INVESTMENT
POLICIES AND STRATEGIES
In addition to the principal investment strategies and the principal risks of the Funds described in the
Prospectus, each Fund may employ other investment practices and may be subject to additional risks, which are described below in alphabetical order. Because the following is a combined description of investment strategies and risks for all of the
Funds, certain strategies and/or risks described below may not apply to particular Funds. Each Fund may engage in each of the practices described below unless a strategy or policy described below is specifically prohibited by the investment
restrictions listed in the Prospectus, under Investment Restrictions in this Statement of Additional Information, or by applicable law. However, no Fund is required to engage in any particular transaction or purchase any particular type
of securities or investment even if to do so might benefit the Fund. Unless otherwise stated herein, all investment policies and restrictions of the Funds may be changed by the Board of Trustees without notice to shareholders or shareholder
approval. In addition, each Fund may be subject to restrictions on its ability to utilize certain investments or investment techniques. Unless otherwise noted, these additional restrictions may be changed with the consent of the Board of Trustees
but without approval by or notice to shareholders.
The Funds subadviser, as applicable, and, in certain cases, portfolio managers,
responsible for making investment decisions for the Funds, are referred to in this section and the remainder of this Statement of Additional Information as the Subadviser.
Bank Capital Securities and Obligations
The Funds may invest in bank capital securities.
Bank capital securities are issued by banks to help fulfill their regulatory capital requirements. There are three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. Bank capital is generally, but not always, of investment grade
quality. Upper Tier II securities are commonly thought of as hybrids of debt and preferred stock. Upper Tier II securities are often perpetual (with no maturity date), callable and have a cumulative interest deferral feature. This means that under
certain conditions, the issuer bank can withhold payment of interest until a later date. However, such deferred interest payments generally earn interest. Tier I securities often take the form of trust preferred securities.
The Funds may also invest in other bank obligations denominated in any currency, including certificates of deposit, bankers acceptances and fixed
time deposits. Certificates of deposit are negotiable certificates that are issued against funds deposited in a commercial bank for a definite period of time and that earn a specified return. Bankers acceptances are negotiable drafts or bills
of exchange, normally 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. Fixed
time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon
market conditions and the remaining maturity of the obligation. There are generally no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is generally no market for such
deposits. A Fund may also hold funds on deposit with its custodian bank in an interest-bearing account for temporary purposes.
Borrowings
A Fund may be permitted to borrow for temporary purposes, for investment purposes and to more efficiently manage the portfolio. Such a
practice will result in leveraging of a Funds assets and may cause a Fund to liquidate portfolio positions when it would not be advantageous to do so. This borrowing may be secured or
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unsecured. Provisions of the 1940 Act require a Fund to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the
amount borrowed from a bank, with an exception for borrowings not in excess of 5% of the Funds total assets made for temporary administrative purposes. Any borrowings for temporary administrative purposes in excess of 5% of the Funds
total assets must maintain continuous asset coverage. 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 the debt
and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint if the Fund sells holdings at that time. Borrowing, like other forms of leverage, will tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of a Funds portfolio. Money borrowed will be subject to interest costs, which may or may not be recovered by appreciation of the securities purchased, if any. 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.
From time to time, the Funds may enter into, and make borrowings for temporary purposes related to the redemption of shares, including under a credit
agreement with third-party lenders or the custodian. Such borrowings will be allocated among the series of the Trust pursuant to guidelines approved by the Board of Trustees. In addition to borrowing money from a bank, a Fund may enter into reverse
repurchase agreements, dollar rolls, sale-buybacks and other transactions that can be viewed as forms of borrowings, but for which the Funds do not have to have 300% asset coverage.
A reverse repurchase agreement involves the sale of a portfolio-eligible security by a Fund to another party, such as a bank or broker-dealer, coupled with its agreement to repurchase the security at a
specified time and price. Under a reverse repurchase agreement, the Fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Such transactions are advantageous if the interest cost to
the Fund of the reverse repurchase transaction is less than the returns it obtains on investments purchased with the cash.
Dollar rolls are
transactions in which a Fund sells mortgage-related securities, such as a security issued by the Government National Mortgage Association (GNMA), for delivery in the current month and simultaneously contracts to repurchase substantially
similar (same type and coupon) securities on a specified future date at a pre-determined price. Unlike in the case of reverse repurchase agreements, the dealer with which a Fund enters into a dollar-roll transaction is not obligated to return the
same securities as those originally sold by the Fund, but only securities that are substantially identical. To be considered substantially identical, the securities returned to a Fund generally must: (1) be
collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market
yields (and therefore price); and (6) satisfy good delivery requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within 0.01% of the initial amount delivered.
A Fund also may engage in simultaneous purchase and sale transactions that are known as sale-buybacks. A sale-buyback is similar to a reverse
repurchase agreement, except that in a sale-buyback, the counterparty who purchases the security is entitled to receive any principal or interest payments made on the underlying security pending settlement of the Funds repurchase of the
underlying security.
A Fund will typically segregate or earmark assets determined to be liquid by the Investment Manager or
Subadviser, as applicable, and equal (on a daily mark-to-market basis) to its obligations under reverse repurchase agreements, dollar rolls and sale-buybacks. Reverse repurchase agreements, dollar rolls and sale-buybacks involve leverage risk and
the risk that the market value of securities retained by a Fund may decline below the repurchase price of the securities that the Fund sold and is obligated to repurchase. In the event the buyer of securities under a reverse repurchase agreement,
dollar roll or sale-buyback files for bankruptcy or becomes insolvent, a Funds use of the proceeds of the agreement may be restricted pending a determination by the other
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party, or its trustee or receiver, whether to enforce the Funds obligation to repurchase the securities. Reverse repurchase agreements, dollar rolls, sale-buybacks and other similar
instruments and transactions will not be subject to the Funds limitations on borrowings as specified under Investment Restrictions below.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued
in bearer form by corporations such as banks or bank holding companies and finance companies. A Fund may invest in commercial paper of any credit quality consistent with such Funds investment objective and policies, including unrated
commercial paper for which the Investment Manager has made a credit quality assessment. See Appendix B to this SAI for a description of the ratings assigned by Moodys Investors Service, Inc. (Moodys), Standard &
Poors, a division of the McGraw-Hill Companies (S&P), and Fitch, Inc. (Fitch Ratings) to commercial paper. The rate of return on commercial paper may be linked or indexed to the level of exchange rates between the
U.S. dollar and a foreign currency or currencies.
Commodity-Related Investments
The Funds may gain exposure to investment returns of commodities, including a range of assets with tangible properties, such as oil, natural gas,
agricultural products (e.g., wheat, corn, and livestock), precious metals (e.g., gold and silver), industrial metals (e.g., copper), and other commodities (e.g., cocoa, coffee, and sugar). The Funds may obtain such exposure by investing in shares of
other investment companies or other instruments, including structured notes, exchange traded notes, interests in master limited partnerships, and derivative contracts whose values are based on the value of a commodity, commodity index, or other
readily-measurable economic variables dependent upon changes in the value of commodities or the commodities markets (commodity-related derivatives).
The value of commodity-related derivatives fluctuates based on changes in the values of the underlying commodity, commodity index, futures contract, or other economic variable to which they are related.
Additionally, economic leverage will increase the volatility of these instruments as they may increase or decrease in value more quickly than the underlying commodity or other relevant economic variable.
Commodity prices can be extremely volatile and may be directly or indirectly affected by many factors, including changes in overall market movements,
real or perceived inflationary trends, commodity index volatility, changes in interest rates or currency exchange rates, population growth and changing demographics, and factors affecting a particular industry or commodity, such as drought, floods,
or other weather conditions, livestock disease, trade embargoes, competition from substitute products, transportation bottlenecks or shortages, fluctuations in supply and demand, tariffs, and international regulatory, political, and economic
developments (e.g., regime changes and changes in economic activity levels). In addition, some commodities are subject to limited pricing flexibility because of supply and demand factors, and others are subject to broad price fluctuations as a
result of the volatility of prices for certain raw materials and the instability of supplies of other materials.
Actions of and changes in
governments, and political and economic instability, in commodity-producing and
-exporting
countries may affect the production and marketing of commodities. In addition, commodity-related industries throughout
the world are subject to greater political, environmental, and other governmental regulation than many other industries. Changes in government policies and the need for regulatory approvals may adversely affect the products and services of companies
in the commodities industries. For example, the exploration, development, and distribution of coal, oil, and gas in the United States are subject to significant federal and state regulation, which may affect rates of return on coal, oil, and gas and
the kinds of services that the federal and state governments may offer to companies in those industries. In addition, compliance with environmental and other safety regulations has caused many companies in commodity-related industries to incur
production delays and significant costs. Government regulation may also impede the development of new technologies. The effect of future regulations affecting commodity-related industries cannot be predicted.
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A Funds investments in commodity-related derivatives can be limited by the Funds intention to
qualify as a regulated investment company (a RIC) for U.S. federal income tax purposes.
Convertible Securities and Synthetic
Convertible Securities
A convertible security is a bond, debenture, note, preferred stock, or other security that entitles the holder to
acquire common stock or other equity securities of the same or a different issuer. A convertible security generally entitles the holder to receive interest paid or accrued until the convertible security matures or is redeemed, converted or
exchanged. Before conversion, convertible securities have characteristics similar to non-convertible debt or preferred securities, as applicable.
Convertible securities rank senior to common stock in a corporations capital structure and, therefore, generally entail less risk than the corporations common stock, although the extent to
which such risk is reduced depends in large measure upon the degree to which the convertible security sells above its value as a fixed income security. Convertible securities are subordinate in rank to any senior debt obligations of the issuer, and,
therefore, an issuers convertible securities entail more risk than its debt obligations. Convertible securities generally offer lower interest or dividend yields than non-convertible debt securities of similar credit quality because of the
potential for capital appreciation. In addition, convertible securities are often lower-rated securities.
Because of the conversion feature,
the price of the convertible security will normally fluctuate in some proportion to changes in the price of the underlying asset, and as such is subject to risks relating to the activities of the issuer and/or general market and economic conditions.
The income component of a convertible security may tend to cushion the security against declines in the price of the underlying asset. However, the income component of convertible securities also causes fluctuations based upon changes in interest
rates and the credit quality of the issuer.
If the convertible securitys conversion value, which is the market value of the
underlying common stock that would be obtained upon the conversion of the convertible security, is substantially below the investment value, which is the value of a convertible security viewed without regard to its conversion feature
(
i.e.
, strictly on the basis of its yield), the price of the convertible security is governed principally by its investment value. If the conversion value of a convertible security increases to a point that approximates or exceeds its
investment value, the value of the security will be principally influenced by its conversion value. A convertible security will sell at a premium over its conversion value to the extent investors place value on the right to acquire the underlying
common stock while holding an income-producing security.
A convertible security may be subject to redemption at the option of the issuer at a
predetermined price. If a convertible security held by a Fund is called for redemption, the Fund would be required to permit the issuer to redeem the security and convert it to underlying common stock, or would sell the convertible security to a
third party, which may have an adverse effect on the Funds ability to achieve its investment objective.
A third party or the Investment
Manager or Subadviser, as applicable, also may create a synthetic convertible security by combining separate securities that possess the two principal characteristics of a traditional convertible security,
i.e.
, an
income-producing security (income producing component) and the right to acquire an equity security (convertible component).
The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments, which may be represented by derivative
instruments. The convertible component is achieved by investing in securities or instruments such as warrants or options to buy common stock at a certain exercise price, or options on a stock index. Unlike a traditional convertible security, which
is a single security having a single market value, a synthetic convertible comprises two or more separate securities, each with its own market value. Therefore, the market value of a synthetic convertible security is the sum of the
values of its income-producing component and its convertible component. For this reason, the values of a synthetic convertible security and a traditional convertible security may respond differently to market fluctuations.
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More flexibility is possible in the assembly of a synthetic convertible security than in the purchase of a
convertible security. Although synthetic convertible securities may be selected where the two components are issued by a single issuer, thus making the synthetic convertible security similar to the traditional convertible security, the character of
a synthetic convertible security allows the combination of components representing distinct issuers, when the Investment Manager or Subadviser, as applicable, believes that such a combination may better achieve a Funds investment objective. A
synthetic convertible security also is a more flexible investment in that its two components may be purchased separately. For example, a Fund may purchase a warrant for inclusion in a synthetic convertible security but temporarily hold short-term
investments while postponing the purchase of a corresponding bond pending development of more favorable market conditions.
A holder of a
synthetic convertible security faces the risk of a decline in the price of the security or the level of the index involved in the convertible component, causing a decline in the value of the security or instrument, such as a call option or warrant,
purchased to create the synthetic convertible security. Should the price of the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the call option or warrant would be lost.
Because a synthetic convertible security includes the income-producing component as well, the holder of a synthetic convertible security also faces the
risk that interest rates will rise, causing a decline in the value of the income-producing instrument.
The Funds also may purchase synthetic
convertible securities created by other parties, including convertible structured notes. Convertible structured notes are income-producing debentures linked to equity, and are typically issued by investment banks. Convertible structured notes have
the attributes of a convertible security; however, the investment bank that issues the convertible note, rather than the issuer of the underlying common stock into which the note is convertible, assumes credit risk associated with the underlying
investment, and the Fund in turn assumes credit risk associated with the convertible note.
Credit-Linked Trust Certificates
The Funds may invest in credit-linked trust certificates, which are investments in a limited purpose trust or other vehicle formed under
state law which, in turn, invests in a basket of derivative instruments, such as credit default swaps, interest rate swaps and other securities, in order to provide exposure to the high yield or another fixed income market. For instance, a Fund may
invest in credit-linked trust certificates as a cash management tool in order to gain exposure to the high yield markets and/or to remain fully invested when more traditional income-producing securities are not available, including during the period
when the net proceeds of this offering and any future offering are being invested.
Like an investment in a bond, investments in these
credit-linked trust certificates represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end of the term of the certificate. However, these payments are conditioned on the trusts
receipt of payments from, and the trusts potential obligations to, the counterparties to the derivative instruments and other securities in which the trust invests. For instance, the trust may sell one or more credit default swaps, under which
the trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default occurs, the stream of payments
may stop and the trust would be obligated to pay to the counterparty the par (or other agreed upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that the Fund would receive as an investor in
the trust. A Funds investments in these instruments are indirectly subject to the risks associated with derivative instruments, including, among others, credit risk, counterparty and third party risk, interest rate risk and leverage risk. It
is expected that the trusts which issue credit-linked trust certificates will constitute private investment companies, exempt from registration under the 1940 Act. Therefore, the certificates will be subject to the risks described under
Other Investment Companies, and will not be subject to applicable investment limitations and other regulation imposed by the 1940 Act (although a Fund will remain
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subject to such limitations and regulation, including with respect to its investments in the certificates). Although the trusts are typically private investment companies, they are generally not
actively managed such as a hedge fund might be. It is also expected that the certificates will be exempt from registration under the Securities Act of 1933, as amended (the 1933 Act). Accordingly, there may be no established
trading market for the certificates and they may constitute illiquid investments. If market quotations are not readily available for the certificates, they will be valued by the Fund at fair value as determined by the Board of Trustees or persons
acting at its direction.
Debt Obligations
The Funds may invest in a variety of bonds and related debt obligations of varying maturities issued by, among others, Emerging Market Country issuers, banks and other business entities. Bonds include
bills, notes, promissory notes, debentures, moral obligation bonds, money market instruments and similar instruments and securities, and are generally used by corporations and other issuers to borrow money from investors for such purposes as working
capital or capital expenditures. Many of these obligations (e.g., promissory notes) are uncollateralized. The issuer pays the investor a variable or fixed rate of interest and normally must repay the amount borrowed on or before maturity. Certain
bonds are perpetual in that they have no maturity date.
The Funds investments in bonds are often subject to a number of
risks described in the Prospectus and/or elaborated upon elsewhere in this section of the Statement of Additional Information, including credit risk, high yield risk, interest rate risk, issuer risk, foreign investment risk, inflation/deflation
risk, and liquidity risk.
Delayed Funding Loans and Revolving Credit Facilities
The Funds may enter into, or acquire participations in, delayed funding loans and revolving credit facilities. Delayed funding loans and revolving credit
facilities are borrowing arrangements in which the lender agrees to make loans up to a maximum amount upon demand by the borrower during a specified term. A revolving credit facility differs from a delayed funding loan in that as the borrower repays
the loan, an amount equal to the repayment may be borrowed again during the term of the revolving credit facility. Delayed funding loans and revolving credit facilities usually provide for floating or variable rates of interest. These commitments
may have the effect of requiring the Fund to increase its investment in a company at a time when it might not otherwise be desirable to do so (including a time when the companys financial condition makes it unlikely that such amounts will be
repaid).
The Funds may invest in delayed funding loans and revolving credit facilities with credit quality comparable to that of issuers of
its securities investments. Delayed funding loans and revolving credit facilities may be subject to restrictions on transfer, and only limited opportunities may exist to resell such instruments. As a result, the Funds may be unable to sell such
investments at an opportune time or may have to resell them at less than fair market value. Delayed funding loans and revolving credit facilities are considered to be debt obligations for the purposes of the Funds investment restriction
relating to the lending of funds or assets by the Funds.
Derivative Instruments
The Funds may (but are not required to) use a variety of other derivative instruments (including both long and short positions) in an attempt to enhance
the Funds investment returns, to more efficiently manage a Funds portfolio, to hedge against market and other risks in the portfolio, to add leverage to the portfolio and/or to obtain market exposure with reduced transaction costs.
Generally, derivatives are financial contracts whose value depends upon, or is derived from, the value of an underlying asset, reference rate or index, and may relate to individual debt instruments, interest rates, currencies or currency exchange
rates, commodities or related indexes. Examples of derivative instruments that the Funds may use include, but are not limited to, options contracts, participation notes, futures contracts, options on futures contracts, swap agreements (including
total return and credit default swaps) and short sales. The Funds may also engage in credit spread trades. A credit spread trade is
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an investment position relating to a difference in the prices or interest rates of two bonds or other securities, where the value of the investment position is determined by changes in the
difference between such prices or interest rates, as the case may be, of the respective securities. The Funds may also have exposure to derivatives, such as interest rate or credit-default swaps, through investment in credit-linked trust
certificates and other securities issued by special purpose or structured vehicles. If other types of financial instruments, including other types of options, futures contracts or futures options are traded in the future, the Funds may also use
those instruments, provided that their use is consistent with each such Funds investment objective and policies.
Like the other
investments of the Funds, the ability of a Fund to utilize derivative instruments successfully may depend in part upon the ability of the Investment Manager or Subadviser, as applicable, to assess the issuers credit characteristics and other
macro-economic factors correctly. If the Investment Manager or Subadviser, as applicable, incorrectly forecasts such factors and has taken positions in derivative instruments contrary to prevailing market trends, a Fund could lose money.
The Funds might not employ any of the strategies described below, and no assurance can be given that any strategy used will succeed. If the Investment
Manager or Subadviser, as applicable, incorrectly forecasts market values or other economic factors in utilizing a derivatives strategy for a Fund, the Fund might have been in a better position if it had not entered into the transaction at all.
Also, suitable derivative transactions may not be available in all circumstances. The use of these strategies involves certain special risks, including a possible imperfect correlation, or even no correlation, between price movements of derivative
instruments and price movements of related investments. While some strategies involving derivative instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price
movements in related investments or otherwise, due to the possible inability of a Fund to purchase or sell a portfolio security at a time that otherwise would be favorable or the possible need to sell a portfolio security at a disadvantageous time
because the Fund is required to maintain asset coverage or offsetting positions in connection with transactions in derivative instruments, and the possible inability of the Fund to close out or to liquidate its derivatives positions. A Funds
use of derivatives could affect the amount, timing and/or character of distributions to shareholders.
Options on Securities and
Indexes.
The Funds may purchase and sell put and call options on securities or indexes in standardized contracts traded on domestic or other securities exchanges, boards of trade, or similar entities, or quoted on NASDAQ or on an
over-the-counter market, and agreements, sometimes called cash puts, which may accompany the purchase of a new issue of debt obligations from a dealer.
An option on a security (or an index) is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer
of the option the security underlying the option (or the cash value of the index) at a specified exercise price at any time 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 features of a particular securities market, a specific group of financial instruments or securities, or certain economic
indicators.)
The Funds will cover their obligations when they write call options or put options. In the case of a call option on
a debt obligation or other security, the option is covered if the applicable Fund owns the security underlying the call or has an absolute and immediate right to acquire that security without additional cash consideration (or, if additional cash
consideration is required, cash or other assets determined to be liquid by the Investment Manager or Subadviser, as applicable, in accordance with procedures established by the Board of Trustees, in such amount are segregated by its custodian or
earmarked by the Fund) upon conversion or exchange of other securities held by the Fund.
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A call option on a security is also covered if the Fund does not hold the underlying security or
have the right to acquire it, but the Fund segregates or earmarks assets determined to be liquid by the Investment Manager or Subadviser, as applicable, in accordance with procedures established by the Board of Trustees in an amount equal to the
contract value of the position (minus any collateral deposited with a broker-dealer), on a mark-to-market basis (a so-called naked call option).
For a call option on an index, the option is covered if the applicable Fund maintains with its custodian liquid assets in an amount equal to the contract value of the index. A call option is also covered
if the Fund holds a call on the same index or security as the call written where the exercise price of the call held is (i) equal to or less than the exercise price of the call written, or (ii) greater than the exercise price of the call
written, provided the difference is maintained by the Fund in segregated or earmarked liquid assets. A put option on a security or an index is covered if the Fund segregates or earmarks liquid assets equal to the exercise price. A put option is also
covered if the Fund holds a put on the same security or index as the put written where the exercise price of the put held is (i) equal to or greater than the exercise price of the put written, or (ii) less than the exercise price of the
put written, provided the difference is maintained by the Fund in segregated or earmarked liquid assets.
If an option written by a Fund
expires unexercised, the Fund realizes on the expiration date a capital gain equal to the premium the Fund received at the time the option was written. If an option purchased by a Fund expires unexercised, the Fund realizes a capital loss equal to
the premium paid. Prior to the earlier of exercise or expiration, an exchange-traded option may be closed out by an offsetting purchase or sale of an option of the same series (type, exchange, underlying security or index, exercise price and
expiration). There can be no assurance, however, that a closing purchase or sale transaction can be effected when a Fund desires.
The Funds
may sell put or call options they have previously purchased, which could result in a net gain or loss depending on whether the amount realized on the sale is more or less than the premium and other transaction costs paid on the put or call option
which is sold. Prior to exercise or expiration, an option may be closed out by an offsetting purchase or sale of an option of the same series. A Fund will realize a capital gain from a closing purchase transaction if the cost of the closing option
is less than the premium received from writing the option, or, if it is more, the Fund will realize a capital loss. If the premium received from a closing sale transaction is more than the premium paid to purchase the option, a Fund will realize a
capital gain or, if it is less, the Fund will realize a capital loss. The principal factors affecting the market value of a put or a call option include supply and demand, interest rates, the current market price of the underlying security or index
in relation to the exercise price of the option, the volatility of the underlying security or index, and the time remaining until the expiration date.
The Funds may write straddles (covered or uncovered) consisting of a combination of a call and a put written on the same underlying security. A straddle will be covered when sufficient assets are
deposited to meet a Funds immediate obligations. The Funds 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 Funds will also segregate or earmark liquid assets equivalent to the amount, if any, by which the put is in the money.
Risks Associated with Options on Securities and Indexes.
There are several risks associated with transactions in options on securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve the intended result. 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 because of market behavior or unexpected events.
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.
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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. If the Fund were unable to close out an
option that it had purchased on a security or index, it would have to exercise the option in order to realize any profit or the option may expire worthless. As the writer of a call option on an individual security held in its portfolio, the Fund
forgoes, during the options life, the opportunity to profit from increases in the market value of the security or index position covering the call option above the sum of the premium and the exercise price of the call.
If trading were suspended in an option purchased by a Fund, the Fund would not be able to close out the option. If restrictions on exercise were imposed,
the Fund might be unable to exercise an option it has 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.
Foreign Currency Options.
The Funds may buy or sell put and call options on foreign currencies for investment purposes or as a hedge against changes in the value of the U.S. dollar (or another
currency) in relation to a foreign currency in which the Funds securities may be denominated. The Funds may buy or sell put and call options on foreign currencies either on exchanges or in the over-the-counter market. A put option on a foreign
currency gives the purchaser of the option the right to sell a foreign currency at the exercise price until the option expires. A call option on a foreign currency gives the purchaser of the option the right to purchase the currency at the exercise
price until the option expires. Currency options traded on U.S. or other exchanges may be subject to position limits which may limit the ability of the Funds to reduce foreign currency risk using such options.
Futures Contracts and Options on Futures Contracts.
The Funds may invest in futures contracts and options thereon (futures options),
including interest rates, securities indexes, debt obligations (to the extent they are available) and U.S. Government and agency securities, as well as purchase put and call options on such futures contracts.
Generally, 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 indexes as well as financial instruments, including, without limitation: U.S. Treasury bonds; U.S. Treasury notes; 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.
The Funds may purchase and write call
and put futures options. Futures options possess many of the same characteristics as options on securities and indexes (discussed above). A futures option gives the holder the right, in return for the premium paid, to assume a long position (call)
or short position (put) in a futures contract at a
12
specified exercise price at any time during the period of the option. Upon exercise of a call option, the holder acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is true.
The Funds 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.
When a purchase or sale of a futures contract is made by a Fund, such Fund is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of assets determined to be liquid by the Investment Manager or Subadviser, as applicable, in accordance with procedures established by the Board of Trustees (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 the Fund upon
termination of the contract, assuming all contractual obligations have been satisfied. The Fund expects to earn taxable interest income on its initial margin deposits. A futures contract held by the Fund is valued daily at the official settlement
price of the exchange on which it is traded. Each day the 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 the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing daily net asset value, a Fund will mark to market
its open futures positions.
The Funds are also required to deposit and to 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, the 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, the Fund realizes a capital loss. The transaction
costs must also be included in these calculations.
The Funds may write straddles (covered or uncovered) 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. The Funds 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 Funds will also segregate or earmark liquid assets equivalent to the amount, if any, by which the put is in
the money.
The Funds are operated by a person who has claimed an exclusion from the definition of the term commodity pool
operator under the Commodity Exchange Act (the CEA) pursuant to Rule 4.5 under the CEA (the exclusion) promulgated by the U.S. Commodity Futures Trading Commission (the CFTC). Accordingly, neither the
Investment Manager (with respect to the Funds) nor the Funds is subject to registration or regulation as a commodity pool operator or commodity pool, respectively, under the CEA. To remain eligible for the exclusion, each of
the Funds will be limited in its ability to use certain financial instruments regulated under the CEA (commodity interests), including futures and options on futures and certain swaps transactions. In the event that a Funds
investments in commodity interests are not within the thresholds set forth in the exclusion, the Investment Manager may be required to register as a commodity pool operator and/or commodity trading advisor with the CFTC with
respect to that Fund. The Investment Managers eligibility to claim the exclusion with respect to a Fund will be based upon, among other things, the level and scope of a Funds investment in
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commodity interests, the purposes of such investments and the manner in which the Fund holds out its use of commodity interests. Each Funds ability to invest in commodity interests
(including, but not limited to, futures and swaps on broad-based securities indexes and interest rates) is limited by the Investment Managers intention to operate the Fund in a manner that would permit the Investment Manager to continue to
claim the exclusion under Rule 4.5, which may adversely affect the Funds total return. In the event the Investment Manager becomes unable to rely on the exclusion in Rule 4.5 and is required to register with the CFTC as a commodity pool
operator with respect to a Fund, the Funds expenses may increase, adversely affecting that Funds total return.
