board leadership structure, the company’s
governance practices, and company performance.
51
• The
Adviser generally supports proxy access proposals that are in line with the
market standards regarding the ownership threshold, ownership duration,
aggregation provisions, cap on nominees, and do not contain any other
unreasonably restrictive guidelines.
• The
Adviser reviews contested elections on a case-by-case basis taking into account
such factors as the company performance, particularly the long-term performance
relative to the industry; the management track record; the nominee
qualifications and compensatory arrangements; the strategic plan of the
dissident and its critique of the current management; the likelihood that the
proposed goals and objectives can be achieved; the ownership stakes of the
relevant parties; and any other context that is particular to the company and
the nature of the election.
Capitalization
& Restructuring
• The
Adviser generally supports capitalization proposals that facilitate a corporate
transaction that is also being supported and for general corporate purposes so
long as the increase is not excessive and there are no issues of superior voting
rights, company performance, previous abuses of capital, or insufficient
justification for the need for additional capital.
Mergers
and Acquisitions
• The
Adviser reviews mergers and acquisitions on a case-by-case basis to balance the
merits and drawbacks of the transaction and factors such as valuation, strategic
rationale, negotiations and process, conflicts of interest, and the governance
profile of the company post-transaction.
Compensation
• The
Adviser reviews all compensation proposals for pay-for-performance alignment,
with emphasis on long-term shareholder value; arrangements that risk pay for
failure; independence in the setting of compensation; inappropriate pay to
non-executive directors, and the quality and rationale of the compensation
disclosure.
• The
Adviser will generally vote FOR advisory votes on executive compensation (“say
on pay”) unless there is a pay-for-performance misalignment; problematic pay
practice or non-performance based element; incentive for excessive risk-taking,
options backdating; or a lack of compensation committee communication and/or
responsiveness to shareholder concerns.
• The
Adviser will vote case-by-case on equity based compensation plans taking into
account factors such as the plan cost; the plan features; and the grant
practices as well as any overriding factors that may have a significant negative
impact on shareholder interests.
Social
and Environmental Issues
• The
Adviser will vote case-by-case on topics such as consumer and product safety;
environment and energy; labor standards and human rights; workplace and board
diversity; and corporate and political issues, taking into account factors such
as the implementation of the proposal is likely to enhance or protect
shareholder value; whether the company has already responded in an appropriate
and sufficient manner to the issue raised; whether the request is unduly
burdensome; and whether the issue is more appropriately or effectively handled
through legislation or other regulations.
Occasionally,
conflicts of interest arise between the Adviser’s interests and those of a Fund
or another client. When this occurs, the Proxy
Committee must document the nature of the conflict and vote the proxy in
accordance with the Proxy Voting Guidelines unless such guidelines are judged by
the Proxy Committee to be inapplicable to the proxy matter at issue. In the
event that the Proxy Voting Guidelines are inapplicable or do not mitigate the
conflict, the Adviser will seek the opinion of the Adviser’s Chief Compliance
Officer or consult with an external independent adviser. In the case of a Proxy
Committee member having a personal conflict of interest (e.g. a family member is
on the board of the issuer), such member will abstain from voting. Finally, the
Adviser reports to the Board annually any proxy votes that took place involving
a conflict, including the nature of the conflict and the basis or rationale for
the voting decision made.
The
Funds’ Proxy Voting Policy provides that the Funds, in accordance with SEC
rules, annually will disclose on Form N- PX the Funds’
proxy voting record. Information regarding how the Funds voted proxies relating
to portfolio securities during the most recent 12-month period ended June 30th
is updated each year by August 31st and is available without charge, upon
request, by calling toll free 800-539-FUND (800-539-3863) or by accessing the
SEC’s website at www.sec.gov.
52
PORTFOLIO
TRANSACTIONS AND BROKERAGE COMMISSIONS
Subject
to the general supervision of the Board, the Adviser is responsible for making
decisions with respect to the purchase and sale of
portfolio securities on behalf of the Funds. The Adviser is also responsible for
the implementation of those decisions, including the selection of broker/dealers
to effect portfolio transactions, the negotiation of commissions, and the
allocation of principal business and portfolio brokerage. Under the terms of the
Advisory Agreement, the Adviser may delegate these responsibilities to a
sub-adviser.
Transactions
on stock exchanges involve the payment of brokerage commissions. In transactions
on stock exchanges in the United
States, these commissions are negotiated. Traditionally, commission rates have
generally been fixed for trades on stock markets outside the United States. In
recent years, however, an increasing number of overseas stock markets have
adopted a system of negotiated commission rates. It is expected that equity
securities will ordinarily be purchased in the primary markets for such
securities, whether over-the-counter or listed, and that listed securities may
be purchased in the over-the-counter market if such market is deemed the primary
market. In the case of securities traded on the over-the- counter markets, there
is generally no stated commission, but the price usually includes an undisclosed
commission or markup. In underwritten offerings, the price includes a disclosed,
fixed commission (the underwriter’s concession) or discount.
Fixed
income and convertible securities are bought and sold through broker-dealers
acting on a principal basis. These trades are not charged a
commission, but rather are marked up or marked down by the executing broker-
dealer. The Adviser does not know the actual value of the markup/markdown.
However, the Adviser attempts to ascertain whether the overall price of a
security is reasonable through the use of competitive bids. Orders to buy or
sell convertible securities and fixed income securities are placed on a
competitive basis with a reasonable attempt made to obtain three competitive
bids or offers. Exceptions are: (1) where the bid/ask spread is 5 basis points
or less, provided the order is actually filled at the bid or better for sales
and at the ask or better for purchases; (2) securities for which there are only
one or two market makers; (3) block purchases considered relatively large; (4)
swaps, a simultaneous sale of one security and purchase of another in
substantially equal amounts for the same account, intended to take advantage of
an aberration in a spread relationship, realize losses, etc.; and (5) purchases
and/or sales of fixed income securities for which, typically, more than one
offering of the same issue is unobtainable; subject to a judgment by the trader
that the bid is competitive.
It
is the policy of the Adviser to obtain the “best execution” of its clients’
securities transactions. The Adviser strives to execute each client’s
securities transactions in such a manner that the client’s total costs or
proceeds in each transaction are the most favorable under the circumstances.
Commission rates paid on securities transactions for client accounts must
reflect comparative market rates.
In
purchasing and selling each Fund’s portfolio securities, it is the Adviser’s
policy to obtain quality execution at the most favorable prices
through responsible broker/dealers and, in the case of agency transactions, at
competitive commission rates where such rates are negotiable. In selecting
broker/dealers to execute a Fund’s portfolio transactions, consideration is
given to such factors as the price of the security, the rate of the commission,
the size and difficulty of the order, the reliability, integrity, financial
condition, general execution and operational capabilities of competing brokers
and dealers, their expertise in particular markets and the brokerage and
research services they provide to the Adviser or the Funds. It is not the
Adviser’s practice to seek the lowest available commission rate where it is
believed that a broker or dealer charging a higher commission rate would offer
greater reliability or provide better price or execution.
As
permitted by Section 28(e) of the Securities Exchange Act of 1934, the Adviser
may cause a Fund to pay broker- dealers that provide brokerage
and research services a commission rate that exceeds the amount other
broker/dealers would have charged for the transaction if the Adviser determines
in good faith that the greater commission is reasonable in relation to the value
of the brokerage and research services provided by the executing broker/dealer
viewed in terms of either a particular transaction or the Adviser’s overall
responsibilities to the Fund or to its other clients. The term “brokerage and
research services” includes advice as to the value of securities, the
advisability of investing in, purchasing, or selling securities, and the
availability of securities or of purchasers or sellers of securities; furnishing
analyses and reports concerning issuers, industries, securities, economic
factors and trends, portfolio strategy and the performance of accounts; and
effecting securities transactions and performing functions incidental thereto
such as clearance and settlement.
The
brokerage and research services are in addition to and do not replace the
services and research that the Adviser is required to perform
and do not reduce the investment advisory fees payable to the Adviser by the
Funds. Such information may be useful to the Adviser in serving both the Funds
and other clients and, conversely, such supplemental research information
obtained by the placement of orders on behalf of other clients may be useful to
the Adviser in carrying out its obligations to the Funds.
Brokerage
commissions may never be used to compensate a third party for client referrals
unless the client has directed such an arrangement.
In addition, brokerage commissions may never be used to obtain research and/or
services for the benefit of any employee or non-client entity.
The
Adviser will make a good faith determination that the commissions paid are
reasonable in relationship to the value of the services received
and continually reviews the quality of execution it receives from and the
commission rates charged by the brokers it uses to
53
carry
out trades for its clients. The Adviser will consider the full range and quality
of a broker’s services in placing brokerage including, but not
limited to, the value of research provided, execution capability, commission
rate, willingness and ability to commit capital and responsiveness. The lowest
possible commission cost alone does not determine broker selection. The
transaction that represents the best quality execution for a client account will
be executed. Commission ranges and the actual commission paid for trades of
listed stocks and over-the-counter stocks may vary depending on, but not limited
to, the liquidity and volatility of the stock and services provided to the
Adviser by the broker.
Some
brokers executing trades for the Adviser’s clients may, from time to time,
receive liquidity rebates in connection with the routing of trades
to Electronic Communications Networks. Since the Adviser is not a broker,
however, it is ineligible to receive such rebates and does not obtain direct
benefits for its clients from this broker practice.
