ADDITIONAL INVESTMENT TECHNIQUES AND RISKS
Additional information concerning investment techniques and
risks associated with certain of the Funds investments is set forth below. Unless otherwise indicated above in Investment Restrictions or below, the following discussion pertains to each of the Funds. From time to time, particular
Funds may purchase these securities or enter into these strategies to an extent that is more than incidental. The Funds may be restricted or prohibited from using certain of the investment techniques described below, as indicated under the heading
Investment Restrictions.
Bank
Obligations
A Fund may invest in bank
obligations such as bankers acceptances, certificates of deposit, and time deposits. Bankers acceptances are negotiable drafts or bills of exchange typically drawn by an importer or exporter to pay for specific merchandise, which are
accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Bankers acceptances, along with notes issued by banking institutions, are only as secure as the
creditworthiness of the issuing or accepting depository institution. Certificates of deposit are negotiable certificates issued against funds deposited in a commercial bank or a savings and loan association for a definite period of time and earning
a specified return.
Borrowing
Each Fund may borrow for temporary administrative or
emergency purposes and this borrowing may be unsecured. Under the 1940 Act, a Fund is required to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount
borrowed. If the 300% asset coverage should decline as a result of market fluctuations or other reasons, a Fund may be required to sell some of its portfolio holdings within three days to reduce its borrowings and restore the 300% asset coverage,
even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing may exaggerate the effect on net asset value of any increase or decrease in the market value of the portfolio. Money borrowed will be
subject to interest costs which may or may not be recovered by appreciation of the securities purchased; in certain cases, interest cost may exceed the return received on the securities purchased. A Fund also may be required to maintain minimum
average balances in connection with such borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate.
Commercial Paper and Variable Amount Demand Master Notes
A Fund may invest in commercial paper, which
represent short-term unsecured promissory notes issued (in bearer form) by banks or bank holding companies, corporations and finance companies. A Fund may also invest in variable amount demand master notes, which are corporate obligations of issuing
organizations that share the credit profile of commercial paper (
e.g.
, banks or corporations). The distinct difference between commercial paper and variable amount demand master notes is in the liquidity characteristics of the issuance. While
commercial paper is mostly negotiable, with a robust secondary trading market for rated issuers, variable amount demand master notes are issued by a bank or corporation and liquidated on demand. Further, there is no secondary market for variable
amount demand master notes. Typically the issuance of a variable amount demand master note consists of two parts, an A note and a B note. Both carry an interest rate higher than the commercial paper issued by the same issuer,
meant to compensate for the increased liquidity risk. Most often the A note is for a fixed investment amount, and can only be redeemed with a fixed notice, such as six to twelve months. The B note can be redeemed at any time
for any amount presently outstanding.
In
selecting commercial paper and other corporate obligations for investment by a Fund and/or Forward Management also considers information concerning the financial history and condition of the issuer and its revenue and expense prospects. If
commercial paper or another corporate obligation held by a Fund is assigned a lower rating or ceases to be rated, Forward Management will promptly reassess whether that security presents credit risks consistent with the Funds credit quality
restrictions and whether the Fund should continue to hold the security in its portfolio. If a portfolio security no longer presents credit risks consistent with the Funds credit quality restrictions or is in default, the Fund will dispose of
the security as soon as reasonably practicable unless Forward Management determines that to do so is not in the best interests of the Fund and its shareholders. Variable amount demand master notes with demand periods of greater than seven days will
be deemed to be liquid and only if they are determined to be so in compliance with procedures approved by the Board of Trustees.
Convertible Securities
A Fund may invest in convertible securities, which may offer higher income than the common stocks into which they are convertible.
Typically, convertible securities are callable by the company, which may, in effect, force conversion before the holder would otherwise choose.
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The convertible securities in which a Fund may invest consist of bonds, notes, debentures,
and preferred stocks that may be converted or exchanged at a stated or determinable exchange ratio into underlying shares of common stock. A Fund may be required to permit the issuer of a convertible security to redeem the security, convert it into
the underlying common stock or sell it to a third party. Thus, the Fund may not be able to control whether the issuer of a convertible security chooses to force conversion of that security. If the issuer chooses to do so, this action could have an
adverse effect on a Funds ability to achieve its investment objective.
In carrying out this policy, a Fund may purchase convertible bonds and convertible preferred stock which may be exchanged for a stated number of shares of the issuers common stock at a price known
as the conversion price. The conversion price is usually greater than the price of the common stock at the time of purchase of the convertible security. The interest rate of convertible bonds and the yield of convertible preferred stock will
generally be lower than that of the non-convertible securities. While the value of the convertible securities will usually vary with the value of the underlying common stock and will normally fluctuate inversely with interest rates, it may show less
volatility in value than the non-convertible securities. A risk associated with the purchase of convertible bonds and convertible preferred stock is that the conversion price of the common stock will not be attained. The Funds will purchase only
those convertible securities which have underlying common stock with potential for long-term growth in the opinion of Forward Management.
Counterparty Credit Risk
Commodity and financial-linked derivative instruments are subject to the risk that the counterparty to the instrument might not pay
interest when due or repay principal at maturity of the obligation. If a counterparty defaults on its interest or principal payment obligations to a Fund, this default will cause the value of your investment in the Fund to decrease. In addition, a
Fund may invest in commodity- and financial-linked structured notes issued by a limited number of issuers, which will act as counterparties. To the extent a Fund focuses its investments in a limited number of issuers, it will be more susceptible to
the risks associated with those issuers.
Debt
Securities
The market value of debt
securities generally varies in response to changes in interest rates and the financial condition of each issuer. During periods of declining interest rates, the value of debt securities generally increases. Conversely, during periods of rising
interest rates, the value of such securities generally declines. These changes in market value will be reflected in a Funds net asset value and could also impact the amount of income a Fund generates through debt investments. The rate of
interest on a corporate debt security may be fixed, floating or variable, and may vary inversely with respect to a reference rate. See Variable and Floating Rate Securities. The rate of return or return of principal on some debt
obligations may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies. An issuer of a debt security may repay principal prior to a securitys maturity, which can adversely affect a
Funds yield, particularly during periods of declining interest rates. Rising interest rates may cause prepayments to occur at slower than expected rates, which effectively lengthens the maturities of the affected securities, making them more
sensitive to interest rate changes and making a Funds net asset value more volatile.
A Fund may invest in debt securities that are rated between BBB and as low as CCC by S&P and between Baa and as low as Caa by Moodys or, if
unrated, are of equivalent investment quality as determined by Forward Management. Such debt securities may include preferred stocks, investment-grade corporate bonds, debentures and notes, and other similar corporate debt instruments, convertible
securities, municipal bonds, and high-quality short-term debt securities such as commercial paper, bankers acceptances, certificates of deposit, repurchase agreements, obligations insured or guaranteed by the U.S. government or its agencies,
and demand and time deposits of domestic banks, U.S. branches and subsidiaries of foreign banks and foreign branches of U.S. banks. Debt securities may be acquired with warrants attached. Corporate income-producing securities may also include forms
of preferred or preference stock. Investments in corporate debt securities that are rated below investment grade (rated below BBB by S&P or Baa by Moodys) are considered speculative with respect to the issuers
ability to pay interest and repay principal.
Rating agencies may periodically change the rating assigned to a particular security. If a debt security satisfies a Funds minimum
rating requirement when purchased, a subsequent downgrade does not require the sale of the security, but Forward Management will consider which action is in the best interest of a Fund and its shareholders, including the sale of the security.
Bonds that are rated Baa by
Moodys are considered as medium grade obligations,
i.e.
, they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or
may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Bonds that are rated C by Moodys are the lowest rated class of
bonds and can be regarded as having extremely poor prospects of attaining any real investment standing.
Bonds rated BBB by S&P are regarded as having an adequate capacity to pay interest and repay principal. Whereas they
normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened
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capacity to pay interest and repay principal for bonds in this category than in higher rated categories. Bonds rated D by S&P are the lowest rated class of bonds and generally are
in payment default. The D rating also will be used upon the filing of a bankruptcy petition if debt service payments are jeopardized.
Although they may offer higher yields than higher-rated securities, high-risk, low-rated debt securities (commonly referred to as
junk bonds) and unrated debt securities generally involve greater volatility of price and risk of principal and income, including the possibility of default by, or bankruptcy of, the issuers of the securities. In addition, the markets in
which low-rated and unrated debt securities are traded are more limited than those in which higher-rated securities are traded. The existence of limited markets for particular securities may diminish a Funds ability to sell the securities at
fair value either to meet redemption requests or to respond to a specific economic event such as a deterioration in the creditworthiness of the issuer. Reduced secondary market liquidity for certain low-rated or unrated debt securities may also make
it more difficult for a Fund to obtain accurate market quotations for the purposes of valuing their portfolios. Market quotations are generally available on many low-rated or unrated securities only from a limited number of dealers and may not
necessarily represent firm bids of such dealers or prices for actual sales.
Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of low-rated debt securities, especially in a thinly traded market. Analysis
of the creditworthiness of issuers of low-rated debt securities may be more complex than for issuers of higher-rated securities, and the ability of a Fund to achieve its investment objective may, to the extent of investment in low-rated debt
securities, be more dependent upon such creditworthiness analysis than would be the case if the Fund were investing in higher-rated securities. In addition, the use of credit ratings as the sole method of evaluating low-rated securities can involve
certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of low-rated securities. In addition, credit rating agencies may fail to change credit ratings in a timely fashion to
reflect events since the security was most recently rated.
Low-rated debt securities may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade securities. The prices of low-rated debt securities have
been found to be less sensitive to interest rate changes than higher-rated investments, but more sensitive to adverse economic downturns or individual corporate developments. A projection of an economic downturn or of a period of rising interest
rates, for example, could cause a decline in low-rated debt securities prices because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities. If the issuer of
low-rated debt securities defaults, a Fund may incur additional expenses seeking recovery.
Depositary Receipts
A Fund may purchase sponsored or unsponsored American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), and Global Depositary Receipts (GDRs)
(collectively, Depositary Receipts). ADRs are Depositary Receipts typically issued by a U.S. bank or trust company which evidence ownership of underlying securities issued by a foreign corporation. EDRs and GDRs are typically issued by
foreign banks or foreign trust companies, although they also may be issued by U.S. banks or trust companies, and evidence ownership of underlying securities issued by either a foreign or a U.S. corporation. Generally, Depositary Receipts in
registered form are designed for use in the U.S. securities market and Depositary Receipts in bearer form are designed for use in securities markets outside the U.S. Depositary Receipts may not necessarily be denominated in the same currency as the
underlying securities into which they may be converted. Depositary Receipts may be issued pursuant to sponsored or unsponsored programs. In sponsored programs, the underlying issuer has made arrangements to have its securities traded in the form of
Depositary Receipts. In unsponsored programs, the underlying issuer may not be directly involved in the creation of the program. Although regulatory requirements with respect to sponsored and unsponsored programs are generally similar, in some cases
it may be easier to obtain financial information from an underlying issuer that has participated in the creation of a sponsored program. Accordingly, there may be less information available regarding underlying issuers of securities in unsponsored
programs and there may not be a correlation between such information and the market value of the Depositary Receipts. Depositary Receipts also involve the risks of other investments in foreign securities, as further discussed below in this section.
For purposes of each Funds investment policies, a Funds investments in Depositary Receipts will be deemed to be investments in the underlying securities.
Derivative Instruments
A Fund may purchase and write call and put options on
securities, securities indices and foreign currencies, and enter into futures contracts and use options on futures contracts as further described below. A Fund may also enter into swap agreements with respect to foreign currencies, interest rates
and securities indices. A Fund may use these techniques to hedge against changes in interest rates, foreign currency exchange rates or securities prices or to attempt to achieve investment returns as part of its overall investment strategies. A Fund
may also purchase and sell options relating to foreign currencies for purposes of increasing exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one country to another. A Fund will segregate or
earmark assets determined to be liquid by Forward Management in accordance with procedures established by the Board of Trustees (or, as permitted by applicable regulation, enter into certain offsetting positions) to cover its obligations
under options, futures, and swaps to avoid leveraging the portfolio of the Fund as described below.
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The Funds consider derivative instruments to consist of securities or other instruments
whose value is derived from or related to the value of some other instrument or asset, and not to include those securities whose payment of principal and/or interest depends upon cash flows from underlying assets, such as mortgage-related or
asset-backed securities. The value of some derivative instruments in which a Fund invests may be particularly sensitive to changes in prevailing interest rates, and, like the other investments of a Fund, the ability of a Fund to successfully utilize
these instruments may depend in part upon the ability of Forward Management to correctly forecast interest rates and other economic factors. If Forward Management incorrectly forecasts such factors and has taken positions in derivative instruments
contrary to prevailing market trends, the Fund could be exposed to the risk of loss. In addition, while the use of derivatives for hedging purposes can reduce losses, it can also reduce or eliminate gains, and hedges are sometimes subject to
imperfect matching between the derivative and security it is hedging, which means that a hedge might not be effective. A Fund might not employ any of the strategies described above, and no assurance can be given that any strategy used will succeed.
A decision as to whether, when and how to utilize derivative instruments involves the exercise of skill and judgment, and even a well-conceived derivatives strategy may be unsuccessful. The use of derivative instruments involves brokerage fees
and/or other transaction costs, which will be borne by the Fund.
Investment in futures-related and commodity-linked derivatives may subject a Fund to additional risks, and in particular may subject a Fund to greater volatility than investments in traditional
securities. The value of futures-related and commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or
commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political and regulatory developments. In order to qualify for the special tax treatment available to regulated investment companies
under the Internal Revenue Code, a Fund must derive at least 90% of its gross income each taxable year from certain specified types of investments. It is currently unclear which types of commodities-linked derivatives fall within these specified
investment types. As a result, if a Funds investment in commodities-linked derivatives were to exceed a certain threshold, the Fund could fail to qualify for the special tax treatment available to regulated investment companies under the
Internal Revenue Code.
Diversification
A Fund that is non-diversified is
not subject to the diversification requirements of the 1940 Act, which generally limit investments, as to 75% of a Funds total assets, to no more than 5% in securities in a single issuer and 10% of an issuers voting securities. A
non-diversified Fund must, however, comply with the tax diversification regulations, which require it to be diversified at each quarter end with respect to at least half of its assets. Because the appreciation or depreciation of a single portfolio
security may have a greater impact on the net asset value of a non-diversified Fund, the net asset value per share of the Fund can be expected to fluctuate more than that of a comparable diversified fund.
Dividend Rolls
A Fund may perform dividend rolls. A dividend
roll is an arrangement in which a Fund purchases stock in a U.S. corporation that is about to pay a dividend. The Fund then collects the dividend. If applicable requirements are met, the dividend will qualify for the corporate
dividends-received deduction.
Duration
Duration is one of the fundamental tools used by Forward Management in security selection for a Fund. Duration is a measure of the price
sensitivity of a security or a portfolio to relative changes in interest rates. For instance, a duration of three means that a portfolios or securitys price would be expected to change by approximately 3% with a 1% change in
interest rates. Assumptions generally accepted by the industry concerning the probability of early payment and other factors may be used in the calculation of duration for debt securities that contain put or call provisions, sometimes resulting in a
duration different from the stated maturity of the security. With respect to certain mortgage-backed securities, duration is likely to be substantially less than the stated maturity of the mortgages in the underlying pools. The maturity of a
security measures only the time until final payment is due and, in the case of a mortgage-backed security, does not take into account the factors included in duration.
A Funds duration directly impacts the degree to which
asset values fluctuate with changes in interest rates. For every 1% change in interest rate, a Funds net asset value is expected to change inversely by approximately 1% for each year of duration. For example, a 1% increase in interest rate
would be expected to cause a fixed-income portfolio with an average dollar weighted duration of five years to decrease in value by approximately 5% (1% interest rate increase multiplied by the five-year duration).
Equity Securities
A Fund may invest in equity securities without regard to
market capitalization. Equity securities consist of exchange-traded, over-the-counter and unlisted common and preferred stocks, warrants, rights, convertible debt securities, trust certificates, limited partnership interests, and equity
participations.
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Investments in equity securities are subject to a number of risks, including the financial
risk of selecting individual companies that do not perform as anticipated, the risk that the stock markets in which a Fund invests may experience periods of turbulence and instability, and the general risk that domestic and global economies may go
through periods of decline and cyclical change. Many factors affect an individual companys performance, such as the strength of its management or the demand for its products or services, and the value of a Funds equity investments may
change in response to stock market movements, information or financial results regarding the issuer, general market conditions, general economic and/or political conditions, and other factors.
Exchange-Traded Funds (ETFs)
A Fund may invest in shares of ETFs. ETFs are baskets of securities that, like stocks, trade on exchanges such
as the American Stock Exchange or New York Stock Exchange. ETFs are priced continuously and trade throughout the day. Each share represents an undivided ownership interest in the portfolio of stocks held by an ETF. ETFs acquire and hold either:
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shares of all of the companies that are represented by a particular index in the same proportion that is represented in the index itself;
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shares of a sampling of the companies that are represented by a particular index in a proportion meant to track the performance of the entire index;
or
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shares of companies included in a basket of securities.
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The value of shares of ETFs that are intended to provide
investment results that, before expenses, generally correspond to the price and yield performance of the corresponding market index or basket of securities, should, under normal circumstances, closely track the value of the underlying component
stocks. Such ETFs generally do not buy or sell securities, except to the extent necessary to conform their portfolios to the corresponding index. Because an ETF has operating expenses and transaction costs, while a market index or basket of
securities does not, ETFs that track particular indices or baskets of securities typically will be unable to match the performance of the index or basket of securities exactly. A Funds investment in ETFs will be subject to the risks of
investing in the ETFs underlying securities.