Limitations on
Use of Futures and Futures Options.
When purchasing a futures contract, the Funds will maintain with their custodian (and mark to market on a daily basis) assets determined to be liquid by the Investment Manager or Subadviser, as applicable, in
accordance with procedures approved by the Board of Trustees that, when added to the amounts deposited with a futures commission merchant as margin, are equal to the market value of the futures contract. Alternatively, a Fund may cover
its position by purchasing a put option on the same futures contract with a strike price as high as or higher than the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its custodian (and mark to market on a daily basis) assets determined to be liquid by the Investment Manager or Subadviser, as applicable, in
accordance with procedures approved by the Board of Trustees that are equal to the market value of the instruments underlying the contract. Alternatively, a Fund may cover its position by owning the instruments underlying the contract
(or, in the case of an index futures contract, a portfolio with a volatility substantially similar to that of the index on which the futures contract is based), or by holding a call option permitting the Fund to purchase the same futures contract at
a price no higher than the price of the contract written by the Fund (or at a higher price if the difference is maintained in liquid assets with the Funds custodian).
With respect to futures contracts that are not legally required to cash settle, a Fund may cover the open position by setting aside or earmarking liquid assets in an amount equal
to the market value of the futures contract. With respect to futures that are required to cash settle, however, a Fund is permitted to set aside or earmark liquid assets in an amount equal to the Funds daily marked to
market (net) obligation, if any, (in other words, the Funds daily net liability, if any) rather than the market value of the futures contract. By setting aside or earmarking assets equal to only its net obligation under
cash-settled futures, a Fund will have the ability to utilize these contracts to a greater extent than if the Fund were required to segregate or earmark assets equal to the full market value of the futures contract.
When selling a call option on a futures contract, a Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that, when
added to the amounts deposited with a futures commission merchant as margin, equal the total market value of the futures contract underlying the call option. Alternatively, a Fund may cover its position by entering into a long position in the same
futures contract at a price no higher than the strike price of the call option, by owning the instruments underlying the futures contract, or by holding a separate call option permitting the Fund to purchase the same futures contract at a price not
higher than the strike price of the call option sold by the Fund, or by taking other offsetting positions.
When selling a put option on a
futures contract, a Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that equal the purchase price of the futures contract, less any margin on deposit. Alternatively, a Fund may cover the position either by
entering into a short position in the same futures contract, or by owning a separate put option permitting it to sell the same futures contract so long as the strike price of the purchased put option is the same as or higher than the strike price of
the put option sold by the Fund, or by taking other offsetting positions.
Segregating or earmarking liquid assets to cover a Funds
obligations under futures contracts and related options generally will not eliminate the leverage risk arising from such use, which may tend to exaggerate the effect on net asset value of any increase or decrease in the market value of the
Funds portfolio, and may require liquidation of portfolio positions when it is not advantageous to do so.
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The requirements for qualification as a regulated investment company also may limit the extent to which the
Fund may enter into futures, futures options or forward contracts.
Risks Associated with Futures and Futures Options.
There are
several risks associated with the use of futures contracts and futures options. A purchase or sale of a futures contract 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 Fund securities being hedged. In addition, there are significant differences between the securities and futures markets that could result in an imperfect correlation between the
markets, causing a given hedge not to achieve its objective. The degree of imperfection of correlation depends on circumstances such as variations in speculative market demand for futures and futures options on securities, including technical
influences in futures trading and futures options, and differences between the financial instruments being hedged and the instruments underlying the standard contracts available for trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge involves the exercise of skill and judgment, and even a well-conceived hedge may be unsuccessful to some degree because of market behavior or unexpected interest rate
trends.
Futures contracts on U.S. Government securities historically have reacted to an increase or decrease in interest rates in a manner
similar to that in which the underlying U.S. Government securities reacted. To the extent, however, that a Fund enters into such futures contracts, the value of such futures will not vary in direct proportion to the value of the Funds holdings
of debt obligations. Thus, the anticipated spread between the price of the futures contract and the hedged security may be distorted due to differences in the nature of the markets. The spread also may be distorted by differences in initial and
variation margin requirements, the liquidity of such markets and the participation of speculators in such markets.
Futures exchanges may
limit the amount of fluctuation permitted in certain futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous days
settlement price at the end of the current trading session. Once the daily limit has been reached in a futures contract subject to the limit, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price
movements during a particular trading day and therefore does not limit potential losses because the limit may work to prevent the liquidation of unfavorable positions. For example, futures prices have occasionally moved to the daily limit for
several consecutive trading days with little or no trading, thereby preventing prompt liquidation of positions and subjecting some holders of futures contracts to substantial losses.
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, and such Fund would remain obligated to meet margin
requirements until the position is closed. As a result, there can be no assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts, Options on Futures Contracts and Forward Currency Exchange Contracts and Options Thereon.
Options on securities or indexes, futures
contracts, options on futures contracts, and options on currencies may be traded on foreign exchanges. Such transactions may not be regulated as effectively as similar transactions in the United States, may not involve a clearing mechanism and
related guarantees, and are subject to the risk of governmental actions affecting trading in, or the prices of, non-U.S. securities. Some foreign exchanges may be principal markets so that no common clearing facility exists and a trader may look
only to the broker for performance of the contract. The value of such positions also could be adversely affected by (i) other complex non-U.S. political, legal and economic factors, (ii) lesser availability than in the United States of
data on which to make trading decisions, (iii) delays in a Funds ability to act upon economic events occurring in non-U.S. markets during non-business hours in the United States, (iv) the imposition of different exercise and
settlement terms and procedures and margin requirements than in the United States and (v) lesser trading volume. In addition, unless a Fund hedges against fluctuations in the exchange rate between the U.S. dollar and the currencies in which
trading is done on non-U.S. exchanges, any profits that the
15
Fund might realize in trading could be eliminated by adverse changes in the exchange rate, or the Fund could suffer losses as a result of those changes. A Funds use of such instruments may
cause the Fund to pay higher amounts of distributions that are taxable to shareholders at ordinary income tax rates than if the Fund had not used such instruments.
Swap Agreements, Options on Swap Agreements and Certain Other Over-The-Counter Derivatives.
The Funds may enter into total return swap agreements, credit default swap agreements and other swap
agreements made with respect to interest rates, currencies, indexes of securities, commodities and other assets or measures of risk or return. These transactions are entered into in an attempt to obtain a particular return when it is considered
desirable to do so, possibly at a lower cost to the Funds than if the Funds had invested directly in an instrument that yielded that desired return.
Swap agreements are two-party contracts entered into primarily by institutional investors for periods ranging from a few weeks to a number of years. Swap agreements are individually negotiated and
structured to include exposure to a variety of types of investments or market factors. 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, such as the
return on or increase in value of a particular dollar amount invested at a particular interest rate 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 rate, 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. A Fund may use interest rate caps, floors and collars to a substantial degree in
connection with its leveraging strategies.
The Funds may also enter into options on swap agreements (swaptions). A swaption is a
contract that gives a counterparty the right (but not the obligation) to enter into a new swap agreement or to shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. The Funds may
write (sell) and purchase put and call swaptions. Depending on the terms of the particular option agreement, a Fund will generally incur a greater degree of risk when it writes a swaption than it will incur when it purchases a swaption. When a Fund
purchases a swaption, it risks losing only the amount of the premium it has paid should it decide to let the option expire unexercised. However, when a Fund writes a swaption, upon exercise of the option the Fund will become obligated according to
the terms of the underlying agreement.
Most swap agreements entered into by the Funds would calculate the obligations of the parties to the
agreement on a net basis. Consequently, a Funds current obligations (or rights) under a swap agreement will generally be equal only to the net amount 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). A Funds current obligations under a swap agreement will be accrued daily (offset against any amounts owed to the Fund). A Fund will generally cover any accrued but
unpaid net amounts owed to a swap counterparty through the segregation or earmarking of liquid assets.
Whether a Funds use of swap
agreements or swap options will be successful in furthering its investment objective will depend on the Investment Managers or Subadvisers, as applicable, ability to predict correctly whether certain types of investments are likely to
produce greater returns than other investments. Swaps are highly specialized instruments that require investment techniques, risk analyses, and tax planning different from those associated with traditional investments. The use of a swap requires an
understanding not only of the referenced asset, reference rate, or index but also of the swap itself, without the benefit of observing the
16
performance of the swap under all possible market conditions. Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way
detrimental to a Funds interest. The Funds bear the risk that the Investment Manager or Subadviser, as applicable, will not accurately forecast future market trends or the values of assets, reference rates, indexes, or other economic factors
in establishing swap positions for the Funds.
Because swaps are two party contracts that may be subject to contractual restrictions on
transferability and termination and because they may have terms of greater than seven days, swap agreements may be illiquid. If a swap is not liquid, it may not be possible to initiate a transaction or liquidate a position at an advantageous time or
price, which may result in significant losses. 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. When a
counterpartys obligations are not fully secured by collateral, a Fund is essentially an unsecured creditor of the counterparty. If the counterparty defaults, a Fund will have contractual remedies, but there is no assurance that a counterparty
will be able to meet its obligations pursuant to such contracts or that, in the event of default, the Fund will succeed in enforcing contractual remedies. Counterparty risk still exists even if a counterpartys obligations are secured by
collateral because, for example, a Funds interest in collateral may not be perfected or additional collateral may not be promptly posted as required. Counterparty risk also may be more pronounced if a counterpartys obligations exceed the
amount of collateral held by a Fund (if any), the Fund is unable to exercise its interest in collateral upon default by the counterparty, or the termination value of the instrument varies significantly from the marked-to-market value of the
instrument.
If the Investment Manager or Subadviser, as applicable, attempts to use a swap as a hedge against, or as a substitute for, a
portfolio investment, the Funds will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the Funds. While hedging strategies involving swap
instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other Fund investments.
Many swaps are complex and often valued subjectively. In particular, the valuation of many over-the-counter (OTC) derivatives requires modeling and judgment, which increases the risk of
mispricing or incorrect valuation. The pricing models used may not produce valuations that are consistent with the values a Fund realizes when it closes or sells an OTC derivative. Valuation risk is more pronounced when a Fund enters into OTC
derivatives with specialized terms because the market value of those derivatives in some cases is determined in part by reference to similar derivatives with more standardized terms. Incorrect valuations may result in increased cash payment
requirements to counterparties, undercollateralization and/or errors in calculation of a Funds net asset value.
Certain swap agreements
are exempt from most provisions of the CEA and, therefore, are not regulated under the CEA.
Credit Default Swaps.
The Funds may enter
into credit default swap contracts for both investment and risk management purposes. As the seller in a credit default swap contract, the Funds would be required to pay the par (or other agreed-upon) value of a referenced debt obligation to the
counterparty in the event of a default by a third party, such as an Emerging Market Country issuer, on the debt obligation. In return, a Fund would receive from the counterparty a periodic stream of payments over the term of the contract provided
that no event of default has occurred. If no default occurs, such Fund would keep the stream of payments and would have no payment obligations. As the seller, the 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.
The spread of a credit default swap is the
annual amount the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount. When market perceived credit risk rises, spreads tend to rise and when market perceived credit risk
falls, spreads tend to fall. Wider credit spreads and decreasing market values, when compared to the notional amount of the swap, represent a deterioration of
17
the referenced entitys credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. For credit default swap
agreements on asset-backed securities and credit indices, the quoted market prices and resulting values, as well as the annual payment rate, serve as an indication of the current status of the payment/performance risk.
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 liquidity risk, counterparty and third party risk and credit risk. The Funds will enter into credit default swap agreements only with counterparties that meet certain standards of creditworthiness. A
buyer generally also will lose its investment and recover nothing should no credit event occur and the swap is held to its termination date. If a credit event were to occur, the value of any deliverable obligation received by the seller, coupled
with the upfront or periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. The Funds obligations under a credit default swap agreement will be accrued
daily (offset against any amounts owing to the Funds). In connection with credit default swaps in which a Fund is the buyer or the seller, the Fund will typically segregate or earmark cash or liquid assets, or enter into certain
offsetting positions, with a value at least equal to the Funds exposure (any accrued but unpaid net amounts owed by the Fund to any counterparty), on a mark-to-market basis (when the Fund is the buyer), or the full notional amount of the swap
(minus any amounts owed to the Fund) (when the Fund is the seller).
Risk of Potential Government Regulation of Derivatives.
It is
possible that government regulation of various types of derivative instruments, including futures and swap agreements, may limit or prevent the Funds from using such instruments as a part of their investment strategy, and could ultimately prevent
the Funds from being able to achieve their investment objectives. It is impossible to predict fully the effects of legislation and regulation in this area, but the effects could be substantial and adverse.
The futures markets are subject to comprehensive statutes, regulations, and margin requirements. The SEC, the CFTC and the exchanges are authorized to
take extraordinary actions in the event of a market emergency, including, for example, the implementation or reduction of speculative position limits, the implementation of higher margin requirements, the establishment of daily price limits and the
suspension of trading.
The regulation of swaps and futures transactions in the U.S. is a rapidly changing area of law and is subject to
modification by government and judicial action. There is a possibility of future regulatory changes altering, perhaps to a material extent, the nature of an investment in a Fund or the ability of a Fund to continue to implement its investment
strategies. In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which was signed into law in July 2010, sets forth a new legislative framework for OTC derivatives, such as swaps, in which
the Funds may invest. Title VII of the Dodd-Frank Act makes broad changes to the OTC derivatives market, grants significant new authority to the SEC and the CFTC to regulate OTC derivatives and market participants, and will require clearing of many
OTC derivatives transactions.
Under recently adopted rules and regulations, transactions in some types of swaps (including interest rate
swaps and credit default swaps on North American and European indices) are required to be centrally cleared. In a transaction involving those swaps (cleared derivatives), a Funds counterparty is a clearing house, rather than a bank
or broker. Since the Funds are not members of clearing houses and only members of a clearing house (clearing members) can participate directly in the clearing house, the Funds will hold cleared derivatives through accounts at clearing
members. In cleared derivatives transactions, the Funds will make payments (including margin payments) to and receive payments from a clearing house through their accounts at clearing members. Clearing members guarantee performance of their
clients obligations to the clearing house.
In many ways, cleared derivative arrangements are less favorable to mutual funds than
bilateral arrangements. For example, the Funds may be required to provide more margin for cleared derivatives transactions than for bilateral derivatives transactions. Also, in contrast to a bilateral derivatives transaction, following a period of
notice to a Fund, a clearing member generally can require termination of an existing cleared derivatives
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transaction at any time or an increase in margin requirements above the margin that the clearing member required at the beginning of a transaction. Clearing houses also have broad rights to
increase margin requirements for existing transactions or to terminate those transactions at any time. Any increase in margin requirements or termination of existing cleared derivatives transactions by the clearing member or the clearing house could
interfere with the ability of a Fund to pursue its investment strategy. Further, any increase in margin requirements by a clearing member could expose a Fund to greater credit risk to its clearing member, because margin for cleared derivatives
transactions in excess of a clearing houses margin requirements typically is held by the clearing member. Also, a Fund is subject to risk if it enters into a derivatives transaction that is required to be cleared (or that the Adviser expects
to be cleared), and no clearing member is willing or able to clear the transaction on the Funds behalf. In those cases, the transaction might have to be terminated, and the Fund could lose some or all of the benefit of the transaction,
including loss of an increase in the value of the transaction and/or loss of hedging protection. In addition, the documentation governing the relationship between the Funds and clearing members is drafted by the clearing members and generally is
less favorable to the Funds than typical bilateral derivatives documentation. For example, documentation relating to cleared derivatives generally includes a one-way indemnity by the Funds in favor of the clearing member for losses the clearing
member incurs as the Funds clearing member and typically does not provide the Funds any remedies if the clearing member defaults or becomes insolvent.
These and other new rules and regulations could, among other things, further restrict a Funds ability to engage in, or increase the cost to the Fund of, derivatives transactions, for example, by
making some types of derivatives no longer available to the Fund, increasing margin or capital requirements, or otherwise limiting liquidity or increasing transaction costs. These regulations are new and evolving, so their potential impact on the
Funds and the financial system are not yet known. While the new regulations and central clearing of some derivatives transactions are designed to reduce systemic risk (i.e., the risk that the interdependence of large derivatives dealers could cause
them to suffer liquidity, solvency or other challenges simultaneously), there is no assurance that the new clearing mechanisms will achieve that result, and in the meantime, as noted above, central clearing exposes the Funds to new kinds of risks
and costs.
Distressed Securities
Securities in which a Fund invests may be subject to significant risk of an issuers inability to meet principal and interest payments on the obligations and also may be subject to price volatility
due to such factors as market perception of the creditworthiness of an issuer and general market liquidity. If the Investment Managers or Subadvisers, as applicable, evaluation of the anticipated outcome of an investment situation should
prove incorrect, a Funds investment in such a situation could result in a loss for the Fund.
Equity Securities
Equity securities, such as common stock, represent an ownership interest, or the right to acquire an ownership interest, in an issuer. Common stock
generally takes the form of shares in a corporation. The value of a companys stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the companys products or
services. A stocks value also may fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a companys
stock also may be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a companys stock generally pays dividends only
after the company invests in its own business and makes required payments to holders of its bonds, other debt and preferred stock. For this reason, the value of a companys stock will usually react more strongly than its bonds, other debt and
preferred stock to actual or perceived changes in the companys financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Stocks of companies that the portfolio
managers believe are fast-growing may trade at a higher multiple of current earnings than other stocks. The value of such stocks may be more sensitive to changes in current or expected earnings than the values of other stocks.
19
Different types of equity securities provide different voting and dividend rights and priority in the event
of the bankruptcy and/or insolvency of the issuer. In addition to common stock, equity securities may include preferred stock, convertible securities and warrants, which are discussed elsewhere in the Prospectus and this Statement of Additional
Information. Equity securities other than common stock are subject to many of the same risks as common stock, although possibly to different degrees. The risks of equity securities are generally magnified in the case of equity investments in
distressed companies.
Event-Linked Exposure
The Funds may obtain event-linked exposure by investing in event-linked bonds or event-linked swaps, or may implement event-linked strategies. Event-linked exposure
results in gains that typically are contingent on the nonoccurrence of a specific trigger event, such as a hurricane, earthquake or other physical or weather-related phenomena. Some event-linked bonds are commonly referred to as
catastrophe bonds. They may be issued by government agencies, insurance companies, reinsurers, special purpose corporations or other on-shore or off-shore entities (such special purpose entities are created to accomplish a narrow and
well-defined objective, such as the issuance of a note in connection with a reinsurance transaction). If a trigger event causes losses exceeding a specific amount in the geographic region and time period specified in a bond, a Fund may lose a
portion or all of its principal invested in the bond. If no trigger event occurs, the Fund will recover its principal plus interest. For some event-linked bonds, the trigger event or losses may be based on company-wide losses, index-portfolio
losses, industry indices or readings of scientific instruments rather than specified actual losses. Often the event-linked bonds provide for extensions of maturity that are mandatory, or optional at the discretion of the issuer, in order to process
and audit loss claims in those cases where a trigger event has, or possibly has, occurred. An extension of maturity may increase volatility. In addition to the specified trigger events, event-linked bonds also may expose a Fund to certain
unanticipated risks including but not limited to issuer risk, credit risk, counterparty and third party risk, adverse regulatory or jurisdictional interpretations and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As such, there is no significant trading history for many of these bonds, and there
can be no assurance that a liquid market in these bonds will develop. Lack of a liquid market may impose the risk of higher transaction costs and the possibility that a Fund may be forced to liquidate positions when it would not be advantageous to
do so.
Exchange Traded Notes
The Funds may invest in exchange traded notes (ETNs). ETNs are typically senior, unsecured, unsubordinated debt securities whose returns are
linked to the performance of a particular market index less applicable fees and expenses. ETNs are listed on an exchange and traded in the secondary market. The Funds may hold an ETN until maturity, at which time the issuer is obligated to pay a
return linked to the performance of the relevant market index. ETNs do not make periodic interest payments and principal is not protected. The market value of an ETN may be influenced by, among other things, time to maturity, level of supply and
demand of the ETN, volatility and lack of liquidity in the underlying assets, changes in the applicable interest rates, the current performance of the market index to which the ETN is linked, and the credit rating of the ETN issuer. The market value
of an ETN may differ from the performance of the applicable market index and there may be times when an ETN trades at a premium or discount. This difference in price may be due to the fact that the supply and demand in the market for ETNs at any
point in time is not always identical to the supply and demand in the market for the securities underlying the market index that the ETN seeks to track. A change in the issuers credit rating may also impact the value of an ETN despite the
underlying market index remaining unchanged. ETNs are also subject to tax risk. No assurance can be given that the Internal Revenue Service will accept, or a court will uphold, how a Fund characterizes and treats ETNs for tax purposes. An ETN that
is tied to a specific market index may not be able to replicate and maintain exactly the composition and relative weighting of securities, commodities or other components in the applicable market index. ETNs also incur certain expenses not incurred
by their applicable market index, and a Fund would bear a proportionate share of any fees and expenses borne by the ETN in which
20
it invests. A Funds decision to sell its ETN holdings may be limited by the availability of a secondary market. In addition, although an ETN may be listed on an exchange, the issuer may not
be required to maintain the listing and there can be no assurance that a secondary market will exist for an ETN. Some ETNs that use leverage in an effort to amplify the returns of an underlying market index can, at times, be relatively illiquid and
may therefore be difficult to purchase or sell at a fair price. Leveraged ETNs may offer the potential for greater return, but the potential for loss and speed at which losses can be realized also are greater. ETNs are generally similar to
structured investments and hybrid instruments.
Floating Rate Bank Loans
The Funds may invest in fixed- and floating-rate loans (including senior floating rate loans made to or issued by U.S. or non-U.S. banks or other corporations (Floating Rate Loans), delayed
funding loans and revolving credit facilities). Loan interests may take the form of direct interests acquired during a primary distribution and may also take the form of assignments of, novations of or participations in a bank loan acquired in
secondary markets.
The Funds may invest in Floating Rate Loans. Floating Rate Loans include floating rate loans and institutionally traded
floating rate debt obligations issued by asset-backed pools and other issues, and interests therein. Loan interests may be acquired from U.S. or non-U.S. commercial banks, insurance companies, finance companies or other financial institutions who
have made loans or are members of a lending syndicate or from other holders of loan interests.
Floating Rate Loans typically pay interest at
rates which are re-determined periodically on the basis of a floating base lending rate (such as the London Inter-Bank Offered Rate, LIBOR) plus a premium. Although Floating Rate Loans are typically of below investment grade quality,
they tend to have more favorable recovery rates than other types of below investment grade quality debt obligations. Floating Rate Loans generally may hold a senior position in the capital structure of a borrower and are often secured with
collateral. A Floating Rate Loan is typically originated, negotiated and structured by a U.S. or non-U.S. commercial bank, insurance company, finance company or other financial institution (the Agent) for a lending syndicate of financial
institutions (Lenders). The Agent typically administers and enforces the Floating Rate Loan on behalf of the other Lenders in the syndicate. In addition, an institution, typically but not always the Agent, holds any collateral on behalf
of the Lenders.
The Funds may purchase assignments and participations in commercial loans, as well as debtor-in-possession loans. Such
indebtedness may be secured or unsecured. Loan participations typically represent direct participations in a loan to a corporate borrower, and generally are offered by banks or other financial institutions or lending syndicates. The Funds may
participate in such syndications, or can buy part of a loan, becoming a part lender. When purchasing loan participations, a Fund assumes the credit risk associated with the corporate or other borrower and may assume the credit risk associated with
an interposed bank or other financial intermediary. The participation interests in which the Funds intend to invest may not be rated by any nationally recognized rating service.
Unless, under the terms of the loan or other indebtedness (such as may be the case in an assignment), a Fund has direct recourse against the borrower, the Fund may have to rely on the Agent or other
financial intermediary to apply appropriate credit remedies against a borrower.
Purchasers of loans and other forms of direct indebtedness
depend primarily upon the creditworthiness of the corporate or other borrower for payment of principal and interest. If a Fund does not receive scheduled interest or principal payments on such indebtedness, the Funds share price and yield
could be adversely affected. Floating Rate Loans that are fully secured offer the Funds more protection than an unsecured loan in the event of non-payment of scheduled interest or principal. However, there is no assurance that the liquidation of
collateral from a secured Floating Rate Loan would satisfy the borrowers obligation, or that such collateral could be liquidated.
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The Funds may invest in loan participations with credit quality comparable to that of many issuers of their
other debt securities investments. Indebtedness of companies whose creditworthiness is poor involves substantially greater risks, and may be highly speculative.
Some companies may never pay off their indebtedness, or may pay only a small fraction of the amount owed. Consequently, when investing in indebtedness of companies with poor credit, the Funds bear a
substantial risk of losing the entire amount invested.
Loans and other types of direct indebtedness may not be readily marketable and may be
subject to restrictions on resale. In some cases, negotiations involved in disposing of indebtedness may require weeks to complete. Consequently, some indebtedness may be difficult or impossible to dispose of readily at what the Investment Manager
or Subadviser, as applicable, believes to be a fair price. In addition, valuation of illiquid indebtedness involves a greater degree of judgment in determining a Funds net asset value than if that value were based on available market
quotations. At the same time, many loan interests are actively traded among certain financial institutions and considered to be liquid.
Investments in loans through a direct assignment of the financial institutions interests with respect to the loan may involve additional risks to a
Fund. For example, if a loan is foreclosed, the Fund could become part owner of any collateral, and would bear the costs and liabilities associated with owning and disposing of the collateral. In addition, it is conceivable that, under emerging
legal theories of lender liability, the Fund could be held liable as co-lender. It is unclear whether loans and other forms of direct indebtedness offer securities law protections against fraud and misrepresentation. In the absence of definitive
regulatory guidance, a Fund relies on the Investment Managers or Subadvisers, as applicable, research in an attempt to avoid situations where fraud or misrepresentations could adversely affect the Fund.
From time to time, the Investment Manager or Subadviser, as applicable, and their affiliates may borrow money from various banks in connection with their
business activities. Such banks may also sell Floating Rate Loans to or acquire them from the Funds or may be intermediate participants with respect to Floating Rate Loans in which the Funds own interests. Such banks may also act as Agents for
Floating Rate Loans held by the Funds.
Lending Fees.
