STATEMENT OF ADDITIONAL INFORMATION
PART I
GENERAL
The Trusts and the
Funds
The California Tax Free Bond Fund, the Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund are series of JPMorgan Trust I
(JPMT I), an open-end, management investment company formed as a statutory trust under the laws of the State of Delaware on November 12, 2004, pursuant to a Declaration of Trust dated November 5, 2004, as subsequently amended.
The California Tax Free Bond Fund, the Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund are successor mutual funds to J.P. Morgan Funds that were series of J.P. Morgan Series Trust or J.P. Morgan Mutual Fund Select Trust
(Predecessor Funds) prior to February 18, 2005.
The Funds (other than the California Tax Free Bond Fund, the
Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund) are series of JPMorgan Trust II (JPMT II), an open-end, management investment company formed as a statutory trust under the laws of the State of Delaware on
November 12, 2004, pursuant to a Declaration of Trust dated November 5, 2004, as subsequently amended. The Funds were formerly series of One Group Mutual Funds, a Massachusetts business trust which was formed on May 23, 1985.
Municipal Bond Funds:
The Arizona Municipal Bond Fund, the Michigan Municipal Bond Fund, the Municipal Income Fund, the
Ohio Municipal Bond Fund, the Short-Intermediate Municipal Bond Fund and the Tax Free Bond Fund are collectively referred to as the Municipal Bond Funds.
Tax Free Bond Funds:
The California Tax Free Bond Fund, the Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund are collectively referred to as the Tax Free Funds.
Fund Names.
Prior to February 19, 2005, the Municipal Bond Funds had the following names listed below
corresponding to their current names:
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Former One Group Name
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Current Name
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One Group Arizona Municipal Bond Fund
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JPMorgan Arizona Municipal Bond Fund
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One Group Michigan Municipal Bond Fund
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JPMorgan Michigan Municipal Bond Fund
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One Group Ohio Municipal Bond Fund
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JPMorgan Ohio Municipal Bond Fund
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One Group Short-Term Municipal Bond Fund
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JPMorgan Short-Intermediate Municipal Bond Fund
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One Group Tax-Free Bond Fund
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JPMorgan Tax Free Bond Fund
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The Predecessor Funds were formerly series of the following business trusts (the Predecessor
Trusts):
J.P. Morgan Series Trust (JPMST)
JPMorgan California Tax Free Bond Fund
J.P. Morgan Mutual Fund Select Trust (JPMMFST)
JPMorgan
Intermediate Tax Free Bond Fund
JPMorgan New York Tax Free Bond Fund
Part I - 1
Shareholders of each of the Predecessor Funds approved an Agreement and Plan of
Reorganization and Redomiciliation (Shell Reorganization Agreements) between the Predecessor Trusts, on behalf of the Predecessor Funds, and JPMMFS, on behalf of its series. Pursuant to the Shell Reorganization Agreements, the
Predecessor Funds were reorganized into the corresponding series of JPMMFS effective after the close of business on February 18, 2005 (Closing Date). With respect to events that occurred or payments that were made prior to the
Closing Date, any reference to Fund(s) in this SAI prior to the Closing Date refers to the Predecessor Funds.
On
January 20, 2005, shareholders of JPMMFS approved the redomiciliation of JPMMFS as a Delaware statutory trust to be called JPMorgan Trust I (Redomiciliation). The Redomiciliation took place after the close of business on
the Closing Date, at which time each Fund became a series of JPMorgan Trust I. The Redomiciliation was effective after each of the reorganizations pursuant to the Shell Reorganization Agreements.
JPMST.
Prior to February 19, 2005, the California Tax Free Bond Fund was a series of JPMST, an open-end management investment
company which was organized as a Massachusetts business trust on August 15, 1996.
JPMMFST.
Prior to
February 19, 2005, the Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund were series of JPMMFST, an open-end management investment company which was organized as a Massachusetts business trust on October 1, 1996.
After the close of business on February 18, 2005, the JPMorgan Intermediate Tax Free Income Fund acquired all of the
assets and liabilities of One Group Intermediate Tax-Free Bond Fund pursuant to an Agreement and Plan of Reorganization dated November 22, 2004 between JPMMFST, on behalf of JPMorgan Intermediate Tax Free Income Fund, and One Group Mutual
Funds, on behalf of One Group Intermediate Tax-Free Bond Fund (Merger Agreement). Following the merger, the terms of which were set forth in the Merger Agreement, the JPMorgan Intermediate Tax Free Income adopted the name JPMorgan
Intermediate Tax Free Bond Fund effective February 19, 2005.
Fund Names.
Effective February 19, 2005,
the following Predecessor Funds were renamed with the approval of the Board of Trustees of JPMST or JPMMFST, as applicable:
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New Name
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Former Name
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JPMorgan California Tax Free Bond Fund
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JPMorgan California Bond Fund
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JPMorgan Intermediate Tax Free Bond Fund
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JPMorgan Intermediate Tax Free Income Fund
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JPMorgan New York Tax Free Bond Fund
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JPMorgan New York Intermediate Tax Free Income Fund
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JPMorgan Short Term Municipal Bond Fund
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One Group Short-Term Municipal Bond Fund
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Effective April 30, 2009, the JPMorgan Short Term Municipal Bond Fund (formerly the One Group
Short-Term Municipal Bond Fund) was renamed, with the approval of the Board of Trustees of JPMT II, to the JPMorgan Short-Intermediate Municipal Bond Fund. For ease of reference, throughout this SAI, the Board of Trustees of JPMT I, the Board of
Trustees of JPMT II and the Boards of Trustees of the Predecessor Trusts are referred to herein collectively as the Board of Trustees.
Share Classes
Shares in the Funds of the
Trusts are generally offered in multiple classes. The Board of Trustees of JPMT I and JPMT II has authorized the issuance and sale of the following share classes of the Funds:
Part I - 2
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Fund
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Class A
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Class B
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Class C
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Select Class
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Institutional
Class
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Arizona Municipal Bond Fund
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X
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X
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X
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X
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Michigan Municipal Bond Fund
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X
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X
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X
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X
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Municipal Income Fund
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X
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X
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X
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X
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Ohio Municipal Bond Fund
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X
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X
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X
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X
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Short-Intermediate Municipal Bond Fund*
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X
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X
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X
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X
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X
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Tax Free Bond Fund
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X
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X
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X
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X
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California Tax Free Bond Fund
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X
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X
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X
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X
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Intermediate Tax Free Bond Fund
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X
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X
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X
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X
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X
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New York Tax Free Bond Fund
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X
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X
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X
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X
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X
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*
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Effective April 30, 2009, the Fund changed its name from the Short Term Municipal Bond Fund to the Short-Intermediate Municipal Bond Fund.
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Miscellaneous
This SAI describes the financial history, investment strategies and policies, management and operation of each of the Funds in order to enable investors to select the Fund or Funds which best suit their
needs.
This SAI provides additional information with respect to the Funds and should be read in conjunction with the relevant
Funds current Prospectuses. Capitalized terms not otherwise defined herein have the meanings accorded to them in the applicable Prospectus. The Funds executive offices are located at 270 Park Avenue, New York, NY 10017.
This SAI is divided into two Parts Part I and Part II. Part I of this SAI contains information that is particular to each Fund.
Part II of this SAI contains information that generally applies to the Funds and other series representing separate investment funds or portfolios of JPMT I, JPMT II, J.P. Morgan Mutual Fund Group (JPMMFG), J.P. Morgan Mutual Fund
Investment Trust (JPMMFIT), and J.P. Morgan Fleming Mutual Fund Group, Inc. (JPMFMFG) (each a J.P. Morgan Fund, and together with the Funds, the J.P. Morgan Funds). JPMMFG liquidated effective
November 29, 2012 and is in the process of winding up its affairs. Throughout this SAI, JPMT I, JPMT II, JPMMFG, JPMMFIT, and JPMFMFG are each referred to as a Trust and collectively, as the Trusts. Each Trusts
Board of Trustees, or Board of Directors in the case of JPMFMFG, is referred to herein as the Board of Trustees and each trustee or director is referred to as a Trustee.
The Funds are advised by J.P. Morgan Investment Management Inc. (JPMIM). Certain other of the J.P. Morgan Funds are
advised by Security Capital Research & Management Incorporated (SCR&M), and/or sub-advised by J.P. Morgan Private Investment Inc. (JPMPI), JF International Management Inc. (JFIMI) or Highbridge
Capital Management, LLC (HCM). JPMIM, SCR&M, JPMPI, JFIMI and HCM are also referred to herein as the Advisers and, individually, as the Adviser. JPMPI, JFIMI and HCM are also referred to herein as the
Sub-Advisers and, individually, as the Sub-Adviser. Effective January 1, 2010, the investment advisory business of JPMorgan Investment Advisors Inc. (JPMIA), which was the adviser for certain of the J.P.
Part I - 3
Morgan Funds, was transferred to JPMIM and JPMIM became the investment adviser for certain other of the J.P. Morgan Funds that were previously advised by JPMIA.
Investments in the Funds are not deposits or obligations of, or guaranteed or endorsed by, JPMorgan Chase Bank, N.A. (JPMorgan Chase
Bank), an affiliate of the Adviser, or any other bank. Shares of the Funds are not federally insured or guaranteed by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other governmental agency. An investment in the
Funds is subject to risk that may cause the value of the investment to fluctuate, and when the investment is redeemed, the value may be higher or lower than the amount originally invested by the investor.
INVESTMENT POLICIES
The following investment policies have been adopted by the Trusts with respect to the applicable Funds. The investment restrictions listed below under the heading Fundamental Investment
Policies are fundamental policies which, under the Investment Company Act of 1940, as amended (the 1940 Act), may not be changed without the vote of a majority of the outstanding voting securities of a Fund, as such
term is defined in Additional Information in Part II of this SAI. All other investment policies of a Fund (including its investment objectives) are non-fundamental, unless otherwise designated in the Prospectuses or herein, and may be
changed by the Trustees of the Fund without shareholder approval.
Except for the restrictions on borrowings set forth below,
the percentage limitations contained in the policies below apply at the time of purchase of the securities. If a percentage or rating restriction on investment or use of assets set forth in a fundamental investment policy or a non-fundamental
investment policy or in a Prospectus is adhered to at the time of investment, later changes in percentage resulting from any cause other than actions by the Fund will not be considered a violation. If the value of the Funds holdings of
illiquid securities at any time exceeds the percentage limitation applicable at the time of acquisition due to subsequent fluctuations in value or other reasons, the Board of Trustees will consider what actions, if any, are appropriate to maintain
adequate liquidity. With respect to each fundamental investment policy regarding borrowing, the 1940 Act generally limits a Funds ability to borrow money on a non-temporary basis if such borrowings constitute senior securities. As
noted in Investment Strategies and Policies Miscellaneous Investment Strategies and Risks Borrowings in the SAI Part II, in addition to temporary borrowing, a Fund may borrow from any bank, provided that immediately after
any such borrowing there is an asset coverage of at least 300% for all borrowings by a Fund and provided further, that in the event that such asset coverage shall at any time fall below 300%, a Fund shall, within three days (not including Sundays
and holidays) thereafter or such longer period as the SEC may prescribe by rules and regulations, reduce the amount of its borrowings to such an extent that the asset coverage of such borrowing shall be at least 300%.
For purposes of fundamental investment policies regarding industry concentration, the Adviser may classify issuers by industry in
accordance with classifications set forth in the Directory of Companies Filing Annual Reports with the U.S. Securities and Exchange Commission (SEC) or other sources. In the absence of such classification or if the Adviser determines in
good faith based on its own information that the economic characteristics affecting a particular issuer make it more appropriate to be considered engaged in a different industry, the Adviser may classify an issuer accordingly. Accordingly, the
composition of an industry or group of industries may change from time to time.
INVESTMENT RESTRICTIONS AND POLICIES OF THE
FUNDS THAT ARE SERIES OF JPMT II
Fundamental Investment Policies.
Part I - 4
The Tax Free Bond Fund, the Short-Intermediate Municipal Bond Fund and the Municipal Income Fund may not:
1. Purchase securities of any issuer if such purchase would not be consistent with the maintenance of the
Funds status as a diversified company under the 1940 Act, or the rules or regulations thereunder, as such statute, rules or regulations may be amended from time to time.
2. Purchase any securities that would cause more than 25% of the total assets of a Fund to be invested in the securities of one or more issuers conducting their principal business
activities in the same industry, provided that this limitation does not apply to Municipal Securities or governmental guarantees of Municipal Securities, and with respect to the Municipal Income Fund, housing authority obligations. For purposes of
this limitation (i) utilities will be divided according to their services (for example, gas, gas transmission, electric and telephone will each be considered a separate industry); and (ii) wholly-owned finance companies will be considered
to be in the industries of their parents if their activities are primarily related to financing the activities of their parents.
The
Arizona Municipal Bond Fund, the Michigan Municipal Bond Fund and the Ohio Municipal Bond Fund may not:
1. Purchase any securities that would cause more than 25% of the total assets of a Fund to be invested in the securities
of one or more issuers conducting their principal business activities in the same industry, provided that (i) this limitation does not apply to investments in obligations issued or guaranteed by the U.S. government or its agencies and
instrumentalities and repurchase agreements involving such securities; and (ii) this limitation does not apply to Municipal Securities or Ohio Municipal Securities, Arizona Municipal Securities, and Michigan Municipal Securities. For purposes
of this limitation (i) utilities will be divided according to their services (for example, gas, gas transmission, electric and telephone will each be considered a separate industry); and (ii) wholly-owned finance companies will be
considered to be in the industries of their parents if their activities are primarily related to financing the activities of their parents. In addition, with respect to the Arizona Municipal Bond Fund, for purposes of this limitation only, private
activity bonds that are backed only by the assets and revenues of a non-governmental issued shall not be deemed to be Municipal Securities or Arizona Municipal Securities (for the Arizona Municipal Bond Fund).
The following policy applies to the Arizona Municipal Bond Fund:
Under normal circumstances, the Fund invests at least 80% of its net assets in municipal bonds, the income from which is exempt from both federal and Arizona personal income tax. For purposes of this
policy, the Funds net assets include borrowings by the Fund for investment purposes.
The following policy applies to the Michigan
Municipal Bond Fund:
Under normal circumstances, the Fund invests at least 80% of its net assets in municipal bonds, the
income from which is exempt from both federal and Michigan personal income tax. For purposes of this policy, the Funds net assets include borrowings by the Fund for investment purposes.
The following policy applies to the Ohio Municipal Bond Fund:
Under normal
circumstances, the Fund invests at least 80% of its net assets in municipal bonds, the income from which is exempt from both federal and Ohio personal income tax. For purposes of this policy, the Funds net assets include borrowings by the Fund
for investment purposes.
The following policy applies to the Short-Intermediate Municipal Bond Fund, the Tax Free Bond Fund and the
Municipal Income Fund:
Under normal circumstances, the Fund will invest at least 80% of its net assets in municipal bonds,
the income from which is exempt from federal income tax. For purposes of this policy, the Funds net assets include borrowings by the Fund for investment purposes.
Part I - 5
The following policy applies to the Municipal Income Fund:
Under normal market circumstances, at least 80% of the assets of the Municipal Income Fund will be invested in Municipal Securities.
None of the Municipal Bond Funds may:
1. Make loans, except that a Fund may (i) purchase or hold debt instruments in accordance with its investment objective and policies; (ii) enter into repurchase agreements;
(iii) engage in securities lending as described in this Prospectus and in the Statement of Additional Information and (iv) make loans to the extent permitted by an order issued by the SEC.
None of the Funds may:
1. Purchase securities on margin or sell securities short except, in the case of the Municipal Bond Funds, for use of
short-term credit necessary for clearance of purchases of portfolio securities.
2. Underwrite the securities
of other issuers except to the extent that a Fund may be deemed to be an underwriter under certain securities laws in the disposition of restricted securities.
3. Purchase physical commodities or contracts relating to physical commodities, except as permitted under the 1940 Act, or operate as a commodity pool, in each case as interpreted or
modified by the regulatory authority having jurisdiction, from time to time.
4. Purchase participation or
other direct interests in oil, gas or mineral exploration or development programs (although investments by all Funds in marketable securities of companies engaged in such activities are not hereby precluded).
5. Borrow money, except to the extent permitted under the 1940 Act, or the rules or regulations thereunder, as such
statute, rules or regulations may be amended from time to time.
6. Purchase securities of other investment
companies except as permitted by the 1940 Act and rules, regulations and applicable exemptive relief thereunder.
7. Issue senior securities except with respect to any permissible borrowings.
8. Purchase or sell real estate (however, each Fund may, to the extent appropriate to its investment objective, purchase
securities secured by real estate or interests therein or securities issued by companies investing in real estate or interests therein).
Non-Fundamental Policies.
The following investment policies are non-fundamental and therefore can be changed by the Board of Trustees without prior shareholder approval.
The Arizona Municipal Bond Fund, the Michigan Municipal Bond Fund and the Ohio Municipal Bond Fund will not:
1. Purchase the securities of an issuer if as a result more than 5% of its total assets would be invested in the
securities of that issuer or the Fund would own more than 10% of the outstanding voting securities of that issuer. This does not include securities issued or guaranteed by the United States, its agencies or instrumentalities, securities of other
investment companies, and repurchase agreements involving these securities. This restriction applies with respect to 50% of the Funds total assets. For purposes of these limitations, a security is considered to be issued by the government
entity whose assets and revenues guarantee or back the security. With respect to private activity bonds or industrial development bonds
Part I - 6
backed only by the assets and revenues of a non-governmental user, such user would be considered the issuer.
No Municipal Bond Fund may:
1. Invest in illiquid
securities in an amount exceeding, in the aggregate 15% of the Funds net assets. An illiquid security is a security which cannot be disposed of promptly (within seven days) and in the usual course of business without a loss, and includes
repurchase agreements maturing in excess of seven days, time deposits with a withdrawal penalty, non-negotiable instruments and instruments for which no market exists.
No Municipal Bond Fund may:
1. Acquire the securities of
registered open-end investment companies or registered unit investment trusts in reliance on Section 12(d)(1)(F) or 12(d)(1)(G) of the 1940 Act.
INVESTMENT RESTRICTIONS AND POLICIES OF THE FUNDS THAT ARE SERIES OF JPMT I
Fundamental
Investment Policies.
(1) (a) The California Tax Free Bond Fund may not purchase any security which would
cause the Fund to concentrate its investments in the securities of issuers primarily engaged in any particular industry except as permitted by the SEC;
(b) The Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not purchase the securities of any issuer (other than securities issued or guaranteed by the U.S. government or any of its
agencies or instrumentalities, or repurchase agreements secured thereby) if, as a result, more than 25% of the Funds total assets would be invested in the securities of companies whose principal business activities are in the same industry.
Notwithstanding the foregoing, with respect to a Funds permissible futures and options transactions in U.S. government securities, positions in options and futures shall not be subject to this restriction. Industrial development bonds, where
the payment of principal and interest is the ultimate responsibility of companies within the same industry, are grouped together as an industry. However, it is not applicable to investments by a Fund in municipal obligations where the
issuer is regarded as a state, city, municipality or other public authority since such entities are not members of an industry. Supranational organizations are collectively considered to be members of any industry;
(2) (a) The California Tax Free Bond Fund may not issue senior securities, except as permitted under the
1940 Act or any rule, order or interpretation thereunder;
(b) The Intermediate Tax Free Bond Fund and the New
York Tax Free Bond Fund may not issue any senior security (as defined in the 1940 Act), except that (i) a Fund may engage in transactions that may result in the issuance of senior securities to the extent permitted under applicable regulations
and interpretations of the 1940 Act or an exemptive order; (ii) a Fund may acquire other securities, the acquisition of which may result in the issuance of a senior security, to the extent permitted under applicable regulations or
interpretations of the 1940 Act; and (iii) subject to the restrictions set forth above, a Fund may borrow money as authorized by the 1940 Act. For purposes of this restriction, collateral arrangements with respect to a Funds permissible
options and futures transactions, including deposits of initial and variation margin, are not considered to be the issuance of a senior security;
(3) The California Tax Free Bond Fund, Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not borrow money, except to the extent permitted by applicable law;
Part I - 7
(4) The Tax Free Funds may not underwrite securities of other issuers,
except to the extent that the Fund, in disposing of portfolio securities, may be deemed an underwriter within the meaning of the 1933 Act;
(5) (a) The California Tax Free Bond Fund may not purchase or sell real estate, except that, to the extent permitted by applicable law, the Fund may (a) invest in securities or
other instruments directly or indirectly secured by real estate, (b) invest in securities or other instruments issued by issuers that invest in real estate and (c) may make direct investments in mortgages;
(b) The Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not purchase or sell real estate unless
acquired as a result of ownership of securities or other instruments (but this shall not prevent a Fund from investing in securities or other instruments backed by real estate or securities of companies engaged in the real estate business).
Investments by a Fund in securities backed by mortgages on real estate or in marketable securities of companies engaged in such activities are not hereby precluded. Real estate includes Real Estate Limited Partnerships;
(6) (a) The California Tax Free Bond Fund may not purchase or sell commodities or commodity contracts unless
acquired as a result of ownership of securities or other instruments issued by persons that purchase or sell commodities or commodities contracts; but this shall not prevent the Fund from purchasing, selling and entering into financial futures
contracts (including futures contracts on indices of securities, interest rates and currencies), options on financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), warrants, swaps, forward
contracts, foreign currency spot and forward contracts or other derivative instruments that are not related to physical commodities;
(b) The Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not purchase or sell physical commodities unless acquired as a result of ownership of securities or other instruments but
this shall not prevent a Fund from (i) purchasing or selling options and futures contracts or from investing in securities or other instruments backed by physical commodities or (ii) engaging in forward purchases or sales of foreign
currencies or securities;
(7) The Funds may make loans to other persons, in accordance with the Funds
investment objective and policies and to the extent permitted by applicable law; and
(8) All of the Funds
have an 80% investment policy which is fundamental and may not be changed without shareholder approval.
The following policy applies to
the California Tax Free Bond Fund:
As a fundamental policy, the Fund normally invests at least 80% of the value of its
Assets in municipal securities, the income from which is exempt from federal and state personal income taxes for California residents and not subject to the federal alternative minimum tax on individuals. Assets means net assets, plus
the amount of borrowings for investment purposes.
The following policy applies to the New York Tax Free Bond Fund:
As a fundamental policy, the Fund normally invests at least 80% of the value of its Assets in municipal obligations whose interest
payments are excluded from gross income for federal income tax purposes and exempt from New York State and New York City personal income taxes, and not subject to the federal alternative minimum tax on individuals. Assets means net
assets, plus the amount of borrowings for investment purposes.
In addition, as a matter of fundamental policy, notwithstanding
any other investment policy or restriction, each of the Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may
Part I - 8
seek to achieve its investment objective by investing all of its investable assets in another investment company having substantially the same investment objective and policies as the Fund.
Non-Fundamental Investment Policies.
The investment policies described below are non-fundamental policies of the Tax
Free Funds and may be changed by the Trustees of the Funds without shareholder approval. These non-fundamental investment policies require that:
(1) The Tax Free Funds may not acquire any illiquid securities, such as repurchase agreements with more than seven days to maturity or fixed time deposits with a duration of over seven
calendar days, if as a result thereof, more than 15% of the market value of the Funds net assets would be in investments which are illiquid;
(2) The Tax Free Funds may not purchase securities on margin, make short sales of securities, or maintain a short position, provided that this restriction shall not be deemed to be
applicable to the purchase or sale of when-issued or delayed delivery securities, or to short sales that are covered in accordance with SEC rules;
(3) The Tax Free Funds may not acquire securities of other investment companies, except as permitted by the 1940 Act or any order pursuant thereto;
(4) The Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not, with respect to 50% of its total
assets, hold more than 10% of the outstanding voting securities of any issuer;
(5) The Intermediate Tax Free
Bond Fund and the New York Tax Free Bond Fund may not purchase or sell interests in oil, gas or mineral leases;
(6) The Intermediate Tax Free Bond Fund and the New York Tax Free Bond Fund may not write, purchase or sell any put or
call option or any combination thereof, provided that this shall not prevent (i) the writing, purchasing or selling of puts, calls or combinations thereof with respect to portfolio securities or (ii) with respect to a Funds
permissible futures and options transactions, the writing, purchasing, ownership, holding or selling of futures and options positions or of puts, calls or combinations thereof with respect to futures.
(7) The Tax Free Funds may not acquire the securities of registered open-end investment companies or registered unit
investment trusts in reliance on Section 12(d)(1)(F) or 12(d)(1)(G) of the 1940 Act.
For purposes of the Tax Free
Funds investment policies, the issuer of a tax-exempt security is deemed to be the entity (public or private) ultimately responsible for the payment of the principal of and interest on the security.
INVESTMENT PRACTICES
The Funds invest in a variety of securities and employ a number of investment techniques. What follows is a list of some of the securities and techniques which may be utilized by the Funds. For a more
complete discussion, see the Investment Strategies and Policies section in Part II of this SAI.
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FUND NAME
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FUND CODE
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Arizona Municipal Bond
Fund
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1
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Michigan Municipal Bond
Fund
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2
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Municipal Income Fund
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3
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Part I - 9
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Ohio
Municipal Bond Fund
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4
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Short-Intermediate Municipal Bond
Fund
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5
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Tax Free Bond Fund
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6
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California Tax Free Bond
Fund
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7
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Intermediate Tax Free Bond
Fund
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8
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New York Tax Free Bond
Fund
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9
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Instrument
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Fund Code
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Part II
Section Reference
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Adjustable Rate Mortgage Loans (ARMs):
Loans in a mortgage pool which
provide for a fixed initial mortgage interest rate for a specified period of time, after which the rate may be subject to periodic adjustments.
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5
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Mortgage-Related Securities
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Asset-Backed Securities:
Securities secured by company receivables, home equity
loans, truck and auto loans, leases, and credit card receivables or other securities backed by other types of receivables or other assets.
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1-9
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Asset-Backed Securities
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Auction Rate Securities:
Auction rate municipal securities and auction rate preferred
securities issued by closed-end investment companies.
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1-9
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Auction Rate Securities
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Bank Obligations:
Bankers acceptances, certificates of deposit and time
deposits. Bankers acceptances are bills of exchange or time drafts drawn on and accepted by a commercial bank. Maturities are generally six months or less. Certificates of deposit and time deposits are non-negotiable receipts issued by a bank
in exchange for the deposit of funds.
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|
1-9
|
|
Bank Obligations
|
Borrowings:
A Fund may borrow for temporary purposes and/or for investment purposes.
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. A Fund must maintain continuous asset coverage of 300% of the amount borrowed, with
the exception for borrowings not in excess of 5% of the Funds total assets made for temporary administrative purposes.
|
|
1-9
|
|
Miscellaneous Investment Strategies and Risks
|
Call and Put Options:
A call option gives the buyer the right to buy, and obligates
the seller of the option to sell a security at a specified price at a future date. A put option gives the buyer the right to sell, and obligates the seller of the option to buy a security at a specified price at a future date.
|
|
1-9
|
|
Options and Futures Transactions
|
Part I - 10
|
|
|
|
|
Commercial Paper:
Secured and unsecured short-term
promissory notes issued by corporations and other entities. Maturities generally vary from a few days to nine months.
|
|
1-9
|
|
Commercial Paper
|
Corporate Debt Securities:
May include bonds and other debt securities of domestic
and foreign issuers, including obligations of industrial, utility, banking and other corporate issuers.
|
|
1-9
|
|
Debt Instruments
|
Credit Default Swap (CDS):
A swap agreement between two parties pursuant
to which one party pays the other a fixed periodic coupon for the specified life of the agreement. The other party makes no payment unless a credit event, relating to a predetermined reference asset, occurs. If such an event occurs, the party will
then make a payment to the first party, and the swap will terminate.
|
|
1-9
|
|
Swaps and Related Swap Products
|
Custodial Receipts:
A Fund may acquire securities in the form of custodial receipts
that evidence ownership of future interest payments, principal payments or both on certain U.S. Treasury notes or bonds in connection with programs sponsored by banks and brokerage firms. These are not considered to be U.S. government securities.
These notes and bonds are held in custody by a bank on behalf of the owners of the receipts.
|
|
1-9
|
|
Custodial Receipts
|
Demand Features:
Securities that are subject to puts and standby commitments to
purchase the securities at a fixed price (usually with accrued interest) within a fixed period of time following demand by a Fund.
|
|
1-9
|
|
Demand Features
|
Exchange Traded Funds (ETFs):
Ownership interest in unit investment
trusts, depositary receipts, and other pooled investment vehicles that hold a portfolio of securities or stocks designed to track the price performance and dividend yield of a particular broad based, sector or international index. ETFs include a
wide range of investments such as iShares, Standard & Poors Depositary Receipts (SPDRs) and NASDAQ 100s.
|
|
1-9
|
|
Investment Company Securities and Exchange Traded Funds
|
High Yield/High Risk Securities/Junk Bonds:
Securities that are generally rated below
investment grade by the primary rating agencies or are unrated but deemed by a Funds adviser to be of comparable quality.
|
|
1-9
|
|
Debt Instruments
|
Part I - 11
|
|
|
|
|
Interfund Lending:
Involves lending money and borrowing
money for temporary purposes through a credit facility.
|
|
1-9
|
|
Miscellaneous Investment Strategies and
Risks
|
Inverse Floating Rate Instruments:
Leveraged variable debt instruments with interest
rates that reset in the opposite direction from the market rate of interest to which the inverse floater is indexed.
|
|
1-9
|
|
Inverse Floating and Interest Rate Caps
|
Investment Company Securities:
Shares of other investment companies, including money
market funds for which the adviser and/or its affiliates serve as investment adviser or administrator. The adviser will waive certain fees when investing in funds for which it serves as investment adviser, to the extent required by law.
|
|
1-9
|
|
Investment Company Securities and Exchange Traded Funds
|
Loan Assignments and Participations:
Assignments of, or participations in, all or a
portion of loans to corporations or to governments, including governments in less developed countries.
|
|
1-9
|
|
Loans
|
Mortgage-Backed Securities:
Debt obligations secured by real estate loans and pools
of loans such as collateralized mortgage obligations (CMOs), commercial mortgage-backed securities (CMBSs) and other asset-backed structures.
|
|
1-9
|
|
Mortgage-Related Securities
|
Mortgage Dollar Rolls:
A transaction in which a Fund sells securities for delivery in
a current month and simultaneously contracts with the same party to repurchase similar but not identical securities on a specified future date.
|
|
5
|
|
Mortgage-Related Securities
|
Municipal Securities:
Securities issued by a state or political subdivision to obtain
funds for various public purposes. Municipal securities include, among others, private activity bonds and industrial development bonds, as well as general obligation notes, tax anticipation notes, bond anticipation notes, revenue anticipation notes,
other short-term tax-exempt obligations, municipal leases, obligations of municipal housing authorities and single family revenue bonds.
|
|
1-9
|
|
Municipal Securities
|
New Financial Products:
New options and futures contracts and other financial
products continue to be developed and a Fund may invest in such options, contracts and products.
|
|
1-9
|
|
Miscellaneous Investment Strategies and Risks
|
Part I - 12
|
|
|
|
|
Obligations of Supranational Agencies:
Obligations
which are chartered to promote economic development and are supported by various governments and governmental agencies.
|
|
5
|
|
Foreign Investments (including Foreign
Currencies)
|
Options and Futures Transactions:
A Fund may purchase and sell (a) exchange
traded and over the counter put and call options on securities, indexes of securities and futures contracts on securities and indexes of securities, and (b) futures contracts on securities and indexes of securities.
|
|
1-9
|
|
Options and Futures Transactions
|
Preferred Stock:
A class of stock that generally pays a dividend at a specified rate
and has preference over common stock in the payment of dividends and in liquidation.
|
|
5
|
|
Equity Securities, Warrants and Rights
|
Private Placements, Restricted Securities and Other Unregistered Securities:
Securities not registered under the Securities Act of 1933 such as privately placed commercial paper and Rule 144A securities.
|
|
1-9
|
|
Miscellaneous Investment Strategies and Risks
|
Repurchase Agreements:
The purchase of a security and the simultaneous commitment to
return the security to the seller at an agreed upon price on an agreed upon date. This is treated as a loan.
|
|
1-9
|
|
Repurchase Agreements
|
Reverse Repurchase Agreements:
The sale of a security and the simultaneous commitment
to buy the security back at an agreed upon price on an agreed upon date. This is treated as borrowing by a Fund.
|
|
5
|
|
Reverse Repurchase Agreements
|
Securities Lending:
The lending of up to 33
1
/
3
% of a Funds total assets. In return, a Fund will receive cash, other securities, and/or letters of credit as collateral.
|
|
1-9
|
|
Securities Lending
|
Short-Term Funding Agreements:
Agreements issued by banks and highly rated U.S.
insurance companies such as Guaranteed Investment Contracts (GICs) and Bank Investment Contracts (BICs).
|
|
1-9
|
|
Short-Term Funding Agreements
|
Part I - 13
|
|
|
|
|
Sovereign Obligations:
Investments in debt obligations
issued or guaranteed by a foreign sovereign government or its agencies, authorities or political subdivisions.
|
|
5
|
|
Foreign Investments (including Foreign
Currencies)
|
Stripped Mortgage-Backed Securities:
Derivative multi-class mortgage securities which
are usually structured with two classes of shares that receive different proportions of the interest and principal from a pool of mortgage assets. These include Interest Only (IO) and Principal Only (PO) securities issued
outside a Real Estate Mortgage Investment Conduit (REMIC) or CMO structure.
|
|
1-9
|
|
Mortgage-Related Securities
|
Structured Investments:
A security having a return tied to an underlying index or
other security or asset class. Structured investments generally are individually negotiated agreements and may be traded over-the-counter. Structured investments are organized and operated to restructure the investment characteristics of the
underlying security.
|
|
1-9
|
|
Structured Investments
|
Swaps and Related Swap Products:
Swaps involve an exchange of obligations by two
parties. Caps and floors entitle a purchaser to a principal amount from the seller of the cap or floor to the extent that a specified index exceeds or falls below a predetermined interest rate or amount. A Fund may enter into these transactions to
manage its exposure to changing interest rates and other factors.
|
|
1-9
|
|
Swaps and Related Swap Products
|
Synthetic Variable Rate Instruments:
Instruments that generally involve the deposit
of a long-term tax exempt bond in a custody or trust arrangement and the creation of a mechanism to adjust the long-term interest rate on the bond to a variable short-term rate and a right (subject to certain conditions) on the part of the purchaser
to tender it periodically to a third party at par.
|
|
1-9
|
|
Swaps and Related Swap Products
|
Temporary Defensive Positions:
To respond to unusual circumstances a Fund may invest
in cash and cash equivalents for temporary defensive purposes.
|
|
1-9
|
|
Miscellaneous Investment Strategies and Risks
|
Part I - 14
|
|
|
|
|
Treasury Receipts:
A Fund may purchase interests in
separately traded interest and principal component parts of U.S. Treasury obligations that are issued by banks or brokerage firms and that are created by depositing U.S. Treasury notes and U.S. Treasury bonds into a special account at a custodian
bank. Receipts include Treasury Receipts (TRs), Treasury Investment Growth Receipts (TIGRs), and Certificates of Accrual on Treasury Securities (CATS).
|
|
1-9
|
|
Treasury Receipts
|
U.S. Government Agency Securities:
Securities issued by agencies and
instrumentalities of the U.S. government. These include all types of securities issued or guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae) and the
Federal Home Loan Mortgage Corporation (Freddie Mac), including funding notes, subordinated benchmark notes, CMOs and REMICs.
|
|
1-9
|
|
Mortgage-Related Securities
|
U.S. Government Obligations:
May include direct obligations of the U.S. Treasury,
including Treasury bills, notes and bonds, all of which are backed as to principal and interest payments by the full faith and credit of the United States, and separately traded principal and interest component parts of such obligations that are
transferable through the Federal book-entry system known as Separate Trading of Registered Interest and Principal of Securities (STRIPS) and Coupon Under Book Entry Safekeeping (CUBES).
|
|
1-9
|
|
U.S. Government Obligations
|
Variable and Floating Rate Instruments:
Obligations with interest rates which are
reset daily, weekly, quarterly or some other frequency and which may be payable to a Fund on demand or at the expiration of a specified term.
|
|
1-9
|
|
Debt Instruments
|
When-Issued Securities, Delayed Delivery Securities and Forward Commitments:
Purchase
or contract to purchase securities at a fixed price for delivery at a future date.
|
|
1-9
|
|
When-Issued Securities, Delayed Delivery Securities and Forward
Commitments
|
Zero-Coupon, Pay-in-Kind and Deferred Payment Securities:
Zero-coupon securities are
securities that are sold at a discount to par value and on which interest payments are not made during the life of the security. Pay-in-kind securities are securities that have interest payable by delivery of additional securities. Deferred payment
securities are zero-coupon debt securities which convert on a specified date to interest bearing debt securities.
|
|
1-9
|
|
Debt Instruments
|
ADDITIONAL INFORMATION REGARDING FUNDS INVESTMENT PRACTICES
Part I - 15
The following information is a summary of special factors that may affect any Fund invested
in municipal securities from the States of Arizona, California, Michigan, New York and Ohio and is derived from public official documents relating to securities offerings of state issuers, which generally are available to investors. The following
information constitutes only a brief summary of the information in such public official documents; it has not been independently verified and does not purport to be a complete description of all considerations regarding investment in the municipal
securities discussed below. Information provided herein may not be current and is subject to change rapidly, substantially and without notice.
The value of the shares of the Funds discussed in this section may fluctuate more widely than the value of shares of a portfolio investing in securities relating to a number of different states. The
ability of state, county or other local governments to meet their obligations will depend primarily on the availability of tax and other revenues to those governments and on their fiscal conditions generally.
Further, downgrades of certain municipal securities insurers during the recent recession negatively impacted the price of certain insured
municipal securities. Given the large number of potential claims against municipal securities insurers, there is a risk that they will be unable to meet all future claims. The perceived increased likelihood of default among municipal issuers
resulted in constrained liquidity, increased price volatility and credit downgrades of municipal issuers. Local and national market forces, such as declines in real estate prices and general business activity, may result in decreasing tax bases,
fluctuations in interest rates, and increasing construction costs, all of which could reduce the ability of certain municipal issuers to repay their obligations. Certain municipal issuers have also been unable to obtain additional financing through,
or must pay higher interest rates on, new issues, which may reduce revenues available for municipal issuers to pay existing obligations. In addition, in certain circumstances it may be difficult for investors to obtain reliable information on the
obligations underlying municipal securities. Adverse developments in the municipal securities market may negatively affect the value of all or a substantial portion of a Funds municipal securities.
Arizona Municipal Securities
As used in this SAI, the term Arizona Municipal Securities refers to municipal securities, the income from which is exempt from both federal and Arizona personal income tax.
Risk Factors Affecting Arizona Municipal Securities.
Given that the Arizona Municipal Bond Fund is invested primarily in Arizona
Municipal Securities, the Fund is subject to risks relating to the economy of the state of Arizona (as used in this section, the State) and the financial condition of the State and local governments and their agencies.
Overview of State Economy
. Although Arizona has a diverse economy, the trade, transportation and public utilities, professional and
business services, education and health services and government sectors are significant sources of employment in the State. As a result, economic problems or factors that negatively impact these sectors may have a negative effect on the value of
Arizona Municipal Securities.
Arizona is continuing to recover from the financial difficulties it suffered during the recent
recession. Arizonas labor market deteriorated during the latter half of 2008 and continued deteriorating until 2011. Between February 2008 and July 2011, the State lost approximately 170,000 jobs and has only recovered approximately 50,000
jobs since then. As of February 2013, the States unemployment rate was 7.9%, which was slightly higher than the national average of 7.7%.
Because of high unemployment, decreased spending and other factors resulting from a weak economy, Arizona had faced declining state tax revenues, prior to fiscal year 2011, including a decrease in total
taxes from approximately $7.4 billion in fiscal year 2009 to approximately $6.7 billion in fiscal
Part I - 16
year 2010. Base revenues had a modest increase to $7.3 billion in fiscal year 2011 and have increased to 7.8 billion in fiscal year 2012. Such increases in revenue remain modest and uncertain and
could be significantly reduced if economic conditions worsen.