Investment
decisions for each Fund are made independently from those made for the other
Funds or any other investment company or account
managed by the Adviser. Such other investment companies or accounts may also
invest in the same securities and may follow similar investment strategies as
the Funds. The Adviser may combine transaction orders (“bunching” or “blocking”
trades) for more than one client account where such action appears to be
equitable and potentially advantageous for each account (e.g., for the purpose
of reducing brokerage commissions or obtaining a more favorable transaction
price.) The Adviser will aggregate transaction orders only if it believes that
the aggregation is consistent with its duty to seek best execution for its
clients and is consistent with the terms of investment advisory agreements with
each client for whom trades are being aggregated. Both equity and fixed income
securities may be aggregated. When making such a combination of transaction
orders for a new issue or secondary market trade in an equity security, the
Adviser adheres to the following objectives:
• Fairness
to clients both in the participation of execution of orders for their account,
and in the allocation of orders for the accounts of more than one
client.
• Allocation
of all orders in a timely and efficient manner.
In
some rare cases, “bunching” or “blocking” trades may affect the price paid or
received by a Fund or the size of the position obtained by the
Fund in an adverse manner relative to the result that would have been obtained
if only that particular Fund had participated in or been allocated such
trades.
The
aggregation of transactions for advisory accounts and proprietary accounts
(including partnerships and other accounts in which the Adviser or
its associated persons are partners or participants, and managed employee
accounts) is permissible. However, no proprietary account may be favored over
any other participating account and such practice must be consistent with the
Adviser’s policies and procedures including its Code of Ethics.
Equity
trade orders are executed based only on trade instructions received from
portfolio managers by the trading desk. Portfolio managers
may enter trades to meet the full target allocation immediately or may meet the
allocation through moves in incremental blocks. Orders are processed on a
“first-come, first-served” basis. At times, a rotation system may determine
“first-come, first-served” treatment when the equity trading desk receives the
same order for multiple accounts simultaneously. The Adviser will utilize a
rotation whereby the Funds, even if aggregated with other orders, are in the
first block(s) to trade within the rotation. To aggregate orders, the equity
trading desk must determine that all accounts in the order will benefit. Any new
trade that can be blocked with an existing open order may be added to the open
order to form a larger block. The Adviser receives no additional compensation or
remuneration of any kind as a result of the aggregation of trades. All accounts
participating in a block execution receive the same execution price, an average
share price, for securities purchased or sold on a trading day. Execution prices
may not be carried overnight. Any portion of an order that remains unfilled at
the end of a given day shall be rewritten (absent contrary instructions) on the
following day as a new order. Accounts with trades executed the next day will
receive a new daily average price to be determined at the end of the following
day.
If
the order is filled in its entirety, securities purchased in the aggregate
transaction will be allocated among accounts participating in the trade
in accordance with an Allocation Statement prepared at the time of order entry.
If the order is partially filled, the securities will be allocated pro rata
based on the Allocation Statement. Portfolio managers may allocate executed
trades in a different manner than indicated on the Allocation Statement (e.g.,
non-pro rata) only if all client accounts receive fair and equitable
treatment.
In
some instances, such as trading in fixed income securities, it may not be
practical to complete the Allocation Statement prior to the placement
of the order. In that case, the trading desk will complete the Allocation
Statement as soon as practicable, but no later than the end of the same business
day on which the securities have been allocated to the trading desk by the
broker.
Where
the full amount of a block execution is not executed, the partial amount
actually executed will be allocated on a pro rata basis whenever
possible. The following execution methods may be used in place of a pro rata
procedure: relative size allocations, security position weighting, priority for
specialized accounts, or a special allocation based on compliance
approval.
In
making investment decisions for the Funds, the Adviser will not inquire or take
into consideration whether an issuer of securities proposed
for purchase or sale by a Fund is a customer of the Adviser, its parents,
subsidiaries or affiliates, and, in dealing with their
54
commercial
customers, the Adviser, its parents, subsidiaries and affiliates will not
inquire or take into consideration whether securities of such
customers are held by the Funds. Portfolio securities will not be purchased from
or sold to the Adviser, or the Distributor, or any affiliated person of any of
them acting as principal, except to the extent permitted by rule or order of the
SEC.
The
following table shows the dollar amount of brokerage commissions paid by each
Fund during the fiscal year ended June 30, 2023, and the
fiscal period ended June 30, 2022, all of which were paid to entities that are
not affiliated with the Funds, the Adviser, or the Distributor.
|
Fund |
2023 |
2022 |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$2,026 |
$638 |
|
VictoryShares
Corporate Bond ETF |
$- |
$- |
|
VictoryShares
THB Mid Cap ESG ETF |
$312 |
$82 |
Affiliated
Brokerage. The Board
has authorized the allocation of brokerage to affiliated broker-dealers on an
agency basis to effect portfolio transactions. The Board has adopted procedures
incorporating the standards of Rule 17e-1 under the 1940 Act, which require that
the commission paid to affiliated broker-dealers must be “reasonable and fair
compared to the commission, fee or other remuneration received, or to be
received, by other broker-dealers in connection with comparable transactions
involving similar securities during a comparable period of time.”
The
Trust will not acquire portfolio securities issued by, make savings deposits in,
or enter into repurchase or reverse repurchase agreements
with the Adviser or its affiliates. From time to time, when determined by the
Adviser or Sub- Adviser to be advantageous to the Funds, the Adviser may execute
portfolio transactions through affiliated broker-dealers. All such transactions
must be consistent with best execution and completed in accordance with
procedures approved by the Board.
For the
last three fiscal years ended June 30, the Funds paid no commissions to
affiliated broker-dealers.
Allocation
of Brokerage in Connection with Research Services. During
the last fiscal year ended June 30, the Adviser, through agreements or
understandings with brokers, or otherwise through an internal allocation
procedure, directed brokerage transactions of the Funds to brokers due to
research services provided.
|
Fund |
Amount
of Transactions to
Brokers
Providing Research |
Related
Commissions |
|
VictoryShares
THB Mid Cap ESG ETF |
$750,023 |
$171 |
Securities
of Regular Brokers or Dealers. The SEC
requires the Trust to provide certain information for those Funds that held
securities of their regular brokers or dealers (or their parent companies)
during the most recent fiscal year. The following table identifies, for each
applicable Fund, those brokers or dealers, the type of security held and the
value of the Fund’s aggregate holdings of the securities of each such issuer as
of the last completed fiscal year.
|
Fund |
Broker-Dealer |
Type
of
Security
(Debt
or
Equity) |
Aggregate
Value
($000s) |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
Bank
of America Corp. |
Debt |
$573 |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
Barclays
Bank PLC |
Debt |
$1,041 |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
JPMorgan
Chase & Co. |
Debt |
$1,069 |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
Mizuho
Financial Group,
Inc. |
Debt |
$393 |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
Morgan
Stanley |
Debt |
$895 |
|
VictoryShares
Core Plus Bond Itermediate Bond ETF |
Wells
Fargo & Co. |
Debt |
$199 |
|
VictoryShares
Corporate Bond ETF |
Bank
of America Corp. |
Debt |
$3,031 |
|
VictoryShares
Corporate Bond ETF |
Barclays
PLC |
Debt |
$1,130 |
|
VictoryShares
Corporate Bond ETF |
JPMorgan
Chase & Co. |
Debt |
$3,013 |
|
VictoryShares
Corporate Bond ETF |
Morgan
Stanley |
Debt |
$3,055 |
|
VictoryShares
Corporate Bond ETF |
Wells
Fargo & Co. |
Debt |
$216 |
Portfolio
Turnover
Each
Fund may sell a portfolio investment soon after its acquisition if the Adviser
believes that such a disposition is consistent with attaining
the investment objective of the Fund. The Funds’ portfolio turnover rates stated
in the Prospectuses are calculated by dividing the lesser of each Fund’s
purchases or sales of portfolio securities for the year by the monthly average
value of the portfolio securities.
55
The
calculation excludes all securities whose maturities, at the time of
acquisition, were one year or less. Portfolio turnover is calculated
on the
basis of a Fund as a whole without distinguishing between the classes of shares
issued.
The
turnover rate for a Fund will vary from year-to-year, and, depending on market
conditions, could be greater in periods of unusual market
movement and volatility. Transaction costs associated with turnover are borne
directly by the Fund and, ultimately, by its shareholders. A high rate of
portfolio turnover (generally, over 100% annually) generally will involve
correspondingly greater transaction costs. High portfolio turnover may result in
the realization of substantial net capital gains. To the extent short-term
capital gains are realized, distributions attributable to such gains will be
ordinary income for federal income tax purposes.
The
following table shows the portfolio turnover rates for each Fund for the fiscal
year ended June 30, 2023 and the fiscal period ended June 30,
2022.
|
Fund |
2023 |
2022 |
|
VictoryShares
Core Plus Intermediate Bond ETF |
60% |
56% |
|
VictoryShares
Corporate Bond ETF |
27% |
9% |
|
VictoryShares
THB Mid Cap ESG ETF |
20% |
17% |
DIVIDENDS,
CAPITAL GAINS AND DISTRIBUTIONS
The
Funds distribute substantially all of their net investment income and net
capital gains, if any, to shareholders within each calendar year as
well as on a fiscal year basis to the extent required for the Funds to qualify
for favorable federal tax treatment. The Funds ordinarily declare and pay
dividends from their net investment income. Each Fund declares and pays
capital gains annually. Ordinarily, dividends from net investment income, if
any, are declared and paid monthly by each Fund.