In the process of buying, selling and holding Floating Rate Loans, the Funds may
receive and/or pay certain fees. These fees are in addition to interest payments received and may include facility fees, commitment fees, commissions and prepayment penalty fees. When a Fund buys a Floating Rate Loan it may receive a facility fee
and when it sells a Floating Rate Loan it may pay a facility fee. On an ongoing basis, the Fund may receive a commitment fee based on the undrawn portion of the underlying line of credit portion of the Floating Rate Loan. In certain circumstances,
the Fund may receive a prepayment penalty fee upon the prepayment of a Floating Rate Loan by a borrower. Other fees received by the Fund may include covenant waiver fees and covenant modification fees.
Borrower Covenants.
A borrower under a Floating Rate Loan typically must comply with various restrictive covenants contained in a loan agreement
or note purchase agreement between the borrower and the Lender or lending syndicate (the Loan Agreement). Such covenants, in addition to requiring the scheduled payment of interest and principal, may include restrictions on dividend
payments and other distributions to stockholders, provisions requiring the borrower to maintain specific minimum financial ratios and limits on total debt. In addition, the Loan Agreement may contain a covenant requiring the borrower to prepay the
Floating Rate Loan with any free cash flow. Free cash flow is generally defined as net cash flow after scheduled debt service payments and permitted capital expenditures, and includes the proceeds from asset dispositions or sales of securities. A
breach of a covenant which is not waived by the Agent, or by the lenders directly, as the case may be, is normally an event of acceleration;
i.e.
, the Agent, or the lenders directly, as the case may be, has the right to call the outstanding
Floating Rate Loan. The typical practice of an Agent or a Lender in relying exclusively or primarily on reports from the borrower may involve a risk of fraud by the borrower. In the case of a Floating Rate Loan in the form of a participation, the
agreement between the buyer and seller may limit the rights of the
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holder of a Floating Rate Loan to vote on certain changes which may be made to the Loan Agreement, such as waiving a breach of a covenant. However, the holder of the participation will, in almost
all cases, have the right to vote on certain fundamental issues such as changes in principal amount, payment dates and interest rate.
Administration of Loans.
In a typical Floating Rate Loan, the Agent administers the terms of the Loan Agreement. In such cases, the Agent is
normally responsible for the collection of principal and interest payments from the borrower and the apportionment of these payments to the credit of all institutions which are parties to the Loan Agreement. The Funds will generally rely upon the
Agent or an intermediate participant to receive and forward to a Fund its portion of the principal and interest payments on the Floating Rate Loan. Furthermore, unless under the terms of a participation agreement the Fund has direct recourse against
the borrower, a Fund will rely on the Agent and the other members of the lending syndicate to use appropriate credit remedies against the borrower. The Agent is typically responsible for monitoring compliance with covenants contained in the Loan
Agreement based upon reports prepared by the borrower. The seller of the Floating Rate Loan usually does, but is often not obligated to, notify holders of Floating Rate Loans of any failures of compliance. The Agent may monitor the value of the
collateral, if any, and if the value of such collateral declines, may accelerate the Floating Rate Loan, may give the borrower an opportunity to provide additional collateral or may seek other protection for the benefit of the participants in the
Floating Rate Loan. The Agent is compensated by the borrower for providing these services under a Loan Agreement, and such compensation may include special fees paid upon structuring and funding the Floating Rate Loan and other fees paid on a
continuing basis. With respect to Floating Rate Loans for which the Agent does not perform such administrative and enforcement functions, the Investment Manager will perform such tasks on behalf of a Fund, although a collateral bank will typically
hold any collateral on behalf of the Fund and the other lenders pursuant to the applicable Loan Agreement.
A financial institutions
appointment as Agent may usually be terminated in the event that it fails to observe the requisite standard of care or becomes insolvent, enters Federal Deposit Insurance Corporation (FDIC) receivership, or, if not FDIC insured, enters
into bankruptcy proceedings. A successor Agent would generally be appointed to replace the terminated Agent, and assets held by the Agent under the Loan Agreement should remain available to holders of Floating Rate Loans. However, if assets held by
the Agent for the benefit of a Fund were determined to be subject to the claims of the Agents general creditors, the Fund might incur certain costs and delays in realizing payment on a Floating Rate Loan, or suffer a loss of principal and/or
interest. In situations involving other intermediate participants similar risks may arise.
Prepayments.
Floating Rate Loans usually
require, in addition to scheduled payments of interest and principal, the prepayment of the Floating Rate Loan from free cash flow, as defined above. The degree to which borrowers prepay Floating Rate Loans, whether as a contractual requirement or
at their election, may be affected by general business conditions, the financial condition of the borrower and competitive conditions among lenders, among others. As such, prepayments cannot be predicted with accuracy. Upon a prepayment, either in
part or in full, the actual outstanding debt on which a Fund derives interest income will be reduced. However, the Fund may receive both a prepayment penalty fee from the prepaying borrower and a facility fee upon the purchase of a new Floating Rate
Loan with the proceeds from the prepayment of the former.
Bridge Financings.
The Funds may acquire interests in Floating Rate Loans
which are designed to provide temporary or bridge financing to a borrower pending the sale of identified assets or the arrangement of longer-term loans or the issuance and sale of debt obligations. The Funds may also invest in Floating
Rate Loans of borrowers who have obtained bridge loans from other parties. A borrowers use of bridge loans involves a risk that the borrower may be unable to locate permanent financing to replace the bridge loan, which may impair the
borrowers perceived creditworthiness.
Secured Floating Rate Loans.
To the extent that the collateral, if any, securing a
Floating Rate Loan consists of the stock of the borrowers subsidiaries or other affiliates, the Funds will be subject to the risk that this stock will decline in value. Such a decline, whether as a result of bankruptcy proceedings or
otherwise, could cause the Floating Rate Loan to be undercollateralized or unsecured. In most credit agreements there is no formal
23
requirement to pledge additional collateral. In addition, the Funds may invest in Floating Rate Loans guaranteed by, or fully secured by assets of, shareholders or owners, even if the Floating
Rate Loans are not otherwise collateralized by assets of the borrower. There may be temporary periods when the principal asset held by a borrower is the stock of a related company, which may not legally be pledged to secure a secured Floating Rate
Loan. On occasions when such stock cannot be pledged, the secured Floating Rate Loan will be temporarily unsecured until the stock can be pledged or is exchanged for or replaced by other assets, which will be pledged as security for such Floating
Rate Loan. However, the borrowers ability to dispose of such securities, other than in connection with such pledge or replacement, will be strictly limited for the protection of the holders of secured Floating Rate Loans.
If a borrower becomes involved in bankruptcy proceedings, a court may invalidate a Funds security interest in any loan collateral or subordinate
the Funds rights under a secured Floating Rate Loan to the interests of the borrowers unsecured creditors. Such action by a court could be based, for example, on a fraudulent conveyance claim to the effect that the borrower
did not receive fair consideration for granting the security interest in the loan collateral to the Fund. For secured Floating Rate Loans made in connection with a highly leveraged transaction, consideration for granting a security interest may be
deemed inadequate if the proceeds of such loan were not received or retained by the borrower, but were instead paid to other persons, such as shareholders of the borrower, in an amount which left the borrower insolvent or without sufficient working
capital. There are also other events, such as the failure to perfect a security interest due to faulty documentation or faulty official filings, which could lead to the invalidation of the Funds security interest in any loan collateral. If a
Funds security interest in loan collateral is invalidated or a secured Floating Rate Loan is subordinated to other debt of a borrower in bankruptcy or other proceedings, it is unlikely that the Fund would be able to recover the full amount of
the principal and interest due on the secured Floating Rate Loan.
The Funds may also invest in Floating Rate Loans that are not secured by
collateral or otherwise.
Floating Rate Debt Instruments
The Funds may invest in floating rate debt instruments, including Floating Rate Loans (described in more detail above). Floating rate debt instruments are debt instruments that pay interest at rates that
adjust whenever a specified interest rate changes, float at a fixed margin above a generally recognized base lending rate and/or reset or are redetermined (
e.g.
, pursuant to an auction) on specified dates (such as the last day of a month or
calendar quarter). These floating rate debt instruments may include, in addition to Floating Rate Loans, instruments such as catastrophe bonds, bank capital securities, unsecured bank loans, corporate bonds, money market instruments and certain
types of mortgage-backed and other asset-backed securities. Due to their floating rate features, these instruments will generally pay higher levels of income in a rising interest rate environment and lower levels of income as interest rates decline.
For the same reason, the market value of a floating rate debt instrument is generally expected to have less sensitivity to fluctuations in market interest rates than a fixed-rate debt instrument, although the value of a floating rate instrument may
nonetheless decline as interest rates rise and due to other factors, such as changes in credit quality.
The Funds 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.
Foreign Corrupt Practices Act
The Investment Manager and Subadviser (on behalf of a Fund), as applicable, intend to request that companies in which the Fund has a controlling equity
investment (if any), and which allow the Fund and/or its affiliates to exert positive control and/or significant influence over such entity (the Investee Companies), adopt and implement policies, to the extent they do not have them
already, to minimize and prohibit the direct or indirect,
24
offer, payment, promise of payment or authorization of payment of anything of value, including but not limited to cash, checks, wire transfers, tangible and intangible gifts, favors, services,
to: (i) an executive, official, employee or agent of a governmental department, agency or instrumentality, (ii) a director, officer, employee or agent of a wholly or partially government-owned or -controlled company or business,
(iii) a political party or official thereof, or candidate for political office, or (iv) an executive, official, employee or agent of a public international organization (a Government Official), with the specific purpose of
exerting an influence, whether positive or negative, over such Government Official to obtain an improper advantage or in order to obtain, retain, or direct business. Notwithstanding the aforementioned policies, the Investment Manager, the Subadviser
and the Funds are solely reliant on the executive management of the Investee Company (the IC Management) to implement and monitor such policies and report to the Investment Manager, the Subadviser, the Funds or their affiliates, in the
Funds capacity as a shareholder of the Investee Company, on such policies, and accordingly there is no guarantee that such policies will be implemented, and even if implemented whether they will be effective and/or adhered to by the IC
Management, and any failure in the IC Management to implement, adhere to, and monitor such policies will compromise the effectiveness of such policies.
Foreign Currency Exchange-Related Securities
Foreign Currency Warrants.
Foreign
currency warrants, such as Currency Exchange Warrants, are warrants that entitle their holders to receive from their issuer an amount of cash (generally, for warrants issued in the United States, in U.S. dollars) that is calculated pursuant to
a predetermined formula and based on the exchange rate between a specified foreign currency and the U.S. dollar as of the exercise date of the warrant. Foreign currency warrants generally are exercisable upon their issuance and expire as of a
specific date and time. Foreign currency warrants have been issued in connection with U.S. dollar-denominated debt offerings by major issuers in an attempt to reduce the foreign currency exchange risk that, from the point of view of the prospective
purchasers of the securities, is inherent in the international debt obligation marketplace. Foreign currency warrants may attempt to reduce the foreign exchange risk assumed by purchasers of a security by, for example, providing for a supplement
payment in the event that the U.S. dollar depreciates against the value of a major foreign currency such as the Japanese yen. The formula used to determine the amount payable upon exercise of a foreign currency warrant may make the warrant worthless
unless the applicable foreign currency exchange rate moves in a particular direction (
e.g.
, unless the U.S. dollar appreciates or depreciates against the particular foreign currency to which the warrant is linked or indexed). Foreign currency
warrants are severable from the debt obligations with which they may be offered, and may be listed on exchanges. Foreign currency warrants may be exercisable only in certain minimum amounts, and an investor wishing to exercise warrants who possesses
less than the minimum number required for exercise may be required either to sell the warrants or to purchase additional warrants, thereby incurring additional transaction costs. In the case of any exercise of warrants, there may be a time delay
between the time a holder of warrants gives instructions to exercise and the time the exchange rate relating to exercise is determined, during which time the exchange rate could change significantly, thereby affecting both the market and cash
settlement values of the warrants being exercised. The expiration date of the warrants may be accelerated if the warrants should be delisted from an exchange or if their trading should be suspended permanently, which would result in the loss of any
remaining time values of the warrants (
i.e.
, the difference between the current market value and the exercise value of the warrants), and, if the warrants were out-of-the-money, in a total loss of the purchase price of
the warrants. Warrants are generally unsecured obligations of their issuers and are not standardized foreign currency options issued by the Options Clearing Corporation (OCC). Unlike foreign currency options issued by the OCC, the terms
of foreign exchange warrants generally will not be amended in the event of government or regulatory actions affecting exchange rates or in the event of the imposition of other regulatory controls affecting the international currency markets. The
initial public offering price of foreign currency warrants is generally considerably in excess of the price that a commercial user of foreign currencies might pay in the interbank market for a comparable option involving significantly larger amounts
of foreign currencies. Foreign currency warrants are subject to significant foreign exchange risk, including risks arising from complex political or economic factors.
25
Principal Exchange Rate Linked Securities.
Principal exchange rate linked securities are debt
obligations the principal on which is payable at maturity in an amount that may vary based on the exchange rate between the U.S. dollar and a particular foreign currency at or about that time. The return on standard principal exchange
rate linked securities is enhanced if the foreign currency to which the security is linked appreciates against the U.S. dollar, and is adversely affected by increases in the foreign exchange value of the U.S. dollar; reverse principal
exchange rate linked securities are like standard securities, except that their return is enhanced by increases in the value of the U.S. dollar and adversely impacted by increases in the value of foreign currency. Interest payments on
the securities are generally made in U.S. dollars at rates that reflect the degree of foreign currency risk assumed or given up by the purchaser of the notes (
i.e.
, at relatively higher interest rates if the purchaser has assumed some of the
foreign exchange risk, or relatively lower interest rates if the issuer has assumed some of the foreign exchange risk, based on the expectations of the current market). Principal exchange rate linked securities may in limited cases be subject to
acceleration of maturity (generally, not without the consent of the holders of the securities), which may have an adverse impact on the value of the principal payment to be made at maturity.
Performance Indexed Paper.
Performance indexed paper is U.S. dollar-denominated commercial paper the yield of which is linked to certain foreign exchange rate movements. The yield to the investor
on performance indexed paper is established at maturity as a function of spot exchange rates between the U.S. dollar and a designated currency as of or about that time (generally, the index maturity two days prior to maturity). The yield to the
investor will be within a range stipulated at the time of purchase of the obligation, generally with a guaranteed minimum rate of return that is below, and a potential maximum rate of return that is above, market yields on
U.S. dollar-denominated commercial paper, with both the minimum and maximum rates of return on the investment corresponding to the minimum and maximum values of the spot exchange rate two business days prior to maturity.
Foreign Currency Transactions
Subject
to the limitations discussed above and in the Prospectus, the Funds also may purchase and sell foreign currency options and foreign currency futures contracts and related options (see Derivative Instruments above), and may engage in
foreign currency transactions either on a spot (cash) basis at the rate prevailing in the currency exchange market at the time or through deliverable and non-deliverable forward foreign currency exchange contracts (forwards). A Fund may
(but is not required to) engage in these transactions in order to protect against uncertainty in the level of future foreign exchange rates in the purchase and sale of securities. A Fund may also use foreign currency options and foreign currency
forward contracts to increase exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one country to another. Suitable currency hedging transactions may not be available in all circumstances and the Investment
Manager or Subadviser, as applicable, may decide not to use hedging transactions that are available.
A forward foreign currency exchange
contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts may
be bought or sold to protect a Fund against a possible loss resulting from an adverse change in the relationship between a foreign currency and another currency (e.g., the U.S. dollar) or to increase exposure to a particular foreign currency.
Although forwards are intended to minimize the risk of loss due to a decline in the value of the hedged currencies, at the same time, they tend to limit any potential gain which might result should the value of such currencies increase. A Fund might
be expected to enter into such contracts under the following circumstances:
Lock In.
When the Investment Manager or Subadviser, as
applicable, desires to lock in the U.S. dollar price on the purchase or sale of a security denominated in a foreign currency.
Cross
Hedge.
If a particular currency is expected to decrease against another currency, a Fund may sell the currency expected to decrease and purchase a currency that is expected to increase against the currency sold in an amount approximately equal
to some or all of the Funds portfolio holdings denominated in the currency sold.
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Direct Hedge.
If the Investment Manager or Subadviser, as applicable, wants to eliminate
substantially all of the risk of owning a particular currency, and/or if the Investment Manager or Subadviser, as applicable, believes that a Fund can benefit from price appreciation in a given countrys debt obligations but does not want to
hold the currency, it may employ a direct hedge back into the U.S. dollar. In either case, a Fund would enter into a forward contract to sell the currency in which a portfolio security is denominated and purchase U.S. dollars at an exchange rate
established at the time it initiated a contract. The cost of the direct hedge transaction may offset most, if not all, of the yield advantage offered by the non-U.S. security, but the Fund would hope to benefit from an increase (if any) in the value
of the debt obligation.
Proxy Hedge.
The Investment Manager or Subadviser, as applicable, might choose to use a proxy hedge, which may
be less costly than a direct hedge. In this case, a Fund, having purchased a security, will sell a currency whose value is believed to be closely linked to the currency in which the security is denominated. Interest rates prevailing in the country
whose currency was sold would be expected to be close to those in the United States and lower than those of securities denominated in the currency of the original holding. This type of hedging entails greater risk than a direct hedge because it is
dependent on a stable relationship between the two currencies paired as proxies and the relationships can be very unstable at times.
Costs
of Hedging.
It is important to note that hedging costs are treated as capital transactions and are not, therefore, deducted from a Funds dividend distribution and are not reflected in its yield. Instead such costs will, over time, be
reflected in the Funds net asset value per share.
The forecasting of currency market movement is extremely difficult, and whether any
hedging strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, a Fund may be required to
buy or sell additional currency on the spot market (and bear the expense of such transaction) if the Investment Managers or Subadvisers, as applicable, predictions regarding the movement of foreign currency or securities markets prove
inaccurate. In addition, the use of cross-hedging transactions may involve special risks, and may leave a Fund in a less advantageous position than if such a hedge had not been established. Because foreign currency forward contracts are privately
negotiated transactions, there can be no assurance that the Fund will have flexibility to roll-over a foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the
contract will perform its services thereunder.
The Funds may hold a portion of their assets in bank deposits denominated in foreign
currencies, so as to facilitate investment in foreign securities as well as to protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are
converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations.
Tax Consequences of Hedging.
Income earned by a Fund from its foreign currency hedging activities, if any, may give rise to ordinary income that,
to the extent there is no offset by losses from such activities, will be distributed to shareholders and taxable at ordinary income rates. Any net ordinary losses so created cannot be carried forward by a Fund to offset income or gains earned in
subsequent taxable years. In addition, under applicable tax law, a Funds foreign currency hedging activities may result in the application of, among other rules, the mark-to-market and straddle provisions of the Code. These provisions could
affect the amount, timing and/or character of distributions to Fund shareholders.
Among the risks of utilizing foreign currencies and related
transactions is the risk that the relative value of currencies will be different than anticipated by the Investment Manager or Subadviser, as applicable.
Certain foreign currency transactions in which the Funds may invest may be over-the-counter transactions (e.g., currency swap transactions). See Derivative InstrumentsSwap Agreements, Options
on Swap Agreements and Certain Other Over-The-Counter Derivatives for a discussion of certain risks associated with such instruments.
27
Foreign/Non-U.S. Securities
A Fund may invest without limit in securities of corporate and other non-U.S./foreign issuers (and securities traded principally outside of the United States), including obligations of non-U.S. banks,
non-U.S. governments or their subdivisions, agencies and instrumentalities, international agencies and supra-national government entities and other issuers, and securities traded principally outside of the United States.
The non-U.S. securities in which a Fund may invest include Eurodollar obligations and Yankee Dollar obligations. Eurodollar obligations are
U.S. dollar-denominated certificates of deposit and time deposits issued outside the U.S. capital markets by non-U.S. branches of U.S. banks and by non-U.S. banks. Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the U.S.
capital markets by non-U.S. banks. Eurodollar and Yankee Dollar obligations are generally subject to the same risks that apply to domestic debt issues, notably credit risk, market risk and liquidity risk. Additionally, Eurodollar (and to a limited
extent, Yankee Dollar) obligations are subject to certain sovereign risks. One such risk is the possibility that a sovereign country might prevent capital, in the form of U.S. dollars, from flowing across its borders. Other risks include adverse
political and economic developments; the extent and quality of government regulation of financial markets and institutions; the imposition of non-U.S. withholding taxes; and the expropriation or nationalization of non-U.S. issuers.
A Fund may invest in American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) or Global Depositary Receipts
(GDRs). ADRs are U.S. dollar-denominated receipts issued generally by domestic banks and represent the deposit with the bank of a security of a non-U.S. issuer. EDRs are foreign currency-denominated receipts similar to ADRs and are
issued and traded in Europe, and are publicly traded on exchanges or over-the-counter in the United States. GDRs may be offered privately in the United States and also trade in public or private markets in other countries. ADRs, EDRs and GDRs may be
issued as sponsored or unsponsored programs. In sponsored programs, an issuer has made arrangements to have its securities trade in the form of ADRs, EDRs or GDRs. In unsponsored programs, the 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 issuer that has participated in the creation of a
sponsored program.
A Fund may invest in Brady Bonds. Brady Bonds are securities created through the exchange of existing commercial bank
loans to sovereign entities for new obligations in connection with debt restructurings under a debt restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the Brady Plan). Brady Plan debt
restructurings have been implemented in a number of countries, including: Albania, Argentina, Bolivia, Brazil, Bulgaria, Columbia, Costa Rica, the Dominican Republic, Ecuador, Ivory Coast, Jordan, Mexico, Morocco, Niger, Nigeria, Panama, Peru, the
Philippines, Poland, Uruguay, Venezuela and Vietnam.
Brady Bonds may be collateralized or uncollateralized, are issued in various currencies
(primarily the U.S. dollar) and are actively traded in the over-the-counter secondary market. Brady Bonds are not considered to be U.S. Government securities. U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are generally collateralized in full as to principal by U.S. Treasury zero-coupon bonds having the same maturity as the Brady Bonds. Interest payments on these Brady Bonds generally are collateralized on a
one-year or longer rolling-forward basis by cash or securities in an amount that, in the case of fixed rate bonds, is equal to at least one year of interest payments or, in the case of floating rate bonds, initially is equal to at least one
years interest payments based on the applicable interest rate at that time and is adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to value recovery payments in certain circumstances, which in effect
constitute supplemental interest payments but generally are not collateralized. Brady Bonds are often viewed as having three or four valuation components: (i) the collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest payments; and (iv) any uncollateralized repayment of principal at maturity (the uncollateralized amounts constitute the residual risk).
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Brady Bonds involve various risk factors including residual risk and the history of defaults with respect to
commercial bank loans by public and private entities of countries issuing Brady Bonds. There can be no assurance that Brady Bonds in which a Fund may invest will not be subject to restructuring arrangements or to requests for new credit, which may
cause the Fund to suffer a loss of interest or principal on any of its holdings.
Investing in the securities of non-U.S. issuers involves
special risks and considerations not typically associated with investing in U.S. companies. These include: differences in accounting, auditing and financial reporting standards; generally higher commission rates on non-U.S. portfolio transactions;
the possibility of expropriation or confiscatory taxation; adverse changes in investment or exchange control regulations (which may include suspension of the ability to transfer currency from a country); political instability which can affect U.S.
investments in non-U.S. countries; and potential restrictions on the flow of international capital. In addition, non-U.S. securities and dividends and interest payable on those securities may be subject to non-U.S. taxes, including taxes withheld
from payments on those securities, which will reduce a Funds yield on those securities. Non-U.S. securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. Changes in
foreign exchange rates will affect the value of those securities which are denominated or quoted in currencies other than the U.S. dollar. The currencies of non-U.S. countries may experience significant declines against the U.S. dollar, and
devaluation may occur subsequent to investments in these currencies by a Fund. To the extent that a Fund invests a significant portion of assets in a concentrated geographic area, the Fund will generally have more exposure to regional economic risks
associated with those investments.
Emerging Market and Frontier Market Securities.
A Fund may invest in the securities of issuers
economically tied to emerging market countries. Investment risk in such investments may be particularly high to the extent that a Fund invests in instruments economically tied to emerging market countries. These securities may present market,
credit, currency, liquidity, legal, political and other risks different from, or greater than, the risks of investing in developed countries. A Fund may invest in emerging markets that may be in the process of opening to trans-national investment,
which may increase these risks. Risks particular to emerging market countries include, but are not limited to, the following risks:
General Emerging Market and Frontier Market Risk.
The securities markets of countries in which a Fund may invest may be relatively small, with a limited number of companies representing a small
number of industries. Additionally, issuers in countries in which a Fund may invest may not be subject to a high degree of regulation and the financial institutions with which the Fund may trade may not possess the same degree of financial
sophistication, creditworthiness or resources as those in developed markets. Furthermore, the legal infrastructure and accounting, auditing and reporting standards in certain countries in which a Fund may invest may not provide the same degree of
investor protection or information to investors as would generally apply in major securities markets.
Nationalization,
expropriation or confiscatory taxation, currency blockage, political changes or diplomatic developments could adversely affect a Funds investments in a foreign country. In the event of nationalization, expropriation or other confiscation, a
Fund could lose its entire investment in that country. Adverse conditions in a certain region can adversely affect securities of other countries whose economies appear to be unrelated. To the extent that a Fund invests a significant portion of
assets in a concentrated geographic area, the Fund will generally have more exposure to regional economic risks associated with those investments.
Restrictions on Foreign Investment.
A number of emerging securities markets restrict foreign investment to varying degrees. Furthermore, repatriation of investment income, capital and the proceeds
of sales by foreign investors may require governmental registration and/or approval in some countries. While a Fund will only invest in markets where these restrictions are considered acceptable, new or additional repatriation or other restrictions
might be imposed subsequent to the Funds investment. If such restrictions were to be imposed subsequent to a Funds investment in the securities markets of a particular country, the Funds response might include, among other things,
applying to the appropriate authorities for a waiver of the restrictions or engaging in transactions in other markets
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designed to offset the risks of decline in that country. Such restrictions will be considered in relation to a Funds liquidity needs and all other acceptable positive and negative factors.
Some emerging markets limit foreign investment, which may decrease returns relative to domestic investors. A Fund may seek exceptions to those restrictions. If those restrictions are present and cannot be avoided by the Fund, the Funds returns
may be lower.
Settlement Risks.
Settlement systems in emerging markets may be less well organized than in developed
markets. Supervisory authorities may also be unable to apply standards comparable with those in developed markets. Thus there may be risks that settlement may be delayed and that cash or securities belonging to a Fund may be in jeopardy because of
failures of or defects in the systems. In particular, market practice may require that payment be made prior to receipt of the security which is being purchased or that delivery of a security must be made before payment is received. In such cases,
default by a broker or bank through whom the relevant transaction is effected might result in a loss being suffered by the Fund. A Fund seeks, when possible, to use counterparties whose financial status is such that this risk is reduced. However,
there can be no certainty that a Fund will be successful in eliminating or reducing this risk, particularly as counterparties operating in developing countries frequently lack the substance, capitalization and/or financial resources of those in
developed countries.