In connection with its investment in ETF shares, a Fund will incur various costs. A Fund may also realize capital gains when ETF shares
are sold, and the purchase and sale of the ETF shares may include a brokerage commission that may result in costs. In addition, a Fund is subject to other fees as an investor in ETFs. Generally, those fees include, but are not limited to,
Trustees fees, operating expenses, licensing fees, registration fees, and marketing expenses.
ETFs that are organized as unit investment trusts are registered under the 1940 Act as investment companies. Examples of such ETFs include iShares and Standard & Poors Depositary Receipts
(SPDRs). These ETFs generally do not sell or redeem their shares for cash, and most investors do not purchase or redeem shares directly from an ETF at all. Instead, these ETF issues and redeems its shares in large blocks (typically
50,000 of its shares) called creation units. Creation units are issued to anyone who deposits a specified portfolio of these ETFs underlying securities, as well as a cash payment generally equal to accumulated dividends of the
securities (net of expenses) up to the time of deposit, and creation units are redeemed in kind for a portfolio of the underlying securities (based on the ETFs net asset value) together with a cash payment generally equal to accumulated
dividends as of the date of redemption. Most ETF investors, however, purchase and sell these ETF shares in the secondary trading market on a securities exchange, in lots of any size, at any time during the trading day. ETF investors generally must
pay a brokerage fee for each purchase or sale of these ETF shares, including purchases made to reinvest dividends. Because these ETF shares are created from the stocks of an underlying portfolio and can be redeemed into the stocks of an underlying
portfolio on any day, arbitrage traders may move to profit from any price discrepancies between the shares and the ETFs portfolio, which in turn helps to close the price gap between the two. Of course, because of the forces of supply and
demand and other market factors, there may be times when an ETF share trades at a premium or discount to its net asset value.
Aggressive ETF Investment Technique Risk
. These ETFs may use investment techniques and financial instruments that could be
considered aggressive, including the use of futures contracts, options on futures contracts, securities and indices, forward contracts, swap agreements, and similar instruments. An ETFs investment in financial instruments may involve a small
investment relative to the amount of investment exposure assumed and may result in losses exceeding the amounts invested in those instruments. Such instruments, particularly when used to create leverage, may expose the ETF to potentially dramatic
changes (losses or gains) in the value of the instruments and imperfect correlation between the value of the instruments and the relevant security or index. The use of aggressive investment techniques also exposes an ETF to risks different from, or
possibly greater than, the risks associated with investing directly in securities contained in an index underlying the ETFs benchmark.
Inverse Correlation ETF Risk
. ETFs benchmarked to an inverse multiple of an index should lose value as the index or security
underlying such ETFs benchmark is increasing (gaining value), a result that is the opposite from traditional mutual funds.
Leveraged ETF Risk
. Leverage offers a means of magnifying market movements into larger changes in an investments value and
provides greater investment exposure than an unleveraged investment. While only certain ETFs employ leverage, many may use
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leveraged investment techniques for investment purposes. The ETFs that employ leverage will normally lose more money in adverse market environments than ETFs that do not employ leverage. Trading
in leveraged ETFs can be relatively illiquid, which means that they may be hard to purchase or sell at a fair price.
Exchange-Traded Notes (ETNs)
ETNs are senior, unsecured, unsubordinated debt securities issued by a financial institution, listed on an exchange and traded in the
secondary market. They are designed to provide investors with a way to access the returns of market benchmarks. ETNs are not equities or index funds, but they do share several characteristics. For example, like equities, they trade on an exchange
and can be shorted. Like an index fund they are linked to the return of a benchmark index.
Unlike regular bonds, there are no periodic interest payments, and principal is not protected. An investor could lose some of or the entire amount invested. The price in the secondary market is determined
by supply and demand, the current performance of the index, and the credit rating of the ETN issuer. At maturity, the issuer pays a return linked to the performance of the market index, such as a commodity index, to which the ETN is linked, minus
the issuers annual fee.
ETFs and ETNs
ETFs or ETNs that are based on a specific
index may not be able to replicate and maintain exactly the composition and relative weighting of securities in the applicable index and will incur certain expenses not incurred by their applicable index. Certain securities comprising the index
tracked by an ETF or ETN may, at times, be temporarily unavailable, which may impede an ETFs or ETNs ability to track its index. Leveraged ETFs and ETNs are subject to the risk of a breakdown in the futures and options markets they use.
Leveraged ETFs or ETNs are subject to the same risk as instruments that use leverage in any form. While leverage allows for greater potential return, the potential for loss is also greater. Finally, additional losses may be incurred if the
investment loses value because, in addition to the money lost on the investment, the loan still needs to be repaid. The market value of ETF or ETN shares may differ from their net asset value per share. This difference in price may be due to the
fact that the supply and demand in the market for ETF or ETN shares at any point in time is not always identical to the supply and demand in the market for the underlying securities that the ETF or ETN holds. There may be times when an ETF or ETN
share trades at a premium or discount to its net asset value.
Foreign Currencies
Investments in foreign currencies are subject to numerous risks, not the least of which is the fluctuation of foreign currency exchange rates with respect to the U.S. dollar. Exchange rates fluctuate for
a number of reasons.
Inflation
. Exchange
rates change to reflect changes in a currencys buying power. Different countries experience different inflation rates due to different monetary and fiscal policies, different product and labor market conditions, and a host of other factors.
Trade Deficits
. Countries with trade
deficits tend to experience a depreciating currency. Inflation may be the cause of a trade deficit, making a countrys goods more expensive and less competitive and so reducing demand for its currency.
Interest Rates
. High interest rates may raise currency
values in the short term by making such currencies more attractive to investors. However, since high interest rates are often the result of high inflation long-term results may be the opposite.
Budget Deficits and Low Savings Rates
. Countries that
run large budget deficits and save little of their national income tend to suffer a depreciating currency because they are forced to borrow abroad to finance their deficits. Payments of interest on this debt can inundate the currency markets with
the currency of the debtor nation. Budget deficits also can indirectly contribute to currency depreciation if a government chooses inflationary measures to cope with its deficits and debt.
Political Factors
. Political instability in a country can cause a currency to depreciate. Demand for a
certain currency may fall if a country appears a less desirable place in which to invest and do business.
Government Control
. Through their own buying and selling of currencies, the worlds central banks sometimes manipulate
exchange rate movements. In addition, governments occasionally issue statements to influence peoples expectations about the direction of exchange rates, or they may instigate policies with an exchange rate target as the goal. The value of a
Funds investments is calculated in U.S. dollars each day that the New York Stock Exchange is open for business. As a result, to the extent that a Funds assets are invested in instruments denominated in foreign currencies and the
currencies appreciate relative to the U.S. dollar, the Funds net asset value as expressed in U.S. dollars should increase. If the U.S. dollar appreciates relative to the other currencies, the opposite should occur. The currency-related gains
and losses experienced by a Fund will be based on changes in the value of portfolio securities attributable to currency fluctuations only in relation to the original purchase price of such securities as stated in U.S. dollars. Gains or losses on
shares of a Fund will be based on changes attributable to fluctuations in the net asset value of such shares, expressed in U.S.
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dollars, in relation to the original U.S. dollar purchase price of the shares. The amount of appreciation or depreciation in a Funds assets also will be affected by the net investment
income generated by the money market instruments in which a Fund invests and by changes in the value of the securities that are unrelated to changes in currency exchange rates.
A Fund may incur currency exchange costs when it sells
instruments denominated in one currency and buys instruments denominated in another.
Investments in foreign securities are normally denominated and traded in foreign currencies. The value of a Funds assets may be affected favorably or unfavorably by currency exchange rates, currency
exchange control regulations, and restrictions or prohibitions on the repatriation of foreign currencies. Some countries in which a Fund may invest may also have fixed or managed currencies that are not free-floating against the U.S. dollar.
Further, certain currencies may not be internationally traded. Certain of these currencies have experienced a steady devaluation relative to the U.S. dollar. Any devaluation in the currencies in which a Funds portfolio securities are
denominated may have a detrimental impact on the Fund.
Foreign Currency Transactions
A Fund may engage in foreign currency transactions, including foreign currency forward contracts, options, swaps, and other strategic transactions in connection with investments in securities of non-U.S.
companies. The Funds will conduct their foreign currency exchange transactions either on a spot (
i.e.
, cash) basis at the spot rate prevailing in the foreign currency exchange market or through forward contracts to purchase or sell foreign
currencies.
A Fund may enter into forward foreign
currency exchange contracts (forward contracts) in order to protect against possible losses on foreign investments resulting from adverse changes in the relationship between the U.S. dollar and foreign currencies, as well as to increase exposure to
a foreign currency or to shift exposure to foreign currency fluctuations from one country to another. A forward contract is an obligation to purchase or sell a specific currency for an agreed price on a future date which is individually negotiated
and privately traded by currency traders and their customers. Although foreign exchange dealers do not charge a fee for conversion, they do realize a profit based on the difference (spread) between the price at which they are buying and selling
various currencies. However, forward contracts may limit the potential gains which could result from a positive change in such currency relationships. A Fund will segregate or earmark assets determined to be liquid by Forward Management,
in accordance with procedures established by the Board of Trustees, to cover its obligations under forward foreign currency exchange contracts entered into for non-hedging purposes.
A Fund may purchase and write put and call options on foreign currencies for the purpose of protecting against
declines in the U.S. dollar value of foreign portfolio securities and against increases in the U.S. dollar cost of foreign securities to be acquired. As with other kinds of options, however, the writing of an option on foreign currency will
constitute only a partial hedge, up to the amount of the premium received, and a Fund could be required to purchase or sell foreign currencies at disadvantageous exchange rates, thereby incurring loses. The purchase of an option on foreign currency
may constitute an effective hedge against fluctuation in exchange rates although, in the event of rate movements adverse to a Funds position, the Fund may forfeit the entire amount of the premium plus related transaction costs. See generally
the discussion below on Options on Securities, Securities Indices, Futures Contracts and Swap Indexes.
A Fund may enter into interest rate swaps on either an asset-based or liability-based basis, depending on whether it is hedging its assets
or its liabilities, and will usually enter into interest rate swaps on a net basis (
i.e.,
the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments). The net amount
of the excess, if any, of a Funds obligations over its entitlement with respect to each interest rate swap will be calculated on a daily basis and an amount of cash or other liquid assets (marked to market daily) having an aggregate net asset
value at least equal to the accrued excess will be segregated or earmarked. If a Fund enters into an interest rate swap on other than a net basis, it would segregate or earmark assets in the full amount accrued on a daily
basis of its obligations with respect to the swap. Forward Management will monitor the creditworthiness of all counterparties on an ongoing basis. If there is a default by the other party to such a transaction, a Fund will have contractual remedies
pursuant to the agreements related to the transaction. There is no limit on the amount of interest rate swap transactions that may be entered into by a Fund, subject to the segregation requirement described above. These transactions may in some
instances involve the delivery of securities or other underlying assets by a Fund or its counterparty to collateralize obligations under the swap. Under the documentation currently used in those markets, the risk of loss with respect to interest
rate swaps is limited to the net amount of the payments that a Fund is contractually obligated to make. If the other party to an interest rate swap that is not collateralized defaults, a Fund would risk the loss of the net amount of the payments
that it contractually is entitled to receive.
While certain Fund portfolio managers are authorized to hedge against currency risk, they are not required to do so.
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Forward Commitments
A Fund may make contracts to purchase securities for a fixed price at a future date beyond customary settlement
time (forward commitments) consistent with a Funds ability to manage its investment portfolio and meet redemption requests. A Fund may dispose of a commitment prior to settlement if it is appropriate to do so and realize short-term
profits or losses upon such sale. When effecting such transactions, cash or liquid assets of a Fund of a dollar amount sufficient to make payment for the portfolio securities to be purchased, measured on a daily basis, will be segregated or
earmarked on the Funds records at the trade date and maintained until the transaction is settled, so that the purchase of securities on a forward commitment basis is not deemed to be the issuance of a senior security. Forward
commitments involve a risk of loss if the value of the security to be purchased declines prior to the settlement date.
Futures Contracts and Options on Futures Contracts
A Fund may invest in interest rate, credit linked, debt
obligation, stock index and foreign currency futures contracts and options thereon for hedging and non-hedging purposes. A futures contract provides for the future sale by one party and purchase by another party of a specified quantity of the
security or other financial instrument at a specified price and time. A futures contract on an index is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to the difference between the value of the
index at the close of the last trading day of the contract and the price at which the index contract was originally written. Although the value of an index might be a function of the value of certain specified securities, physical delivery of these
securities is not always made. A public market exists in futures contracts covering a number of indices as well as financial instruments, including without limitation: U.S. Treasury bonds; U.S. Treasury notes; Government National Mortgage
Association (GNMA) Certificates; three-month U.S. Treasury bills; 90-day commercial paper; bank certificates of deposit; Eurodollar certificates of deposit; the Australian dollar; the Canadian dollar; the British pound; the Japanese yen;
the Swiss franc; the Mexican peso; and certain multinational currencies, such as the euro. It is expected that other futures contracts will be developed and traded in the future.
A Fund may purchase and write call and put futures options.
Options on futures contracts give 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), rather than to purchase or
sell the futures contract, at a specified exercise price at any time during the period of the option. Upon exercise of the option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writers futures margin account which represents the amount by which the market price of the futures contract, at exercise, exceeds (in the case of a call) or is less than (in the case of a put) the
exercise price of the option on the futures contract. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash equal to the difference on the expiration date between
the exercise price of the option and the closing level of the securities upon which the futures contracts are based. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid. As an
alternative to purchasing call and put options on futures, a Fund may purchase call and put options on the underlying securities.
A Fund may enter into futures contracts and futures options that are standardized and traded on a U.S. or other exchange, board of trade,
or similar entity, or quoted on an automated quotation system, and the Funds may also enter into over-the-counter options on futures contracts.
Futures transactions may result in losses in excess of the amount invested in the futures contract. There can be no guarantee that there
will be a correlation between price movements in the hedging vehicle and in the portfolio securities being hedged. An incorrect correlation could result in a loss on both the hedged securities in a Fund and the hedging vehicle so that the portfolio
return might have been greater had hedging not been attempted. There can be no assurance that a liquid market will exist at a time when a Fund seeks to close out a futures contract or a futures option position. Most futures exchanges and boards of
trade limit the amount of fluctuation permitted in futures contract prices during a single day; once the daily limit has been reached on a particular contract, no trades may be made that day at a price beyond that limit. In addition, certain of
these instruments are relatively new and without a significant trading history. As a result, there is no assurance that an active secondary market will develop or continue to exist. Lack of a liquid market for any reason may prevent a Fund from
liquidating an unfavorable position, and the Fund would remain obligated to meet margin requirements until the position is closed.
A Fund may write covered straddles consisting of a call and a put written on the same underlying futures contract. A straddle will be
covered when sufficient assets are deposited to meet a Funds immediate obligations. A Fund may use the same liquid assets to cover both the call and put options where the exercise price of the call and put are the same, or the exercise price
of the call is higher than that of the put. In such cases, the Fund will also segregate or earmark liquid assets equivalent to the amount, if any, by which the put is in the money.
A Fund will only enter into futures contracts or futures
options which are standardized and traded on a U.S. or foreign exchange or board of trade, or similar entity, or quoted on an automated quotation system, or where quoted prices are generally available in the
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over-the-counter market. Pursuant to applicable regulatory exemptions, a Fund and Forward Management are not deemed to be a commodity pool or commodity pool operator under
the Commodity Exchange Act and are not subject to registration or regulation as such under the Commodity Exchange Act.
When a purchase or sale of a futures contract is made by a Fund, the Fund is required to deposit with its custodian (or broker, if legally
permitted) a specified amount of liquid assets (initial margin). The margin required for a futures contract is set by the exchange on which the contract is traded and may be modified during the term of the contract. The initial margin is
in the nature of a performance bond or good faith deposit on the futures contract that is returned to a Fund upon termination of the contract, assuming all contractual obligations have been satisfied. A Fund expects to earn taxable interest income
on initial margin deposits. A futures contract held by a Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day a Fund pays or receives cash, called variation margin, equal to the daily
change in value of the futures contract. This process is known as marking to market. Variation margin does not represent a borrowing or loan by a Fund but is instead a settlement between a Fund and the broker of the amount one would owe
the other if the futures contract expired.
Each
Fund is also required to deposit and maintain margin with respect to put and call options on futures contracts written by it. Such margin deposits will vary depending on the nature of the underlying futures contract (and the related initial margin
requirements), the current market value of the option, and other futures positions held by a Fund.
Although some futures contracts call for making or taking delivery of the underlying securities, generally these obligations are closed out prior to delivery by offsetting purchases or sales of matching
futures contracts (involving the same exchange, underlying security or index, and delivery month). If an offsetting purchase price is less than the original sale price, a Fund realizes a capital gain, or if it is more, a Fund realizes a capital
loss. Conversely, if an offsetting sale price is more than the original purchase price, a Fund realizes a capital gain, or if it is less, a Fund realizes a capital loss. The transaction costs must also be included in these calculations.