The
amount of distributions may vary from time to time depending on market
conditions, the composition of a Fund’s portfolio and expenses
borne by a Fund. Dividends are calculated in the same manner, at the same time
and on the same day for shares.
For
this purpose, the net income of a Fund, from the time of the immediately
preceding determination thereof, shall consist of all interest
income accrued on the portfolio assets of the Fund, dividend income, if any,
income from securities loans, if any and realized capital gains and losses on
the Fund’s assets, less all expenses and liabilities of the Fund chargeable
against income. Interest income shall include discount earned, including both
original issue and market discount, on discount paper accrued ratably to the
date of maturity. Expenses, including the compensation payable to the Adviser,
are accrued each day. The expenses and liabilities of a Fund shall include those
appropriately allocable to the Fund as well as a share of the general expenses
and liabilities of the Trust in proportion to the Fund’s share of the total net
assets of the Trust.
TAXES
Information
set forth in the Prospectuses that relates to federal income taxation is only a
summary of certain key federal income tax considerations
generally affecting purchasers of shares of the Funds. The following is only a
summary of certain additional income and excise tax considerations generally
affecting each Fund and its shareholders that are not described in the
Prospectuses. No attempt has been made to present a complete explanation of the
federal tax treatment of the Funds or the implications to shareholders and the
discussions here and in each Fund’s Prospectus are not intended as substitutes
for careful tax planning. In addition, the following summary does not describe
the tax consequences to an Authorized Participant from the creation and
redemption of Creation Units. Accordingly, potential purchasers of shares
of the Funds are urged to consult their tax advisers with specific reference to
their own tax circumstances. Special tax considerations may apply to certain
types of investors subject to special treatment under the Code (including, for
example, insurance companies, banks and tax-exempt organizations). In addition,
the following summary does not describe the tax consequences to foreign trusts,
foreign estates and foreign partnerships. Lastly, the tax discussion in the
Prospectuses and this SAI is based on tax law in effect on the date of the
Prospectuses and this SAI; such laws and regulations may be changed by
legislative, judicial, or administrative action, sometimes with retroactive
effect.
Qualification
as a Regulated Investment Company
Each
Fund intends to qualify as a regulated investment company under Subchapter M of
the Code. As a regulated investment company, a Fund is
not subject to federal income tax on the portion of its net investment income
(i.e., taxable interest, dividends and other taxable ordinary income, net of
expenses) and net capital gain (i.e., the excess of long-term capital gains over
short-term capital losses) that it distributes to shareholders, provided that it
distributes at least the sum of 90% of its investment company taxable income
(i.e., net investment income and the excess of net short-term capital gain over
net long-term capital loss) and 90% of its tax-exempt income (net of expenses
allocable thereto) for the taxable year (the “Distribution Requirement”) and
satisfies certain other requirements of the Code that are described below.
Distributions by a Fund made during the taxable year or, under specified
circumstances, within twelve months
56
after
the close of the taxable year, will be considered distributions of income and
gains for the taxable year and will therefore count toward
satisfaction of the Distribution Requirement.
If
a Fund has a net capital loss (i.e., an excess of capital losses over capital
gains), the amount thereof may be carried forward and would retain its
character as either a short-term capital loss or a long-term capital loss that
can be used to offset such capital gains in future years. There is no limitation
on the number of years to which net capital losses may be carried. However, the
amount of capital loss that can be carried forward and used in any single year
is subject to an annual limitation if there is a more than 50% “change in
ownership” of the Fund.
The
following table summarizes the capital loss carryforwards not subject to
expiration for the applicable Funds as of June 30, 2023.
|
Fund |
Short-Term
Amount |
Long-Term
Amount |
|
VictoryShares
Core Plus Intermediate Bond ETF |
$11,755,396 |
$4,402,318 |
|
VictoryShares
Corporate Bond ETF |
$2,453,747 |
$2,493,991 |
|
VictoryShares
THB Mid Cap ESG ETF |
$78,267 |
$28,272 |
In
addition to satisfying the Distribution Requirement, a regulated investment
company must derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign currencies
(to the extent such currency gains are directly related to the regulated
investment company’s principal business of investing in stock or securities),
other income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in such
stock, securities, or currencies and net income from interests in qualified
publicly traded partnerships (the “Income Requirement”).
A
regulated investment company, in determining its investment company taxable
income and net capital gain (i.e., the excess of net long-term
capital gain over net short-term capital loss) for any taxable year, may elect
(unless it has made a taxable year election for excise tax purposes as discussed
below, in which case different rules apply) to treat all or any part of certain
net capital losses incurred after October 31 of a taxable year, and certain net
ordinary losses incurred after October 31 or December 31 of a taxable year, as
if they had been incurred in the succeeding taxable year.
In
addition to satisfying the Income and Distribution Requirements described above,
a Fund must satisfy an asset diversification test in order
to qualify as a regulated investment company. Under this test, at the close of
each quarter of a Fund’s taxable year, at least 50% of the value of the Fund’s
assets must consist of cash and cash items, U.S. government securities,
securities of other regulated investment companies and securities of other
issuers (provided that, with respect to each issuer, the Fund has not invested
more than 5% of the value of the Fund’s total assets in securities of each such
issuer and the Fund does not hold more than 10% of the outstanding voting
securities of each such issuer), and no more than 25% of the value of its total
assets may be invested in the securities of any one issuer (other than U.S.
government securities and securities of other regulated investment companies),
two or more issuers that the Fund controls and that are engaged in the same or
similar trades or businesses (other than securities of other regulated
investment companies), or the securities of one or more qualified publicly
traded partnerships. Generally, an option (call or put) with respect to a
security is treated as issued by the issuer of the security, not the issuer of
the option. For purposes of asset diversification testing, obligations issued or
guaranteed by certain agencies or instrumentalities of the U.S. government, such
as the Federal Agricultural Mortgage Corporation, the FFCB, FHLB, FHLMC, FNMA,
GNMA, and SLMA, are treated as U.S. government securities.
Certain
Funds may invest in futures contracts, options on futures contracts and other
similar investments that provide exposure to commodities
such as gold or other precious metals, energy, or other commodities. Income or
gain, if any, from such investments may not be qualifying income for purposes of
the Income Requirements and a Fund’s investments in such instruments may not be
treated as an investment in a “security” for purposes of the asset
diversification test.
If
for any taxable year a Fund does not qualify as a regulated investment company
after taking into account cure provisions available for
certain failures to so qualify (certain of which would result in the imposition
of a tax on the Fund), all of its taxable income (including its net capital
gain) will be subject to tax at the regular corporate rate without any deduction
for distributions to shareholders and such distributions will be taxable to the
shareholders as dividends to the extent of the Fund’s current and accumulated
earnings and profits. Such distributions may be eligible for: (i) the
dividends-received deduction, in the case of corporate shareholders; or (ii)
treatment as “qualified dividend income,” in the case of non-corporate
shareholders. In addition, to qualify again to be taxed as a regulated
investment company in a subsequent year, the Fund would be required to
distribute to shareholders its earnings and profits attributable to
non-qualifying years. Further, if the Fund failed to qualify for a period
greater than two taxable years, then, in order to qualify as a regulated
investment company in a subsequent year, the Fund would be required to elect to
recognize and pay tax on any net built-in gain (i.e., the excess of aggregate
gain, including items of income, over aggregate loss that would have been
realized if the Fund had been liquidated) or, alternatively, be subject to
taxation on such built-in gain recognized for a period of five
years.
57
Excise
Tax on Regulated Investment Companies
A
4% non-deductible excise tax is imposed on a regulated investment company that
fails to distribute in each calendar year an amount equal to
at least the sum of (i) 98% of its ordinary taxable income for the calendar year
and (ii) 98.2% of its capital gain net income for the one-year period ended on
October 31 of such calendar year (or, with respect to capital gain net income,
at the election of a regulated investment company having a taxable year ending
November 30 or December 31, for its taxable year (a “taxable year election”)).
Tax-exempt interest on municipal obligations is not subject to the excise tax.
The balance of such income must be distributed during the next calendar year.
For the foregoing purposes, any ordinary income or capital gain net income
retained by a regulated investment company that is subject to corporate income
tax will be treated as having been distributed during the taxable year ending in
such calendar year.
Each
Fund intends to make sufficient distributions or deemed distributions of its
ordinary taxable income and capital gain net income prior to
the end of each calendar year to avoid liability for the excise tax. However,
investors should note that a Fund may in certain circumstances be required to
liquidate portfolio investments to make sufficient distributions to avoid excise
tax liability.
Fund
Investments
In
general, gain or loss recognized by a Fund on the disposition of an asset will
be a capital gain or loss. In addition, gain will be recognized
as a result of certain constructive sales, including short sales “against the
box.” However, gain recognized on the disposition of a debt obligation
(including municipal obligations) purchased by a Fund at a market discount
(generally, at a price less than its principal amount) will be treated as
ordinary income to the extent of the portion of the market discount that accrued
while the Fund held the debt obligation. In addition, under the rules of Code
Section 988, gain or loss recognized on the disposition of a debt obligation
denominated in a foreign currency or an option with respect thereto, and gain or
loss recognized on the disposition of a foreign currency forward contract,
futures contract, option or similar financial instrument, or of foreign currency
itself, except for regulated futures contracts or non-equity options subject to
Code Section 1256 (unless a Fund elects otherwise), generally will be treated as
ordinary income or loss to the extent attributable to changes in foreign
currency exchange rates.