However, spending cuts, coupled with increased revenues and
continued economic improvement, have helped to prevent potential budget gaps. As a result, the State ended fiscal year 2012 with a balance of $397 million. Introduced in January 2013, the Governors Executive Budget for fiscal years 2014 and
2015 (as used in this section, the Governors Budget) (discussed in more detail below) estimated a budget balance of $725 million in fiscal year 2013 and $313 million in fiscal year 2014. Although the State has experienced
improvements in its financial condition, there remain a number of risks and pressures that threaten the States budget. For example, revenues may fall short of projections due to recent mandatory reductions in federal spending and a potential
slowdown in the States economic recovery, among other things.
Accordingly, there can be no assurances that the State
will not continue to face fiscal stress or that such circumstances will not become more difficult in the future. Moreover, there can be no guarantee that the current economic situation and the lingering effects from the recession will not have a
materially adverse impact on the States financial condition. Any deterioration of the States financial condition may have a negative effect on the value of the securities issued by the State and its municipalities, which could reduce the
performance of a Fund.
In addition, the pension funds managed by the States public employee retirement systems have seen
declining funding levels every year since 2003. By 2011, the states pension plans had just 73% of the assets on hand necessary to meet their long-term pension obligations for state and local government employees and teachers. Arizona faces a
$13 billion shortfall between what should have been set aside to pay future pension benefits and what the states pension plans have on hand.
There can be no assurance that any issuer of an Arizona Municipal Security will make full or timely payments of principal or interest or remain solvent. However, it should be noted that the
creditworthiness of obligations issued by local Arizona issuers may be unrelated to the creditworthiness of obligations issued by the State, and there is no obligation on the part of the State to make payment on such local obligations in the event
of default.
Structural Deficit
. While the Governors Budget currently projects budget surpluses for fiscal years
2013 and 2014, Arizona also has a long evolving structural deficit in which there is a misalignment between its revenues and its expenditures. Factors contributing to this misalignment include a combination of reduced revenues, program expansions,
continuing population growth, constraints imposed by voters and the federal government. The Governors Budget
estimates that fiscal year 2014 will be the third consecutive year with no budget deficit.
Reduced Revenues.
State revenues have been reduced partially by a series of tax cuts in personal and corporate income taxes. The
most recent significant reduction for the corporate income tax occurred in calendar year 2005. This change (relating to the allocation of multi-state corporate income to Arizona) was estimated at the time of enactment to have, in fiscal year 2011, a
fully phased-in impact of $120 million. The most recent significant reduction to the individual income tax was enacted in calendar year 2006. This legislation provided for a 5% rate reduction in fiscal year 2006 and an additional 5% rate reduction
in fiscal year 2007. The cumulative impact of these reductions was estimated at the time of enactment to be $334 million per year. Revenues from corporate income taxes and individual income taxes are currently projected to reach pre-recession levels
by 2015 and 2016.
Part I - 17
Program Expansions.
Before the recession started in December 2007, the State, via
legislation, judicial mandate or public vote, embarked on several costly programs and initiatives without identifying ways to pay for them. An example involves a property tax reform that has gradually reduced the local property tax and shifted the
school funding obligation to the State General Fund (as used in this section, the General Fund). Another example involves a voter initiative (Proposition 204) (discussed in more detail below) that expanded AHCCCS eligibility, resulting
in additional enrollment in AHCCCS.
Population Growth.
Since the end of World War II, Arizona has consistently ranked
among Americas fastest growing states. While that growth has fueled State revenues, it has also increased demand for a variety of State services, which include education, health care and corrections.
Voter-Imposed Constraints.
Two voter-approved initiatives have limited the ability of State government to manage revenues and
expenditures and exercise budgetary control: Proposition 108 and Proposition 105. In 1992, in order to make it more difficult for the State Legislature to raise taxes or fees, Arizona voters approved Proposition 108. The measure requires a
two-thirds vote of each house of the State Legislature for any act that results in a net increase in State revenues. In 1998, the voters approved Proposition 105, which limits the State Legislatures ability to change the provisions
of voter-approved programs and forces the State to continue spending for those same programs without any consideration of budget problems.
Federal Government.
The American Recovery and Reinvestment Act of 2009 (ARRA) provides economic stimulus funding and federal assistance to state governments to balance budgets. From
February 17, 2009 to March 31, 2013, the States General Fund received approximately $6.7 billion in ARRA funding, to be used largely for education and for health care for low-income persons. Approximately $1.9 billion in stimulus funds
has been used to enhance the Title XIX Federal Medical Assistance Percentage (FMAP) in the health and welfare agencies. In fiscal year 2010, the ARRA FMAP enhancement increased the federal match from 65.75% to 75.93%. In fiscal year
2011, the ARRA-enhanced FMAP was extended from its original expiration date of December 31, 2010, through June 30, 2011, though at stepped-down enhancements of 73.1% and 71.22%.
General Risks
. Many complex political, social and economic factors influence the States economy and finances, which may
affect the States budget unpredictably from year to year. Such factors include, but are not limited to: (i) developments with respect to the national economy as a whole, (ii) developments with respect to the trade, transportation and
public utilities, professional and business services, education and health services, and government sectors of the economy; (iii) developments with respect to consumer confidence; (iv) developments with respect to the construction and real
estate; (v) developments with respect to U.S. fiscal and economic policies, including fiscal stimulus efforts in general and the amount of federal aid to the State; and (vi) actions taken by the federal government, including audits,
disallowances and changes in aid levels.
These factors are continually changing, and no assurances can be given with respect
to how these factors or other factors will materialize in the future or what impact they will have on the States fiscal and economic condition. Such factors could have an adverse impact on the States budget and could result in declines,
possibly severe, in the value of the States outstanding obligations. These factors may also lead to an increase in the States future borrowing costs and could impair the States ability to make timely payments of interest and
principal on its obligations. These factors may also impact the ability of Arizonas municipal issuers to issue new debt or service their outstanding obligations.
Governors Budget
. The Governors Budget, introduced in January, 2013, contains recommendations based on the States moderately improving economic condition, to improve the
States
Part I - 18
public safety, modernize and reform its K-12 system, and improve the States competitive standing in the global market.
Medicaid.
Arizona voters enacted Proposition 204 in 2000. The proposition increased eligibility for Arizonas Health Care Cost
Containment System (AHCCCS) (Arizonas Medicaid agency that offers health care programs for Arizona residents) to residents up to 100% of the federal poverty level, including parents and childless adults. As a condition to receiving
ARRA funding from the federal government, the State agreed to maintain AHCCCS eligibility criteria as of the date of ARRAs enactment, notwithstanding that, since the enactment date, Arizonas AHCCCS enrollment has grown substantially. In
August 2009 there were 1,115,000 individuals enrolled in Medicaid. This number had grown to 1,370,000 individuals in August 2011. As part of the States budget-balancing efforts, the State during the recent recession decided to freeze the
eligibility of childless adults by disallowing new enrollment in the program. The number of childless adults on the program has dropped from 227,000 to 86,000 and is projected to be reduced even further. Because the Proposition 204 population is
protected by federal law, the recommendation is based on an October 1, 2011 start date, giving the federal government time to either grant a waiver or change the maintenance requirements through Congressional action. There is no guarantee that
the federal government will waive or change the eligibility standards.
K-12 Education.
The Governors Budget
recommends several K-12 funding changes that include implementing Common Core State Standards along with needed technology upgrades, instituting a performance-based funding model to reward academic performance, enhancing school safety by funding
additional school resource officers and providing funding for the Microsoft IT Academy, which gives students, teachers and support staff access to skills training and certification.
School Facilities.
The Governors Budget suggests transitioning the School Facilities Board Building Renewal program from a
formula-based program to a direct grants program. The Governors Budget also recommends reforming and lifting the freeze on new construction funding.
Higher Education.
In fiscal year 2009, funding for Arizonas universities was reduced to fiscal year 2006 levels. University funding has been protected under the federal maintenance
requirements agreed to by the State as a condition of receiving ARRA funds. That protection was lifted in fiscal year 2012 and State university funding has been reduced to allocate more state funds to community colleges. In addition, the
Governors Budget recommends implementing performance-based funding, investing in soft capital needs, increasing medical education and fulfilling the second year of parity funding.
Public Safety.
The Governors Budget recommends 50 new Child Protective Services caseworkers in 2013 and 150 new Child
Protective Services caseworkers in 2014.
Healthcare.
The Governors Budget also recommends funding for AHCCCS to
restore eligibility for childless adults under Proposition 204 and implement the federally funded expansion for adults to 133% of the federal poverty level. In addition, the Governors Budget recommends funding the General Fund cost of
Proposition 204 through a provider assessment.
Constitutional Limitations on Taxes
. The Arizona Constitution limits the
amount of debt that can be issued by the States counties, cities, towns, school districts and other municipal corporations in the form of indebtedness payable from property taxes or other General Fund sources. In general, those political
subdivisions may not become indebted in an amount exceeding 6% of the value of the taxable property in the political subdivision without the approval of a majority of the qualified electors voting at an election. Furthermore, no county or school
district may become indebted in an amount exceeding 15% (30% for unified school districts) of the value of the taxable property, even with voter approval. In addition, with voter approval, incorporated cities or towns may become indebted in an
amount up to 20%
Part I - 19
of the value of the taxable property for the purposes of supplying water, light, sewers, open space preserves, parks, playgrounds, recreational facilities, transportation and public safety. These
constitutional debt limits generally do not apply to revenue bonds payable from special fund revenue sources.
State
Debt
. The State, itself, has no general obligation debt. The Arizona Department of Transportation, the Arizona Board of Regents, the Arizona Power Authority, the Water Infrastructure and Finance Authority of Arizona and the Arizona School
Facilities Board are authorized to issue revenue bonds for their respective purposes. In addition, the State has financed certain capital improvements and equipment through the execution and sale of certificates of participation, which represent
undivided agreements that are subject to annual appropriations by the Arizona Legislature.
Municipal Downgrades and
Bankruptcies
. Municipal bonds may be more susceptible to being downgraded, and issuers of municipal bonds may be more susceptible to default and bankruptcy, during recessions or similar periods of economic stress. Factors contributing to the
economic stress on municipalities may include lower property tax collections as a result of lower home values, lower sales tax revenue as a result of consumers cutting back from spending and lower income tax revenue as a result of a high
unemployment rate. In addition, as certain municipal obligations may be secured or guaranteed by banks and other institutions, the risk to a fund could increase if the banking or financial sector suffers an economic downturn and/or if the credit
ratings of the institutions issuing the guarantee are downgraded or at risk of being downgraded by a national rating organization. Such a downward revision or risk of being downgraded may have an adverse effect on the market prices of the bonds and
thus the value of a Funds investments.
Downgrades of certain municipal securities insurers during the recent recession
negatively impacted the price of certain insured municipal securities. Given the large number of potential claims against municipal securities insurers, there is a risk that they will be unable to meet all future claims.
Certain municipal
issuers either have been unable to issue bonds or access the market to sell their issues or, if able to access the market, have issued bonds at much higher rates, which may reduce revenues available for municipal issuers to pay existing obligations.
Should the State or municipalities fail to sell bonds when and at the rates projected, the State could experience significantly increased costs in the General Fund and a weakened overall cash position in the current fiscal year.
Further, an insolvent municipality may file for bankruptcy. For example, Chapter 9 of the U.S. Bankruptcy Code provides a financially
distressed municipality protection from its creditors while it develops and negotiates a plan for reorganizing its debts. Municipality is defined broadly by the Bankruptcy Code as a political subdivision or public agency or
instrumentality of a state and may include various issuers of securities in which a Fund invests. The reorganization of a municipalitys debts may be accomplished by extending debt maturities, reducing the amount of principal or interest,
refinancing the debt or other measures, which may significantly affect the rights of creditors and the value of the securities issued by the municipality. Because a Funds performance depends, in part, on the ability of issuers to make
principal and interest payments on their debt, any actions to avoid making these payments could reduce a Funds returns.
Litigation
. The State is party to numerous legal proceedings, many of which normally occur in government operations. In addition,
the State is involved in certain other legal proceedings that, if decided against the State, might require the State to make significant future expenditures or substantially impair future revenue sources. Because of the prospective nature of these
proceedings, it is not presently possible to predict the outcome of such litigation, estimate the potential impact on the ability of the State to pay debt service costs on its obligations, or determine what impact, if any, such proceedings may have
on a Funds investments.
Part I - 20
Bond Ratings
. As of May 6, 2013, Arizonas issuer credit rating was assigned a
rating of Aa3 by Moodys Investors Service, Inc. (Moodys), AA- by Standard & Poors Rating Services, a division of the McGraw-Hill Companies, Inc. (S&P) and AA by Fitch, Inc. (Fitch).
These ratings reflect only the views of the respective rating agency, an explanation of which may be obtained from each such rating agency. There is no assurance that these ratings will continue for any given period of time or that they will not be
revised or withdrawn entirely by the rating agency if, in the judgment of such rating agency, circumstances so warrant. A downward revision or withdrawal of any such rating may have an adverse effect on the market prices of the securities issued by
the State, its municipalities, and their political subdivisions, instrumentalities and authorities.
California Municipal Securities
Under normal circumstances, the California Tax Free Bond Fund invests at least 80% of its total assets in municipal
securities. For purposes of this policy, municipal securities has the same meaning as California Municipal Securities. California Municipal Securities are obligations of any duration (or maturity) issued by California, its political
subdivisions and their agencies, authorities and instrumentalities and any other obligations, the interest from which is exempt from California personal income tax. The interest from many but not all California Municipal Securities also is exempt
from federal income tax. The California Tax Free Bond Fund may also invest in debt obligations of state and municipal issuers outside of California. In general, the interest on such securities is exempt from federal income tax but subject to
California income tax. A portion of the Funds distributions from interest on California Municipal Securities and other municipal securities in which the California Tax Free Bond Fund invests may under certain circumstances be subject to
federal alternative minimum tax. See Tax Matters.
Risk Factors Affecting California Municipal Securities.
Given that the California Tax Free Bond Fund is invested primarily in California Municipal Securities, the Fund is subject to risks relating to the economy of the state of California (as used in this section, the State) and the financial
condition of the State and local governments and their agencies.
Overview of State Economy
. Californias economy,
the largest among the 50 states, has major components in high technology, trade, entertainment, agriculture, manufacturing, government, tourism, construction and services. As a result, economic problems or factors that negatively impact these
sectors may have a negative effect on the value of California Municipal Securities.
California is continuing to recover from
the financial difficulties it suffered during the recent recession. Californias labor market deteriorated dramatically during the latter half of 2008 and the first nine months of 2009, suffering its worst losses on record. Between July 2007
and September 2009, the State lost nearly 1.4 million non-farm jobs. Beginning in 2010, the State experienced a modest rise in employment, which accelerated in 2012. From September 2009 through December 2012, the State recovered approximately
539,000 jobs, helping to reduce the States unemployment rate from 12.5% in October 2010 to 9.6% in February 2013.
Because of high unemployment, decreased spending and other factors resulting from a weak economy, California faced a severe erosion of its
tax base between 2008 and 2011. This erosion caused the State to face projected budget gaps of approximately $24.3 billion in fiscal year 2009, $60 billion in fiscal year 2010, and $20 billion in fiscal year 2011. However, significant spending cuts,
coupled with increased revenues and continued economic improvement in recent years, have helped to close future budget gaps. As a result, the State is projected to end fiscal year 2013 with a positive reserve. Although the State has experienced some
improvements in its financial condition, there remain a number of serious risks and pressures that threaten the States budget. For example, the State may incur significant costs
Part I - 21
related to the billions of dollars of obligations that had to be deferred in prior years to balance budgets. Furthermore, revenues may fall short of projections due to recent mandatory reductions
in federal spending and a potential slowdown in the States economic recovery, among other things.
Accordingly, there can
be no assurances that the State will not continue to face fiscal stress or that such circumstances will not become more difficult in the future. Moreover, there can be no guarantee that the current economic situation and the lingering effects from
the recession will not have a materially adverse impact on the States financial condition. Any deterioration in the States financial condition may have a negative effect on the value of the securities issued by the State and its
municipalities, which could reduce the performance of a Fund.
In addition, the pension funds managed by the States
principal retirement systems, the California Public Employees Retirement System and the California State Teachers Retirement System, sustained significant investment losses during the economic downturn and face unfunded actuarial
liabilities that will require increased contributions from the States General Fund (as used in this section, General Fund) in future years. The State also has significant unfunded liability relating to retirees
post-employment healthcare benefits.
There can be no assurance that any issuer of a California Municipal Security will make
full or timely payments of principal or interest or remain solvent. However, it should be noted that the creditworthiness of obligations issued by local California issuers may be unrelated to the creditworthiness of obligations issued by the State,
and there is no obligation on the part of the State to make payment on such local obligations in the event of default.
General Risks
. Many complex political, social and economic factors influence the States economy and finances, which may
affect the States budget unpredictably from year to year. Such factors include, but are not limited to: (i) the performance of the national and State economies; (ii) the receipt of revenues below projections; (iii) a delay in or
an inability of the State to implement budget solutions as a result of current or future litigation; (iv) an inability to implement all planned expenditure reductions; and (v) actions taken by the federal government, including audits,
disallowances, and changes in aid levels.
These factors are continually changing, and no assurances can be given with respect
to how these factors or other factors will materialize in the future or what impact they will have on the States fiscal and economic condition. Such factors could have an adverse impact on the States budget and could result in declines,
possibly severe, in the value of the States outstanding obligations. These factors may also lead to an increase in the States future borrowing costs and could impair the States ability to make timely payments of interest and
principal on its obligations. These factors may also impact the ability of Californias municipal issuers to issue new debt or service their outstanding obligations.
Budget for Fiscal Year 2013
. On June 27, 2012, the Governor signed the 2012 Budget Act, which closed an estimated $15.7 billion budget gap for fiscal years 2012 and 2013. The budget-closing
measures included a combination of expenditure reductions, higher revenues and other actions, leaving a projected reserve of approximately $948 million by the end of fiscal year 2013.
The budget projects total General Fund revenues and transfers of $95.9 billion, an increase of $9.1 billion from the prior fiscal year,
which includes estimated personal income tax receipts of $60.3 billion, sales tax receipts of $20.6 billion and corporation tax receipts of $8.4 billion. Additionally, the budget includes special fund expenditures of $39.4 billion and bond fund
expenditures of $11.7 billion. The approval of Proposition 30 by voters in November 2012 allowed the Governor to avoid implementing certain automatic spending cuts that were schedule to occur during the fiscal year if that measure failed to pass.
Proposition 30 included a temporary tax initiative that increases sales and use tax rates by 0.25%
Part I - 22
for four years and increases personal income tax rates on higher-income residents for seven years, generating an estimated $11.6 billion in additional revenues for the State in fiscal years 2013
and 2014.
Proposed Budget for Fiscal Year 2014
. On January 10, 2013, the Governor proposed a budget for fiscal
year 2014 (Proposed Budget). The Proposed Budget estimates that the General Fund will receive $98.5 billion in revenues and transfers, which would represent a 3.3% increase from revised fiscal year 2013 estimates. Against these revenues,
the Proposed Budget calls for approximately $97.7 billion in General Fund expenditures, which would be an increase of approximately 5% from revised fiscal year 2013 estimates. As a result, the Proposed Budget would produce an estimated $851 million
operating surplus in 2014, leaving the General Fund with a $1 billion reserve for fiscal year 2015. If approved, the Proposed Budget would be the first budget in several years that would not rely on corrective measures to avoid a year-end deficit in
the General Fund.
To achieve this budget balance, the Proposed Budget would largely limit State-supported programs and
services to levels established in fiscal year 2013. However, the Proposed Budget contains major new Proposition 98 initiatives to fund State education programs. As part of these initiatives, the Proposed Budget would increase Proposition 98 funding
for State education programs by $2.7 billion, an increase of 5% from the revised level for fiscal year 2013. The increased funding would be used primarily to retire a portion of the States outstanding deferrals on previous Proposition 98
payments, which would reduce the States outstanding deferrals from $8.2 billion to $6.3 billion in fiscal year 2014. The increased funding would also be used to consolidate the States various K-12 revenue limits and categorical programs
into one streamlined funding formula that would provide a base funding grant per student, significantly transforming the way the State funds its public education system.
LAO Report
. On January 14, 2013, the Legislative Analysts Office (LAO), a nonpartisan fiscal and policy advisor to the State, released its analysis of the Proposed Budget
(LAO Report). In reaching its conclusions, the LAO performs an independent assessment of the outlook for Californias economy, demographics, revenues and expenditures. The LAO Report commends the Governors focus on fiscal
discipline and paying off portions of the States accumulated debts in recent years, noting that these efforts contributed to the Governors ability to propose a balanced budget for fiscal year 2014. However, the LAO Report notes that
there are considerable risks to the revenue estimates contained in the Proposed Budget.
The LAO Report states that one of the
largest risks facing the Proposed Budgets revenue estimates relate to the uncertainty at the federal level over certain fiscal cliff issues. For example, because the Proposed Budget was completed prior to passage of the American
Taxpayer Relief Act of 2012, which averted certain aspects of the fiscal cliff including previously scheduled tax increases and spending reductions, the Proposed Budgets revenue estimates did not take into account the possible reduction in
revenues that may result from the expiration of the federal payroll tax holiday and the increase in federal income and capital gains tax rates on wealthy individuals. The LAO Report also notes that uncertainty surrounding the increase of the federal
debt ceiling and implementation of mandatory $85 billion cuts to federal spending (known as the sequester) may have a deleterious effect on State and national economic growth, which could impact the States revenues. Other major
risks to the Proposed Budgets revenue estimates arise from the normal volatility in the States revenue structure, uncertainty regarding how individuals and businesses will respond to Proposition 30 and other State-level policy changes,
and increases in commodity prices, such as oil, stemming from global conflict and increased world-wide demand.
The LAO Report
also expresses concern that the Governors proposal would leave the State without a sizable reserve at the end of fiscal year 2017, which could cause the State to rely on certain corrective measures in the event that revenues fall short of
expectations. Further, the LAO Report notes
Part I - 23
that although the Proposed Budget continues to promote the Governors agenda of reducing approximately $30 billion worth of debt incurred by the State in recent years, the Proposed Budget
does not address substantial unfunded liabilities associated with the States retirement system for teachers and other state retiree health benefits.
Limitation on Property Taxes.
Certain State debt obligations may be obligations of issuers that rely in whole or in part, directly or indirectly, on
ad valorem
property taxes as a source of
revenue. The taxing powers of State local governments and districts are limited by Article XIIIA of the State Constitution, enacted by the voters in 1978 and commonly known as Proposition 13. Article XIIIA limits the rate of
ad
valorem
property taxes to 1% of full cash value of real property and generally restricts the reassessment of property to 2% per year, except upon new construction or change of ownership (subject to a number of exemptions). Taxing entities
may, however, raise
ad valorem
taxes above the 1% limit to pay debt service on voter-approved bonded indebtedness. Under Article XIIIA, the basic 1%
ad valorem
tax levy is applied against the assessed value of property as of the
owners date of acquisition (or as of March 1, 1975, if acquired earlier), subject to certain adjustments. This system has resulted in widely varying amounts of tax on similarly situated properties. Article XIIIA prohibits local
governments from raising revenues through
ad valorem
taxes above the 1% limit. Article XIIIA also requires voters of any governmental unit to give two-thirds approval to levy any special tax (
i.e.
, a tax devoted to a
specific purpose).
Limitations on Other Taxes, Fees and Charges.
On November 5, 1996, the voters of the State
approved Proposition 218. Proposition 218 added Articles XIIIC and XIIID to the State Constitution, which contain a number of provisions affecting the ability of local agencies to levy and collect both existing and future taxes, assessments, fees
and charges. Article XIIIC requires that all new or increased local taxes be submitted to the voters before they become effective. Taxes for general governmental purposes require a majority vote and taxes for specific purposes require a two-thirds
vote. Article XIIID contains several provisions that make it generally more difficult for local agencies to levy and maintain assessments for municipal services and programs. Article XIIID also contains several provisions affecting
fees and charges, defined for purposes of Article XIIID to mean any levy other than an
ad valorem
tax, a special tax, or an assessment, imposed by a local government upon a parcel or upon a person as an incident
of property ownership, including a user fee or charge for a property related service. All new and existing property related fees and charges must conform to requirements prohibiting, among other things, fees and charges that generate revenues
exceeding the funds required to provide the property related service or are used for unrelated purposes. There are new notice, hearing and protest procedures for levying or increasing property related fees and charges, and, except for fees or
charges for sewer, water and refuse collection services (or fees for electrical and gas service, which are not treated as property related for purposes of Article XIIID), no property related fee or charge may be imposed or increased
without majority approval by the property owners subject to the fee or charge or, at the option of the local agency, two-thirds voter approval by the electorate residing in the affected area. The interpretation and application of Proposition 218
will ultimately be determined by the courts with respect to a number of matters, and it is not possible at this time to predict with certainty the outcome of such cases.
Appropriations Limits.
The State and its local governments are subject to an annual appropriations limit imposed by Article XIIIB of the California Constitution, enacted by the voters
in 1979 and significantly amended by Propositions 98 and 111 in 1988 and 1990, respectively. Article XIIIB prohibits the State or any covered local government from spending appropriations subject to limitation in excess of the
appropriations limit imposed. Appropriations subject to limitation are authorizations to spend proceeds of taxes, which consist of tax revenues and certain other funds, including proceeds from regulatory licenses, user
charges or other fees, to the extent that such proceeds exceed the cost of providing the product or service, but proceeds of taxes exclude most State
Part I - 24
subventions to local governments. No limit is imposed on appropriations of funds that are not proceeds of taxes, such as reasonable user charges or fees, and certain other non-tax
funds, including bond proceeds. The appropriations limit for each year is adjusted annually to reflect changes in cost of living and population, and any transfers of service responsibilities between government units. The definitions for such
adjustments were liberalized in 1990 to follow more closely growth in the States economy. Excess revenues are measured over a two-year cycle. Local governments must return any excess to taxpayers by rate reductions. The State must
refund 50% of any excess, with the other 50% paid to schools and community colleges. Local governments may exceed their spending limits for up to four years by voter approval.
Because of the complex nature of Articles XIIIA, XIIIB, XIIIC and XIIID of the California Constitution, the ambiguities and possible inconsistencies in their terms, the impossibility of predicting future
appropriations or changes in population and cost of living and the probability of continuing legal challenges, it is not currently possible to determine fully the impact of these Articles on California debt obligations or on the ability of the State
or local governments to pay debt service on such California debt obligations. It is not possible, at the present time, to predict the outcome of any pending litigation with respect to the ultimate scope, impact or constitutionality of these Articles
or the impact of any such determinations upon State agencies or local governments, or upon their ability to pay debt service on their obligations. Further initiatives or legislative changes in laws or the California Constitution may also affect the
ability of the State or local issuers to repay their obligations.
State Debt
. From July 2006 to February 2013,
voters and the State Legislature authorized more than $40 billion of new general obligation bonds and lease-revenue bonds, which are paid solely from the General Fund. This new authorization substantially increased the amount of outstanding debt
supported by the General Fund. As of February 1, 2013, the State had outstanding approximately $72.9 billion principal amount of general obligations bonds, $11.7 billion of lease-revenue bonds and $1.9 billion for repayment of budgetary
borrowing from local governments. These obligations are payable principally from the States General Fund or from lease payments paid from the operating budget of the respective lessees, which operating budgets are primarily, but not
exclusively, derived from the General Fund. Additionally, as of February 1, 2013, there was approximately $31.9 billion of authorized and unissued voter-approved general obligation bonds and approximately $7.2 billion of authorized and unissued
lease revenue bonds. The State Treasurers office estimates that approximately $4.7 billion of new money general obligation bonds, a portion of which may be in the form of commercial paper notes, and approximately $1.8 billion of lease-revenue
bonds will be issued in calendar year 2013. These projections are subject to change based upon updated funding needs, actual spending, budget constraints and market considerations, among other things.
In calendar years 2009 and 2010, the State sold more than $35 billion of new money general obligation bonds, lease-revenue bonds and
Proposition 1A bonds, reaching record levels for new money bond issuances by the State. Bond issuances declined substantially in calendar years 2011 and 2012. Over this period, the State sold $8 billion of new money general obligation and
lease-revenue bonds and $5.8 billion of refunding general obligation and lease-revenue bonds.
Because the State plans to issue
authorized, but unused, new bond sales in the future, the ratio of debt service on general obligation, lease-revenue bonds supported by the General Fund to annual General Fund revenues and transfers (General Fund Debt Ratio) is expected
to increase in future years. Based on the revenue estimates contained in the Proposed Budget and the bond issuance estimates noted above, the General Fund Debt Ratio is estimated to equal approximately 9% in fiscal year 2013 and 7.8% in fiscal year
2014.
Part I - 25
In addition to general obligation bonds, lease-revenue bonds, and other types of debt, the
State may issue certain short-term obligations such as revenue anticipation notes (RANs) and revenue anticipation warrants (RAWs). Due to the timing differences between when the State receives General Fund receipts and when
it makes General Fund disbursements, the State regularly issues short-term obligations to meet its cash flow needs. By law, RANs must mature prior to the end of the fiscal year in which they are issued, while RAWs may mature in a subsequent fiscal
year.
The State began fiscal year 2013 in a better cash position than it had in previous years due, in part, to the timely
enactment of the budget. The enactment of the budget allowed the State to carry out its regular cash management by issuing $10 billion of RANs on August 23, 2012. In addition, the State Legislature approved a cash management bill authorizing
deferral of certain payments during fiscal year 2013, including payments to public schools and universities, certain reimbursements to the federal government, certain local government social services costs and transportation payments, among others.
The approved deferrals were made in July and October 2012. Furthermore, the State also benefitted from $1.7 billion of additional internal borrowable resources during fiscal year 2013 from the legislatively enacted State Agency Investment Fund.
The Proposed Budget anticipates using RANs, internal borrowing and intra-year deferrals to meet its cash management
requirements in fiscal year 2014. The Proposed Budget currently projects that the State will issue $7 billion worth of RANs in fiscal year 2014, which is a decrease of $3 billion from the previous fiscal year. Should the States fiscal position
follow the Governors projections, it is not expected that the State will need to rely on certain extraordinary cash management measures to meet its cash requirements in fiscal year 2014.
Balanced Budget Amendment
. On March 2, 2004, voters approved Proposition 58, a constitutional amendment called the
Balanced Budget Amendment, which affects future State budgeting procedures by, among other things, requiring that the States budget be in balance and establishing a special reserve. On November 2, 2010, the voters of the State
approved Proposition 25, an initiative measure amending the States constitution to provide that the States budget must be approved by a majority (as opposed to two-thirds) vote of each House of the State Legislature. Proposition 58 was
linked to Proposition 57, also approved by the voters in 2004, which authorized the issuance of $15 billion of economic recovery bonds (ERBs) to finance the negative General Fund reserve balance left at the end of fiscal year 2004. The
General Fund is obligated to repay these ERBs. However, repayment of these bonds was secured by a pledge of revenues from a 1/4 cent increase in the States sales and use tax that became effective on July 1, 2004.
The Balanced Budget Amendment requires the State Legislature to enact a budget bill in which General Fund expenditures do not exceed
estimated General Fund revenues and available reserves. After passage of the budget act for a given fiscal year, if the Governor determines that the State is facing substantial revenue shortfalls or spending deficiencies, the Governor may declare a
fiscal emergency and propose legislation to address the emergency. The State Legislature would be called in to special session to address this proposal. If the State Legislature fails to send legislation to the Governor to address the fiscal
emergency within 45 days, it will be prohibited from acting on any other bills or adjourning until fiscal legislation is passed. The Governor declared several such fiscal emergencies in 2008, 2009, 2010, and 2011, and called the State Legislature
into various special sessions to address budget shortfalls.
The Balanced Budget Amendment also created a rainy day
reserve called the Budget Stabilization Account (BSA) in the State General Fund. Beginning in fiscal year 2007, a portion of estimated annual General Fund revenues are transferred by the Controller into the BSA not later than
September 30 of each year. These transfers continue until the balance in the BSA reaches $8 billion or 5% of the estimated General Fund revenues for that fiscal year, whichever is greater. Additional transfers
Part I - 26
will be required whenever the account balance drops below these limits in a given fiscal year. Annual transfers to the BSA may be suspended or reduced during a fiscal year pursuant to an
executive order issued by the Governor, subject to certain conditions.
Funds in the BSA may be used to make up for unexpected
budget imbalances, but will then have to be replenished with future transfers until the target level is reached. In response to a fiscal emergency declared by the Governor in 2008, the Director of Finance transferred the entire balance of the BSA
(approximately $1.5 billion) to the General Fund to retire a portion of the ERBs issued pursuant to Proposition 58. Since that time, the Governor has suspended BSA transfers in each of the following fiscal years. The Proposed Budget would continue
this trend by suspending the required $3 billion transfer to the BSA in fiscal year 2014. Because of these suspensions, the BSA is currently unfunded.
Finally, Proposition 58 also prohibits the State from selling general obligation bonds or lease-revenue bonds to cover fiscal year end budget deficits. Therefore, the State must rely on certain other
types of borrowing (such as RANs, RAWs and inter-fund borrowing) to address fiscal year end budget deficits.
State-Local
Fiscal Relations
. In November 2004, voters approved Proposition 1A, which made significant changes to the fiscal relationship between the State and Californias local governments by, among other things, reducing the State Legislatures
authority over local government revenue sources by restricting the States access to local governments property, sales and vehicle license fee revenues without meeting certain conditions. Proposition 22, adopted on November 2,
2010, supersedes some parts of Proposition 1A of 2004 and completely prohibits any future borrowing by the State from local government funds. Additionally, Proposition 22 generally prohibits the State Legislature from making changes in local
government funding sources.
Proposition 1A also prohibits the State from requiring localities to comply with certain unfunded
mandates. Under the law, if the State does not provide the funding necessary to implement the mandate, the mandate is suspended and the locality is relieved from compliance. In addition, Proposition 1A requires the State to reimburse localities for
mandated costs incurred prior to fiscal year 2005, which is estimated at approximately $900 million. The current budget defers payment of these claims through fiscal year 2015 and, if passed, the Proposed Budget would maintain this deferral.
In 2009, the State Legislature passed legislation authorizing the State to exercise certain borrowing authority under
Proposition 1A. This borrowing generated nearly $2 billion that was used to offset General Fund costs for a variety of programs. The legislation also created a securitization mechanism for local governments to sell their right to receive the
States payment obligations to a local government-operated joint powers agency (JPA). In November 2009, the JPA sold bonds in an aggregate amount of approximately $1.9 billion to pay the localities their property tax allocations
when they otherwise would receive them. Pursuant to Proposition 1A, the State is required to repay the local government borrowing (which in turn will be used to prepay the bonds of the JPA) no later than June 15, 2013. The current budget
allocates approximately $2.1 billion from the General Fund to retire these outstanding obligations.
Municipal Downgrades
and Bankruptcies
. Municipal bonds may be more susceptible to being downgraded, and issuers of municipal bonds may be more susceptible to default and bankruptcy, during recessions or similar periods of economic stress. Factors contributing to the
economic stress on municipalities may include lower property tax collections as a result of lower home values, lower sales tax revenue as a result of consumers cutting back from spending and lower income tax revenue as a result of a high
unemployment rate. In addition, as certain municipal obligations may be secured or guaranteed by banks and other institutions, the risk to a Fund could increase if the banking or financial sector suffers an economic downturn and/or if the credit
ratings of the institutions issuing the guarantee are downgraded or at risk of being downgraded by a national rating organization. Such a downward revision or risk of
Part I - 27
being downgraded may have an adverse effect on the market prices of the bonds and thus the value of a Funds investments.
Downgrades of certain municipal securities insurers during the recent recession negatively impacted the price of certain insured municipal
securities. Given the large number of potential claims against municipal securities insurers, there is a risk that they will be unable to meet all future claims. Certain municipal issuers either have been unable to issue bonds or access the market
to sell their issues or, if able to access the market, have issued bonds at much higher rates, which may reduce revenues available for municipal issuers to pay existing obligations. Should the State or municipalities fail to sell bonds when and at
the rates projected, the State could experience significantly increased costs in the General Fund and a weakened overall cash position in the current fiscal year.
Further, an insolvent municipality may file for bankruptcy. For example, Chapter 9 of the U.S. Bankruptcy Code provides a financially distressed municipality protection from its creditors while it
develops and negotiates a plan for reorganizing its debts. Municipality is defined broadly by the Bankruptcy Code as a political subdivision or public agency or instrumentality of a state and may include various issuers of
securities in which a Fund invests. The reorganization of a municipalitys debts may be accomplished by extending debt maturities, reducing the amount of principal or interest, refinancing the debt or other measures, which may significantly
affect the rights of creditors and the value of the securities issued by the municipality. Because a Funds performance depends, in part, on the ability of issuers to make principal and interest payments on their debt, any actions to avoid
making these payments could reduce a Funds returns.
In 2012, the cities of San Bernardino and Stockton, as well as the
town of Mammoth Lakes, each filed for bankruptcy protection under Chapter 9. Due to the current conditions facing many municipalities in California, it is possible that additional municipalities could file for bankruptcy protection in the future.
Any such action could negatively impact the value of a Funds investments in the securities of those municipalities.
Litigation
. The State is a party to numerous legal proceedings, many of which normally occur in government operations. In addition,
the State is involved in certain other legal proceedings (described in the States recent financial statements) that, if decided against the State, might require the State to make significant future expenditures or substantially impair future
revenue sources. Because of the prospective nature of these proceedings, it is not presently possible to predict the outcome of such litigation, estimate the potential impact on the ability of the State to pay debt service costs on its obligations,
or determine what impact, if any, such proceedings may have on a Funds investments.
Bond Ratings
. As of
May 6, 2013, Californias general obligation debt was assigned a rating of A1 by Moodys, A by S&P and A- by Fitch. These ratings reflect only the views of the respective rating agency, an explanation of which may be obtained from
each such rating agency. There is no assurance that these ratings will continue for any given period of time or that they will not be revised or withdrawn entirely by the rating agency if, in the judgment of such rating agency, circumstances so
warrant. A downward revision or withdrawal of any such rating may have an adverse effect on the market prices of the securities issued by the State, its municipalities, and their political subdivisions, instrumentalities and authorities.
Michigan Municipal Securities
As used in this SAI, the term Michigan Municipal Securities refers to municipal securities, the income from which is exempt from both federal and Michigan personal income tax.
Part I - 28
Risk Factors Regarding Michigan Municipal Securities.
Given that the Michigan
Municipal Bond Fund is invested primarily in Michigan Municipal Securities, the Fund is subject to risks relating to the economy of the state of Michigan (as used in this section, the State) and the financial condition of the State and
local governments and their agencies.
Overview of State Economy
. Manufacturing, particularly of automobiles and durable
goods, is of prime importance to the States economy and historically has been highly cyclical. The Big Three United States automakers, General Motors Company (GM), Chrysler Group LLC (Chrysler) and Ford Motor Company
(Ford), are headquartered in the State. Because of the prominence of Michigan in the United States auto industry, economic problems or factors that negatively impact the auto industry may have a negative effect on the value of Michigan
Municipal Securities.
Michigan is continuing to recover from the financial difficulties it suffered during the recent
recession. In the aftermath of the recession, new car sales fell considerably, which caused manufacturers to cut production and employment dramatically. Both GM and Chrysler filed for Chapter 11 bankruptcy protection in calendar year 2009. Although
new car sales have increased since then, such increases remain modest and uncertain, and could be significantly reduced if economic conditions worsen.
Michigans labor market deteriorated during the latter half of 2008 and during 2009. Between January 2008 and December 2009, the State lost over 500,000 jobs. Beginning in 2010, the State experienced
a modest rise in employment, which continued in 2011 and 2012. From December 2009 through February 2013, the State recovered approximately 116,000 jobs, reducing the States unemployment rate from its peak of 14.28% in August 2009. As of
February 2013, the States unemployment rate was 8.8%, which was higher than the national average of 7.7%.