With respect to forwards and futures contracts that are not
contractually required to cash-settle, a Fund must cover its open positions by segregating or earmarking liquid assets equal to the contracts full, notional value. With respect to forwards and futures that are
contractually required to cash-settle, however, a Fund is permitted to segregate or earmark liquid assets in an amount equal to the Funds daily marked-to-market (net) obligation (
i.e.,
the Funds daily net
liability, if any) rather than the notional value. By setting aside assets equal to only its net obligation under cash-settled forwards or futures, a Fund will have the ability to employ leverage to a greater extent than if the Fund were required to
segregate or earmark assets equal to the full notional value of such contracts. Options on futures and forward contracts will be covered in the manner set forth under Options on Securities, Securities Indices, Futures Contracts and
Swap Indices.
Because of the low margin
deposits required for certain futures, futures trading involves an extremely high degree of leverage. As a result, a relatively small price movement in a futures contract may result in immediate and substantial loss or gain to the investor. For
example, if at the time of purchase 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit, if the contract were closed out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. However, a Fund would presumably have sustained comparable losses if, instead of the futures contract, it had invested in the underlying financial instrument and sold it after the decline.
A Funds ability to reduce or eliminate its
futures and related options positions will depend upon the liquidity of the secondary markets for such futures and options. The Funds intend to purchase or sell futures and related options only where there appears to be an active secondary market,
but there is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. The prices of futures contracts may be volatile, and the trading of futures contracts is subject to the risk of exchange or
clearing house equipment failures, government intervention, insolvency of a brokerage firm or clearing house or other disruption of normal trading activity, which could at times make it difficult or impossible to liquidate existing positions or to
recover excess variation margin payments. Use of futures and options on futures for hedging may also involve risks because of imperfect correlations between movements in the prices of the futures or options on futures and movements in the prices of
the securities being hedged. Successful use of futures and related options by a Fund for hedging purposes also depends upon the ability of Forward Management to predict correctly movements in the direction of the market, as to which no assurance can
be given. A Funds use of futures and/or options on futures may leave the Fund in a worse position than if such strategies were not used.
A Funds investments in commodity futures contracts will be subject to additional costs and risks. In particular, the price of a
commodity futures contract will reflect the storage cost of purchasing the underlying commodity and will subject a Fund to risks relating to reinvestment and economic and non-economic variables such as drought, floods, weather, livestock disease,
embargoes, tariffs, and international economic, political and regulatory developments.
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Hybrid Securities
Hybrid securities are securities that have characteristics of both equity securities and debt securities.
Hybrid securities are typically junior and fully subordinated liabilities of a corporate entity or a trust or partnership affiliated with a corporate entity. Hybrid securities typically permit an issuer to defer the payment of income or dividends
for a period of time, commonly eighteen months or more, without triggering an event of default. Because of their subordinated position in the capital structure of an issuer, the ability to defer payments for extended periods of time without default
consequences to the issuer, and certain other features (such as restrictions on common dividend payments by the issuer), hybrid securities are often treated as close substitutes for traditional preferred securities, both by issuers and investors.
Hybrid securities have many characteristics of equity securities due to their subordinated position in an issuers capital structure and because their quality and value are heavily dependent on the profitability of the issuer rather than on any
legal claims to specific assets or cash flows. Hybrid securities include, but are not limited to, types of securities referred to as trust preferred securities, trust-originated preferred securities, corporate trust securities, contingent capital
securities and other similarly structured securities.
Hybrid securities can be perpetual or may have a maturity date. In certain instances, a maturity date may be extended and/or the final payment of principal may be deferred at the issuers option for
a specified time without default. No redemption can typically take place unless all payment obligations have been met, although issuers may be able to engage in open-market repurchases without regard to whether all payments have been paid.
Many hybrid securities, including trust preferred
securities, are issued by trusts or other special purpose entities established by operating companies and are not a direct obligation of an operating company. At the time the trust or special purpose entity sells such securities to investors, it
purchases debt of the operating company, and holders of the securities issued by the trust or other special purpose entity are generally treated as owning beneficial interests in the underlying debt of the operating company. Under this structure,
payments on the hybrid securities are generally treated as interest rather than dividends for U.S. federal income tax purposes and, as such, are not eligible for the dividends received deduction or the reduced rates of tax that apply to qualified
dividend income. Typically a hybrid security issued by a trust or special purpose entity will have a credit rating that is lower than that of its corresponding operating companys senior debt securities.
In some cases hybrid securities may include loss absorption
provisions that make the securities more equity-like. Such a provision may provide that the liquidation value of the security may be adjusted downward to below the original par value, including to zero, under certain circumstances. This may occur,
for instance, in the event that operating losses have substantially reduced an issuers capital. The write down of the par value would occur automatically and would not entitle the holders of the hybrid security to seek bankruptcy of the
issuer. Such securities may provide for circumstances under which the liquidation value may be adjusted back up to par, such as an improvement in capitalization and/or earnings.
Another type of hybrid security with loss absorption
characteristics is contingent capital securities. These securities provide for mandatory conversion into common shares of the issuer under certain circumstances. The mandatory conversion might relate to maintenance of a capital minimum, and if the
issuers capital were to fall below the minimum it would trigger automatic conversion of the issuers contingent capital securities to common shares. Upon conversion, the security holder may receive less income because an issuers
common shares may not pay a dividend or may pay a dividend that is lower than the amount paid on the issuers contingent capital securities, and may have fewer rights in the event of the bankruptcy of the issuer.
Hybrid securities may be subject to changes in regulations
and there can be no assurance that the current regulatory treatment of hybrid securities will continue. Hybrid securities are frequently issued by banking institutions for purposes of complying with regulatory capital requirements, and as reforms to
the international framework for regulatory capital requirements by regulators such as the Basel Committee on Banking Supervision continue to evolve, the use features and regulation of hybrid securities issued by banking institutions may change in
the future.
Illiquid Securities
A Fund may invest in illiquid or restricted
securities if Forward Management believes that they present an attractive investment opportunity. A Fund may not invest more than 15% of its net assets (5% of its total assets with respect to the Forward U.S. Government Money Fund) in illiquid or
restricted securities. Generally, a security is considered illiquid if it cannot be disposed of in the ordinary course of business within seven days at approximately the price at which a Fund has valued the investment. Its illiquidity might prevent
the sale of such a security at a time when Forward Management might wish to sell, and these securities could have the effect of decreasing the overall level of a Funds liquidity. Further, the lack of an established secondary market may make it
more difficult to value illiquid securities, requiring a Fund to rely on judgments that may be somewhat subjective in determining value, which could vary from the amount that a Fund could realize upon disposition.
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Illiquid securities generally include, among other things, written over-the-counter options,
securities or other liquid assets being used as cover for such options, repurchase agreements with maturities in excess of seven days, certain loan participation interests, fixed-time deposits which are not subject to prepayment or provide for
withdrawal penalties upon prepayment (other than overnight deposits), securities that are subject to legal or contractual restrictions on resale and other securities whose disposition is restricted under the federal securities laws (other than
securities issued pursuant to Rule 144A under the 1933 Act and certain commercial paper that Forward Management has determined to be liquid under procedures approved by the Board of Trustees).
A Funds investments may include privately placed securities, which are sold directly to a small number of
investors, usually institutions. Unlike public offerings, such securities are not registered under the federal securities laws. Although certain of these securities may be readily sold, for example, under Rule 144A, others may be illiquid, and their
sale may involve substantial delays and additional costs.
Restricted securities, including private placements, are subject to legal or contractual restrictions on resale. They can be eligible for purchase without SEC registration by certain institutional
investors known as qualified institutional buyers, and under the Funds procedures, restricted securities may be treated as liquid. However, some restricted securities may be illiquid and restricted securities that are treated as
liquid could be less liquid than registered securities traded on established secondary markets.
Infrastructure Investments
A Fund may invest in the securities of infrastructure-related companies. (The Forward Global Infrastructure Fund invests, under normal conditions, at least 80% of its net assets in such companies). The
Funds consider a company to be an infrastructure-related company if at least 50% of its assets, gross income or net profits are attributable to infrastructure operations. These companies include businesses involved in the ownership, operation or
financing of the physical structures and networks used to provide essential services to society. Infrastructure-related companies may include, but are not necessarily limited to, those companies that are active in transportation services (including
toll roads, bridges, tunnels, parking facilities, railroads, rapid transit links, airports, refueling facilities and seaports), utilities (including electricity, electricity transmission, electricity generation, gas and water distribution, sewage
treatment, broadcast and wireless towers, cable and satellite networks), social assets (including courthouses, hospitals, schools, correctional facilities, stadiums and subsidized housing), and those companies whose products and services are related
to the infrastructure industry (such as manufacturers and distributors of building supplies and financial institutions that issue or service debt secured by infrastructure assets).
Infrastructure-related companies are subject to a variety of
factors that may affect their business or operations including high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity,
increased competition from other providers of services, uncertainties concerning the availability of fuel at reasonable prices, the effects of energy conservation policies, and other factors. These companies may also be subject to regulation by
various governmental authorities and may also be affected by governmental regulation of rates charged to customers, service interruption due to environmental, operational or other mishaps, and the imposition of special tariffs and changes in tax
laws, regulatory policies, and accounting standards.
Other factors that may affect the operations of infrastructure-related companies include changes in technology that could render the way in which a company delivers a product or service obsolete,
significant changes to the number of ultimate end-users of a companys products, increased susceptibility to terrorist acts or political actions, and risks of environmental damage due to a companys operations or an accident.
Initial Public Offering (IPO) Holding
IPO holding is the practice of participating
in an IPO with the intent of holding the security for investment purposes. Because an IPO is an equity security that is new to the public market, the value of IPOs may fluctuate dramatically. Because of the cyclical nature of the IPO market, from
time to time there may not be any IPOs in which a Fund can participate. Even when a Fund requests to participate in an IPO, there is no guarantee that the Fund will receive an allotment of shares in an IPO sufficient to satisfy the Funds
desired participation. Due to the volatility of IPOs, these investments can have a significant impact on performance, which may be positive or negative.
International Sanctions
From time to time, certain of the companies in which a Fund expects to invest may operate in, or have dealings with, countries subject to
sanctions or embargoes imposed by the U.S. government and the United Nations and/or countries identified by the U.S. government as state sponsors of terrorism. A company may suffer damage to its reputation if it is identified as a company which
operates in, or has dealings with, countries subject to sanctions or embargoes imposed by the U.S. government and the United Nations and/or countries identified by the U.S. government as state sponsors of terrorism. As an investor in such companies,
a Fund will be indirectly subject to those risks.
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Investment in Foreign and Developing Markets
A Fund may purchase securities of companies domiciled in any
foreign country, developed or developing. Potential investors in these Funds should consider carefully the substantial risks involved in securities of companies and governments of foreign social instability, or diplomatic developments which could
affect investments in securities of issuers in foreign nations, which are in addition to the usual risks inherent in domestic investments.
There may be less publicly available information about foreign companies comparable to the reports and ratings published about U.S.
companies. Most foreign companies are not generally subject to uniform accounting and financial reporting standards, and auditing practices and requirements may not be comparable to those applicable to U.S. companies. A Fund, therefore, may
encounter difficulty in obtaining market quotations for purposes of valuing its portfolio and calculating its net asset value. Foreign markets have substantially less volume than the New York Stock Exchange and securities of some foreign companies
are less liquid and more volatile than securities of comparable U.S. companies. Commission rates in foreign countries are generally subject to negotiation, as in the U.S., but they are likely to be higher. Transaction costs and custodian expenses
are likely to be higher in foreign markets. In many foreign countries there may be less government supervision and regulation of stock exchanges, brokers and listed companies than in the U.S. Furthermore, securities in which a Fund invests may be
held in foreign banks and securities depositories, which may be recently organized and subject to limited or no regulatory oversight.
Throughout the last decade many emerging markets have experienced, and continue to experience, high rates of inflation. In certain
countries, inflation has accelerated rapidly at times to hyper inflationary levels, creating a negative interest rate environment and sharply eroding the value of outstanding financial assets in those countries.
Investments in businesses domiciled in developing countries
may be subject to potentially higher risks than investments in developed countries. These risks include: (i) less social, political, and economic stability; (ii) the small current size of the markets for such securities and the currently
low or nonexistent volume of trading, which result in a lack of liquidity and in greater price volatility; (iii) certain national policies which may restrict the Funds investment opportunities, including restrictions on investments in
issuers or industries deemed sensitive to national interests; (iv) foreign taxation; (v) the absence of developed structures governing private or foreign investment or allowing for judicial redress for injury to private property;
(vi) the absence, until recently in certain Eastern European countries, of a capital market structure or market-oriented economy; (vii) the possibility that recent favorable economic developments in Eastern Europe may be slowed or reversed
by unanticipated political or social events in such countries; (viii) currency fluctuations; and (ix) the contagious effect of market or economic setbacks in one country on another developing country.
A Fund will attempt to buy and sell foreign currencies on as
favorable a basis as practicable. Some price spread on currency exchanges (to cover service charges) may be incurred, particularly when a Fund changes investments from one country to another or when proceeds of the sale of shares in U.S. dollars are
used for the purchase of securities in foreign countries. Also, some countries may adopt policies which would prevent a Fund from transferring cash out of the country or withholding portions of interest and dividends at the source. There is the
possibility of cessation of trading on national exchanges, expropriation, nationalization or confiscatory taxation, exit levies, withholding and other foreign taxes on income or other amounts, foreign exchange controls (which may include suspension
of the ability to transfer currency from a given country), default in foreign government securities, political or social instability, or diplomatic developments which could affect investments in securities of issuers in foreign nations.
Investments in foreign securities and deposits with foreign
banks or foreign branches of U.S. banks may be subject to nationalization, expropriation, confiscatory taxation, adverse changes in investment or exchange control regulations (which may include suspension of the ability to transfer currency from a
country), government approval for the repatriation of investment income, capital, or the sale of securities, delays in settlement of transactions, changes in governmental economic or monetary policy in the U.S. or abroad, or other political,
diplomatic, and economic developments that could adversely affect a Funds investments. In the event of nationalization, expropriation, or other confiscation, a Fund could lose its entire investment in a foreign security. The Funds will treat
investments that are subject to repatriation restrictions of more than seven days as illiquid securities.
European Economic Risk.
European financial markets have recently experienced volatility and have been adversely affected by
concerns about rising government debt levels, credit rating downgrades, and possible default on or restructuring of government debt. These events have affected the value and exchange rate of the euro, which subjects a Funds investments tied
economically to Europe or the euro to additional risks. Investing in euro-denominated (or other European currency-denominated) securities also entails the risk of being exposed to a currency that may not fully reflect the strengths and weaknesses of
the disparate European economies. The governments of several member countries of the European Union (EU) have experienced large public budget deficits, which have adversely affected the sovereign debt issued by those countries and may ultimately
lead to declines in the value of the euro.
It is
possible that EU member countries that have already adopted the euro could abandon the euro and return to a national currency and/or that the euro will cease to exist as a single currency in its current form. The effects of such an abandonment or a
countrys
32
forced expulsion from the euro on that country, the rest of the EU, and global markets are impossible to predict, but are likely to be negative and may include, but are not limited to:
(i) flight of capital from perceived weaker countries to stronger countries in the EU; (ii) default on the domestic debt of any exiting country; (iii) collapse of the domestic banking system of any exiting country; (iv) seizure
of cash or assets in the effected countries; (v) imposition of capital controls that may discriminate in particular against foreigners asset holdings; and (vi) political or civil unrest. The exit of any country out of the EU would
likely have an extremely destabilizing effect on all EU member countries and their economies and a negative effect on the global economy as a whole. In addition, under these circumstances, it may be difficult to value investments denominated in
euros or in a replacement currency and there may be operational difficulties related to the settlement of trades of euro-denominated holdings.
Leverage
A Fund can buy securities with borrowed money (a form of leverage) or engage in certain transactions, such as derivatives, reverse
repurchase agreements and dollar rolls, that may give rise to a form of leverage. Leverage exaggerates the effect on net asset value of any increase or decrease in the market value of a Funds portfolio securities. The use of leverage may cause
a Fund to liquidate portfolio positions to satisfy its obligations or to meet asset coverage or asset segregation requirements when it may not be advantageous to do so. If a Fund borrows money, the 1940 Act requires the Fund to maintain continuous
asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed. To the extent a Fund borrows money, the Fund may incur interest costs that may or may not be recovered by
appreciation of the securities purchased. To mitigate leverage risk with respect to transactions that may give rise to a form of leverage, a Fund will maintain segregated or earmarked liquid assets to cover its obligations. To maintain
minimum average balances in connection with such borrowing or pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate.
Liquidity Management Practices
A Fund may periodically enter into Letter of Credit or Line
of Credit arrangements with banks and other financial intermediaries for the specific purpose of providing liquidity to the Fund. As capital markets are not always liquid or efficiently priced, it may from time to time be necessary for the Fund to
borrow money or put securities to banks or other financial intermediaries in order to meet shareholder liquidity demands. The percentage of net assets of which a Fund may enter into a Letter of Credit or Line of Credit arrangement are limited to the
extent permitted by the 1940 Act and rules and interpretations thereunder.
In the case of a Letter of Credit arrangement, for a fee paid by the Fund, a bank or other suitable financial intermediary would agree to assume ownership (irrevocably) of securities held in the portfolio
for the amortized cost of those securities. In the case of a Line of Credit arrangement, the Fund enters into agreements with banks or other financial intermediaries to supply loan availability to the Fund, where the Fund pledges securities
positions within the Fund as collateral.