Certain
transactions that may be engaged in by a Fund (such as regulated futures
contracts, certain foreign currency contracts and options on
stock indexes and futures contracts) will be subject to special tax treatment as
“Section 1256 Contracts.” Section 1256 Contracts are treated as if they are sold
for their fair market value on the last business day of the taxable year, even
though a taxpayer’s obligations (or rights) under such Section 1256 Contracts
have not terminated (by delivery, exercise, entering into a closing transaction,
or otherwise) as of such date. Any gain or loss recognized as a consequence of
the year-end deemed disposition of Section 1256 Contracts is taken into account
for the taxable year together with any other gain or loss that was recognized
previously upon the termination of Section 1256 Contracts during that taxable
year. Any capital gain or loss for the taxable year with respect to Section 1256
Contracts (including any capital gain or loss arising as a consequence of the
year-end deemed sale of such Section 1256 Contracts) generally is treated as 60%
long-term capital gain or loss and 40% short-term capital gain or loss. A Fund,
however, may elect not to have this special tax treatment apply to Section 1256
Contracts that are part of a “mixed straddle” with other investments of the Fund
that are not Section 1256 Contracts.
A
Fund may enter into notional principal contracts, including interest rate swaps,
caps, floors and collars. Treasury Regulations provide, in
general, that the net income or net deduction from a notional principal contract
for a taxable year is included in or deducted from gross income for that taxable
year. The net income or deduction from a notional principal contract for a
taxable year equals the total of all of the periodic payments (generally,
payments that are payable or receivable at fixed periodic intervals of one year
or less during the entire term of the contract) that are recognized from that
contract for the taxable year, all of the non-periodic payments (including
premiums for caps, floors and collars) that are recognized from that contract
for the taxable year and any termination payments that are recognized from that
contract for the taxable year. No portion of a payment by a party to a notional
principal contract is recognized prior to the first year to which any portion of
a payment by the counterparty relates. A periodic payment is recognized ratably
over the period to which it relates. In general, a non-periodic payment must be
recognized over the term of the notional principal contract in a manner that
reflects the economic substance of the contract. A non-periodic payment that
relates to an interest rate swap, cap, floor, or collar is recognized over the
term of the contract by allocating it in accordance with the values of a series
of cash-settled forward or option contracts that reflect the specified index and
notional principal amount upon which the notional principal contract is based
(or under an alternative method provided in Treasury Regulations). A termination
payment is recognized in the year the notional principal contract is
extinguished, assigned, or terminated (i.e., in the year the termination payment
is made).
Income
from options on individual securities written by a Fund will not be recognized
by the Fund for tax purposes until an option is
exercised or lapses. Any gain recognized by a Fund on the lapse of, or any gain
or loss recognized by a Fund from a closing transaction with respect to, an
option written by the Fund will be treated as a short-term capital gain or loss.
If the Fund enters into a closing transaction, the difference between the
premiums received and the amount paid by the Fund to close out its position will
generally be treated as short-term capital gain or loss. If an option written by
the Fund is exercised, thereby requiring the Fund to sell the underlying
security, the premium will increase the amount realized upon the sale of the
security, and the character of any gain on such sale of the underlying security
as short-term or long-term capital gain will depend on the holding period of the
Fund in the
58
underlying
security. Because the Fund will not have control over the exercise of the
options it writes, such exercises or other required sales of
the underlying securities may cause the Fund to realize gains or losses at
inopportune times.
A
Fund may purchase securities of certain foreign investment funds or trusts that
constitute passive foreign investment companies (“PFICs”)
for federal income tax purposes. If a Fund invests in a PFIC, it has three
separate options. First, it may elect to treat the PFIC as a qualified electing
fund (a “QEF”), in which event the Fund will each year have ordinary income
equal to its pro rata share of the PFIC’s ordinary earnings for the year and
long-term capital gain equal to its pro rata share of the PFIC’s net capital
gain for the year, regardless of whether the Fund receives distributions of any
such ordinary earnings or capital gains from the PFIC, and such amounts would be
subject to the 90% and excise tax distribution requirements described above. In
order to make this election with respect to a PFIC in which it invests, a Fund
must obtain certain information from the PFIC on an annual basis, which the PFIC
may be unwilling or unable to provide. Second, a Fund that invests in marketable
stock of a PFIC may make a mark-to-market election with respect to such stock.
Pursuant to such election, the Fund will include as ordinary income any excess
of the fair market value of such stock at the close of any taxable year over the
Fund’s adjusted tax basis in the stock. If the adjusted tax basis of the PFIC
stock exceeds the fair market value of the stock at the end of a given taxable
year, such excess will be deductible as ordinary loss in an amount equal to the
lesser of the amount of such excess or the net mark-to-market gains on the stock
that the Fund included in income in previous years. Solely for purposes of Code
Sections 1291 through 1298, the Fund’s holding period with respect to its PFIC
stock subject to the election will commence on the first day of the first
taxable year beginning after the last taxable year for which the mark-to-market
election applied. If the Fund makes the mark-to-market election in the first
taxable year it holds PFIC stock, it will not incur the tax described below
under the third option.
Finally,
if a Fund does not elect to treat the PFIC as a QEF and does not make a
mark-to-market election, then, in general, (1) any gain recognized
by the Fund upon the sale or other disposition of its interest in the PFIC or
any excess distribution received by the Fund from the PFIC will be allocated
ratably over the Fund’s holding period of its interest in the PFIC stock, (2)
the portion of such gain or excess distribution so allocated to the year in
which the gain is recognized or the excess distribution is received shall be
included in the Fund’s gross income for such year as ordinary income (and the
distribution of such portion by the Fund to shareholders will be taxable as a
dividend, but such portion will not be subject to tax at the Fund level), (3)
the Fund shall be liable for tax on the portions of such gain or excess
distribution so allocated to prior years in an amount equal to, for each such
prior year, (i) the amount of gain or excess distribution allocated to such
prior year multiplied by the highest corporate tax rate in effect for such prior
year, plus (ii) interest on the amount determined under clause (i) for the
period from the due date for filing a return for such prior year until the date
for filing a return for the year in which the gain is recognized or the excess
distribution is received, at the rates and methods applicable to underpayments
of tax for such period, and (4) the distribution by the Fund to its shareholders
of the portions of such gain or excess distribution so allocated to prior years
(net of the tax payable by the Fund thereon) will be taxable to the shareholders
as a dividend.
Some
of the debt securities (with a fixed maturity date of more than one year from
the date of issuance) that may be acquired by the Fund may
be treated as debt securities that are issued originally at a discount.
Generally, the amount of the original issue discount (“OID”) is treated as
interest income and is included in income over the term of the debt security,
even though payment of that amount is not received until a later time, usually
when the debt security matures. A portion of the OID includable in income with
respect to certain high-yield corporate debt securities (including certain
pay-in-kind securities) may be treated as a dividend for U.S. federal income tax
purposes.
Some
of the debt securities (with a fixed maturity date of more than one year from
the date of issuance) that may be acquired by the Fund in
the secondary market may be treated as having market discount. Generally, any
gain recognized on the disposition of, and any partial payment of principal on,
a debt security having market discount is treated as ordinary income to the
extent the gain, or principal payment, does not exceed the “accrued market
discount” on such debt security. Market discount generally accrues in equal
daily installments. The Fund may make one or more of the elections applicable to
debt securities having market discount, which could affect the character and
timing of recognition of income.
A
Fund that holds the foregoing kinds of securities may be required to pay out as
an income distribution each year an amount, which is greater
than the total amount of cash interest the Fund actually received. Such
distributions may be made from the cash assets of the Fund or by liquidation of
portfolio securities, if necessary (including when it is not advantageous to do
so). The Fund may realize gains or losses from such liquidations. In the event
the Fund realizes net capital gains from such transactions, its shareholders may
receive a larger capital gain distribution, if any, than they would in the
absence of such transactions.
Gain
or loss on the sale of securities by the Fund will generally be long-term
capital gain or loss if the securities have been held by the Fund
for more than one year. Gain or loss on the sale of securities held for one year
or less will be short-term capital gain or loss.
The
Fund may invest in preferred securities or other securities the federal income
tax treatment of which may not be clear or may be subject to
recharacterization by the Internal Revenue Service (“IRS”). To the extent the
tax treatment of such securities or the income from such securities differs from
the tax treatment expected by the Fund, it could affect the timing or character
of income recognized by the Fund, potentially requiring the Fund to purchase or
sell securities, or otherwise change its portfolio, in order to comply with the
tax rules applicable to regulated investment companies under the
Code.
59
The
Fund may invest a portion of its net assets in below investment grade
securities. Investments in these types of securities may present
special tax issues for the Fund. Federal income tax rules are not entirely clear
about issues such as when the Fund may cease to accrue interest, original issue
discount or market discount, when and to what extent deductions may be taken for
bad debts or worthless securities, how payments received on obligations in
default should be allocated between principal and interest and whether
modifications or exchanges of debt obligations in a bankruptcy or workout
context are taxable. These and other issues could affect the Fund’s ability to
distribute sufficient income to preserve its status as a regulated investment
company or to avoid the imposition of U.S. federal income or excise
tax.