There may also be a danger that, because of uncertainties in the operation of settlement systems in
individual markets, competing claims may arise in respect of securities held by or to be transferred to a Fund. Furthermore, compensation schemes may be non-existent, limited or inadequate to meet a Funds claims in any of these events.
Counterparty and Third Party Risk.
Trading in the securities of developing markets presents additional credit and
financial risks. A Fund may have limited access to, or there may be a limited number of, potential counterparties that trade in the securities of emerging market issuers. Governmental regulations may restrict potential counterparties to certain
financial institutions located or operating in the particular emerging market. Potential counterparties may not possess, adopt or implement creditworthiness standards, financial reporting standards or legal and contractual protections similar to
those in developed markets. Currency hedging techniques may not be available or may be limited. A Fund may not be able to reduce or mitigate risks related to trading with emerging market counterparties. The Funds seek, when possible, to use
counterparties whose financial status is such that the risk of default is reduced, but the risk of losses resulting from default is still possible.
Government in the Private Sector.
Government involvement in the private sector varies in degree among the emerging markets in which a Fund may invest. Such involvement may, in some cases, include
government ownership of companies in certain sectors, wage and price controls or imposition of trade barriers and other protectionist measures. With respect to any developing country, there is no guarantee that some future economic or political
crisis will not lead to price controls, forced mergers of companies, expropriation, or creation of government monopolies, to the possible detriment of a Funds investment in that country.
Litigation.
A Fund may encounter substantial difficulties in obtaining and enforcing judgments against individuals and companies
located in certain developing countries. It may be difficult or impossible to obtain or enforce legislation or remedies against governments, their agencies and sponsored entities.
Fraudulent Securities.
It is possible, particularly in markets in developing countries, that purported securities in which a Fund
invests may subsequently be found to be fraudulent and as a consequence the Fund could suffer losses.
Local Taxation.
The local taxation of income and capital gains accruing to non-residents varies among emerging market countries and, in some cases, is comparatively high. In addition, emerging market countries typically have less well-defined tax laws and
procedures and such laws may permit retroactive taxation so that a Fund could in the future become subject to local tax liabilities that had not been anticipated in conducting its investment activities or valuing its assets. The Funds seek to reduce
these risks by careful management of assets. However, there can be no assurance that these efforts will be successful.
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Political Risks/Risks of Conflicts.
Recently, various countries have seen significant
internal conflicts and in some cases, civil wars have had an adverse impact on the securities markets of the countries concerned. In addition, the occurrence of new disturbances due to acts of war or other political developments cannot be excluded.
Apparently stable systems may experience periods of disruption or improbable reversals of policy. Nationalization, expropriation or confiscatory taxation, currency blockage, political changes, government regulation, political, regulatory or social
instability or uncertainty or diplomatic developments could adversely affect a Funds investments. The transformation from a centrally planned, socialist economy to a more market oriented economy has also resulted in many economic and social
disruptions and distortions. Moreover, there can be no assurance that the economic, regulatory and political initiatives necessary to achieve and sustain such a transformation will continue or, if such initiatives continue and are sustained, that
they will be successful or that such initiatives will continue to benefit foreign (or non-national) investors. Certain instruments, such as inflation indexed instruments, may depend upon measures compiled by governments (or entities under their
influence), which are also the obligors.
Custody Risk
. Custody services in many Emerging Market Countries remain
undeveloped and, although a Funds custodian and the Investment Manager will seek to establish control mechanisms, including the selection of sub-custodians, nominees or agents (Sub-custodians) to register securities on behalf of a
Fund and perform regular checks of entries on relevant securities registers to ensure that the Funds interests continue to be recorded, there is a transaction and custody risk of dealing in emerging market securities.
Although a Funds custodian will seek to satisfy itself that each Sub-custodian selected to provide for the safe custody or control
of a Funds investments is fit and proper and that arrangements are in place to safeguard the interests of shareholders of a Fund, under the Funds agreement with the custodian, the custodian will only be liable for certain limited acts of
the Sub-custodian (e.g., fraud). The Fund may therefore have a potential exposure on the default of any Sub-custodian and, as a result, many of the protections which would normally be provided to an investment fund by a trustee, custodian or
Sub-custodian will not be available to a Fund.
It must be appreciated that the Fund will be investing in Emerging Market
Countries where the current law and market practice carry fewer safeguards than in more developed markets, including the protection of client securities against claims from general creditors in the event of the insolvency of an agent selected to
hold securities on behalf of a Fund and that the custodian, the Investment Manager, the Subadviser, as applicable, and a Funds administrator have assumed no liability for losses resulting from a Fund acting in accordance with such practice.
In certain circumstances, as a result of market practice, law or regulation in the jurisdictions in which a Fund may invest,
it may not be practicable or possible for the Funds custodian to take into its custody an investment by registering such investment in the name of the custodian, its Sub-custodian or by the holding of such investment in an account in a central
securities depositary over which the custodian or its Sub-custodian has control. In these circumstances, a Fund may invest directly in such investments and title to such assets will be in the name of the Fund. In spite of any controls that may
be established by the Funds custodian, the holding of such investments in this manner may mean that such investments may not be as well protected from a concerted fraud against the Fund than if such investments had been registered in the name
of the custodian or its Sub-custodian.
Frontier markets countries generally have smaller economies or less developed capital markets than
traditional emerging markets countries, and, as a result, the risks described above may be magnified in these countries.
Foreign
Government & Supra-National Debt.
A Fund may invest in debt issued by non-U.S. developed, emerging market and frontier market governments and their respective sub-divisions, agencies or instrumentalities, government sponsored
enterprises and supra-national government entities. Supra-national entities include international organizations that are organized or supported by one or more government entities to
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promote economic reconstruction or development and by international banking institutions and related governmental agencies. Investment in foreign government debt can involve a high degree of
risk. The governmental entity that controls the repayment of debt may not be able or willing to repay the principal and/or interest when due in accordance with the terms of the debt. A governmental entitys willingness or ability to repay
principal and interest due in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entitys policy toward the International Monetary Fund, and the political constraints to which a governmental entity may be subject. Governmental entities may also depend on
expected disbursements from non-U.S. governments, multilateral agencies and others to reduce principal and interest arrearages on their debt. The commitment on the part of these governments, agencies and others to make such disbursements may be
conditioned on a governmental entitys implementation of economic reforms and/or economic performance and the timely service of such debtors obligations. Failure to implement such reforms, achieve such levels of economic performance or
repay principal or interest when due may result in the cancellation of such third parties commitments to lend funds to the governmental entity, which may further impair such debtors ability or willingness to service its debts in a timely
manner. Consequently, governmental entities may default on their debt. Holders of such debt (including the Funds) may be requested to participate in the rescheduling of such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which foreign government debt on which governmental entities have defaulted may be collected in whole or in part.
A
Funds investments in foreign currency-denominated debt obligations and hedging activities will likely produce a difference between its book income and its taxable income. This difference may cause a portion of a Funds income
distributions to constitute returns of capital for tax purposes or require the Fund to make distributions exceeding book income to qualify as a regulated investment company or to eliminate fund-level tax for U.S. federal income tax purposes.
High Yield Securities (Junk Bonds)
A Fund may invest without limit in debt instruments that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys, below BBB- by either S&P or Fitch Ratings), or unrated
but judged by the Investment Manager to be of comparable quality. These securities are sometimes referred to as high yield securities or junk bonds.
Investments in high yield securities generally provide greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail
greater price volatility and principal and income risk, including the possibility of issuer default and bankruptcy. High yield securities are regarded as predominantly speculative with respect to the issuers continuing ability to meet
principal and interest payments. Debt securities in the lowest investment grade category also may be considered to possess some speculative characteristics by certain rating agencies. In addition, analysis of the creditworthiness of issuers of high
yield securities may be more complex than for issuers of higher quality securities.
High yield securities may be more susceptible to real or
perceived adverse economic and competitive industry conditions than investment grade securities. A projection of an economic downturn or of a period of rising interest rates, for example, could cause a decline in high yield security prices because
the advent of a recession could lessen the ability of an issuer to make principal and interest payments on its debt obligations. If an issuer of high yield securities defaults, in addition to risking non-payment of all or a portion of interest and
principal, the Fund may incur additional expenses to seek recovery. The market prices of high yield securities structured as zero-coupon, step-up or payment-in-kind securities will normally be affected to a greater extent by interest rate changes,
and therefore tend to be more volatile than the prices of securities that pay interest currently and in cash.
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The secondary market on which high yield securities are traded may be less liquid than the market for
investment grade securities. Less liquidity in the secondary trading market could adversely affect the price at which a Fund could sell a high yield security, and could adversely affect the net asset value of the shares. Adverse publicity and
investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of high yield securities, especially in a thinly-traded market. When secondary markets for high yield securities are less liquid than the
market for investment grade securities, it may be more difficult to value the lower rated securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable,
objective data available. During periods of thin trading in these markets, the spread between bid and asked prices is likely to increase significantly and a Fund may have greater difficulty selling its portfolio securities. A Fund will be more
dependent on the Investment Managers or Subadvisers, as applicable, research and analysis when investing in high yield securities.
A general description of the ratings of securities by Moodys, S&P and Fitch Ratings is set forth in Appendix B to this SAI. The ratings of
Moodys, S&P, and Fitch Ratings represent their opinions as to the quality of the securities they rate. It should be emphasized, however, that ratings are general and are not absolute standards of quality. Consequently, debt obligations
with the same maturity, coupon and rating may have different yields while obligations with the same maturity and coupon with different ratings may have the same yield. For these reasons, the use of credit ratings as the sole method of evaluating
high yield securities can involve certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield securities. Also, credit rating agencies may fail to change credit ratings
in a timely fashion to reflect events since the security was last rated. The Investment Manager or Subadviser, as applicable, does not rely solely on credit ratings when selecting securities for a Fund.
Hybrid Instruments
A hybrid instrument
is a type of potentially high-risk derivative that combines a traditional stock, bond, or commodity with an option or forward contract. Generally, the principal amount, amount payable upon maturity or redemption, or interest rate of a hybrid is tied
(positively or negatively) to the price of some commodity, currency or securities index or another interest rate or some other economic factor (each a benchmark). The interest rate or (unlike most fixed income securities) the principal
amount payable at maturity of a hybrid security may be increased or decreased, depending on changes in the value of the benchmark. An example of a hybrid could be a bond issued by an oil company that pays a small base level of interest with
additional interest that accrues in correlation to the extent to which oil prices exceed a certain predetermined level. Such a hybrid instrument would be a combination of a bond and a call option on oil.
Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management and increased total
return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These
benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be
zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal amount and pays a fixed rate or floating rate of
interest. The purchase of hybrids also exposes a Fund to the credit risk of the issuer of the hybrids. These risks may cause significant fluctuations in the net asset value of a Fund.
Certain hybrid instruments may provide exposure to the commodities markets. These are derivative securities with one or more commodity-linked components that have payment features similar to commodity
futures contracts, commodity options, or similar instruments. Commodity-linked hybrid instruments may be either equity or debt securities, leveraged or unleveraged, and are considered hybrid instruments because they have both security and
commodity-like characteristics. A portion of the value of these instruments may be derived from the value of a commodity, futures contract, index or other economic variable.
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Certain issuers of structured products such as hybrid instruments may be deemed to be investment companies,
as defined in the 1940 Act. As a result, a Funds investments in these products may be subject to limits applicable to investments in investment companies and may be subject to restrictions contained in the 1940 Act.
Structured Notes and Indexed Securities.
Structured notes are derivative debt instruments, the interest rate or principal of which is determined
by an unrelated indicator (for example, a currency, security, commodity or index thereof). The terms of the instrument may be structured by the purchaser and the borrower issuing the note. Indexed securities may include structured notes
as well as securities other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. Indexed securities may include a multiplier that multiplies the indexed element by a specified factor and, therefore,
the value of such securities may be very volatile. The terms of structured notes and indexed securities may provide that in certain circumstances no principal is due at maturity, which may result in a loss of invested capital. Structured notes and
indexed securities may be positively or negatively indexed, so that appreciation of the unrelated indicator may produce an increase or a decrease in the interest rate or the value of the structured note or indexed security at maturity may be
calculated as a specified multiple of the change in the value of the unrelated indicator. Therefore, the value of such notes and securities may be very volatile. Structured notes and indexed securities may entail a greater degree of market risk than
other types of debt securities because the investor bears the risk of the unrelated indicator. Structured notes or indexed securities also may be more volatile, less liquid, and more difficult to accurately price than less complex securities and
instruments or more traditional debt securities.
Illiquid Securities
The Funds may invest in illiquid securities (i.e., securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the
securities).
Illiquid securities 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, others may be illiquid, and their sale may involve substantial delays and
additional costs.
Inflation-Indexed Bonds
The Funds may invest in inflation-indexed bonds, which are debt obligations whose principal value is periodically adjusted according to the rate of inflation. Two structures are common. The U.S. Treasury
and some other issuers utilize a structure that accrues inflation into the principal value of the bond. Many other issuers pay out the Consumer Price Index accruals as part of a semiannual coupon.
Inflation-indexed bonds issued by the U.S. Treasury have maturities of approximately five, ten or thirty years, although it is possible that securities
with other maturities will be issued in the future. The U.S. Treasury securities pay interest on a semi-annual basis equal to a fixed percentage of the inflation-adjusted principal amount. For example, if a Fund purchased an inflation-indexed bond
with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5% semi-annually), and the rate of inflation over the first six months was 1%, the mid-year par value of the bond would be $1,010 and the first semi-annual interest payment
would be $15.15 ($1,010 times 1.5%). If inflation during the second half of the year resulted in the whole years inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and the second semi-annual interest payment would be
$15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal value of inflation-indexed bonds will be
adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in
the case of U.S. Treasury inflation-indexed bonds, even during a period of deflation. However, the current market value of the bonds is not guaranteed and will fluctuate. The Funds may
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also invest in other inflation-related bonds which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at
maturity may be less than the original principal amount.
The value of inflation-indexed bonds is expected to change in response to changes in
real interest rates. Real interest rates in turn are tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if the rate of inflation rises at a faster rate than nominal interest rates, real interest rates might
decline, leading to an increase in value of inflation-indexed bonds. In contrast, if nominal interest rates increase at a faster rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-indexed bonds.
While these securities are expected to provide protection from long-term inflationary trends, short-term increases in inflation may lead to a
decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the
bonds inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer Price Index for Urban
Consumers (CPI-U), which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-indexed
bonds issued by a non-U.S. government are generally adjusted to reflect a comparable inflation index calculated by that government. There can be no assurance that the CPI-U or any non-U.S. inflation index will accurately measure the real rate of
inflation in the prices of goods and services. Moreover, there can be no assurance that the rate of inflation in a non-U.S. country will be correlated to the rate of inflation in the United States.
For federal income tax purposes, any increase in the principal amount of an inflation-indexed bond will be original issue discount which is taxable as
ordinary income in the year accrued, even though investors do not receive their principal, including any increases thereto, until maturity.
Master Limited Partnerships
Certain
companies are organized as master limited partnerships (MLPs) in which ownership interests are publicly traded. MLPs often own several properties or businesses (or directly own interests) that are related to real estate development and
oil and gas industries, but they also may finance motion pictures, research and development and other projects or provide financial services. 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. They are allocated income and capital gains associated with the partnership project in accordance with the terms established in the
partnership agreement.
The risks of investing in an MLP are generally those inherent in investing in a partnership as opposed to a
corporation. For example, state law governing partnerships is often less restrictive than state law governing corporations. Accordingly, there may be fewer protections afforded investors in an MLP than investors in a corporation. Additional risks
involved with investing in an MLP are risks associated with the specific industry or industries in which the partnership invests, such as the risks of investing in real estate, or oil and gas industries. A Funds investments in MLPs can be
limited by the Funds intention to qualify as a RIC.
Mortgage Dollar Rolls
A mortgage dollar roll is similar to a reverse repurchase agreement in certain respects. In a dollar roll transaction, a Fund
sells a mortgage-related security, such as a security issued by GNMA, to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A dollar roll can be
viewed, like a reverse repurchase agreement, as a collateralized borrowing in which a Fund pledges a mortgage-related security to a dealer to obtain cash. However, unlike
35
reverse repurchase agreements, the dealer with which a Fund enters into a dollar roll transaction is not obligated to return the same securities as those originally sold by the Fund, but only
securities which are substantially identical. To be considered substantially identical, the securities returned to the Fund generally must: (1) be collateralized by the same types of underlying mortgages; (2) be
issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market yields (and therefore price); and (6) satisfy good
delivery requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within 2.5% of the initial amount delivered.
Mortgage-Related and Other Asset-Backed Securities
A Fund may invest in mortgage-related
securities, and may also invest in other asset-backed securities (whether or not related to mortgage loans) that are offered to investors currently or in the future. Mortgage-related securities are interests in pools of residential or commercial
mortgage loans, including mortgage loans made by savings and loan institutions, mortgage bankers, commercial banks and others. Pools of mortgage loans are assembled as securities for sale to investors by various governmental, government-related and
private organizations. 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 other debt securities, the ability of the Fund to
successfully utilize these instruments may depend in part upon the ability of the Investment Manager or Subadviser, as applicable, to forecast certain macro-economic factors correctly. See Mortgage Pass-Through Securities below.
Certain debt obligations are also secured with collateral consisting of mortgage-related securities. See Collateralized Mortgage Obligations (CMOs) below.
The mortgage-related securities in which a Fund may invest may pay variable or fixed rates of interest.
Through investments in mortgage-related securities, including those that are issued by private issuers, a Fund may have some exposure to subprime loans as well as to the mortgage and credit markets
generally. Private issuers include commercial banks, savings associations, mortgage companies, investment banking firms, finance companies and special purpose finance entities (called special purpose vehicles or SPVs) and other entities that acquire
and package mortgage loans for resale as mortgage-related securities.
In addition, mortgage-related securities that are issued by private
issuers are not subject to the underwriting requirements for the underlying mortgages that are applicable to those mortgage-related securities that have a government or government-sponsored entity guarantee. As a result, the mortgage loans
underlying private mortgage-related securities may, and frequently do, have less favorable collateral, credit risk or other underwriting characteristics than government or government-sponsored mortgage-related securities and have wider variances in
a number of terms including interest rate, term, size, purpose and borrower characteristics. Privately issued pools more frequently include second mortgages, high loan-to-value mortgages and manufactured housing loans. The coupon rates and
maturities of the underlying mortgage loans in a private-label mortgage-related securities pool may vary to a greater extent than those included in a government guaranteed pool, and the pool may include subprime mortgage loans. Subprime loans refer
to loans made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their loans. For these reasons, the loans underlying these securities have had in many cases higher default rates than those loans that
meet government underwriting requirements.
The risk of non-payment is greater for mortgage-related securities that are backed by mortgage
pools that contain subprime loans, but a level of risk exists for all loans. Market factors adversely affecting mortgage loan repayments may include a general economic turndown, high unemployment, a general slowdown in the real estate market, a drop
in the market prices of real estate, or an increase in interest rates resulting in higher mortgage payments by holders of adjustable rate mortgages.
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Mortgage Pass-Through Securities.
Mortgage pass-through securities are securities representing
interests in pools of mortgage loans secured by residential or commercial real property. Interests in pools of mortgage-related securities differ from other forms of debt obligations, which normally provide for periodic payment of
interest in fixed or variable amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment that consists of both interest and principal payments. In effect, these payments are a
pass-through of the monthly payments made by the individual borrowers on their residential or commercial mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of
principal resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs that may be incurred. Some mortgage-related securities (such as securities issued by the Government National Mortgage Association
(GNMA)) are described as modified pass-through. These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at the scheduled payment dates regardless of
whether or not the mortgagor actually makes the payment.
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 duration of the security relative to what was anticipated at the time of purchase. Early repayment of principal on some mortgage-related securities
(arising from prepayments of principal due to the sale of the underlying property, refinancing, or foreclosure, net of fees and costs that may be incurred) may expose the 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-rate debt obligations, when interest rates rise, the value of a fixed-rate mortgage-related security
generally will decline; however, when interest rates are declining, the value of fixed-rate mortgage-related securities with prepayment features may not increase as much as other debt obligations. Adjustable rate mortgage-related and other
asset-backed securities are also subject to some interest rate risk. For example, because interest rates on most adjustable rate mortgage- and other asset-backed securities only reset periodically (
e.g.
, monthly or quarterly), changes in
prevailing interest rates (and particularly sudden and significant changes) can be expected to cause some fluctuations in the market value of these securities, including declines in value as interest rates rise. In addition, to the extent that
unanticipated rates of prepayment on underlying mortgages increase the effective maturity of a mortgage-related security, the volatility of such security can be expected to increase.
The residential mortgage market in the United States recently has experienced difficulties that may adversely affect the performance and market value of certain of the Funds mortgage-related
investments. Delinquencies and losses on residential mortgage loans (especially subprime and second-lien mortgage loans) generally have increased recently and may continue to increase, and a decline in or flattening of housing values (as has
recently been experienced and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their
monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have recently experienced serious financial difficulties or bankruptcy. Owing
largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely
affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
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 (FNMA) or the Federal Home Loan Mortgage
Corporation (FHLMC)). The principal governmental guarantor of mortgage-related securities is GNMA. GNMA is a wholly-owned U.S. Government corporation within the Department of Housing and
37
Urban Development. GNMA is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by institutions
approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of mortgages insured by the Federal Housing Administration (the FHA), or guaranteed by the Department of Veterans Affairs
(the VA).
Government-related guarantors (
i.e.
, not backed by the full faith and credit of the U.S. Government) include the
FNMA and the FHLMC. FNMA was, until recently, a government-sponsored corporation owned entirely by private stockholders and subject to general regulation by the Department of Housing and Urban Development and the Office of Federal Housing Enterprise
Oversight. FNMA is now under conservatorship by the Federal Housing Finance Agency (FHFA). FNMA primarily purchases conventional (
i.e.
, not insured or guaranteed by any government agency) residential mortgages from a list of
approved seller/servicers, which includes state and federally chartered savings and loan associations, mutual savings banks, commercial banks, and credit unions and mortgage bankers, although it may purchase other types of mortgages as well.
Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA but are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of
the U.S. Government to purchase the agencys obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It was, until recently, a government-sponsored corporation formerly owned by the twelve Federal Home Loan Banks and then owned entirely by private stockholders. FHLMC is now under
conservatorship by the FHFA. FHLMC issues Participation Certificates (PCs) which represent interests in conventional mortgages from FHLMCs national portfolio. FHLMC guarantees the timely payment of interest and ultimate collection
of principal, but PCs are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agencys obligations.
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.
FNMA and FHLMC are dependent upon the continued support of the U.S. Treasury
and the FHFA in order to continue operating their businesses.
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 Senior Preferred Stock Purchase Agreement is 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.
38
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 therefore. The future financial performance of Fannie Mae and Freddie Mac is heavily dependent on the performance of the U.S. housing market.
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. 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.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create pass-through pools of conventional residential mortgage loans. Such issuers may, in addition, be the originators and/or servicers of the underlying mortgage loans as well as
the guarantors of the mortgage-related securities. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government or agency
guarantees of payments in such pools. However, timely payment of interest and principal of these pools may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit.
The insurance and guarantees are issued by governmental entities, private insurers and the mortgage poolers. There can be no assurance that the private insurers or guarantors can meet their obligations under the insurance policies or guarantee
arrangements. The Funds may buy mortgage-related securities without insurance or guarantees. Securities issued by certain private organizations may not be readily marketable.
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Mortgage-related securities that are issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, are not subject to the Funds industry concentration restriction (see Investment Restrictions) by virtue of the exclusion from that restriction available to all U.S. Government securities. The assets underlying
such securities may be represented by a portfolio of first lien residential mortgages (including both whole mortgage loans and mortgage participation interests) or portfolios of mortgage pass-through securities issued or guaranteed by GNMA, FNMA or
FHLMC. Mortgage loans underlying a mortgage-related security may in turn be insured or guaranteed by the FHA or the VA. In the case of private issue mortgage-related securities whose underlying assets are neither U.S. Government securities nor U.S.
Government insured mortgages, to the extent that real properties securing such assets may be located in the same geographical region, the security may be subject to a greater risk of default than other comparable securities in the event of adverse
economic, political or business developments that may affect such region and, ultimately, the ability of residential homeowners to make payments of principal and interest on the underlying mortgages.
Collateralized Mortgage Obligations (CMOs).
A CMO is a hybrid between a mortgage-backed bond and a mortgage pass-through security.
Similar to a bond, interest and prepaid principal is paid, in most cases, semi-annually or 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, and their income streams.
CMOs are structured into multiple classes, often referred to as
tranches, with each class bearing a different stated maturity and entitled to a different schedule for payments of principal and interest, including prepayments. Actual maturity and average life will depend upon the prepayment experience
of the collateral. CMOs provide for a modified form of call protection through a de facto breakdown of the underlying pool of mortgages according to how quickly the loans are repaid. Monthly payment of principal received from the pool of underlying
mortgages, including prepayments, is first returned to investors holding the shortest maturity class. Investors holding the longer maturity classes receive principal only after the first class has been retired. An investor is partially guarded
against a sooner than desired return of principal because of the sequential payments.
In a typical CMO transaction, a corporation
(issuer) issues multiple series (
e.g.
, A, B, C, Z) of CMO bonds (the Bonds). Proceeds of the Bond offering are used to purchase mortgages or mortgage pass-through certificates (the Collateral). The
Collateral is pledged to a third party trustee as security for the Bonds. Principal and interest payments from the Collateral are used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B and C Bonds all bear current interest.
Interest on the Series Z Bond is accrued and added to principal and a like amount is paid as principal on the Series A, B or C Bond currently being paid off. When the Series A, B and C Bonds are paid in full, interest and principal on the Series Z
Bond begin to be paid currently. With some CMOs, the issuer serves as a conduit to allow loan originators (primarily builders or savings and loan associations) to borrow against their loan portfolios. CMOs may be less liquid and may exhibit greater
price volatility than other types of mortgageor asset-backed securities.
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 the Funds diversification tests.
FHLMC Collateralized Mortgage Obligations.
FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are secured by the pledge of a pool of conventional mortgage loans purchased by FHLMC. Payments of principal and interest on the CMOs are made semi-annually, as opposed to
monthly. The amount of principal payable on each semi-annual payment date is determined in accordance with FHLMCs mandatory sinking fund schedule, which in turn, is equal to approximately 100% of FHA prepayment experience applied to the
mortgage collateral pool. All sinking fund payments in the CMOs are allocated to the retirement of the individual classes of bonds in the order of their stated maturities. Payments of principal on the mortgage loans in the collateral pool in excess
of the amount of FHLMCs minimum sinking fund obligation for any payment date are paid to the holders of the CMOs as additional sinking fund payments.
40
Because of the pass-through nature of all principal payments received on the collateral pool in excess of FHLMCs minimum sinking fund requirement, the rate at which principal of
the CMOs is actually repaid is likely to be such that each class of bonds will be retired in advance of its scheduled maturity date.