Because of
high unemployment, decreased spending and other factors resulting from a weak economy, Michigan has faced revenue challenges in recent years, although the economic environment has recently improved. The State faced projected budget gaps of
approximately $3.7 billion in fiscal year 2009 and $1.0 billion in fiscal year 2010. However, increased revenues and continued economic improvement have helped to close future budget gaps. As a result, the State ended fiscal years 2011 and 2012 with
a positive balance. Introduced on February 7, 2013, the Governors Executive Budget for fiscal years 2014 and 2015 (as used in this section, the Governors Budget) (discussed in more detail below) estimated a budget
balance of $622.8 million in fiscal year 2013 and $856.2 million in fiscal year 2014. Although the State has experienced significant improvements in its financial condition, there remain a number of serious risks and pressures that threaten the
States budget. For example, revenues may fall short of projections due to recent mandatory reductions in federal spending and a potential slowdown in the States economic recovery, among other things.
Accordingly, there can be no assurances that the State will not continue to face fiscal stress or that such circumstances will not become
more difficult in the future. Moreover, there can be no guarantee that the current economic situation and the lingering effects from the recession will not have a materially adverse impact on the States financial condition. Any deterioration
of the States financial condition may have a negative effect on the value of the securities issued by the State and its municipalities, which could reduce the performance of a Fund.
Michigans personal income tax receipts (less refunds) increased from approximately $3.9 billion in fiscal year 2010 to approximately
$4.4 billion in fiscal year 2011. The increase was due to an increase in employment and economic activity. According to the Governors Budget, revenue is expected to decline in fiscal year 2013 due to the net impact of individual income and
business tax reforms, but is expected to increase again in fiscal years 2014 and 2015.
Part I - 29
As a result of the recovering yet still challenging, economic and fiscal environment,
Michigan has anticipated a more stable fiscal environment in the coming fiscal years.
The sharp drop in revenues during the
recession caused a significant depletion of cash resources to pay the States obligations, causing the State to issue general obligation notes in 2008, 2009 and 2010 for cash flow purposes. For example, on November 4, 2010, the State
issued approximately $1.1 billion in general obligation notes for cash flow purposes. As of September 30, 2012, the State had total bonded debt of approximately $2.0 billion for general obligation bonds, as well as total bonded debt of $5.3
billion for revenue bonds and notes backed by specific tax and fee revenues.
In addition, the Michigan state government had a
$21.7 billion total unfunded liability in the pensions in its two largest pension systems, the Michigan Public School Employees Retirement System and the Michigan State Employees Retirement System as of September 30, 2010.
There can be no assurance that any issuer of a Michigan Municipal Security will make full or timely payments of principal or
interest or remain solvent. However, it should be noted that the creditworthiness of obligations issued by local Michigan issuers may be unrelated to the creditworthiness of obligations issued by the State, and there is no obligation on the part of
the State to make payment on such local obligations in the event of default.
General Risks
.
Many complex
political, social and economic factors influence the States economy and finances, which may affect the States budget unpredictably from year to year. Such factors include, but are not limited to: (i) developments with respect to the
national economy as a whole, (ii) developments with respect to level of motor vehicle sales and other factors that impact the auto industry; (iii) the impact of an anticipated shift in monetary policy actions on interest rates and the
financial markets; and (iv) actions taken by the federal government, including audits, disallowances and changes in aid levels.
These factors are continually changing, and no assurances can be given with respect to how these factors or other factors will materialize in the future or what impact they will have on the States
fiscal and economic condition. Such factors could have an adverse impact on the States budget and could result in declines, possibly severe, in the value of the States outstanding obligations. These factors may also lead to an increase
in the States future borrowing costs and could impair the States ability to make timely payments of interest and principal on its obligations. These factors may also impact the ability of Michigans municipal issuers to issue new
debt or service their outstanding obligations.
State Debt
. The State Constitution limits State general obligation debt
to: (i) short term debt for State operating purposes, (ii) short and long-term debt for the purpose of making loans to school districts and (iii) long term debt for voter approved purposes.
Short-term debt for operating purposes is limited to an amount not to exceed 15% of undedicated revenues received during the preceding
fiscal year. Under the State Constitution as implemented by statutory provisions, such debt must be authorized by the State Administrative Board and issued only to meet obligations incurred pursuant to appropriation and must be repaid during the
fiscal year in which incurred.
The amount of debt incurred by the State for making loans to school districts is recommended by
the State Treasurer, who certifies the amounts necessary for loans to school districts. The bonds may be issued in whatever amount is required without voter approval. All other general obligation bonds issued by the State must be approved as to
amount, purpose and method of repayment by a two-thirds vote of
Part I - 30
each house of the State Legislature and by a majority vote of the public at a general election. There is no limitation as to number or size of such general obligation issues.
Constitutional Limitations on Taxes
. The State Constitution limits the amount of total State revenues that can be raised from taxes
and certain other sources. State revenues (excluding federal aid and revenues for payment of principal and interest on general obligation bonds) are limited in a fiscal year to 9.49% of State personal income in the prior calendar year or the average
of the prior three calendar years, whichever is greater.
The State may raise taxes in excess of the limit when deemed
necessary by the Governor and two-thirds of the members of each house of the State Legislature.
The State Constitution also
provides that the proportion of State spending paid to all units of local government to total State spending may not be reduced below the percentage in effect in the 1979 fiscal year. Michigan originally determined that percentage to be 41.6%. As a
result of litigation, effective with fiscal year 1993, the State recalculated the required percentage of spending paid to local government units to 48.97%. The Governors Budget recommends $711.1 million in required revenue sharing payments in
fiscal year 2013 and $730.6 million in such payments in fiscal year 2014.
Additionally, the State Constitution includes a
provision that limits revenue growth. This constitutional limitation (commonly known as the Headlee amendment) has been in place since 1978. The Headlee amendment limits annual growth in State revenues to a level that cannot exceed the year-to-year
growth in personal income. This limit is intended to ensure that the States overall revenues, both tax and non-tax, do not grow faster than the incomes of Michigans citizens. It is anticipated that state revenues will be below the
constitutional revenue limit in fiscal year 2013 and in fiscal year 2014.
Governors Budget
. The Governors
Budget was introduced on February 7, 2013. The Governors Budget estimates $50.9 billion in revenue from both state and federal services. The Governors Budget projects a State General Fund (as used in this section, General
Fund) of $9.3 billion and $11.4 billion in School Aid Fund. Under the Governors Budget, 45% of General Fund expenditures are directed towards Health and Human Services. The Governors Budget estimates a balanced General Fund for
fiscal years 2014 and 2015. The Governors Budget also includes more than a billion dollars to pay down the debt burden of post-employment benefits and adds an additional $1.2 billion to adequately maintain and improve Michigans roads.
The Governors Budget increases funding to early childhood education by $130 million over the next two years and also allocates $75 million for the Budget Stabilization Fund, commonly referred to as the Rainy Day Fund. The Governors
Budget also expands Medicaid for adults to 133% of the federal poverty level, which calls for $12.3 billion to provide health care to 2.2 million Michigan residents. In addition, the Governors Budget recommends $10 million for a new
skilled trades training program and nearly $20 million towards bolstering human and veteran services. Moreover, the Governors Budget includes over $50 million towards a variety of programs to make Michigan safer and over $100 million towards a
variety of programs to protect Michigans natural resources.
In fiscal year 2011, Michigans Governor proposed and
the State Legislature passed legislation reforming Michigans tax system. The changes to the Michigan tax system replace Michigans business tax with a flat corporate income tax set at 6% and eliminate many of the tax credits for
individual taxpayers under Michigans personal income tax. Under the law, generally only those business entities that issue public or private stock, known as C corporations for federal tax purposes, would be subject to the proposed
6% tax. Other businesses, such as partnerships, sole-proprietorships, limited liability companies and S corporations that are not classified as C corporations for federal tax purposes would be exempt, resulting in tax relief
for certain companies. The business tax, which was eliminated for most
Part I - 31
business effective January 1, 2012, and the corporate income tax generated an estimated $696.2 million in fiscal year 2012.
Municipal Downgrades and Bankruptcies
. Municipal bonds may be more susceptible to being downgraded, and issuers of municipal bonds
may be more susceptible to default and bankruptcy, during recessions or similar periods of economic stress. Factors contributing to the economic stress on municipalities may include lower property tax collections as a result of lower home values,
lower sales tax revenue as a result of consumers cutting back from spending and lower income tax revenue as a result of a high unemployment rate. In addition, as certain municipal obligations may be secured or guaranteed by banks and other
institutions, the risk to a Fund could increase if the banking or financial sector suffers an economic downturn and/or if the credit ratings of the institutions issuing the guarantee are downgraded or at risk of being downgraded by a national rating
organization. Such a downward revision or risk of being downgraded may have an adverse effect on the market prices of the bonds and thus the value of a Funds investments.
Downgrades of certain municipal securities insurers during the recent recession negatively impacted the price of certain insured municipal securities. Given the large number of potential claims against
municipal securities insurers, there is a risk that they will be unable to meet all future claims. Certain municipal issuers either have been unable to issue bonds or access the market to sell their issues or, if able to access the market, have
issued bonds at much higher rates, which may reduce revenues available for municipal issuers to pay existing obligations. Should the State or municipalities fail to sell bonds when and at the rates projected, the State could experience significantly
increased costs in the General Fund and a weakened overall cash position in the current fiscal year.
Further, an insolvent
municipality may file for bankruptcy. For example, Chapter 9 of the U.S. Bankruptcy Code provides a financially distressed municipality protection from its creditors while it develops and negotiates a plan for reorganizing its debts.
Municipality is defined broadly by the Bankruptcy Code as a political subdivision or public agency or instrumentality of a state and may include various issuers of securities in which a Fund invests. The reorganization of a
municipalitys debts may be accomplished by extending debt maturities, reducing the amount of principal or interest, refinancing the debt or other measures, which may significantly affect the rights of creditors and the value of the securities
issued by the municipality. Because a Funds performance depends, in part, on the ability of issuers to make principal and interest payments on their debt, any actions to avoid making these payments could reduce a Funds returns.
Litigation
. The State is a party to numerous legal proceedings, many of which normally occur in government operations.
In addition, the State is involved in certain other legal proceedings (described in the States recent financial statements) that, if decided against the State, might require the State to make significant future expenditures or substantially
impair future revenue sources. Because of the prospective nature of these proceedings, it is not presently possible to predict the outcome of such litigation, estimate the potential impact on the ability of the State to pay debt service costs on its
obligations, or determine what impact, if any, such proceedings may have on a Funds investments.
Bond Ratings
. As
of May 6, 2013, Michigans general obligation debt was assigned a rating of Aa2 by Moodys, AA- by S&P and AA by Fitch. These ratings reflect only the views of the respective rating agency, an explanation of which may be obtained
from each such rating agency. There is no assurance that these ratings will continue for any given period of time or that they will not be revised or withdrawn entirely by the rating agency if, in the judgment of such rating agency, circumstances so
warrant. A downward revision or withdrawal of any such rating may have an adverse effect on the market prices of the securities issued by the State, its municipalities, and their political subdivisions, instrumentalities and authorities.
Part I - 32
New York Municipal Securities
As used in this SAI, the term New York Municipal Securities refers to municipal securities, the income from which is exempt
from federal, New York and New York City personal income tax.
Risk Factors Regarding Investments in New York Municipal
Securities.
Given that the New York Tax Free Bond Fund is invested primarily in New York Municipal Securities, the Fund is subject to risks relating to the economy of the state of New York (as used in this section, the State) and the
financial condition of the State and local governments and their agencies.
Overview of State Economy
. Although New York
has a diverse economy, it is heavily dependent on the financial sector, in part, because New York City is the nations leading center of banking and finance. Even though the financial sector accounts for under one-tenth of all non-agricultural
jobs in the State, it contributes more than one-fifth of total wages, the highest of any sector in New York. In addition to the financial sector, the State has a comparatively large share of the nations information, education and health
services employment. As a result, economic problems or factors that negatively impact these sectors may have a negative effect on the value of New York Municipal Securities.
During the recent recession, New York experienced a significant economic downturn. While some signs of improvement have appeared, the recovery may continue to be slow as the State faces significant fiscal
challenges including a high unemployment rate, which was at 8.4% in February 2013, and severe damage caused by Hurricane Sandy. As a result of these and other factors, New York has faced budget deficits in recent years.
On October 29, 2012, Hurricane Sandy struck New York, causing caused widespread flooding, power failures and wind damage to public
and private property in New York City, Long Island and other downstate areas. Public infrastructure in these areas, including mass transit systems, public schools and municipal buildings sustained serious damage. In January 2013, the Federal
government approved approximately $60 billion in federal disaster aid for general recovery, rebuilding and mitigation activity nationwide, of which New York expects to receive $30 billion. The State anticipates that the federal government will
provide $5.1 billion in extraordinary federal assistance during fiscal year 2014 for expenses related to Hurricane Sandy.
Although the State suffered significant economic costs related to Hurricane Sandy, the States labor market is expected to continue
its recent trend of moderate growth. Recent forecasts project that the States employment rate will grow by 1.3% in both fiscal years 2013 and 2014. Wages are expected to rise by 3.2% and 5.0% in fiscal years 2013 and 2014, while personal
income is expected to increase by 2.5% in fiscal year 2013 and 5.4% in fiscal year 2014. Due to this sustained economic growth, the States base receipts are expected to grow by 5.8% in fiscal year 2013 and 4.6% in fiscal year 2014. However,
substantial risks remain that could undermine these projections. For example, mandatory federal spending cuts, increases in certain federal taxes, unexpected changes to the Federal Reserves current stimulus policies, recession in Europe, and
elevated commodity prices, among others, could contribute to weakened economic growth, which could reduce State revenues.
Accordingly, there can be no assurances that the State will not continue to face fiscal stress or that such circumstances will not become
more difficult in the future. Moreover, there can be no guarantee that the current economic situation and the lingering effects from the recession will not have a materially adverse impact on the States financial condition. Any deterioration
in the States financial condition may have a negative effect on the value of the securities issued by the State and its municipalities, which could reduce the performance of a Fund.
Part I - 33
Furthermore, there can be no assurance that any issuer of a New York Municipal Security will
make full or timely payments of principal or interest or remain solvent. However, it should be noted that the creditworthiness of obligations issued by local New York issuers may be unrelated to the creditworthiness of obligations issued by the
State, and there may be no obligation on the part of the State to make payment on such local obligations in the event of default.
General Risks
. Many complex political, social and economic factors influence the States economy and finances, which may affect the States budget unpredictably from year to year. Such
factors include, but are not limited to: (i) the performance of the national and State economies; (ii) the impact of behavioral changes concerning financial sector bonus payouts, as well as any future legislation governing the structure of
compensation; (iii) the impact of shifts in monetary policy on interest rates and the financial markets; (iv) the impact of financial and real estate market developments on bonus income and capital gains realizations; (v) the impact
of household deleveraging on consumer spending and the impact of that activity on State tax collections; (vi) increased demand in entitlement and claims based programs such as Medicaid, public assistance and general public health;
(vii) access to the capital markets in light of disruptions in the municipal bond market; (viii) litigation against the State; (ix) actions taken by the federal government, including audits, disallowances, changes in aid levels, and
changes to Medicaid rules; and (x) the impact of federal statutory and regulatory changes concerning financial sector activities.
These factors are continually changing, and no assurances can be given with respect to how these factors or other factors will materialize in the future or what impact they will have on the States
fiscal and economic condition. Such factors could have an adverse impact on the States budget and could result in declines, possibly severe, in the value of the States outstanding obligations. These factors may also lead to an increase
in the States future borrowing costs and could impair the States ability to make timely payments of interest and principal on its obligations. These factors may also impact the ability of New Yorks municipal issuers to issue new
debt or service their outstanding obligations.
Budget for Fiscal Year 2014
. On April 10, 2013, the Governor
finalized the enactment of the budget for fiscal year 2014. The budget calls for approximately $61.2 billion in the States General Fund (as used in this section, General Fund) expenditures for fiscal year 2014, which represents an
increase of 3.7% from estimated expenditures in fiscal year 2013. The budget assumes that the General Fund will receive tax receipts of nearly $61.3 billion in fiscal year 2014, which includes $28.5 billion in personal income tax revenues (an
increase of 6.0%), $6.4 billion in business tax receipts (an increase of 2.0%) and $1.1 billion in estate taxes (an increase of 3.4%), among others. The budget also assumes that the General Fund will receive $6.5 billion in user taxes and fees,
which represents a decrease of 28.1% from the previous fiscal year. This change is due primarily to the way the State accounts for sales tax receipts. Absent this change, expected sales tax receipts would increase approximately 4.5% from the prior
fiscal year. The budget also projects transfers from other funds of approximately $15.7 billion. As a result of these projections, the New York State Division of the Budget (DOB) estimates that the State will end fiscal year 2014 with a
General Fund balance of $1.7 billion, which would be an increase of 6.1% from the expected balance left at the end of fiscal year 2013.
The budget estimates that the State will face budget gaps of $1.35 billion in fiscal year 2014, $4.0 billion in fiscal year 2015, $5.2 billion in fiscal year 2016, and $5.7 billion in fiscal year 2017.
The budget includes a variety of measures to close the budget gap in fiscal year 2014. Among these measures are continued reductions in State agency operations, decreases in disbursements for certain public health programs, increased reliance on
federal funds for child care, and extensions of certain revenue-generating laws that would otherwise expire. The gap-closing plan also provides recurring savings, which are projected to reduce future budget gaps by $2.0 billion in fiscal year 2015,
$2.3 billion in fiscal year 2016 and $2.8 billion in fiscal year 2017.
Part I - 34
Public Authorities
. Public authorities are created pursuant to State law, are not
subject to the constitutional restrictions on the incurrence of debt that apply to the State itself and may issue bonds and notes subject to restrictions set forth in legislative authorization. The States access to the public credit markets
could be impaired and the market price of its outstanding debt may be materially and adversely affected if certain of its public authorities were to default on their respective obligations.
The State has numerous public authorities with various responsibilities, including those that finance, construct and/or operate
revenue-producing public facilities. Public authorities generally pay their operating expenses and debt service costs from revenues generated by the projects they finance or operate, such as tolls charged for the use of highways, bridges or tunnels,
charges for public power, electric and gas utility services, rentals charged for housing units, and charges for occupancy at medical care facilities. Because of the structure of these public authorities, they may also suffer in poor economic
environments.
In addition, there are statutory arrangements providing for State local assistance payments otherwise payable to
localities to be made instead to the issuing public authorities in order to secure the payment of debt service on their revenue bonds and notes. However, the State has no obligation to provide additional assistance to localities beyond any amounts
that have been appropriated in a given year. Some authorities also receive funds from State appropriations to pay for the operating costs of certain programs.
State Debt
. As of March 31, 2012, total State-related debt outstanding was approximately $56.8 billion. State-related debt is a broad measure of State debt that includes general obligation
debt, State-guaranteed debt, moral obligation financing and contingent-contractual obligations.
In 2000, the State Legislature
passed the Debt Reform Act of 2000 (the Debt Reform Act), which allows the issuance of State-supported debt only for capital purposes and limits the maximum term of any such debt to 30 years. The Debt Reform Act also limits the amount of
new State-supported debt to 4% of State personal income and new State-supported debt service costs to 5% of all State funds receipts. Once these caps are met, the State is prohibited from issuing any new State-supported debt until such time as the
States debt is found to be within the applicable limits. As of March 31, 2012, outstanding State-supported debt was below these limits.
As part of its cash management program, the General Fund is authorized to borrow resources temporarily from other available funds in the States short-term investment pool (STIP) for up
to four months, or until the end of the fiscal year, whichever period is shorter. The amount of resources that can be borrowed by the General Fund is limited to the available balances in STIP, as determined by the State Comptroller. Although the
State is expected to have sufficient liquidity to make payments as they become due in fiscal year 2014, due to normal variations in income and disbursements from the General Fund, the State may need may need to rely on this borrowing authority at
times during the fiscal year.
Localities
. New Yorks weakened economy and reduced spending have increased the
fiscal pressure on municipal issuers in the State, though such impacts have had wide variability. Local governments derive revenues from sales tax, real property tax, transfer tax and fees relating to real property transactions. Revenue losses
caused by a slower real estate market and declining real property value, among other reasons, could make it difficult for local governments to address their various economic, social and health care obligations.
New York City
. The fiscal demands on the State may be affected by the fiscal condition of New York City, which relies on State aid
to balance its budget and meet its cash requirements. It is also possible that the States finances may be affected by the ability of the City, and certain entities issuing
Part I - 35
debt for the benefit of the City, to market securities successfully in the public credit markets. Conversely, the Citys finances, and thus its ability to market its securities successfully,
could be negatively affected by delays or reductions in projected State aid. In addition, the City is the recipient of certain federal grants that, if reduced or delayed, could negatively affect the Citys finances. Further, the City, like the
State, may be party to litigation that may be resolved in a manner that negatively affects the Citys finances. As of June 30, 2012, New York Citys outstanding general obligation debt totaled $42.3 billion, while the Citys
primary government debt totaled $77.3 billion. The Citys primary government debt burden represents a per capita gross debt of more than $9,300.
Other Localities
. Certain localities outside New York City have experienced financial problems and have requested and received additional State assistance during the last several State fiscal
years. While a relatively infrequent practice, deficit financing has become more common in recent years. Between 2004 and January 2012, the State Legislature passed 21 special acts authorizing, or amending authorizations for, bond issuances to
finance local government operating deficits. Although four of these acts were passed during the 2009 and 2010 legislative sessions, the State Legislature rejected proposed legislation in 2012 that would have authorized two localities to issue bonds
to address accumulated deficits.
In addition, the State has periodically enacted legislation to create oversight boards in
order to address deteriorating fiscal conditions within a locality. In 2004, the Buffalo Fiscal Stability Authority was created to oversee the financial operations of the City of Buffalo, the Buffalo School District and other public agencies and
authorities in Buffalo, but transitioned to advisory status in fiscal year 2013. In January 2011, the Nassau County Interim Finance Authority declared it would assume control powers with respect to the finances of the County of Nassau, and, after
court review, it now exercises those powers. New York City, Troy and Erie County each have fiscal stability boards exercising advisory status with respect to the finances of those entities. Although the City of Yonkers no longer operates under an
oversight board, it must adhere to a separate fiscal agent act. Likewise, the City of Newburgh operates under fiscal monitoring by the State Comptroller. The potential impact on the State of any future requests by localities for additional oversight
or financial assistance is not included in the projections of the States receipts and disbursements for the States budget.
Like the State, local governments must respond to changing political, economic and financial influences over which they have little or no control. Such changes may adversely affect the financial condition
of certain local governments. For example, the State or federal government may reduce (or in some cases eliminate) funding of some local programs or disallow certain claims which, in turn, may require local governments to fund these expenditures
from their own resources. The loss of federal funding, new constraints for certain localities on raising property tax revenue and significant upfront costs for some communities affected by Hurricane Sandy, among other things, may have an impact on
the fiscal condition of local governments and school districts in the State. Localities may also face unanticipated problems resulting from certain pending litigation, judicial decisions and long-term economic trends. Other large-scale potential
problems, such as declining urban populations, declines in the real property tax base, increasing pension, health care and other fixed costs and the loss of skilled manufacturing jobs, may also adversely affect localities and necessitate State
assistance.
Ultimately, localities as well as local public authorities may suffer serious financial difficulties that could
jeopardize local access to the public credit markets, which may adversely affect the marketability of notes and bonds issued by localities within the State. As a result, one or more of these localities could file for bankruptcy protection under
Chapter 9 of the U.S. Bankruptcy Code in the future.
Municipal Downgrades and Bankruptcies
. Municipal bonds may be more
susceptible to being downgraded, and issuers of municipal bonds may be more susceptible to default and bankruptcy, during
Part I - 36
recessions or similar periods of economic stress. Factors contributing to the economic stress on municipalities may include lower property tax collections as a result of lower home values, lower
sales tax revenue as a result of consumers cutting back from spending and lower income tax revenue as a result of a high unemployment rate. In addition, as certain municipal obligations may be secured or guaranteed by banks and other institutions,
the risk to a Fund could increase if the banking or financial sector suffers an economic downturn and/or if the credit ratings of the institutions issuing the guarantee are downgraded or at risk of being downgraded by a national rating organization.
Such a downward revision or risk of being downgraded may have an adverse effect on the market prices of the bonds and thus the value of a Funds investments.
Downgrades of certain municipal securities insurers during the recent recession negatively impacted the price of certain insured municipal securities. Given the large number of potential claims against
municipal securities insurers, there is a risk that they will be unable to meet all future claims. Certain municipal issuers either have been unable to issue bonds or access the market to sell their issues or, if able to access the market, have
issued bonds at much higher rates, which may reduce revenues available for municipal issuers to pay existing obligations. Should the State or municipalities fail to sell bonds when and at the rates projected, the State could experience significantly
increased costs in the General Fund and a weakened overall cash position in the current fiscal year.
Further, an insolvent
municipality may file for bankruptcy. For example, Chapter 9 of the Bankruptcy Code provides a financially distressed municipality protection from its creditors while it develops and negotiates a plan for reorganizing its debts.
Municipality is defined broadly by the Bankruptcy Code as a political subdivision or public agency or instrumentality of a state and may include various issuers of securities in which a Fund invests. The reorganization of a
municipalitys debts may be accomplished by extending debt maturities, reducing the amount of principal or interest, refinancing the debt or other measures, which may significantly affect the rights of creditors and the value of the securities
issued by the municipality. Because a Funds performance depends, in part, on the ability of issuers to make principal and interest payments on their debt, any actions to avoid making these payments could reduce a Funds returns.
Litigation
. The State and its officers and employees are parties to numerous legal proceedings, many of which normally
occur in government operations. In addition, the State is involved in certain other legal proceedings (described in the States official statements) that, if decided against the State, might require the State to make significant future
expenditures or substantially impair future revenue sources. Because of the prospective nature of these proceedings, this document does not attempt to predict the outcome of such litigation, estimate the potential impact on the ability of the State
to pay debt service costs on its obligations, or determine what impact, if any, such proceedings may have on a Funds investments.
Bond Ratings
. As of May 6, 2013, New Yorks general obligation debt was assigned a rating of Aa2 by Moodys. and AA by both S&P and Fitch. These ratings reflect only the views of
the respective rating agency, an explanation of which may be obtained from each such rating agency. There is no assurance that these ratings will continue for any given period of time or that they will not be revised or withdrawn entirely by the
rating agency if, in the judgment of such rating agency, circumstances so warrant. A downward revision or withdrawal of any such rating may have an adverse effect on the market prices of the securities issued by the State, its municipalities, and
their political subdivisions, instrumentalities and authorities.
Ohio Municipal Securities
As used in this SAI, the term Ohio Municipal Securities refers to municipal securities, the income from which is exempt from
both federal and Ohio personal income tax.
Part I - 37
Risk Factors Regarding Investments in Ohio Municipal Securities.
Given that the Ohio
Municipal Bond Fund is invested primarily in Ohio Municipal Securities, the Fund is subject to risks relating to the economy of the state of Ohio (as used in this section, the State) and the financial condition of the State and local
governments and their agencies.
Overview of State Economy
. The services sector has become a significant source of
employment in the State. The manufacturing sector, despite its downward trend since its peak in 1969, continues to be a significant source of employment in the State, along with the trade, transportation & public utilities sector, the
government sector, and the leisure and hospitality sector. As a result, economic problems or factors that negatively impact these sectors may have a negative effect on the value of Ohio Municipal Securities.
Ohio is continuing to experience financial difficulties stemming from the recession that began in December 2007. In February 2010, the
States unemployment rate was at 10.6%. Although the States unemployment rate has fallen, with the February 2013 unemployment rate at 7.1%, unemployment still remains high, but is lower than the national average of 7.7%.
Because of high unemployment, decreased spending and other factors resulting from a weak economy, Ohio faced a severe erosion of its tax
base and has only recently approached pre-recession levels. Ohios total tax receipts for fiscal year 2010 (approximately $16.2 billion) were approximately $3.2 billion less than the total tax receipts for fiscal year 2008 (approximately $19.4
billion). Tax receipts began to recover in fiscal year 2011 and reached $19.0 billion in fiscal year 2012. They are projected to increase at modest rates in fiscal years 2013 and 2014. Such increases in revenue remain modest and uncertain and could
be significantly reduced if economic conditions worsen.
This erosion in the tax base caused the State to face a projected
budget gap of $733 million in the 2008-2009 biennium. However, significant spending cuts, coupled with increased revenues and continued economic improvement, have helped to prevent potential budget gaps. As a result, the State projected a budget
balance of $600 million for the 2010-2011 biennium and the Governors Biennium Budget for fiscal years 2014 and 2015 estimated a balanced budget with a surplus of approximately 100 million in 2014 and a surplus of approximately
160 million in 2015 (including federal grants and reimbursements). Although the State has experienced significant improvements in its financial condition, there remain a number of serious risks and pressures that threaten the States
budget. For example, revenues may fall short of projections due to recent mandatory reductions in federal spending and a potential slowdown in the States economic recovery, among other things.
The sharp drop in revenues that occurred in the aftermath of the recession caused a significant depletion of cash resources to pay the
States obligations. Statutory provisions provided for the management of the cash flow deficiencies by permitting the adjustment of payment schedules and the use of the Total Operating Fund (TOF). The TOF included the total
consolidated cash balances, revenues, disbursements and transfers of the States General Revenue Fund (GRF) and several other specified funds. The TOF cash balances were consolidated only for the purpose of meeting cash flow
requirements, and, except for the GRF, a positive cash balance needed to be maintained for each discrete fund included in the TOF. The GRF was permitted to incur a temporary cash deficiency by drawing upon the available consolidated cash balance in
the TOF. The amount of that permitted GRF cash deficiency at any time was limited by statute to 10% of GRF revenues for the then preceding fiscal year, but that limitation was suspended for the 2010-11 biennium. The State has not done external
revenue anticipation borrowing.
Accordingly, there can be no assurances that the State will not continue to face fiscal stress
or that such circumstances will not become more difficult in the future. Moreover, there can be no guarantee that
Part I - 38
the current economic situation and the lingering effects from the recession will not have a materially adverse impact on the States financial condition. Any deterioration of the
States financial condition may have a negative effect on the value of the securities issued by the State and its municipalities, which could reduce the performance of a Fund.
In addition, the pension plans managed by the States public pension systems are underfunded. In 2009 and 2010, the states
pension plans had just 75.2% of the assets on hand necessary to meet their long-term pension obligations for state and local government employees and teachers. Although this percentage increased slightly to 78.9% in 2011, the unfunded liability
could impose difficulties in balancing Ohios budget in the future.
There can be no assurance that any issuer of an Ohio
Municipal Security will make full or timely payments of principal or interest or remain solvent. However, it should be noted that the creditworthiness of obligations issued by local Ohio issuers may be unrelated to the creditworthiness of
obligations issued by the State, and there is no obligation on the part of the State to make payment on such local obligations in the event of default.
General Risks
.
Many complex political, social and economic factors influence the States economy and finances, which may affect the States budget unpredictably from year to year.
Such factors include, but are not limited to: (i) developments with respect to the national economy as a whole, (ii) developments with respect to the service, manufacturing, trade, transportation & public utilities, government,
leisure and hospitality sectors of the economy; (iii) U.S. fiscal and economic policies, including fiscal stimulus efforts in general and the amount of federal aid to the State; and (iv) actions taken by the Federal government, including
audits, disallowances and changes in aid levels.
These factors are continually changing, and no assurances can be given with
respect to how these factors or other factors will materialize in the future or what impact they will have on the States fiscal and economic condition. Such factors could have an adverse impact on the States budget and could result in
declines, possibly severe, in the value of the States outstanding obligations. These factors may also lead to an increase in the States future borrowing costs and could impair the States ability to make timely payments of interest
and principal on its obligations. These factors may also impact the ability of Ohios municipal issuers to issue new debt or service their outstanding obligations.
2012-13 Biennium Budget
. Consistent with the constitutional provision that no appropriation may be made for a period longer than two years, the State operates on the basis of a fiscal biennium for
its appropriations and expenditures. The current fiscal biennium began July 1, 2011 and ends June 30, 2013. Within a fiscal biennium, the State operates on the basis of a July 1 to June 30 fiscal year.
Most State operations are financed through the GRF. Individual income and sales and use taxes are the major sources of GRF tax revenue.
The last complete fiscal year ended June 30, 2012 with a GRF fund balance (after year-end transfers) of $135.9 million. The State has a rainy day fund the Budget Stabilization Fund (BSF) which under current
law and until used may carry a balance of up to 5% of the GRF revenue for the preceding fiscal year. As of June 30, 2012 the BSF balance is $482.0 million.
Consistent with State law, the Governors Executive Budget for the 2012-13 biennium was released in March 2011. After extended hearings and review, the 2012-13 biennial appropriations act
(2012-13 Biennial Budget Act) was passed by the General Assembly and signed by the Governor on June 30, 2011. To address the use of non-recurring funding sources in the prior budget, including amounts received under the American
Recovery and Reinvestment Act of 2009, the 2012-13 Biennial Budget Act includes targeted spending cuts across most State agencies and Medicaid reform. The 2012-13 Biennial Budget Act provides $55.78 billion in total GRF biennial appropriations (an
11% increase
Part I - 39
from the previous biennial budget) and total biennial revenue of $56 billion (a 6% increase). The 2012-13 Biennial Budget Act includes 30% increases in Medicaid, 3% increases in elementary and
secondary education, and 9% reductions in higher education spending. The 2012-13 Biennial Budget Act also anticipates a one-time increase in revenue of $500 million from the transfer of the States liquor system to a nonprofit corporation,
JobsOhio. Various lawsuits have challenged the validity of the creation of JobsOhio, and those lawsuits are still pending. The 2012-13 Biennial Budget Act also reduces local government fund allocations by $111 million in fiscal year 2012 and $340
million in fiscal year 2013, as well as phase-outs of reimbursements to local governments.
The 2012-13 Biennial Budget Act
also includes the implementation of a 4.2% annual decrease in personal income tax rates, elimination of the States estate tax effective January 1, 2013, and an income tax credit for investors in small businesses. The 2012-13 Biennial
Budget Act also creates a Medicaid reserve fund and $104 million Unemployment Compensation Contingency Fund.
2014-15
Biennium Budget
.
On February 4, 2013, the Governor submitted his Executive Budget for the 2014-2015 biennium (the Executive Budget) to the Ohio General Assembly. To attempt to address the use of non-recurring funding
sources in the prior budget, including amounts received under the American Recovery and Reinvestment Act of 2009, the Executive Budge proposes targeted spending cuts across most State agencies and Medicaid reform. It also proposes increases in
fiscal year 2014 (over fiscal year 2013) of 18.8% on Medicaid, 5.7% on primary and secondary education, as well as increases in other sectors. The Executive Budge proposes increases in fiscal year 2015 (over fiscal year 2014) of 11.4% in Medicaid
and 3.0% in primary and secondary education, as well as increases in other sectors. The Executive Budget also proposes local government fund allocations to a total of $2.0 billion in fiscal year 2014 (2.6% above fiscal year 2013) and $2.1 billion in
fiscal year 2015 (3.6% above fiscal year 2014).
The Executive Budge recommends the implementation of proposed income tax cut
of 20% for all brackets that is phased in from 2013 to 2015, a tax cut for small business owners that gives pass-through entities a deduction of 50% of their annual pass-through entity income, up to $750,000 with the deduction capped at $375,000,
and a reduction of the state sales tax rate from 5.5% to 5.0%. The Executive Budget also proposes the reduction of local tax rates by an average of 20%, and recommends a severance tax for high-volume horizontal wells operating in the Utica shale
formation.
Constitutional Limitations on Taxes
. Since 1934, the State Constitution has limited the amount of the
aggregate levy of
ad valorem
property taxes on particular property, without a vote of the electors or municipal charter provision, to 1% of true value in money, and statutes limit the amount of that aggregate levy without a vote or charter
provision to 10 mills per $1 of assessed valuation.
The State Constitution directs or restricts the use of certain revenues.
Highway fees and excises, including gasoline taxes, are limited in use to highway-related purposes. Not less than 50% of the receipts from State income taxes and estate taxes must be returned to the originating political subdivisions and school
districts. State net lottery profits are allocated to elementary, secondary, vocational and special education program purposes, including application to debt service on obligations issued to finance capital facilities for a system of common schools.
Constitutional amendments relating to taxation, revenues, expenditures, debt or other subjects may be proposed by action of
three-fifths of the members elected to each house of the State General Assembly or by initiative petition signed by electors numbering at least 10% of the total number of votes last cast for the office of governor. Adoption of a proposed amendment
requires approval by a majority of electors voting on it at a statewide election. The State Constitution expressly provides that the General Assembly has no power to pass laws impairing the obligation of contracts.
Part I - 40
State Debt
. The incurrence or assumption of debt by the State without a popular vote
is, with limited exceptions, prohibited by the State Constitution. The State may incur debt to cover casual deficits or to address failures in revenues or to meet expenses not otherwise provided for, but limited in amount to $750,000. The State
Constitution expressly precludes the State from assuming the debts of any county, city, town or township, or of any corporation, subject to limited exceptions. The State Constitution provides that Except the debts above specified . . . no debt
whatever shall hereafter be created by, or on behalf of the state.
By 19 constitutional amendments approved from 1921 to
present, Ohio voters have authorized the incurrence of State general obligation debt and the pledge of taxes or excises to its payment, all related to the financing of capital facilities, except for four that funded bonuses for veterans, one that
funded coal technology research and development, and one for research and development activities. Currently, tax supported general obligation debt of the State is authorized to be incurred for the following purposes: highways, local infrastructure,
coal development, natural resources, higher education, common schools, conservation, research and development, site development and veterans compensation. Although supported by the general obligation pledge, highway debt is also backed by a pledge
of and has always been paid from the States motor fuel taxes and other highway user receipts that are constitutionally restricted in use to highway related purposes.
A 1999 constitutional amendment provides an annual debt service cap applicable to most future issuances of State general obligations and other State direct obligations payable from the GRF or
net State lottery proceeds. Generally, new obligations may not be issued if debt service for any future fiscal year on those new and the then outstanding bonds of those categories would exceed 5% of the total of estimated GRF revenues (excluding GRF
receipts from the American Recovery and Reinvestment Act of 2009) plus net State lottery proceeds for the fiscal year of issuance. Those direct obligations of the State include general obligation and special obligation bonds that are paid from the
States GRF, but exclude (i) general obligation debt for third frontier research and development, development of sites and facilities, and veterans compensation, and (ii) general obligation debt payable from non-GRF funds (such as
highway bonds that are paid from highway user receipts). Pursuant to the implementing legislation, the Governor has designated the Office of Budget and Management Director as the State official responsible for making the 5% determinations and
certifications. Application of the 5% cap may be waived in a particular instance by a three-fifths vote of each house of the Ohio General Assembly and may be changed by future constitutional amendments.
Municipal Downgrades and Bankruptcies
. Municipal bonds may be more susceptible to being downgraded, and issuers of municipal bonds
may be more susceptible to default and bankruptcy, during recessions or similar periods of economic stress. Factors contributing to the economic stress on municipalities may include lower property tax collections as a result of lower home values,
lower sales tax revenue as a result of consumers cutting back from spending and lower income tax revenue as a result of a high unemployment rate. In addition, as certain municipal obligations may be secured or guaranteed by banks and other
institutions, the risk to a Fund could increase if the banking or financial sector suffers an economic downturn and/or if the credit ratings of the institutions issuing the guarantee are downgraded or at risk of being downgraded by a national rating
organization. Such a downward revision or risk of being downgraded may have an adverse effect on the market prices of the bonds and thus the value of a Funds investments.
Downgrades of certain municipal securities insurers during the recent recession negatively impacted the price of certain insured municipal securities. Given the large number of potential claims against
municipal securities insurers, there is a risk that they will be unable to meet all future claims. Certain municipal issuers either have been unable to issue bonds or access the market to sell their issues or, if able to access the market, have
issued bonds at much higher rates, which may reduce revenues
Part I - 41
available for municipal issuers to pay existing obligations. Should the State or municipalities fail to sell bonds when and at the rates projected, the State could experience significantly
increased costs in the General Fund and a weakened overall cash position in the current fiscal year.