Loan
Participations and Assignments
A Fund may
invest in fixed- and floating-rate loans arranged through private negotiations between an issuer of debt instruments and one or more financial institutions (lenders). Generally, a Funds investments in loans are expected to take the
form of loan participations and assignments of loans from third parties. Large loans to corporations or governments may be shared or syndicated among several lenders, usually banks. A Fund may participate in such syndicates, or can buy part of a
loan. Participations and assignments involve special types of risk, including limited marketability and the risks of being a lender. See Illiquid Securities for a discussion of the limits on the Funds investments in loan
participations and assignments with limited marketability. If a Fund purchases a participation, it may only be able to enforce its rights through the lender, and may assume the credit risk of the lender in addition to that of the borrower. In
assignments, a Funds rights against the borrower may be more limited than those held by the original lender.
In addition, loan investments are subject to a number of other risks, including but not limited to the following: (1) non-payment of
interest and/or principal; (2) to the extent a loan is collateralized, a decline in the value of collateral and difficulty or delay in obtaining or selling collateral in the event of the borrowers default or bankruptcy; (3) lack of
publicly available information about borrowers; and (4) the highly speculative nature of indebtedness of companies with poor creditworthiness, including the risk that companies will never pay off their indebtedness.
Master Limited Partnerships (MLPs)
A Fund may invest in MLPs, which are limited
partnerships in which ownership units are publicly traded. Generally, an MLP is operated under the supervision of one or more managing general partners. Limited partners (like a Fund that invests in an MLP) are not involved in the day-to-day
management of the partnership. Investments in MLPs are generally subject to many of the risks that apply to partnerships. For example, holders of the units of MLPs may have limited control and limited voting rights on matters affecting the
partnership. There may be fewer corporate protections afforded investors in an MLP than investors in a corporation. Conflicts of
33
interest may exist among unit holders, subordinated unit holders and the general partner of an MLP, including those arising from incentive distribution payments. MLPs that concentrate in a
particular industry or region are subject to risks associated with such industry or region. MLPs holding credit-related investments are subject to interest rate risk and the risk of default on payment obligations by debt issuers. Investments held by
MLPs may be illiquid. MLP units may trade infrequently and in limited volume, and they may be subject to more abrupt or erratic price movements than securities of larger or more broadly based companies.
Money Market Instruments
A Fund may invest in the following instruments which are
commonly referred to as money market instruments:
(i) Obligations (including certificates of deposit and bankers acceptances) maturing in 13 months or less of (a) banks organized under the laws of the U.S. or any state thereof (including
foreign branches of such banks) or (b) U.S. branches of foreign banks or (c) foreign banks and foreign branches thereof; provided that such banks have, at the time of acquisition by the Fund of such obligations, total assets of not less
than $1 billion or its equivalent. The term certificates of deposit includes both Eurodollar certificates of deposit, for which there is generally a market, and Eurodollar time deposits, for which there is generally not a market.
Eurodollars are dollars deposited in banks outside the U.S.; the Funds may invest in Eurodollar instruments of foreign and domestic banks; and
(ii) Commercial paper, variable amount demand master notes, bills, notes, and other obligations issued by a U.S. company,
a foreign company or a foreign government, its agencies or instrumentalities, maturing in 13 months or less, an denominated in U.S. dollars. If such obligations are guaranteed or supported by a letter of credit issued by a bank, such bank (including
a foreign bank) must meet the requirements set forth in paragraph (i) above. If such obligations are guaranteed or insured by an insurance company or other non-bank entity, such insurance company or other non-bank entity must represent a credit
of high quality, as determined by Forward Management.
Mortgage-Related and Other Asset-Backed Securities
A Fund may invest in mortgage-related or other asset-backed securities. The value of some mortgage-related or asset-backed securities in
which a Fund invests may be particularly sensitive to changes in prevailing interest rates, and, like the other investments of a Fund, the ability of a Fund to successfully utilize these instruments may depend in part upon the ability of Forward
Management to correctly forecast interest rates and other economic factors.
Mortgage pass-through securities are securities representing interests in pools of mortgage loans secured by residential or commercial real property in which payments of both interest and
principal on the securities are generally made monthly, in effect passing through monthly payments made by the individual borrowers on the mortgage loans that underlie the securities (net of fees paid to the issuer or guarantor of the
securities). Early repayment of principal on some mortgage-related securities (arising from prepayments of principal due to sale of the underlying property, refinancing, or foreclosure, net of fees and costs that may be incurred) may expose a Fund
to a lower rate of return upon reinvestment of principal. Also, if a security subject to prepayment has been purchased at a premium, the value of the premium would be lost in the event of prepayment. Like other fixed income securities, when interest
rates rise, the value of a mortgage-related security generally will decline; however, when interest rates are declining, the value of mortgage-related securities with prepayment features may not increase as much as other fixed income securities. The
rate of prepayments on underlying mortgages will affect the price and volatility of a mortgage-related security, and may have the effect of shortening or extending the effective maturity of the security beyond what was anticipated at the time of
purchase. To the extent that unanticipated rates of prepayment on underlying mortgages increase the effective maturity of a mortgage-related security, the volatility of such securities can be expected to increase.
Payment of principal and interest on some mortgage
pass-through securities (but not the market value of the securities themselves) may be guaranteed by the full faith and credit of the U.S. government (in the case of securities guaranteed by GNMA); or guaranteed by agencies or instrumentalities of
the U.S. government (in the case of securities guaranteed by the Federal National Mortgage Association or FNMA or the Federal Home Loan Mortgage Corporation or FHLMC), which are supported only by the discretionary authority
of the U.S. government to purchase the agencys obligations. Mortgage-related securities created by non-governmental issuers (such as commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers, and
other secondary market issuers) may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit, which may be issued by governmental entities, private insurers or the
mortgage poolers.
Collateralized mortgage
obligations (CMOs) are hybrid mortgage-related instruments. Interest and pre-paid principal on a CMO are paid, in most cases, on a monthly basis. CMOs may be collateralized by whole mortgage loans but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC or FNMA. CMOs are structured into multiple classes, with each class bearing a different stated maturity. Monthly payments of principal, including prepayments, are first
returned to investors holding the shortest maturity class; investors holding the longer maturity classes receive principal only after the first class has
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been retired. CMOs that are issued or guaranteed by the U.S. government or by any of its agencies or instrumentalities will be considered U.S. government securities by a Fund, while other CMOs,
even if collateralized by U.S. government securities, will have the same status as other privately issued securities for purposes of applying a Funds diversification tests.
A real estate mortgage investment conduct (REMIC)
must elect to be, and must qualify for treatment as such, under the Internal Revenue Code. A REMIC must consist of one or more classes of regular interests, some of which may be adjustable rate, and a single class of residual
interests. To qualify as a REMIC, substantially all the assets of the entity must be in assets directly or indirectly secured, principally by real property. Congress intended for REMICs to ultimately become the exclusive vehicle for the
issuance of multi-class securities backed by real estate mortgages. If a trust or partnership that issues CMOs does not elect and qualify for REMIC status, it will be taxed at the entity level as a corporation.
Commercial mortgage-backed securities include securities that
reflect an interest in, and are secured by, mortgage loans on commercial real property. The market for commercial mortgage-backed securities developed more recently and in terms of total outstanding principal amount of issues is relatively small
compared to the market for residential single-family mortgage-backed securities. 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. Commercial mortgage-backed securities may be less
liquid and exhibit greater price volatility than other types of mortgage-related or asset-backed securities. Certain commercial mortgage-backed securities are issued in several classes with different levels of yield and credit protection. A
Funds investments in commercial mortgage-backed securities with several classes may be in the lower classes that have greater risks than the higher classes, including greater interest rate, credit, and prepayment risks.
Mortgage-related securities include securities other than
those described above that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property, such as mortgage dollar rolls (see Reverse Repurchase Agreements and Dollar Roll
Arrangements below), CMO residuals or stripped mortgage-backed securities (SMBS), and may be structured in classes with rights to receive varying proportions of principal and interest.
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 Funds yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated
prepayments of principal, a Fund may not fully recoup its investment in IOs. Conversely, if the underlying mortgage assets experience less than anticipated prepayments of principal, the yield on POs could be materially adversely affected. A Fund may
invest in other asset-backed securities that have been offered to investors. Each Fund (except the Forward U.S. Government Money Fund) will treat IOs and POs as illiquid securities except where the security can be sold within seven days at
approximately the same amount at which it is valued by the Fund and there is reasonable assurance that the security will remain marketable throughout the period it is expected to be held by the Fund, taking into account the actual frequency of
trades and quotations for the security (expected frequency in the case of initial offerings). Additionally, the security will be treated as illiquid unless: (i) it is rated at least BBB/Baa or a comparable rating from
another nationally recognized statistical ratings organization, (ii) at least two dealers make a market in the security, (iii) there are at least three sources from which a price for the security is readily available; and (iv) the
security is U.S. government issued and backed by fixed-rate mortgages.
The yield characteristics of mortgage-related securities and asset-backed securities differ from traditional debt securities. Among the major differences are that interest and principal payments are made
more frequently, usually monthly, and that principal may be prepaid at any time because the underlying mortgage loans or other assets generally may be prepaid at any time. As a result, if a Fund purchases such a security at a premium, a prepayment
rate that is faster than expected will reduce yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity. Alternatively, if a Fund purchases these securities at a discount,
faster than expected prepayments will increase, while slower than expected prepayments will reduce, yield to maturity.
Although the extent of prepayments in a pool of mortgage loans depends on various economic and other factors, as a general rule
prepayments on fixed-rate mortgage loans will increase during a period of falling interest rates and decrease during a period of rising interest rates. Accordingly, amounts available for reinvestment by a Fund are likely to be greater during a
period of declining interest rates and, as a result, likely to be reinvested at lower interest rates than during a period of rising interest rates. Asset-backed securities, although less likely to experience the same prepayment rates as
mortgage-related securities, may respond to certain of the same factors influencing prepayments, while at other times different factors will predominate. Mortgage-related securities and asset-backed securities may decrease in value as a result of
increases in interest rates and may benefit less than other fixed-income securities from declining interest rates because of the risk of prepayment.
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Asset-backed securities involve certain risks that are not posed by mortgage-related
securities, because asset-backed securities do not usually have the type of security interest in the related collateral that mortgage-related securities have. For example, credit card receivables generally are unsecured and the debtors are entitled
to the protection of a number of state and federal consumer credit laws, some of which may reduce a creditors ability to realize full payment. In the case of automobile receivables, due to various legal and economic factors, proceeds from
repossessed collateral may not always be sufficient to support payments on these securities.
At times the value of mortgage or asset-backed securities may be particularly sensitive to changes in the general level of interest rates. Early repayment of principal on some mortgage or asset-backed
securities may expose the Fund to a lower rate of return upon reinvestment of principal. When the general level of interest rates rise, the value of a mortgage or asset-backed securities generally will decline; however, when interest rates are
declining, the value of mortgage or asset-backed securities with prepayment features may not increase as much as other fixed income securities. The rate of prepayments on underlying mortgages or assets will affect the price and volatility of a
mortgage or asset-backed securities, and may shorten or extend the effective maturity of the security beyond what was anticipated at the time of purchase. If unanticipated rates of prepayment on underlying mortgages or assets increase the effective
maturity of these securities, the volatility of the security can be expected to increase. The value of these securities may also fluctuate in response to other idiosyncratic circumstances.
Options on Securities, Securities Indices, Futures Contracts, Swap Contracts, and Swap Indices
A Fund may write covered put and call options
and/or purchase put and call options on securities, securities indices, and futures contracts that are traded on U.S. and foreign exchanges and over-the-counter, as well as options on swaps and swap indices for hedging and/or non-hedging purposes.
An option on a security, futures contract or swap contract is a contract that gives the purchaser of the option, in return for the premium paid, the right to buy a specified security, futures contract or swap contract (in the case of a call option)
or to sell a specified security, futures contract or swap contract (in the case of a put option) from or to the writer of the option at a designated price during the term of the option. The writer of an option on a security has the obligation upon
exercise of the option to deliver the underlying security upon payment of the exercise price or to pay the exercise price upon delivery of the underlying security. Upon exercise, the writer of an option on an index is obligated to pay the difference
between the cash value of the index and the exercise price multiplied by the specified multiplier for the index option. An index is designed to reflect specified facets of a particular financial or securities market, a specific group of financial
instruments or securities, or certain economic indicators. An option on an index gives the purchaser of the option, in return for the premium paid, the right to receive from the seller cash equal to the difference between the closing price of the
index and the exercise price of the option. One purpose of purchasing put options is to protect holdings in an underlying or related security or swap contract against a substantial decline in market value. One purpose of purchasing call options is
to protect against substantial increases in prices of securities or swap contracts.
A Fund may write a call or put option only if the option is covered. A call option on a security, index, futures contract, swap contract or swap index written by a Fund is covered
if the Fund owns the underlying security, index, futures contract, swap contract or swap index covered by the call or has an absolute and immediate right to acquire that security without additional cash consideration (or for additional cash
consideration held in a segregated or earmarked account by its custodian) upon conversion or exchange of other securities held in its portfolio, or otherwise segregates or earmarks liquid assets in an amount equal to the
value of the underlying instrument on a daily, marked-to-market basis. A call option on a security, index, futures contract, swap contract or swap index is also covered if a Fund holds a call on the same security, index, futures contract, swap
contract or swap index and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price of the call written, or (b) is greater than the exercise price of the
call written if the difference is maintained by a Fund in cash or high-grade U.S. government securities in a segregated or earmarked account with its custodian. A put option on a security, index, futures contract, swap contract or swap
index written by a Fund is covered if the Fund maintains liquid assets with a value equal to the exercise price in a segregated or earmarked account with its custodian, or else holds a put on the same security, index, futures
contract, swap contract or swap index, and in the same principal amount as the put written where the exercise price of the put held is equal to or greater than the exercise price of the put written.
A Fund may write covered straddles consisting of a
combination of a call and a put written on the same underlying security, index, futures contract, swap contract or swap index. A straddle will be covered when sufficient assets are deposited to meet a Funds immediate obligations. A Fund may
use the same liquid assets to cover both the call and put options where the exercise price of the call and put are the same, or the exercise price of the call is higher than that of the put. In such cases, a Fund will also segregate or
earmark liquid assets equivalent to the amount, if any, by which the put is in the money.
A Fund will receive a premium from writing a put or call option, which increases gross income in the event the option expires unexercised
or is closed out at a profit. If the value of a security, index, futures contract, swap contract or swap index on which a Fund has written a call option falls or remains the same, the Fund will realize a profit in the form of the premium received
(less transaction costs) that could offset all or a portion of any decline in the value of the portfolio securities being hedged. If the value of the underlying security, index, futures contract, swap contract or swap index rises, however, a Fund
will realize a loss in its call option position, which will reduce the benefit of any unrealized appreciation in its investments. By writing a put option, a Fund assumes the risk of a
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decline in the underlying security, index, futures contract, swap contract or swap index. To the extent that the price changes of the portfolio securities being hedged correlate with changes in
the value of the underlying security, index, futures contract, swap contract or swap index, writing covered put options will increase a Funds losses in the event of a market decline, although such losses will be offset in part by the premium
received for writing the option.
A Fund may also
purchase put options to hedge its investments against a decline in value. By purchasing a put option, a Fund will seek to offset a decline in value of the portfolio investments being hedged through appreciation of the put option. If the value of a
Funds investments does not decline as anticipated, or if the value of the option does not increase, the Funds loss will be limited to the premium paid for the option plus related transaction costs. The success of this strategy will
depend, in part, on the accuracy of the correlation between the changes in value of the underlying security, index, futures contract, swap contract or swap index, and the changes in value of a Funds investment holdings being hedged.
A Fund may purchase call options on individual
securities or futures or swap contracts to hedge against an increase in the price of securities or futures or swap contracts that it anticipates purchasing in the future. Similarly, a Fund may purchase call options on a securities or swap index to
attempt to reduce the risk of missing a broad market advance, or an advance in an industry or market segment, at a time when the Fund holds uninvested cash or short-term debt securities awaiting reinvestment. When purchasing call options, a Fund
will bear the risk of losing all or a portion of the premium paid if the value of the underlying security, index, futures contract, swap contract or swap index does not rise.
A Fund may purchase and write covered put and covered call
options that are traded on U.S. or foreign securities exchanges or that are listed on the NASDAQ Stock Market. Currency options may be either listed on an exchange or traded over-the-counter. Options on financial futures and stock indices are
generally settled in cash as opposed to the underlying securities.
Listed options are third-party contracts (
i.e.
, performance of the obligations of the purchaser and seller is guaranteed by the exchange or clearing corporation) and have standardized strike prices
and expiration dates. Over-the-counter options are privately negotiated with the counterparty to such contract and are purchased from and sold to dealers, financial institutions or other counterparties which have entered into direct agreements with
a Fund. Over-the-counter options differ from exchange-traded options in that over-the-counter options are transacted with the counterparty directly and not through a clearing corporation (which guarantees performance). If the counterparty fails to
take delivery of the securities underlying an option it has written, a Fund would lose the premium paid for the option as well as any anticipated benefit of the transaction. Consequently, a Fund must rely on the credit quality of the counterparty
and there can be no assurance that a liquid secondary market will exist for any particular over-the-counter options at any specific time.
The purchase and writing of options involves certain risks. During the option period, the covered call writer has, in return for the
premium on the option, given up the opportunity to profit from a price increase in the underlying security above the exercise price, but, as long as its obligation as a writer continues, has retained the risk of loss should the price of the
underlying security decline. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase
transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price. If a put or call option purchased by a Fund is not sold when it has remaining value, and if the market price of the
underlying security remains equal to or greater than the exercise price (in the case of a put), or remains less than or equal to the exercise price (in the case of a call), the Fund will lose its entire investment in the option. Also, where a put or
call option on a particular security is purchased to hedge against price movements in a related security, the price of the put or call option may move more or less than the price of the related security.