If
collection of principal (including prepayments) on the mortgage loans during any semi-annual payment period is not sufficient to meet FHLMCs minimum sinking fund obligation on the next sinking fund payment date, FHLMC agrees to make up the
deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are identical to those of FHLMC PCs.
FHLMC has the right to substitute collateral in the event of delinquencies and/or defaults.
Commercial Mortgage-Backed Securities.
Commercial mortgage-backed securities include securities that reflect an interest in, and are secured by, mortgage loans on commercial real property. 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- or asset-backed securities.
CMO Residuals.
CMO residuals are mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings
and loan associations, homebuilders, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
The
cash flow generated by the mortgage assets underlying a series of CMOs is applied first to make required payments of principal and interest on the CMOs and second to pay the related administrative expenses of the issuer. The residual in a CMO
structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related CMO residual represents income and/or a return of capital. The amount
of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the prepayment
experience on the mortgage assets. In particular, the yield to maturity on CMO residuals is extremely sensitive to prepayments on the related underlying mortgage assets. In addition, if a series of a CMO includes a class that bears interest at an
adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. A Fund may fail to recoup some or all of its initial investment
in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors through several investment banking firms acting
as brokers or dealers. The CMO residual market has developed fairly recently and CMO residuals currently may not have the liquidity of other more established securities trading in other markets. CMO residuals may, or pursuant to an exemption
therefrom, may not, have been registered under the Securities Act of 1933, as amended (the 1933 Act). CMO residuals, whether or not registered under the 1933 Act, may be subject to certain restrictions on transferability, and may be
deemed illiquid. As used in this Statement of Additional Information, the term CMO residual does not include residual interests in real estate mortgage investment conduits.
Adjustable Rate Mortgage Backed Securities.
Adjustable rate mortgage-backed securities (ARMBSs) have interest rates that reset at periodic intervals. Acquiring ARMBSs permits the Fund
to participate in increases in prevailing current interest rates through periodic adjustments in the coupons of mortgages underlying the pool on which ARMBSs are based. Such ARMBSs generally have higher current yield and lower price fluctuations
than is the case with more traditional fixed income debt securities of comparable rating and maturity. In addition, when prepayments of principal are made on the underlying mortgages during periods of rising interest rates, the Fund can reinvest the
proceeds of such prepayments at rates higher than those at which they were previously
41
invested. Mortgages underlying most ARMBSs, however, have limits on the allowable annual or lifetime increases that can be made in the interest rate that the mortgagor pays. Therefore, if current
interest rates rise above such limits over the period of the limitation, the Fund if holding an ARMBS does not benefit from further increases in interest rates. Moreover, when interest rates are in excess of coupon rates (
i.e.
, the rates
being paid by mortgagors) of the mortgages, ARMBSs behave more like fixed income securities and less like adjustable rate securities and are subject to the risks associated with fixed income securities. In addition, during periods of rising interest
rates, increases in the coupon rate of adjustable rate mortgages generally lag current market interest rates slightly, thereby creating the potential for capital depreciation on such securities.
Stripped Mortgage-Backed Securities
. SMBS are derivative multi-class mortgage securities. SMBS may be issued by agencies or instrumentalities of
the U.S. Government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets.
A common type of SMBS will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one
class will receive all of the interest (the 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 pre-payments) 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 pre-payments of principal, a Fund may fail to recoup some or all of its initial investment in these securities even if the security is in one of the highest rating categories.
Other Mortgage-Related Securities.
Other 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, including CMO residuals and stripped mortgage-backed securities. Other mortgage-related securities may be equity or debt securities issued
by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks, partnerships,
trusts and special purpose entities of the foregoing.
Asset-Backed Securities.
A Fund may invest in, or have exposure to, asset-backed
securities, which are securities that represent a participation in, or are secured by and payable from, a stream of payments generated by particular assets, most often a pool or pools of similar assets (
e.g.
, trade receivables). The credit
quality of these securities depends primarily upon the quality of the underlying assets and the level of credit support and/or enhancement provided.
The underlying assets (
e.g.
, loans) are subject to prepayments which shorten the securities weighted average maturity and may lower their return. If the credit support or enhancement is
exhausted, losses or delays in payment may result if the required payments of principal and interest are not made. The value of these securities also may change because of changes in the markets perception of the creditworthiness of the
servicing agent for the pool, the originator of the pool, or the financial institution or trust providing the credit support or enhancement. Typically, there is no perfected security interest in the collateral that relates to the financial assets
that support asset-backed securities. Asset-backed securities have many of the same characteristics and risks as the mortgage backed securities described above.
A Fund may purchase or have exposure to commercial paper, including asset-backed commercial paper (ABCP), that is issued by structured investment vehicles or other conduits. These conduits may
be sponsored by mortgage companies, investment banking firms, finance companies, hedge funds, private equity firms and special purpose finance entities. ABCP typically refers to a short-term debt security, the payment of which is supported by cash
flows from underlying assets, or one or more liquidity or credit support providers, or both.
42
Assets backing ABCP include credit card, car loan and other consumer receivables and home or commercial mortgages, including subprime mortgages. The repayment of ABCP issued by a conduit depends
primarily on the cash collections received from the conduits underlying asset portfolio and the conduits ability to issue new ABCP. Therefore, there could be losses to a Fund if investing in ABCP in the event of credit or market value
deterioration in the conduits underlying portfolio, mismatches in the timing of the cash flows of the underlying asset interests and the repayment obligations of maturing ABCP, or the conduits inability to issue new ABCP. To protect
investors from these risks, ABCP programs may be structured with various protections, such as credit enhancement, liquidity support, and commercial paper stop-issuance and wind-down triggers. However there can be no guarantee that these protections
will be sufficient to prevent losses to investors in ABCP. Some ABCP programs provide for an extension of the maturity date of the ABCP if, on the related maturity date, the conduit is unable to access sufficient liquidity through the issue of
additional ABCP. This may delay the sale of the underlying collateral and the Fund may incur a loss if the value of the collateral deteriorates during the extension period. Alternatively, if collateral for ABCP deteriorates in value, the collateral
may be required to be sold at inopportune times or at prices insufficient to repay the principal and interest on the ABCP. ABCP programs may provide for the issuance of subordinated notes as an additional form of credit enhancement. The subordinated
notes are typically of a lower credit quality and have a higher risk of default. To the extent a Fund purchases these subordinated notes, it will have a higher likelihood of loss than investors in the senior notes.
Collateralized Debt Obligations.
A Fund may invest in Collateralized Debt Obligations (CDOs), which include collateralized bond
obligations (CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. CBOs and CLOs are types of asset-backed securities. A CBO is a trust which is backed by a diversified pool of high risk,
below investment grade fixed income securities. A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans,
including loans that may be rated below investment grade or equivalent unrated loans. CDOs may charge management fees and administrative expenses. The cash flows from the CDO trust are generally split into two or more portions, called tranches,
varying in risk and yield. Senior tranches are paid from the cash flows from the underlying assets before the junior tranches and equity or first loss tranches. Losses are first borne by the equity tranches, next by the junior tranches,
and finally by the senior tranches. Senior tranches pay the lowest interest rates but are generally safer investments than more junior tranches because, should there be any default, senior tranches are typically paid first. The most junior tranches,
such as equity tranches, would attract the highest interest rates but suffer the highest risk should the holder of an underlying loan default. If some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those
in the lowest, most junior tranches suffer losses first. Since it is partially protected from defaults, a senior tranche from a CDO trust typically has higher ratings and lower yields than the underlying securities, and can be rated investment
grade. Despite the protection from the equity tranche, more senior CDO tranches can experience substantial losses due to actual defaults, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market
anticipation of defaults and aversion to CDO securities as a class. Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash), which involves continued
exposure to default risk with respect to such payments.
The risks of an investment in a CDO depend largely on the type of the collateral
securities and the class of the CDO in which the Fund invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus, are not registered under the securities laws. As a result, investments in CDOs may be characterized by the
Fund as illiquid securities; however, an active dealer market may exist for CDOs allowing a CDO to qualify for Rule 144A transactions. In addition to the normal risks associated with debt instruments discussed elsewhere in this SAI and the
Prospectus (
e.g.
, interest rate risk and default risk), CDOs carry additional risks that include, but are not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other
payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization (NRSRO); (iii) a Fund may invest in tranches of CDOs that are
subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment
43
return achieved by a Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) risk of forced
fire sale liquidation due to technical defaults such as coverage test failures; and (viii) the CDOs manager may perform poorly.
Other Asset-Backed Securities.
Other asset-backed securities (unrelated to mortgage loans) will be offered to investors in the future and may be purchased by a Fund, including Enhanced Equipment
Trust Certificates (EETCs) and Certificates for Automobile Receivables (CARS).
Although any entity may issue EETCs,
to date, U.S. airlines are the primary issuers. An airline EETC is an obligation secured directly by aircraft or aircraft engines as collateral. Airline EETCs generally have credit enhancement in the form of over-collateralization and
cross-subordination (
i.e.
, multiple tranches and multiple aircraft as collateral). They also generally have a dedicated liquidity facility provided by a third-party insurer to insure that coupon payments are made on a timely basis until
collateral is liquidated in the event of a default by the lessor of the collateral. Aircraft EETCs issued by registered U.S. carriers also benefit from a special section of the U.S. Bankruptcy Code, which allows the aircraft to be sold by the trust
holding the collateral to repay note holders without participating in bankruptcy proceedings. EETCs tend to be less liquid than bonds.
CARS
represent undivided fractional interests in a trust whose assets consist of a pool of motor vehicle retail installment sales contracts and security interests in the vehicles securing the contracts. Payments of principal and interest on CARS are
passed through monthly to certificate holders, and are guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution unaffiliated with the trustee or originator of the trust. An
investors return on CARS may be affected by early prepayment of principal on the underlying vehicle sales contracts. If the letter of credit is exhausted, the trust may be prevented from realizing the full amount due on a sales contract
because of state law requirements and restrictions relating to foreclosure sales of vehicles and the obtaining of deficiency judgments following such sales or because of depreciation, damage or loss of a vehicle, the application of federal and state
bankruptcy and insolvency laws, or other factors. As a result, certificate holders may experience delays in payments or losses if the letter of credit is exhausted.
Consistent with a Funds investment objective and policies, the Investment Manager or Subadviser, as applicable, also may invest in other types of asset-backed securities. Other asset-backed
securities may be collateralized by the fees earned by service providers. The value of asset-backed securities may be substantially dependent on the servicing of the underlying asset pools and are therefore subject to risks associated with the
negligence by, or defalcation of, their servicers. In certain circumstances, the mishandling of related documentation may also affect the rights of the security holders in and to the underlying collateral. The insolvency of entities that generate
receivables or that utilize the assets may result in added costs and delays in addition to losses associated with a decline in the value of the underlying assets.
Investors should note that Congress from time to time may consider actions that would limit or remove the explicit or implicit guarantee of the payment of principal and/or interest on many types of
asset-backed securities. Any such action would likely adversely impact the value of such securities.
Municipal Bonds
The Funds may invest in municipal bonds which pay interest that, in the opinion of bond counsel to the issuer (or on the basis of other authority believed
by the Investment Manager or Subadviser, as applicable, to be reliable), is exempt from federal income taxes (municipal bonds), although dividends that the Funds pay that are attributable to such interest will not be tax-exempt to
shareholders of the Funds.
Municipal bonds share the attributes of debt obligations in general, but are generally issued by states,
municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies or authorities. The municipal bonds that a Fund may purchase include general obligation bonds and limited obligation
bonds (or revenue bonds), including industrial development bonds issued pursuant to former federal tax law. General obligation bonds are obligations involving the credit of an issuer possessing
44
taxing power and are payable from such issuers general revenues and not from any particular source. Limited obligation bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Tax-exempt private activity bonds and industrial development bonds generally are also revenue bonds and thus are not payable
from the issuers general revenues. The credit and quality of private activity bonds and industrial development bonds are usually related to the credit of the user of the facilities. Payment of interest on and repayment of principal of such
bonds is the responsibility of the user (and/or any guarantor).
Municipal bonds are subject to credit and market risk. Generally, prices of
higher quality issues tend to fluctuate less with changes in market interest rates than prices of lower quality issues and prices of longer maturity issues tend to fluctuate more than prices of shorter maturity issues. Prices and yields on municipal
bonds are dependent on a variety of factors, including general money-market conditions, the financial condition of the issuer, general conditions of the municipal bond market, the size of a particular offering, the maturity of the obligation and the
rating of the issue. A number of these factors, including the ratings of particular issues, are subject to change from time to time. Information about the financial condition of an issuer of municipal bonds may not be as extensive as that which is
made available by corporations whose securities are publicly traded. Obligations of issuers of municipal bonds are subject to the provisions of bankruptcy, insolvency and other laws, such as the Federal Bankruptcy Reform Act of 1978, affecting the
rights and remedies of creditors. Congress or state legislatures may seek to extend the time for payment of principal or interest, or both, or to impose other constraints upon enforcement of such obligations. There is also the possibility that as a
result of litigation or other conditions, the power or ability of issuers to meet their obligations for the payment of interest and principal on their municipal bonds may be materially affected or their obligations may be found to be invalid or
unenforceable.
A Fund may also invest in residual interest municipal bonds (RIBS) whose interest rates bear an inverse
relationship to the interest rate on another security or the value of an index. RIBS are created by dividing the income stream provided by the underlying bonds to create two securities, one short-term and one long-term. The interest rate on the
short-term component is reset by an index or auction process normally every seven to 35 days. After income is paid on the short-term securities at current rates, the residual income from the underlying bond(s) goes to the long-term securities.
Therefore, rising short-term interest rates result in lower income for the longer-term portion, and vice versa. The longer-term bonds can be very volatile and may be less liquid than other municipal bonds of comparable maturity. An investment in
RIBS typically will involve greater risk than an investment in a fixed rate bond. Because increases in the interest rate on the other security or index reduce the residual interest paid on a RIB, the value of a RIB is generally more volatile than
that of a fixed rate bond. RIBS have interest rate adjustment formulas that generally reduce or, in the extreme, eliminate the interest paid to the Fund when short-term interest rates rise, and increase the interest paid to the Fund when short-term
interest rates fall. RIBS have varying degrees of liquidity that approximate the liquidity of the underlying bond(s), and the market price for these securities is volatile. These securities generally will underperform the market of fixed rate bonds
in a rising interest rate environment, but tend to outperform the market of fixed rate bonds when interest rates decline or remain relatively stable. Although volatile, RIBS typically offer the potential for yields exceeding the yields available on
fixed rate bonds with comparable credit quality, coupon, call provisions and maturity. A Fund may also invest in RIBS for the purpose of increasing such Funds leverage. Should short-term and long-term interest rates rise, the combination of a
Funds investment in RIBS and its use of other forms of leverage (including the use of various derivative instruments) likely will adversely affect the Funds net asset value per share and income, distributions and total returns to
shareholders. Trusts in which RIBS may be held could be terminated, in which case the residual bond holder would take possession of the underlying bond(s) on an unleveraged basis.
Municipal Leases
The Funds may acquire participations in lease obligations or installment
purchase contract obligations (collectively, lease obligations) of municipal authorities or entities. Lease obligations do not constitute general obligations of the municipality for which the municipalitys taxing power is pledged.
Certain of these lease
45
obligations contain non-appropriation clauses, which provide that the municipality has no obligation to make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. In the case of a non-appropriation lease, a Funds ability to recover under the lease in the event of non-appropriation or default will be limited solely to the repossession of the
leased property, and in any event, foreclosure of that property might prove difficult.
Other Investment Companies and Pooled Investment
Vehicles
The Funds may invest in securities of open- or closed-end investment companies, including exchange-traded funds
(ETFs). The Funds may also invest in other types of investment companies and pooled investment vehicles, including hedge and private equity funds, some of which may be highly leveraged and investments in which may be illiquid.
The Funds may invest in other investment companies either during periods when they have large amounts of uninvested cash, during periods when
there is a shortage of attractive variable rate and other debt instruments available in the market, or when the Investment Manager or Subadviser, as applicable, believes share prices of other investment companies offer attractive values. The Funds
may invest in investment companies that are advised by the Investment Manager or Subadviser, as applicable, or its affiliates to the extent permitted by applicable law and/or pursuant to exemptive relief from the SEC.
As a shareholder in an investment company, the Funds will bear their ratable share of that investment companys expenses and would remain subject to
payment of the Funds management fees with respect to assets so invested. Holders of a Funds Shares would therefore be subject to duplicative expenses to the extent such Fund invests in other investment companies. In addition, the
securities of other investment companies may also be leveraged and will therefore be subject to the same leverage risks described in the Prospectus and herein. The net asset value and market value of leveraged shares will be more volatile and the
yield to shareholders will tend to fluctuate more than the yield generated by unleveraged shares.
The Investment Manager or Subadviser, as
applicable, may cause each Fund to invest in vehicles established for the purpose of investing, holding or trading in one or more investments or classes of investments if the Investment Manager or Subadviser, as applicable, considers that investing
in such vehicles would be more efficient or required for legal, tax or regulatory reasons or would otherwise be to the advantage of the Fund. Such vehicles would be funded by way of debt and/or equity investment from the Fund and, subject to
other applicable laws, other persons (if any), including collective investment schemes or accounts managed by the Investment Manager or Subadviser, as applicable. In such instances, the vehicles may be domiciled in one country (e.g., Cayman
Islands) and make investments in other countries (e.g., Brazil and Russia). For purposes of applying a Funds investment restrictions, any such investment would generally be treated as an investment in the Funds relevant percentage of the
underlying holdings of the vehicle and not the vehicle itself (e.g., as an investment in Brazil and Russia, not the Cayman Islands).
Participation on Creditors Committees
The Funds may from time to time participate on committees formed by creditors to negotiate with the management of financially troubled issuers of
securities held by a Fund. Such participation may subject a Fund to expenses such as legal fees and may make such Fund an insider of the issuer for purposes of the federal securities laws, and therefore may restrict the Funds
ability to trade in or acquire additional positions in a particular security when it might otherwise desire to do so. Participation by a Fund on such committees also may expose the Fund to potential liabilities under the federal bankruptcy laws or
other laws governing the rights of creditors and debtors. A Fund would participate on such committees only when the Investment Manager or Subadviser, as applicable, believes that such participation is necessary or desirable to enforce the
Funds rights as a creditor or to protect the value of securities held by the Fund.
46
Participation Notes
The Funds may buy participation notes from a bank or broker-dealer (issuer) that entitle a Fund to a return measured by the change in value of an identified underlying security or basket of
securities (collectively, the underlying security). Participation notes are typically used when a direct investment in the underlying security is restricted due to country-specific regulations.
A Fund is subject to counterparty risk associated with each issuer. Investment in a participation note is not the same as investment in the constituent
shares of the company. A participation note represents only an obligation of the issuer to provide a Fund the economic performance equivalent to holding shares of an underlying security. A participation note does not provide any beneficial or
equitable entitlement or interest in the relevant underlying security. In other words, shares of the underlying security are not in any way owned by the Fund.
However each participation note synthetically replicates the economic benefit of holding shares in the underlying security. Because a participation note is an obligation of the issuer, rather than a
direct investment in shares of the underlying security, a Fund may suffer losses potentially equal to the full value of the participation note if the issuer fails to perform its obligations. The Funds generally attempt to mitigate that risk by
purchasing only from issuers which the Investment Manager or Subadviser, as applicable, deems to be creditworthy at the time of purchase.
The
counterparty may, but is not required to, purchase the shares of the underlying security to hedge its obligation. The Funds may, but are not required to, purchase credit protection against the default of the issuer. When the participation note
expires or a Fund exercises the participation note and closes its position, that Fund receives a payment that is based upon the then-current value of the underlying security converted into U.S. dollars (less transaction costs).
Due to liquidity and transfer restrictions, the secondary markets on which participation notes are traded may be less liquid than the markets for other
securities, which may lead to the absence of readily available market quotations for the notes and may cause the value of the participation notes to decline. The ability of a Fund to value its securities becomes more difficult and the Investment
Managers or Subadvisers, as applicable, judgment in the application of fair value procedures (through fair value procedures adopted by the Trustees) may play a greater role in the valuation of the Funds securities due to reduced
availability of reliable objective pricing data. Consequently, while such determinations will be made in good faith, it may nevertheless be more difficult for a Fund to accurately assign a daily value to such securities.
Preferred Stock
Preferred stock
represents an equity interest in a company that generally entitles the holder to receive, in preference to the holders of other stocks such as common stocks, dividends and a fixed share of the proceeds resulting from a liquidation of the company.
Some preferred stocks also entitle their holders to receive additional liquidation proceeds on the same basis as holders of a companys common stock, and thus also represent an ownership interest in that company. A Fund may invest in preferred
stocks that pay variable or fixed rates of return. The value of a companys preferred stock may fall as a result of factors relating directly to that companys products or services. A preferred stocks value may also fall because of
factors affecting not just the company, but companies in the same industry or in a number of different industries, such as increases in production costs. The value of preferred stock may also be affected by changes in financial markets that are
relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a companys preferred stock generally pays dividends only after the company makes required payments to holders of
its bonds and other debt. For this reason, the value of the preferred stock will usually react more strongly than bonds and other debt to actual or perceived changes in the companys financial condition or prospects. Preferred stocks of smaller
companies may be more vulnerable to adverse developments than those of larger companies.
Adjustable Rate and Auction Preferred Stocks.
Typically, the dividend rate on an adjustable rate preferred stock is determined prospectively each quarter by applying an adjustment formula established at the time of issuance of
47
the stock. Although adjustment formulas vary among issues, they typically involve a fixed premium or discount relative to rates on specified debt securities issued by the U.S. Treasury.
Typically, an adjustment formula will provide for a fixed premium or discount adjustment relative to the highest base yield of three specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year Treasury note and the 20-year
Treasury bond. The premium or discount adjustment to be added to or subtracted from this highest U.S. Treasury base rate yield is fixed at the time of issue and cannot be changed without the approval of the holders of the stock. The dividend rate on
other preferred stocks in which the Fund may invest, commonly known as auction preferred stocks, is adjusted at intervals that may be more frequent than quarterly, such as every 49 days, based on bids submitted by holders and prospective purchasers
of such stocks and may be subject to stated maximum and minimum dividend rates. The issues of most adjustable rate and auction preferred stocks currently outstanding are perpetual, but are redeemable after a specified date at the option of the
issuer.
Certain issues supported by the credit of a high-rated financial institution provide for mandatory redemption prior to expiration of
the credit arrangement. No redemption can occur if full cumulative dividends are not paid. Although the dividend rates on adjustable and auction preferred stocks are generally adjusted or reset frequently, the market values of these preferred stocks
may still fluctuate in response to changes in interest rates. Market values of adjustable preferred stocks also may substantially fluctuate if interest rates increase or decrease once the maximum or minimum dividend rate for a particular stock is
approached. Auctions for U.S. auction preferred stocks have failed since early 2008, and the dividend rates payable on such preferred shares since that time typically have been paid at their maximum applicable rate (typically a function of a
reference rate of interest). The Funds cannot predict whether or when the auction markets for auction preferred stocks may resume normal functioning.
Fixed Rate Preferred Stocks.
Some fixed rate preferred stocks in which the Funds may invest, known as perpetual preferred stocks, offer a fixed return with no maturity date. Because they never
mature, perpetual preferred stocks act like long-term bonds, can be more volatile than other types of preferred stocks that have a maturity date and may have heightened sensitivity to changes in interest rates. The Funds may also invest in sinking
fund preferred stocks. These preferred stocks also offer a fixed return, but have a maturity date and are retired or redeemed on a predetermined schedule. The shorter duration of sinking fund preferred stocks makes them perform somewhat like
intermediate-term bonds and they typically have lower yields than perpetual preferred stocks.
Real Estate Securities and Related
Derivatives
A Fund may gain exposure to the real estate sector by investing in real estate-linked derivatives, real estate investment
trusts (REITs) and common, preferred and convertible securities of issuers in real estate-related industries. Each of these types of investments is subject to risks similar to those associated with direct ownership of real estate,
including loss to casualty or condemnation, increases in property taxes and operating expenses, zoning law amendments, changes in interest rates, overbuilding and increased competition, variations in market value and possible environmental
liabilities.
REITs are pooled investment vehicles that own, and typically operate, income-producing real estate. If a REIT meets certain
requirements, including distributing to shareholders annually substantially all of its taxable income (other than net capital gains), then it is not taxed on the income distributed to shareholders. REITs are subject to management fees and other
expenses, and so the Fund would bear its proportionate share of the costs of the REITs operations.
There are three general categories
of REITs: equity REITs, mortgage REITs and hybrid REITs. Equity REITs invest primarily in direct fee ownership or leasehold ownership of real property; they derive most of their income from rents. Mortgage REITs invest mostly in mortgages on real
estate, which may secure construction, development or long-term loans, and the main source of their income is mortgage interest payments. Hybrid REITs hold both ownership and mortgage interests in real estate.
48
Along with the risks common to different types of real estate-related securities, REITs, no matter the type,
involve additional risk factors. These include poor performance by the REITs manager, changes to the tax laws, and failure by the REIT to qualify for tax-free distribution of income or exemption under the 1940 Act. Furthermore, REITs are not
diversified and are heavily dependent on cash flow.
Repurchase Agreements
The Funds may enter into repurchase agreements with banks or registered broker/dealers. A repurchase agreement is a contract under which a Fund would acquire a security for a relatively short period
subject to the obligation of the seller to repurchase and the Fund to resell such security at a fixed time and price (representing the Funds cost plus interest). A Fund bears a risk of loss in the event that the other party to a repurchase
agreement defaults on its obligations and such Fund is delayed or prevented from exercising its rights to dispose of the collateral securities. This risk includes the risk of procedural costs or delays in addition to a loss on the securities if
their value should fall below their repurchase price. The Investment Manager or Subadviser, as applicable, will monitor the creditworthiness of the counterparties.
Reverse Repurchase Agreements
The Funds may use reverse repurchase agreements (and may use
economically similar transactions) in order to add leverage to their portfolio. A reverse repurchase agreement involves the sale of a portfolio-eligible security by a Fund, coupled with its agreement to repurchase the instrument at a specified time
and price. Under a reverse repurchase agreement, a Fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Reverse repurchase agreements involve leverage risk and the risk that the
market value of securities retained by a Fund may decline below the repurchase price of the securities sold by the Fund which it is obligated to repurchase. A Fund will generally segregate (or earmark on its records) liquid assets equal
(on a daily mark-to-market basis) to its obligations under reverse repurchase agreements.
The Funds also may effect simultaneous purchase and
sale transactions that are known as sale-buybacks. A sale-buyback is similar to a reverse repurchase agreement, except that in a sale-buyback, the counterparty who purchases the security is entitled to receive any principal or interest
payments made on the underlying security pending settlement of a Funds repurchase of the underlying security.