Further, an insolvent
municipality may file for bankruptcy. For example, Chapter 9 of the U.S. Bankruptcy Code provides a financially distressed municipality protection from its creditors while it develops and negotiates a plan for reorganizing its debts.
Municipality is defined broadly by the Bankruptcy Code as a political subdivision or public agency or instrumentality of a state and may include various issuers of securities in which a Fund invests. The reorganization of a
municipalitys debts may be accomplished by extending debt maturities, reducing the amount of principal or interest, refinancing the debt or other measures, which may significantly affect the rights of creditors and the value of the securities
issued by the municipality. Because a Funds performance depends, in part, on the ability of issuers to make principal and interest payments on their debt, any actions to avoid making these payments could reduce a Funds returns.
Litigation
. The State is party to numerous legal proceedings, many of which normally occur in government operations. In
addition, the State is involved in certain other legal proceedings (described in the States official statements) that, if decided against the State, might require the State to make significant future expenditures or substantially impair future
revenue sources. Because of the prospective nature of these proceedings, it is not presently possible to predict the outcome of such litigation, estimate the potential impact on the ability of the State to pay debt service costs on its obligations,
or determine what impact, if any, such proceedings may have on a Funds investments.
Bond Ratings
. As of
May 6, 2013, Ohios general obligation debt was assigned a rating of Aa1 by Moodys and AA+ by both S&P and Fitch. These ratings reflect only the views of the respective rating agency, an explanation of which may be obtained from
each such rating agency. There is no assurance that these ratings will continue for any given period of time or that they will not be revised or withdrawn entirely by the rating agency if, in the judgment of such rating agency, circumstances so
warrant. A downward revision or withdrawal of any such rating may have an adverse effect on the market prices of the securities issued by the State, its municipalities, and their political subdivisions, instrumentalities and authorities.
QUALITY DESCRIPTION
Tax Free Funds.
Each Tax Free Fund invests principally in a portfolio of investment grade tax exempt securities. An investment grade bond is rated, on the date of investment, within the
four highest ratings of Moodys, currently Aaa, Aa, A and Baa or of Standard & Poors, currently AAA, AA, A and BBB, while high grade debt is rated, on the date of the investment, within the two highest of such ratings. Investment
grade municipal notes are rated, on the date of investment, MIG-1 or MIG-2 by Standard & Poors or SP-1 and SP-2 by Moodys. Investment grade municipal commercial paper is rated, on the date of investment, Prime 1 or Prime 2 by
Moodys and A-1 or A-2 by Standard & Poors. A Tax Free Fund may also invest up to 10% of its total assets in securities which are below investment grade. Such securities must be rated, on the date of investment, B or
better by Moodys or Standard & Poors, or of comparable quality. Securities rated Ba or B by Moodys and BB or B by Standard & Poors are below investment grade and considered to be speculative with regard to
payment of interest and principal. If the quality of the investment later declines, a Fund may continue to hold the investment. The Fund may invest in debt securities which are not rated or other debt securities to which these ratings are not
applicable, if in the opinion of the Adviser, such securities are of comparable quality to the rated securities discussed above. In addition, at the time the Fund invests in any commercial paper, bank obligation, repurchase agreement, or any other
money market instruments, the investment must have received a short term rating of investment grade or better (currently Prime-3 or better by Moodys or A-3
Part I - 42
or better by Standard & Poors) or the investment must have been issued by an issuer that received a short term investment grade rating or better with respect to a class of
investments or any investment within that class that is comparable in priority and security with the investment being purchased by the Fund. If no such ratings exists, the investment must be of comparable investment quality in the Advisers
opinion, but will not be eligible for purchase if the issuer or its parent has long term outstanding debt rated below BBB. For a more complete discussion of below investment grade securities, see the Debt Instruments section
in Part II of this SAI.
Municipal Bond Funds.
Municipal securities that are bonds must be rated as investment grade.
JPMIM will look at a securitys rating at the time of investment. If the securities are unrated, JPMIM must determine that they are of comparable quality to rated securities. Subsequent to its purchase by the Fund, a security may cease to be
rated or its rating may be reduced below the minimum rating required for purchase by the Fund. JPMIM will consider such an event in determining whether the Fund should continue to hold the security.
Short-term securities such as tax-exempt commercial paper, notes and variable rate demand obligations must be rated in one of the two
highest investment grade categories. If a security has both a long-term and a short-term rating, it must have a long-term investment grade rating or be rated in one of the two highest short-term investment grade categories.
Commercial Paper
The
Municipal Bond Funds may purchase commercial paper consisting of issues rated at the time of purchase in the highest or second highest rating category by at least one NRSRO (such as A-2 or better by S&P, Prime-2 or better by Moodys, F2 or
better by Fitch, or R-2 or better by Dominion) or if unrated, determined by the applicable Manager to be comparable quality. If commercial paper has both a long-term and a short-term rating, it must have either a long-term investment grade rating or
be rated in one of the two highest short-term investment grade categories. For a more complete discussion, see the Commercial Paper section in Part II of this SAI.
Limitations on the use of Mortgage-Backed Securities
The Municipal Bond
Funds may invest in mortgage-backed securities that are rated in one of the four highest rating categories by at least one NRSRO at the time of investment or, if unrated, determined by the adviser to be of comparable quality.
Limitations on the Use of Municipal Securities
The Arizona Municipal Bond Fund, the Michigan Municipal Bond Fund and the Ohio Municipal Bond Fund may invest in Municipal Securities either by purchasing them directly or by purchasing certificates of
accrual or similar instruments evidencing direct ownership of interest payments or principal payments, or both, on Municipal Securities, provided that, in the opinion of counsel to the initial seller of each such certificate or instrument, any
discount accruing on such certificate or instrument that is purchased at a yield not greater than the coupon rate of interest on the related Municipal Securities will to the same extent as interest on such Municipal Securities be exempt from federal
income tax and state income tax (where applicable) and not treated as a preference item for individuals for purposes of the federal alternative minimum tax.
The Arizona Municipal Bond Fund, the Michigan Municipal Bond Fund and the Ohio Municipal Bond Fund may also invest in Municipal Securities by purchasing from banks participation interests in all or part
of specific holdings of Municipal Securities. Such participation interests may be backed in whole
Part I - 43
or in part by an irrevocable letter of credit or guarantee of the selling bank. The selling bank may receive a fee from a Fund in connection with the arrangement. A Fund will not purchase
participation interests unless it receives an opinion of counsel or a ruling of the Internal Revenue Service that interest earned by it on Municipal Securities in which it holds such participation interest is exempt from federal income tax and state
income tax (where applicable) and not treated as a preference item for individuals for purposes of the federal alternative minimum tax.
The Funds may not be a desirable investment for substantial users of facilities financed by private activity bonds or industrial development bonds or for related persons of
substantial users.
DIVERSIFICATION
JPMT I and JPMT II are registered management investment companies and the California Tax Free Bond Fund, the Intermediate Tax Free Bond
Fund and the New York Tax Free Bond Fund are diversified series of JPMT I. The Arizona Municipal Bond Fund, Michigan Municipal Bond Fund, the Municipal Income Fund, the Ohio Municipal Bond Fund, the Short-Intermediate Municipal Bond Fund and
the Tax Free Bond Fund are diversified series of JPMT II. For a more complete discussion, see the Diversification section in Part II of this SAI.
PORTFOLIO TURNOVER
A portfolio turnover rate
is, in summary, the percentage computed by dividing the lesser of a Funds purchases or sales of securities (excluding short-term securities) by the average market value of the Fund. The Adviser intends to manage each Funds assets by
buying and selling securities to help attain its investment objective. A rate of 100% indicates that the equivalent of all of a Funds assets have been sold and reinvested in a year. Higher portfolio turnover may affect the amount, timing and
character of distributions, and, as a result, may increase the amount of taxes payable by shareholders. High portfolio turnover also results in higher transaction costs. To the extent that net short-term capital gains are realized by a Fund, any
distributions resulting from such gains are considered ordinary income for federal income tax purposes. For a more complete discussion, see the Distribution and Tax Matters section in Part II of this SAI.
The table below sets forth the Funds portfolio turnover rates for the last two fiscal years.
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|
|
|
|
|
|
|
|
|
|
Fiscal Year
Ended 2/29/12
|
|
|
Fiscal Year
Ended 2/28/13
|
|
Arizona Municipal Bond Fund
|
|
|
6
|
%
|
|
|
7
|
%
|
Michigan Municipal Bond Fund
|
|
|
8
|
%
|
|
|
21
|
%
|
Municipal Income Fund
|
|
|
6
|
%
|
|
|
13
|
%
|
Ohio Municipal Bond Fund
|
|
|
6
|
%
|
|
|
6
|
%
|
Short-Intermediate Municipal Bond Fund
|
|
|
43
|
%
|
|
|
33
|
%
|
Tax Free Bond Fund
|
|
|
24
|
%
|
|
|
43
|
%
|
California Tax Free Bond Fund
|
|
|
7
|
%
|
|
|
21
|
%
|
Intermediate Tax Free Bond Fund
|
|
|
14
|
%
|
|
|
14
|
%
|
New York Tax Free Bond Fund
|
|
|
5
|
%
|
|
|
7
|
%
|
Part I - 44
TRUSTEES
Standing Committees
There are four standing committees of the Board of Trustees: the Audit and Valuation Committee, the Compliance Committee, the Governance Committee and the Investments Committee.
During the fiscal year ended February 28, 2013, the Audit and Valuation Committee met four times, the Compliance Committee met four
times, the Governance Committee met six times, and each Investments Sub-Committee met six times. For a more complete discussion, see the Trustees section in Part II of this SAI.
Ownership of Securities
The following table
shows the dollar range of each Trustees beneficial ownership as of December 31, 2012, in the Funds and each Trustees aggregate dollar range of ownership in any Funds that the Trustee oversees in the Family of Investment Companies.
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Name of Trustee
|
|
Ownership of
Arizona Municipal
Bond Fund
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|
|
Ownership of
Michigan
Municipal
Bond Fund
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|
|
Ownership of
Municipal
Income Fund
|
|
|
Ownership of
Ohio
Municipal
Bond Fund
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|
Independent Trustees
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Finn
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Dr. Matthew Goldstein
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Robert J. Higgins
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Peter C. Marshall
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|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Mary E. Martinez
(3)
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|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Marilyn McCoy
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Mitchell M. Merin
(3)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
William G. Morton, Jr.
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Dr. Robert A. Oden, Jr.
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Marian U. Pardo
(4)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Frederick W. Ruebeck
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
James J. Schonbachler
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
|
|
|
Name of Trustee
|
|
Ownership of
Short-Intermediate
Municipal
Bond
Fund
|
|
|
Ownership of
Tax Free
Bond Fund
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|
|
Ownership of
California
Tax Free
Bond Fund
|
|
|
Ownership of
Intermediate
Tax Free
Bond Fund
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Finn
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Dr. Matthew Goldstein
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Robert J. Higgins
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Peter C. Marshall
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Mary E. Martinez
(3)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
Part I - 45
|
|
|
|
|
|
|
|
|
|
|
|
|
Marilyn McCoy
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
Mitchell M. Merin
(3)
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
William G. Morton, Jr.
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
Dr. Robert A. Oden, Jr.
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
Marian U. Pardo
(4)
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
Frederick W. Ruebeck
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
James J. Schonbachler
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
|
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
|
|
None
|
|
None
|
|
|
None
|
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Ownership of New
York Tax Free
Bond Fund
|
|
Aggregate Dollar Range
of Equity
Securities in
All Registered
Investment Companies
Overseen by
the
Trustee in the Family of
Investment
Companies
(1)(2)
|
Independent Trustees
|
|
|
|
|
John F. Finn
|
|
None
|
|
Over $100,000
|
Dr. Matthew Goldstein
|
|
None
|
|
Over $100,000
|
Robert J. Higgins
|
|
None
|
|
Over $100,000
|
Peter C. Marshall
|
|
None
|
|
Over $100,000
|
Mary E. Martinez
(3)
|
|
None
|
|
None
|
Marilyn McCoy
|
|
None
|
|
Over $100,000
|
Mitchell M. Merin
(3)
|
|
None
|
|
None
|
William G. Morton, Jr.
|
|
None
|
|
Over $100,000
|
Dr. Robert A. Oden, Jr.
|
|
None
|
|
Over $100,000
|
Marian U. Pardo
(4)
|
|
None
|
|
$50,000$100,000
(5)
|
Frederick W. Ruebeck
|
|
None
|
|
Over $100,000
|
James J. Schonbachler
|
|
None
|
|
Over $100,000
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
Frankie D. Hughes
|
|
None
|
|
Over $100,000
|
(1)
|
A Family of Investment Companies means any two or more registered investment companies that share the same investment adviser or principal underwriter and hold
themselves out to investors as related companies for purposes of investment and investor services. The Family of Investment Companies for which the Board of Trustees currently serves includes eleven registered investment companies (172 Funds),
including JPMMFG which liquidated effective November 29, 2012 and is in the process of winding up its affairs.
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(2)
|
For Ms. McCoy and Messrs. Finn, Higgins, Marshall, Oden, and Ruebeck, these amounts include deferred compensation balances, as of December 31, 2012, through
participation in the J.P. Morgan Funds Deferred Compensation Plan for Eligible Trustees. For a more complete discussion, see the Trustees Compensation section in Part II of this SAI.
|
(3)
|
Ms. Martinez and Mr. Merin became members of the Board of Trustees effective January 1, 2013.
|
(4)
|
Ms. Pardo became a member of the Board of Trustees effective February 1, 2013.
|
(5)
|
Over $100,000 as of February 5, 2013.
|
Part I - 46
As of December 31, 2012, none of the independent Trustees or their immediate family
members owned securities of the Adviser or JPMDS or a person (other than a registered investment company) directly or indirectly controlling, controlled by or under common control with the Adviser or JPMDS.
Trustee Compensation
Prior to January 1, 2013, the Funds of the J.P. Morgan Funds Complex overseen by the Trustees paid each Trustee an annual fee of $275,000 and reimbursed each Trustee for expenses incurred in
connection with service as a Trustee. Beginning January 1, 2013, the Funds of the J.P. Morgan Funds Complex overseen by the Trustees will pay each Trustee an annual fee of $315,000 and reimburse each Trustee for expenses incurred in connection
with service as a Trustee. In addition, the Funds pay the Chairman $225,000, the Vice Chairman $75,000 and from December 1, 2011 through February 29, 2012, the assistant to the Audit and Valuation Committee Chairman $6,250. The Chairman
and Vice Chairman receive no additional compensation for service as committee or sub-committee chairmen. Committee chairs and sub-committee chairs who are not already receiving an additional fee are each paid $50,000. The Trustees may hold various
other directorships unrelated to the J.P. Morgan Funds Complex. The J.P. Morgan Funds bore expenses related to administrative and staffing services provided to the former Chairman, in lieu of establishing an office of the former Chairman, in the
amount of $6,000 per month.
Trustee aggregate compensation paid by the Funds and the J.P. Morgan Funds Complex for the
calendar year ended December 31, 2012, is set forth below:
Aggregate Trustee Compensation Paid by the Funds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Arizona Municipal
Bond Fund
|
|
|
Michigan
Municipal Bond
Fund
|
|
|
Municipal Income
Fund
|
|
|
Ohio
Municipal
Bond Fund
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Finn
|
|
$
|
70
|
|
|
$
|
63
|
|
|
$
|
457
|
|
|
$
|
155
|
|
Dr. Matthew Goldstein
|
|
|
83
|
|
|
|
75
|
|
|
|
540
|
|
|
|
184
|
|
Robert J. Higgins
|
|
|
83
|
|
|
|
75
|
|
|
|
540
|
|
|
|
184
|
|
Peter C. Marshall
|
|
|
90
|
|
|
|
80
|
|
|
|
581
|
|
|
|
198
|
|
Mary E. Martinez
(2)
|
|
|
11
|
|
|
|
11
|
|
|
|
73
|
|
|
|
27
|
|
Marilyn McCoy
|
|
|
83
|
|
|
|
75
|
|
|
|
540
|
|
|
|
184
|
|
Mitchell M. Merin
(2)
|
|
|
11
|
|
|
|
11
|
|
|
|
73
|
|
|
|
27
|
|
William G. Morton, Jr.
|
|
|
70
|
|
|
|
63
|
|
|
|
457
|
|
|
|
155
|
|
Dr. Robert A. Oden, Jr.
|
|
|
70
|
|
|
|
63
|
|
|
|
457
|
|
|
|
155
|
|
Marian U. Pardo
(3)
|
|
|
11
|
|
|
|
11
|
|
|
|
73
|
|
|
|
27
|
|
Frederick W. Ruebeck
|
|
|
83
|
|
|
|
75
|
|
|
|
540
|
|
|
|
184
|
|
James J. Schonbachler
|
|
|
82
|
|
|
|
74
|
|
|
|
532
|
|
|
|
181
|
|
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
|
|
|
70
|
|
|
|
63
|
|
|
|
457
|
|
|
|
155
|
|
|
|
|
|
|
Name of Trustee
|
|
Short-Intermediate
Municipal Bond
Fund
|
|
|
Tax Free Bond
Fund
|
|
|
California Tax
Free Bond Fund
|
|
|
Intermediate
Tax Free
Bond Fund
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John F. Finn
|
|
|
762
|
|
|
|
278
|
|
|
|
238
|
|
|
|
3,202
|
|
Dr. Matthew Goldstein
|
|
|
901
|
|
|
|
329
|
|
|
|
281
|
|
|
|
3,785
|
|
Robert J. Higgins
|
|
|
901
|
|
|
|
329
|
|
|
|
281
|
|
|
|
3,785
|
|
Peter C. Marshall
|
|
|
970
|
|
|
|
354
|
|
|
|
303
|
|
|
|
4,076
|
|
Mary E. Martinez
(2)
|
|
|
138
|
|
|
|
48
|
|
|
|
44
|
|
|
|
551
|
|
Marilyn McCoy
|
|
|
901
|
|
|
|
329
|
|
|
|
281
|
|
|
|
3,785
|
|
Mitchell M. Merin
(2)
|
|
|
138
|
|
|
|
48
|
|
|
|
44
|
|
|
|
551
|
|
William G. Morton, Jr.
|
|
|
762
|
|
|
|
278
|
|
|
|
238
|
|
|
|
3,202
|
|
Part I - 47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dr. Robert A. Oden, Jr.
|
|
|
762
|
|
|
|
278
|
|
|
|
238
|
|
|
|
3,202
|
|
Marian U. Pardo
(3)
|
|
|
138
|
|
|
|
48
|
|
|
|
44
|
|
|
|
551
|
|
Frederick W. Ruebeck
|
|
|
901
|
|
|
|
329
|
|
|
|
281
|
|
|
|
3,785
|
|
James J. Schonbachler
|
|
|
889
|
|
|
|
325
|
|
|
|
278
|
|
|
|
3,737
|
|
|
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
|
|
|
762
|
|
|
|
278
|
|
|
|
238
|
|
|
|
3,202
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
New York Tax Free
Bond Fund
|
|
|
Total
Compensation
Paid From
Fund
Complex
(1)
(9)
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
John F. Finn
|
|
|
511
|
|
|
$
|
275,000
|
(
4
)
|
Dr. Matthew Goldstein
|
|
|
604
|
|
|
|
325,000
|
|
Robert J. Higgins
|
|
|
604
|
|
|
|
325,000
|
(
5
)
|
Peter C. Marshall
|
|
|
650
|
|
|
|
350,000
|
|
Mary E. Martinez
(2)
|
|
|
89
|
|
|
|
45,833
|
(2)
|
Marilyn McCoy
|
|
|
604
|
|
|
|
325,000
|
|
Mitchell M. Merin
(2)
|
|
|
89
|
|
|
|
45,833
|
(2)
|
William G. Morton, Jr.
|
|
|
511
|
|
|
|
275,000
|
|
Dr. Robert A. Oden, Jr.
|
|
|
511
|
|
|
|
275,000
|
(
6
)
|
Marian U. Pardo
(3)
|
|
|
89
|
|
|
|
45,833
|
(
3
)
|
Frederick W. Ruebeck
|
|
|
604
|
|
|
|
325,000
|
(
7
)
|
James J. Schonbachler
|
|
|
596
|
|
|
|
320,833
|
(
8
)
|
|
|
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
|
|
|
511
|
|
|
|
275,000
|
|
(1)
|
A Fund Complex means two or more registered investment companies that (i) hold themselves out to investors as related companies for purposes of investment and
investor services or (ii) have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other registered investment companies. The J.P. Morgan Funds Complex for which the
Board of Trustees currently serves includes eleven registered investment companies (172 Funds), including JPMMFG which liquidated effective November 29, 2012 and is in the process of winding up its affairs.
|
(2)
|
Ms. Martinez and Mr. Merin became members of the Board of Trustees effective January 1, 2013. Compensation includes amounts paid prior to becoming a
trustee for attendance at Board meetings and service as a trustee nominee.
|
(3)
|
Ms. Pardo became a member of the Board of Trustees effective February 1, 2013. Compensation includes amounts paid prior to becoming a trustee for attendance
at Board meetings and as a trustee nominee.
|
(4)
|
Includes $275,000 of Deferred Compensation.
|
(5)
|
Includes $325,000 of Deferred Compensation.
|
(6)
|
Includes $27,500 of Deferred Compensation.
|
(7)
|
Includes $130,000 of Deferred Compensation.
|
(8)
|
Includes $64,167 of Deferred Compensation.
|
Part I - 48
(9)
|
William J. Armstrong, Fergus Reid III, and Leonard M. Spalding, Jr. retired as Trustees of the Trusts effective December 31, 2012. For the period specified in the
table above, the former trustees were paid the following total compensation from the J.P. Morgan Funds Complex.
|
|
|
|
|
|
|
|
Name of Former Trustee
|
|
Total Compensation Paid
From Fund Complex
|
|
|
Amount of Deferred
Compensation Included in
Total
|
William J. Armstrong
|
|
$
|
283,333
|
|
|
None
|
Fergus Reid III
|
|
$
|
500,000
|
|
|
Includes $100,000 of Deferred Compensation.
|
Leonard M. Spalding, Jr.
|
|
$
|
325,000
|
|
|
Includes $325,000 of Deferred Compensation.
|
INVESTMENT ADVISER
Investment Advisory Fees
The table below sets forth the investment advisory fees paid by the following Funds to JPMIM or JPMIA (waived amounts are in parentheses), with respect to the fiscal years indicated (amounts in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Fund
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
Arizona Municipal Bond Fund
|
|
$
|
448
|
|
|
($
|
3
|
)
|
|
$
|
340
|
|
|
($
|
2
|
)
|
|
$
|
323
|
|
|
($
|
3
|
)
|
Michigan Municipal Bond Fund
|
|
|
460
|
|
|
|
(3
|
)
|
|
|
313
|
|
|
|
(1
|
)
|
|
|
292
|
|
|
|
(4
|
)
|
Municipal Income Fund
|
|
|
3,539
|
|
|
|
(57
|
)
|
|
|
2,502
|
|
|
|
(88
|
)
|
|
|
2,009
|
|
|
|
(28
|
)
|
Ohio Municipal Bond Fund
|
|
|
889
|
|
|
|
(24
|
)
|
|
|
714
|
|
|
|
(5
|
)
|
|
|
738
|
|
|
|
(11
|
)
|
Short-Intermediate Municipal Bond Fund
|
|
|
1,474
|
|
|
|
(1,817
|
)
|
|
|
1,483
|
|
|
|
(1,365
|
)
|
|
|
2,687
|
|
|
|
(426
|
)
|
Tax Free Bond Fund
|
|
|
1,976
|
|
|
|
(16
|
)
|
|
|
1,317
|
|
|
|
(18
|
)
|
|
|
1,314
|
|
|
|
(31
|
)
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Fund
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
California Tax Free Bond Fund
|
|
$
|
776
|
|
|
($
|
153
|
)
|
|
$
|
786
|
|
|
($
|
138
|
)
|
|
$
|
1,048
|
|
|
($
|
67
|
)
|
Intermediate Tax Free Bond Fund
|
|
|
15,512
|
|
|
|
(482
|
)
|
|
|
14,515
|
|
|
|
(264
|
)
|
|
|
15,253
|
|
|
|
(344
|
)
|
New York Tax Free Bond Fund
|
|
|
2,763
|
|
|
|
(33
|
)
|
|
|
2,284
|
|
|
|
(8
|
)
|
|
|
2,288
|
|
|
|
(60
|
)
|
For a more complete discussion, see the Investment Advisers section in Part II of this SAI.
PORTFOLIO MANAGERS
Portfolio Managers Other Accounts Managed
The following table shows information regarding all of the other accounts for which advisory fees are not based on the performance of the accounts managed by each portfolio manager as of February 28,
2013:
Part I - 49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Performance Based Fee Advisory Accounts
|
|
|
|
Registered Investment
Companies
|
|
|
Other Pooled Investment
Vehicles
|
|
|
Other Accounts
|
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
Arizona Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kimberly Bingle
|
|
|
2
|
|
|
$
|
549,632
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
33
|
|
|
$
|
9,293,132
|
|
David Sivinski
|
|
|
6
|
|
|
|
7,390,442
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
6
|
|
|
|
7,398,685
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
Kimberly Bingle
|
|
|
2
|
|
|
|
557,875
|
|
|
|
0
|
|
|
|
0
|
|
|
|
33
|
|
|
|
9,293,132
|
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jennifer Tabak
|
|
|
3
|
|
|
|
571,644
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
David Sivinski
|
|
|
6
|
|
|
|
6,903,617
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
6
|
|
|
|
7,246,598
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
Jennifer Tabak
|
|
|
3
|
|
|
|
914,625
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
James Ahn
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
168
|
|
|
|
3,951,859
|
|
Kevin Ellis
|
|
|
1
|
|
|
|
685,431
|
|
|
|
0
|
|
|
|
0
|
|
|
|
195
|
|
|
|
3,894,998
|
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard Taormina
|
|
|
6
|
|
|
|
9,133,368
|
|
|
|
0
|
|
|
|
0
|
|
|
|
7
|
|
|
|
90,372
|
|
Kimberly Bingle
|
|
|
2
|
|
|
|
201,870
|
|
|
|
0
|
|
|
|
0
|
|
|
|
33
|
|
|
|
9,293,132
|
|
|
|
|
|
|
|
|
California Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
6
|
|
|
|
7,157,374
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
Michelle Hallam
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
195
|
|
|
|
2,906,779
|
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard Taormina
|
|
|
6
|
|
|
|
4,156,897
|
|
|
|
0
|
|
|
|
0
|
|
|
|
7
|
|
|
|
90,372
|
|
David Sivinski
|
|
|
6
|
|
|
|
2,066,209
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
6
|
|
|
|
6,810,067
|
|
|
|
0
|
|
|
|
0
|
|
|
|
6
|
|
|
|
87,314
|
|
Part I - 50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kevin Ellis
|
|
|
1
|
|
|
|
1,296,026
|
|
|
|
0
|
|
|
|
0
|
|
|
|
195
|
|
|
|
3,894,998
|
|
The following table shows information on the other accounts managed by each portfolio manager that have
advisory fees wholly or partly based on performance as of February 28, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performance Based Fee Advisory Accounts
|
|
|
|
Registered Investment
Companies
|
|
|
Other Pooled Investment
Vehicles
|
|
|
Other Accounts
|
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
|
Number
of
Accounts
|
|
|
Total Assets
|
|
Arizona Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kimberly Bingle
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Kimberly Bingle
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jennifer Tabak
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Jennifer Tabak
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
James Ahn
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
1
|
|
|
|
3,428
|
|
Kevin Ellis
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard Taormina
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Kimberly Bingle
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
California Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Michelle Hallam
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard Taormina
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Part I - 51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Kevin Ellis
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Portfolio Managers Ownership of Securities
The following table indicates for each Fund the dollar range of securities of each Fund beneficially owned by each portfolio manager, as
of February 28, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollar Range of Securities in the Fund
|
Fund
|
|
|
|
None
|
|
|
$1-$10,000
|
|
$10,001-
$50,000
|
|
$50,001-
$100,000
|
|
$100,001-
$500,000
|
|
|
$500,001-
$1,000,000
|
|
Over
$1,000,000
|
Arizona Municipal Bond Fund
|
|
Kimberly Bingle
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kimberly Bingle
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
Jennifer Tabak
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
David Sivinski
|
|
|
|
|
|
|
|
|
|
|
|
|
X
|
|
|
|
|
|
|
|
Jennifer Tabak
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
James Ahn
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kevin Ellis
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
Richard Taormina
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kimberly Bingle
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Part I - 52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollar Range of Securities in the Fund
|
Fund
|
|
|
|
None
|
|
|
$1-$10,000
|
|
|
$10,001-
$50,000
|
|
$50,001-
$100,000
|
|
$100,001-
$500,000
|
|
$500,001-
$1,000,000
|
|
Over
$1,000,000
|
California Tax Free Bond Fund
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michelle Hallam
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
Richard Taormina
|
|
|
|
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
David Sivinski
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kevin Ellis
|
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For a more complete discussion, see the Portfolio Manager Compensation section in Part II of
the SAI.
ADMINISTRATOR
Administrator Fees
The table below sets
forth the administration, administrative services and co-administration fees paid by the Funds (the amounts waived are in parentheses) for the fiscal years indicated (amounts in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Fund
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
Arizona Municipal Bond Fund
|
|
$
|
138
|
|
|
$
|
|
|
|
$
|
101
|
|
|
$
|
|
|
|
$
|
93
|
|
|
$
|
|
|
Michigan Municipal Bond Fund
|
|
|
142
|
|
|
|
|
|
|
|
92
|
|
|
|
|
|
|
|
85
|
|
|
|
|
|
Municipal Income Fund
|
|
|
1,098
|
|
|
|
|
|
|
|
762
|
|
|
|
|
|
|
|
585
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
279
|
|
|
|
|
|
|
|
212
|
|
|
|
|
|
|
|
215
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
1,206
|
|
|
|
|
|
|
|
1,005
|
|
|
|
|
|
|
|
|
|
|
|
(1,072
|
)
|
Tax Free Bond Fund
|
|
|
609
|
|
|
|
|
|
|
|
393
|
|
|
|
|
|
|
|
386
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
Fiscal Year Ended
2/29/12
|
|
Fiscal Year Ended
2/28/13
|
Fund
|
|
Paid
|
|
Waived
|
|
Paid
|
|
Waived
|
|
Paid
|
|
Waived
|
Part I - 53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
California Tax Free Bond Fund
|
|
$
|
202
|
|
|
($
|
82
|
)
|
|
$
|
187
|
|
|
($
|
85
|
)
|
|
$
|
126
|
|
|
($
|
194
|
)
|
Intermediate Tax Free Bond Fund
|
|
|
4,883
|
|
|
|
|
|
|
|
4,347
|
|
|
|
|
|
|
|
4,474
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
854
|
|
|
|
|
|
|
|
674
|
|
|
|
|
|
|
|
674
|
|
|
|
|
|
For a more complete discussion, see the Administrator section in Part II of this SAI.
DISTRIBUTOR
Compensation Paid to JPMDS
The following
table describes the compensation paid to the principal underwriter, JPMDS, for the fiscal year ended February 28, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Net Underwriting
Discounts and
Commissions
|
|
|
Compensation on
Redemptions and
Repurchases
|
|
|
Brokerage
Commissions
|
|
|
Other
Compensation*
|
|
Arizona Municipal Bond Fund
|
|
$
|
9,283.21
|
|
|
$
|
3,292.24
|
|
|
$
|
|
|
|
$
|
227,593.69
|
|
Michigan Municipal Bond Fund
|
|
|
9,702.31
|
|
|
|
4,974.28
|
|
|
|
13.01
|
|
|
|
190,756.27
|
|
Municipal Income Fund
|
|
|
14,358.46
|
|
|
|
7,863.00
|
|
|
|
65.00
|
|
|
|
432,783.63
|
|
Ohio Municipal Bond Fund
|
|
|
15,610.26
|
|
|
|
9,614.24
|
|
|
|
|
|
|
|
648,752.79
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
3,070.44
|
|
|
|
150.28
|
|
|
|
|
|
|
|
507,628.68
|
|
Tax Free Bond Fund
|
|
|
76,391.58
|
|
|
|
44,034.62
|
|
|
|
81.25
|
|
|
|
873,601.77
|
|
California Tax Free Bond Fund
|
|
|
59,005.08
|
|
|
|
53,346.25
|
|
|
|
|
|
|
|
738,964.95
|
|
Intermediate Tax Free Bond Fund
|
|
|
55,823.39
|
|
|
|
51,569.32
|
|
|
|
|
|
|
|
1,697,234.53
|
|
New York Tax Free Bond Fund
|
|
|
105,576.36
|
|
|
|
60,413.16
|
|
|
|
154.00
|
|
|
|
1,961,806.86
|
|
*
|
Fees paid by the Fund pursuant to Rule 12b-1 are provided in the Distribution Fees section below.
|
The following table sets forth the aggregate amount of underwriting commissions retained by JPMDS from the Funds with respect to the
fiscal years indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Arizona Municipal Bond Fund
|
|
$
|
11,370.27
|
|
|
$
|
8,022.24
|
|
|
$
|
9,283.21
|
|
Michigan Municipal Bond Fund
|
|
|
10,953.59
|
|
|
|
3,533.17
|
|
|
|
9,702.31
|
|
Municipal Income Fund
|
|
|
16,413.04
|
|
|
|
10,952.67
|
|
|
|
14,358.46
|
|
Ohio Municipal Bond Fund
|
|
|
34,602.22
|
|
|
|
12,428.91
|
|
|
|
15,610.26
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
3,414.96
|
|
|
|
1,466.72
|
|
|
|
3,070.44
|
|
Tax Free Bond Fund
|
|
|
98,597.60
|
|
|
|
7,887.06
|
|
|
|
76,391.58
|
|
Part I - 54
|
|
|
|
|
|
|
|
|
|
|
|
|
California Tax Free Bond Fund
|
|
|
39,685.29
|
|
|
|
9,738.49
|
|
|
|
59,005.08
|
|
Intermediate Tax Free Bond Fund
|
|
|
78,383.69
|
|
|
|
2,775.69
|
|
|
|
55,823.39
|
|
New York Tax Free Bond Fund
|
|
|
128,839.91
|
|
|
|
52,971.43
|
|
|
|
105,576.36
|
|
For more information on JPMDS, see the Distributor section in Part II of this SAI.
Distribution Fees
The tables below sets forth the Rule 12b-1 fees that the Funds paid to or that were accrued by JPMDS (waived amounts are in parentheses) with respect to the fiscal years indicated (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
Arizona Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
$
|
113
|
|
|
$
|
|
|
|
$
|
81
|
|
|
$
|
|
|
|
$
|
80
|
|
|
$
|
|
|
Class B Shares
|
|
|
8
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
Class C Shares
|
|
|
176
|
|
|
|
|
|
|
|
123
|
|
|
|
|
|
|
|
143
|
|
|
|
|
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
146
|
|
|
|
|
|
|
|
119
|
|
|
|
|
|
|
|
115
|
|
|
|
|
|
Class B Shares
|
|
|
33
|
|
|
|
|
|
|
|
13
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
Class C Shares
|
|
|
83
|
|
|
|
|
|
|
|
55
|
|
|
|
|
|
|
|
69
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
253
|
|
|
|
|
|
|
|
232
|
|
|
|
|
|
|
|
224
|
|
|
|
|
|
Class B Shares
|
|
|
45
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
Class C Shares
|
|
|
256
|
|
|
|
|
|
|
|
195
|
|
|
|
|
|
|
|
203
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
299
|
|
|
|
|
|
|
|
241
|
|
|
|
|
|
|
|
227
|
|
|
|
|
|
Class B Shares
|
|
|
53
|
|
|
|
|
|
|
|
21
|
|
|
|
|
|
|
|
13
|
|
|
|
|
|
Class C Shares
|
|
|
496
|
|
|
|
|
|
|
|
355
|
|
|
|
|
|
|
|
409
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
352
|
|
|
|
|
|
|
|
248
|
|
|
|
|
|
|
|
210
|
|
|
|
|
|
Class B Shares
|
|
|
5
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
Class C Shares
|
|
|
463
|
|
|
|
|
|
|
|
335
|
|
|
|
|
|
|
|
297
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
546
|
|
|
|
|
|
|
|
448
|
|
|
|
|
|
|
|
481
|
|
|
|
|
|
Class B Shares
|
|
|
31
|
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
Class C Shares
|
|
|
354
|
|
|
|
|
|
|
|
268
|
|
|
|
|
|
|
|
382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Fiscal Year Ended
2/28/11
|
|
Fiscal Year Ended
2/29/12
|
|
Fiscal Year Ended
2/28/13
|
|
|
Paid
|
|
Waived
|
|
Paid
|
|
Waived
|
|
Paid
|
|
Waived
|
California Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Part I - 55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
$
|
148
|
|
|
($
|
37
|
)
|
|
$
|
136
|
|
|
($
|
34
|
)
|
|
$
|
197
|
|
|
($
|
49
|
)
|
Class C Shares
|
|
|
384
|
|
|
|
(27
|
)
|
|
|
385
|
|
|
|
(27
|
)
|
|
|
542
|
|
|
|
(39
|
)
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
893
|
|
|
|
|
|
|
|
755
|
|
|
|
|
|
|
|
707
|
|
|
|
|
|
Class B Shares
|
|
|
62
|
|
|
|
|
|
|
|
23
|
|
|
|
|
|
|
|
12
|
|
|
|
|
|
Class C Shares
|
|
|
1,256
|
|
|
|
|
|
|
|
906
|
|
|
|
|
|
|
|
978
|
|
|
|
|
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
712
|
|
|
|
|
|
|
|
604
|
|
|
|
|
|
|
|
661
|
|
|
|
|
|
Class B Shares
|
|
|
32
|
|
|
|
|
|
|
|
14
|
|
|
|
|
|
|
|
11
|
|
|
|
|
|
Class C Shares
|
|
|
1,381
|
|
|
|
|
|
|
|
1,058
|
|
|
|
|
|
|
|
1,290
|
|
|
|
|
|
SHAREHOLDER SERVICING
Shareholder Services Fees
Under the Shareholder Servicing Agreement, each Fund has agreed to pay JPMDS, for providing shareholder services and other related services, a fee at the following annual rates (expressed as a percentage
of the average daily NAV of Fund shares owned by or for shareholders):
|
|
|
|
|
Select Class, Class A, Class B and Class C
|
|
|
0.25
|
%
|
Institutional Class
|
|
|
0.10
|
%
|
The table below sets forth the fees paid to JPMorgan Chase Bank or JPMDS (the amounts waived are in
parentheses) for the fiscal years indicated (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Fund
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
Arizona Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
$
|
56
|
|
|
($
|
57
|
)
|
|
$
|
41
|
|
|
($
|
41
|
)
|
|
$
|
34
|
|
|
($
|
46
|
)
|
Class B Shares
|
|
|
3
|
|
|
|
|
^
|
|
|
2
|
|
|
|
|
|
|
|
2
|
|
|
|
|
^
|
Class C Shares
|
|
|
59
|
|
|
|
|
^
|
|
|
41
|
|
|
|
|
|
|
|
48
|
|
|
|
|
^
|
Select Class Shares
|
|
|
101
|
|
|
|
(100
|
)
|
|
|
79
|
|
|
|
(81
|
)
|
|
|
61
|
|
|
|
(81
|
)
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
77
|
|
|
|
(69
|
)
|
|
|
48
|
|
|
|
(71
|
)
|
|
|
45
|
|
|
|
(70
|
)
|
Class B Shares
|
|
|
11
|
|
|
|
|
^
|
|
|
4
|
|
|
|
|
^
|
|
|
2
|
|
|
|
|
^
|
Class C Shares
|
|
|
27
|
|
|
|
|
^
|
|
|
18
|
|
|
|
|
^
|
|
|
23
|
|
|
|
|
^
|
Select Class Shares
|
|
|
108
|
|
|
|
(93
|
)
|
|
|
49
|
|
|
|
(72
|
)
|
|
|
41
|
|
|
|
(66
|
)
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
197
|
|
|
|
(56
|
)
|
|
|
182
|
|
|
|
(50
|
)
|
|
|
175
|
|
|
|
(49
|
)
|
Class B Shares
|
|
|
15
|
|
|
|
|
^
|
|
|
4
|
|
|
|
|
|
|
|
2
|
|
|
|
|
^
|
Class C Shares
|
|
|
86
|
|
|
|
|
^
|
|
|
65
|
|
|
|
|
|
|
|
67
|
|
|
|
|
^
|
Select Class Shares
|
|
|
2,062
|
|
|
|
(582
|
)
|
|
|
1,457
|
|
|
|
(401
|
)
|
|
|
1,098
|
|
|
|
(306
|
)
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Part I - 56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
Fund
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
Class A Shares
|
|
|
194
|
|
|
|
(105
|
)
|
|
|
151
|
|
|
|
(90
|
)
|
|
|
146
|
|
|
|
(81
|
)
|
Class B Shares
|
|
|
18
|
|
|
|
|
^
|
|
|
7
|
|
|
|
|
|
|
|
4
|
|
|
|
|
^
|
Class C Shares
|
|
|
165
|
|
|
|
|
^
|
|
|
118
|
|
|
|
|
|
|
|
136
|
|
|
|
|
^
|
Select Class Shares
|
|
|
180
|
|
|
|
(99
|
)
|
|
|
145
|
|
|
|
(88
|
)
|
|
|
164
|
|
|
|
(92
|
)
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
352
|
|
|
|
|
|
|
|
248
|
|
|
|
|
|
|
|
210
|
|
|
|
|
|
Class B Shares
|
|
|
2
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
^
|
|
|
|
|
Class C Shares
|
|
|
155
|
|
|
|
|
|
|
|
112
|
|
|
|
|
|
|
|
99
|
|
|
|
|
|
Select Class Shares
|
|
|
2,020
|
|
|
|
(218
|
)
|
|
|
1,996
|
|
|
|
|
|
|
|
2,229
|
|
|
|
|
|
Institutional Class Shares
|
|
|
218
|
|
|
|
|
|
|
|
|
|
|
|
(196
|
)
|
|
|
|
|
|
|
(230
|
)
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
126
|
|
|
|
(420
|
)
|
|
|
77
|
|
|
|
(371
|
)
|
|
|
106
|
|
|
|
(375
|
)
|
Class B Shares
|
|
|
10
|
|
|
|
|
|
|
|
5
|
|
|
|
|
^
|
|
|
3
|
|
|
|
|
^
|
Class C Shares
|
|
|
117
|
|
|
|
(1
|
)
|
|
|
83
|
|
|
|
(6
|
)
|
|
|
124
|
|
|
|
(3
|
)
|
Select Class Shares
|
|
|
543
|
|
|
|
(443
|
)
|
|
|
281
|
|
|
|
(289
|
)
|
|
|
275
|
|
|
|
(234
|
)
|
^
|
Amount rounds to less than one thousand.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Fiscal Year Ended
2/28/11
|
|
|
Fiscal Year Ended
2/29/12
|
|
|
Fiscal Year Ended
2/28/13
|
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
|
Paid
|
|
|
Waived
|
|
California Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
$
|
|
|
|
($
|
185
|
)
|
|
$
|
|
|
|
($
|
170
|
)
|
|
$
|
|
|
|
($
|
246
|
)
|
Class C Shares
|
|
|
|
|
|
|
(137
|
)
|
|
|
|
|
|
|
(137
|
)
|
|
|
|
|
|
|
(194
|
)
|
Institutional Class Shares
|
|
|
41
|
|
|
|
|
|
|
|
35
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
Select Class Shares
|
|
|
210
|
|
|
|
(140
|
)
|
|
|
225
|
|
|
|
(151
|
)
|
|
|
220
|
|
|
|
(146
|
)
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
296
|
|
|
|
(597
|
)
|
|
|
263
|
|
|
|
(492
|
)
|
|
|
254
|
|
|
|
(453
|
)
|
Class B Shares
|
|
|
21
|
|
|
|
|
^
|
|
|
8
|
|
|
|
|
|
|
|
4
|
|
|
|
|
^
|
Class C Shares
|
|
|
419
|
|
|
|
|
|
|
|
302
|
|
|
|
|
|
|
|
326
|
|
|
|
|
^
|
Institutional Class Shares
|
|
|
736
|
|
|
|
(151
|
)
|
|
|
772
|
|
|
|
(115
|
)
|
|
|
872
|
|
|
|
(99
|
)
|
Select Class Shares
|
|
|
6,766
|
|
|
|
(3,013
|
)
|
|
|
6,395
|
|
|
|
(2,639
|
)
|
|
|
6,859
|
|
|
|
(2,675
|
)
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A Shares
|
|
|
188
|
|
|
|
(524
|
)
|
|
|
147
|
|
|
|
(457
|
)
|
|
|
174
|
|
|
|
(487
|
)
|
Class B Shares
|
|
|
11
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
Class C Shares
|
|
|
460
|
|
|
|
|
|
|
|
353
|
|
|
|
|
|
|
|
430
|
|
|
|
|
|
Institutional Class Shares
|
|
|
30
|
|
|
|
(16
|
)
|
|
|
27
|
|
|
|
(17
|
)
|
|
|
35
|
|
|
|
(19
|
)
|
Select Class Shares
|
|
|
1,032
|
|
|
|
|
|
|
|
840
|
|
|
|
|
|
|
|
677
|
|
|
|
(49
|
)
|
^
|
Amount rounds to less than one thousand.
|
Part I - 57
For a more complete discussion, see the Shareholder Servicing section in Part II
of this SAI.