There can be no assurance that a liquid market will exist
when a Fund seeks to close out an option position. Reasons for the absence of a liquid secondary market on an exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities;
(iv) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (v) the facilities of an exchange or a clearing corporation may not at all times be adequate to handle current trading volume; (vi) one or more
exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market on that exchange (or in the class or
series of options) would cease to exist, although outstanding options on that exchange that had been issued by a clearing corporation as a result of trades on that exchange would continue to be exercisable in accordance with their terms. Although a
Fund may be able to offset to some extent any adverse effects of being unable to liquidate an option position, it may experience losses in some cases as a result of such inability. The value of over-the-counter options purchased by a Fund, as well
as the cover for options written by a Fund, are considered not readily marketable and are subject to the Trusts limitation on investments in securities that are not readily marketable, unless the over-the-counter option written by a Fund is
sold to a dealer who agrees that the Fund may repurchase the option at a maximum price determined by a formula in the option agreement. The cover for that option will be considered illiquid only to the extent that the maximum repurchase price under
the formula exceeds the intrinsic value of the option.
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There are several risks associated with transactions in options on securities, futures or
swaps indices, and even a small investment in securities such as options can have a significant impact on a Funds exposure to stock market values, interest rates or the currency exchange rate. For example, there are significant differences
between the securities, futures or swaps markets, and the options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A decision as to whether, when and how to use
options involves the exercise of skill and judgment, and even a well-conceived transaction may be unsuccessful to some degree because of market behavior or unexpected events. There can be no assurance that a liquid market will exist when a Fund
seeks to close out an option position. If a Fund were unable to close out an option that it had purchased on a securities, futures or swaps index, it would have to exercise the option in order to realize any profit or the option may expire
worthless. If trading were suspended in an option purchased by a Fund, it would not be able to close out the option. If restrictions on exercise were imposed, a Fund might be unable to exercise an option it had purchased. Except to the extent that a
call option on an index written by a Fund is covered by an option on the same index purchased by the Fund, movements in the index may result in a loss to the Fund; however, such losses may be mitigated by changes in the value of the Funds
securities during the period the option was outstanding. A Funds use of options may leave the Fund in a worse position than if it had not invested in options.
Participation Notes (P-Notes)
P-Notes are participation interest notes that are issued by
banks or broker-dealers and are designed to offer a return linked to a particular underlying equity, debt, currency or market. The P-Notes in which a Fund may invest will typically have a maturity of one year. When purchasing a P-Note, the posting
of margin is not required because the full cost of the P-Note (plus commission) is paid at the time of purchase. When the P-Note matures, the issuer will pay to, or receive from, the purchaser the difference between the minimal value of the
underlying instrument at the time of purchase and that instruments value at maturity. Investments in P-Notes involve the same risks associated with a direct investment in the underlying foreign companies of foreign securities markets that they
seek to replicate.
In addition, there can be no
assurance that the trading price of P-Notes will equal the underlying value of the foreign companies or foreign securities markets that they seek to replicate. The holder of a participation note that is linked to a particular underlying security is
entitled to receive any dividends paid in connection with an underlying security or instrument. However, the holder of a participation note does not receive voting rights as it would if it directly owned the underlying security or instrument.
P-Notes are generally traded over-the-counter. P-Notes constitute general unsecured contractual obligations of the banks or broker-dealers that issue them and the counterparty. There is also counterparty risk associated with these investments
because a Fund is relying on the creditworthiness of such counterparty and has no rights under a participation note against the issuer of the underlying security. In addition, a Fund will incur transaction costs as a result of investment in P-Notes.
Preferred Stock
A Fund may invest in preferred stock. Preferred stock, unlike
common stock, offers a stated dividend rate payable from the issuers earnings. Preferred stock dividends may be cumulative or non-cumulative, participating, or auction rate. If interest rates rise, the fixed dividend on preferred stocks may be
less attractive, causing the price of the preferred stocks to decline. Preferred stock may have mandatory sinking fund provisions, as well as call/redemption provisions prior to maturity, a negative feature when interest rates decline. A Fund may
purchase preferred stock of companies which have also issued other classes of preferred stock or debt obligations that may take priority as to payment of dividends over the preferred stock held by the Fund.
Private Investment Funds
A Fund may invest in private investment funds, also known as
hedge funds, which will pursue alternative investment strategies. An investment in a private investment fund involves certain risks relating to, among other things, the nature of the investments and investment techniques to be employed by the
private investment fund. Because of the speculative nature of the investments and trading strategies of private investment funds, there is a risk that a Fund may suffer a significant or complete loss of its invested capital in one or more private
investment funds. Private investment funds may utilize a variety of special investment instruments and techniques to hedge the portfolios of the funds against various risks (such as changes in interest rates or other factors that affect security
values) or for non-hedging purposes to pursue a funds investment objective. Certain of the special investment instruments and techniques that the fund may use are speculative and involve a high degree of risk, particularly in the context of
non-hedging transactions. Interests in a private investment fund are not generally registered under the 1933 Act and the transferability or withdrawal of such interests is substantially restricted.
Privately-Issued Stripped Securities
A Fund may invest in principal portions or coupon portions of
U.S. government Securities that have been separated (stripped) by banks, brokerage firms, or other entities. Stripped securities are usually sold separately in the form of receipts or certificates representing undivided interests in the stripped
portion and are not considered to be issued or guaranteed by the U.S. government. Stripped securities may be more volatile than nonstripped securities.
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Privatizations
A Fund may invest in privatizations. The Funds believe that
foreign government programs of selling interests in government-owned or controlled enterprises (privatizations) may represent opportunities for significant capital appreciation. The ability of U.S. entities, such as a Fund, to
participate in privatizations may be limited by local law, or the terms for participation may be less advantageous than for local investors. There can be no assurance that privatization programs will be available or successful.
Quantitative Strategy
A quantitative strategy means that investments are selected
based upon a customized group of proprietary models designed by Forward Management. A model attempts to enhance returns, within defined risk parameters, relative to a benchmark by analyzing relevant market related information. The success of a
Funds principal investment strategies may depend on the skill of Forward Management in designing and using its analytical model as a tool for selecting investments. A flaw in the design of an analytical models may result in a Fund having a
lower return than if the Fund was managed using a fundamental or passive investment management strategy.
Real Estate Securities
A Fund may invest in the common and senior securities of real estate investment trusts (REITs) and other real estate
companies, including preferred stock, convertible preferred stock, and corporate debt. (The Forward International Real Estate Fund invests primarily in non-U.S. securities of real estate and real estate-related companies). A REIT is a corporation or
a business trust that would otherwise be taxed as a corporation, which meets the definitional requirements of the Internal Revenue Code. The Internal Revenue Code permits a qualifying REIT to deduct dividends paid, thereby effectively eliminating
corporate level federal income tax and making the REIT a pass-through vehicle for federal income tax purposes. To meet the definitional requirements of the Internal Revenue Code, a REIT must, among other things, invest substantially all of its
assets in interests in real estate (including mortgages and other REITs) or cash and government securities, derive most of its income from rents from real property or interest on loans secured by mortgages on real property; and distribute to
shareholders annually 90% or more of its otherwise taxable income.
REITs are sometimes informally characterized as equity REITs, mortgage REITs, and hybrid REITs. An equity REIT invests primarily in the fee ownership of land and buildings and derives its income primarily
from rental income. An equity REIT may also realize capital gains (or losses) by selling real estate properties in its portfolio and have appreciated (or depreciated) in value. A mortgage REIT invests primarily in mortgages on real estate, which may
secure construction, development or long-term loans. A mortgage REIT generally derives its income primarily from interest payments on the credit it has extended. A hybrid REIT combines the characteristics of equity REITs and mortgage REITs,
generally by holding both ownership interests and mortgage interests in real estate.
Investments in REITs and real estate securities may be subject to certain of the same risks associated with the direct ownership of real estate. These risks include: declines in the value of real estate
generally; changes in neighborhood or property appeal; environmental clean-up costs; condemnation or casualty losses; risks related to general and local economic conditions; legislative or regulatory changes; over-building and competition; increases
in property taxes and operating expenses; lack of availability of mortgage funds; high or extended vacancy rates; and rent controls or variations in rental income. The general performance of the real estate industry has historically been cyclical
and particularly sensitive to economic downturns. Rising interest rates may cause REIT investors to demand a higher annual return, which may cause a decline in the prices of REIT equity securities. Rising interest rates also generally increase the
costs of obtaining financing, which could cause the value of a Funds investments to decline. During periods of declining interest rates, certain mortgage REITs may hold mortgages that the mortgagors may elect to prepay, and such prepayment may
diminish the yield on securities issued by those REITs. In addition, mortgage REITs may be affected by the borrowers ability to repay their debt to the REIT when due. Equity REIT securities may be affected by changes in the value of the
underlying property owned by the REIT and the ability of tenants to pay rent. In addition, REITs may not be diversified and are subject to heavy cash flow dependency and self liquidation. REITs are subject to the possibility of failing to qualify
for tax-free pass-through of income and failing to maintain exemption under the 1940 Act. Also, equity REITs may be dependent upon management skill and may be subject to the risks of obtaining adequate financing for projects on favorable terms.
REITs may have limited financial resources, may trade less frequently and in a limited volume, and may be subject to more abrupt or erratic price movements than more widely held securities.
In the event that an issuer of real estate-related securities suffers adverse changes in its financial
condition, this could lower the credit quality of the securities it has issued, leading to greater volatility in the price of the securities and in the shares of a Fund. A change in the quality rating of a security can also affect its liquidity and
make it more difficult for a Fund to sell. To the extent that an issuer has exposure to sub-prime investments, this may further affect the liquidity and valuation risk associated with the issuer.
A Funds investment in a REIT may require the Fund to
accrue and distribute income not yet received or may result in the Fund making distributions that constitute a return of capital to Fund shareholders for federal income tax purposes. In addition, distributions by a Fund from REITs will not qualify
for the corporate dividends received deduction, or, generally, for treatment as qualified dividend income.
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ReFlow
A Fund may participate in ReFlow, a program designed to
provide an alternative liquidity source for mutual funds experiencing redemptions of their shares. In order to pay cash to shareholders who redeem their shares on a given day, a mutual fund typically must hold cash in its portfolio, liquidate
portfolio securities, or borrow money, all of which impose certain costs on the fund. ReFlow provides participating mutual funds with another source of cash by standing ready to purchase shares from a fund equal to the amount of the funds net
redemptions on a given day. ReFlow then generally redeems those shares when the fund experiences net sales. In return for this service, the Fund will pay a fee to ReFlow at a rate determined by a daily auction with other participating mutual funds.
The costs to a Fund for participating in ReFlow are expected to be influenced by and comparable to the cost of other sources of liquidity, such as the Funds short-term lending arrangements or the costs of selling portfolio securities to meet
redemptions. ReFlow will be prohibited from acquiring more than 3% of the outstanding voting securities of any Fund, but in no case will ReFlows position in any Fund exceed $15 million.
ReFlow Services, LLC (ReFlow Services), the entity which facilitates the day-to-day operations of
ReFlow, is under common control with Forward Management, the investment advisor to the Funds. In light of this, the Board of Trustees has adopted certain procedures to govern the Funds participation in ReFlow. Among other things, the
procedures require that all decisions with respect to whether to participate in a particular auction or the terms bid in an auction will be made solely by the relevant portfolio management personnel of Forward Management. In addition, ReFlow
Services may not provide any information to Forward Management with respect to the ReFlow auctions that differs in kind from that provided to any other participating funds in ReFlow. The Board will receive quarterly reports regarding the Funds
usage of the program, and shall determine annually whether continued participation in the program is in the best interests of the Funds and their shareholders.
Regulatory and Market Developments
Recent instability in the financial markets has led the U.S. government to take a number of unprecedented actions designed to support
certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Federal, state, and non-U.S. governments, their regulatory agencies, or self regulatory
organizations may take actions that affect the regulation of the instruments in which a Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Legislation or regulation may also change the way in which a Fund itself is
regulated. Such legislation or regulation could diminish or preclude a Funds ability to achieve its investment objective. Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership
interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation, and performance of a Funds portfolio
holdings.
Repurchase Agreements
Securities held by a Fund may be subject to
repurchase agreements. A repurchase agreement is a contract under which a Fund acquires a security for a relatively short time period (usually not more than one week) subject to the obligation of the seller to repurchase and the Fund to resell such
security at a fixed time and price which represents the Funds cost plus interest. The arrangement results in a fixed rate of return that is not subject to market fluctuations during the period that the underlying security is held by the Fund.
Repurchase agreements involve certain risks, including sellers default on its obligation to repurchase or sellers bankruptcy. The Funds will enter into such agreements only with commercial banks and registered broker-dealers, as well as
other financial institutions which Forward Management deems creditworthy under guidelines approved by the Board of Trustees. In these transactions, the securities issued by the Funds will have a total value in excess of the value of the repurchase
agreement during the term of the agreement. If the seller defaults, the respective Fund could realize a loss on the sale of the underlying security to the extent that the proceeds of the sale, including accrued interest, are less than the resale
price provided in the agreement including interest, and it may incur expenses in selling the security. In addition, if the other party to the agreement becomes insolvent and subject to liquidation or reorganization under the U.S. Bankruptcy Code of
1983 or other laws, a court may determine that the underlying security is collateral for a loan by the Fund not within the control of the Fund and therefore the Fund may not be able to substantiate its interest in the underlying security and may be
deemed an unsecured creditor of the other party to the agreement. While the Funds management acknowledges these risks, it is expected that they can be controlled through careful monitoring procedures.
In a repurchase agreement, a Fund purchases a security and
simultaneously commits to sell that security back to the original seller at an agreed-upon price. The resale price reflects the purchase price plus an agreed-upon incremental amount that is unrelated to the coupon rate or maturity of the purchased
security. To protect a Fund from risk that the original seller will not fulfill its obligations, the securities are held in accounts of the Fund at a bank, marked-to-market daily, and maintained at a value at least equal to the sale price plus the
accrued incremental amount. If a seller defaults on its repurchase obligations, a Fund may suffer a loss in disposing of the security subject to the repurchase agreement. While it does not presently appear possible to eliminate all risks from these
transactions (particularly the possibility that the value of the underlying security will be less than the resale price, as well as costs and delays to a
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Fund in connection with bankruptcy proceedings), it is the current policy of the Funds to engage in repurchase agreement transactions with parties whose creditworthiness has been reviewed and
found satisfactory by Forward Management.
Reverse Repurchase Agreements and Dollar Roll Agreements
A Fund may enter into reverse repurchase agreements and
dollar roll agreements in accordance with applicable investment restrictions. In a reverse repurchase agreement, a Fund sells a portfolio instrument to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase the
instrument at a particular price and time. A dollar roll agreement is identical to a reverse repurchase agreement except for the fact that substantially similar securities may be repurchased. While a reverse repurchase agreement is outstanding, a
Fund will maintain segregated or earmarked liquid assets to cover its obligation under the agreement. A Fund will enter into reverse repurchase agreements only with parties whose creditworthiness has been found satisfactory by Forward
Management. Such transactions may increase fluctuations in the market value of a Funds assets and may be viewed as a form of leverage. Reverse repurchase agreements and dollar roll agreements involve the risk that the market value of the
securities sold by a Fund may decline below the price at which the Fund is obligated to repurchase the securities.
Rule 144A Securities
A Fund may purchase securities that are not registered under the 1933 Act, but that can be sold to qualified institutional
buyers in accordance with Rule 144A under the 1933 Act (Rule 144A Securities). In addition to an adequate trading market, the Board will also consider factors such as trading activity, availability of reliable price information,
and other relevant information in determining whether a Rule 144A Security is liquid. This investment practice could have the effect of increasing the level of illiquidity in the Funds to the extent that qualified institutional buyers become
uninterested for a time in purchasing Rule 144A Securities. The Board will carefully monitor any investments by the Funds in Rule 144A Securities.
Rule 144A securities may involve a high degree of business and financial risk and may result in substantial losses. These securities may
be less liquid than publicly traded securities, and a Fund may take longer to liquidate these positions than would be the case for publicly traded securities. Although these securities may be resold in privately negotiated transactions, the price
realized from these sales could be less than those originally paid by a Fund.
Further, companies whose securities are not publicly traded may not be subject to the disclosure and other investor protection requirements that would be applicable if their securities were publicly
traded.
Rule 144A under the 1933 Act allows for a
broader institutional trading market for securities otherwise subject to restriction on resale to the general public by establishing a safe harbor from the registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers (as such term is defined under Rule 144A). Forward Management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the Financial Industry Regulatory Authority, Inc. An insufficient
number of qualified institutional buyers interested in purchasing Rule 144A eligible restricted securities held by a Fund, however, could affect adversely the marketability of such Funds securities and, consequently, the Fund might be unable
to dispose of such securities promptly or at favorable prices. Forward Management will monitor the liquidity of such restricted securities under the supervision of the Board.
Securities issued pursuant to Rule 144A are not deemed to be
illiquid. Forward Management will monitor the liquidity of such restricted securities subject to the supervision of the Board. In reaching liquidity decisions, Forward Management must first find that the security can be sold within seven days at
approximately the same amount at which it is valued by the Fund and that there is reasonable assurance that the security will remain marketable throughout the period it is expected to be held by the Fund, taking into account the actual frequency of
trades and quotations for the security (expected frequency in the case of initial offerings). Furthermore, the security will be considered liquid if the following criteria are met: (a) at least two dealers make a market in the security;
(ii) there are at least three sources from which a price for the security is readily available; and (iii) settlement is made in a regular way for the type of security at issue.