Securities Loans
Subject to the Funds Investment Restrictions listed below, the Funds may make secured loans of their portfolio
securities to brokers, dealers and other financial institutions amounting to no more than one-third of each Funds total assets. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delay in
recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. Securities loans are made to broker-dealers pursuant to agreements requiring that loans be continuously secured by collateral consisting of
U.S. Government securities, cash or cash equivalents (negotiable certificates of deposit, bankers acceptances or letters of credit) maintained on a daily mark-to-market basis in an amount at least equal at all times to the market value of the
securities lent. The borrower pays to a Fund, as the lender, an amount equal to any dividends or interest received on the securities lent.
A
Fund may invest the cash collateral received in interest-bearing, short-term securities or receive a fee from the borrower. In the case of cash collateral, a Fund typically pays a rebate to the lender. Although voting rights or rights to consent
with respect to the loaned securities pass to the borrower, the Fund, as the lender, retains the right to call the loans and obtain the return of the securities loaned at any time on reasonable notice, and it will do so in order that the securities
may be voted by the Fund if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. A Fund may also call such loans in order to sell the securities involved. When engaged in securities
lending, a Funds performance will continue to reflect changes in the value of the securities loaned and will also reflect the receipt of either interest, through investment of cash collateral by the Fund in permissible investments, or a fee,
if the collateral is U.S. Government securities.
49
Short Sales
The Funds may make short sales of securities as part of its overall portfolio management strategies involving the use of derivative instruments 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, it generally borrows the security sold short and delivers 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. A 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 that a 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.
To the extent 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) maintain additional asset coverage in the
form of segregated or earmarked liquid assets equal to the current market value of the securities sold short, or may ensure that such positions are covered by offsetting positions, until the Fund replaces the borrowed
security. A short sale is against the box to the extent that a Fund contemporaneously owns, or has the right to obtain at no added cost, securities identical to those sold short. A Fund will engage in short selling to the extent
permitted by the federal securities laws and rules and interpretations thereunder. To the extent a Fund engages in short selling in foreign (non-U.S.) jurisdictions, the Fund will do so to the extent permitted by the laws and regulations of such
jurisdiction.
As of the date of this Statement of Additional Information, the Funds do not expect to utilize short sales, but may do so
without providing prior notice.
Temporary Defensive Strategies
As described in the Prospectus, the Investment Manager or Subadviser, as applicable, may at times judge that conditions in the securities markets make pursuing a Funds basic investment strategies
inconsistent with the best interests of its shareholders and may temporarily use alternate investment strategies primarily designed to reduce fluctuations in the value of the Funds assets. In implementing these defensive
strategies, a Fund would invest in investment grade debt securities, cash, or money market instruments to any extent the Investment Manager or Subadviser, as applicable, considers consistent with such defensive strategies. It is impossible to
predict when, or for how long, a Fund will use these alternate strategies, and the Fund is not required to use alternate strategies in any case. One risk of taking such temporary defensive positions is that the Fund may not achieve its investment
objective.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities. The U.S. Government does not guarantee the net asset value of the Funds
shares. Some U.S. Government securities, such as Treasury bills, notes and bonds, floating rate notes, and securities guaranteed by the GNMA, are supported by the full faith and credit of the United States; others, such as those of the Federal
Home Loan Banks, are supported by the right of the issuer to borrow from the U.S. Treasury; others, such as those of the FNMA, are supported by the discretionary authority of the U.S. Government to purchase the agencys obligations; and still
others, such as those of the Student Loan Marketing Association, are supported only by the credit of the instrumentality.
U.S.
Government securities include securities that have no coupons, or have been stripped of their unmatured interest coupons, individual interest coupons from such securities that trade separately, and evidences of receipt of such securities. Such
securities may pay no cash income, and are purchased at a deep discount from their value
50
at maturity. See Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities. Custodial receipts issued in connection with so-called trademark zero-coupon securities, such as CATs and
TIGRs, are not issued by the U.S. Treasury, and are therefore not U.S. Government securities, although the underlying bond represented by such receipt is a debt obligation of the U.S. Treasury. Other zero-coupon Treasury securities
(
e.g.
, STRIPs and CUBEs) are direct obligations of the U.S. Government.
Warrants to Purchase Securities
A Fund may invest in warrants to purchase equity or debt securities. Bonds issued with warrants attached to purchase equity securities have many
characteristics of convertible bonds and their prices may, to some degree, reflect the performance of the underlying stock. Bonds also may be issued with warrants attached to purchase additional fixed income securities at the same coupon rate. A
decline in interest rates would permit the Fund to buy additional bonds at the favorable rate or to sell the warrants at a profit. If interest rates rise, the warrants would generally expire with no value.
A Fund may also invest in equity-linked warrants. The Fund purchases the equity-linked warrants from a broker, who in turn is expected to purchase shares
in the local market and issue a call warrant hedged on the underlying holding. If the Fund exercises its call and closes its position, the shares are expected to be sold and the warrant redeemed with the proceeds. Each warrant represents one share
of the underlying stock. Therefore, the price, performance and liquidity of the warrant are all directly linked to the underlying stock, less transaction costs. In addition to the market risk related to the underlying holdings, the Fund bears
additional counterparty risk with respect to the issuing broker. Moreover, there is currently no active trading market for equity-linked warrants.
In addition to warrants on securities, the Fund may purchase put warrants and call warrants whose values vary depending on the change in the value of one or more specified securities indices
(index-linked warrants). Index-linked warrants are generally issued by banks or other financial institutions and give the holder the right, at any time during the term of the warrant, to receive upon exercise of the warrant a cash
payment from the issuer based on the value of the underlying index at the time of exercise. In general, if the value of the underlying index rises above the exercise price of the index-linked warrant, the holder of a call warrant will be entitled to
receive a cash payment from the issuer upon exercise based on the difference between the value of the index and the exercise price of the warrant; if the value of the underlying index falls, the holder of a put warrant will be entitled to receive a
cash payment from the issuer upon exercise based on the difference between the exercise price of the warrant and the value of the index. The holder of a warrant would not be entitled to any payments from the issuer at any time when, in the case of a
call warrant, the exercise price is greater than the value of the underlying index, or, in the case of a put warrant, the exercise price is less than the value of the underlying index. If the Fund were not to exercise an index-linked warrant prior
to its expiration, then the Fund would lose the amount of the purchase price paid by it for the warrant.
The risks of the Funds use of
index-linked warrants are generally similar to those relating to its use of index-related options. Unlike most index-related options, however, index-linked warrants are issued in limited amounts and are not obligations of a regulated clearing
agency, but are backed only by the credit of the bank or other institution that issues the warrant. Also, index-linked warrants generally have longer terms than index-related options. Index-linked warrants are not likely to be as liquid as certain
index options backed by a recognized clearing agency. In addition, the terms of index-linked warrants may limit the Funds ability to exercise the warrants at such time, or in such quantities, as the Fund would otherwise wish to do.
When-Issued, Delayed Delivery and Forward Commitment Transactions
The Funds may purchase or sell securities on a when-issued, delayed delivery or forward commitment basis. When such purchases are outstanding, a Fund will generally segregate or earmark on its records
liquid assets in an amount sufficient to meet the purchase price. Typically, no income accrues on securities a Fund has committed to purchase prior to the time delivery of the securities is made, although the Fund may earn income on securities it
has segregated or earmarked.
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When purchasing a security on a when-issued, delayed delivery or forward commitment basis, a Fund assumes
the rights and risks of ownership of the security, including the risk of price and yield fluctuations, and takes such fluctuations into account when determining its net asset value. Because a Fund is not required to pay for the security until the
delivery date, these risks are in addition to the risks associated with the Funds other investments. If the other party to a transaction fails to deliver the securities, the Fund could miss a favorable price or yield opportunity. If a Fund
remains substantially fully invested at a time when when-issued, delayed delivery or forward commitment purchases are outstanding, the purchases may result in a form of leverage.
When a Fund has sold a security on a when-issued, delayed delivery or forward commitment basis, the Fund does not participate in future gains or losses with respect to the security. If the other party to
a transaction fails to pay for the securities, the Fund could suffer a loss. Additionally, when selling a security on a when-issued, delayed delivery or forward commitment basis without owning the security, a Fund will incur a loss if the
securitys price appreciates in value such that the securitys price is above the agreed upon price on the settlement date.
The
Funds may dispose of or renegotiate a transaction after it is entered into, and may sell when-issued, delayed delivery or forward commitment securities before the settlement date, which may result in a capital gain or loss.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon securities are debt obligations that do not entitle the holder to any periodic payments of interest either for the entire life of the obligation or for an initial period after the issuance of
the obligations. Like zero-coupon bonds, step-up bonds pay no interest initially but eventually begin to pay a coupon rate prior to maturity, which rate may increase at stated intervals during the life of the security. Payment-in-kind
securities (PIKs) pay dividends or interest in the form of additional securities of the issuer, rather than in cash. Each of these instruments is typically issued and traded at a deep discount from its face amount. The amount of the
discount varies depending on such factors as the time remaining until maturity of the securities, prevailing interest rates, the liquidity of the security and the perceived credit quality of the issuer. The market prices of zero-coupon bonds,
step-ups and PIKs generally are more volatile than the market prices of debt instruments that pay interest currently and in cash and are likely to respond to changes in interest rates to a greater degree than do other types of securities having
similar maturities and credit quality.
In order to satisfy a requirement for qualification as a regulated investment company
under the Code, an investment company, such as a Fund, must distribute each year at least 90% of its net investment income, including the original issue discount accrued on zero-coupon bonds, step-ups and PIKs. Because the Funds will not, on a
current basis, receive cash payments from the issuer of these securities in respect of any accrued original issue discount, in some years, the Funds may have to sell other portfolio holdings in order to obtain cash to satisfy the distribution
requirements under the Code even though investment considerations might otherwise make it undesirable for the Fund to sell securities at such time. Under many market conditions, investments in zero-coupon bonds, step-ups and PIKs may be illiquid,
making it difficult for the Funds to dispose of them or determine their current value.
INVESTMENT
RESTRICTIONS
Fundamental Policies:
Except as indicated below, the investment policies set forth below are fundamental policies of each of the Funds and may not be changed with respect to any such Fund without shareholder approval by vote
of a majority of the outstanding voting securities (as defined in the 1940 Act) of that Fund. Under these policies, each such Fund:
1.
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May borrow money to the maximum extent permitted by the 1940 Act and other applicable law, as interpreted or modified, or as otherwise permitted by regulatory authority
having jurisdiction from time to time.
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Note
: Currently, under the 1940 Act, the Fund generally is not permitted to engage in borrowings
unless immediately after a borrowing the value of the Funds total assets less all liabilities and indebtedness (other than the borrowing and any other outstanding borrowings) is at least 300% of the principal amount of such borrowing and any
other outstanding borrowings. This investment restriction does not limit a Funds ability to invest in instruments or engage in transactions that have economic effects similar to borrowings (
e.g.
, reverse repurchase agreements and dollar
roll transactions).
2.
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May not issue senior securities, except for permitted borrowings or as otherwise permitted by the 1940 Act and other applicable law, as interpreted or modified, or as
otherwise permitted by regulatory authority having jurisdiction from time to time.
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3.
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May not act as underwriter of securities of other issuers except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be
an underwriter under certain federal securities laws.
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4.
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May not concentrate its investments in a particular industry, as that term is used in the 1940 Act, as interpreted or modified, except as otherwise
permitted by regulatory authority having jurisdiction from time to time (except that the Ashmore Emerging Markets Frontier Equity Fund may concentrate its investments in securities of issuers in any one industry or group of industries if the
components of its benchmark index are concentrated in an industry or group of industries).
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Note
: A Fund would be deemed
to concentrate in a particular industry if it invested more than 25% of its total assets (taken at market value at the time of investment) in that particular industry. The industry concentration policy does not preclude a Fund from
investing in issuers in a group of related sectors or industries. The Funds interpret the industry concentration policy to apply to direct investments in the securities of issuers in a particular industry, as defined by the Funds. The SEC staff
takes the position that investments in government securities of a single foreign country (including agencies and instrumentalities of such government, if such obligations are backed by the assets and revenues of such government) represent
investments in a particular industry for these purposes. The Funds do not consider currency positions to be an investment in a foreign government or industry for purposes of this policy. Mortgage-backed securities that are issued or guaranteed by
the U.S. Government, its agencies or instrumentalities are not subject to the industry concentration policy, by virtue of the exclusion from that test available to all U.S. Government securities. Similarly, municipal bonds issued by states,
municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies and authorities are not subject to the industry concentration policy. As of the date of this Statement of Additional
information, the Ashmore Emerging Markets Frontier Equity Funds benchmark index is the MSCI Frontier Markets Index.
5.
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May not make loans, except as permitted by the 1940 Act and other applicable law, as interpreted or modified, or as otherwise permitted by regulatory authority having
jurisdiction from time to time.
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Note
: This policy does not prohibit a Fund from purchasing debt obligations,
participating in the primary distribution of a loan as a co-lender, entering into repurchase agreements or similar transactions, or lending cash and its portfolio securities to the extent permitted by the 1940 Act and related interpretations.
6.
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May not purchase or sell commodities, provided that this policy shall not apply to or prohibit a Fund from purchasing, selling or entering into futures contracts,
options contracts, options on futures contracts, forward contracts, foreign exchange contracts, swap agreements and other financial transactions and derivative and other instruments, including commodity-related financial transactions and derivative
instruments.
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7.
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May not purchase or sell real estate, provided that this policy shall not apply to or prohibit a Fund from purchasing or selling securities or instruments secured by
real estate or interests therein, or securities issued by companies, including limited partnership or similar entities, which invest in real estate or are in the real estate industry, or interests therein, and shall not prohibit a Fund from selling
real estate it holds as a result of any such investments.
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53
The following policy applies only with respect to Ashmore Emerging Markets Equity Fund, Ashmore Emerging
Markets Frontier Equity Fund and Ashmore Emerging Markets Small-Cap Equity Fund:
8.
|
May not purchase securities of any issuer unless such purchase is consistent with the maintenance of the Funds status as a diversified company under the
Investment Company Act of 1940, as amended.
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Non-Fundamental Policies:
Except for the investment restrictions listed above as fundamental or to the extent designated as such in the Prospectus, the other investment policies
described in this SAI or in the Prospectus, including the explanatory notes included above under the heading Investment RestrictionsFundamental Policies are not fundamental and may be changed by approval of the Trustees without
notice to or approval by the shareholders.
Policies Relating to Rule 35d-1 under the 1940 Act
:
The Funds have adopted policies pursuant to Rule 35d-1(a) under the 1940 Act. Each Fund will provide to its shareholders the notice required by Rule 35d-1
under the 1940 Act, as such may be interpreted or revised from time to time, with respect to any change in any policy adopted pursuant to Rule 35d-1(a).
Below are the Funds policies adopted pursuant to Rule 35d-1:
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Fund
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Policy
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Ashmore Emerging Markets
Corporate Debt Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in bonds and other debt instruments of Corporate
issuers.
(1)
|
|
|
Ashmore Emerging Markets
Equity Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in equity securities and other equity-related investments
of Emerging Market Issuers.
|
|
|
Ashmore Emerging Markets
Frontier Equity Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in equity securities and other equity-related investments
of Frontier Market Issuers.
|
|
|
Ashmore Emerging Markets
Currency Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in instruments that provide investment exposure to the
local currencies of Emerging Market Countries.
|
|
|
Ashmore Emerging Markets
Local Currency Bond Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in bonds and other debt instruments denominated in the
local currencies of Emerging Market Countries.
|
|
|
Ashmore Emerging Markets
Small-Cap Equity Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in equity securities and other equity-related investments
of Small-Capitalization Emerging Market Issuers.
|
|
|
Ashmore Emerging Markets Debt Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in bonds and other debt instruments issued by Sovereign,
Quasi-Sovereign or Corporate issuers
(2)
of Emerging Market
Countries.
|
|
|
Ashmore Emerging Markets Total Return Fund
|
|
The Fund observes a policy to normally invest at least 80% of its net assets (plus borrowings made for investment purposes) in securities and instruments issued by Sovereign,
Quasi-Sovereign, or Corporate issuers
(2)
of Emerging
Market Countries and Emerging Market currency-related derivative instruments.
|
(1)
|
For purposes of this Fund, a Corporate issuer is an issuer located in an Emerging Market Country or an issuer deriving at least 50% of its revenues or
profits from goods produced or sold, investments made, or
|
54
|
services performed in one or more Emerging Market Countries or that has at least 50% of its assets in one or more Emerging Market Countries. Corporate issuers do not include Sovereigns
or governmental agency issuers, but may include corporate or other business entities in which a Sovereign or governmental agency or entity may have, indirectly or directly, an interest, including a majority or greater ownership interest
(
e.g.
, Gazprom, CITIC, Qatar Telecom).
|
(2)
|
For purposes of these Funds, a Corporate issuer is a Non-Governmental issuer that is located in an Emerging Market Country, or an issuer deriving at
least 50% of its revenues or profits from goods produced or sold, investments made, or services performed in one or more Emerging Market Countries or that has at least 50% of its assets in one or more Emerging Market Countries.
|
Accounts and Assets for Which the Advisory Fee is Based on Performance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Registered Investment
Companies
|
|
|
Other Pooled Investment
Vehicles
|
|
|
Other Accounts
|
|
|
|
Number
of
Accounts
|
|
|
Total
Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
Investment Committee (Mark Coombs, Ricardo Xavier, Herbert Saller and Robin Forrest)
|
|
|
0
|
|
|
|
0
|
|
|
|
19
|
|
|
$
|
9,618,951,544
|
|
|
|
8
|
|
|
$
|
1,307,828,883
|
|
Felicia Morrow
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
1
|
|
|
$
|
49,405,426
|
|
|
|
4
|
|
|
$
|
2,711,115,102
|
|
Peter Trofimenko
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
4
|
|
|
$
|
2,711,115,102
|
|
Cindy Chi
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
4
|
|
|
$
|
2,711,115,102
|
|
John DiTieri
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
4
|
|
|
$
|
2,711,115,102
|
|
Alejandro Garza
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
4
|
|
|
$
|
2,711,115,102
|
|
Bryan DAguiar
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
Material Conflicts of Interest.
The following summarizes the policies of the Investment Manager and the
Subadviser for managing conflicts of interest. It is not intended to provide a comprehensive account of the processes and procedures the Investment Manager and the Subadviser have adopted in connection with the management of conflicts of interest,
but is instead intended to be a statement of principles through which the Investment Manager and the Subadviser seek to manage such potential conflicts.
Conflicts of interest can arise where: (i) the interests of the Investment Manager or Subadviser conflict with those of a client (firm vs. client conflicts) and (ii) the interests of one client
of the Investment Manager or Subadviser conflict with those of another of the Investment Managers or Subadvisers, as applicable, clients (client vs. client conflicts). The Investment Manager and the Subadviser have policies and
arrangements in place to identify and manage conflicts of interest that may arise between the Investment Manager or Subadviser, as applicable, and its clients or between the Investment Managers or Subadvisers. as applicable, different
clients. The Investment Manager and the Subadviser each have a policy of independence that requires the Investment Managers or Subadvisers, as applicable, staff to disregard any personal interest, relationship or arrangement which gives
rise to a conflict of interest and to ensure that the interests of clients prevail.
72
The Investment Manager and the Subadviser place significant emphasis on their strong compliance culture, and
the efficient operation of systems and controls, to manage issues such as conflicts of interest. The compliance department of each of the Investment Manager and the Subadviser conduct regular monitoring checks to confirm that internal policies and
procedures are followed.
Firm vs. client conflicts
Connected entity investment decisions
The Investment Manager and the Subadviser act as manager, investment manager, advisor, general partner or subadviser to and may receive different
rates of remuneration, including investment management/advisory fees and performance fees from multiple client accounts. While the Investment Manager or Subadviser may make decisions to buy or sell securities or other investments for one account and
not another account, which may affect relative performance and hence the value of the Investment Managers or Subadvisers, as applicable, remuneration based thereon, the Investment Manager and the Subadviser will at all times have regard
to their obligations to each client, taking into account such clients investment restrictions and other relevant factors.
Investment as principal
The Investment Manager may from time to time take a long-term or short-term position in a client fund, in
some cases to provide initial capital and establish a solid platform for the future growth of such client fund. The Investment Manager may also co-invest in an investment alongside a client or client fund, either directly or indirectly, or invest in
any entity which forms part of a client funds assets. The Investment Managers return on investment in a client fund will be determined by reference to the investment decisions the Investment Manager makes for such client fund, and in the
case of co-investment or other investment, by reference to the change in value of such investment. The Investment Managers policies require that all personal interests, relationships or arrangements, including those of its affiliated companies
must be disregarded to ensure that the best interests of all clients are served.
Staff personal investments
certain
directors and employees of the Investment Manager, Subadviser or of an affiliated company may hold or deal for their personal account in securities of a client or of any issuer in which securities or investments are held or dealt in on behalf of a
client. They may also deal, outside closed periods, in the securities of the ultimate holding company, Ashmore Group plc or, in the case of joint ventures, hold shares or other investments in an affiliated company.
Client vs. client conflicts
Aggregation of transactions in investments
The Investment Manager and the Subadviser may aggregate purchase and sale transactions in investments (and associated transaction costs) for
applicable clients. The applicable clients may have different or similar investment strategies, objectives and restrictions, and they may be structured differently (such as redemption and subscription (or analogous) terms). Accordingly, aggregation
may result in different outcomes for certain such clients, for instance in respect of the holding period for an investment, the size of a clients exposure to such investment, and the price at which an investment may be acquired or disposed of.
Depending on the circumstances, aggregation may be advantageous or disadvantageous to the client.
Allocation of transactions in
investments
Aggregated transactions as referred to above, including costs and expenses thereof, are allocated to ensure that the Investment Managers or Subadvisers, as applicable, clients have broadly equal access to a
similar quality and quantity of suitable investment transactions, taking into account the factors mentioned above, amongst others. The Investment Managers and the Subadvisers policies further require all allocations to be effected at the
same price, but in very limited instances this may not be achievable due to the mechanics of certain markets.
Transactions between
clients
The Investment Manager or Subadviser may make decisions for one client to buy or sell units, shares or other investments in other funds, investment companies or other entities to which the Investment Manager, Subadviser or an
affiliated company is the manager or investment manager (for example for a fund of fund).
73
The Investment Manager or Subadviser may in certain circumstances effect a transaction between clients
whereby one client buys an asset from another client for reasons that are beneficial to each client, on arms length terms. For example, a transaction between clients may be appropriate when a client fund has an obligation to meet applicable
investment restrictions or investor redemption requirements, and where the Investment Manager or Subadviser determines that the investment continues to represent a valid opportunity to generate added value for one or more other clients to acquire
the investment.
The Investment Manager and the Subadviser have adopted certain compliance procedures that are designed to address these, and
other, types of conflicts. However, there is no guarantee that such procedures will detect each and every situation where a conflict arises.
Notice
In providing the above set of principles through which the Investment Manager and the Subadviser intend to manage any
potential conflicts of interest, the Investment Manager and the Subadviser intend that this disclosure should be for guidance only. Accordingly, this disclosure is being provided (to the extent permitted by law) without liability, and in publishing
this disclosure the Investment Manager and the Subadviser make no representation or warranty as to how they may act in connection with any particular situation or set of circumstances that may arise in relation to a conflict. This disclosure is not
intended to create third party rights or duties that would not already exist if the policy had not been made available, nor is it intended to form part of any contract between the Investment Manager or Subadviser, as applicable, and any client.
Compensation
.
The Investment Committee Members are compensated by the Investment Manager by fixed annual salaries, as
well as by performance-based annual bonuses determined at the discretion of the Ashmore Group plcs Chief Executive and, in the case of the Chief Executive himself, at the discretion of the Remuneration Committee of the Board of Directors of
Ashmore Group plc. The performance on which bonuses are based is calculated on pre-tax returns for a one-year period. The determination of an Investment Committee Members total compensation involves a thorough and on-going assessment of the
individuals performance and contribution to the Investment Managers profitability. This assessment is performed on a continuous basis as well as part of a formal annual review. The Investment Committee Members may also be granted access
to equity in the Investment Managers business through shares in Ashmore Group plc, equity options and other earned-in mechanisms.
The
Investment Manager pays the Subadviser a fee based on the assets under management of each applicable Fund as set forth in an investment sub-advisory agreement between the Investment Manager and the Subadviser. The Subadviser pays its investment
professionals out of its total revenues and other resources, including the sub-advisory fees earned with respect to the applicable Funds.
The
Subadviser compensates all full-time employees, including portfolio managers, in the form of a base salary plus bonus, as well as via a profit sharing plan out of which the Subadviser makes matching contributions to a 401(k) plan. The bonus pool is
based on the Subadvisers annual pre-tax profits and is allocated with the input of various managers on the basis of each persons individual contribution to the Subadviser. There is no fixed formula that compensates staff members directly
for asset growth, investment performance, or other factors, and compensation is not directly tied to a published or private benchmark. In addition, several key staff members, including but not limited to each of the portfolio managers referenced
above, hold a direct equity interest in the Subadviser.
Ownership of Securities.
As of the date of this SAI, the Investment
Committee Members and the Portfolio Managers did not beneficially own any securities issued by the Funds, except that, with respect to Ashmore Emerging Markets Equity Fund, the following table discloses the dollar range of equity securities
beneficially owned by each portfolio manager in the Fund(s) the portfolio manager manages as of October 31, 2013:
Ashmore
Emerging Markets Equity Fund
|
|
|
|
|
Felicia W. Morrow
|
|
Over $
|
100,000
|
|
74
BROKERAGE ALLOCATION AND OTHER PRACTICE
Selection of Brokers
. The Investment Manager or Subadviser, in selecting brokers to effect transactions on behalf of the Funds, seeks to obtain the
best execution available.
Allocation
. The Investment Manager or Subadviser may deem the purchase or sale of a security to be in the
best interests of a Fund as well as other clients of the Investment Manager or Subadviser. In such cases, the Investment Manager or Subadviser may, but is under no obligation to, aggregate all such transactions in order to seek the most favorable
price or lower brokerage commissions and efficient execution. Orders are normally allocated on a pro rata basis, except that in certain circumstances, such as the small size of an issue, orders will be allocated among clients in a manner believed by
the Investment Manager or Subadviser to be fair and equitable over time.
Brokerage and Research Services
. Certain transactions involve
the payment by the Funds of negotiated brokerage commissions. The Investment Manager or Subadviser may determine to pay a particular broker varying commissions according to such factors as the difficulty and size of the transaction. Transactions in
foreign securities often involve the payment of fixed brokerage commissions, which are generally higher than those in the United States, and therefore certain portfolio transaction costs may be higher than the costs for similar transactions executed
on U.S. securities exchanges. There is generally no stated commission in the case of debt securities or securities traded in the over-the-counter markets, but the price paid by a Fund usually includes an undisclosed dealer commission or mark-up. In
underwritten offerings, the price paid by the Funds includes a disclosed, fixed commission or discount retained by the underwriter or dealer.