BROKERAGE AND RESEARCH SERVICES
Brokerage Commissions
The Funds paid the following brokerage commissions for the indicated fiscal years (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
Ended
2/28/11
|
|
|
Fiscal Year
Ended
2/29/12
|
|
|
Fiscal Year
Ended
2/28/13
|
|
Arizona Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michigan Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
3
|
|
|
|
2
|
|
|
|
2
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
Part I - 58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
Ended
2/28/11
|
|
|
Fiscal Year
Ended
2/29/12
|
|
|
Fiscal Year
Ended
2/28/13
|
|
California Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New York Tax Free Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Brokerage Commissions
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Commissions to Affiliated Broker Dealers
|
|
|
|
|
|
|
|
|
|
|
|
|
For a more complete discussion, see the Portfolio Transactions section in Part II of this SAI.
Broker Research
During the fiscal year ended February 28, 2013, the Adviser allocated brokerage commissions to brokers who provided broker research including third party broker research for the Funds as follows:
|
|
|
|
|
Fund Name
|
|
Amount
|
|
Arizona Municipal Bond Fund
|
|
$
|
0
|
|
Michigan Municipal Bond Fund
|
|
|
0
|
|
Municipal Income Fund
|
|
|
0
|
|
Ohio Municipal Bond Fund
|
|
|
0
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
0
|
|
Tax Free Bond Fund
|
|
|
0
|
|
California Tax Free Bond Fund
|
|
|
0
|
|
Intermediate Tax Free Bond Fund
|
|
|
0
|
|
New York Tax Free Bond Fund
|
|
|
0
|
|
Securities of Regular Broker-Dealers
As of February 28, 2013, because the Funds invested only in the Underlying Funds for the fiscal period ended February 28, 2013,
the Funds did not own securities of their regular broker-dealers
FINANCIAL INTERMEDIARY
Other
Cash Compensation Payments
During the 12 months ended October 31, 2013, JPMIM and SCR&M paid approximately $139,011,582 and $117,498, respectively, for all the
J.P. Morgan Funds pursuant to written agreements with Financial Intermediaries (including both FINRA members and non-members) including written agreements for sub-transfer agency and/or omnibus accounting services (collectively, Omnibus
Sub-Accounting) and networking. For a more complete discussion, see the Additional Compensation to Financial Intermediaries section in Part II of this SAI.
Part I - 59
Finders Fee Commissions
Financial Intermediaries who sell $500,000 or more of Class A Shares in the aggregate of certain J.P. Morgan Income Funds or who sell $1
million or more of Class A Shares in the aggregate of the J.P. Morgan Equity Funds, the J.P. Morgan Specialty Funds, the J.P. Morgan International Funds, the J.P. Morgan Investor Funds, the JPMorgan SmartRetirement Funds, JPMorgan SmartAllocation
Funds, the other J.P. Morgan Income Funds and certain other J.P. Morgan Funds (collectively, Qualifying Funds) may receive finders fees.
With respect to sales of Class A Shares of the
Short-Intermediate Municipal Bond Fund
made prior to January 2, 2014, such fees are paid in accordance with the following schedule:
|
|
|
|
|
Amount of Purchases
|
|
Finders Fees
|
|
$500,000 $9,999,999*
|
|
|
0.50
|
%
|
$10,000,000 or more
|
|
|
0.25
|
%
|
*
|
If the total sale of Class A Shares of Qualifying Funds is $500,000 or more but the amount of the sale applicable to the Short-Intermediate Municipal Bond Fund is less
than $500,000, the Financial Intermediary will receive a finders fee equal to 0.50% of the sale of the Class A Shares of the Short-Intermediate Municipal Bond Fund. The Finders Fee Schedule for other Qualifying Funds can be found in the
Statement of Additional Information for such Qualifying Funds.
|
The Distributor may also pay Financial
Intermediaries a commission of up to 0.50% of gross sales on sales of Class A Shares of the
Short-Intermediate Municipal Bond Fund purchased prior to January 2, 2014
to certain defined contribution plans. If such defined contribution
plan redeems all of the shares that it owns of the Fund on behalf of participants within 12 months of the purchase date, then the Financial Intermediaries that have received these commissions will be required to reimburse the Distributor up to 0.50%
of the lower of the cost of the shares being redeemed or their NAV at the time of redemption. JPMDS reserves the right to alter or change the finders fee policy on these plans at any time at its own discretion. If a plan redeems all of the
shares for which a finders fee has been paid within 12 months of the purchase date, JPMDS will reclaim the finders fee paid to the Financial Intermediary rather than charge a CDSC to the plan.
With respect to sales of Class A Shares of the
Short-Intermediate Municipal Bond Fund
made on or after January 2, 2014, such
fees are paid in accordance with the following schedule:
|
|
|
|
|
Amount of Purchases
|
|
Finders Fees
|
|
$500,000 $3,999,999*
|
|
|
0.75
|
%
|
$4,000,000 $9,999,999
|
|
|
0.50
|
%
|
$10,000,000 or more
|
|
|
0.25
|
%
|
*
|
If the total sale of Class A Shares of Qualifying Funds is $500,000 or more but the amount of the sale applicable to the Short-Intermediate Municipal Bond Fund
is less than $500,000, the Financial Intermediary will receive a finders fee equal to 0.75% of the sale of the Class A Shares of the Short-Intermediate Municipal Bond Fund. The Finders Fee Schedule for other Qualifying Funds can be
found in the Statement of Additional Information for such Qualifying Funds.
|
The Distributor may also pay
Financial Intermediaries a commission of up to 0.75% of gross sales on sales of Class A Shares of the
Short-Intermediate Municipal Bond Fund purchased on or after January 2, 2014
to certain defined contribution plans. If such defined
contribution plan redeems all of the shares that it owns of the Fund on behalf of participants within 18 months of the purchase date, then the Financial Intermediaries that have received these commissions will be required to reimburse the
Distributor up to 0.75% of the lower of the cost of the shares being redeemed or their NAV at the time of redemption. JPMDS reserves the right to alter or change the finders fee policy on these plans at any time at its own discretion. If a
plan redeems all of the shares for which a finders fee has been paid within 18 months of the purchase date, JPMDS will reclaim the finders fee paid to the Financial Intermediary rather than charge a CDSC to the plan.
Part I - 60
With respect to sales of Class A Shares of the other Municipal Bond Funds, such fees are
paid in accordance with the following schedule:
|
|
|
|
|
Amount of Purchases
|
|
Finders Fees
|
|
$1,000,000 $3,999,999*
|
|
|
0.75
|
%
|
$4,000,000 $49,999,999
|
|
|
0.50
|
%
|
$50,000,000 or more
|
|
|
0.25
|
%
|
*
|
If the total sale of Class A Shares of Qualifying Funds is $1,000,000 or more but the amount of the sale applicable to a Fund (other than Class A Shares of the
Short-Intermediate Municipal Bond Fund
) is less than $1,000,000, the Financial Intermediary will receive a finders fee equal to 0.75% of the sale of the Class A Shares of the Fund (other than the
Short-Intermediate Municipal Bond
Fund
). The Finders Fee Schedule for other Qualifying Funds can be found in the Statement of Additional Information for such Qualifying Funds.
|
The Distributor may also pay Financial Intermediaries a commission of up to 0.75% of gross sales on sales of Class A Shares of the other Municipal Bond Funds to certain defined contribution plans. If such
defined contribution plan redeems all of the shares that it owns on behalf of participants within 18 months of the purchase date, then the Financial Intermediaries that have received these commissions will be required to reimburse the Distributor up
to 0.75% of the lower of the cost of the shares being redeemed or their NAV at the time of redemption. JPMDS reserves the right to alter or change the finders fee policy on these plans at any time at its own discretion. If a plan redeems all
of the shares for which a finders fee has been paid within 18 months of the purchase date, JPMDS will reclaim the finders fee paid to the Financial Intermediary rather than charge a CDSC to the plan.
For a more complete discussion, see the Cash Compensation to Financial Intermediaries section in Part II of this SAI.
Finders Fees Paid By Distributor
During the fiscal year ended February 28, 2013, JPMDS paid approximately $13,523,071 in finders fees.
TAX MATTERS
The Funds intend to minimize the payment of taxable income to shareholders by investing in tax-exempt or municipal securities in reliance at the time of purchase on an opinion of bond counsel to the
issuer that the interest paid on those securities will be excludable from gross income for Federal income tax purposes. Such securities, however, may be determined to pay, or have paid, taxable income subsequent to the Funds acquisition of the
securities. In that event, the Internal Revenue Service may demand that the Fund pay Federal income taxes on the affected interest income, and, if the Fund agrees to do so, the Funds yield could be adversely affected. In addition, the
treatment of dividends previously paid or to be paid by the Fund as exempt interest dividends could be adversely affected, subjecting the Funds shareholders to increased Federal income tax liabilities. In addition, the treatment of
dividends previously paid or to be paid by the Fund as exempt interest dividends could be adversely affected, subjecting the Funds shareholders to increased Federal income tax liabilities. In addition, future laws, regulations,
rulings or court decisions may cause interest on municipal securities to be subject, directly or indirectly, to Federal income taxation or interest on state municipal securities to be subject to state or local income taxation, or the value of state
municipal securities to be subject to state or local intangible personal property tax, or may otherwise prevent the Fund from realizing the full current benefit of the tax-exempt status of such securities. Any such change could also affect the
market price of such securities, and thus the value of an investment in the Fund.
The exemption from federal income tax for
exempt-interest dividends does not necessarily result in exemption for such dividends under the income or other tax laws of any state or local authority. Shareholders are advised to consult with their own tax advisors about state and local tax
matters. Following is a brief discussion of treatment of exempt-interest dividends by certain states.
Arizona Taxes.
Shareholders of the Arizona Municipal Bond Fund will not be subject to Arizona income taxes on exempt-interest dividends received from the Fund to the extent that such dividends are attributable to interest on tax-exempt obligations of the State of
Arizona and its political subdivisions (Arizona Obligations). However, interest from Arizona Obligations may be included in federal gross income to the extent that any interest thereon is treated as a preference item for purposes of the
alternative minimum tax.
California Taxes.
In general, as long as the California Tax Free Bond Fund continues to
qualify as a regulated investment company under the federal Internal Revenue Code of 1986, as amended (the Code), it will incur no California income or franchise tax liability on income and capital gains distributed to shareholders.
Part I - 61
California personal income tax law provides that dividends paid by a regulated investment
company, or series thereof, from interest on obligations that would be exempt from California personal income tax if held directly by an individual, are excludable from gross income if such dividends are reported by the Fund as such exempt-interest
dividends in written statements furnished to shareholders. In general, such exempt obligations will include California exempt and U.S. exempt obligations. Moreover, for a fund to qualify to pay such exempt-interest dividends under California law, at
least 50% of the value of its assets must consist of such exempt obligations at the close of each quarter of its fiscal year and such fund must be qualified as a regulated investment company. Under California law, exempt-interest dividends
(including some dividends paid after the close of the year as described in Section 855 of the Code) may not exceed the excess of (A) the amount of interest received by the fund which would be tax-exempt interest if the obligations on which
the interest was paid were held by an individual over (B) the amount that would be considered expenses related to exempt income and thus would not be deductible under California personal income tax law.
Distributions to individual shareholders derived from items other than exempt-interest described above will be subject to California
personal income tax. In addition, corporate shareholders should note that dividends will not be exempt from California corporate franchise tax and may not be exempt from California corporate income tax.
California has an alternative minimum tax similar to the federal AMT. However, the California AMT does not include interest from private
activity municipal obligations as an item of tax preference. Interest on indebtedness incurred or continued by a shareholder in connection with the purchase of shares of a fund will not be deductible for California personal income tax purposes.
Investors should consult their advisers about other state and local tax consequences of the investment in the fund as well as
about any California tax consequences related to any special tax status or considerations applicable to such investors.
Michigan Taxes.
Distributions received from the Michigan Municipal Bond Fund are exempt from Michigan personal income tax and
Michigan corporate income tax to the extent they are derived from interest on tax-exempt securities of the State of Michigan or its political subdivisions. For Michigan personal income tax, and corporate income tax purposes, Fund distributions
attributable to any source other than interest on tax-exempt securities of the State of Michigan or its political subdivisions will be fully taxable. Fund distributions are not subject to the uniform city income tax imposed by certain Michigan
cities to the extent that they are not subject to Michigan personal income tax.
New York Taxes.
Distributions received
from the New York Tax Free Bond Fund that are derived from interest attributable to obligations of the State of New York or its political subdivisions or certain other governmental entities (for example, the Commonwealth of Puerto Rico or the U.S.
Virgin Islands), the interest on which was excludable from gross income for purposes of both federal income taxation and New York State and City personal income taxation (New York Tax-Exempt Bonds) and designated as such, generally are
exempt from New York State and New York City personal income tax as well as from the New York City unincorporated business tax (but not the New York State corporation franchise tax or New York City general corporation tax), provided that such
dividends constitute exempt-interest dividends under Section 852(b)(5) of the Code. Dividends and other distributions (aside from exempt-interest dividends derived from New York Tax-Exempt Bonds) generally are not exempt from New York State and
City taxes. For New York State and City tax purposes, distributions of net long-term capital gain will be taxable at the same rates as ordinary income.
Distributions by the Fund from investment income and capital gains, including exempt-interest dividends, also generally are included in a corporations net investment income for purposes of
Part I - 62
calculating such corporations obligations under the New York State corporate franchise tax and the New York City general corporation tax, if received by a corporation subject to those
taxes, and will be subject to such taxes to the extent that a corporations net investment income is allocated to New York State and/or New York City. To the extent that investors are subject to state and local taxes outside of New York State,
all dividends paid by the Fund may be taxable income for purposes thereof. To the extent that the Funds dividends are derived from interest attributable to the obligations of any other state or of a political subdivision of any such other
state or are derived from capital gains, such dividends will generally not be exempt from New York State or New York City tax. The New York AMT excludes tax-exempt interest as an item of tax preference. Interest incurred to buy or carry shares of
the Fund is not deductible for federal, New York State or New York City personal income tax purposes. Investors should consult their advisers about New York and other state and local tax consequences of the investment in the Fund.
Ohio Taxes.
Distributions from the Ohio Municipal Bond Fund representing interest on obligations held by this Fund which are issued
by the State of Ohio, and political or governmental subdivisions thereof as defined in Section 5709.76(D)(10) of the Ohio Revised Code, or nonprofit corporations authorized to issue public securities for or on behalf of Ohio or its political
subdivisions or agencies or instrumentalities (Ohio Obligations), are exempt from Ohio personal income tax as well as Ohio municipal or school district income taxes. Shareholders that are subject to the Ohio commercial activity tax may
exclude such distributions from their taxable gross receipts for purposes of such tax. Shareholders that are subject to the Ohio corporation franchise tax may exclude such distributions from the Ohio corporation franchise tax net income base. Please
note that for most entities, the corporation franchise tax has been phased out as of the 2010 tax year.
Distributions that are
properly attributable to profit on the sale, exchange or other disposition of Ohio Obligations will not be subject to Ohio personal income tax, or municipal or school district income taxes in Ohio and will not be included in the gross receipts base
of the Ohio commercial activity tax or the net income base of the Ohio corporation franchise tax. Distributions attributable to other sources generally will not be exempt from Ohio personal income tax, municipal or school district income taxes in
Ohio or the gross receipts base of the Ohio commercial activity tax or the net income base of the Ohio corporation franchise tax.
This discussion of Ohio taxes assumes that the Ohio Municipal Bond Fund will continue to qualify as a regulated investment company under the Internal Revenue Code and that at all times at least 50% of the
value of the total assets of the Fund consists of Ohio Obligations or similar obligations of other states or their subdivisions.
Ca
pital Loss Carryforwards
Under the Regulated Investment Company Modernization Act of 2010 (the 2010 Act),
net capital losses recognized by the Funds after February 28, 2011 are carried forward indefinitely and retain their character as short-term and/or long-term losses. Prior to the 2010 Act, net capital losses incurred by the Funds were carried
forward eight years and treated as short-term losses. The 2010 Act requires that net capital losses after February 28, 2011 be used before any prior net capital losses.
For federal income tax purposes, the following Funds had capital loss carryforwards for the fiscal year ended February 28, 2013 (amounts in thousands) incurred prior to the enactment of the 2010 Act:
Part I - 63
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
|
|
|
Capital Loss
Carryforward
|
|
|
Expiration Date
|
|
Municipal Income Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
822
|
|
|
|
2/28/2017
|
|
|
|
|
|
|
|
|
579
|
|
|
|
2/28/2018
|
|
|
|
|
Total
|
|
|
$
|
1,401
|
|
|
|
|
|
|
|
|
|
Short-Intermediate Municipal Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
11,664
|
|
|
|
2/28/2014
|
|
|
|
|
|
|
|
|
2,707
|
|
|
|
2/28/2015
|
|
|
|
|
|
|
|
|
3,672
|
|
|
|
2/29/2016
|
|
|
|
|
|
|
|
|
969
|
|
|
|
2/28/2017
|
|
|
|
|
|
|
|
|
647
|
|
|
|
2/28/2018
|
|
|
|
|
Total
|
|
|
$
|
19,659
|
|
|
|
|
|
As of February 28, 2013, the following Fund had capital loss carryforwards (amounts in thousands)
incurred after the enactment of the 2010 Act:
|
|
|
|
|
|
|
|
|
|
|
Capital Loss Carryforward Character
|
|
Fund
|
|
Short-Term
|
|
|
Long-Term
|
|
Short-Intermediate Municipal Bond Fund
|
|
$
|
0
|
|
|
$
|
86
|
|
To the extent that these capital losses are used to offset future capital gains, it is probable that
gains so offset will not be distributed to shareholders. For a more complete discussion, see the Distributions and Tax Matters section in Part II of this SAI.
PORTFOLIO HOLDINGS DISCLOSURE
A list of the
entities that receive the Funds portfolio holdings information, the frequency with which it is provided to them and the length of the lag between the date of the information and the date it is disclosed is provided below:
|
|
|
|
|
All Funds
|
|
|
|
|
Vickers Stock Research Corp.
|
|
Monthly
|
|
30 days after month end
|
MorningStar Inc.
|
|
Monthly
|
|
30 days after month end
|
Lipper, Inc.
|
|
Monthly
|
|
30 days after month end
|
Thomson Financial
|
|
Monthly
|
|
30 days after month end
|
Bloomberg LP
|
|
Monthly
|
|
30 days after month end
|
JPMorgan Chase & Co.
|
|
Monthly
|
|
30 days after month end
|
The McGraw-Hill Companies, Inc. Standard & Poors
|
|
Monthly
|
|
30 days after month end
|
Factset
|
|
Monthly
|
|
30 days after month end
|
|
|
|
Tax Free Bond Fund
|
|
|
|
|
Commonwealth
|
|
Quarterly
|
|
10 days after month end
|
ManagersInvest
|
|
Quarterly
|
|
30 days after month end
|
|
|
|
Intermediate Tax Free Bond Fund
|
|
|
|
|
ManagersInvest
|
|
Quarterly
|
|
30 days after month end
|
Morgan Stanley Smith Barney
|
|
Quarterly
|
|
30 days after month end
|
Part I - 64
For a more complete discussion, see the Portfolio Holdings Disclosure section in
Part II of this SAI.
SHARE OWNERSHIP
Trustees and Officers.
As of December 31, 2012, the officers and Trustees, as a group, owned less
than 1% of the shares of any class of each Fund.
Principal Holders.
As of May 31,
2013, the persons who owned of record, or were known by the Trusts to own beneficially, 5% or more of the outstanding shares of any class of the Funds included in this SAI are shown in Attachment I-A, Principal Shareholders.
FINANCIAL STATEMENTS
The Financial Statements are incorporated by reference into this SAI. The Financial Statements for the fiscal year ended February 28, 2013 have been audited by PricewaterhouseCoopers LLP, the
independent registered public accounting firm to the Trusts, as indicated in its reports with respect thereto, and are incorporated herein by reference in reliance upon the authority of said firm as experts in accounting and auditing in giving said
reports. These Financial Statements are available without charge upon request by calling J.P. Morgan Funds Services at
1-800-480-4111.
Part I - 65
J.P. Morgan Funds
STATEMENT OF ADDITIONAL INFORMATION
PART II
Part II of this SAI describes policies and practices that apply
to each of the J.P. Morgan Funds, for which Part I precedes this Part II. Part II is not a standalone document and must be read in conjunction with Part I. References in this Part II to a Fund mean each J.P. Morgan Fund, unless noted
otherwise. Capitalized terms used and not otherwise defined in this Part II have the meanings given to them in Part I of this SAI.
PART II
TABLE OF CONTENTS
Part II - i
Part II - ii
Part II - iii
INVESTMENT STRATEGIES AND POLICIES
As noted in the applicable Prospectuses for each of the Funds, in addition to the main investment strategy and the main investment risks
described in the Prospectuses, each Fund may employ other investment strategies and may be subject to other risks, which are described below. The Funds may engage in the practices described below to the extent consistent with their investment
objectives, strategies, polices and restrictions. 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. Because the following is a
combined description of investment strategies of all of the Funds, certain matters described herein may not apply to particular Funds.
For a list of investment strategies and policies employed by each Fund, see INVESTMENT PRACTICES in Part I of this SAI.
Asset-Backed Securities
Asset-backed
securities consist of securities secured by company receivables, home equity loans, truck and auto loans, leases, or credit card receivables. Asset-backed securities also include other securities backed by other types of receivables or other assets,
including collateralized debt obligations (CDOs), which include collateralized bond obligations (CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. Such assets are generally
securitized through the use of trusts or special purpose corporations. Asset-backed securities are backed by a pool of assets representing the obligations often of a number of different parties. Certain of these securities may be illiquid.
Asset-backed securities are generally subject to the risks of the underlying assets. In addition, asset-backed securities, in
general, are subject to certain additional risks including depreciation, damage or loss of the collateral backing the security, failure of the collateral to generate the anticipated cash flow or in certain cases more rapid prepayment because of
events affecting the collateral, such as accelerated prepayment of loans backing these securities or destruction of equipment subject to equipment trust certificates. In addition, the underlying assets (for example, the underlying credit card debt)
may be refinanced or paid off prior to maturity during periods of declining interest rates. Changes in prepayment rates can result in greater price and yield volatility. If asset-backed securities are
pre-paid,
a Fund may have to reinvest the proceeds from the securities at a lower rate. Potential market gains on a security subject to prepayment risk may be more limited than potential market gains on a
comparable security that is not subject to prepayment risk. Under certain prepayment rate scenarios, a Fund may fail to recover additional amounts paid (i.e., premiums) for securities with higher interest rates, resulting in an unexpected loss.
A CBO is a trust or other special purpose entity (SPE) which is typically backed by a diversified pool of fixed
income securities (which may include high risk, below investment grade securities). A CLO is a trust or other SPE that is 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. Although certain CDOs may receive
credit enhancement in the form of a senior-subordinate structure, over-collateralization or bond insurance, such enhancement may not always be present and may fail to protect a Fund against the risk of loss on default of the collateral. Certain CDOs
may use derivatives contracts to create synthetic exposure to assets rather than holding such assets directly, which entails the risks of derivative instruments described elsewhere in this SAI. CDOs may charge management fees and
administrative expenses, which are in addition to those of a Fund.
For both CBOs and CLOs, the cash flows from the SPE are
split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the equity tranche, which bears the first loss from defaults from the bonds or loans in the SPE and serves to protect the other, more
senior tranches from default (though such protection is not complete). Since it is partially protected from defaults, a senior tranche from a CBO or CLO typically has higher ratings and lower yields than its underlying securities, and may be rated
investment grade. Despite the protection from the equity tranche, CBO or CLO tranches can experience substantial losses due to actual defaults, downgrades of the underlying collateral by rating agencies, forced liquidation of the collateral pool due
to a failure of coverage tests, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults, as well as investor aversion to CBO or CLO 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 a 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 a 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 fixed income securities and
asset-backed securities generally discussed elsewhere in this SAI, CDOs carry additional risks including, but 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 return achieved by the 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.
Total Annual Fund Operating Expenses set forth in
the fee table and Financial Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment
company provided by Section
3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended (the 1940 Act).
Auction Rate
Securities
Auction rate securities consist of auction rate municipal securities and auction rate preferred securities sold
through an auction process issued by
closed-end
investment companies, municipalities and governmental agencies. For more information on risks associated with municipal securities, see Municipal
Securities below.
Provided that the auction mechanism is successful, auction rate securities usually permit the holder
to sell the securities in an auction at par value at specified intervals. The dividend is reset by Dutch auction in which bids are made by broker-dealers and other institutions for a certain amount of securities at a specified minimum
yield. The dividend rate set by the auction is the lowest interest or dividend rate that covers all securities offered for sale. While this process is designed to permit auction rate securities to be traded at par value, there is the risk that an
auction will fail due to insufficient demand for the securities. Since February 2008, numerous auctions have failed due to insufficient demand for securities and have continued to fail for an extended period of time. Failed auctions may adversely
impact the liquidity of auction rate securities investments. Although some issuers of auction rate securities are redeeming or are considering redeeming such securities, such issuers are not obligated to do so and, therefore, there is no guarantee
that a liquid market will exist for a Funds investments in auction rate securities at a time when the Fund wishes to dispose of such securities.
Dividends on auction rate preferred securities issued by a
closed-end
fund may be designated as exempt from federal income tax to the extent they are attributable
to
tax-exempt
interest income earned by the
closed-end
fund on the securities in its portfolio and distributed to holders of the preferred securities. However, such
designation may be made only if the
closed-end
fund treats preferred securities as equity securities for federal income tax purposes and the
closed-end
fund complies
with certain requirements under the Internal Revenue Code of 1986, as amended (the Code).
A Funds investment
in auction rate preferred securities of
closed-end
funds is subject to limitations on investments in other U.S. registered investment companies, which limitations are prescribed under the 1940 Act. Except as
permitted by rule or exemptive order (see Investment Company Securities and Exchange Traded Funds below for more information), a Fund is generally prohibited from acquiring more than 3% of the voting securities of any other such
investment company, and investing more than 5% of a Funds total assets in securities of any one such investment company or more than 10% of its total assets in securities of all such investment companies. A Fund will indirectly bear its
proportionate share of any management fees paid by such
closed-end
funds in addition to the advisory fee payable directly by the Fund.
Bank Obligations
Bank obligations consist of
bankers acceptances, certificates of deposit, and time deposits.
Bankers acceptances are negotiable drafts or
bills of exchange typically drawn by an importer or exporter to pay for specific merchandise, which are accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. To
be eligible for purchase by a Fund, a bankers acceptance must be guaranteed by a domestic or foreign bank or savings and loan association having, at the time of investment, total assets in excess of $1 billion (as of the date of its most
recently published financial statements).
Part II - 2
Certificates of deposit are negotiable certificates issued against funds deposited in a
commercial bank or a savings and loan association for a definite period of time and earning a specified return. Certificates of deposit may also include those issued by foreign banks outside the United States (U.S.) with total assets at
the time of purchase in excess of the equivalent of $1 billion. Such certificates of deposit include Eurodollar and Yankee certificates of deposits. Eurodollar certificates of deposit are U.S. dollar-denominated certificates of deposit issued by
branches of foreign and domestic banks located outside the U.S. Yankee certificates of deposit are certificates of deposit issued by a U.S. branch of a foreign bank denominated in U.S. dollars and held in the U.S. Certain Funds may also invest in
obligations (including bankers acceptances and certificates of deposit) denominated in foreign currencies (see Foreign Investments (including Foreign Currencies)) herein. To be eligible for purchase by a Fund, a certificate of
deposit must be issued by (i) a domestic or foreign branch of a U.S. commercial bank which is a member of the Federal Reserve System or the deposits of which are insured by the Federal Deposit Insurance Corporation, or (ii) a domestic
savings and loan association, the deposits of which are insured by the Federal Deposit Insurance Corporation provided that, in each case, at the time of purchase, such institution has total assets in excess of $1 billion (as of the date of their
most recently published financial statements).
Time deposits are interest-bearing
non-negotiable
deposits at a bank or a savings and loan association that have a specific maturity date. A time deposit earns a specific rate of interest over a definite period of time. Time deposits cannot be
traded on the secondary market and those exceeding seven days and with a withdrawal penalty are considered to be illiquid. Time deposits will be maintained only at banks and savings and loan associations from which a Fund could purchase certificates
of deposit.
The Funds will not invest in obligations for which a Funds Adviser, or any of its affiliated persons, is the
ultimate obligor or accepting bank, provided, however, that the Funds maintain demand deposits at their affiliated custodian, JPMorgan Chase Bank, N.A. (JPMorgan Chase Bank).
Subject to the Funds limitations on concentration in a particular industry, there is no limitation on the amount of a Funds
assets which may be invested in obligations of banks which meet the conditions set forth herein.
Commercial
Paper
Commercial paper is defined as short-term obligations with maturities from 1 to 270 days issued by banks or bank
holding companies, corporations and finance companies. Although commercial paper is generally unsecured, the Funds may also purchase secured commercial paper. In the event of a default of an issuer of secured commercial paper, a Fund may hold the
securities and other investments that were pledged as collateral even if it does not invest in such securities or investments. In such a case, the Fund would take steps to dispose of such securities or investments in a commercially reasonable
manner. Commercial paper includes master demand obligations. See Variable and Floating Rate Instruments below.
Certain Funds may also invest in Canadian commercial paper, which is commercial paper issued by a Canadian corporation or a Canadian
counterpart of a U.S. corporation, and in Europaper, which is U.S. dollar denominated commercial paper of a foreign issuer. See Risk Factors of Foreign Investments below.
Convertible Securities
Certain Funds may
invest in convertible securities. Convertible securities include any debt securities or preferred stock which may be converted into common stock or which carry the right to purchase common stock. Generally, convertible securities entitle the holder
to exchange the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period of time.
The terms of any convertible security determine its ranking in a companys capital structure. In the case of subordinated convertible debentures, the holders claims on assets and earnings are
subordinated to the claims of other creditors, and are senior to the claims of preferred and common shareholders. In the case of convertible preferred stock, the holders claims on assets and earnings are subordinated to the claims of all
creditors and are senior to the claims of common shareholders.
Convertible securities have characteristics similar to both
debt and equity securities. Due to the conversion feature, the market value of convertible securities tends to move together with the market value of the underlying common stock. As a result, selection of convertible securities, to a great extent,
is based on the potential for capital appreciation that may exist in the underlying stock. The value of convertible securities is also affected by prevailing interest rates, the credit quality of the issuer, and any call provisions. In some cases,
the issuer may cause a convertible security to convert to common stock. In other situations, it may be advantageous for a Fund to cause the
Part II - 3
conversion of convertible securities to common stock. If a convertible security converts to common stock, a Fund may hold such common stock in its portfolio even if it does not ordinarily invest
in common stock.
Custodial Receipts
Certain Funds may acquire securities in the form of custodial receipts that evidence ownership of future interest payments, principal
payments or both on certain U.S. Treasury notes or bonds in connection with programs sponsored by banks and brokerage firms. These are not considered U.S. government securities and are not backed by the full faith and credit of the U.S. government.
These notes and bonds are held in custody by a bank on behalf of the owners of the receipts.
Debt Instruments
Below Investment Grade Securities.
Securities that were rated investment grade at the
time of purchase may subsequently be rated below investment grade (BB+ or lower by Standard & Poors Corporation (S&P) and Bal or lower by Moodys Investors Service, Inc. (Moodys)). Certain Funds that do not invest in below
investment grade securities as a main investment strategy may nonetheless continue to hold such securities if the Adviser believes it is advantageous for the Fund to do so. The high degree of risk involved in these investments can result in
substantial or total losses. These securities are subject to greater risk of loss, greater sensitivity to interest rate and economic changes, valuation difficulties, and a potential lack of a secondary or public market for securities. The market
price of these securities also can change suddenly and unexpectedly.
Catastrophe
Bonds
.
The JPMorgan Strategic Income Opportunities Fund, JPMorgan Total Return Fund, and JPMorgan Tax Aware Income Opportunities Fund may invest in debt instruments structured as event-driven or event-linked or insurance-linked notes or
catastrophe bonds (collectively, catastrophe bonds) and related instruments. These instruments are generally debt obligations for which the return of principal and the payment of interest typically are contingent on the non-occurrence of
a specific trigger event, such as a hurricane, earthquake, or other physical or weather-related phenomena. For some catastrophe bonds, the magnitude of the effect of the trigger event on the bond may be based on losses to a company or
industry, modeled losses to a notional portfolio, industry indexes, readings of scientific instruments, or certain other parameters associated with a catastrophe rather than actual losses. If a trigger event, as defined within the terms of each
catastrophe bond, occurs, a Fund may lose a portion or all of its accrued interest and/or principal invested in such catastrophe bond. In addition, if there is a dispute regarding a trigger event, there may be delays in the payment of principal
and/or interest on the bonds. A Fund is entitled to receive principal and interest payments so long as no trigger event occurs of the description and magnitude specified by the catastrophe bond.
Catastrophe bonds may be sponsored by government agencies, insurance companies or reinsurers and issued by special purpose corporations or
other off-shore or on-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 specific reinsurance transaction). Typically, catastrophe bonds
are issued by off-shore entities including entities in emerging markets and may be non-dollar denominated. As a result, the Funds will be subject to currency and foreign and emerging markets risk including the risks described in Foreign
Investments. Often, catastrophe bonds provide for extensions of maturity that are mandatory, or optional at the discretion of the issuer or sponsor, 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, catastrophe bonds
also may expose a Fund to certain unanticipated risks including but not limited to issuer risk, credit risk, counterparty risk, adverse regulatory or jurisdictional interpretations, and adverse tax consequences. Additionally, catastrophe bonds are
subject to the risk that modeling used to calculate the probability of a trigger event may not be accurate and/or underestimate the likelihood of a trigger event. This may result in more frequent and greater than expected loss of principal and/or
interest.
Catastrophe bonds are a relatively new type of financial instrument. As such, there is no significant trading
history of these securities, and there can be no assurance that markets for these instruments will be liquid at all times. 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. Catastrophe bonds are generally rated below investment grade or the unrated equivalent and have the same or similar risks as high yield debt securities (also known as junk
bonds) including the risks described under High Yield/High Risk Securities/Junk Bonds and are subject to the risk that the Fund may lose some or all of its investment in such bonds if the particular trigger identified under the bond occurs.
Part II - 4
Catastrophe bonds typically are restricted to qualified institutional buyers and, therefore,
are not subject to registration with the Securities and Exchange Commission (SEC) or any state securities commission and are not always listed on any national securities exchange. The amount of public information available with respect
to catastrophe bonds is generally less extensive than that which is available for issuers of registered or exchange listed securities. There can be no assurance that future regulatory determinations will not adversely affect the overall market for
catastrophe bonds.