Fund
Distributions
Each
Fund anticipates distributing substantially all of its investment company
taxable income for each taxable year. Such distributions will be
treated as dividends for federal income tax purposes and may be taxable to
non-corporate shareholders as long-term capital gains (a “qualified dividend”),
provided that certain requirements, as discussed below, are met. Dividends
received by corporate shareholders and dividends that do not constitute
qualified dividends are taxable as ordinary income. The portion of dividends
received from a Fund that are qualified dividends generally will be determined
on a look-through basis. If the aggregate qualified dividends received by the
Fund are less than 95% of the Fund’s gross income (as specially computed), the
portion of dividends received from the Fund that constitute qualified dividends
will be reported by the Fund and cannot exceed the ratio that the qualified
dividends received by the Fund bears to its gross income. If the aggregate
qualified dividends received by the Fund equal at least 95% of its gross income,
then all of the dividends received from the Fund will constitute qualified
dividends.
No
dividend will constitute a qualified dividend (1) if it has been paid with
respect to any share of stock that the Fund has held for less than
61 days (91 days in the case of certain preferred stock) during the 121-day
period (181-day period in the case of certain preferred stock) beginning on the
date that is 60 days (90 days in the case of certain preferred stock) before the
date on which such share becomes ex-dividend with respect to such dividend,
excluding for this purpose, under the rules of Code Section 246(c), any period
during which the Fund has an option to sell, is under a contractual obligation
to sell, has made and not closed a short sale of, is the grantor of an option to
buy, or has otherwise diminished its risk of loss by holding other positions
with respect to, such (or substantially identical) stock; (2) if the
non-corporate shareholder fails to meet the holding period requirements set
forth in (1) with respect to its shares in the Fund to which the dividend is
attributable; or (3) to the extent that the Fund (or shareholder, as applicable)
is under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in property substantially similar or related
to stock with respect to which an otherwise qualified dividend is
paid.
Qualified
dividends are, in general, dividends from taxable U.S. corporations and certain
foreign corporations. Dividends from a foreign
corporation may be qualified dividends if (1) the stock with respect to which
the dividend is paid is readily tradable on an established securities market in
the United States, (2) the foreign corporation is incorporated in a possession
of the United States or (3) the foreign corporation is eligible for the benefits
of a comprehensive income tax treaty with the United States that includes an
exchange of information program (and that the Treasury Department determines to
be satisfactory for these purposes). The Treasury Department has issued guidance
identifying which treaties are satisfactory for these purposes. Notwithstanding
the above, dividends received from a foreign corporation that for the taxable
year of the corporation in which the dividend was paid, or the preceding taxable
year, is a PFIC will not constitute qualified dividends.
Distributions
attributable to dividends received by a Fund from domestic corporations will
qualify for the 50% dividends-received deduction
(“DRD”) for corporate shareholders only to the extent discussed below.
Distributions attributable to dividends paid by a foreign corporation, a REIT or
a corporation exempt from tax generally do not qualify for the DRD.
Ordinary
income dividends paid by a Fund with respect to a taxable year may qualify for
the 50% DRD generally available to corporations
(other than corporations such as S corporations, which are not eligible for the
deduction because of their special characteristics, and other than for purposes
of special taxes such as the accumulated earnings tax and the personal holding
company tax) to the extent of the amount of dividends received by the Fund from
domestic corporations for the taxable year. No DRD will be allowed with respect
to any dividend (1) if it has been received with respect to any share of stock
that the Fund has held for less than 46 days (91 days in the case of certain
preferred stock) during the 91-day period (181-day period in the case of certain
preferred stock) beginning on the date that is 45 days (90 days in the case of
certain preferred stock) before the date on which such share becomes ex-dividend
with respect to such dividend, excluding for this purpose under the rules of
Code Section 246(c) any period during which the Fund has an option to sell, is
under a contractual obligation to sell, has made and not closed a short sale of,
is the grantor of an option to buy, or has otherwise diminished its risk of loss
by holding other positions with respect to, such (or substantially identical)
stock; (2) to the extent that the Fund is under an obligation (pursuant to a
short sale or otherwise) to make related payments with respect to positions in
substantially similar or related property; or (3) to the extent the stock on
which the dividend is paid is treated as debt-financed under the rules of Code
Section 246A. Moreover, the DRD for a corporate shareholder may be disallowed or
reduced (1) if the corporate shareholder fails to satisfy the foregoing
requirements with respect to its shares of the Fund or (2) by application of
Code Section 246(b), which in general limits the DRD to 50% of the shareholder’s
taxable income (determined without regard to the DRD and certain other
items).
60
If
a Fund receives a dividend (other than a capital gain dividend) in respect of
any share of REIT stock, then Fund dividends attributable to that
REIT dividend income (as reduced by certain Fund expenses) may be reported by
the Fund as eligible for the 20% deduction for “qualified REIT dividends”
generally available to non-corporate shareholders under the Code. However, a
dividend from a Fund may not be treated as a qualified REIT dividend (1) if it
has been paid with respect to any share of REIT stock that the Fund has held for
less than 46 days during the 91-day period beginning on the date that is 45 days
before the date on which such share becomes ex-dividend with respect to such
dividend, excluding for this purpose, under the rules of Code Section 246(c),
any period during which the Fund has an option to sell, is under a contractual
obligation to sell, has made and not closed a short sale of, is the grantor of
an option to buy, or has otherwise diminished its risk of loss by holding other
positions with respect to, such (or substantially identical) stock; (2) if the
non-corporate shareholder fails to meet the holding period requirements set
forth in (1) with respect to its shares in the Fund to which the dividend is
attributable; or (3) to the extent that the Fund (or shareholder, as applicable)
is under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in property substantially similar or related
to stock with respect to which an otherwise qualified dividend is
paid.
A
Fund may either retain or distribute to shareholders its net capital gain for
each taxable year. Each Fund currently intends to distribute any such
amounts. If net capital gain is distributed and reported as a capital gain
dividend, it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or whether
such gain was recognized by the Fund prior to the date on which the shareholder
acquired his shares. The Code provides, however, that under certain conditions
none of the capital gain recognized upon a Fund’s disposition of domestic
qualified “small business” stock will be subject to tax (with certain
limitations).
Conversely,
if a Fund elects to retain its net capital gain, the Fund will be subject to tax
thereon (except to the extent of any available capital
loss carryovers) at the corporate tax rates. If a Fund elects to retain its net
capital gain, it is expected that the Fund also will elect to have shareholders
of record on the last day of its taxable year treated as if each received a
distribution of his pro rata share of such gain, with the result that each
shareholder will be required to report his pro rata share of such gain on his
tax return as long-term capital gain, will receive a refundable tax credit for
his pro rata share of tax paid by the Fund on the gain, and will increase the
tax basis for his shares by an amount equal to the deemed distribution less the
tax credit. Organizations or persons not subject to U.S. federal income tax on
such capital gains will be entitled to a refund of their pro rata share of such
taxes paid by the Fund upon filing appropriate returns or claims for refund with
the IRS.
Distributions
by a Fund in excess of its current and accumulated earnings and profits will be
treated as a tax-free return of capital to the extent
of (and in reduction of) the shareholder’s tax basis in his shares; any excess
will be treated as gain from the sale of his shares, as discussed
below.
Distributions
by a Fund will be treated in the manner described above regardless of whether
such distributions are paid in cash or reinvested
in additional shares of the Fund (if that option is available). Distributions
reinvested in additional shares of the Fund through the means of a dividend
reinvestment service, if available, will be taxable to shareholders acquiring
the additional shares to the same extent as if such distributions had been
received in cash. In addition, if the NAV at the time a shareholder purchases
shares of a Fund reflects undistributed net investment income, recognized net
capital gain, or unrealized appreciation in the value of the assets of the Fund,
distributions of such amounts will be taxable to the shareholder in the manner
described above, although such distributions economically constitute a return of
capital to the shareholder.
Ordinarily,
shareholders are required to take distributions by a Fund into account in the
year in which the distributions are made. However,
dividends declared in October, November, or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and paid by a Fund) on December 31 of
such calendar year if such dividends are actually paid in January of the
following year. In addition, certain other distributions made after the close of
the Fund’s taxable year may be “spilled back” and treated as paid by the Fund
(except for the purposes of the 4% nondeductible excise tax) during such taxable
year. In such case, a shareholder will be treated as having received such
dividends in the taxable year in which the distributions were actually made.
Shareholders will be advised annually as to the U.S. federal income tax
consequences of distributions made (or deemed made) during the
year.
Certain
U.S. shareholders, including individuals and estates and trusts, are subject to
an additional 3.8% Medicare tax on all or a portion of their
“net investment income,” which should include dividends from a Fund and net
gains from the disposition of shares of a Fund. U.S. shareholders are urged to
consult their own tax advisers regarding the implications of the additional
Medicare tax resulting from an investment in a Fund.
Each
Fund will be required in certain cases to withhold and remit to the U.S.
Treasury backup withholding taxes at the applicable rate on
distributions paid to any shareholder (1) who has failed to provide a correct
taxpayer identification number, (2) who is subject to backup withholding for
failure to report the receipt of interest or dividend income properly, or (3)
who has failed to certify to the Fund that it is not subject to backup
withholding or is an “exempt recipient” (such as a corporation). Amounts
withheld under the backup withholding rules will be allowed as a refund or a
credit against a shareholder’s U.S. federal income tax liability provided the
required information is furnished to the IRS.