Securities Issued by Other Investment Companies
A Fund may invest in securities of other
investment companies, including investment companies which may not be registered under the 1940 Act. A Fund may invest in affiliated and unaffiliated no-load, open-end money market funds and short-term bond funds for cash management purposes. By
investing in another investment company, a Fund is exposed to the risks of the underlying investment company in which it invests in proportion to the amount of assets the Fund allocates to the underlying investment company. In addition, a
Funds investment in other investment companies is limited by the 1940 Act, and will involve the indirect payment of a portion of the expenses, including advisory fees, of such other investment companies.
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A Funds investments in other investment companies may include investments in various
ETFs, subject to the Funds investment objective, policies, and strategies as described in the prospectus. ETFs are discussed above in greater detail.
Generally, a Fund will not purchase securities of another investment company if, as a result: (i) more than 10% of the Funds
total assets would be invested in securities of other investment companies, (ii) such purchase would result in more than 3% of the total outstanding voting securities of any such investment company being held by the Fund, or (iii) more
than 5% of the Funds total assets would be invested in any one such investment company. Many ETFs have obtained exemptive relief from the SEC to permit unaffiliated funds to invest in the ETFs shares beyond the above statutory
limitations, subject to certain conditions and pursuant to a contractual arrangement between the particular ETF and the investing fund. A Fund may rely on these exemptive orders to invest in unaffiliated ETFs.
Securities Lending
In order to generate additional income, a Fund from time to
time may lend portfolio securities to broker-dealers, banks or institutional borrowers of securities, provided that outstanding loans do not exceed in the aggregate the maximum allowable percentage of the value of the Funds net assets under
applicable laws and regulations, currently 33-1/3%. Each Fund may lend securities if such loans are secured continuously by liquid assets consisting of cash, U.S. Government securities or other liquid, high-grade debt securities, or by a letter of
credit in favor of the Fund in a separate account maintained by the custodian at least equal at all times to 100% of the market value of the securities loaned, plus accrued interest. This collateral must be valued daily and, should the market value
of the loaned securities increase, the borrower must furnish additional collateral to the lending Fund. During the time portfolio securities are on loan, the borrower pays the lending Fund any dividends or interest paid on such securities. Loans are
subject to termination by the lending Fund or the borrower at any time. While the lending Fund does not have the right to vote securities on loan, it intends to terminate the loan and regain the right to vote if that is considered important with
respect to the investment. In the event the borrower defaults on its obligation to the lending Fund, the lending Fund could experience delays in recovering its securities and possible capital losses. A Fund may pay reasonable finders and
custodial fees in connections with loans. In addition, a Fund will consider all facts and circumstances, including the creditworthiness of the borrowing financial institution, and a Fund will not lend its securities to any director, officer,
employee, or affiliate of Forward Management, the Administrator or the Distributor, unless permitted by applicable law.
Short Sales
A Fund may make short sales of securities as part of its overall portfolio management strategies and to offset potential declines in long
positions in similar securities. A short sale is a transaction in which a Fund sells a security it does not own in anticipation that the market price of that security will decline.
When a Fund makes a short sale (other than a short sale
against the box, as discussed below), it must borrow the security sold short and deliver it to the broker-dealer through which it made the short sale as collateral for its obligation to deliver the security upon conclusion of the sale.
The Fund may have to pay a fee to borrow particular securities and is often obligated to pay over any accrued interest and dividends on such borrowed securities.
If the price of the security sold short increases between the
time of the short sale and the time the Fund replaces the borrowed security, the Fund will incur a loss; conversely, if the price declines, the Fund will realize a capital gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely affected by imperfect correlation between movements in the price of the security sold short and the securities being hedged.
To the extent that a Fund engages in short sales, it will
provide collateral to the broker-dealer and (except in the case of short sales against the box) will maintain additional asset coverage in the form of segregated assets determined to be liquid by Forward Management in accordance with
procedures established by the Board of Trustees.
A Fund may engage in short selling to the extent permitted by the 1940 Act and rules and interpretations thereunder.
Short Sales Against the Box
A Fund may enter into a short sale of a security such that,
so long as the short position is open, the Fund will own an equal amount of preferred stock or debt securities, convertible or exchangeable without payment of further consideration, into an equal number of shares of the common stock sold short. This
kind of short sale, which is described as one against the box, will be entered into by a Fund for the purpose of receiving a portion of the interest earned by the executing broker from the proceeds of the sale. The proceeds of the sale
will be held by the broker until the settlement date, when the Fund delivers the convertible securities to close out its short position. Although, prior to delivery, a Fund will have to pay an amount equal to any dividends paid on the common stock
sold short, the Fund will receive the dividends from the preferred stock or interest from the debt securities convertible into the stock sold short,
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plus a portion of the interest earned from the proceeds of the short sale. A Fund will deposit, in a segregated account with its custodian, convertible preferred stocks or convertible debt
securities in connection with short sales against the box.
Sovereign Debt Securities
Sovereign debt securities are issued by governments of foreign countries. The sovereign debt in which a Fund may invest may be rated below investment grade. These securities usually offer higher yields
than higher rated securities but are also subject to greater risk than higher rated securities. Brady Bonds represent a type of sovereign debt. These obligations were created under a debt restructuring plan introduced by former U.S. Secretary of the
Treasury, Nicholas F. Brady, in which foreign entities issued these obligations in exchange for their existing commercial bank loans. Brady Bonds have been issued by Argentina, Brazil, Bulgaria, Costa Rica, Dominican Republic, Ecuador, Mexico,
Morocco, Nigeria, Philippines, Poland, and Uruguay, and may be issued by other emerging countries.
Structured Notes
A Fund may invest in structured notes, which are debt obligations that also contain an embedded derivative component with characteristics that adjust the obligations risk/return profile. Generally,
the performance of a structured note will track that of the underlying debt obligation and the derivative embedded within it. A Fund has the right to receive periodic interest payments from the issuer of the structured notes at an agreed-upon
interest rate and a return of the principal at the maturity date.
Structured notes are typically privately negotiated transactions between two or more parties. A Fund bears the risk that the issuer of the structured note will default or become bankrupt. A Fund bears the
risk of the loss of its principal investment and periodic interest payments expected to be received for the duration of its investment in the structured notes.
In the case of structured notes on credit default swaps, a Fund is also subject to the credit risk of the corporate credits underlying the
credit default swaps. If one of the underlying corporate credits defaults, a Fund may receive the security that has defaulted, or alternatively a cash settlement may occur, and the Funds principal investment in the structured note would be
reduced by the corresponding face value of the defaulted security.
A Fund may invest in equity-linked structured notes (which would be linked to an equity index) to a significant extent. A highly liquid secondary market may not exist for the structured notes a Fund
invests in, and there can be no assurance that a highly liquid secondary market will develop. The lack of a highly liquid secondary market may make it difficult for a Fund to sell the structured notes it holds at an acceptable price or accurately
value such notes.
The market for structured notes
may be, or suddenly can become, illiquid. The other parties to the transaction may be the only investors with sufficient understanding of the derivative to be interested in bidding for it. Changes in liquidity may result in significant, rapid, and
unpredictable changes in the prices for structured notes. In certain cases, a market price for a credit-linked security may not be available. The collateral for a structured note may be one or more credit default swaps, which are subject to
additional risks.
Swap Agreements
A Fund may enter into interest rate, index,
equity, currency exchange rate, total return and credit default swap agreements as well as purchase and sell options to enter into such swap agreements, for hedging and non-hedging purposes. These transactions would be entered into in an attempt to
obtain a particular return when it is considered desirable to do so, possibly at a lower cost to a Fund than if the Fund had invested directly in the asset that yielded the desired return. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to more than one year. In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments, which may be adjusted for an interest factor. The gross returns to be exchanged or swapped between the parties are generally calculated with respect to a notional amount,
i.e.
,
the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular foreign currency, or in a basket of securities representing a particular index.
Forms of swap agreements include interest rate caps, under
which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or cap; interest rate floors, under which, in return for a premium, one party agrees to make
payments to the other to the extent that interest rates fall below a specified level, or floor; and interest rate collars, under which a party sells a cap and purchases a floor or vice versa, in an attempt to protect itself against
interest rate movements exceeding given minimum or maximum levels. Credit default swaps are a type of swap agreement in which the protection buyer is generally obligated to pay the protection seller an upfront and/or a
periodic stream of payments over the term of the contract provided that no credit event, such as a default, on a reference obligation has occurred. The credit default swap agreement may have as reference obligations one or more securities that are
not currently held by a Fund. If a credit event occurs, the seller generally must pay the buyer the par value (full notional value) of the swap in exchange for an equal face amount of deliverable obligations of the
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reference entity described in the swap, or the seller may be required to deliver the related net cash amount, if the swap is cash settled. A Fund may be either the buyer or seller in the
transaction. If a Fund is a buyer and no credit event occurs, the Fund may recover nothing if the swap is held through its termination date. However, if a credit event occurs, the buyer generally may elect to receive the full notional value of the
swap in exchange for an equal face amount of deliverable obligations of the reference entity whose value may have significantly decreased. As a seller, a Fund generally receives an upfront payment and/or a fixed rate of income throughout the term of
the swap provided that there is no credit event. As the seller, a Fund would effectively add leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap.
Credit default swap agreements involve greater risks than if a Fund had invested in the reference obligation directly since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit
risk. A Fund will enter into credit default swap agreements only with counterparties that meet certain standards of creditworthiness.
A Fund may enter into total return swap agreements. Total return swap agreements are contracts in which one party agrees to make periodic
payments based on the change in market value of underlying assets, which may include a specified security, basket of securities, defined portfolios of bonds, loans and mortgages, or securities indices during the specified period, in return for
periodic payments based on a fixed or variable interest rate or the total return from other underlying assets. Total return swap agreements may be used to obtain exposure to a security or market without owning or taking physical custody of such
security or market. Total return swap agreements may effectively add leverage to a Funds portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap. Total return
swaps are a mechanism for the user to accept the economic benefits of asset ownership without utilizing the balance sheet. The other leg of the swap, usually the London Interbank Offered Rate (LIBOR), is spread to reflect the non-balance sheet
nature of the product. Total return swaps can be designed with any underlying asset agreed between two parties. Typically no notional amounts are exchanged with total return swaps. Total return swap agreements entail the risk that a party will
default on its payment obligations to a Fund thereunder. Swap agreements also entail the risk that a Fund will not be able to meet its obligation to the counterparty. Generally, a Fund will enter into total return swaps on a net basis (
i.e.
,
the two payment streams are netted out with the Fund receiving or paying, as the case may be, only the net amount of the two payments).
Most swap agreements entered into by a Fund calculate the obligations of the parties to the agreement on a net basis.
Consequently, the Funds current obligations (or rights) under a swap agreement will generally be equal only to the net present value of amounts to be paid or received under the agreement based on the relative values of the positions held by
each party to the agreement (the net amount). The Funds current obligations under a swap agreement will be accrued daily (offset against amounts owed to the Fund), and any accrued but unpaid net amounts owed to a swap counterparty
will be covered by the maintenance of a segregated or earmarked account consisting of assets determined to be liquid by Forward Management in accordance with procedures established by the Board of Trustees, to limit any potential
leveraging of the Funds portfolio.
Obligations under swap agreements so covered will not be construed to be senior securities for purposes of the Funds
investment restriction concerning senior securities.
Whether a Funds use of swap agreements will be successful in furthering its investment objective will depend on the ability of Forward Management to correctly predict whether certain types of
investments are likely to produce greater returns than other investments. Because they are two-party contracts and because they may have terms of greater than seven days, swap agreements may be considered to be illiquid investments. Moreover, a Fund
bears the risk of loss of the amount expected to be received under a swap agreement in the event of the default or bankruptcy of a swap agreement counterparty. A Fund will enter into swap agreements only with counterparties that meet certain
standards for creditworthiness (generally, such counterparties would have to be eligible counterparties under the terms of the Funds repurchase agreement guidelines). Certain restrictions imposed on the Funds by the Internal Revenue Code may
limit a Funds ability to use swap agreements. The swap market is a relatively new market and is largely unregulated. It is possible that developments in the swap market, including potential government regulation, could adversely affect the
Funds ability to terminate existing swap agreements or to realize amounts to be received under such agreements. In addition, a Funds use of swaps may reduce the Funds returns and increase volatility.
U.S. Government Obligations
Obligations of certain agencies and instrumentalities of the
U.S. government, such as GNMA, are supported by the full faith and credit of the U.S. Treasury; others, such as those of FNMA, are supported by the right of the issuer to borrow from the Treasury; others, such as those of the Student Loan Marketing
Association, are supported by the discretionary authority of the U.S. government to purchase the agencys obligations; still others, such as those of the Federal Farm Credit Banks or FHLMC, are supported only by the credit of the
instrumentality. No assurance can be given that the U.S. government would provide financial support to U.S. government-sponsored agencies or instrumentalities if it is not obligated to do so by law.
Regarding certain federal agency securities or
government-sponsored entity securities (such as debt securities or mortgage-backed securities issued by FHLMC, FNMA, Federal Home Loan Banks, and other government-sponsored entities), you should be aware that
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although the issuer may be chartered or sponsored by Acts of Congress, the issuer is not funded by Congressional appropriations, and its securities are neither guaranteed nor issued by the U.S.
Treasury.
On September 6, 2008, the Federal
Housing Finance Agency (FHFA) placed FNMA and FHLMC into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC
with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. FHFA selected a new chief executive officer and chairman of the board of directors for each of FNMA and FHLMC.
On September 7, 2008, the U.S. Treasury announced three
additional steps taken by it in connection with the conservatorship. First, the U.S. Treasury entered into a Senior Preferred Stock Purchase Agreement with each of FNMA and FHLMC pursuant to which the U.S. Treasury will purchase up to an aggregate
of $100 billion of each of FNMA and FHLMC to maintain a positive net worth in each enterprise. This agreement contains various covenants that severely limit each enterprises operations. In exchange for entering into these agreements, the U.S.
Treasury received $1 billion of each enterprises senior preferred stock and warrants to purchase 79.9% of each enterprises common stock. Second, the U.S. Treasury announced the creation of a new secured lending facility which is
available to each of FNMA and FHLMC as a liquidity backstop. Third, the U.S. Treasury announced the creation of a temporary program to purchase mortgage-backed securities issued by each of FNMA and FHLMC. Both the liquidity backstop and the
mortgage-backed securities purchase program expired in December 2009.
FNMA and FHLMC are continuing to operate as going concerns while in conservatorship and each remain liable for all of its obligations, including its guaranty obligations, associated with its
mortgage-backed securities. The liquidity backstop and the Senior Preferred Stock Purchase Agreement were both intended to enhance each of FNMAs and FHLMCs ability to meet its obligations.
Under the Federal Housing Finance Regulatory Reform Act of
2008 (the Reform Act), which was included as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by FNMA or FHLMC prior to FHFAs appointment
as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly administration of FNMAs or FHLMCs affairs.
The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver.
FHFA, in its capacity as conservator, has indicated that it
has no intention to repudiate the guaranty obligations of FNMA or FHLMC because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for
FNMA or FHLMC, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability
could be satisfied only to the extent of FNMAs or FHLMCs assets available therefor.
In the event of repudiation, the payments of interest to holders of FNMA or FHLMC mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups
related to such mortgage-backed securities are not made by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by
such mortgage-backed security holders.
Further,
in its capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of FNMA or FHLMC without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as
conservator or receiver, were to transfer any such guaranty obligation to another party, holders of FNMA or FHLMC mortgage-backed securities would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the
credit risk of that party.
In addition, certain
rights provided to holders of mortgage-backed securities issued by FNMA and FHLMC under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or
any future receivership. The operative documents for FNMA and FHLMC mortgage-backed securities may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided) that upon the occurrence of
an event of default on the part of FNMA or FHLMC, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right to replace FNMA or FHLMC as trustee if the
requisite percentage of mortgage-backed securities holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has been appointed. The
Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which FNMA or FHLMC is a party, or obtain possession of or exercise control over any property
of FNMA or FHLMC, or affect any contractual rights of FNMA or FHLMC, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days following the appointment of FHFA as conservator or receiver, respectively.
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Variable and Floating Rate Securities
Variable and floating rate securities are instruments that
have a coupon or interest rate that is adjusted periodically due to changes in a base or benchmark rate. Variable and floating rate securities provide for a periodic adjustment in the interest rate paid on the obligations. The terms of such
obligations must provide that interest rates are adjusted periodically based upon an interest rate adjustment index as provided in the respective obligations. The adjustment intervals may be regular, and range from daily to annually, or may be
event-based, such as based on a change in the prime rate.
A Fund may engage in credit spread trades and invest in floating rate debt instruments (floaters). A credit spread trade is an investment position relating to a difference in the prices or
interest rates of two securities or currencies, where the value of the investment position is determined by movements in the difference between the prices or interest rates, as the case may be, of the respective securities or currencies. The
interest rate on a floater is a variable rate that is tied to another interest rate, such as a money-market index or Treasury bill rate. The interest rate on a floater resets periodically, typically every six months. Because of the interest rate
reset feature, floaters provide a Fund with a certain degree of protection against a rise in interest rates, although a Fund will participate in any declines in interest rates as well.