Corporate Debt Securities
.
Corporate debt securities may
include bonds and other debt securities of U.S. and
non-U.S.
issuers, including obligations of industrial, utility, banking and other corporate issuers. All debt securities are subject to the risk of an
issuers inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to such factors as market interest rates, market perception of the creditworthiness of the issuer and general market
liquidity.
High Yield/High Risk Securities/Junk Bonds
.
Certain Funds may invest in
high yield securities, to varying degrees. High yield, high risk bonds are securities that are generally rated below investment grade by the primary rating agencies (BB+ or lower by S&P and Bal or lower by Moodys) or unrated but determined
by the Funds Adviser to be of comparable quality. Other terms used to describe such securities include lower rated bonds, non-investment grade bonds, below investment grade bonds, and junk bonds.
These securities are considered to be high-risk investments.
High yield securities are regarded as predominately speculative.
There is a greater risk that issuers of lower rated securities will default than issuers of higher rated securities. Issuers of lower rated securities generally are less creditworthy and may be highly indebted, financially distressed, or bankrupt.
These issuers are more vulnerable to real or perceived economic changes, political changes or adverse industry developments. In addition, high yield securities are frequently subordinated to the prior payment of senior indebtedness. If an issuer
fails to pay principal or interest, a Fund would experience a decrease in income and a decline in the market value of its investments. A Fund may also incur additional expenses in seeking recovery from the issuer.
The income and market value of lower rated securities may fluctuate more than higher rated securities.
Non-investment
grade securities are more sensitive to short-term corporate, economic and market developments. During periods of economic uncertainty and change, the market price of the investments in lower
rated securities may be volatile. The default rate for high yield bonds tends to be cyclical, with defaults rising in periods of economic downturn.
It is often more difficult to value lower rated securities than higher rated securities. If an issuers financial condition deteriorates, accurate financial and business information may be limited or
unavailable. The lower rated investments may be thinly traded and there may be no established secondary market. Because of the lack of market pricing and current information for investments in lower rated securities, valuation of such investments is
much more dependent on the judgment of the Adviser than is the case with higher rated securities. In addition, relatively few institutional purchasers may hold a major portion of an issue of lower-rated securities at times. As a result, a Fund that
invests in lower rated securities may be required to sell investments at substantial losses or retain them indefinitely even where an issuers financial condition is deteriorating.
Credit quality of
non-investment
grade securities can change suddenly and unexpectedly, and even
recently issued credit ratings may not fully reflect the actual risks posed by a particular high-yield security.
Future
legislation may have a possible negative impact on the market for high yield, high risk bonds. As an example, in the late 1980s, legislation required federally-insured savings and loan associations to divest their investments in high yield,
high risk bonds. New legislation, if enacted, could have a material negative effect on a Funds investments in lower rated securities.
Inflation-Linked Debt Securities
.
Inflation-linked securities include fixed and floating rate debt securities of varying maturities issued by the U.S.
government, its agencies and instrumentalities, such as Treasury Inflation Protected Securities (TIPS), as well as securities issued by other entities such as corporations, municipalities, foreign governments and foreign issuers,
including foreign issuers from emerging markets. See also Foreign Investments (including Foreign Currencies). Typically, such securities are structured as fixed income investments whose principal value is periodically adjusted according
to the rate of inflation. The following two structures are common: (i) the U.S. Treasury and some other issuers issue inflation-linked securities that accrue inflation into the principal value of the security and (ii) other issuers may pay
out the Consumer Price Index (CPI) accruals as part of a semi-annual coupon. Other types of inflation-linked securities exist which use an inflation index other than the CPI.
Part II - 5
Inflation-linked securities issued by the U.S. Treasury, such as TIPS, have maturities of
approximately five, ten or thirty years, although it is possible that securities with other maturities will be issued in the future. Typically, TIPS 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 of 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 TIPS, even
during a period of deflation, although the inflation-adjusted principal received could be less than the inflation-adjusted principal that had accrued to the bond at the time of purchase. However, the current market value of the bonds is not
guaranteed and will fluctuate. Other inflation-related bonds exist which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the
original principal.
The value of inflation-linked securities 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-linked securities.
While inflation-linked securities are expected to be protected
from long-term inflationary trends, short-term increases in inflation may lead to a decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities
may not be protected to the extent that the increase is not reflected in the bonds inflation measure.
The periodic
adjustment of U.S. inflation-linked securities is tied to the Consumer Price Index for All Urban Consumers (CPI-U), which is not seasonably adjusted and 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-linked securities issued by a foreign government are generally adjusted to
reflect a comparable inflation index calculated by that government. There can be no assurance that the
CPI-U
or a foreign inflation index will accurately measure the real rate of inflation in the prices of
goods and services. Moreover, there can be no assurance that the rate of inflation in a foreign country will be correlated to the rate of inflation in the U.S.
Any increase in the principal amount of an inflation-linked security will be considered taxable ordinary income, even though investors do not receive their principal until maturity.
Variable and Floating Rate Instruments
.
Certain obligations purchased by the Funds may carry
variable or floating rates of interest, may involve a conditional or unconditional demand feature and may include variable amount master demand notes. Variable and floating rate instruments are issued by a wide variety of issuers and may be issued
for a wide variety of purposes, including as a method of reconstructing cash flows.
Subject to their investment objective
policies and restrictions, certain Funds may acquire variable and floating rate instruments. A variable rate instrument is one whose terms provide for the adjustment of its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. Certain Funds may purchase extendable commercial notes. Extendable commercial notes are variable rate notes which normally mature within a short period of time (e.g., 1 month) but
which may be extended by the issuer for a maximum maturity of thirteen months.
A floating rate instrument is one whose terms
provide for the adjustment of its interest rate whenever a specified interest rate changes and which, at any time, can reasonably be expected to have a market value that approximates its par value. Floating rate instruments are frequently not rated
by credit rating agencies; however, unrated variable and floating rate instruments purchased by a Fund will be determined by the Funds Adviser to be of comparable quality at the time of purchase to rated instruments eligible for purchase under
the Funds investment policies. In making such determinations, a Funds Adviser will consider the earning power, cash flow and other liquidity ratios of the issuers of such instruments (such issuers include financial, merchandising, bank
holding and other companies) and will continuously monitor their financial condition. There may be no active secondary market with respect to a particular variable or floating rate instrument purchased by a Fund. The absence of such an active
Part II - 6
secondary market could make it difficult for the Fund to dispose of the variable or floating rate instrument involved in the event the issuer of the instrument defaulted on its payment
obligations, and the Fund could, for this or other reasons, suffer a loss to the extent of the default. Variable or floating rate instruments may be secured by bank letters of credit or other assets. A Fund may purchase a variable or floating rate
instrument to facilitate portfolio liquidity or to permit investment of the Funds assets at a favorable rate of return.
As a result of the floating and variable rate nature of these investments, the Funds yields may decline, and they may forego the
opportunity for capital appreciation during periods when interest rates decline; however, during periods when interest rates increase, the Funds yields may increase, and they may have reduced risk of capital depreciation.
Past periods of high inflation, together with the fiscal measures adopted to attempt to deal with it, have seen wide fluctuations in
interest rates, particularly prime rates charged by banks. While the value of the underlying floating or variable rate securities may change with changes in interest rates generally, the nature of the underlying floating or variable rate
should minimize changes in value of the instruments. Accordingly, as interest rates decrease or increase, the potential for capital appreciation and the risk of potential capital depreciation is less than would be the case with a portfolio of fixed
rate securities. A Funds portfolio may contain floating or variable rate securities on which stated minimum or maximum rates, or maximum rates set by state law limit the degree to which interest on such floating or variable rate securities may
fluctuate; to the extent it does, increases or decreases in value may be somewhat greater than would be the case without such limits. Because the adjustment of interest rates on the floating or variable rate securities is made in relation to
movements of the applicable banks prime rates or other short-term rate securities adjustment indices, the floating or variable rate securities are not comparable to long-term fixed rate securities. Accordingly, interest rates on
the floating or variable rate securities may be higher or lower than current market rates for fixed rate obligations of comparable quality with similar maturities.
Variable Amount Master Notes.
Variable amount master notes are notes, which may possess a demand feature, that permit the indebtedness to vary and provide for periodic adjustments in the interest
rate according to the terms of the instrument. Variable amount master notes may not be secured by collateral. To the extent that variable amount master notes are secured by collateral, they are subject to the risks described under the section
LoansCollateral and Subordination Risk.
Because master notes are direct lending arrangements between a Fund
and the issuer of the notes, they are not normally traded. Although there is no secondary market in the notes, a Fund may demand payment of principal and accrued interest. If the Fund is not repaid such principal and accrued interest, the Fund may
not be able to dispose of the notes due to the lack of a secondary market.
While master notes are not typically rated by
credit rating agencies, issuers of variable amount master notes (which are normally manufacturing, retail, financial, brokerage, investment banking and other business concerns) must satisfy the same criteria as those set forth with respect to
commercial paper, if any, in Part I of this SAI under the heading Diversification. A Funds Adviser will consider the credit risk of the issuers of such notes, including its earning power, cash flow, and other liquidity ratios of
such issuers and will continuously monitor their financial status and ability to meet payment on demand. In determining average weighted portfolio maturity, a variable amount master note will be deemed to have a maturity equal to the period of time
remaining until the principal amount can be recovered from the issuer.
Variable Rate Instruments and Money Market
Funds
. Variable or floating rate instruments with stated maturities of more than 397 days may, under the SECs amortized cost rule applicable to money market funds,
Rule 2a-7
under the 1940 Act,
be deemed to have shorter maturities (other than in connection with the calculation of dollar-weighted average life to maturity of a portfolio) as follows:
(1)
Adjustable Rate Government Securities.
A Government Security which is a variable rate security where the variable rate of interest is readjusted no less frequently than every 397 days shall be
deemed to have a maturity equal to the period remaining until the next readjustment of the interest rate. A Government Security which is a floating rate security shall be deemed to have a remaining maturity of one day.
(2)
Short-Term Variable Rate Securities.
A variable rate security, the principal amount of which, in accordance
with the terms of the security, must unconditionally be paid in 397 calendar days or less shall be deemed to have maturity equal to the earlier of the period remaining until the next readjustment of the interest rate or the period remaining until
the principal amount can be recovered through demand.
(3)
Long-Term Variable Rate Securities.
A
variable rate security, the principal amount of which is scheduled to be paid in more than 397 days, that is subject to a demand feature shall be deemed to have a
Part II - 7
maturity equal to the longer of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand.
(4)
Short-Term Floating Rate Securities.
A floating rate security, the principal amount of which, in
accordance with the terms of the security, must unconditionally be paid in 397 calendar days or less shall be deemed to have a maturity of one day.
(5)
Long-Term Floating Rate Securities.
A floating rate security, the principal amount of which is scheduled to be paid in more than 397 days, that is subject to a demand feature, shall be deemed
to have a maturity equal to the period remaining until the principal amount can be recovered through demand.
As used above, a
note is subject to a demand feature where the Fund is entitled to receive the principal amount of the note either at any time on no more than 30 days notice or at specified intervals not exceeding 397 calendar days and upon no more
than 30 days notice.
Limitations on the Use of Variable and Floating Rate Notes.
Variable and floating rate
instruments for which no readily available market exists (e.g., illiquid securities) will be purchased in an amount which, together with securities with legal or contractual restrictions on resale or for which no readily available market exists
(including repurchase agreements providing for settlement more than seven days after notice), exceeds 15% of a Funds net assets (5% of total assets for the J.P. Morgan Funds which are money market funds (the Money Market Funds))
only if such instruments are subject to a demand feature that will permit the Fund to demand payment of the principal within seven days after demand by the Fund. There is no limit on the extent to which a Fund may purchase demand instruments that
are not illiquid or deemed to be liquid in accordance with the Advisers liquidity determination procedures (except, with regard to the Money Market Funds, as provided under Rule
2a-7).
If not rated, such
instruments must be found by the Funds Adviser to be of comparable quality to instruments in which a Fund may invest. A rating may be relied upon only if it is provided by an NRSRO that is not affiliated with the issuer or guarantor of the
instruments.
Zero-Coupon
,
Pay-in-Kind
and Deferred Payment Securities
.
Zero-coupon securities are securities that are sold at a discount to par value and on which interest payments are not made during the life of the
security. Upon maturity, the holder is entitled to receive the par value of the security.
Pay-in-kind
securities are securities that have interest payable by delivery of
additional securities. Upon maturity, the holder is entitled to receive the aggregate par value of the securities. A Fund accrues income with respect to zero-coupon and
pay-in-kind
securities prior to the receipt of cash payments. Deferred payment securities are securities that remain zero-coupon securities until a predetermined date,
at which time the stated coupon rate becomes effective and interest becomes payable at regular intervals. While interest payments are not made on such securities, holders of such securities are deemed to have received phantom income.
Because a Fund will distribute phantom income to shareholders, to the extent that shareholders elect to receive dividends in cash rather than reinvesting such dividends in additional shares, the applicable Fund will have fewer assets
with which to purchase income-producing securities. Zero-coupon,
pay-in-kind
and deferred payment securities may be subject to greater fluctuation in value and lesser
liquidity in the event of adverse market conditions than comparably rated securities paying cash interest at regular interest payment periods.
Demand Features
Certain Funds may acquire securities that are subject to puts and standby commitments (Demand Features) to purchase the securities at their principal amount (usually with accrued interest)
within a fixed period (usually seven days) following a demand by the Fund. The Demand Feature may be issued by the issuer of the underlying securities, a dealer in the securities or by another third party and may not be transferred separately from
the underlying security. The underlying securities subject to a put may be sold at any time at market rates. Applicable Funds expect that they will acquire puts only where the puts are available without the payment of any direct or indirect
consideration. However, if advisable or necessary, a premium may be paid for put features. A premium paid will have the effect of reducing the yield otherwise payable on the underlying security. Demand Features provided by foreign banks involve
certain risks associated with foreign investments. See Foreign Investments (including Foreign Currencies) for more information on these risks.
Under a
stand-by
commitment, a dealer would agree to purchase, at a Funds option, specified securities at a specified price. A Fund will acquire
these commitments solely to facilitate portfolio liquidity and does not intend to exercise its rights thereunder for trading purposes.
Stand-by
commitments may also be referred to as put options.
Part II - 8
The purpose of engaging in transactions involving puts is to maintain flexibility and
liquidity to permit a Fund to meet redemption requests and remain as fully invested as possible.
Equity
Securities, Warrants and Rights
Common Stock
.
Common stock represents a share
of ownership in a company and usually carries voting rights and may earn dividends. Unlike preferred stock, common stock dividends are not fixed but are declared at the discretion of the issuers board of directors. Common stock occupies the
most junior position in a companys capital structure. As with all equity securities, the price of common stock fluctuates based on changes in a companys financial condition and overall market and economic conditions.
Common Stock Warrants and Rights
.
Common stock warrants entitle the holder to buy common stock
from the issuer of the warrant at a specific price (the strike price) for a specific period of time. The market price of warrants may be substantially lower than the current market price of the underlying common stock, yet warrants are
subject to similar price fluctuations. As a result, warrants may be more volatile investments than the underlying common stock. If a warrant is exercised, a Fund may hold common stock in its portfolio even if it does not ordinarily invest in common
stock.
Rights are similar to warrants but normally have a shorter duration and are typically distributed directly by the
issuers to existing shareholders, while warrants are typically attached to new debt or preferred stock issuances.
Warrants and
rights generally do not entitle the holder to dividends or voting rights with respect to the underlying common stock and do not represent any rights in the assets of the issuer company. Warrants and rights will expire if not exercised on or prior to
the expiration date.
Preferred Stock
.
Preferred stock is a class of stock that
generally pays dividends at a specified rate and has preference over common stock in the payment of dividends and liquidation. Preferred stock generally does not carry voting rights. As with all equity securities, the price of preferred stock
fluctuates based on changes in a companys financial condition and on overall market and economic conditions.
Initial Public Offerings (IPOs
)
.
The Funds may purchase securities in IPOs. These securities are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs
have no trading history, and information about the companies may be available for very limited periods. The prices of securities sold in IPOs may be highly volatile. At any particular time or from time to time, a Fund may not be able to invest in
securities issued in IPOs, or invest to the extent desired, because, for example, only a small portion (if any) of the securities being offered in an IPO may be made available to the Fund. In addition, under certain market conditions, a relatively
small number of companies may issue securities in IPOs. Similarly, as the number of Funds to which IPO securities are allocated increases, the number of securities issued to any one Fund may decrease. The investment performance of a Fund during
periods when it is unable to invest significantly or at all in IPOs may be lower than during periods when the Fund is able to do so. In addition, as a Fund increases in size, the impact of IPOs on the Funds performance will generally decrease.
Foreign Investments (including Foreign Currencies)
Some of the Funds may invest in certain obligations or securities of foreign issuers. For purposes of a
non-Money
Market Funds investment policies and unless described otherwise in a Funds prospectus, an issuer of a security will be deemed to be located in a particular country if: (i) the
principal trading market for the security is in such country, (ii) the issuer is organized under the laws of such country or (iii) the issuer derives at least 50% of its revenues or profits from such country or has at least 50% of its
total assets situated in such country. Possible investments include equity securities and debt securities (e.g., bonds and commercial paper) of foreign entities, obligations of foreign branches of U.S. banks and of foreign banks, including, without
limitation, Eurodollar Certificates of Deposit, Eurodollar Time Deposits, Eurodollar Bankers Acceptances, Canadian Time Deposits and Yankee Certificates of Deposit, and investments in Canadian Commercial Paper, and Europaper. Securities of
foreign issuers may include sponsored and unsponsored American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), and Global Depositary Receipts (GDRs). Sponsored ADRs are listed on the New York
Stock Exchange; unsponsored ADRs are not. Therefore, there may be less information available about the issuers of unsponsored ADRs than the issuers of sponsored ADRs. Unsponsored ADRs are restricted securities. EDRs and GDRs are not listed on the
New York Stock Exchange. As a result, it may be difficult to obtain information about EDRs and GDRs.
Part II - 9
The Money Market Funds may only invest in U.S. dollar-denominated securities.
Risk Factors of Foreign Investments.
The following is a summary of certain risks associated with
foreign investments:
Political and Exchange Risks.
Foreign investments may subject a Fund to investment risks that
differ in some respects from those related to investments in obligations of U.S. domestic issuers. Such risks include potential future adverse political and economic developments, possible imposition of withholding taxes on interest or other income,
possible seizure, nationalization or expropriation of foreign deposits, possible establishment of exchange controls or taxation at the source, greater fluctuations in value due to changes in exchange rates, or the adoption of other foreign
governmental restrictions which might adversely affect the payment of principal and interest on such obligations.
Higher
Transaction Costs.
Foreign investments may entail higher custodial fees and sales commissions than domestic investments.
Accounting and Regulatory Differences.
Foreign issuers of securities or obligations are often subject to accounting treatment and
engage in business practices different from those of domestic issuers of similar securities or obligations. In addition, foreign issuers are usually not subject to the same degree of regulation as domestic issuers, and their securities may trade on
relatively small markets, causing their securities to experience potentially higher volatility and more limited liquidity than securities of domestic issuers. Foreign branches of U.S. banks and foreign banks are not regulated by U.S. banking
authorities and may be subject to less stringent reserve requirements than those applicable to domestic branches of U.S. banks. In addition, foreign banks generally are not bound by accounting, auditing, and financial reporting standards comparable
to those applicable to U.S. banks. Dividends and interest paid by foreign issuers may be subject to withholding and other foreign taxes which may decrease the net return on foreign investments as compared to dividends and interest paid to a Fund by
domestic companies.
Currency Risk.
Foreign securities may be denominated in foreign currencies, although foreign
issuers may also issue securities denominated in U.S. dollars. The value of a Funds investments denominated in foreign currencies and any funds held in foreign currencies will be affected by changes in currency exchange rates, the relative
strength of those currencies and the U.S. dollar, and exchange-control regulations. Changes in the foreign currency exchange rates also may affect the value of dividends and interest earned, gains and losses realized on the sale of securities and
net investment income and gains, if any, to be distributed to shareholders by a Fund. The exchange rates between the U.S. dollar and other currencies are determined by the forces of supply and demand in foreign exchange markets. Accordingly, the
ability of a Fund that invests in foreign securities as part of its principal investment strategy to achieve its investment objective may depend, to a certain extent, on exchange rate movements. In addition, while the volume of transactions effected
on foreign stock exchanges has increased in recent years, in most cases it remains appreciably below that of domestic securities exchanges. Accordingly, a Funds foreign investments may be less liquid and their prices may be more volatile than
comparable investments in securities of U.S. companies. In buying and selling securities on foreign exchanges, purchasers normally pay fixed commissions that are generally higher than the negotiated commissions charged in the U.S. In addition, there
is generally less government supervision and regulation of securities exchanges, brokers and issuers located in foreign countries than in the U.S.
Settlement Risk.
The settlement periods for foreign securities and instruments are often longer than those for securities or obligations of U.S. issuers or instruments denominated in U.S. dollars.
Delayed settlement may affect the liquidity of a Funds holdings. Certain types of securities and other instruments are not traded delivery versus payment in certain markets (e.g., government bonds in Russia) meaning that a Fund may
deliver securities or instruments before payment is received from the counterparty. In such markets, the Fund may not receive timely payment for securities or other instruments it has delivered and may be subject to increased risk that the
counterparty will fail to make payments when due or default completely.
Brady Bonds.
Brady bonds are securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings. Brady bonds have been issued since 1989.
In light of the history of defaults of countries issuing Brady bonds on their commercial bank loans, investments in Brady bonds may be viewed as speculative and subject to the same risks as emerging market securities. Brady bonds may be fully or
partially collateralized or uncollateralized, are issued in various currencies (but primarily the U.S. dollar) and are actively traded in
over-the-counter
(OTC) secondary markets. Incomplete collateralization of interest or principal payment obligations results in increased credit risk. Dollar-denominated collateralized Brady bonds, which may be either fixed-rate or floating rate bonds,
are generally collateralized by U.S. Treasury securities.
Part II - 10
Obligations of Supranational Entities.
Obligations of
supranational entities include securities designated or supported by governmental entities to promote economic reconstruction or development of international banking institutions and related government agencies. Examples include the International
Bank for Reconstruction and Development (the World Bank), the European Coal and Steel Community, the Asian Development Bank and the Inter-American Development Bank. Each supranational entitys lending activities are limited to a
percentage of its total capital (including callable capital contributed by its governmental members at the entitys call), reserves and net income. There is no assurance that participating governments will be able or willing to
honor their commitments to make capital contributions to a supranational entity.
Sukuk.
Foreign securities and emerging market securities include Sukuk. Sukuk are certificates, similar to bonds, issued by the issuer to obtain an upfront payment in exchange for an income stream to be generated by certain assets of the issuer. Generally,
the issuer sells the investor a certificate, which the investor then rents back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the certificate at a future date at par value. While the
certificate is linked to the returns generated by certain assets of the issuer, the underlying assets are not pledged as security for the certificates, and the Fund (as the investor) is relying on the creditworthiness of the issuer for all payments
required by the sukuk. Issuers of sukuk may include international financial institutions, foreign governments and agencies of foreign governments. Underlying assets may include, without limitation, real estate (developed and undeveloped), lease
contracts and machinery and equipment.
Emerging Market Securities.
Investing in companies
domiciled in emerging market countries may be subject to potentially higher risks than investments in developed countries. These risks include: (i) less social, political, and economic stability; (ii) greater illiquidity and price
volatility due to smaller or limited local capital markets for such securities, or low
non-existent
trading volumes; (iii) less scrutiny and regulation by local authorities of the foreign exchanges and
broker-dealers; (iv) the seizure or confiscation by local governments of securities held by foreign investors, and the possible suspension or limiting by local governments of an issuers ability to make dividend or interest payments;
(v) limiting or entirely restricting repatriation of invested capital, profits, and dividends by local governments; (vi) possible local taxation of capital gains, including on a retroactive basis; (vii) the attempt by issuers facing
restrictions on dollar or euro payments imposed by local governments to make dividend or interest payments to foreign investors in the local currency; (viii) difficulty in enforcing legal claims related to the securities and/or local judges
favoring the interests of the issuer over those of foreign investors; (ix) bankruptcy judgments being paid in the local currency; (x) greater difficulty in determining market valuations of the securities due to limited public information
regarding the issuer, and (xi) difficulty of ascertaining the financial health of an issuer due to lax financial reporting on a regular basis, substandard disclosure and differences in accounting standards.
Emerging country securities markets are typically marked by a high concentration of market capitalization and trading volume in a small
number of issuers representing a limited number of industries, as well as a high concentration of ownership of such securities by a limited number of investors. Although some emerging markets have become more established and tend to issue securities
of higher credit quality, the markets for securities in other emerging countries are in the earliest stages of their development, and these countries issue securities across the credit spectrum. Even the markets for relatively widely traded
securities in emerging countries may not be able to absorb, without price disruptions, a significant increase in trading volume or trades of a size customarily undertaken by institutional investors in the securities markets of developed countries.
The limited size of many of these securities markets can cause prices to be erratic for reasons apart from factors that affect the soundness and competitiveness of the securities issuers. For example, prices may be unduly influenced by traders who
control large positions in these markets. Additionally, market making and arbitrage activities are generally less extensive in such markets, which may contribute to increased volatility and reduced liquidity of such markets. The limited liquidity of
emerging country securities may also affect a Funds ability to accurately value its portfolio securities or to acquire or dispose of securities at the price and time it wishes to do so or in order to meet redemption requests.
Many emerging market countries suffer from uncertainty and corruption in their legal frameworks. Legislation may be difficult to interpret
and laws may be too new to provide any precedential value. Laws regarding foreign investment and private property may be weak or
non-existent.
Sudden changes in governments may result in policies which are
less favorable to investors, such as policies designed to expropriate or nationalize sovereign assets. Certain emerging market countries in the past have expropriated large amounts of private property, in many cases with little or no
compensation, and there can be no assurance that such expropriation will not occur in the future.
Foreign investment in the
securities markets of certain emerging countries is restricted or controlled to varying degrees. These restrictions may limit a Funds investment in certain emerging countries and may increase the expenses of the Fund. Certain emerging
countries require governmental approval prior to investments by foreign
Part II - 11
persons or limit investment by foreign persons to only a specified percentage of an issuers outstanding securities or to a specific class of securities, which may have less advantageous
terms (including price) than securities of the company available for purchase by nationals.
Many developing countries lack the
social, political, and economic stability characteristic of the U.S. Political instability among emerging market countries can be common and may be caused by an uneven distribution of wealth, social unrest, labor strikes, civil wars, and religious
oppression. Economic instability in emerging market countries may take the form of: (i) high interest rates; (ii) high levels of inflation, including hyperinflation; (iii) high levels of unemployment or underemployment;
(iv) changes in government economic and tax policies, including confiscatory taxation; and (v) imposition of trade barriers.
Currencies of emerging market countries are subject to significantly greater risks than currencies of developed countries. Many emerging market countries have experienced steady declines or even sudden
devaluations of their currencies relative to the U.S. dollar. Some emerging market currencies may not be internationally traded or may be subject to strict controls by local governments, resulting in undervalued or overvalued currencies.
Some emerging market countries have experienced balance of payment deficits and shortages in foreign exchange reserves. Governments have
responded by restricting currency conversions. Future restrictive exchange controls could prevent or restrict a companys ability to make dividend or interest payments in the original currency of the obligation (usually U.S. dollars). In
addition, even though the currencies of some emerging market countries may be convertible into U.S. dollars, the conversion rates may be artificial to their actual market values.
A Funds income and, in some cases, capital gains from foreign stocks and securities will be subject to applicable taxation in
certain of the countries in which it invests, and treaties between the U.S. and such countries may not be available in some cases to reduce the otherwise applicable tax rates. Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of a Fund remains uninvested and no return is earned on such assets. The inability of the Fund to make intended security purchases or sales due to settlement problems could result either in losses to the Fund due to
subsequent declines in value of the portfolio securities, in the Fund deeming those securities to be illiquid, or, if the Fund has entered into a contract to sell the securities, in possible liability to the purchaser.
In the past, governments within the emerging markets have become overly reliant on the international capital markets and other forms of
foreign credit to finance large public spending programs which cause huge budget deficits. Often, interest payments have become too overwhelming for a government to meet, representing a large percentage of total gross domestic product
(GDP). These foreign obligations have become the subject of political debate and have served as fuel for political parties of the opposition, which pressure the government not to make payments to foreign creditors, but instead to use
these funds for social programs. Either due to an inability to pay or submission to political pressure, foreign governments have been forced to seek a restructuring of their loan and/or bond obligations, have declared a temporary suspension of
interest payments or have defaulted. These events have adversely affected the values of securities issued by foreign governments and corporations domiciled in emerging market countries and have negatively affected not only their cost of borrowing,
but their ability to borrow in the future as well.
Sovereign Obligations.
Sovereign debt
includes investments in securities issued or guaranteed by a foreign sovereign government or its agencies, authorities or political subdivisions. An investment in sovereign debt obligations involves special risks not present in corporate debt
obligations. The issuer of the sovereign debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or interest when due, and a Fund may have limited recourse in the event of a default.
During periods of economic uncertainty, the market prices of sovereign debt, and the Funds NAV, may be more volatile than prices of U.S. debt obligations. In the past, certain emerging markets have encountered difficulties in servicing their
debt obligations, withheld payments of principal and interest and declared moratoria on the payment of principal and interest on their sovereign debts.
A sovereign debtors willingness or ability to repay principal and pay interest in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign currency
reserves, the availability of sufficient foreign exchange, the relative size of the debt service burden, the sovereign debtors policy toward principal international lenders and local political constraints. Sovereign debtors may also be
dependent on expected disbursements from foreign governments, multilateral agencies and other entities to reduce principal and interest arrearages on their debt. The failure of a sovereign debtor to implement economic reforms, achieve specified
levels
Part II - 12
of economic performance or repay principal or interest when due may result in the cancellation of third-party commitments to lend funds to the sovereign debtor, which may further impair such
debtors ability or willingness to service its debts.
Foreign Currency Transactions.
Certain Funds may engage in foreign currency transactions which include the following, some of which also have been described elsewhere in this SAI: options on currencies, currency futures, options on such futures, forward foreign currency
transactions, forward rate agreements and currency swaps, caps and floors. Certain Funds may engage in such transactions in both U.S. and
non-U.S.
markets. To the extent a Fund enters into such transactions in
markets other than in the U.S., the Fund may be subject to certain currency, settlement, liquidity, trading and other risks similar to those described above with respect to the Funds investments in foreign securities including emerging markets
securities. Certain Funds may engage in such transactions to hedge against currency risks, as a substitute for securities in which the Fund invests, to increase or decrease exposure to a foreign currency, to shift exposure from one foreign currency
to another, for risk management purposes or to increase income or gain to the Fund. To the extent that a Fund uses foreign currency transactions for hedging purposes, the Fund may hedge either specific transactions or portfolio positions.
While a Funds use of hedging strategies is intended to reduce the volatility of the net asset value of Fund shares, the
net asset value of the Fund will fluctuate. There can be no assurance that a Funds hedging transactions will be effective. Furthermore, a Fund may only engage in hedging activities from time to time and may not necessarily be engaging in
hedging activities when movements in currency exchange rates occur.
Certain Funds are authorized to deal in forward foreign
exchange between currencies of the different countries in which the Fund will invest and multi-national currency units as a hedge against possible variations in the foreign exchange rate between these currencies. This is accomplished through
contractual agreements entered into in the interbank market to purchase or sell one specified currency for another currency at a specified future date (up to one year) and price at the time of the contract.
Transaction Hedging.
Generally, when a Fund engages in transaction hedging, it enters into foreign currency transactions with
respect to specific receivables or payables of the Fund generally arising in connection with the purchase or sale of its portfolio securities. A Fund may engage in transaction hedging when it desires to lock in the U.S. dollar price (or
a
non-U.S.
dollar currency (reference currency)) of a security it has agreed to purchase or sell, or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By
transaction hedging, a Fund attempts to protect itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar or other reference currency and the applicable foreign currency during the period between the
date on which the security is purchased or sold, or on which the dividend or interest payment is declared, and the date on which such payments are made or received.
A Fund may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in that foreign
currency. Certain Funds reserve the right to purchase and sell foreign currency futures contracts traded in the U.S. and subject to regulation by the Commodity Futures Trading Commission (CFTC).
For transaction hedging purposes, a Fund may also purchase U.S. exchange-listed call and put options on foreign currency futures contracts
and on foreign currencies. A put option on a futures contract gives a Fund the right to assume a short position in the foreign currency futures contract until expiration of the option. A put option on currency gives a Fund the right to sell a
currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Fund the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives a Fund
the right to purchase a currency at the exercise price until the expiration of the option.
Position Hedging.
When
engaging in position hedging, a Fund will enter into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which their portfolio securities are denominated or an increase in the value of
currency for securities which a Funds Adviser expects to purchase. In connection with the position hedging, the Fund may purchase or sell foreign currency forward contracts or foreign currency on a spot basis. A Fund may purchase U.S.
exchange-listed put or call options on foreign currency and foreign currency futures contracts and buy or sell foreign currency futures contracts traded in the U.S. and subject to regulation by the CFTC.
The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not
generally be possible because the future value of such securities in foreign currencies will change as a consequence of market movements in the value of those securities between the dates the currency exchange transactions are entered into and the
dates they mature.
Part II - 13
Forward Foreign Currency Exchange Contracts.
Certain Funds may purchase forward
foreign currency exchange contracts, sometimes referred to as currency forwards (Forward Contracts), which involve 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 as agreed by the parties in an amount and at a price set at the time of the contract. In the case of a cancelable Forward Contract, the holder has the unilateral right to cancel the contract at maturity by paying a
specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers, so no intermediary is required. A Forward Contract generally has no deposit
requirement, and no commissions are charged at any stage for trades.
At the maturity of a Forward Contract, a Fund may either
accept or make delivery of the currency specified in the contract or, at or prior to maturity, enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward contracts are
usually effected with the currency trader who is a party to the original forward contract. Certain Funds may also engage in
non-deliverable
forwards which are cash settled and which do not involve delivery of
the currency specified in the contract. For more information on
Non-Deliverable
Forwards, see Non-Deliverable Forwards below.
Foreign Currency Futures Contracts.
Certain Funds may purchase foreign currency futures contracts. Foreign currency futures
contracts traded in the U.S. are designed by and traded on exchanges regulated by the CFTC, such as the New York Mercantile Exchange. A Fund may enter into foreign currency futures contracts for hedging purposes and other risk management purposes as
defined in CFTC regulations. Certain Funds may also enter into foreign currency futures transactions to increase exposure to a foreign currency, to shift exposure from one foreign currency to another or to increase income or gain to the Fund.
At the maturity of a futures contract, the Fund may either accept or make delivery of the currency specified in the contract,
or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated
with the exchange assumes responsibility for closing out such contracts.
Positions in the foreign currency futures contracts
may be closed out only on an exchange or board of trade which provides a secondary market in such contracts. There is no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or at any particular
time. In such event, it may not be possible to close a futures position; in the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin.
For more information on futures contacts, see Futures Contracts under the heading Options and Futures Transactions
below.
Foreign Currency Options.
Certain Funds may purchase and sell U.S. exchange-listed and over the counter call and
put options on foreign currencies. Such options on foreign currencies operate similarly to options on securities. When a Fund purchases a put option, the Fund has the right but not the obligation to exchange money denominated in one currency into
another currency at a
pre-agreed
exchange rate on a specified date. When a Fund sells or writes a call option, the Fund has the obligation to exchange money denominated in one currency into another currency at
a
pre-agreed
exchange rate if the buyer exercises option. Some of the Funds may also purchase and sell
non-deliverable
currency options (Non-Deliverable
Options).
Non-Deliverable
Options are cash-settled, options on foreign currencies (each a Option Reference Currency) that are
non-convertible
and that
may be thinly traded or illiquid.
Non-Deliverable
Options involve an obligation to pay an amount in a deliverable currency (such as U.S. Dollars, Euros, Japanese Yen, or British Pounds Sterling) equal to the
difference between the prevailing market exchange rate for the Option Reference Currency and the agreed upon exchange rate (the Non-Deliverable Option Rate), with respect to an agreed notional amount. Options on foreign currencies are
affected by all of those factors which influence foreign exchange rates and investments generally.
A Fund is authorized to
purchase or sell listed foreign currency options and currency swap contracts as a short or long hedge against possible variations in foreign exchange rates, as a substitute for securities in which a Fund may invest, and for risk management purposes.
Such transactions may be effected with respect to hedges on
non-U.S.
dollar denominated securities (including securities denominated in the Euro) owned by the Fund, sold by the Fund but not yet delivered,
committed or anticipated to be purchased by the Fund, or in transaction or cross-hedging strategies. As an illustration, a Fund may use such techniques to hedge the stated value in U.S. dollars of an investment in a Japanese
yen-dominated
security. In such circumstances, the Fund may purchase a foreign currency put option enabling it to sell a specified amount of yen for dollars at a specified price by a future date. To the extent the
hedge is successful, a loss in the value of the dollar relative to the yen will tend to be offset by an increase in the
Part II - 14
value of the put option. To offset, in whole or in part, the cost of acquiring such a put option, the Fund also may sell a call option which, if exercised, requires it to sell a specified amount
of yen for dollars at a specified price by a future date (a technique called a collar). By selling the call option in this illustration, the Fund gives up the opportunity to profit without limit from increases in the relative value of
the yen to the dollar. Certain Funds may also enter into foreign currency futures transactions for
non-hedging
purposes including to increase or decrease exposure to a foreign currency, to shift exposure from
one foreign currency to another or to increase income or gain to the Fund.
Certain differences exist among these foreign
currency instruments. Foreign currency options provide the holder thereof the right to buy or to sell a currency at a fixed price on a future date. Listed options are third-party contracts (i.e., performance of the parties obligations is
guaranteed by an exchange or clearing corporation) which are issued by a clearing corporation, traded on an exchange and have standardized strike prices and expiration dates. OTC options are
two-party
contracts and have negotiated strike prices and expiration dates. Options on futures contracts are traded on boards of trade or futures exchanges. Currency swap contracts are negotiated
two-party
agreements
entered into in the interbank market whereby the parties exchange two foreign currencies at the inception of the contract and agree to reverse the exchange at a specified future time and at a specified exchange rate.
The JPMorgan Emerging Markets Debt Fund may also purchase and sell barrier/touch options (Barrier Options),
including
knock-in
options
(Knock-In
Options) and
knock-out
options
(Knock-Out
Options). A Barrier Option is a type of exotic option that gives an investor a payout once the price of the underlying currency reaches or surpasses (or falls below) a predetermined
barrier. This type of option allows the buyer of the option to set the position of the barrier, the length of time until expiration and the payout to be received once the barrier is broken. There are two kinds of
Knock-In
Options, (i) up and in and (ii) down and in. With
Knock-In
Options, if the buyer has selected an upper price barrier, and the
currency hits that level, the
Knock-In
Option turns into a more traditional option (Vanilla Option) whereby the owner has the right but not the obligation to exchange money denominated in one
currency into another currency at a
pre-agreed
exchange rate on a specified date. This type of
Knock-In
Option is called up and in. The down and
in
Knock-In
Option is the same as the up and in, except the currency has to reach a lower barrier. Upon hitting the chosen lower price level, the down and in
Knock-In
Option turns into a Vanilla Option. As in the
Knock-In
Option, there are two kinds of
Knock-Out
Options, ( i) up and
out and (ii) down and out. However, in a
Knock-Out
Option, the buyer begins with a Vanilla Option, and if the predetermined price barrier is hit, the Vanilla Option is cancelled and the
seller has no further obligation. If the option hits the upper barrier, the option is cancelled and the investor loses the premium paid, thus, up and out. If the option hits the lower price barrier, the option is cancelled, thus,
down and out. Barrier Options usually call for delivery of the underlying currency.