61
Sale
of Shares
A
shareholder will generally recognize gain or loss on the sale of shares of a
Fund in an amount equal to the difference between the proceeds
of the sale the shareholder’s adjusted tax basis in the shares. All or a portion
of any loss may be disallowed if the shareholder purchases other shares of the
same Fund within 30 days before or after the sale. In such a case, the basis of
the shares acquired will be increased to reflect the disallowed loss. In
general, any gain or loss arising from (or treated as arising from) the sale of
shares of a Fund will be considered capital gain or loss and will be long-term
capital gain or loss if the shares were held for longer than one year. However,
any capital loss arising from the sale of shares held for six months or less
will be disallowed to the extent of the amount of exempt-interest dividends
received on such shares (unless the loss is with respect to shares of a Fund for
which the holding period began after December 22, 2010, and the Fund declares
exempt-interest dividends on a daily basis in an amount equal to at least 90% of
its net tax-exempt interest and distributes such dividends at least monthly) and
(to the extent not disallowed) will be treated as a long-term capital loss to
the extent of the amount of capital gain dividends received on such shares. For
these purposes, the special holding period rules of Code Section 246(c)
(discussed above in connection with qualified dividends, qualified REIT
dividends and the dividends-received deduction) generally will apply in
determining the holding period of shares. Capital losses in any year are
deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.
Tax
Shelter and Other Reporting Requirements
If
a shareholder realizes a loss on the disposition of shares of a Fund of at least
$2 million in any single taxable year or at least $4 million
in any combination of taxable years for an individual shareholder, or at least
$10 million in any single taxable year or at least $20 million in any
combination of taxable years for a corporate shareholder, the shareholder must
file with the IRS a disclosure statement on Form 8886. Shareholders should
consult their tax advisers to determine the applicability of this requirement in
light of their individual circumstances.
Foreign
Taxation
Income
received by a Fund from sources within foreign countries may be subject to
withholding and other taxes imposed by such countries.
Tax treaties and conventions between certain countries and the United States may
reduce or eliminate such taxes. If more than 50% of the value of a Fund’s total
assets at the close of its taxable year consists of securities of foreign
corporations, the Fund may be able to elect to “pass through” to the Fund’s
shareholders the amount of eligible foreign income and similar taxes paid by the
Fund. If this election is made, a shareholder generally subject to tax will be
required to include in gross income (in addition to taxable dividends actually
received) his or her pro rata share of the foreign taxes paid by the Fund, and
may be entitled either to deduct (as an itemized deduction) his or her pro rata
share of foreign taxes in computing his or her taxable income or to use it as a
foreign tax credit against his or her U.S. federal income tax liability, subject
to certain limitations. In particular, a shareholder must hold his or her shares
(without protection from risk of loss) on the ex-dividend date and for at least
15 more days during the 30-day period surrounding the ex-dividend date to be
eligible to claim a foreign tax credit with respect to a gain dividend. No
deduction for foreign taxes may be claimed by a non-corporate shareholder who
does not itemize deductions. Each shareholder will be notified days after the
close of the Fund’s taxable year whether the foreign taxes paid by the Fund will
“pass through” for that year.
Generally,
a credit for foreign taxes is subject to the limitation that it may not exceed
the shareholder’s U.S. tax attributable to his or her total
foreign source taxable income. For this purpose, if the pass-through election is
made, the source of the Fund’s income will flow through to shareholders of the
Fund. With respect to a Fund, gains from the sale of securities will be treated
as derived from U.S. sources and certain currency fluctuation gains, including
fluctuation gains from foreign currency-denominated debt securities, receivables
and payables will be treated as ordinary income derived from U.S. sources. The
limitation on the foreign tax credit is applied separately to foreign source
passive income, and to certain other types of income. A shareholder may be
unable to claim a credit for the full amount of his or her proportionate share
of the foreign taxes paid by the Fund.
Foreign
Shareholders
Taxation
of a shareholder who, as to the United States, is a nonresident alien individual
or foreign corporation (“foreign shareholder”), depends on
whether the income from a Fund is “effectively connected” with a U.S. trade or
business carried on by such shareholder.
If
the income from a Fund is not effectively connected with a U.S. trade or
business carried on by a foreign shareholder, subject to the
discussion below with respect to “interest-related dividends” and “short-term
capital gain dividends,” ordinary income dividends (including dividends that
would otherwise be treated as qualified dividends to an applicable non-foreign
shareholder) paid to such foreign shareholder would be subject to a 30% U.S.
withholding tax (or lower applicable treaty rate) upon the gross amount of the
dividend. Such foreign shareholder would generally be exempt from U.S. federal
income tax, including withholding tax, on gains realized on the sale of shares
of a Fund or capital gain dividends unless the foreign shareholder is a
nonresident alien individual present in the United States for a period or
periods aggregating 183 days or more during the calendar
year.
62
U.S.
withholding tax generally does not apply to amounts properly designated by a
Fund as an “interest-related dividend” or a “short-term
capital gain dividend.” The aggregate amount treated as an interest-related
dividend for a year is limited to the Fund’s qualified net interest income for
the year, which is the excess of the sum of the Fund’s qualified interest income
(generally, its U.S.-source interest income) over the deductions properly
allocable to such income. The aggregate amount treated as a “short-term capital
gain dividend” is limited to the excess of the Fund’s net short-term capital
gain over its net long-term capital loss. In order to qualify for this exemption
from withholding, a foreign investor needs to comply with applicable
certification requirements relating to its non-U.S. status (including, in
general, furnishing an IRS Form W-8BEN, W-8BEN-E or substitute Form). In the
case of shares held through an intermediary, the intermediary may withhold even
if the Fund reported the payment as qualified net interest income or qualified
short-term capital gain. Foreign investors should contact their intermediaries
with respect to the application of these rules to their accounts.
If
the income from a Fund is effectively connected with a U.S. trade or business
carried on by a foreign shareholder, then any dividends, and any
gains realized upon the sale of shares of the Fund will be subject to U.S.
federal income tax at the rates applicable to U.S. citizens or domestic
corporations, and, if the foreign shareholder is a corporation, the shareholder
may be subject to an additional “branch profits tax” imposed at the rate of 30%
(or lower applicable treaty rate).
In
the case of foreign noncorporate shareholders, a Fund may be required to
withhold backup withholding taxes at the applicable rate on
distributions that are otherwise exempt from withholding tax (or taxable at a
reduced treaty rate) unless such shareholders furnish the Fund with proper
notification of their foreign status.
Special
rules may apply to a foreign shareholder receiving a Fund distribution if at
least 50% of the Fund’s assets consist of interests in U.S.
real property interests, including certain REITs and U.S. real property holding
corporations (as defined in the Code and Treasury Regulations). Fund
distributions that are attributable to gain from the disposition of a U.S. real
property interest will be taxable as ordinary dividends and subject to
withholding at a 30% or lower treaty rate if the foreign shareholder held no
more than 5% of the Fund's shares at any time during the one-year period ending
on the date of the distribution. If the foreign shareholder held at least 5% of
the Fund's shares, the distribution would be treated as income effectively
connected with a trade or business within the U.S. and the foreign shareholder
would be subject to withholding tax at a rate of 21% and would generally be
required to file a U.S. federal income tax return. Similar consequences would
generally apply to a foreign shareholder's gain on the sale of Fund shares
unless the Fund is domestically controlled (meaning that more than 50% of the
value of the Fund's shares is held by U.S. shareholders) or the foreign
shareholder owns no more than 5% of the Fund's shares at any time during the
five-year period ending on the date of sale. Finally, a domestically controlled
Fund may be required to recognize a portion of its gain on the in-kind
distribution of certain U.S. real property interests. Foreign shareholders are
urged to consult their own tax advisors concerning the particular tax
consequences to them of an investment in the Fund.
Under
the “Foreign Account Tax Compliance Act” and existing guidance thereunder,
commonly known as “FATCA,” a 30% withholding
tax on dividends paid by the Fund generally applies if paid to a foreign entity
unless: (i) if the foreign entity is a “foreign financial institution” as
defined under FATCA, the foreign entity undertakes certain due diligence,
reporting, withholding, and certification obligations, (ii) if the foreign
entity is not a “foreign financial institution,” it identifies certain of its
U.S. investors or (iii) the foreign entity is otherwise excepted under FATCA. If
withholding is required under FATCA on a payment related to any Fund
distribution, investors that otherwise would not be subject to withholding (or
that otherwise would be entitled to a reduced rate of withholding) on such
payment generally will be required to seek a refund or credit from the IRS to
obtain the benefit of such exemption or reduction. An intergovernmental
agreement between the United States and an applicable foreign country, or future
Treasury regulations or other guidance, may modify the foregoing requirements.
The Funds will not pay any additional amounts in respect of amounts withheld
under FATCA. Each investor should consult its tax adviser regarding the effect
of FATCA based on its individual circumstances.
The
tax consequences to a foreign shareholder entitled to claim the benefits of an
applicable tax treaty might be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in a Fund,
including the applicability of foreign taxes.