A Fund also may invest in inverse floating rate debt instruments (inverse floaters). The interest
rate on an inverse floater resets in the opposite direction from the market rate of interest to which the inverse floater is indexed. An inverse floating rate security may exhibit greater price volatility than a fixed rate obligation of similar
credit quality, and a Fund accordingly may be forced to hold such an instrument for long periods of time and/or may experience losses of principal in such investment. In particular, when interest rates are declining, coupon payments will rise at
periodic intervals. This rise in coupon payments causes rapid dramatic increases in prices compared to those expected from conventional fixed-income instruments of similar maturity. Conversely, during times of rising interest rates, the coupon
payments will fall at periodic intervals. This fall in coupon payments causes rapid dramatic decreases in prices compared to those expected from conventional fixed-income instruments of similar maturity. See Mortgage-Related and Other
Asset-Backed Securities for a discussion of IOs and POs.
If a Fund invests in inverse floaters, it will generally treat inverse floaters as illiquid securities except for (i) inverse floaters issued by U.S. government agencies and instrumentalities backed
by fixed-rate mortgages, whose liquidity is monitored by Forward Management subject to the supervision of the Board of Trustees or (ii) where such securities can be disposed of promptly in the ordinary course of business at a value reasonably
close to that used in the calculation of net asset value per share.
Variable and floating rate notes are frequently not rated by credit rating agencies; however, unrated variable and floating rate notes purchased by a Fund will be determined by Forward Management under
guidelines approved by the Board of Trustees to be of comparable quality at the time of purchase to rated instruments eligible for purchase under the Funds investment policies. In making such determinations, Forward Management will consider
the earning power, cash flow, and other liquidity ratios of the issuers of such notes (such issuers include financial, merchandising, bank holding, and other companies) and will continuously monitor their financial condition. Although there may be
no active secondary market with respect to a particular variable or floating rate note purchased by a Fund, the Fund may resell the note at any time to a third party. The absence of an active secondary market, however, could make it difficult for
the Fund to dispose of a variable or floating rate note in the event the issuer of the note defaulted on its payment obligations and the Fund could, as a result or for other reasons, suffer a loss to the extent of the default. Variable or floating
rate notes may be secured by bank letters of credit.
Warrants
A Fund may invest in warrants. A Fund may purchase warrants issued by domestic and foreign companies to purchase newly created equity securities consisting of common and preferred stock. Warrants are
securities that give the holder the right, but not the obligation to purchase equity issues of the company issuing the warrants, or a related company, at a fixed price either on a date certain or during a set period. The equity security underlying a
warrant is authorized at the time the warrant is issued or is issued together with the warrant.
Investing in warrants can provide a greater potential for profit or loss than an equivalent investment in the underlying security, and, thus, can be a speculative investment. At the time of issue, the
cost of a warrant is substantially less than the cost of the underlying security itself, and price movements in the underlying security are generally magnified in the price movements of the warrant. This leveraging effect enables the investor to
gain exposure to the underlying security with a relatively low capital investment.
This leveraging increases an investors risk, however, in the event of a decline in the value of the underlying security and can result in a complete loss of the amount invested in the warrant. In
addition, the price of a warrant tends to be more volatile than, and may not correlate exactly to, the price of the underlying security. If the market price of the underlying security is below the exercise price of the warrant on its expiration
date, the warrant will generally expire without value. The value of a warrant may decline because of a decline in the value of the underlying security, the passage of time, changes in interest rates or in the dividend or other policies of the
46
company whose equity underlies the warrant or a change in the perception as to the future price of the underlying security, or any combination thereof. Warrants generally pay no dividends and
confer no voting or other rights other than to purchase the underlying security.
When-Issued Securities and Firm Commitment Agreements
A Fund may purchase securities on a delayed delivery or when-issued basis and enter into firm commitment agreements
(transactions whereby the payment obligation and interest rate are fixed at the time of the transaction but the settlement is delayed). A Fund will not purchase securities the value of which is greater than 15% of its net assets on a when-issued or
firm commitment basis. A Fund, as purchaser, assumes the risk of any decline in value of the security beginning on the date of the agreement or purchase, and no interest accrues to a Fund until it accepts delivery of the security. A Fund will not
use such transactions for leveraging purposes and, accordingly, will segregate or earmark cash, cash equivalents, or liquid securities in an amount sufficient to meet its payment obligations thereunder. Although these transactions will
not be entered into for leveraging purposes, to the extent a Funds aggregate commitments under these transactions exceed its holdings of cash and securities that do not fluctuate in value (such as short-term money market instruments), the Fund
temporarily will be in a leveraged position (
i.e.
, it will have an amount greater than its net assets subject to market risk). Should market values of a Funds portfolio securities decline while the Fund is in a leveraged position,
greater depreciation of its net assets would likely occur than were it not in such a position. As a Funds aggregate commitments under these transactions increase, the opportunity for leverage similarly increases. A Fund will not borrow money
to settle these transactions and, therefore, will liquidate other portfolio securities in advance of settlement if necessary to generate additional cash to meet its obligations thereunder.
Zero-Coupon Securities
A Fund may invest in zero-coupon securities. A zero-coupon
security has no cash coupon payments. Instead, the issuer sells the security at a substantial discount from its maturity value. The interest equivalent received by the investor from holding this security to maturity is the difference between the
maturity value and the purchase price. Zero-coupon securities are more volatile than cash pay securities. A Fund accrues income on these securities prior to the receipt of cash payments. A Fund intends to distribute substantially all of its income
to its shareholders to qualify for pass-through treatment under the tax laws and may, therefore, need to use its cash reserves to satisfy distribution requirements.
DIVIDENDS AND DISTRIBUTIONS
Shareholders have the privilege of reinvesting both income
dividends and capital gain distributions, if any, in additional shares of the Funds at the then current net asset value, with no sales charge. Alternatively, a shareholder can elect at any time to receive dividends and/or capital gain distributions
in cash.
In the absence of such an election, each
purchase of shares of the Funds is made upon the condition and understanding that the Transfer Agent is automatically appointed the shareholders agent to receive the investors dividends and distributions upon all shares registered in the
investors name and to reinvest them in full and fractional shares of the Funds at the applicable net asset value in effect at the close of business on the reinvestment date. A shareholder may still at any time after a purchase of shares of the
Funds request that dividends and/or capital gain distributions be paid to the shareholder in cash.
If you elect to receive cash dividends and/or capital gains distributions and a check is returned as undelivered by the United States Postal Service, the Funds reserve the right to invest the check in
additional shares of the Funds at the then-current net asset value and to convert your accounts election to automatic reinvestment of all distributions, until the Funds Transfer Agent receives a corrected address in writing from the
number of account owners authorized on your application to change the registration. If the Transfer Agent receives no written communication from the account owner(s) and there are no purchases, sales or exchanges in your account for a period of time
mandated by state law, then that state may require the Transfer Agent to turn over to the applicable state government the value of the account as well as any dividends or distributions paid.
After a dividend or capital gains distribution is paid, the Funds share price will drop by the amount of
the dividend or distribution. If you have chosen to have your dividends or distributions paid to your account in additional shares, the total value of your account will not change after the dividend or distribution is paid. In such cases, while the
value of each share will be lower, each reinvesting shareholder will own more shares. Reinvested shares will be purchased at the price in effect at the close of business on the day after the record date.
52
TAX CONSIDERATIONS
The following discussion relates solely to U.S. federal
income tax law as applicable to U.S. persons (
i.e.
, U.S. citizens or residents and U.S. domestic corporations, trusts or estates) and certain foreign persons (
i.e.
, non-U.S. persons) subject to tax under such law. The discussion does
not address special tax rules applicable to certain classes of investors, such as tax-exempt entities, partnerships, insurance companies, and financial institutions. Dividends, capital gain distributions, and ownership of or gains realized on the
redemption (including an exchange) of Fund shares also may be subject to state and local taxes. Shareholders should consult their own tax advisors as to the Federal, state or local tax consequences of ownership of shares of, and receipt of
distributions from, a Fund in their particular circumstances.
The following discussion summarizes certain U.S. federal tax considerations generally affecting the Funds and their shareholders. This discussion is based upon present provisions of the Code, the
regulations promulgated thereunder, and judicial and administrative ruling authorities, all of which are subject to change, which change may be retroactive. This discussion does not provide a detailed explanation of all tax consequences, and
shareholders are advised to consult their own tax advisors with respect to the particular consequences to them of an investment in the Funds, as well as the tax consequences arising under the laws of any state, foreign country, or other taxing
jurisdiction.
Qualification as a Regulated
Investment Company
Each of the Funds intends
to qualify as a regulated investment company (RIC) under the Code. To so qualify, a Fund must, among other things, in each taxable year: (a) derive at least 90% of its gross income from dividends, interest, payments with respect to
securities loans, gains from the sale or other disposition of stock or securities, and gains from the sale or other disposition of foreign currencies, net income derived from an interest in a qualified publicly traded partnership or other income
(including gains from options, futures contracts, and forward contracts) derived with respect to the Funds business of investing in stocks, securities or currencies and (b) diversify its holdings so that, at the end of each quarter,
(i) at least 50% of the value of the Funds total assets (including borrowings for investment purposes, if any) is represented by cash and cash items, U.S. government securities, securities of other regulated investment companies, and
other securities, with such other securities limited in respect of any one issuer to an amount not greater in value than 5% of the Funds total assets (including borrowings for investment purposes, if any) and to not more than 10% of the
outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets (including borrowings for investment purposes, if any) is invested in the securities (other than U.S. government securities or
securities of other regulated investment companies) of any one issuer, or any two or more issuers that the Fund control, and that are determined to be engaged in the same business or similar or related businesses, or of one or more qualified
publicly traded partnerships.
As a regulated
investment company, each Fund generally is not subject to U.S. federal income tax on income and gains it distributes to shareholders, if at least the sum of 90% of the Funds investment company taxable income (which includes, among other items,
dividends, interest, and net short-term capital gains in excess of net long-term capital losses) and 90% of the Funds net tax-exempt interest income for the taxable year is distributed. Amounts not distributed on a timely basis in accordance
with a calendar year distribution requirement also are subject to a nondeductible 4% excise tax. To prevent application of the excise tax, the Funds intend to make distributions in accordance with the calendar year distribution requirement.
If, in any taxable year, a Fund fails to qualify
as a RIC under the Code or fails to meet the distribution requirement, it generally would (unless a cure provision applies) be taxed in the same manner as an ordinary corporation and distributions to its shareholders would not be deductible by the
Fund in computing its taxable income. In addition, the Funds distributions, to the extent derived from its current or accumulated earnings and profits, would constitute dividends (which may be eligible for the corporate-dividends received
deduction) which are taxable to shareholders as ordinary income, or as qualifying dividends eligible for a reduced rate of tax as discussed below. If a Fund fails to qualify as a RIC in any year, it must pay out its earnings and profits accumulated
in that year in order to qualify again as a RIC. Moreover, if the Fund failed to qualify as a RIC for a period greater than two taxable years, the Fund may be required to recognize any net built-in gains with respect to certain of its assets (the
excess of the aggregate gains, including items of income, over aggregate losses that would have been realized if the Fund had been liquidated) in order to qualify as a RIC in a subsequent year.
Distributions
Dividends of investment company taxable income (including net
short-term capital gains) are generally taxable to shareholders as ordinary income (subject to the discussion of qualifying dividends below), whether received in cash or reinvested in Fund shares. The Funds distributions of investment company
taxable income may be eligible for the corporate dividends-received deduction to the extent attributable to the applicable Funds dividend income from U.S. corporations, and if other applicable requirements are met. However, the alternative
minimum tax applicable to corporations may reduce the benefit of the dividends-received deduction.
53
Distributions of net capital gains (the excess of net long-term capital gain over net
short-term capital losses) reported by the Funds as capital gain dividends are taxable to shareholders, whether received in cash or reinvested in Fund shares, as long-term capital gain, regardless of the length of time the Funds shares have
been held by a shareholder, and are not eligible for the dividends-received deduction. Any distributions that are not from the Funds investment company taxable income or net capital gains may be characterized as a return of capital to
shareholders or, in some cases, as capital gains. Shareholders will be notified annually as to the federal tax status of dividends and distributions they receive and any tax withheld thereon.
For more information on the declaration and payment of dividends, please see Dividends and Taxes in
the Funds prospectus.
Dividends, including
capital gain dividends, declared in October, November or December with a record date in such month and paid during the following January will be treated as having been paid by the Funds and received by shareholders on December 31 of the
calendar year in which declared, rather than the calendar year in which the dividends are actually received.
Distributions by a Fund reduce the net asset value of that Funds shares. Should a distribution reduce the net asset value below a
shareholders cost basis, the distribution nevertheless may be taxable to the shareholder as ordinary income or capital gain as described above, even though, from an investment standpoint, it may constitute a partial return of capital. In
particular, investors should be careful to consider the tax implication of buying shares just prior to a distribution by a Fund. The price of shares purchased at that time includes the amount of the forthcoming distribution, but the distribution
will generally be taxable to the shareholder.
Current tax law generally provides for a maximum tax rate for individual taxpayers of either 15% or 20% (depending on whether the
individuals income exceeds certain threshold amounts) on long-term capital gains from sales and on certain qualifying dividends on corporate stock. The rate reductions do not apply to corporate taxpayers. Each Fund will be able to separately
report distributions of any qualifying long-term capital gains or qualifying dividends earned by the Fund that would be eligible for the lower maximum rate. A shareholder would also have to satisfy a more than 60-day holding period with respect to
any distributions of qualifying dividends in order to obtain the benefit of the lower rate. Distributions from a Funds investments in bonds and other debt instruments will not generally qualify for the lower rates. Note that distributions of
earnings from dividends paid by qualified foreign corporations can also qualify for the lower tax rates on qualifying dividends. Qualified foreign corporations are corporations incorporated in a U.S. possession, corporations whose stock
is readily tradable on an established securities market in the U.S., and corporations eligible for the benefits of a comprehensive income tax treaty with the United States which satisfy certain other requirements. Passive foreign investment
companies are not treated as qualified foreign corporations.
Medicare Tax
For taxable years beginning after December 31, 2012, an additional 3.8% Medicare tax will be imposed on certain net investment income (including ordinary dividends and capital gain distributions
received from a Fund and net gains from redemptions or other taxable dispositions of Fund shares) of U.S. individuals, estates and trusts to the extent that such persons modified adjusted gross income (in the case of an individual)
or adjusted gross income (in the case of an estate or trust) exceeds certain threshold amounts.
Sale or Other Disposition of Shares
Upon the redemption or exchange of shares, a shareholder will realize a taxable gain or loss depending upon the basis in the shares. Such
gain or loss will be treated as capital gain or loss if the shares are capital assets in the shareholders hands; a gain will generally be taxed as long-term capital gain if the shareholders holding period is more than one year. A gain
from disposition of shares held not more than one year will be treated as short-term capital gain. Any loss realized on a sale or exchange will be disallowed to the extent that the shares disposed of are replaced (including replacement through the
reinvesting of dividends and capital gain distributions) within a period of 61 days, beginning 30 days before and ending 30 days after the disposition of the shares. In such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Any loss recognized on shares held for six months or less will be treated as long-term capital loss to the extent of any long-term capital gain distributions that were received with respect to the shares.
In some cases, shareholders will not be
permitted to take sales charges into account for purposes of determining the amount of gain or loss realized on the disposition of their shares. This prohibition generally applies where (1) the shareholder incurs a sales charge in acquiring
Fund shares, (2) the shares are disposed of before the 91st day after the date on which they were acquired, and (3) the shareholder subsequently acquires shares of the same or another Fund, prior to February 1
st
of the year following the initial acquisition of Fund shares and the
otherwise applicable sales charge is reduced or eliminated under a reinvestment right received upon the initial purchase of shares. In that case, the gain or loss recognized will be determined by excluding from the tax basis of the
shares exchanged all or a portion of the sales charge incurred in acquiring those shares. This exclusion applies to the extent that the otherwise applicable sales charge with respect to the newly acquired shares is reduced as a result of having
incurred a sales charge initially. Sales charges affected by this rule are treated as if they were incurred with respect to the shares acquired under the reinvestment right. This provision may be applied to successive acquisitions of shares.
54
Backup Withholding
The Funds generally will be required to withhold federal income tax, currently at a rate of 28% (backup
withholding) from dividends, capital gain distributions and redemption proceeds paid to a shareholder if (1) the shareholder fails to furnish the Funds with the shareholders correct taxpayer identification number or social security
number and to make such certifications as the Funds may require, (2) the IRS notifies the shareholder or the Funds that the shareholder has failed to report properly certain interest and dividend income to the IRS and to respond to notices to
that effect, or (3) when required to do so, the shareholder fails to certify that he is not subject to backup withholding. Any amounts withheld may be credited against the shareholders Federal income tax liability.
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership (foreign shareholder), depends on whether the income from the applicable Fund is effectively connected with a U.S. trade or
business carried on by such shareholder.
If the
income from the applicable Fund is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will generally be subject to U.S. withholding tax at the rate of 30% (or, if applicable, a
lower treaty rate) upon the gross amount of the dividend. The foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the applicable Fund, capital gain dividends, and amounts retained by
the applicable Fund that are designated as undistributed capital gains. Note that the preferential rate of tax applicable to certain dividends (discussed above) does not apply to dividends paid to foreign shareholders.