The value of a foreign
currency option is dependent upon the value of the foreign currency and the U.S. dollar and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve
substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than those for round lots.
There is no systematic reporting of
last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealer or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of
very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global,
around-the-clock
market. To the extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate
movements may take place in the underlying markets that cannot be reflected in the options market.
In addition to writing call
options on currencies when a Fund owns the underlying currency, the Funds may also write call options on currencies even if they do not own the underlying currency as long as the Fund segregates cash or liquid assets that, when added to the amounts
deposited with a futures commission merchant or a broker as margin, equal the market value of the currency underlying the call option (but not less than the strike price of the call option). The Funds may also cover a written call option by owning a
separate call option permitting the Fund to purchase the reference currency at a price no higher than the strike price of the call option sold by the Fund. In addition, a Fund may write a
non-deliverable
call
option if the Fund segregates an amount equal to the current notional value (amount obligated to pay). Netting is generally permitted of long and short positions of a specific
Part II - 15
country (assuming long and short contracts are similar). If there are securities or currency held in that specific country at least equal to the current notional value of the net currency
positions, no segregation is required.
Non-Deliverable
Forwards.
Some of the Funds may also invest in
non-deliverable
forwards (NDFs). NDFs are cash-settled, short-term forward contracts on foreign currencies (each a Reference Currency)
that are
non-convertible
and that may be thinly traded or illiquid. NDFs involve an obligation to pay an amount (the Settlement Amount) equal to the difference between the prevailing market
exchange rate for the Reference Currency and the agreed upon exchange rate (the NDF Rate), with respect to an agreed notional amount. NDFs have a fixing date and a settlement (delivery) date. The fixing date is the date and time at
which the difference between the prevailing market exchange rate and the agreed upon exchange rate is calculated. The settlement (delivery) date is the date by which the payment of the Settlement Amount is due to the party receiving payment.
Although NDFs are similar to forward foreign currency exchange contracts, NDFs do not require physical delivery of the
Reference Currency on the settlement date. Rather, on the settlement date, the only transfer between the counterparties is the monetary settlement amount representing the difference between the NDF Rate and the prevailing market exchange rate. NDFs
typically may have terms from one month up to two years and are settled in U.S. dollars.
NDFs are subject to many of the
risks associated with derivatives in general and forward currency transactions including risks associated with fluctuations in foreign currency and the risk that the counterparty will fail to fulfill its obligations. The Funds will segregate or
earmark liquid assets in an amount equal to the marked to market, on a daily basis, of the NDF.
The Funds will typically use
NDFs for hedging purposes, but may also, use such instruments to increase income or gain. The use of NDFs for hedging or to increase income or gain may not be successful, resulting in losses to the Fund, and the cost of such strategies may reduce
the Funds respective returns.
Foreign Currency Conversion.
Although foreign exchange dealers do not charge a fee
for currency conversion, they do realize a profit based on the difference (the spread) between prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to a Fund at one rate
while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer.
Other Foreign
Currency Hedging Strategies.
New options and futures contracts and other financial products, and various combinations thereof, continue to be developed, and certain Funds may invest in any such options, contracts and products as may be developed
to the extent consistent with the Funds investment objective and the regulatory requirements applicable to investment companies, and subject to the supervision of the Trusts Board of Trustees.
Risk Factors in Foreign Currency Transactions.
The following is a summary of certain risks
associated with foreign currency transactions:
Imperfect Correlation.
Foreign currency transactions present certain
risks. In particular, the variable degree of correlation between price movements of the instruments used in hedging strategies and price movements in a security being hedged creates the possibility that losses on the hedging transaction may be
greater than gains in the value of a Funds securities.
Liquidity.
Hedging instruments may not be liquid in all
circumstances. As a result, in volatile markets, the Funds may not be able to dispose of or offset a transaction without incurring losses. Although foreign currency transactions used for hedging purposes may reduce the risk of loss due to a decline
in the value of the hedged security, at the same time the use of these instruments could tend to limit any potential gain which might result from an increase in the value of such security.
Leverage and Volatility Risk
. Derivative instruments, including foreign currency derivatives, may sometimes increase or leverage a
Funds exposure to a particular market risk. Leverage enhances the price volatility of derivative instruments held by a Fund.
Strategy Risk.
Certain Funds may use foreign currency derivatives for hedging as well as
non-hedging
purposes including to gain or adjust exposure to
currencies and securities markets or to increase income or gain to a Fund. There is no guarantee that these strategies will succeed and their use may subject a Fund to greater volatility and loss. Foreign currency transactions involve complex
securities transactions that involve risks in addition to direct investments in securities including leverage risk and the risks associated with derivatives in general, currencies, and investments in foreign and emerging markets.
Part II - 16
Judgment of the Adviser.
Successful use of foreign currency transactions by a Fund
depends upon the ability of the applicable Adviser to predict correctly movements in the direction of interest and currency rates and other factors affecting markets for securities. If the expectations of the applicable Adviser are not met, a Fund
would be in a worse position than if a foreign currency transaction had not been pursued. For example, if a Fund has hedged against the possibility of an increase in interest rates which would adversely affect the price of securities in its
portfolio and the price of such securities increases instead, the Fund will lose part or all of the benefit of the increased value of its securities because it will have offsetting losses in its hedging positions. In addition, when utilizing
instruments that require variation margin payments, if the Fund has insufficient cash to meet daily variation margin requirements, it may have to sell securities to meet such requirements.
Other Risks
. Such sales of securities may, but will not necessarily, be at increased prices which reflect the rising market. Thus,
a Fund may have to sell securities at a time when it is disadvantageous to do so.
It is impossible to forecast with precision
the market value of portfolio securities at the expiration or maturity of a forward contract or futures contract. Accordingly, a Fund may have to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the
market value of the security or securities being hedged is less than the amount of foreign currency a Fund is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it
may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security or securities if the market value of such security or securities exceeds the amount of foreign currency the Fund is obligated
to deliver.
Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which a
Fund owns or expects to purchase or sell. Rather, an Adviser may employ these techniques in an effort to maintain an investment portfolio that is relatively neutral to fluctuations in the value of the U.S. dollar relative to major foreign currencies
and establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they also tend to limit any
potential gain which might result from the increase in the value of such currency. Moreover, it may not be possible for a Fund to hedge against a devaluation that is so generally anticipated that the Fund is not able to contract to sell the currency
at a price above the anticipated devaluation level.
Inverse Floaters and Interest Rate Caps
Inverse floaters are instruments whose interest rates bear an inverse relationship to the interest rate on another security or the value
of an index. The market value of an inverse floater will vary inversely with changes in market interest rates and will be more volatile in response to interest rate changes than that of a fixed rate obligation. Interest rate caps are financial
instruments under which payments occur if an interest rate index exceeds a certain predetermined interest rate level, known as the cap rate, which is tied to a specific index. These financial products will be more volatile in price than securities
which do not include such a structure.
Investment Company Securities and Exchange Traded Funds
Investment Company Securities.
A Fund may acquire the securities of other investment
companies (acquired funds) to the extent permitted under the 1940 Act and consistent with its investment objective and strategies. As a shareholder of another investment company, a Fund would bear, along with other shareholders, its pro
rata portion of the other investment companys expenses, including advisory fees. These expenses would be in addition to the advisory and other expenses that a Fund bears directly in connection with its own operations. Except as described
below, the 1940 Act currently requires that, as determined immediately after a purchase is made, (i) not more than 5% of the value of a funds total assets will be invested in the securities of any one investment company, (ii) not
more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group and (iii) not more than 3% of the outstanding voting stock of any one investment company will be owned by a fund.
In addition, Section 17 of the 1940 Act prohibits a Fund from investing in another J.P. Morgan Fund except as permitted by
Section 12 of the 1940 Act, by rule, or by exemptive order.
The limitations described above do not apply to investments in
money market funds subject to certain conditions. All of the J.P. Morgan Funds may invest in affiliated and unaffiliated money market funds without limit under Rule 12d1-1 of the 1940 Act subject to the acquiring funds investment policies and
restrictions and the conditions of the Rule.
In addition, the 1940 Acts limits and restrictions summarized above do not
apply to J.P. Morgan Funds that invest in other J.P. Morgan Funds in reliance on Section 12(d)(1)(G) of the 1940 Act, SEC rule, or an exemptive
Part II - 17
order issued by the SEC (each, a Fund of Funds; collectively, Funds of Funds). Such Funds of Funds include JPMorgan Investor Funds (the Investor Funds), the
JPMorgan SmartRetirement Funds and the JPMorgan SmartRetirement Blend Funds (collectively, the JPMorgan SmartRetirement Funds), JPMorgan SmartAllocation Funds, JPMorgan Diversified Real Return Fund, JPMorgan Access Funds, JPMorgan
Alternative Strategies Fund, JPMorgan Diversified Fund, and such other J.P. Morgan Funds that invest in other J.P. Morgan Funds in reliance on Section 12(d)(G) of the 1940 Act or the rules issued Section 12.
Section 12(d)(1)(G) of the 1940 Act permits a fund to invest in acquired funds in the same group of investment companies
(affiliated funds), government securities and short-term paper. In addition to the investments permitted by Section 12(d)(1)(G), Rule 12d1-2 permits funds of funds to make investments in addition to affiliated funds under certain
circumstances including: (1) unaffiliated investment companies (subject to certain limits), (2) other types of securities (such as stocks, bonds and other securities) not issued by an investment company that are consistent with the fund of
funds investment policies and (3) affiliated and unaffiliated money market funds. In order to be an eligible investment under Section 12(d)(1)(G), an affiliated fund must have a policy prohibiting it from investing in other funds under Section
12(d)(1)(F) or (G) of the 1940 Act.
In addition to investments permitted by Section 12(d)(1)(G) and Rule 12d1-2, the J.P.
Morgan Funds may invest in derivatives pursuant to an exemptive order issued by the SEC. Under the exemptive order, the Funds of Funds are permitted to invest in financial instruments that may not be considered securities for purposes of
Rule 12d-1 subject to certain conditions, including a finding of the Board of Trustees that the advisory fees charged by the Adviser to the Funds of Funds are for services that are in addition to, and not duplicative of, the advisory services
provided to an underlying fund.
Exchange Traded Funds (ETFs).
ETFs are pooled
investment vehicles whose ownership interests are purchased and sold on a securities exchange. ETFs may be structured investment companies, depositary receipts or other pooled investment vehicles. As shareholders of an ETF, the Funds will bear their
pro rata portion of any fees and expenses of the ETFs. Although shares of ETFs are traded on an exchange, shares of certain ETFs may not be redeemable by the ETF. In addition, ETFs may trade at a price below their net asset value (also known as a
discount).
Certain Funds may use ETFs to gain exposure to various asset classes and markets or types of strategies and
investments By way of example, ETFs may be structured as broad based ETFs that invest in a broad group of stocks from different industries and market sectors; select sector or market ETFs that invest in debt securities from a select sector of the
economy, a single industry or related industries; or ETFs that invest in foreign and emerging markets securities. Other types of ETFs continue to be developed and the Fund may invest in them to the extent consistent with such Funds investment
objectives, policies and restrictions. The ETFs in which the Funds invest are subject to the risks applicable to the types of securities and investments used by the ETFs (e.g., debt securities are subject to risks like credit and interest rate
risks; emerging markets securities are subject risks like currency risks and foreign and emerging markets risk; derivatives are subject to leverage and counterparty risk).
ETFs may be actively managed or index-based. Actively managed ETFs are subject to management risk and may not achieve their objective if the ETFs managers expectations regarding particular
securities or markets are not met. An index based ETFs objective is to track the performance of a specified index. Index based ETFs invest in a securities portfolio that includes substantially all of the securities (in substantially the same
amount as the securities included in the designated index. Because passively managed ETFs are designed to track an index, securities may be purchased, retained and sold at times when an actively managed ETF would not do so. As a result, shareholders
of a Fund that invest in such an ETF can expect greater risk of loss (and a correspondingly greater prospect of gain) from changes in the value of securities that are heavily weighted in the index than would be the case if ETF were not fully
invested in such securities. This risk is increased if a few component securities represent a highly concentrated weighting in the designated index.
Unless permitted by the 1940 Act or an order or rule issued by the SEC (see Investment Company Securities above for more information), the Funds investments in unaffiliated ETFs that are
structured as investment companies as defined in the 1940 Act are subject to certain percentage limitations of the 1940 Act regarding investments in other investment companies. As a general matter, these percentage limitations currently require a
Fund to limit its investments in any one issue of ETFs to 5% of the Funds total assets and 3% of the outstanding voting securities of the ETF issue. Moreover, a Funds investments in all ETFs may not currently exceed 10% of the
Funds total assets under the 1940 Act, when aggregated with all other investments in investment companies. ETFs that are not structured as investment companies as defined in the 1940 Act are not subject to these percentage limitations.
Part II - 18
SEC exemptive orders granted to various iShares funds (which are ETFs) and other ETFs and
their investment advisers permit the Funds to invest beyond the 1940 Act limits, subject to certain terms and conditions, including a finding of the Board of Trustees that the advisory fees charged by the Adviser to the Fund are for services that
are in addition to, and not duplicative of, the advisory services provided to those ETFs.
Loans
Some of the Funds may invest in fixed and floating rate loans (Loans). Loans may include senior floating rate
loans (Senior Loans) and secured and unsecured loans, second lien or more junior loans (Junior Loans) and bridge loans or bridge facilities (Bridge Loans). Loans are typically arranged through private negotiations
between borrowers in the U.S. or in foreign or emerging markets which may be corporate issuers or issuers of sovereign debt obligations (Obligors) and one or more financial institutions and other lenders (Lenders). Generally,
the Funds invest in Loans by purchasing assignments of all or a portion of Loans (Assignments) or Loan participations (Participations) from third parties.
A Fund has direct rights against the Obligor on the Loan when it purchases an Assignment. Because Assignments are arranged through private
negotiations between potential assignees and potential assignors, however, the rights and obligations acquired by a Fund as the purchaser of an Assignment may differ from, and be more limited than, those held by the assigning Lender. With respect to
Participations, typically, a Fund will have a contractual relationship only with the Lender and not with the Obligor. The agreement governing Participations may limit the rights of a Fund 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 a Participation will generally have the right to vote on certain fundamental issues such as changes in principal amount, payment dates and interest rate. Participations may
entail certain risks relating to the creditworthiness of the parties from which the participations are obtained.
A Loan is
typically originated, negotiated and structured by a U.S. or foreign commercial bank, insurance company, finance company or other financial institution (the Agent) for a group of Loan investors. The Agent typically administers and
enforces the Loan on behalf of the other Loan investors in the syndicate. The Agents duties may include responsibility for the collection of principal and interest payments from the Obligor and the apportionment of these payments to the credit
of all Loan investors. The Agent is also typically responsible for monitoring compliance with the covenants contained in the Loan agreement based upon reports prepared by the Obligor. In addition, an institution, typically but not always the Agent,
holds any collateral on behalf of the Loan investors. In the event of a default by the Obligor, it is possible, though unlikely, that the Fund could receive a portion of the borrowers collateral. If the Fund receives collateral other than
cash, any proceeds received from liquidation of such collateral will be available for investment as part of the Funds portfolio.
In the process of buying, selling and holding Loans, a Fund 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 or sells a Loan it may pay a fee. In certain circumstances, a Fund may receive a prepayment penalty fee upon prepayment of a Loan.
Additional Information concerning Senior Loans.
Senior Loans typically hold the most senior position in the capital structure of
the Obligor, are typically secured with specific collateral and have a claim on the assets and/or stock of the Obligor that is senior to that held by subordinated debtholders and shareholders of the Obligor. Collateral for Senior Loans may include
(i) working capital assets, such as accounts receivable and inventory; (ii) tangible fixed assets, such as real property, buildings and equipment; (iii) intangible assets, such as trademarks and patent rights; and/or
(iv) security interests in shares of stock of subsidiaries or affiliates.
Additional Information concerning Junior
Loans.
Junior Loans include secured and unsecured loans including subordinated loans, second lien and more junior loans, and bridge loans. Second lien and more junior loans (Junior Lien Loans) are generally second or further in line
in terms of repayment priority. In addition, Junior Lien Loans may have a claim on the same collateral pool as the first lien or other more senior liens or may be secured by a separate set of assets. Junior Loans generally give investors priority
over general unsecured creditors in the event of an asset sale.
Additional Information concerning Bridge Loans.
Bridge
Loans are short-term loan arrangements (e.g., 12 to 18 months) typically made by an Obligor in anticipation of intermediate-term or long-term permanent financing. Most Bridge Loans are structured as floating-rate debt with
step-up
provisions under which the interest rate on the Bridge Loan rises the longer the Loan remains outstanding. In addition, Bridge Loans commonly contain a conversion feature that allows the Bridge Loan investor
to convert its Loan interest to senior exchange notes if the Loan has not been prepaid in full on or prior to its maturity date. Bridge Loans typically are structured as Senior Loans but may be structured as Junior Loans.
Part II - 19
Additional Information concerning Unfunded Commitments.
Unfunded commitments are
contractual obligations pursuant to which the Fund agrees to invest in a Loan at a future date. Typically, the Fund receives a commitment fee for entering into the Unfunded Commitment.
Additional Information concerning Synthetic Letters of Credit.
Loans include synthetic letters of credit. In a synthetic letter of
credit transaction, the Lender typically creates a special purpose entity or a credit-linked deposit account for the purpose of funding a letter of credit to the borrower. When a Fund invests in a synthetic letter of credit, the Fund is typically
paid a rate based on the Lenders borrowing costs and the terms of the synthetic letter of credit. Synthetic letters of credit are typically structured as Assignments with the Fund acquiring direct rights against the Obligor.
Additional Information concerning Loan Originations.
In addition to investing in loan assignments and participations, the
Strategic Income Opportunities Fund may originate Loans in which the Fund would lend money directly to a borrower by investing in limited liability companies or corporations that make loans directly to borrowers. The terms of the Loans are
negotiated with borrowers in private transactions. Such Loans would be collateralized, typically with tangible fixed assets such as real property or interests in real property. Such Loans may also include mezzanine loans. Unlike Loans secured
by a mortgage on real property, mezzanine loans are collateralized by an equity interest in a special purpose vehicle that owns the real property.
Limitations on Investments in Loan Assignments and Participations
. If a government entity is a borrower on a Loan, the Fund will consider the government to be the issuer of an Assignment or
Participation for purposes of a Funds fundamental investment policy that it will not invest 25% or more of its total assets in securities of issuers conducting their principal business activities in the same industry (i.e., foreign
government).
Risk Factors of Loans
. Loans are subject to the risks associated with debt obligations in general
including interest rate risk, credit risk and market risk. When a Loan is acquired from a Lender, the risk includes the credit risk associated with the Obligor of the underlying Loan. The Fund may incur additional credit risk when the Fund acquires
a participation in a Loan from another lender because the Fund must assume the risk of insolvency or bankruptcy of the other lender from which the Loan was acquired. To the extent that Loans involve Obligors in foreign or emerging markets, such
Loans are subject to the risks associated with foreign investments or investments in emerging markets in general. The following outlines some of the additional risks associated with Loans.
High Yield Securities Risk.
The Loans that a Fund invests in may not be rated by an NRSRO, will not be registered
with the SEC or any state securities commission and will not be listed on any national securities exchange. To the extent that such high yield Loans are rated, they typically will be rated below investment grade and are subject to an increased risk
of default in the payment of principal and interest as well as the other risks described under
High Yield/High Risk Securities/Junk Bonds.
Loans are vulnerable to market sentiment such that economic conditions or other events may
reduce the demand for Loans and cause their value to decline rapidly and unpredictably.
Liquidity Risk.
Although the Funds limit their investments in illiquid securities to no more than 15% of a Funds net assets (5% of the total assets for the Money Market Funds) at the time of purchase, Loans that are deemed to be liquid at the time of
purchase may become illiquid or less liquid. No active trading market may exist for certain Loans and certain Loans may be subject to restrictions on resale or have a limited secondary market. Certain Loans may be subject to irregular trading
activity, wide bid/ask spreads and extended trade settlement periods. The inability to dispose of certain Loans in a timely fashion or at a favorable price could result in losses to a Fund.
Collateral and Subordination Risk.
With respect to Loans that are secured, a Fund is subject to the risk that
collateral securing the Loan will decline in value or have no value or that the Funds lien is or will become junior in payment to other liens. A decline in value of the collateral, whether as a result of market value declines, bankruptcy
proceedings or otherwise, could cause the Loan to be under collateralized or unsecured. In such event, the Fund may have the ability to require that the Obligor pledge additional collateral. The Fund, however, is subject to the risk that the Obligor
may not pledge such additional collateral or a sufficient amount of collateral. In some cases, there may be no formal requirement for the Obligor to pledge additional collateral. In addition, collateral may consist of assets that may not be readily
liquidated, and there is no assurance that the liquidation of such assets would satisfy an Obligors obligation on a Loan. If the Fund were unable to obtain sufficient proceeds upon a liquidation of such assets, this could negatively affect
Fund performance.
If an Obligor becomes involved in bankruptcy proceedings, a court may restrict the ability
of the Fund to demand immediate repayment of the Loan by Obligor or otherwise liquidate the collateral. A court may also
Part II - 20
invalidate the Loan or the Funds security interest in collateral or subordinate the Funds rights under a Senior Loan or Junior Loan to the interest of the Obligors other
creditors, including unsecured creditors, or cause interest or principal previously paid to be refunded to the Obligor. If a court required interest or principal to be refunded, it could negatively affect Fund performance. Such action by a court
could be based, for example, on a fraudulent conveyance claim to the effect that the Obligor did not receive fair consideration for granting the security interest in the Loan collateral to a Fund. For Senior Loans made in connection with
a highly leveraged transaction, consideration for granting a security interest may be deemed inadequate if the proceeds of the Loan were not received or retained by the Obligor, but were instead paid to other persons (such as shareholders of the
Obligor) in an amount which left the Obligor 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 a Funds security interest in Loan collateral. If the Funds security interest in Loan collateral is invalidated or a Senior Loan were subordinated to other debt of an Obligor in bankruptcy or other proceedings, the
Fund would have substantially lower recovery, and perhaps no recovery on the full amount of the principal and interest due on the Loan, or the Fund could have to refund interest. Lenders and investors in Loans can be sued by other creditors and
shareholders of the Obligors. Losses can be greater than the original Loan amount and occur years after the principal and interest on the Loan have been repaid.
Agent Risk.
Selling Lenders, Agents and other entities who may be positioned between a Fund and the Obligor will likely conduct their principal business activities in the banking, finance and
financial services industries. Investments in Loans may be more impacted by a single economic, political or regulatory occurrence affecting such industries than other types of investments. Entities engaged in such industries may be more susceptible
to, among other things, fluctuations in interest rates, changes in the Federal Open Market Committees monetary policy, government regulations concerning such industries and concerning capital raising activities generally and fluctuations in
the financial markets generally. An Agent, Lender or other entity positioned between a Fund and the Obligor may become insolvent or enter FDIC receivership or bankruptcy. The Fund might incur certain costs and delays in realizing payment on a Loan
or suffer a loss of principal and/or interest if assets or interests held by the Agent, Lender or other party positioned between the Fund and the Obligor are determined to be subject to the claims of the Agents, Lenders or such other
partys creditors.
Regulatory Changes.
To the extent that legislation or state or federal
regulators that regulate certain financial institutions impose additional requirements or restrictions with respect to the ability of such institutions to make Loans, particularly in connection with highly leveraged transactions, the availability of
Loans for investment may be adversely affected. Furthermore, such legislation or regulation could depress the market value of Loans held by the Fund.
Inventory Risk.
Affiliates of the Adviser may participate in the primary and secondary market for Loans. Because of limitations imposed by applicable law, the presence of the Advisers
affiliates in the Loan market may restrict a Funds ability to acquire some Loans, affect the timing of such acquisition or affect the price at which the Loan is acquired.
Information Risk
. There is typically less publicly available information concerning Loans than other types of fixed
income investments. As a result, a Fund generally will be dependent on reports and other information provided by the Obligor, either directly or through an Agent, to evaluate the Obligors creditworthiness or to determine the Obligors
compliance with the covenants and other terms of the Loan Agreement. Such reliance may make investments in Loans more susceptible to fraud than other types of investments. In addition, because the Adviser may wish to invest in the publicly traded
securities of an Obligor, it may not have access to material
non-public
information regarding the Obligor to which other Loan investors have access.
Junior Loan Risk.
Junior Loans are subject to the same general risks inherent to any Loan investment. Due to their
lower place in the Obligors capital structure and possible unsecured status, Junior Loans involve a higher degree of overall risk than Senior Loans of the same Obligor. Junior Loans that are Bridge Loans generally carry the expectation that
the Obligor will be able to obtain permanent financing in the near future. Any delay in obtaining permanent financing subjects the Bridge Loan investor to increased risk. An Obligors use of Bridge Loans also involves the risk that the Obligor
may be unable to locate permanent financing to replace the Bridge Loan, which may impair the Obligors perceived creditworthiness.
Mezzanine Loan Risk.
In addition to the risk factors described above, mezzanine loans are subject to additional risks. Unlike conventional mortgage loans, mezzanine loans are not secured by a
mortgage on the underlying real property but rather by a pledge of equity interests (such as a partnership or limited liability
Part II - 21
company membership) in the property owner or another company in the ownership structures that has control over the property. Such companies are typically structured as special purpose entities.
Generally, mezzanine loans may be more highly leveraged than other types of Loans and subordinate in the capital structure of the Obligor. While foreclosure of a mezzanine loan generally takes substantially less time than foreclosure of a
traditional mortgage, the holders of a mezzanine loan have different remedies available versus the holder of a first lien mortgage loan. In addition, a sale of the underlying real property would not be unencumbered, and thus would be subject to
encumbrances by more senior mortgages and liens of other creditors. Upon foreclosure of a mezzanine loan, the holder of the mezzanine loan acquires an equity interest in the Obligor. However, because of the subordinate nature of a mezzanine loan,
the real property continues to be subject to the lien of the mortgage and other liens encumbering the real estate. In the event the holder of a mezzanine loan forecloses on its equity collateral, the holder may need to cure the Obligors
existing mortgage defaults or, to the extent permissible under the governing agreements, sell the property to pay off other creditors. To the extent that the amount of mortgages and senior indebtedness and liens exceed the value of the real estate,
the collateral underlying the mezzanine loan may have little or no value.
Foreclosure Risk.
There may
be additional costs associated with enforcing a Funds remedies under a Loan including additional legal costs and payment of real property transfer taxes upon foreclosure in certain jurisdictions. As a result of these additional costs, the Fund
may determine that pursuing foreclosure on the Loan collateral is not worth the associated costs. In addition, if the Fund incurs costs and the collateral loses value or is not recovered by the Fund in foreclosure, the Fund could lose more than its
original investment in the Loan. Foreclosure risk is heightened for Junior Loans, including certain mezzanine loans.
Miscellaneous Investment Strategies and Risks
Borrowings
.
A Fund may borrow for temporary purposes and/or for
investment purposes. 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 unsecured. If a Fund utilizes
borrowings, for investment purposes or otherwise, it may pledge up to 33
1
/
3
% of its total assets to secure such borrowings. 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, with an exception for borrowings not in excess of 5% of the Funds total assets made for temporary administrative or
emergency 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 to sell securities at that time.
Borrowing 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. 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.
Certain types of investments are considered to be borrowings under precedents
issued by the SEC. Such investments are subject to the limitations as well as asset segregation requirements. In addition, each Fund may enter into Interfund Lending Arrangements. Please see Interfund Lending.
Commodity-Linked Derivatives
.
Commodity-linked derivatives are derivative instruments the
value of which is linked to the value of a commodity, commodity index or commodity futures contract. A Funds investment in commodity-linked derivative instruments may subject the Fund to greater volatility than investments in traditional
securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a
particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates the possibility for
greater loss (including the likelihood of greater volatility of the Funds net asset value), and there can be no assurance that a Funds use of leverage will be successful. Tax considerations may limit a Funds ability to pursue
investments in commodity-linked derivatives.
Exchange-Traded Notes (ETNs)
are
senior, unsecured notes linked to an index. Like ETFs, they may be bought and sold like shares of stock on an exchange. However, ETNs have a different underlying structure. While ETF shares represent an interest in a portfolio of securities, ETNs
are structured products that are an obligation of
Part II - 22
the issuing bank, whereby the bank agrees to pay a return based on the target index less any fees. Essentially, these notes allow individual investors to have access to derivatives linked to
commodities and assets such as oil, currencies and foreign stock indexes. ETNs combine certain aspects of bonds and ETFs. Similar to ETFs, ETNs are traded on a major exchange (e.g., the New York Stock Exchange) during normal trading hours. However,
investors can also hold the ETN until maturity. At maturity, the issuer pays to the investor a cash amount equal to principal amount, subject to the days index factor. ETN returns are based upon the performance of a market index minus
applicable fees. ETNs do not make periodic coupon payments and provide no principal protection. The value of an ETN may be influenced by time to maturity, level of supply and demand for the ETN, volatility and lack of liquidity in underlying
commodities markets, changes in the applicable interest rates, changes in the issuers credit rating and economic, legal, political or geographic events that affect the referenced commodity. The value of the ETN may drop due to a downgrade in
the issuers credit rating, despite the underlying index remaining unchanged. The timing and character of income and gains derived from ETNs is under consideration by the U.S. Treasury and Internal Revenue Service and may also be affected by
future legislation.
Impact of Large Redemptions and Purchases of Fund Shares
From time to
time, shareholders of a Fund (which may include the Adviser or affiliates of the Adviser or accounts for which the Adviser or its affiliates serve as investment adviser or trustee or, for certain Funds, affiliated and/or
non-affiliated
registered investment companies that invest in a Fund) may make relatively large redemptions or purchases of Fund shares. These transactions may cause the Fund to have to sell securities, or invest
additional cash, as the case may be. While it is impossible to predict the overall impact of these transactions over time, there could be adverse effects on the Funds performance to the extent that the Fund is required to sell securities or
invest cash at times when it would not otherwise do so, which may result in a loss to the Fund. These transactions may result in higher portfolio turnover, accelerate the realization of taxable income if sales of securities resulted in capital gains
or other income and increase transaction costs, which may impact the Funds expense ratio. To the extent that such transactions result in short-term capital gains, such gains will generally be taxed at the ordinary income tax rate.
Government Intervention in Financial Markets.
Events in the financial sector over the past several
years have resulted in reduced liquidity in credit and fixed income markets and in an unusually high degree of volatility in the financial markets, both domestically and internationally. While entire markets have been impacted, issuers that have
exposure to the real estate, mortgage and credit markets have been particularly affected. These events and the potential for continuing market turbulence may have an adverse effect on the Funds investments. It is uncertain how long these
conditions will continue.
Recent instability in the financial markets has led governments and regulators around the
world to take a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Governments, their regulatory
agencies, or self regulatory organizations may take actions that affect the regulation of the instruments in which the Funds invest, or the issuers of such instruments, in ways that are unforeseeable. Legislation or regulation may also change the
way in which the Funds themselves are regulated. Such legislation or regulation could limit or preclude a Funds ability to achieve its investment objective.
Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition
of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of a Funds portfolio holdings. Furthermore, volatile financial markets can expose the Funds to greater market and
liquidity risk and potential difficulty in valuing portfolio instruments held by the Funds.
Interfund Lending
.
To satisfy redemption requests or to cover unanticipated cash shortfalls, a
Fund may enter into lending agreements (Interfund Lending Agreements) under which the Fund would lend money and borrow money for temporary purposes directly to and from another J.P. Morgan Fund through a credit facility (Interfund
Loan), subject to meeting the conditions of an SEC exemptive order granted to the Funds permitting such interfund lending. No Fund may borrow more than the lesser of the amount permitted by Section 18 of the 1940 Act or the amount
permitted by its investment limitations. All Interfund Loans will consist only of uninvested cash reserves that the Fund otherwise would invest in short-term repurchase agreements or other short-term instruments.
If a Fund has outstanding borrowings, any Interfund Loans to the Fund (a) will be at an interest rate equal to or lower than any
outstanding bank loan, (b) will be secured at least on an equal priority basis with at least an equivalent percentage of collateral to loan value as any outstanding bank loan that requires collateral, (c) will have a maturity no longer
than any outstanding bank loan (and in any event not over seven days) and (d) will provide that, if an event of default occurs under any agreement evidencing an outstanding bank loan to the Fund, the event of
Part II - 23
default will automatically (without need for action or notice by the lending Fund) constitute an immediate event of default under the Interfund Lending Agreement entitling the lending Fund to
call the Interfund Loan (and exercise all rights with respect to any collateral) and that such call will be made if the lending bank exercises its right to call its loan under its agreement with the borrowing Fund.
A Fund may make an unsecured borrowing through the credit facility if its outstanding borrowings from all sources immediately after the
interfund borrowing total 10% or less of its total assets; provided, that if the Fund has a secured loan outstanding from any other lender, including but not limited to another J.P. Morgan Fund, the Funds interfund borrowing will be secured on
at least an equal priority basis with at least an equivalent percentage of collateral to loan value as any outstanding loan that requires collateral. If a Funds total outstanding borrowings immediately after an interfund borrowing would be
greater than 10% of its total assets, the Fund may borrow through the credit facility on a secured basis only. A Fund may not borrow through the credit facility nor from any other source if its total outstanding borrowings immediately after the
interfund borrowing would exceed the limits imposed by Section 18 of the 1940 Act.
No Fund may lend to another Fund
through the interfund lending credit facility if the loan would cause its aggregate outstanding loans through the credit facility to exceed 15% of the lending Funds net assets at the time of the loan. A Funds Interfund Loans to any one
Fund shall not exceed 5% of the lending Funds net assets. The duration of Interfund Loans is limited to the time required to receive payment for securities sold, but in no event may the duration exceed seven days. Loans effected within seven
days of each other will be treated as separate loan transactions for purposes of this condition. Each Interfund Loan may be called on one business days notice by a lending Fund and may be repaid on any day by a borrowing Fund.
The limitations detailed above and the other conditions of the SEC exemptive order permitting interfund lending are designed to minimize
the risks associated with interfund lending for both the lending fund and the borrowing fund. However, no borrowing or lending activity is without risk. When a Fund borrows money from another Fund, there is a risk that the loan could be called on
one days notice or not renewed, in which case the Fund may have to borrow from a bank at higher rates if an Interfund Loan were not available from another Fund. A delay in repayment to a lending Fund could result in a lost opportunity or
additional lending costs.
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.
New Financial Products
.
New options and futures
contracts and other financial products, and various combinations thereof, including
over-the-counter
products, continue to be developed. These various products may be
used to adjust the risk and return characteristics of certain Funds investments. These various products may increase or decrease exposure to security prices, interest rates, commodity prices, or other factors that affect security values,
regardless of the issuers credit risk. If market conditions do not perform as expected, the performance of a Fund would be less favorable than it would have been if these products were not used. In addition, losses may occur if counterparties
involved in transactions do not perform as promised. These products may expose the Fund to potentially greater return as well as potentially greater risk of loss than more traditional fixed income investments.
Private Placements, Restricted Securities and Other Unregistered Securities.
Subject to its policy
limitation, a Fund may acquire investments that are illiquid or have limited liquidity, such as commercial obligations issued in reliance on the
so-called
private placement exemption from
registration afforded by Section 4(2) under the Securities Act of 1933, as amended (the 1933 Act), and cannot be offered for public sale in the U.S. without first being registered under the 1933 Act. An illiquid investment is any
investment that cannot be disposed of within seven days in the normal course of business at approximately the amount at which it is valued by a Fund. The price a Fund pays for illiquid securities or receives upon resale may be lower than the price
paid or received for similar securities with a more liquid market. Accordingly the valuation of these securities will reflect any limitations on their liquidity.
Part II - 24
A Fund is subject to a risk that should the Fund decide to sell illiquid securities when a
ready buyer is not available at a price the Fund deems representative of their value, the value of the Funds net assets could be adversely affected. Where an illiquid security must be registered under the 1933 Act before it may be sold, a Fund
may be obligated to pay all or part of the registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Fund may be permitted to sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop, a Fund might obtain a less favorable price than prevailed when it decided to sell.
The Funds may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(2) of the 1933 Act and other restricted securities (i.e., other securities subject
to restrictions on resale). Section 4(2) commercial paper (4(2) paper) is restricted as to disposition under federal securities law and is generally sold to institutional investors, such as the Funds, that agree that they are
purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. 4(2) paper is normally resold to other institutional investors through or with the assistance of
the issuer or investment dealers who make a market in 4(2) paper, thus providing liquidity. The Funds believe that 4(2) paper and possibly certain other restricted securities which meet the criteria for liquidity established by the Trustees are
quite liquid. The Funds intend, therefore, to treat restricted securities that meet the liquidity criteria established by the Board of Trustees, including 4(2) paper and Rule 144A Securities, as determined by the Funds Adviser, as liquid and
not subject to the investment limitation applicable to illiquid securities.
The ability of the Trustees to determine the
liquidity of certain restricted securities is permitted under an SEC Staff position set forth in the adopting release for Rule 144A under the 1933 Act (Rule 144A). Rule 144A is a nonexclusive safe-harbor for certain secondary market
transactions involving securities subject to restrictions on resale under federal securities laws. Rule 144A provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. Rule 144A was
expected to further enhance the liquidity of the secondary market for securities eligible for resale. The Funds believe that the Staff of the SEC has left the question of determining the liquidity of all restricted securities to the Trustees. The
Trustees have directed each Funds Adviser to consider the following criteria in determining the liquidity of certain restricted securities:
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the frequency of trades and quotes for the security;
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the number of dealers willing to purchase or sell the security and the number of other potential buyers;
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dealer undertakings to make a market in the security; and
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the nature of the security and the nature of the marketplace trades.
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Certain 4(2) paper programs cannot rely on Rule 144A because, among other things, they were established before the adoption of the rule.
However, the Trustees may determine for purposes of the Trusts liquidity requirements that an issue of 4(2) paper is liquid if the following conditions, which are set forth in a 1994 SEC
no-action
letter, are met:
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The 4(2) paper must not be traded flat or in default as to principal or interest;
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The 4(2) paper must be rated in one of the two highest rating categories by at least two NRSROs, or if only one NRSRO rates the security, by that
NRSRO, or if unrated, is determined by a Funds Adviser to be of equivalent quality;
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The Funds Adviser must consider the trading market for the specific security, taking into account all relevant factors, including but not limited
to, whether the paper is the subject of a commercial paper program that is administered by an issuing and paying agent bank and for which there exists a dealer willing to make a market in that paper, or whether the paper is administered by a direct
issuer pursuant to a direct placement program;
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The Funds Adviser shall monitor the liquidity of the 4(2) paper purchased and shall report to the Board of Trustees promptly if any such
securities are no longer determined to be liquid if such determination causes a Fund to hold more than 10% of its net assets in illiquid securities in order for the Board of Trustees to consider what action, if any, should be taken on behalf of the
Trust, unless the Funds Adviser is able to dispose of illiquid assets in an orderly manner in an amount that reduces the Funds holdings of illiquid assets to less than 10% of its net assets; and
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The Funds Adviser shall report to the Board of Trustees on the appropriateness of the purchase and retention of liquid restricted securities
under these guidelines no less frequently than quarterly.
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Part II - 25
Securities Issued in Connection with Reorganizations and
Corporate Restructuring
.
Debt securities may be downgraded and issuers of debt securities including investment grade securities may default in the payment of principal or interest or be subject to bankruptcy proceedings. In connection
with reorganizing or restructuring of an issuer, an issuer may issue common stock or other securities to holders of its debt securities. A Fund may hold such common stock and other securities even though it does not ordinarily invest in such
securities.
Temporary Defensive Positions.
To respond to unusual market conditions, all
of the Funds may invest their assets in cash or cash equivalents. Cash equivalents are highly liquid, high quality instruments with maturities of three months or less on the date they are purchased (Cash Equivalents) for temporary
defensive purposes. These investments may result in a lower yield than lower-quality or longer term investments and may prevent the Funds from meeting their investment objectives. The percentage of Funds total assets that a Fund may invest in
cash or cash equivalents is described in the applicable Funds Prospectuses. They include securities issued by the U.S. government, its agencies and instrumentalities, repurchase agreements with maturities of 7 days or less (other than equity
repurchase agreements), certificates of deposit, bankers acceptances, commercial paper (rated in one of the two highest rating categories), variable rate master demand notes, money market mutual funds, and bank money market deposit accounts.