Cost
Basis Reporting
A
Fund is generally required by law to report to shareholders and the IRS on Form
1099-B “cost basis” information for shares of the Fund
acquired on or after January 1, 2012, and sold or redeemed after that date. Upon
a disposition of such shares, a Fund will be required to report the adjusted
cost basis, the gross proceeds from the disposition, and the character of
realized gains or losses attributable to such shares. These requirements do not
apply to investments through a tax-deferred arrangement, such as a 401(k) plan
or an individual retirement plan. The “cost basis” of a share is generally its
purchase price adjusted for returns of capital, and other corporate actions.
“Cost basis” is used to determine whether a sale or other disposition of the
shares results in a gain or loss.
The
Fund will permit shareholders to elect among several IRS-accepted cost basis
methods to determine the cost basis in their shares. If a
shareholder does not affirmatively elect a cost basis method, then the Fund’s
default cost basis calculation method, which is
63
currently
the average cost method, will be applied to their account. The cost basis method
elected or applied may not be changed after the
settlement date of a sale of shares.
If
a shareholder holds shares through a broker, the shareholder should contact that
broker with respect to the reporting of cost basis information.
Shareholders
are urged to consult their tax advisers regarding specific questions with
respect to the application of the new cost basis reporting
rules and, in particular, which cost basis calculation method to
elect.
Effect
of Future Legislation, Foreign, State and Local Tax Considerations
The
foregoing general discussion of U.S. federal income and excise tax consequences
is based on the Code and the Treasury Regulations
issued thereunder as in effect on the date of this SAI. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein and any such changes or decisions may have a
retroactive effect.
Rules
of foreign, state and local taxation of ordinary income dividends, qualified
dividends, exempt-interest dividends and capital gain dividends
from regulated investment companies may differ from the rules for U.S. federal
income taxation described above. Shareholders are urged to consult their tax
advisers as to the consequences of these and other foreign, state and local tax
rules affecting an investment in a Fund.
ADDITIONAL
INFORMATION
Description
of Shares
As
a Delaware statutory trust, the Trust need not hold regular annual shareholder
meetings and, in the normal course, does not expect to hold
such meetings. The Trust, however, must hold shareholder meetings for such
purposes as, for example: (1) approving certain agreements as required by the
1940 Act; (2) changing fundamental investment objectives, policies, and
restrictions of the Funds; and (3) filling vacancies on the Board of Trustees of
the Trust in the event that less than a majority of the Trustees were elected by
shareholders. Under the Trust’s Second Amended and Restated Agreement and
Declaration of Trust dated February 26, 2019 (“Declaration of Trust”), each
Trustee will continue in office until the termination of the Trust or his/her
earlier death, incapacity, resignation, or removal. Vacancies may be filled by a
majority of the remaining Trustees, except insofar as the 1940 Act may require
the election by shareholders. Therefore, the Trust expects that there will be no
meetings of shareholders for the purpose of electing Trustees unless and until
such time as less than a majority of the Trustees holding office have been
elected by shareholders or unless matters arise requiring a vote of shareholders
under the Declaration of Trust or the 1940 Act. At such time, the Trustees then
in office will call a shareholders meeting. In addition, holders of record of
not less than two-thirds of the outstanding shares of the Trust may remove a
Trustee from office by a vote cast in person or by proxy at a shareholder
meeting called for that purpose at the request of holders of 10% or more of the
outstanding shares of the Trust. The Funds have the obligation to assist in such
shareholder communications. Except as set forth above, Trustees will continue in
office and may appoint successor Trustees.
The
Declaration of Trust authorizes the Trustees to issue an unlimited number of
shares, which are units of beneficial interest, with no par value.
The Declaration of Trust authorizes the Trustees to divide or re-divide any
unissued shares of the Trust into one or more additional series by setting or
changing in any one or more aspects their respective preferences, conversion, or
other rights, voting power, restrictions, limitations as to dividends,
qualifications and terms and conditions of redemption.
Shares
have no subscription or preemptive rights and only such conversion or exchange
rights as the Trustees may grant in their discretion.
When issued for payment as described in the Prospectus and this SAI, the Trust’s
shares will be fully paid and non-assessable. In the event of a liquidation or
dissolution of the Trust, shares of a Fund are entitled to receive the assets
available for distribution belonging to the Fund, and a proportionate
distribution, based upon the relative asset values of the respective series, of
any general assets not belonging to any particular series that are available for
distribution. The Board may classify and reclassify the shares of a Fund into
classes of shares at a future date.
Fund
shareholders are entitled to one vote per share (with proportional voting for
fractional shares) on such matters as shareholders are
entitled to vote (“share-based voting”). Alternatively (except where the 1940
Act requires share-based voting), the Trustees in their discretion may determine
that shareholders are entitled to one vote per dollar of NAV (with proportional
voting for fractional dollar amounts). Shareholders of all series and classes
will vote together as a single class on all matters except (1) when required by
the 1940 Act or when the Trustees have determined that a matter affects one or
more series or classes materially differently, shares shall be voted by
individual series or class; and (2) when the Trustees have determined that the
matter affects only the interests of a particular series or class, then only
shareholders of such series or class shall be entitled to vote
thereon.
There
will normally be no meetings of shareholders for the purpose of electing
Trustees unless and until such time as less than a majority
of the Trustees have been elected by the shareholders, at which time the
Trustees then in office will call a shareholders’
64
meeting
for the election of Trustees. A meeting shall be held for such purpose upon the
written request of the holders of not less than one-third
of the outstanding shares. Upon written request by ten or more shareholders of
record meeting the qualifications of Section 16(c) of the 1940 Act, (i.e.,
persons who have been shareholders of record for at least six months, and who
hold shares having an NAV of at least $25,000 or constituting 1% of the
outstanding shares, whichever is less) stating that such shareholders wish to
communicate with the other shareholders for the purpose of obtaining the
signatures necessary to demand a meeting to consider removal of a Trustee, the
Trust will provide a list of shareholders or disseminate appropriate materials
(at the expense of the requesting shareholders). Except as set forth above, the
Trustees shall continue to hold office and may appoint their
successors.
The
Declaration of Trust permits the Trustees to take certain actions without
obtaining shareholder approval, if the Trustees determine that doing
so would be in the best interests of shareholders. These actions include: (a)
reorganizing a Fund with another investment company or another series of the
Trust; (b) liquidating a Fund; (c) restructuring a Fund into a “master/feeder”
structure, in which a Fund (the “feeder”) would invest all of its assets in a
separate “master” fund; and (d) amending the Declaration of Trust, unless
shareholder consent is required by law.
Rule
18f-2 under the 1940 Act provides that any matter required to be submitted to
the holders of the outstanding voting securities of an
investment company such as the Trust shall not be deemed to have been
effectively acted upon unless approved by the holders of a majority of the
outstanding shares, as defined under the 1940 Act, of the series affected by the
matter. For purposes of determining whether the approval of a majority of the
outstanding shares of a Fund will be required in connection with a matter, a
Fund will be deemed to be affected by a matter unless it is clear that the
interests of the Fund and any other series in the matter are identical, or that
the matter does not affect any interest of other series of the Trust. Under Rule
18f-2, the approval of an investment advisory agreement or any change in
investment policy would be effectively acted upon with respect to a Fund only if
approved by a majority of the outstanding shares of the Fund. However, Rule
18f-2 also provides that the ratification of independent accountants, the
approval of principal underwriting contracts, and the election of Trustees may
be effectively acted upon by shareholders of the Trust voting without regard to
series.
Shareholder
and Trustee Liability
The
Delaware Statutory Trust Act provides that a shareholder of a Delaware statutory
trust shall be entitled to the same limitation of personal
liability extended to shareholders of Delaware corporations and the Declaration
of Trust provides that shareholders of the Trust shall not be liable for the
obligations of the Trust. The Declaration of Trust also provides for
indemnification out of the trust property of any shareholder held personally
liable solely by reason of his or her being or having been a shareholder. The
risk of a shareholder incurring financial loss on account of shareholder
liability is considered to be extremely remote.
The
Declaration of Trust states further that to the fullest extent permitted by
Delaware law, no Trustee or officer of the Trust shall be personally
liable in connection with the administration or preservation of the assets of
the Funds or the conduct of the Trust’s business; nor shall any Trustee,
officer, or agent be personally liable to any person for any action or failure
to act except for his own bad faith, willful misfeasance, gross negligence, or
reckless disregard of his duties. The Declaration of Trust also provides that
all persons having any claim against the Trustees or the Trust shall look solely
to the assets of the Trust for payment.
Derivative
Actions Brought by Shareholders
Pursuant
to the Declaration of Trust, a shareholder may bring a derivative action on
behalf of the Trust only if the shareholder or shareholders
first make a pre-suit demand upon the Trustees to bring the subject action
unless an effort to cause the Trustees to bring such action is excused. A demand
on the Trustees shall only be excused if a majority of the Board, or a majority
of any committee established to consider the merits of such action, has a
personal financial interest in the action at issue. A Trustee shall not be
deemed to have a personal financial interest in an action or otherwise be
disqualified from ruling on a shareholder demand by virtue of the fact that such
Trustee receives remuneration from his service on the Board or on the boards of
one or more investment companies managed by the Adviser or that share the same
principal underwriter. For purposes of this requirement, the Board may designate
a committee of one Trustee to consider a shareholder demand if necessary to
create a committee with a majority of Trustees who do not have a personal
financial interest in the transaction at issue.