The Investment Manager or Subadviser, as applicable, places all orders for the purchase and sale of portfolio securities and buys and sells securities
through a substantial number of brokers and dealers. In so doing, it uses its best efforts to obtain the best execution available. In seeking the best price and execution, the Investment Manager or Subadviser, as applicable, considers all factors it
deems relevant, including price, the size of the transaction, the nature of the market for the security, the amount of the commission, the timing of the transaction (taking into account market prices and trends), the reputation, experience, and
financial stability of the broker-dealer involved, and the quality of service rendered by the broker-dealer in other transactions.
It has for
many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive research, statistical, and quotation services from several broker-dealers that execute portfolio
transactions for the clients of such advisers. Consistent with this practice, the Investment Manager or Subadviser, as applicable, receives research, statistical, and quotation services from many broker-dealers with which it places the Funds
portfolio transactions. These services, which in some cases may also be purchased for cash, include such matters as general economic and security market reviews, industry and company reviews, evaluations of securities, and recommendations as to the
purchase and sale of securities. Some of these services are of value to the Investment Manager, the Subadviser and their affiliates in advising various of their clients (including the Trust), although not all of these services are necessarily useful
and of value in managing each of the Funds. The investment advisory fee paid by each of the Funds is not reduced because the Investment Manager, the Subadviser, as applicable, and their affiliates receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, as amended (the Securities Exchange Act), and by the Investment
Management Agreement, the Investment Manager or Subadviser, as applicable, may cause the Funds to pay a broker that provides brokerage and research services to the Investment Manager or Subadviser, as applicable, an amount of disclosed commission
for effecting a securities transaction for a Fund in excess of the commission that another broker would have charged for effecting that transaction. The Investment Managers and Subadvisers, as applicable, authority to cause a Fund to pay
any such greater commissions is also subject to such policies as the Trustees may adopt from time to time.
75
The amount of brokerage commissions and fees paid by a Fund may vary substantially from year to year due to
differences in shareholder purchase and redemption activity, portfolio turnover rates and other factors. For the fiscal year indicated below, the amount of commissions and fees paid by certain Funds was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Brokerage Commissions
Paid for Fiscal Year
Ended 10/31/13
|
|
|
Brokerage Commissions
Paid for Fiscal Year
Ended 10/31/12
|
|
|
Brokerage Commissions
Paid for Fiscal Year
Ended 10/31/11
|
|
Ashmore Emerging Markets Equity Fund
|
|
$
|
24,158
|
|
|
$
|
21,051
|
|
|
$
|
16,905
|
|
Ashmore Emerging Markets Small-Cap Equity Fund
|
|
$
|
117,891
|
|
|
$
|
28,428
|
|
|
$
|
4,619
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Brokerage Fees Paid for
Fiscal Year Ended
10/31/13
|
|
|
Brokerage Fees Paid for
Fiscal Year Ended
10/31/12
|
|
|
Brokerage Commissions
Paid for Fiscal Year
Ended 10/31/11
|
|
Ashmore Emerging Markets Equity Fund
|
|
$
|
10,922
|
|
|
$
|
7,748
|
|
|
$
|
6,302
|
|
Ashmore Emerging Markets Small-Cap Equity Fund
|
|
$
|
45,234
|
|
|
$
|
9,791
|
|
|
$
|
2,701
|
|
No commissions were paid by the Funds to any direct or indirect affiliated person (as defined in the
1940 Act) of the Funds for the fiscal year ended October 31, 2013.
The Funds did not acquire any securities of its regular brokers
or dealers or their parents during the fiscal year ended October 31, 2013.
DISTRIBUTION OF TRUST SHARES AND MULTIPLE SHARE CLASSES
Distributor and Distribution Contract
Ashmore Investment Management (US) Corporation (AIMUS or the Distributor), located at 122 E. 42nd Street, New York, New York
10168, serves as the principal underwriter of each class of the Trusts shares pursuant to a distribution contract (as amended, the Distribution Contract) with the Trust. The Distributor is an indirect, wholly-owned subsidiary
of Ashmore Group plc and an affiliate of the Investment Manager. The Distributor is a broker-dealer registered with the Securities and Exchange Commission.
The Distribution Contract is terminable with respect to a Fund or class of shares without penalty, at any time, by a Fund or class upon 60 days written notice to the Distributor, or by the
Distributor upon 60 days written notice to the Trust. The Distributor is not obligated to sell any specific amount of Trust shares and does not receive any compensation other than what is described below for executing securities transactions.
The Distribution Contract will continue in effect with respect to each Fund, and each class of shares thereof, for successive one-year
periods, provided that each such continuance is specifically approved (i) by the vote of a majority of the entire Board of Trustees or by the majority of the outstanding shares of the Fund or class, and (ii) by a majority of the Trustees
who are not interested persons (as defined in the 1940 Act) of the Trust and who have no direct or indirect financial interest in the Distribution Contract or the 12b-1 Plans (as defined below), by vote cast in person at a meeting called for the
purpose. If the Distribution Contract is terminated (or not renewed) with respect to one or more Funds or share classes, it may continue in effect with respect to any Fund or class as to which it has not been terminated (or has been renewed).
Multiple Share Classes Class A, Class C and Institutional Class Shares
The Trust currently offers the following three classes of shares of each of the Funds: Class A Shares, Class C Shares and Institutional Class Shares.
76
Class A and Class C Shares of the Trust are offered primarily through financial intermediaries that
have dealer or other agreements with the Distributor, or which have agreed to act as introducing brokers for the Distributor (introducing brokers). Class A and Class C Shares are subject to initial sales charges (Class A Shares),
contingent deferred sales charges (CDSCs) (Class A and C Shares) and ongoing distribution and/or servicing fees as described below and in the Prospectus.
Institutional Class Shares are offered primarily for direct investment by investors such as pension and profit sharing plans, employee benefit trusts, endowments, foundations, corporations and high net
worth individuals. Institutional Class Shares may also be offered through certain fund networks and other financial intermediaries that charge their customers transaction or other fees with respect to their customers investments in the Funds.
Institutional Class Shares are not subject to any sales charges or ongoing distribution and/or servicing fees.
Multi-Class Plan.
The
Trust has adopted a Multi-Class Plan pursuant to Rule 18f-3 under the 1940 Act which sets forth the separate arrangements, expense allocations and other features of the Trusts share classes. Under the Multi-Class Plan, shares of each class of
each Fund represent an equal pro rata interest in the Fund and, generally, have identical voting, dividend, liquidation, and other rights preferences, powers, restrictions, limitations, qualifications and terms and conditions, except that:
(a) each class has a different designation; (b) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its distribution or service arrangements; and (c) each class has separate voting
rights on any matter submitted to shareholders in which the interests of one class differ from the interests of any other class.
Each class
of shares bears any class specific expenses allocated to such class, such as expenses related to the distribution and/or shareholder servicing of such class. In addition, each class may, at the Trustees discretion, also pay a different share
of other expenses, not including management or custodial fees or other expenses related to the management of the Trusts assets, if these expenses are actually incurred in a different amount by that class, or if the class receives services of a
different kind or to a different degree than the other classes. All other expenses are allocated to each class on the basis of the net asset value of that class in relation to the net asset value of the particular Fund. Each class may have a
differing sales charge structure, and differing exchange and conversion features.
The alternative share class and related purchase
arrangements described in Prospectus and in this SAI are designed to enable investors to choose the method of purchasing Fund shares that is most beneficial to the investor based on all factors to be considered, including, without limitation, the
amount and intended length of the investment, the particular Fund and whether the investor intends to exchange shares for shares of other Funds.
If an investor qualifies (through satisfying applicable investment minimums or otherwise) to invest in Institutional Class Shares of the Funds, the investor should choose Institutional Class Shares over
either Class A or Class C Shares due to the lower fees and expenses associated with Institutional Class Shares. Generally, when making an investment decision as between Class A and Class C Shares, investors should consider the anticipated
life of an intended investment in the Funds, the size of the investment, the accumulated distribution and servicing fees plus contingent deferred sales charges (CDSCs) on Class C Shares, the initial sales charge plus accumulated servicing fees on
Class A Shares (plus a CDSC in certain circumstances), and the difference in the CDSCs applicable to Class A and Class C Shares, among other factors.
Investors should understand that initial sales charges, distribution and/or servicing fees and CDSCs imposed with respect to Class A and Class C Shares are all used directly or indirectly to fund the
compensation of financial intermediaries that sell Fund shares. Depending on the arrangements in place at any particular time, a financial intermediary may have a financial incentive for recommending a particular share class over other share
classes.
In determining which class of shares of the Funds to purchase, an investor should always consider whether any waiver or reduction of
an initial sales charge or a CDSC is available as described below.
77
Initial Sales Charges Class A Shares
As described in the Prospectus under the caption Classes of SharesClass A and C Shares, Class A Shares of the Funds are sold at a
public offering price equal to their net asset value per share plus an initial sales charge (unless a waiver applies as specified below) according to the following schedule.
All Funds, except Ashmore Emerging Markets Equity Fund, Ashmore Emerging Markets Frontier Equity Fund and Ashmore Emerging Markets Small-Cap Equity Fund:
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of Purchase
|
|
Sales Charge as a %
of Net Amount
Invested
|
|
|
Sales Charge as a %
of Public Offering
Price
|
|
|
Discount or
Commission to
Dealers as a % of
Public
Offering
Price*
|
|
$0$99,999
|
|
|
4.17
|
%
|
|
|
4.00
|
%
|
|
|
3.50
|
%
|
$100,000$249,999
|
|
|
3.63
|
%
|
|
|
3.50
|
%
|
|
|
3.00
|
%
|
$250,000$499,999
|
|
|
2.56
|
%
|
|
|
2.50
|
%
|
|
|
2.25
|
%
|
$500,000$999,999
|
|
|
2.04
|
%
|
|
|
2.00
|
%
|
|
|
1.75
|
%
|
$1,000,000 +
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%**
|
*
|
From time to time, these discounts and commissions may be increased pursuant to special arrangements between the Distributor and certain participating
brokers.
|
**
|
The Distributor will pay a commission to dealers that sell amounts of $1,000,000 or more of Class A Shares according to the following schedule:
0.75% of the first $2,000,000, 0.50% of amounts from $2,000,001 to $5,000,000, and 0.25% of amounts over $5,000,000. The Distributor will then also pay to such dealers a Rule 12b-1 trail fee of 0.25% beginning in the thirteenth month after purchase.
These payments are not made in connection with sales to employer-sponsored plans.
|
Ashmore Emerging Markets Equity
Fund, Ashmore Emerging Markets Frontier Equity Fund and Ashmore Emerging Markets Small-Cap Equity Fund:
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of Purchase
|
|
Sales Charge as a %
of Net Amount
Invested
|
|
|
Sales Charge as a %
of Public Offering
Price
|
|
|
Discount or
Commission to
Dealers as a % of
Public
Offering
Price*
|
|
$0$99,999
|
|
|
5.54
|
%
|
|
|
5.25
|
%
|
|
|
4.50
|
%
|
$100,000$249,999
|
|
|
3.63
|
%
|
|
|
3.50
|
%
|
|
|
3.00
|
%
|
$250,000$499,999
|
|
|
2.56
|
%
|
|
|
2.50
|
%
|
|
|
2.25
|
%
|
$500,000$999,999
|
|
|
2.04
|
%
|
|
|
2.00
|
%
|
|
|
1.75
|
%
|
$1,000,000 +
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%**
|
*
|
From time to time, these discounts and commissions may be increased pursuant to special arrangements between the Distributor and certain participating
brokers.
|
**
|
The Distributor will pay a commission to dealers that sell amounts of $1,000,000 or more of Class A Shares according to the following schedule:
0.75% of the first $2,000,000, 0.50% of amounts from $2,000,001 to $5,000,000, and 0.25% of amounts over $5,000,000. The Distributor will then also pay to such dealers a Rule 12b-1 trail fee of 0.25% beginning in the thirteenth month after purchase.
These payments are not made in connection with sales to employer-sponsored plans.
|
Each Fund receives the entire net asset
value of its Class A Shares purchased by investors (
i.e.
, the gross purchase price minus any applicable sales charge). The Distributor receives the sales charge shown above less any applicable discount or commission reallowed
to participating brokers in the amounts indicated in the table above. The Distributor may, however, elect to reallow the entire sales charge to participating brokers for all sales with respect to which orders are placed with the Distributor for any
particular Fund during a particular period.
78
During such periods as may from time to time be designated by the Distributor, the Distributor will pay an additional amount of up to 0.50% of the purchase price on sales of Class A Shares
of all or selected Funds purchased to each participating broker that obtains purchase orders in amounts exceeding thresholds established from time to time by the Distributor. For Class A Shares, the Distributor may also pay participating
brokers annual servicing fees of 0.25% of the net asset value of such shares.
Shares issued pursuant to the automatic reinvestment of income
dividends or capital gains distributions are issued at net asset value and are not subject to any sales charges.
No initial sales charge is
imposed on purchases of Class C or Institutional Class Shares.
The Trust commenced offering Class A Shares of all Funds, except
Ashmore Emerging Markets Frontier Equity Fund, before the most recent fiscal year end and the Distributor has received $26,973.75 in initial sales charges with respect to sales of Class A Shares for the year ended October 31, 2013.
Waivers or Reductions of Initial Sales Charges on Class A Shares
Under the circumstances described below, investors may be entitled to a complete waiver or to pay reduced initial sales charges with respect to purchases
of Class A Shares. These discounts and commissions may be increased pursuant to special arrangements from time to time agreed upon between the Distributor and certain participating brokers.
Class A Shares Sales at Net Asset Value.
Each Fund may sell its Class A Shares at net asset value without a sales charge to certain
categories of investors as set forth below:
(i) current or retired officers, trustees, directors or employees of the Trust,
the Investment Manager, the Subadviser or the Distributor; a parent, brother or sister of any such officer, trustee, director or employee or a spouse or child of any of the foregoing persons, or any trust, profit-sharing or pension plan for the
benefit of any such person and to any other person if the Distributor anticipates that there will be minimal sales expenses associated with the sale;
(ii) current registered representatives and other full-time employees of participating brokers or such persons spouses or for trust or custodial accounts for their minor children;
(iii) trustees or other fiduciaries purchasing shares for certain plans sponsored by employers, professional organizations or
associations or charitable organizations, the trustee, administrator, recordkeeper, fiduciary, broker, trust company or registered investment adviser for which has an agreement with the Distributor, the Investment Manager or the Subadviser with
respect to such purchases (including provisions related to minimum levels of investment in the Trust), and to participants in such plans and their spouses purchasing for their account(s) or IRAs;
(iv) participants investing through accounts known as wrap accounts established with brokers or dealers approved by the
Distributor where such brokers or dealers are paid a single, inclusive fee for brokerage and investment management services;
(v) client accounts of broker-dealers or registered investment advisers affiliated with such broker-dealers with which the Distributor,
the Investment Manager or the Subadviser has an agreement for the use of a Fund in particular investment products or programs or in particular situations;
(vi) accounts for which the company that serves as trustee or custodian either (a) is affiliated with the Investment Manager, (b) is affiliated with the Subadviser or (c) has a specific
agreement to that effect with the Distributor; and
(vii) investors who purchase shares in Exempt Transactions, as
described under Exempt Transactions; No CDSCs or Payments to Brokers below.
The Distributor will only pay service fees and will
not pay any initial commission or other fees to dealers upon the sale of Class A Shares of the Funds to the purchasers described in sub-paragraphs (i) through (vii) above
79
except that the Distributor will pay initial commissions to any dealer for sales to purchasers described under
sub-paragraph
(iii) above provided such
dealer has a written agreement with the Distributor specifically providing for the payment of such initial commissions.
Right of
Accumulation and Combined Purchase Privilege (Initial Sales Charge Breakpoints).
A Qualifying Investor (as defined below) may qualify for a reduced sales charge on Class A Shares (the Combined Purchase Privilege) by combining
concurrent purchases of Class A Shares of one or more of the Funds into a single purchase. In addition, a Qualifying Investor may qualify for a reduced sales charge on Class A Shares (the Right of Accumulation or
Cumulative Quantity Discount) by combining the purchase of Class A Shares of a Fund with the current aggregate net asset value of all Class A and Class C Shares of any Fund held by accounts for the benefit of such Qualifying
Investor.
The term Qualifying Investor refers to:
|
(i)
|
an individual, such individuals spouse, such individuals children under the age of 21 years, or such individuals siblings (each a family
member) (including family trust* accounts established by such a family member)
|
or
|
(ii)
|
a trustee or other fiduciary for a single trust (except family trusts* noted above), estate or fiduciary account although more than one beneficiary may be involved
|
or
|
(iii)
|
an employee benefit plan of a single employer.
|
*
|
For the purpose of determining whether a purchase would qualify for a reduced sales charge under the Combined Purchase Privilege or Right of Accumulation, a
family trust is one in which a family member(s) described in section (i) above is/are a beneficiary/ies and such person(s) and/or another family member is the trustee.
|
Shares purchased or held through a plan investor or any other employer-sponsored benefit program do not count for purposes of determining whether an
investor qualifies for a Cumulative Quantity Discount.
Letter of Intent.
An investor may also obtain a reduced sales charge on
purchases of Class A Shares of the Funds by means of a written Letter of Intent, which expresses an intention to invest not less than $100,000 within a period of 13 months in Class A Shares of any Fund. The maximum intended investment
amount allowable in a Letter of Intent is $1,000,000. Each purchase of Class A Shares under a Letter of Intent will be made at the public offering price or prices applicable at the time of such purchase to a single purchase of the dollar amount
indicated in the Letter of Intent. At the investors option, a Letter of Intent may include purchases of Class A Shares of any Fund made not more than 90 days prior to the date the Letter of Intent is signed; however, the
13-month
period during which the Letter of Intent is in effect will begin on the date of the earliest purchase to be included and the sales charge on any purchases prior to the Letter of Intent will not be adjusted.
In making computations concerning the amount purchased for purpose of a Letter of Intent, any redemptions during the operative period are deducted from the amount invested.
Investors qualifying for the Combined Purchase Privilege described above may purchase shares of the Funds under a single Letter of Intent. For example, if at the time you sign a Letter of Intent to invest
at least $150,000 in Class A Shares of any Fund, you and your spouse each purchase Class A Shares of a Fund worth $45,000 (for a total of $90,000), it will only be necessary to invest a total of $60,000 during the following 13 months in
Class A Shares of any of the Funds to qualify for the 3.50% sales charge on the total amount being invested (
i.e
., $150,000).
80
A Letter of Intent is not a binding obligation to purchase the full amount indicated. The minimum initial
investment under a Letter of Intent is $100,000 within a period of 13 months. Up to 4% of the amount indicated in the Letter of Intent will be held in escrow (while remaining registered in your name) to secure payment of the higher sales charge
applicable to the shares actually purchased in the event the full intended amount is not purchased. If the full amount indicated is not purchased, a sufficient amount of such shares will be involuntarily redeemed to pay the additional sales charge
applicable to the amount actually purchased, if necessary. Dividends on escrowed shares, whether paid in cash or reinvested in additional Fund shares, are not subject to escrow. When the full amount indicated has been purchased, the escrow will be
released.
If an investor wishes to enter into a Letter of Intent in conjunction with an initial investment in Class A Shares of a Fund,
the investor should complete the appropriate portion of the Account Application. A current Class A shareholder desiring to do so may obtain a form of Letter of Intent by contacting the Trusts transfer agent at 866-876-8294 or any
financial intermediary participating in this program.
Shares purchased or held through an employer-sponsored benefit program do not count for
purposes of determining whether an investor has qualified for a reduced sales charge through the use of a Letter of Intent.
Reinstatement Privilege.
A Class A shareholder who has caused any or all of his shares of the Funds to be redeemed may reinvest all or any
portion of the redemption proceeds in Class A Shares of any Fund at net asset value without any sales charge, provided that such reinvestment is made within 120 calendar days after the redemption or repurchase date. Class A Shares will be
sold to a reinvesting shareholder at the net asset value next determined. See How the Funds Shares are Priced in the Prospectus. A reinstatement pursuant to this privilege will not cancel the redemption transaction and,
consequently, any gain or loss so realized may be recognized for federal tax purposes except that no loss may be recognized to the extent that the proceeds are reinvested in shares of the same Fund within 30 days. An investor may exercise the
reinstatement privilege by written request sent to the Trusts transfer agent or to the investors financial intermediary.
Notifications Regarding Waivers or Discounts of Initial Sales Charges on Class A Shares.
In many cases, neither the Trust, the Distributor
nor the Trusts transfer agent will have the information necessary to determine whether a quantity discount or reduced sales charge is applicable to a particular purchase of Class A Shares of the Funds. An investor or financial
intermediary must notify the Trusts transfer agent whenever a quantity discount or reduced sales charge is applicable to a purchase of Class A Shares and must provide the transfer agent with sufficient information at the time of purchase
to verify that each purchase qualifies for the privilege or discount, including such information as is necessary to obtain any applicable combined treatment of an investors holdings in multiple accounts. Upon such notification, the
investor will receive the lowest applicable sales charge. For investors investing in Class A Shares of the Funds through a financial intermediary, it is the responsibility of the financial intermediary to ensure that the investor obtains the
proper quantity discount or reduced sales charge.
The quantity discounts and commission schedules described above may be modified or
terminated at any time by the Trust in its discretion.
Contingent Deferred Sales Charges (CDSCs) Class A and C Shares
As described in the Prospectus under the caption Classes of SharesClass A and C Shares, a contingent deferred sales
charge (CDSC) is imposed upon certain redemptions of Class A and Class C Shares.
Unless a waiver applies, investors who
purchase $1,000,000 or more of Class A Shares (and, thus, pay no initial sales charge) will be subject to a 1% CDSC if the shares are redeemed within 18 months of their purchase. The Class A CDSC does not apply if you are otherwise
eligible to purchase Class A Shares without an initial sales charge or if you are eligible for a waiver of the CDSC.
81
Unless a waiver applies, if you sell (redeem) your Class C Shares within one year of the purchase of the
shares, you will pay a 1% CDSC.
No CDSC is currently imposed upon redemptions of Institutional Class Shares.
Because CDSCs are calculated on a Fund-by-Fund basis, instead of redeeming an investment from a Fund and making no reinvestment in the Funds,
shareholders should consider whether to exchange shares of one Fund for shares of another Fund of the Trust if such an exchange would reduce or delay the payment of any CDSC applicable to such redemption.
The Trust commenced offering Class A and Class C Shares of all Funds, except Ashmore Emerging Markets Frontier Equity Fund before the most recent
fiscal year end and the Distributor has received $0 in CDSCs with respect to redemptions of Class A or Class C Shares.
Calculation of CDSCs.
As described above, whether a CDSC is imposed on Class A or Class C Shares and the amount of the CDSC will depend, in
part, on the number of years or months since the investor purchased the shares being redeemed. When shares are redeemed, any shares acquired through the reinvestment of dividends or capital gains distributions will be redeemed first and will not be
subject to any CDSC. For the redemption of all other shares, the CDSC will be based on either the shareholders original per-share purchase price or the then current net asset value of the shares being sold, whichever is lower. CDSCs will be
deducted from the proceeds of the shareholders redemption, not from the amounts remaining in the shareholders account. In determining whether a CDSC is payable, it is assumed that the shareholder will redeem first the lot of shares that
will incur the lowest CDSC. Any CDSC imposed on a redemption of Class A or Class C Shares is paid to the Distributor. For investors investing in Class A or Class C Shares through a financial intermediary, it is the responsibility of the
financial intermediary to ensure that the investor is credited with the proper holding period for the shares redeemed.
Waiver of
Contingent Deferred Sales Charges (CDSCs).
The CDSC applicable to Class A and Class C Shares is currently waived for:
(i) any partial or complete redemption in connection with (a) required minimum distributions to IRA account owners or beneficiaries
who are age 70 1/2 or older or (b) distributions to participants in employer-sponsored retirement plans upon attaining age 59 1/2 or on account of death or permanent and total disability (as defined in Section 22(e) of the Internal Revenue
Code) that occurs after the purchase of Class A or Class C Shares;
(ii) any partial or complete redemption in connection
with a qualifying loan or hardship withdrawal from an employer sponsored retirement plan;
(iii) any complete redemption in
connection with a distribution from a qualified employer retirement plan in connection with termination of employment or termination of the employers plan and the transfer to another employers plan or to an IRA;
(iv) any partial or complete redemption following death or permanent and total disability (as defined in Section 22(e) of the
Internal Revenue Code) of an individual holding shares for his or her own account and/or as the last survivor of a joint tenancy arrangement (this provision, however, does not cover an individual holding in a fiduciary capacity or as a nominee or
agent or a legal entity that is other than an individual or the owners or beneficiaries of any such entity) provided the redemption is requested within one year of the death or initial determination of disability and provided the death or disability
occurs after the purchase of the shares;
(v) any redemption resulting from a return of an excess contribution to a qualified
employer retirement plan or an IRA;
82
(vi) affiliates of the Trust, the Investment Manager, the Subadviser, and the Distributor
and redemptions by Trustees, officers and employees of the Trust, and by directors, officers and employees of the Investment Manager, the Subadviser and the Distributor;
(vii) redemptions effected pursuant to a Funds right to involuntarily redeem a shareholders Fund account if the aggregate net asset value of shares held in such shareholders account is
less than a minimum account size as specified in the Prospectus;
(viii) involuntary redemptions caused by operation of
law;
(ix) redemptions of shares of any Fund that is combined with another Fund, investment company, or personal holding
company by virtue of a merger, acquisition or other similar reorganization transaction;
(x) redemptions effected by trustees
or other fiduciaries who have purchased shares for employer-sponsored plans, the trustee, administrator, fiduciary, broker, trust company or registered investment adviser for which has an agreement with the Distributor with respect to such
purchases;
(ix) a redemption by a holder of Class A or Class C Shares where the participating broker or dealer involved
in the purchase of such shares waived all payments it normally would receive from the Distributor at the time of purchase (
i.e.
, commissions or reallowances of initial sales charges and advancements of service and distribution fees); and
(x) a redemption by a holder of Class A or Class C Shares where, by agreement with the Distributor, the participating
broker or dealer involved in the purchase of such shares waived a portion of any payment it normally would receive from the Distributor at the time of purchase (or otherwise agreed to a variation from the normal payment schedule) in connection with
such purchase.
Exempt Transactions; No CDSCs or Payments to Brokers.
In addition to the waivers noted above, investors will not be
subject to CDSCs, and brokers and dealers will not receive any commissions or reallowances of initial sales charges or advancements of service and distribution fees, on the transactions described below (which are sometimes referred to as
Exempt Transactions):
|
|
|
A redemption by a holder of Class A or Class C Shares where the participating broker or dealer involved in the purchase of such shares waived all
payments it normally would receive from the Distributor at the time of purchase (
e.g.
, commissions and/or reallowances of initial sales charges and advancements of service and distribution fees).
|
Distribution and Servicing Plans for Class A and Class C Shares
As stated in the Prospectus under the caption Classes of SharesClass A and C SharesDistribution and Servicing (12b-1) Plans and Share Purchases, Exchanges and
Redemptions, Class A and Class C Shares of the Funds are continuously offered, including through participating brokers that are members of the Financial Industry Regulatory Authority Inc. (FINRA) and that have dealer or other
agreements with the Distributor, or that have agreed to act as introducing brokers, and through other financial intermediaries.