For taxable years beginning before January 1, 2014
(unless further extended by Congress), properly designated dividends received by a foreign shareholder are generally exempt from U.S. federal withholding tax when they (a) are paid in respect of a Funds qualified net interest
income (generally, the Funds U.S. source interest income, reduced by expenses that are allocable to such income), or (b) are paid in connection with a Funds qualified short-term capital gains (generally, the excess
of the Funds net short-term capital gain over the Funds long-term capital loss for such taxable year). However, depending on the circumstances, a Fund may designate all, some or none of the Funds potentially eligible dividends as
such qualified net interest income or as qualified short-term capital gains, and a portion of the Funds distributions (e.g. interest from non-U.S. sources or any foreign currency gains) would be ineligible for this potential exemption from
withholding.
There can be no
assurance as to whether or not legislation will be enacted to extend this exemption.
If the income from the applicable Fund is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and any gains
realized upon the sale of shares of the applicable Fund will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. Additionally, with respect to a foreign shareholder that is treated as a
corporation for U.S. Federal income tax purposes, such dividends and gains realized may, under certain circumstances, be subject to an additional branch profits tax at a 30% rate (or at a lower rate if provided for by an applicable
treaty).
Foreign non-corporate shareholders may
be subject to backup withholding on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the Funds with proper certification of their foreign status.
Effective January 1, 2014, the Funds will be required to
withhold U.S. tax (at a 30% rate) on payments of dividends and, effective January 1, 2017, redemption proceeds made to certain non-U.S. entities that fail to comply (or be deemed compliant) with extensive new reporting and withholding
requirements designed to inform the U.S. Department of the Treasury of U.S.-owned foreign investment accounts. Shareholders may be requested to provide additional information to the funds to enable the Funds to determine whether withholding is
required.
Foreign shareholders may also be
subject to U.S. Federal estate tax on the value of their shares. Foreign shareholders are urged to consult their own tax advisors with respect to the particular tax consequences to them of an investment in the Funds, including the applicability of
foreign taxes.
Original Issue Discount
Certain debt securities acquired by a Fund
may be treated as debt securities that were originally issued at a discount. Original issue discount can generally be defined as the difference between the price at which a security was issued and its stated redemption price at maturity. Although no
cash income is actually received by a Fund, original issue discount that accrues on a debt security in a given year generally is treated for federal income tax purposes as interest and, therefore, such income would be subject to the distribution
requirements of the Code.
55
Market Discount
Some debt securities may be purchased by a Fund at a discount
which exceeds the original issue discount on such debt securities, if any. This additional discount represents market discount for federal income tax purposes. The gain realized on the disposition of any taxable debt security having market discount
generally will be treated as ordinary income to the extent it does not exceed the accrued market discount on such debt security. If the amount of market discount is more than a de minimis amount, a portion of such market discount must be included as
ordinary income (not capital gain) by a Fund in each taxable year in which such Fund owns an interest in such debt security and receives a principal payment on it. In particular, a Fund will be required to allocate that principal payment first to
the portion of the market discount on the debt security that has accrued but has not previously been included in income. In general, the amount of market discount that must be included for each period is equal to the lesser of (i) the amount of
market discount accruing during such period (plus any accrued market discount for prior periods not previously taken into account) or (ii) the amount of the principal payment with respect to such period. Generally, market discount accrues on a
daily basis for each day the debt security is held by a Fund at a constant rate over the time remaining to the debt securitys maturity or, at the election of the Fund, at a constant yield to maturity which takes into account the semi-annual
compounding of interest.
Options, Futures, and
Foreign Currency Forward Contracts; Straddle Rules
A Funds transactions in foreign currencies, forward contracts, options, and futures contracts (including options and futures contracts on foreign currencies) will be subject to special provisions of
the Code that, among other things, may affect the character of gains and losses realized by the Fund (that is, may affect whether gains or losses are ordinary or capital), accelerate recognition of income to the Fund, defer Fund losses, and affect
the determination of whether capital gains and losses are treated as long-term or short-term capital gains or losses. These rules could therefore, in turn, affect the character, amount, and timing of distributions to shareholders. These provisions
also may require the Fund to mark-to-market certain positions in its portfolio (that is, treat them as if they were sold), which may cause the Fund to recognize income without receiving cash to use to make distributions in amounts necessary to avoid
income and excise taxes. A Fund will monitor its transactions and may make such tax elections as management deems appropriate with respect to foreign currency, options, futures contracts, forward contracts or hedged investments. A Funds status
as a regulated investment company may limit its ability to engage in transactions involving foreign currency, futures, options, and forward contracts.
Certain transactions undertaken by the Funds may result in straddles for federal income tax purposes. The straddle rules may
affect the character of gains (or losses) realized by the Funds, and losses realized by the Funds on positions that are part of a straddle may be deferred under the straddle rules, rather than being taken into account in calculating the taxable
income for the taxable year in which the losses are realized. In addition, certain carrying charges (including interest expense) associated with positions in a straddle may be required to be capitalized rather than deducted currently. Certain
elections that the Funds may make with respect to its straddle positions may also affect the amount, character, and timing of the recognition of gains or losses from the affected positions.
Dividend Rolls
The Funds may perform dividend rolls. A dividend roll is an arrangement in which a Fund purchases stock in a U.S. corporation
that is about to pay a dividend. The Fund then collects the dividend. If applicable requirements are met, the dividend may qualify for the corporate dividends-received deduction. If so, the Funds distributions of investment company
taxable income may in turn be eligible for the corporate dividends-received deduction (pursuant to which corporate shareholders of the Fund may exclude from income up to 70% of the portion of such qualifying distributions) to the extent attributable
to its dividend income from U.S. corporations (including its income from dividend roll transactions if the applicable requirements are met). The Fund then sells the stock after the dividend is paid. This usually results in a short term capital loss.
Dividend roll transactions are subject to less favorable tax treatment if the sale of the stock is prearranged or where there is otherwise no risk of loss during the holding period. Under those circumstances, the dividend would not qualify for the
dividends-received deduction.
Constructive
Sales
Under certain circumstances, a Fund may
recognize a gain from a constructive sale of an appreciated financial position it holds if it enters into a short sale, forward contract or other transaction that substantially reduces the risk of loss with respect to the appreciated
position. In that event, the Fund would be treated as if it had sold and immediately repurchased the property and would be taxed on any gain (but not loss) from the constructive sale. The character of gain from a constructive sale would depend upon
the Funds holding period in the property. Loss would be recognized when the property was subsequently disposed of, and its character would depend on the Funds holding period and the application of various loss deferral provisions of the
Code. Constructive sale treatment does not apply to transactions that are closed before the end of the 30th day after the close of the taxable year and where the Fund holds the appreciated financial position throughout the 60-day period beginning on
the date the transaction is closed, if certain other conditions are met.
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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 conventions between certain countries and the U.S. may reduce or eliminate such taxes. If more than 50% of the value of a Funds total assets at the close of
its taxable year consists of stock or securities of foreign corporations, or if at least 50% of the value of a Funds total assets at the close of each quarter of its taxable year is represented by interests in other RICs, that Fund may elect
to pass through to its shareholders the amount of foreign taxes paid or deemed paid by that fund. If that Fund so elects, each of its shareholders would be required to include in gross income, even though not actually received, its pro
rata share of the foreign taxes paid or deemed paid by that Fund, but would be treated as having paid its pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount
(subject to various limitations) as a foreign tax credit against federal income tax (but not both).
Currency FluctuationSection 988 Gains and Losses
Gains or losses attributable to fluctuations in foreign currency exchange rates that occur between the time the Funds accrue income or
other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time the Funds actually collect such receivables or pay such liabilities generally are treated as ordinary income or loss. Similarly, on disposition
of certain investments (including debt securities denominated in a foreign currency and certain futures contracts, forward contracts, and options), gains or losses attributable to fluctuations in the value of foreign currency between the date of
acquisition of the security or other instrument and the date of disposition also are treated as ordinary income or loss. These gains or losses, referred to under the Code as section 988 gains or losses, may increase or decrease the
amount of a Funds investment company taxable income available to be distributed to its shareholders as ordinary income.
Passive Foreign Investment Companies
Some of the Funds may invest in the stock of foreign companies that may be classified under the Code as passive foreign investment
companies (PFICs). In general, a foreign corporation is classified as a PFIC if at least one-half of its assets constitute passive assets (such as stocks or securities) or if 75% or more of its gross income is passive income (such as,
but not limited to, interest, dividends, and gain from the sale of securities). If a Fund receives an excess distribution with respect to PFIC stock, the Fund will generally be subject to tax on the distribution as if it were realized
ratably over the period during which the Fund held the PFIC stock. The Fund will be subject to tax on the portion of an excess distribution that is allocated to prior Fund taxable years, and an interest factor will be added to the tax, as if it were
payable in such prior taxable years. Certain distributions from a PFIC and gain from the sale of PFIC shares are treated as excess distributions. Excess distributions are taxable as ordinary income.
The Funds may be eligible to elect alternative tax treatment
with respect to PFIC stock. Under an election that is available in some circumstances, a Fund generally would be required to include in its gross income its share of the earnings of a PFIC on a current basis, regardless of whether distributions were
received from the PFIC in a given year. If this election were made, the rules relating to the taxation of excess distributions would not apply. In addition, another election would involve marking-to-market the Funds PFIC shares at the end of
each taxable year, with the result that unrealized gains would be treated as though they were realized and reported as ordinary income. Any mark-to-market losses and any loss from an actual disposition of PFIC shares would be deductible as ordinary
losses to the extent of any net mark-to-market gains included in income in prior years. Note that distributions from a PFIC are not eligible for the reduced rate of tax on qualifying dividends.
Other Investment Companies
It is possible that by investing in other investment
companies, the Funds may not be able to meet the calendar year distribution requirement and may be subject to federal income and excise tax. The diversification and distribution requirements applicable to the Funds may limit the extent to which the
Funds will be able to invest in other investment companies.
Real Estate Investment Fund Investments
A Fund may invest in real estate investment trusts (REITs) that hold residual interests in real estate mortgage investment conduits (REMICs) or taxable mortgage pools
(TMPs). Although the Investment Advisor does not intend to invest Fund assets in REITs that hold primarily residual interests in REMICs or TMPs, under applicable Treasury regulations and other guidance, a portion of the Funds
income from a REIT that is attributable to the REITs residual interest in a REMIC or an interest in a TMP (referred to in the Code as an excess inclusion) may be subject to federal income tax. Excess inclusion income of the Fund
may be allocated to shareholders of the Fund in proportion to the dividends received by the shareholders, with the same tax consequences as if the shareholder directly held the REMIC residual interest or interest in the TMP. In general, excess
inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (ii) will constitute unrelated
57
business taxable income to entities (including qualified pension plans, individual retirement accounts or other tax-exempt entities) subject to tax on unrelated business income, thereby
potentially requiring such an entity to file a tax return and pay tax on such income, and (iii) in the case of a foreign shareholder, will not qualify for any reduction in U.S. federal withholding tax. In addition, if at any time during any
taxable year a disqualified organization (as defined in the Code) is a record holder of Fund shares, then the Fund will be subject to a tax equal to that portion of its excess inclusion income for the taxable year that is allocable to
the disqualified organization, multiplied by the highest federal income tax rate imposed on corporations. The Investment Advisor has not historically invested in mortgage REITs or vehicles that primarily hold residual interest in REMICS or TMPs and
do not intend to do so in the future.
Under the
Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), a foreign shareholder is subject to withholding tax in respect of a disposition of a U.S. real property interest and any gain from such disposition is subject to U.S. federal
income tax as if such person were a U.S. person. Such gain is sometimes referred to as FIRPTA gain. If a Fund is a U.S. real property holding corporation and is not domestically controlled, any gain realized on the sale or
exchange of Fund shares by a foreign shareholder that owns at any time during the five-year period ending on the date of disposition more than 5% of a class of Fund shares would be FIRPTA gain. After December 31, 2013, the same rule will apply
to dispositions of Fund shares by foreign shareholders but without regard to whether the Fund is domestically controlled. A Fund will be a U.S. real property holding corporation if, in general, 50% or more of the fair market value of its
assets consists of U.S. real property interests, including stock of certain U.S. REITs.
The Code provides a look-through rule for distributions of FIRPTA gain by a RIC if all of the following requirements are met: (i) the RIC is classified as a qualified investment entity
(which includes a RIC if, in general more than 50% of the RICs assets consists of interest in REITs and U.S. real property holding corporations); and (ii) you are a foreign shareholder that owns more than 5% of the Funds shares at
any time during the one-year period ending on the date of the distribution. If these conditions are met, Fund distributions to you to the extent derived from gain from the disposition of a U.S. real property interest, may also be treated as FIRPTA
gain and therefore subject to U.S. federal income tax, and requiring that you file a nonresident U.S. income tax return. Also, such gain may be subject to a 30% branch profits tax in the hands of a foreign shareholder that is a corporation. Even if
a foreign shareholder does not own more than 5% of the Funds shares, Fund distributions that are attributable to gain from the sale or disposition of a U.S. real property interest will be taxable as ordinary dividends subject to withholding at
a 30% or lower treaty rate.
These rules apply to
dividends paid by a Fund before January 1, 2014 (unless such sunset date is extended or made permanent). After such sunset date, Fund distributions from a REIT attributable to gain from the disposition of a U.S. real property interest will
continue to be subject to the withholding rules described above provided the Fund would otherwise be classified as a qualified investment entity.
Short Sales
Short sales are subject to special tax rules which will impact the character of gains and losses realized and affect the timing of income
recognition. Short sales entered into by the Fund by increase the amount of ordinary income dividends received by shareholders and may impact the amount of qualified dividend income and income eligible for the dividends received deduction that it is
able to pass through to shareholders.
Personal
Holding Company
Based upon the number of
shareholders of a Fund, the Fund could be considered to be personal holding companies (a PHC) under the Code. A company is considered a PHC if: (1) at least 60% of its income is derived from certain types of passive income (e.g.,
interest, dividends, rents, and royalties) and (2) at any time during the last half of the taxable year more than 50% in value of its outstanding stock is owned directly, or indirectly, by or for not more than 5 individuals. A company
satisfying this test is taxed on its undistributed personal holding company income (UPHCI) at 20%. UPHCI is computed by making certain adjustments to taxable income, including a downward adjustment for distributions made to shareholders
during the taxable year.
The tax on UPHCI is in
addition to any other tax. Under the Code, a regulated investment company that is also a PHC will also be taxed on any undistributed investment company taxable income at the highest corporate rate under the Code. Each of the Funds intends to
distribute sufficient taxable income to its shareholders in any applicable taxable period in which it is treated as a PHC to reduce or eliminate its UPHCI.
Other Tax Matters
Each Fund is required to recognize income currently each taxable year for federal income tax purposes under the Codes original issue
discount rules in the amount of the unpaid, accrued interest with respect to bonds structured as zero coupon or deferred interest bonds or pay-in-kind securities, even though it receives no cash interest until the securitys maturity or payment
date. As discussed above, in
58
order to qualify for treatment as a regulated investment company, each Fund must distribute substantially all of its income to shareholders. Thus, a Fund may have to dispose of its portfolio
securities under disadvantageous circumstances to generate cash or leverage itself by borrowing cash, so that it may satisfy the distribution requirement.
Exchange control regulations that may restrict repatriation of investment income, capital, or the proceeds of securities sales by foreign
investors may limit a Funds ability to make sufficient distributions to satisfy the 90% and calendar year distribution requirements described above.
Different tax treatment, including penalties on certain excess contributions and deferrals, certain pre-retirement and post-retirement
distributions, and certain prohibited transactions, is accorded to accounts maintained as qualified retirement plans. Shareholders should consult their tax advisors for more information.
The foregoing discussion relates solely to U.S. federal income tax law as applicable to U.S. persons (i.e.,
U.S. citizens or residents and U.S. domestic corporations, partnerships, trusts, or estates) subject to tax under such law. The discussion does not address special tax rules applicable to certain classes of investors, such as tax-exempt entities,
insurance companies, and financial institutions. Dividends, capital gain distributions, and ownership of or gains realized on the redemption (including an exchange) of Fund shares also may be subject to state and local taxes. Shareholders should
consult their own tax advisors as to the Federal, state or local tax consequences of ownership of shares of, and receipt of distributions from, a Fund in their particular circumstances.
Liquidation of Funds
The Board of Trustees of the Trust may determine to close and
liquidate a Fund at any time, which may have adverse tax consequences to shareholders. In the event of the liquidation of a Fund, shareholders will receive a liquidating distribution in cash or in-kind equal to their proportionate interest in the
Fund. A liquidating distribution may be a taxable event to shareholders, resulting in a gain or loss for tax purposes, depending upon a shareholders basis in his or her shares of the Fund.
GENERAL INFORMATION
Description of the Trust and Its Shares
The Trust consists of thirty-four portfolios described in
separate prospectuses and this SAI. Each share represents an equal proportionate interest in a Forward Fund with other shares of that Fund, and is entitled to such dividends and distributions out of the income earned on the assets belonging to that
Fund as are declared at the discretion of the Trustees. Shareholders are entitled to one vote for each share owned.
An annual or special meeting of shareholders to conduct necessary business is not required by the Declaration of Trust, the 1940 Act or
other authority except, under certain circumstances, to elect Trustees, amend the Certificate of Trust, approve an investment advisory agreement and satisfy certain other requirements. To the extent that such a meeting is not required, the Trust may
elect not to have an annual or special meeting.
The Trust will call a special meeting of shareholders for purposes of considering the removal of one or more Trustees upon written request
from shareholders holding not less than 10% of the outstanding votes of the Trust. At such a meeting, a quorum of shareholders (constituting a majority of votes attributable to all outstanding shares of the Trust), by majority vote, has the power to
remove one or more Trustees.