Disclosure
of Portfolio Holdings
The
Board has adopted policies and procedures with respect to the disclosure of each
Fund’s portfolio holdings by the Fund, the Adviser,
or their affiliates. These policies and procedures provide that each Fund’s
portfolio holdings information generally may not be disclosed to any party prior
to the information becoming public. Certain limited exceptions are described
below. These policies and procedures apply to disclosures to all categories of
persons, including individual investors, institutional investors, intermediaries
who sell shares of a Fund, third parties providing services to the Funds
(accounting agent, print vendors, etc.), rating and ranking organizations
(Lipper, Morningstar, etc.) and affiliated persons of the
Funds.
65
The
Trust’s Chief Compliance Officer is responsible for monitoring each Fund’s
compliance with these policies and procedures, and for
providing regular reports (at least annually) to the Board regarding the
adequacy and effectiveness of the policy and recommend changes, if
necessary.
Public
Disclosure
Each
business day, each Fund’s portfolio holdings information will generally be
provided for dissemination through the facilities of the
National Securities Clearing Corporation (“NSCC”) and/or other fee-based
subscription services to NSCC members and/or subscribers to those other
fee-based subscription services, including Authorized Participants (as defined
below), and to entities that publish and/or analyze such information in
connection with the process of purchasing or redeeming Creation Units or trading
shares of each Fund in the secondary market. This information typically reflects
the Fund’s anticipated holdings on the current business day.
For
in-kind creations, a basket composition file, which includes the names and
quantities of Deposit Securities to deliver in exchange for a
Creation Unit of shares, together with an estimated Cash Component for the
current business day, will be publicly disseminated daily prior to the opening
of the Exchange via the NSCC. The basket represents one Creation Unit of a Fund.
The Trust and the Adviser will not disseminate non-public information concerning
a Fund’s portfolio holdings. However, access to information concerning a Fund’s
portfolio holdings may be permitted to personnel of third party service
providers, including a Fund’s custodian, transfer agent, auditors, and counsel,
as may be necessary to conduct business in the ordinary course in a manner
consistent with such service providers’ agreements with the Trust on behalf of a
Fund. From time to time, information concerning portfolio holdings other than
portfolio holding information made available in connection with the Creation
Unit process, as discussed above, may be provided to other entities that provide
services to the Funds, including rating or raking organizations, in the ordinary
course of business, no earlier than one business day following the date of the
information.
The
Funds also disclose their complete portfolio holdings in its annual and
semiannual reports to shareholders, which are sent to shareholders
no later than 60 days after the relevant fiscal period (June 30th and December
31st, respectively) and are available on the Funds’ website,
VictorySharesLiterature.com. The Funds also file their complete portfolio
holdings with the SEC for the first and third fiscal quarters on Form N-PORT.
You can find these filings on the SEC’s website, www.sec.gov.
Non-Public
Disclosures
The
Adviser may authorize the disclosure of non-public portfolio holdings
information under certain limited circumstances. The Funds’ policies
provide that non-public disclosures of a Fund’s portfolio holdings may only be
made if: (i) the Fund has a “legitimate business purpose” (as determined by the
President of the Trust) for making such disclosure; and (ii) the party receiving
the non-public information enters into a confidentiality agreement, which
includes a duty not to trade on the non-public information and describes any
compensation to be paid to the Fund or any “affiliated person” of the Adviser or
Distributor, including any arrangement to maintain assets in the Fund or in
other investment companies or accounts managed by the Adviser or by any
“affiliated person” of the Adviser or Distributor.
The
Adviser will consider any actual or potential conflicts of interest between the
Adviser and a Fund’s shareholders and will act in the best
interest of the Fund’s shareholders with respect to any such disclosure of
portfolio holdings information. If a potential conflict can be resolved in a
manner that does not present detrimental effects to Fund shareholders, the
Adviser may authorize release of portfolio holdings information. Conversely, if
the potential conflict cannot be resolved in a manner that does not present
detrimental effects to Fund shareholders, the Adviser will not authorize such
release.
Expenses
Unless
agreed upon otherwise with a third party, all expenses incurred in
administration of the Funds will be charged to a particular Fund,
including investment management fees; fees and expenses of the Board; interest
charges; taxes; brokerage commissions; expenses of valuing assets; expenses of
continuing registration and qualification of the Funds and the shares under
federal and state law; share issuance expenses; fees and disbursements of
independent accountants and legal counsel; fees and expenses of custodians,
including, transfer agents and shareholder account servicing organizations;
expenses of preparing, printing and mailing prospectuses, reports, proxies,
notices and statements sent to shareholders; expenses of shareholder meetings;
costs of investing in underlying funds; and insurance premiums. The Funds are
also liable for nonrecurring expenses, including litigation to which they may
from time to time be a party. Expenses incurred for the operation of a
particular Fund, including the expenses of communications with its shareholders,
are paid by that Fund.
Legal
Counsel
Sidley
Austin LLP, 787 Seventh Avenue, New York, New York 10019, serves as counsel to
the Trust.
66
Independent
Registered Public Accounting Firm
Cohen
& Company, Ltd., located at 1350 Euclid Avenue, Suite 800, Cleveland, OH
44115, serves as the independent registered public accounting
firm for the Funds.
Miscellaneous
As
used in the Prospectuses and in this SAI, “assets belonging to a fund” (or
“assets belonging to the Fund”) means the consideration received
by the Trust upon the issuance or sale of shares of a Fund, together with all
income, earnings, profits and proceeds derived from the investment thereof,
including any proceeds from the sale, exchange, or liquidation of such
investments and any funds or payments derived from any reinvestment of such
proceeds and any general assets of the Trust, which general liabilities and
expenses are not readily identified as belonging to a particular series that are
allocated to that series by the Trustees. The Trustees may allocate such general
assets in any manner they deem fair and equitable. It is anticipated that the
factor that will be used by the Trustees in making allocations of general assets
to a particular series will be the relative NAV of each respective series at the
time of allocation. Assets belonging to a particular series are charged with the
direct liabilities and expenses in respect of that series and with a share of
the general liabilities and expenses of each of the series not readily
identified as belonging to a particular series, which are allocated to each
series in accordance with its proportionate share of the NAVs of the Trust at
the time of allocation. The timing of allocations of general assets and general
liabilities and expenses of the Trust to a particular series will be determined
by the Trustees and will be in accordance with generally accepted accounting
principles. Determinations by the Trustees as to the timing of the allocation of
general liabilities and expenses and as to the timing and allocable portion of
any general assets with respect to a particular series are
conclusive.
As
used in the Prospectuses and in this SAI, a “vote of a majority of the
outstanding shares” of the Fund means the affirmative vote of the
lesser of (a) 67% or more of the shares of the Fund present at a meeting at
which the holders of more than 50% of the outstanding shares of the Fund are
represented in person or by proxy, or (b) more than 50% of the outstanding
shares of the Fund.
Each
Prospectus and this SAI are not an offering of the securities described in these
documents in any state in which such offering
may not lawfully be made. No salesperson, dealer, or other person is authorized
to give any information or make any representation other than those contained in
a Prospectus and this SAI.
While
this SAI and each Prospectus describe pertinent information about the Trust and
the Funds, neither this SAI nor any Prospectus
represents a contract between the Trust or a Fund and any
shareholder.
67
APPENDIX
A
Description
of Security Ratings
Set
forth below are descriptions of the relevant ratings of some of the NRSROs.
These NRSROs and the descriptions of the ratings are as of
the date of this SAI and may subsequently change.
Ratings
represent a rating agency’s opinion regarding the quality of the security and
are not a guarantee of quality. In addition, rating agencies
may fail to make timely changes to credit ratings in response to subsequent
events and a rating may become stale in that it fails to reflect changes in an
issuer’s financial condition.
Moody’s
Investors Service, Inc. (“Moody’s”)
Global
Long-Term Ratings. Ratings
assigned on Moody’s global long-term rating scales are forward-looking opinions
of the relative credit risks of financial obligations issued by non-financial
corporates, financial institutions, structured finance vehicles, project finance
vehicles, and public sector entities. Moody’s defines credit risk as the risk
that an entity may not meet its contractual financial obligations as they come
due and any estimated financial loss in the event of default or impairment. The
contractual financial obligations addressed by Moody’s ratings are those that
call for, without regard to enforceability, the payment of an ascertainable
amount, which may vary based upon standard sources of variation (e.g., floating
interest rates), by an ascertainable date. Moody’s rating addresses the issuer’s
ability to obtain cash sufficient to service the obligation, and its willingness
to pay. Moody’s ratings do not address non-standard sources of variation in the
amount of the principal obligation (e.g., equity indexed), absent an express
statement to the contrary in a press release accompanying an initial rating.
Long-term ratings are assigned to issuers or obligations with an original
maturity of 11 months or more and reflect both on the likelihood of a default or
impairment on contractual financial obligations and the expected financial loss
suffered in the event of default or impairment. The following describes the
global long- term ratings by Moody’s.
Aaa
—
Obligations rated Aaa are judged to be of the highest quality, subject to the
lowest level of credit risk.
Aa
—
Obligations rated Aa are judged to be of high quality and are subject to very
low credit risk.
A
—
Obligations rated A are judged to be upper-medium grade and are subject to low
credit risk.
Baa
—
Obligations rated Baa are judged to be medium-grade and subject to moderate
credit risk and as such may possess certain speculative
characteristics.
Ba