Pursuant
to separate Distribution and Servicing Plans for Class A Shares and Class C Shares (each a
12b-1 Plan),
the Distributor receives (i) in connection with the distribution of Class C
Shares of the Funds, certain distribution fees from the Trust, and (ii) in connection with personal services rendered to Class A and Class C shareholders of the Funds and the maintenance of shareholder accounts, certain servicing fees from
the Trust. Subject to the percentage limitations on these distribution and servicing fees set forth below, the distribution and servicing fees may be paid with respect to services rendered and expenses borne in the past with respect to Class A
and Class C Shares as to which no distribution and servicing fees were paid on account of such limitations.
The Distributor makes
distribution and servicing payments to participating brokers and servicing payments to certain banks and other financial intermediaries (including certain benefit plans, their service providers and their
83
sponsors) in connection with the sale of Class C Shares and servicing payments to participating brokers, certain banks and other financial intermediaries in connection with the sale of
Class A Shares. In the case of Class A Shares, these parties are also compensated based on the amount of an initial sales charge reallowed by the Distributor, except in cases where Class A Shares are sold without an initial sales
charge (although the Distributor may pay brokers additional compensation in connection with sales of Class A Shares without a sales charge). In the case of Class C Shares, part or all of the first years distribution and servicing fee is
generally paid at the time of sale. Pursuant to the Distribution Agreement, with respect to each Funds Class A and Class C Shares, the Distributor bears various other promotional and sales related expenses, including the cost of printing
and mailing prospectuses to persons other than current shareholders.
Each 12b-1 Plan may be terminated with respect to any Fund to which the
12b-1 Plan relates by vote of a majority of the Trustees who are not interested persons of the Trust (as defined in the 1940 Act) and who have no direct or indirect financial interest in the operation of the 12b-1 Plan or the Distribution Contract
(disinterested 12b-1 Plan Trustees), or by vote of a majority of the outstanding voting securities of the relevant class of that Fund. Any change in any 12b-1 Plan that would materially increase the cost to the class of shares of any
Fund to which the 12b-1 Plan relates requires approval by the affected class of shareholders of that Fund.
The Trustees review quarterly
written reports of such costs and the purposes for which such costs have been incurred. Each 12b-1 Plan may be amended by vote of the Trustees, including a majority of the disinterested
12b-1
Plan Trustees,
cast in person at a meeting called for the purpose. As long as the 12b-1 Plans are in effect, selection and nomination of those Trustees who are not interested persons of the Trust shall be committed to the discretion of such disinterested Trustees.
The 12b-1 Plans will continue in effect with respect to each Fund, and each applicable class of shares thereof, for successive one-year
periods, provided that each such continuance is specifically approved (i) by the vote of a majority of the disinterested 12b-1 Plan Trustees and (ii) by the vote of a majority of the entire Board of Trustees cast in person at a meeting
called for the purpose of voting on such approval.
If a 12b-1 Plan is terminated (or not renewed) with respect to one or more Funds or
classes thereof, it may continue in effect with respect to any class of any Fund as to which it has not been terminated (or has been renewed).
The Trustees believe that the 12b-1 Plans will provide benefits to the Trust. In this regard, the Trustees believe that the 12b-1 Plans will result in
greater sales and/or fewer redemptions of Trust shares, although it is impossible to know for certain the level of sales and redemptions of Trust shares that would occur in the absence of the 12b-1 Plans or under alternative distribution schemes.
The Trustees believe that the effect of the 12b-1 Plans on sales and/or redemptions may benefit the Trust by allowing the Funds to potentially benefit from economies of scale as the Funds achieve higher asset levels. From time to time, expenses of
the Distributor incurred in connection with the sale of Class C Shares of the Trust, and in connection with the servicing of Class A and Class C shareholders and the maintenance of shareholder accounts, may exceed the distribution and servicing
fees collected by the Distributor. The Trustees consider such unreimbursed amounts, among other factors, in determining whether to cause the Funds to continue payments of distribution and servicing fees in the future with respect to Class A and
Class C Shares.
Certain officers and employees of the Investment Manager and affiliates of the Investment Manager, including persons who may
also serve as Officers or Interested Directors of the Funds, may have a financial interest in the operation of the 12b-1 Plans or related agreements. For example, they may be employed by and receive compensation from AIMUS or their compensation may
be based on the financial performance of the Investment Manager, which can be indirectly affected by the success of the 12b-1 Plans.
Class A and Class C Servicing Fees / Class C Distribution Fees.
As compensation for services rendered and expenses borne by the Distributor
in connection with personal services rendered to Class A and Class C
84
shareholders of the Trust and the maintenance of Class A and Class C shareholder accounts (including in each case the accounts of plan participants or similar investors where shares are held
by a financial intermediary through an omnibus account), the Trust pays the Distributor servicing fees up to the annual rate of 0.25%, calculated as a percentage of each Funds average daily net assets attributable to the particular share
class.
In addition, as compensation for services rendered and expenses borne by the Distributor in connection with the distribution of Class
C Shares of the Trust, the Trust pays the Distributor distribution fees up to the annual rate of 0.75%, calculated as a percentage of each Funds average daily net assets attributable to Class C Shares.
The 12b-1 Plans were adopted pursuant to Rule 12b-1 under the 1940 Act and are of the type known as compensation plans. This means that,
although the Trustees of the Trust are expected to take into account the expenses of the Distributor and its predecessors in their periodic review of the 12b-1 Plans, the fees are payable to compensate the Distributor for services rendered even if
the amount paid exceeds the Distributors expenses.
The servicing fee, which is applicable to Class A and Class C Shares of the
Funds, may be spent by the Distributor on personal services rendered to shareholders of the Trust and the maintenance of shareholder accounts, including compensation to, and expenses (including telephone and overhead expenses) of, financial
consultants or other employees of participating or introducing brokers, certain banks and other financial intermediaries (including certain benefit plans, their service providers and their sponsors who provide services to plan participants) who aid
in the processing of purchase or redemption requests or the processing of dividend payments, who provide information periodically to shareholders showing their positions in a Funds shares, who forward communications from the Trust to
shareholders, who render ongoing advice concerning the suitability of particular investment opportunities offered by the Trust in light of the shareholders needs, who respond to inquiries from shareholders relating to such services, or who
train personnel in the provision of such services. The distribution fee applicable to Class C Shares may be spent by the Distributor on any activities or expenses primarily intended to result in the sale of Class C Shares of the Funds, including,
without limitation, compensation to, and expenses (including overhead and telephone expenses) of, financial consultants or other employees of the Distributor or of participating or introducing brokers who engage in distribution of Class C Shares,
printing of prospectuses and reports for other than existing Class C shareholders, advertising, and preparation, printing and distributions of sales literature. Distribution and servicing fees may also be spent on interest relating to unreimbursed
distribution or servicing expenses from prior years.
Many of the Distributors sales and servicing efforts involve the Trust as a whole,
so that fees paid by Class A or Class C Shares of any Fund may indirectly support sales and servicing efforts relating to the other share classes of the same Fund or the other Funds shares of the same or different classes. In reporting
its expenses to the Trustees, the Distributor itemizes expenses that relate to the distribution and/or servicing of a single Funds shares, and allocates other expenses among the Funds, based on their relative net assets. Expenses allocated to
each Fund are further allocated among its classes of shares annually based on the relative sales of each class, except for any expenses that relate only to the sale or servicing of a single class. The Distributor may make payments to brokers (and
with respect to servicing fees only, to certain banks and other financial intermediaries) of up to the following percentages annually of the average daily net assets attributable to shares in the accounts of their customers or clients:
|
|
|
|
|
|
|
|
|
|
|
Servicing
Fee
|
|
|
Distribution
Fee
|
|
Class A Shares
|
|
|
0.25
|
%
|
|
|
None
|
|
|
|
|
|
|
|
|
|
|
Class C Shares
|
|
|
0.25
|
%
|
|
|
0.75
|
%
|
|
|
|
|
|
|
|
|
|
Some or all of the sales charges, distribution fees and servicing fees described above are paid or reallowed
to the broker, dealer or other financial intermediary (collectively, financial intermediaries) through which an investor purchases shares.
85
With respect to Class C Shares, except as provided below, the financial intermediaries are also paid at the
time of a purchase a commission equal to 1.00% (representing 0.75% distribution fees and 0.25% servicing fees) of an investment in Class C Shares. A financial intermediary for these purposes is one that, in exchange for compensation, sells, among
other products, mutual fund shares (including shares of the Trust) or provides services for mutual fund shareholders. Financial intermediaries include brokers, dealers, insurance companies, third party administrators and banks. Financial
intermediaries that receive distribution and/or servicing fees may in certain circumstances pay and/or reimburse all or a portion of those fees to their customers, although neither the Trust nor the Distributor are involved in establishing any such
arrangements and may not be aware of their existence.
In addition, the Distributor, the Investment Manager, the Subadviser and their
affiliates from time to time may make payments such as cash bonuses or provide other incentives to selected financial intermediaries as compensation for services such as, without limitation, providing the Funds with shelf space or a
higher profile for the financial intermediaries financial consultants and their customers, placing the Funds on the financial intermediaries preferred or recommended fund list, granting the Distributor, the Investment Manager, the
Subadviser and their affiliates access to the financial intermediaries financial consultants, providing assistance in training and educating the financial intermediaries personnel, and furnishing marketing support and other specified
services. The actual services provided, and the payments made for such services, vary from intermediary to intermediary. These payments may be significant to the financial intermediaries and may also take the form of sponsorship of seminars or
informational meetings or payment for attendance by persons associated with the financial intermediaries at seminars or informational meetings. Financial intermediaries include brokers, dealers, insurance companies, third party administrators and
banks.
A number of factors will be considered in determining the amount of these additional payments to financial intermediaries. On some
occasions, such payments are conditioned upon levels of sales, including the sale of a specified minimum dollar amount of the shares of a Fund, all other series of the Trust, other funds sponsored by the Investment Manager or the Subadviser and/or a
particular class of shares, possibly during a specified period of time. The Distributor, the Investment Manager, the Subadviser and their affiliates may also make payments to certain participating financial intermediaries based upon factors such as
the amount of assets a financial intermediarys clients have invested in the Funds and the quality of the financial intermediarys relationship with the Distributor, the Investment Manager or the Subadviser. The additional payments
described above are made at the expense of the Distributor, the Investment Manager, the Subadviser and their affiliates. These payments are made to financial intermediaries selected by the Distributor, the Investment Manager or the Subadviser,
generally to the intermediaries that have sold significant amounts of shares of the Funds or other Ashmore-sponsored funds. In certain cases, these payments are subject to certain minimum payment levels. In some cases, in lieu of payments pursuant
to a formula, the Distributor, the Investment Manager, the Subadviser and their affiliates may make payments of an agreed-upon amount that normally will not exceed the amount that would have been payable pursuant to the formula. There may be a few
relationships on different bases.
The Distributor, the Investment Manager and their affiliates, at their own expense and out of their own
assets, may also provide compensation to financial intermediaries in connection with conferences, sales, or training programs for their employees, seminars for the public, advertising or sales campaigns, or other financial intermediary-sponsored
special events. In some instances, the compensation may be made available only to certain financial intermediaries whose representatives have sold or are expected to sell significant amounts of shares of the Funds. Intermediaries that are registered
broker-dealers may not use sales of Fund shares to qualify for this compensation to the extent prohibited by the laws or rules of any state or any self-regulatory agency, such as the Financial Industry Regulatory Authority (FINRA).
If investment advisers, distributors or affiliates of mutual funds pay bonuses and incentives in differing amounts, financial intermediaries
and their financial consultants may have financial incentives for recommending a particular mutual fund over other mutual funds. In addition, depending on the arrangements in place at any particular time, a financial intermediary and its financial
consultants may also have a financial incentive for
86
recommending a particular share class over other share classes.
You should consult your financial advisor and review carefully any disclosure by the financial firm as to compensation received
by your financial advisor
.
As of the date of this Statement of Additional Information, the Distributor and the Investment Manager
anticipate that the firms that will receive the additional payments described above for distribution services and/or educational support include:
1. Fidelity: National Financial Services LLC, Fidelity Brokerage Services LLC and Fidelity Investments Institutional Operations, Company Inc.
2. UBS: UBS Financial Services Inc.
3. Pershing: Pershing LLC
4. LPL Financial LLC
5. Charles Schwab & Co., Inc.
6. T. Rowe Price Retirement Plan Services, Inc. and T. Rowe Price Investment Services, Inc.
7. TD AMERITRADE Clearing, Inc. and TD AMERITRADE, Inc.
8. JP Morgan Chase Bank, N.A.
9. Merrill Lynch
The Distributor expects that additional firms may be added to this list from time to time. Representatives of the Distributor, the Investment Manager, the Subadviser or their affiliates intend to visit
brokerage firms on a regular basis to educate financial advisors about the Funds and to encourage the sale of Fund shares to their clients. The costs and expenses associated with these efforts may include travel, lodging, sponsorship at educational
seminars and conferences, entertainment and meals to the extent permitted by law.
Although the Funds use financial intermediaries that sell
Fund shares to effect transactions for the Funds portfolios, the Funds, the Investment Manager and the Subadviser will not consider the sale of Fund shares as a factor when choosing financial intermediaries to effect those transactions.
If in any year the Distributors expenses incurred in connection with the distribution of Class C Shares and, for Class A and Class
C Shares, in connection with the servicing of shareholders and the maintenance of shareholder accounts, exceed the distribution and/or servicing fees paid by the Trust, the Distributor would recover such excess only if the 12b-1 Plan with respect to
such class of shares continues to be in effect in some later year when such distribution and/or servicing fees exceed the Distributors expenses. The Trust is not obligated to repay any unreimbursed expenses that may exist at such time, if any,
as the relevant 12b-1 Plan terminates.
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The following table sets forth the amount paid by the Trust pursuant to the 12b-1 Plans for the last
three fiscal years.
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Year Ended
10/31/13
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Year Ended
10/31/12
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Year Ended
10/31/11
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Fund
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Class A
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Class C
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Class A
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Class C
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Class A
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Class C
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Ashmore Emerging Markets Corporate Debt Fund
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$5,992
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$837
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$133
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$67
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$1
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$5
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Ashmore Emerging Markets Equity Fund
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$32
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$11
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$2
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$2
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$0
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$0
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Ashmore Emerging Markets Frontier Equity Fund
(1)
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N/A
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N/A
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N/A
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N/A
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N/A
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N/A
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Ashmore Emerging Markets Currency Fund
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$2
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$9
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$2
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$9
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$1
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$4
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Ashmore Emerging Markets Local Currency Bond Fund
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$3,736
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$952
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$754
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$43
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$100
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$5
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Ashmore Emerging Markets Small-Cap Equity Fund
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$1,777
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$134
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$253
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$3
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$0
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$0
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Ashmore Emerging Markets Debt Fund
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$24
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$11
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$15
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$11
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$1
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$5
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Ashmore Emerging Markets Total Return Fund
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$20,978
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$8,642
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$2,068
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$1,501
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$507
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$5
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(1)
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The Fund is newly formed and the Trust has not paid any amounts pursuant to the 12b-1 Plans for the Fund for any of the past three fiscal years
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The amounts collected pursuant to the 12b-1 Plan with respect to Class A and C Shares will be used for the
following purposes by the Distributor: sales commissions and other compensation to sales personnel; preparing, printing and distributing sales material and advertising (including preparing, printing and distributing prospectuses to non-shareholders)
and other expenses related to the same.
Additional Payments For Other Services.
The Funds may make payments to financial
intermediaries for sub-administration, sub-transfer agency, or other shareholder services. The Distributor, the Investment Manager, the Subadviser or any of their affiliates may also, from time to time, make such payments to financial intermediaries
out of their own resources and without additional cost to a Fund or its shareholders. These financial intermediaries are firms that, for compensation, provide certain administrative and account maintenance services to mutual fund shareholders. These
financial intermediaries may include, among others, brokers, financial planners or advisers, banks (including bank trust departments), retirement plan and qualified tuition program administrators, third-party administrators, and insurance companies.
In some cases, a financial intermediary may hold its clients shares of a Fund in nominee or street name. Financial intermediaries
may provide shareholder services, which may include, among other things: processing and mailing trade confirmations, periodic statements, prospectuses, annual and semiannual reports, shareholder notices, and other SEC-required communications;
processing tax data; issuing and mailing dividend checks to shareholders who have selected cash distributions; preparing record date shareholder lists for proxy solicitations; collecting and posting distributions to shareholder accounts; and
establishing and maintaining systematic withdrawals and automated investment plans and shareholder account registrations.
The compensation
paid by the Funds or by the Distributor, the Investment Manager, the Subadviser or their affiliates to an intermediary is typically paid continually over time, during the period when the intermediarys clients hold investments in the Fund. The
amount of continuing compensation paid to different financial intermediaries varies. In addition, the Funds or the Distributor, the Investment Manager, the Subadviser and their affiliates may also make payments to financial intermediaries to offset
the cost associated with processing transactions in Fund shares or to pay financial intermediaries one-time charges for setting up access for the Funds on particular platforms, as well as transaction fees, or per position fees.
88
In addition, the Distributor, the Investment Manager, the Subadviser and their affiliates may also make
payments out of their own resources, at no cost to the Funds, to financial intermediaries for services that may be deemed to be primarily intended to result in the sale of Institutional Class Shares of the Funds. These payments may be significant to
the payors and the payees.
SHARE PURCHASES, EXCHANGES AND REDEMPTIONS
Purchases, exchanges and redemptions of the Trusts shares are discussed in the Prospectus, under the headings Share Purchases, Exchanges and
Redemptions and How to Sell or Exchange Shares and that information is incorporated herein by reference. This section of the SAI contains additional information regarding purchases, exchanges and redemptions.
PurchasesInvestment Minimums
. The minimum initial investment in Class A or Class C Shares of any Fund is $1,000, with a minimum
additional investment of $50 per Fund as described in the Prospectus. The minimum investment in Institutional Class Shares of any Fund is $1,000,000, with a minimum additional investment of $5,000 per Fund as described in the Prospectus. The minimum
initial investment may be modified for certain financial intermediaries that submit trades on behalf of underlying investors. The Trust may also lower or waive these minimum investment amounts for certain categories of investors.
To obtain more information about exceptions to the minimum initial investment for Fund Shares, please call the Funds transfer agent at
866-876-8294.
Exchange Privilege.
As described and subject to any limits in the Prospectus under How to Sell or Exchange
Shares and in this SAI, a shareholder may exchange shares of any Fund for shares of the same class of any other series of the Trust that is available for investment, on the basis of their respective net asset values. The original purchase
date(s) of shares exchanged for purposes of calculating any CDSC will carry over to the investment in the new Fund. For example, if a shareholder invests in Class C Shares of one Fund and 6 months later (when the CDSC upon redemption would normally
be 1.00%) exchanges his shares for Class C Shares of another Fund, no sales charge would be imposed upon the exchange, but the investment in the other Fund would be subject to the 1% CDSC until one year after the date of the shareholders
investment in the first Fund as described herein.
Exchanges are subject to any minimum initial purchase requirements for each share class of
each Fund. An exchange will constitute a taxable sale for federal income tax purposes.
With respect to Class C shares, or Class A Shares
subject to a CDSC, if less than all of an investment is exchanged out of a Fund, any portion of the investment exchanged will be from the lot of shares that would incur the lowest CDSC if such shares were being redeemed rather than exchanged.
Shareholders should take into account the effect of any exchange on the applicability of any CDSC that may be imposed upon any subsequent
redemption.
The Trust, the Investment Manager and the Subadviser each reserves the right to refuse exchange purchases (or purchase and
redemption and/or redemption and purchase transactions) if, in the judgment of the Trust, or the Subadviser, the transaction would adversely affect a Fund and its shareholders. In particular, a pattern of transactions characteristic of market
timing strategies may be deemed by the Investment Manager or the Subadviser to be detrimental to the Trust or a particular Fund. Although the Trust has no current intention of terminating or modifying the exchange privilege, it reserves the
right to do so at any time. Except as otherwise permitted by the Securities and Exchange Commission, the Trust will give you 60 days advance notice if it exercises its right to terminate or materially modify the exchange privilege. Because the
Funds will not always be able to detect market timing activity, investors should not assume that the Funds will be able to prevent all market timing or other trading practices that may disadvantage the Funds. For example, it is more difficult for
the
89
Funds to monitor trades that are placed by omnibus or other nominee accounts because the broker, retirement plan administrator, fee-based program sponsor or other financial intermediary maintains
the record of the applicable Funds underlying beneficial owners.
Redemptions.
Other than an applicable CDSC, a shareholder will
not pay any special fees or charges (including any redemption fees) to the Trust or the Distributor when the shareholder sells (redeems) his or her shares. However, if a shareholder sells his or her shares through a broker, dealer or other financial
intermediary, that firm may charge the shareholder a commission or other fee for processing the shareholders redemption request.
Due to
the relatively high cost of maintaining smaller accounts, the Trust reserves the right to redeem shares in any account for their then-current value (which will be promptly paid to the investor) if at any time, due to shareholder redemption, the
shares in the account do not have a value of at least a specified amount. The applicable minimums and other information about such mandatory redemptions are set forth in the applicable Prospectus or in this SAI. The Trusts Declaration of Trust
also authorizes the Trust to redeem shares under certain other circumstances as may be specified by the Board of Trustees. The Funds may also charge periodic account fees for accounts that fall below minimum balances as described in the Prospectus.
Upon the redemption or exchange of Fund shares, the Fund or, in the case of shares purchased through a financial intermediary, the financial
intermediary may be required to provide you and the IRS with cost basis and certain other related tax information about the Fund shares you redeemed or exchanged. See the Funds Prospectus for more information.
Other Information Regarding Purchases, Exchanges and Redemptions
The Distributor does not provide investment advice and will not accept any responsibility for your selection of investments in the Funds as it does not have access to the information necessary to assess
your financial situation.
Pursuant to provisions of agreements between the Distributor and participating brokers, introducing brokers,
service organizations and other financial intermediaries (together, intermediaries) that offer and sell shares and/or process transactions in shares of the Funds, intermediaries are required to engage in such activities in compliance
with applicable federal and state securities laws and in accordance with the terms of the Prospectus and this SAI. Among other obligations, to the extent an intermediary has actual knowledge of violations of Fund policies (as set forth in the then
current Prospectus and this SAI) regarding (i) the timing of purchase, redemption or exchange orders and pricing of Fund shares, or (ii) market timing or excessive short-term trading, the intermediary is required to report such known
violations promptly to the Trust by calling 866-876-8294.
One or more classes of shares of the Funds may not be qualified or registered for
sale in all States. Prospective investors should inquire as to whether shares of a particular Fund, or class of shares thereof, are available for offer and sale in their State of domicile or residence. Shares of a Fund may not be offered or sold in
any State unless registered or qualified in that jurisdiction, unless an exemption from registration or qualification is available.
Persons
selling Fund shares may receive different compensation for selling Class A, Class C or Institutional Class shares of the Funds.
Share
purchases are accepted subject to collection of checks at full value and conversion into federal funds. Payment by a check drawn on any member of the Federal Reserve System can normally be converted into federal funds within five business days after
receipt of the check. Checks drawn on a non-member bank may take up to 15 days to convert into federal funds. In all cases, the purchase price is based on the net asset value next determined after the purchase order and check are accepted, even
though the check may not yet have been converted into federal funds.
90
The Trust reserves the right to require payment by wire or official U.S. bank check. The Trust generally
does not accept payments made by cash, money order, temporary/starter checks, credit cards, travelers checks, credit card checks, or checks drawn on non-U.S. banks even if payment may be effected through a U.S. bank.
You may connect your Fund account(s) with a bank account for subsequent purchases, redemptions and other transactions in Fund shares. Such arrangements
must be requested on your Account Application. To link to your bank account, you may need to have all shareholders of record sign the Account Application and have those signatures guaranteed. See Signature Guarantee below. Trading
privileges will apply to each shareholder of record for the account unless and until the transfer agent receives written instructions from a shareholder of record canceling such privileges. Changes of bank account information must be made by
completing a new application signed by all owners of record of the account, with all signatures guaranteed. The Trust and the transfer agent may rely on any telephone instructions believed to be genuine and will not be responsible to shareholders
for any damage, loss or expenses arising out of such instructions. The Trust reserves the right to amend, suspend or discontinue any such arrangements at any time without prior notice. You cannot link your bank account if you hold your shares of the
Fund through a broker in a street name account or in other omnibus accounts.
Signature Guarantee.
When a signature
guarantee is called for as described in the Prospectus, a medallion signature guarantee will be required. The Stamp 2000 Medallion Guarantee is the only acceptable form of guarantee. Signature guarantees from financial institutions that
are not participating in the Stamp 2000 Medallion Guarantee program will not be accepted. A shareholder can obtain this signature guarantee from a commercial bank, savings bank, credit union, or broker-dealer that participates in this program. The
Trust reserves the right to modify its signature guarantee standards at any time upon notice to shareholders, which may, but is not required to, be given by means of a new or supplemented Prospectus. Shareholders should contact the Trusts
transfer agent for additional details regarding the Trusts signature guarantee requirements.
Account Registration Changes.
Changes in registration or account privileges may be made in writing to the Trusts transfer agent. Signature guarantees may be required. See Signature Guarantee above. All correspondence must include the account number and must be
sent to:
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REGULAR MAIL
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OVERNIGHT OR EXPRESS MAIL
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Ashmore Funds
c/o The Northern
Trust Company
PO Box 4766
Chicago, IL
60680-4766
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Ashmore Funds
c/o The Northern
Trust Company
801 South Canal Street C5S
Chicago, IL 60607
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Transfer on Death Registration.
The Trust may accept transfer on death (TOD) registration
requests from investors. The laws of a state selected by the Trust in accordance with the Uniform TOD Security Registration Act will govern the registration. The Trust may require appropriate releases and indemnifications from investors as a
prerequisite for permitting TOD registration. The Trust may from time to time change these requirements (including by changes to the determination as to which states law governs TOD registration.
Special Arrangements of Financial Intermediaries.
Brokers, dealers, banks and other financial intermediaries provide varying arrangements for
their clients to purchase, exchange and redeem Fund shares. Some may establish higher minimum investment requirements than specified in the Prospectus or this SAI. Financial intermediaries may arrange with their clients for other investment or
administrative services and may independently establish and charge transaction fees and/or other additional amounts to their clients for such services, which charges would reduce clients return. Financial intermediaries also may hold Fund
shares in nominee or street name as agent for and on behalf of their customers. In such instances, the Trusts transfer agent will have no information with respect to or control over accounts of specific shareholders. Such shareholders may
obtain access to their accounts and information about their accounts only from their financial intermediary. In addition, certain privileges with respect to the purchase, exchange and redemption of Fund shares or the
91
reinvestment of dividends may not be available through such firms. Some firms may participate in a program allowing them access to their clients accounts for servicing including, without
limitation, transfers of registration and dividend payee changes; and may perform functions such as generation of confirmation statements and disbursement of cash dividends.