In order to invest in repurchase agreements with the Federal Reserve Bank of New York for temporary defensive purposes, certain Funds may engage in periodic test trading in order to assess operational abilities at times when the Fund
would otherwise not enter into such a position. These exercises may vary in size and frequency.
Mortgage-Related Securities
Mortgages (Directly Held)
.
Mortgages are debt instruments secured by real property. Unlike mortgage-backed securities, which generally represent an interest in
a pool of mortgages, direct investments in mortgages involve prepayment and credit risks of an individual issuer and real property. Consequently, these investments require different investment and credit analysis by a Funds Adviser.
Directly placed mortgages may include residential mortgages, multifamily mortgages, mortgages on cooperative apartment
buildings, commercial mortgages, and sale-leasebacks. These investments are backed by assets such as office buildings, shopping centers, retail stores, warehouses, apartment buildings and single-family dwellings. In the event that a Fund forecloses
on any
non-performing
mortgage, and acquires a direct interest in the real property, such Fund will be subject to the risks generally associated with the ownership of real property. There may be fluctuations
in the market value of the foreclosed property and its occupancy rates, rent schedules and operating expenses. There may also be adverse changes in local, regional or general economic conditions, deterioration of the real estate market and the
financial circumstances of tenants and sellers, unfavorable changes in zoning, building, environmental and other laws, increased real property taxes, rising interest rates, reduced availability and increased cost of mortgage borrowings, the need for
unanticipated renovations, unexpected increases in the cost of energy, environmental factors, acts of God and other factors which are beyond the control of a Fund or the Funds Adviser. Hazardous or toxic substances may be present on, at or
under the mortgaged property and adversely affect the value of the property. In addition, the owners of property containing such substances may be held responsible, under various laws, for containing, monitoring, removing or cleaning up such
substances. The presence of such substances may also provide a basis for other claims by third parties. Costs of clean up or of liabilities to third parties may exceed the value of the property. In addition, these risks may be uninsurable. In light
of these and similar risks, it may be impossible to dispose profitably of properties in foreclosure.
Mortgage-Backed Securities (CMOs and REMICs)
.
Mortgage-backed securities include collateralized mortgage obligations (CMOs) and Real Estate Mortgage Investment Conduits (REMICs). A REMIC is a CMO that
qualifies for special tax treatment under the Code and invests in certain mortgages principally secured by interests in real property and other permitted investments.
Mortgage-backed securities represent pools of mortgage loans assembled for sale to investors by:
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various governmental agencies such as the Government National Mortgage Association (Ginnie Mae);
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organizations such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac); and
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non-governmental
issuers such as commercial banks, savings and loan institutions, mortgage bankers, and private
mortgage insurance companies (non-governmental mortgage securities cannot be treated as U.S. government securities for purposes of investment policies).
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There are a number of important differences among the agencies and instrumentalities of the U.S. government that issue mortgage-related securities and among the securities that they issue.
Part II - 26
Ginnie Mae Securities
. Mortgage-related securities issued by Ginnie
Mae include Ginnie Mae Mortgage Pass-Through Certificates which are guaranteed as to the timely payment of principal and interest by Ginnie Mae. Ginnie Maes guarantee is backed by the full faith and credit of the U.S. Ginnie Mae is a
wholly-owned U.S. government corporation within the Department of Housing and Urban Development. Ginnie Mae certificates also are supported by the authority of Ginnie Mae to borrow funds from the U.S. Treasury to make payments under its guarantee.
Fannie Mae Securities.
Mortgage-related securities issued by Fannie Mae include Fannie Mae Guaranteed
Mortgage Pass-Through Certificates which are solely the obligations of Fannie Mae and are not backed by or entitled to the full faith and credit of the U.S. Fannie Mae is a government-sponsored organization owned entirely by private stockholders.
Fannie Mae Certificates are guaranteed as to timely payment of the principal and interest by Fannie Mae.
Freddie Mac Securities.
Mortgage-related securities issued by Freddie Mac include Freddie Mac Mortgage
Participation Certificates. Freddie Mac is a corporate instrumentality of the U.S., created pursuant to an Act of Congress, which is owned by private stockholders. Freddie Mac Certificates are not guaranteed by the U.S. or by any Federal Home Loan
Bank and do not constitute a debt or obligation of the U.S. or of any Federal Home Loan Bank. Freddie Mac Certificates entitle the holder to timely payment of interest, which is guaranteed by Freddie Mac. Freddie Mac guarantees either ultimate
collection or timely payment of all principal payments on the underlying mortgage loans. When Freddie Mac does not guarantee timely payment of principal, Freddie Mac may remit the amount due on account of its guarantee of ultimate payment of
principal at any time after default on an underlying mortgage, but in no event later than one year after it becomes payable.
For more information on recent events impacting Fannie Mae and Freddie Mac securities, see
Recent Events Regarding Fannie Mae and
Freddie Mac Securities
under the heading Risk Factors of Mortgage-Related Securities below.
CMOs and
guaranteed REMIC pass-through certificates (REMIC Certificates) issued by Fannie Mae, Freddie Mac, Ginnie Mae and private issuers are types of multiple class pass-through securities. Investors may purchase beneficial interests in REMICs,
which are known as regular interests or residual interests. The Funds do not currently intend to purchase residual interests in REMICs. The REMIC Certificates represent beneficial ownership interests in a REMIC Trust,
generally consisting of mortgage loans or Fannie Mae, Freddie Mac or Ginnie Mae guaranteed mortgage pass-through certificates (the Mortgage Assets). The obligations of Fannie Mae, Freddie Mac or Ginnie Mae under their respective guaranty
of the REMIC Certificates are obligations solely of Fannie Mae, Freddie Mac or Ginnie Mae, respectively.
Fannie Mae REMIC Certificates.
Fannie Mae REMIC Certificates are issued and guaranteed as to timely distribution of
principal and interest by Fannie Mae. In addition, Fannie Mae will be obligated to distribute the principal balance of each class of REMIC Certificates in full, whether or not sufficient funds are otherwise available.
Freddie Mac REMIC Certificates.
Freddie Mac guarantees the timely payment of interest, and also guarantees the
payment of principal as payments are required to be made on the underlying mortgage participation certificates (PCs). PCs represent undivided interests in specified residential mortgages or participation therein purchased by Freddie Mac
and placed in a PC pool. With respect to principal payments on PCs, Freddie Mac generally guarantees ultimate collection of all principal of the related mortgage loans without offset or deduction. Freddie Mac also guarantees timely payment of
principal on certain PCs referred to as Gold PCs.
Ginnie Mae REMIC Certificates.
Ginnie Mae
guarantees the full and timely payment of interest and principal on each class of securities (in accordance with the terms of those classes as specified in the related offering circular supplement). The Ginnie Mae guarantee is backed by the full
faith and credit of the U.S.
REMIC Certificates issued by Fannie Mae, Freddie Mac and Ginnie Mae are treated as U.S.
Government securities for purposes of investment policies.
CMOs and REMIC Certificates provide for the redistribution of cash
flow to multiple classes. Each class of CMOs or REMIC Certificates, often referred to as a tranche, is issued at a specific adjustable or fixed interest rate and must be fully retired no later than its final distribution date. This
reallocation of interest and principal results in the redistribution of prepayment risk across different classes. This allows for the creation of bonds with more or less risk than the underlying collateral exhibits. Principal prepayments on the
mortgage loans or the Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all of the classes of CMOs or REMIC Certificates
Part II - 27
to be retired substantially earlier than their final distribution dates. Generally, interest is paid or accrues on all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest on the Mortgage Assets may be allocated among the several classes of CMOs or REMIC Certificates in various
ways. In certain structures (known as sequential pay CMOs or REMIC Certificates), payments of principal, including any principal prepayments, on the Mortgage Assets generally are applied to the classes of CMOs or REMIC Certificates in
the order of their respective final distribution dates. Thus, no payment of principal will be made on any class of sequential pay CMOs or REMIC Certificates until all other classes having an earlier final distribution date have been paid in full.
Additional structures of CMOs and REMIC Certificates include, among others, principal only structures, interest only
structures, inverse floaters and parallel pay CMOs and REMIC Certificates. Certain of these structures may be more volatile than other types of CMO and REMIC structures. Parallel pay CMOs or REMIC Certificates are those which are
structured to apply principal payments and prepayments of the Mortgage Assets to two or more classes concurrently on a proportionate or disproportionate basis. These simultaneous payments are taken into account in calculating the final distribution
date of each class.
A wide variety of REMIC Certificates may be issued in the parallel pay or sequential pay structures. These
securities include accrual certificates (also known as
Z-Bonds),
which only accrue interest at a specified rate until all other certificates having an earlier final distribution date have been
retired and are converted thereafter to an interest-paying security, and planned amortization class (PAC) certificates, which are parallel pay REMIC Certificates which generally require that specified amounts of principal be applied on
each payment date to one or more classes of REMIC Certificates (the PAC Certificates), even though all other principal payments and prepayments of the Mortgage Assets are then required to be applied to one or more other classes of the
certificates. The scheduled principal payments for the PAC Certificates generally have the highest priority on each payment date after interest due has been paid to all classes entitled to receive interest currently. Shortfalls, if any, are added to
the amount of principal payable on the next payment date. The PAC Certificate payment schedule is taken into account in calculating the final distribution date of each class of PAC. In order to create PAC tranches, one or more tranches generally
must be created that absorb most of the volatility in the underlying Mortgage Assets. These tranches tend to have market prices and yields that are much more volatile than the PAC classes. The
Z-Bonds
in which
the Funds may invest may bear the same
non-credit-related
risks as do other types of
Z-Bonds.
Z-Bonds
in which the Fund may
invest will not include residual interest.
Total Annual Fund Operating Expenses set forth in the fee table and Financial
Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment company provided by
section 3(c)(1) or 3(c)(7) of the 1940 Act.
Mortgage TBAs.
The Fund may invest in
mortgage pass-through securities eligible to be sold in the
to-be-announced
or TBA market (Mortgage TBAs). Mortgage TBAs provide for the forward
or delayed delivery of the underlying instrument with settlement up to 180 days. The term TBA comes from the fact that the actual mortgage-backed security that will be delivered to fulfill a TBA trade is not designated at the time the trade is made,
but rather is generally announced 48 hours before the settlement date. Mortgage TBAs are subject to the risks described in the When-Issued Securities, Delayed Delivery Securities and Forward Commitments section.
Mortgage Dollar Rolls.
In a mortgage dollar roll transaction, one party sells mortgage-backed
securities, principally Mortgage TBAs, for delivery in the current month and simultaneously contracts with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities on a specified future date. When a
Fund enters into mortgage dollar rolls, the Fund will earmark and reserve until the settlement date Fund assets, in cash or liquid securities, in an amount equal to the forward purchase price. During the period between the sale and repurchase in a
mortgage dollar roll transaction, the Fund will not be entitled to receive interest and principal payments on securities sold. Losses may arise due to changes in the value of the securities or if the counterparty does not perform under the terms of
the agreement. If the counterparty files for bankruptcy or becomes insolvent, the Funds right to repurchase or sell securities may be limited. Mortgage dollar rolls may be subject to leverage risks. In addition, mortgage dollar rolls may
increase interest rate risk and result in an increased portfolio turnover rate which increases costs and may increase taxable gains. The benefits of mortgage dollar rolls may depend upon a Funds Advisers ability to predict mortgage
prepayments and interest rates. There is no assurance that mortgage dollar rolls can be successfully employed. For purposes of diversification and investment limitations, mortgage dollar rolls are considered to be mortgage-backed securities.
Part II - 28
Stripped Mortgage-Backed Securities.
Stripped
Mortgage-Backed Securities (SMBS) are derivative multi-class mortgage securities issued outside the REMIC or CMO structure. SMBS are usually structured with two classes that receive different proportions of the interest and principal
distributions from a pool of mortgage assets. A common type of SMBS will have one class receiving all of the interest from the mortgage assets (IOs), while the other class will receive all of the principal (POs). Mortgage IOs
receive monthly interest payments based upon a notional amount that declines over time as a result of the normal monthly amortization and unscheduled prepayments of principal on the associated mortgage POs.
In addition to the risks applicable to Mortgage-Related Securities in general, SMBS are subject to the following additional risks:
Prepayment/Interest Rate Sensitivity.
SMBS are extremely sensitive to changes in prepayments and
interest rates. Even though these securities have been guaranteed by an agency or instrumentality of the U.S. government, under certain interest rate or prepayment rate scenarios, the Funds may lose money on investments in SMBS.
Interest Only SMBS.
Changes in prepayment rates can cause the return on investment in IOs to be highly volatile.
Under extremely high prepayment conditions, IOs can incur significant losses.
Principal Only SMBS.
POs
are bought at a discount to the ultimate principal repayment value. The rate of return on a PO will vary with prepayments, rising as prepayments increase and falling as prepayments decrease. Generally, the market value of these securities is
unusually volatile in response to changes in interest rates.
Yield Characteristics.
Although SMBS may
yield more than other mortgage-backed securities, their cash flow patterns are more volatile and there is a greater risk that any premium paid will not be fully recouped. A Funds Adviser will seek to manage these risks (and potential benefits)
by investing in a variety of such securities and by using certain analytical and hedging techniques.
Adjustable Rate Mortgage Loans
.
Certain Funds may invest in adjustable rate mortgage loans (ARMs). ARMs eligible for inclusion in a mortgage pool will generally provide for a fixed initial mortgage interest rate for a
specified period of time. Thereafter, the interest rates (the Mortgage Interest Rates) may be subject to periodic adjustment based on changes in the applicable index rate (the Index Rate). The adjusted rate would be equal to
the Index Rate plus a gross margin, which is a fixed percentage spread over the Index Rate established for each ARM at the time of its origination.
Adjustable interest rates can cause payment increases that some borrowers may find difficult to make. However, certain ARMs may provide that the Mortgage Interest Rate may not be adjusted to a rate above
an applicable lifetime maximum rate or below an applicable lifetime minimum rate for such ARM. Certain ARMs may also be subject to limitations on the maximum amount by which the Mortgage Interest Rate may adjust for any single adjustment period (the
Maximum Adjustment). Other ARMs (Negatively Amortizing ARMs) may provide instead or as well for limitations on changes in the monthly payment on such ARMs. Limitations on monthly payments can result in monthly payments which
are greater or less than the amount necessary to amortize a Negatively Amortizing ARM by its maturity at the Mortgage Interest Rate in effect in any particular month. In the event that a monthly payment is not sufficient to pay the interest accruing
on a Negatively Amortizing ARM, any such excess interest is added to the principal balance of the loan, causing negative amortization and will be repaid through future monthly payments. It may take borrowers under Negatively Amortizing ARMs longer
periods of time to achieve equity and may increase the likelihood of default by such borrowers. In the event that a monthly payment exceeds the sum of the interest accrued at the applicable Mortgage Interest Rate and the principal payment which
would have been necessary to amortize the outstanding principal balance over the remaining term of the loan, the excess (or accelerated amortization) further reduces the principal balance of the ARM. Negatively Amortizing ARMs do not
provide for the extension of their original maturity to accommodate changes in their Mortgage Interest Rate. As a result, unless there is a periodic recalculation of the payment amount (which there generally is), the final payment may be
substantially larger than the other payments. These limitations on periodic increases in interest rates and on changes in monthly payments protect borrowers from unlimited interest rate and payment increases.
Certain ARMs may provide for periodic adjustments of scheduled payments in order to amortize fully the mortgage loan by its stated
maturity. Other ARMs may permit their stated maturity to be extended or shortened in accordance with the portion of each payment that is applied to interest as affected by the periodic interest rate adjustments.
There are two main categories of indices which provide the basis for rate adjustments on ARMs: those based on U.S. Treasury securities and
those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the
one-year,
three-year and five-year constant
Part II - 29
maturity Treasury bill rates, the three-month Treasury bill rate, the
180-day
Treasury bill rate, rates on longer-term Treasury securities, the 11th
District Federal Home Loan Bank Cost of Funds, the National Median Cost of Funds, the
one-month,
three-month,
six-month
or
one-year
London InterBank Offered Rate (LIBOR), the prime rate of a specific bank, or commercial paper rates. Some indices, such as the
one-year
constant
maturity Treasury rate, closely mirror changes in market interest rate levels. Others, such as the 11th District Federal Home Loan Bank Cost of Funds index, tend to lag behind changes in market rate levels and tend to be somewhat less volatile. The
degree of volatility in the market value of the Funds portfolio and therefore in the net asset value of the Funds shares will be a function of the length of the interest rate reset periods and the degree of volatility in the applicable
indices.
In general, changes in both prepayment rates and interest rates will change the yield on Mortgage-Backed Securities.
The rate of principal prepayments with respect to ARMs has fluctuated in recent years. As is the case with fixed mortgage loans, ARMs may be subject to a greater rate of principal prepayments in a declining interest rate environment. For example, if
prevailing interest rates fall significantly, ARMs could be subject to higher prepayment rates than if prevailing interest rates remain constant because the availability of fixed rate mortgage loans at competitive interest rates may encourage
mortgagors to refinance their ARMs to
lock-in
a lower fixed interest rate. Conversely, if prevailing interest rates rise significantly, ARMs may prepay at lower rates than if prevailing rates
remain at or below those in effect at the time such ARMs were originated. As with fixed rate mortgages, there can be no certainty as to the rate of prepayments on the ARMs in either stable or changing interest rate environments. In addition, there
can be no certainty as to whether increases in the principal balances of the ARMs due to the addition of deferred interest may result in a default rate higher than that on ARMs that do not provide for negative amortization.
Other factors affecting prepayment of ARMs include changes in mortgagors housing needs, job transfers, unemployment,
mortgagors net equity in the mortgage properties and servicing decisions.
Risk Factors
of Mortgage-Related Securities
.
The following is a summary of certain risks associated with Mortgage-Related Securities:
Guarantor Risk.
There can be no assurance that the U.S. government would provide financial support to Fannie Mae or Freddie Mac if necessary in the future. Although certain mortgage-related
securities are guaranteed by a third party or otherwise similarly secured, the market value of the security, which may fluctuate, is not so secured.
Interest Rate Sensitivity.
If a Fund purchases a mortgage-related security at a premium, that portion may be lost if there is a decline in the market value of the security whether resulting from
changes in interest rates or prepayments in the underlying mortgage collateral. As with other interest-bearing securities, the prices of such securities are inversely affected by changes in interest rates. Although the value of a mortgage-related
security may decline when interest rates rise, the converse is not necessarily true since in periods of declining interest rates the mortgages underlying the securities are prone to prepayment. For this and other reasons, a mortgage-related
securitys stated maturity may be shortened by unscheduled prepayments on the underlying mortgages and, therefore, it is not possible to predict accurately the securitys return to the Fund. In addition, regular payments received in
respect of mortgage-related securities include both interest and principal. No assurance can be given as to the return the Fund will receive when these amounts are reinvested.
Market Value.
The market value of the Funds adjustable rate Mortgage-Backed Securities may be adversely affected if interest rates increase faster than the rates of interest payable on such
securities or by the adjustable rate mortgage loans underlying such securities. Furthermore, adjustable rate Mortgage-Backed Securities or the mortgage loans underlying such securities may contain provisions limiting the amount by which rates may be
adjusted upward and downward and may limit the amount by which monthly payments may be increased or decreased to accommodate upward and downward adjustments in interest rates. When the market value of the properties underlying the Mortgage-Backed
Securities suffer broad declines on a regional or national level, the values of the corresponding Mortgage-Backed Securities or Mortgage-Backed Securities as a whole, may be adversely affected as well.
Prepayments.
Adjustable rate Mortgage-Backed Securities have less potential for capital appreciation than fixed rate
Mortgage-Backed Securities because their coupon rates will decline in response to market interest rate declines. The market value of fixed rate Mortgage-Backed Securities may be adversely affected as a result of increases in interest rates and,
because of the risk of unscheduled principal prepayments, may benefit less than other fixed rate securities of similar maturity from declining interest rates. Finally, to the extent Mortgage-Backed Securities are purchased at a premium, mortgage
foreclosures and unscheduled principal prepayments may result in some loss of the Funds principal investment to the extent of the premium paid. On the other hand, if such securities
Part II - 30
are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the recognition of
income.
Yield Characteristics.
The yield characteristics of Mortgage-Backed Securities differ from those of traditional
fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possibility that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in
current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. As with fixed rate mortgage loans, adjustable rate mortgage loans may be subject to a greater prepayment rate in a
declining interest rate environment. The yields to maturity of the Mortgage-Backed Securities in which the Funds invest will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans. The
mortgage loans underlying such securities generally may be prepaid at any time without penalty. In a fluctuating interest rate environment, a predominant factor affecting the prepayment rate on a pool of mortgage loans is the difference between the
interest rates on the mortgage loans and prevailing mortgage loan interest rates taking into account the cost of any refinancing. In general, if mortgage loan interest rates fall sufficiently below the interest rates on fixed rate mortgage loans
underlying mortgage pass-through securities, the rate of prepayment would be expected to increase. Conversely, if mortgage loan interest rates rise above the interest rates on the fixed rate mortgage loans underlying the mortgage pass-through
securities, the rate of prepayment may be expected to decrease.
Recent Events Regarding Fannie Mae and Freddie Mac
Securities
. On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of Fannie Mae
and Freddie Mac and of any stockholder, officer or director of Fannie Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of Fannie Mae and Freddie Mac. FHFA selected a new chief executive officer and chairman of the board
of directors for each of Fannie Mae and Freddie Mac. In connection with the conservatorship, the U.S. Treasury entered into a Senior Preferred Stock Purchase Agreement with each of Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will
purchase up to an aggregate of $100 billion of each of Fannie Mae and Freddie Mac to maintain a positive net worth in each enterprise. This agreement contains various covenants, discussed below, that severely limit each enterprises operations.
In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprises senior preferred stock and warrants to purchase 79.9% of each enterprises common stock. In 2009, the U.S. Treasury announced that
it was doubling the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasurys obligations under the Senior Preferred Stock Program are for an indefinite period of time for a maximum
amount of $200 billion per enterprise. In 2009, the U.S. Treasury further amended the Senior Preferred Stock Purchase Agreement to allow the cap on the U.S. Treasurys funding commitment to increase as necessary to accommodate any cumulative
reduction in Fannie Maes and Freddie Macs net worth through the end of 2012. In August 2012, the Senior Preferred Stock Purchase Agreement was further amended to, among other things, accelerate the wind down of the retained portfolio,
terminate the requirement that Fannie Mae and Freddie Mac each pay a 10% dividend annually on all amounts received under the funding commitment, and require the submission of an annual risk management plan to the U.S. Treasury.
Fannie Mae and Freddie Mac 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 Fannie Maes and Freddie Macs ability to meet its obligations.
The FHFA has indicated that the conservatorship of each enterprise will end when the director of FHFA determines that FHFAs plan to restore the enterprise to a safe and solvent condition has been completed.
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 Fannie Mae or Freddie Mac 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 Fannie Maes or Freddie Macs affairs. The Reform Act requires FHFA to exercise
its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver. FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of Fannie Mae
or Freddie Mac because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for Fannie Mae or Freddie Mac, 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
Fannie
Part II - 31
Maes or Freddie Macs assets available therefor. In the event of repudiation, the payments of interest to holders of Fannie Mae or Freddie Mac 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 Fannie
Mae or Freddie Mac without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as conservator or receiver, were to transfer any such guaranty obligation to another party, holders of
Fannie Mae or Freddie Mac 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 Fannie Mae and Freddie Mac 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 Fannie Mae and Freddie Mac 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 Fannie Mae or Freddie Mac, 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 Fannie Mae or Freddie Mac 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 Fannie Mae or Freddie Mac is a party, or obtain possession of or exercise control over any property of Fannie Mae or Freddie Mac, or affect any
contractual rights of Fannie Mae or Freddie Mac, 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.
In addition, in a February 2011 report to Congress from the Treasury Department and the Department of Housing and Urban Development, the
Obama administration provided a plan to reform Americas housing finance market. The plan would reduce the role of and eventually eliminate Fannie Mae and Freddie Mae. Notably, the plan does not propose similar significant changes to Ginnie
Mae, which guarantees payments on mortgage-related securities backed by federally insured or guaranteed loans such as those issued by the Federal Housing Association or guaranteed by the Department of Veterans Affairs. The report also identified
three proposals for Congress and the administration to consider for the long-term structure of the housing finance markets after the elimination of Fannie Mae and Freddie Mac, including implementing: (i) a privatized system of housing finance
that limits government insurance to very limited groups of creditworthy low- and moderate-income borrowers; (ii) a privatized system with a government backstop mechanism that would allow the government to insure a larger share of the housing
finance market during a future housing crisis; and (iii) a privatized system where the government would offer reinsurance to holders of certain highly-rated mortgage-related securities insured by private insurers and would pay out under the
reinsurance arrangements only if the private mortgage insurers were insolvent.
The conditions attached to the financial
contribution made by the Treasury to Freddie Mac and Fannie Mae and the issuance of senior preferred stock place significant restrictions on the activities of Freddie Mac and Fannie Mae. Freddie Mac and Fannie Mae must obtain the consent of the
Treasury to, among other things, (i) make any payment to purchase or redeem its capital stock or pay any dividend other than in respect of the senior preferred stock, (ii) issue capital stock of any kind, (iii) terminate the conservatorship of the
FHFA except in connection with a receivership, or (iv) increase its debt beyond certain specified levels. In addition, significant restrictions are placed on the maximum size of each of Freddie Macs and Fannie Maes respective portfolios
of mortgages and mortgage-backed securities, and the purchase agreements entered into by Freddie Mac and Fannie Mae provide that the maximum size of their portfolios of these assets must decrease by a specified percentage each year. The future
status and role of Freddie Mac and Fannie Mae could be impacted by (among other things) the actions taken and restrictions placed on Freddie Mac and Fannie Mae by the FHFA in is role as conservator, the restrictions placed on Freddie Macs and
Fannie Maes operations and activities as a result of the senior preferred stock investment made by the U.S. Treasury, market responses to developments at Freddie Mac and Fannie Mac, and future legislative and regulatory action that alters the
operations, ownership, structure and/or mission of these institutions, each of which may, in turn, impact the value of, and cash flows on, any mortgage-backed securities guaranteed by Freddie Mac and Fannie Mae, including any such mortgage-backed
securities held by a Fund.
Part II - 32
Municipal Securities
Municipal Securities are issued to obtain funds for a wide variety of reasons. For example, municipal securities may be issued to obtain
funding for the construction of a wide range of public facilities such as:
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5.
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waterworks and sewer systems; and
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Other public
purposes for which Municipal Securities may be issued include:
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1.
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refunding outstanding obligations;
|
|
2.
|
obtaining funds for general operating expenses; and
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|
3.
|
obtaining funds to lend to other public institutions and facilities.
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In addition, certain debt obligations known as Private Activity Bonds may be issued by or on behalf of municipalities and public authorities to obtain funds to provide:
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1.
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water, sewage and solid waste facilities;
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|
2.
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qualified residential rental projects;
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3.
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certain local electric, gas and other heating or cooling facilities;
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4.
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qualified hazardous waste facilities;
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5.
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high-speed intercity rail facilities;
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6.
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governmentally-owned airports, docks and wharves and mass transportation facilities;
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8.
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student loan and redevelopment bonds; and
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9.
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bonds used for certain organizations exempt from Federal income taxation.
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Certain debt obligations known as Industrial Development Bonds under prior Federal tax law may have been issued by or on behalf of public authorities to obtain funds to provide:
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1.
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privately operated housing facilities;
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4.
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convention or trade show facilities;
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5.
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airport, mass transit, port or parking facilities;
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6.
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air or water pollution control facilities;
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7.
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sewage or solid waste disposal facilities; and
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8.
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facilities for water supply.
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Other private activity bonds and industrial development bonds issued to fund the construction, improvement, equipment or repair of
privately-operated industrial, distribution, research, or commercial facilities may also be Municipal Securities, however the size of such issues is limited under current and prior Federal tax law. The aggregate amount of most private activity bonds
and industrial development bonds is limited (except in the case of certain types of facilities) under Federal tax law by an annual volume cap. The volume cap limits the annual aggregate principal amount of such obligations issued by or
on behalf of all governmental instrumentalities in the state.
Part II - 33
The two principal classifications of Municipal Securities consist of general
obligation and limited (or revenue) issues. General obligation bonds are obligations involving the credit of an issuer possessing taxing power and are payable from the issuers general unrestricted revenues and not from any
particular fund or source. The characteristics and method of enforcement of general obligation bonds vary according to the law applicable to the particular issuer, and payment may be dependent upon appropriation by the issuers legislative
body. 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. Private activity bonds and
industrial development bonds generally are revenue bonds and thus not payable from the unrestricted revenues of the issuer. The credit and quality of such bonds is generally related to the credit of the bank selected to provide the letter of credit
underlying the bond. Payment of principal of and interest on industrial development revenue bonds is the responsibility of the corporate user (and any guarantor).
The Funds may also acquire moral obligation issues, which are normally issued by special purpose authorities, and in other
tax-exempt
investments
including pollution control bonds and
tax-exempt
commercial paper. Each Fund that may purchase municipal bonds may purchase:
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1.
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Short-term
tax-exempt
General Obligations Notes;
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2.
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Tax Anticipation Notes;
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3.
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Bond Anticipation Notes;
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4.
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Revenue Anticipation Notes;
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6.
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Other forms of short-term
tax-exempt
loans.
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Such notes are issued with a short-term maturity in anticipation of the receipt of tax funds, the proceeds of bond placements, or other
revenues. Project Notes are issued by a state or local housing agency and are sold by the Department of Housing and Urban Development. While the issuing agency has the primary obligation with respect to its Project Notes, they are also secured by
the full faith and credit of the U.S. through agreements with the issuing authority which provide that, if required, the Federal government will lend the issuer an amount equal to the principal of and interest on the Project Notes.
There are, of course, variations in the quality of Municipal Securities, both within a particular classification and between
classifications. Also, the yields on Municipal Securities depend upon a variety of factors, including:
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1.
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general money market conditions;
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3.
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the financial condition of the issuer;
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4.
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general conditions of the municipal bond market;
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5.
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the size of a particular offering;
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6.
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the maturity of the obligations; and
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7.
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the rating of the issue.
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The
ratings of Moodys and S&P represent their opinions as to the quality of Municipal Securities. However, ratings are general and are not absolute standards of quality. Municipal Securities with the same maturity, interest rate and rating may
have different yields while Municipal Securities of the same maturity and interest rate with different ratings may have the same yield. Subsequent to its purchase by a Fund, an issue of Municipal Securities may cease to be rated or its rating may be
reduced below the minimum rating required for purchase by the Fund. The Adviser will consider such an event in determining whether the Fund should continue to hold the obligations.
Municipal Securities may include obligations of municipal housing authorities and single-family mortgage revenue bonds. Weaknesses in
Federal housing subsidy programs and their administration may result in a decrease of subsidies available for payment of principal and interest on housing authority bonds. Economic developments, including fluctuations in interest rates and
increasing construction and operating costs, may also adversely impact revenues of housing authorities. In the case of some housing authorities, inability to obtain additional financing could also reduce revenues available to pay existing
obligations.
Part II - 34
Single-family mortgage revenue bonds are subject to extraordinary mandatory redemption at
par in whole or in part from the proceeds derived from prepayments of underlying mortgage loans and also from the unused proceeds of the issue within a stated period which may be within a year from the date of issue.
Municipal leases are obligations issued by state and local governments or authorities to finance the acquisition of equipment and
facilities. Municipal leases may be considered to be illiquid. They may take the form of a lease, an installment purchase contract, a conditional sales contract, or a participation interest in any of the above. The Board of Trustees is responsible
for determining the credit quality of unrated municipal leases on an ongoing basis, including an assessment of the likelihood that the lease will not be canceled.
Premium Securities
. During a period of declining interest rates, many Municipal Securities in which the Funds invest likely will bear coupon rates higher than current market rates, regardless of
whether the securities were initially purchased at a premium.
Risk Factors in Municipal
Securities
.
The following is a summary of certain risks associated with Municipal Securities
Tax Risk.
The
Code imposes certain continuing requirements on issuers of
tax-exempt
bonds regarding the use, expenditure and investment of bond proceeds and the payment of rebates to the U.S. Failure by the issuer to comply
subsequent to the issuance of
tax-exempt
bonds with certain of these requirements could cause interest on the bonds to become includable in gross income retroactive to the date of issuance.
Housing Authority Tax Risk.
The exclusion from gross income for Federal income tax purposes for certain housing authority bonds
depends on qualification under relevant provisions of the Code and on other provisions of Federal law. These provisions of Federal law contain requirements relating to the cost and location of the residences financed with the proceeds of the
single-family mortgage bonds and the income levels of tenants of the rental projects financed with the proceeds of the multi-family housing bonds. Typically, the issuers of the bonds, and other parties, including the originators and servicers of the
single-family mortgages and the owners of the rental projects financed with the multi-family housing bonds, covenant to meet these requirements. However, there is no assurance that the requirements will be met. If such requirements are not met:
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the interest on the bonds may become taxable, possibly retroactively from the date of issuance;
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the value of the bonds may be reduced;
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you and other Shareholders may be subject to unanticipated tax liabilities;
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a Fund may be required to sell the bonds at the reduced value;
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it may be an event of default under the applicable mortgage;
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the holder may be permitted to accelerate payment of the bond; and
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the issuer may be required to redeem the bond.
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In addition, if the mortgage securing the bonds is insured by the Federal Housing Administration (FHA), the consent of the FHA may be required before insurance proceeds would become payable.
Information Risk.
Information about the financial condition of issuers of Municipal Securities may be less available
than that of corporations having a class of securities registered under the SEC.
State and Federal Laws.
An
issuers obligations under its Municipal Securities are subject to the provisions of bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors. These laws may extend the time for payment of principal or interest, or
restrict the Funds ability to collect payments due on Municipal Securities. In addition, recent amendments to some statutes governing security interests (e.g., Revised Article 9 of the Uniform Commercial Code (UCC)) change the way
in which security interests and liens securing Municipal Securities are perfected. These amendments may have an adverse impact on existing Municipal Securities (particularly issues of Municipal Securities that do not have a corporate trustee who is
responsible for filing UCC financing statements to continue the security interest or lien).
Litigation and Current
Developments.
Litigation or other conditions may materially and adversely affect the power or ability of an issuer to meet its obligations for the payment of interest on and principal of its Municipal Securities. Such litigation or conditions
may from time to time have the effect of introducing uncertainties in the market for
tax-exempt
obligations, or may materially affect the credit risk with respect to particular bonds or notes.
Part II - 35
Adverse economic, business, legal or political developments might affect all or a substantial portion of a Funds Municipal Securities in the same manner.
New Legislation.
From time to time, proposals have been introduced before Congress for the purpose of restricting or eliminating
the federal income tax exemption for interest on tax exempt bonds, and similar proposals may be introduced in the future. The Supreme Court has held that Congress has the constitutional authority to enact such legislation. It is not possible to
determine what effect the adoption of such proposals could have on (i) the availability of Municipal Securities for investment by the Funds, and (ii) the value of the investment portfolios of the Funds.
Limitations on the Use of Municipal Securities.
Certain Funds may invest in Municipal Securities if
the Adviser determines that such Municipal Securities offer attractive yields. The Funds may invest in Municipal Securities either by purchasing them directly or by purchasing certificates of accrual or similar instruments evidencing direct
ownership of interest payments or principal payments, or both, on Municipal Securities, provided that, in the opinion of counsel to the initial seller of each such certificate or instrument, any discount accruing on such certificate or instrument
that is purchased at a yield not greater than the coupon rate of interest on the related Municipal Securities will to the same extent as interest on such Municipal Securities be exempt from federal income tax and state income tax (where applicable)
and not treated as a preference item for individuals for purposes of the federal alternative minimum tax. The Funds may also invest in Municipal Securities by purchasing from banks participation interests in all or part of specific holdings of
Municipal Securities. Such participation interests may be backed in whole or in part by an irrevocable letter of credit or guarantee of the selling bank. The selling bank may receive a fee from a Fund in connection with the arrangement.
Each Fund will limit its investment in municipal leases to no more than 5% of its total assets.
Options and Futures Transactions
A Fund may purchase and sell (a) exchange traded and OTC put and call options on securities, on indexes of securities and other types of instruments, and on futures contracts on securities and
indexes of securities and (b) futures contracts on securities and other types of instruments and on indexes of securities and other types of instruments. Each of these instruments is a derivative instrument as its value derives from the
underlying asset or index.
Subject to its investment objective and policies, a Fund may use futures contracts and options for
hedging and risk management purposes and to seek to enhance portfolio performance.
Options and futures contracts may be used
to manage a Funds exposure to changing interest rates and/or security prices. Some options and futures strategies, including selling futures contracts and buying puts, tend to hedge a Funds investments against price fluctuations. Other
strategies, including buying futures contracts and buying calls, tend to increase market exposure. Options and futures contracts may be combined with each other or with forward contracts in order to adjust the risk and return characteristics of a
Funds overall strategy in a manner deemed appropriate by the Funds Adviser and consistent with the Funds objective and policies. Because combined options positions involve multiple trades, they result in higher transaction costs
and may be more difficult to open and close out.
The use of options and futures is a highly specialized activity which
involves investment strategies and risks different from those associated with ordinary portfolio securities transactions, and there can be no guarantee that their use will increase a Funds return. While the use of these instruments by a Fund
may reduce certain risks associated with owning its portfolio securities, these techniques themselves entail certain other risks. If a Funds Adviser applies a strategy at an inappropriate time or judges market conditions or trends incorrectly,
options and futures strategies may lower a Funds return. Certain strategies limit a Funds possibilities to realize gains, as well as its exposure to losses. A Fund could also experience losses if the prices of its options and futures
positions were poorly correlated with its other investments, or if it could not close out its positions because of an illiquid secondary market. In addition, the Fund will incur transaction costs, including trading commissions and option premiums,
in connection with its futures and options transactions, and these transactions could significantly increase the Funds turnover rate.
Certain Funds have filed a notice under the Commodity Exchange Act under Regulation 4.5 and are operated by a person that has claimed an exclusion from the definition of the term commodity pool
operator under the Commodity Exchange Act and, therefore, is not subject to registration or regulation as a pool operator under the Commodity Exchange Act. Certain other Funds may rely on no action relief issued by the CFTC.
Part II - 36
Purchasing Put and Call Options.
By purchasing a put
option, a Fund obtains the right (but not the obligation) to sell the instrument underlying the option at a fixed strike price. In return for this right, a Fund pays the current market price for the option (known as the option premium). Options have
various types of underlying instruments, including specific securities, indexes of securities, indexes of securities prices, and futures contracts. A Fund may terminate its position in a put option it has purchased by allowing it to expire or by
exercising the option. A Fund may also close out a put option position by entering into an offsetting transaction, if a liquid market exists. If the option is allowed to expire, a Fund will lose the entire premium it paid. If a Fund exercises a put
option on a security, it will sell the instrument underlying the option at the strike price. If a Fund exercises an option on an index, settlement is in cash and does not involve the actual purchase or sale of securities. If an option is American
style, it may be exercised on any day up to its expiration date. A European style option may be exercised only on its expiration date.
The buyer of a typical put option can expect to realize a gain if the value of the underlying instrument falls substantially. However, if the price of the instrument underlying the option does not fall
enough to offset the cost of purchasing the option, a put buyer can expect to suffer a loss (limited to the amount of the premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put options, except that the purchaser of a call option obtains the right to purchase, rather than sell, the instrument underlying the
option at the options strike price. A call buyer typically attempts to participate in potential price increases of the instrument underlying the option with risk limited to the cost of the option if security prices fall. At the same time, the
buyer can expect to suffer a loss if security prices do not rise sufficiently to offset the cost of the option.
Selling (Writing) Put and Call Options on Securities.
When a Fund writes a put option on a security, it takes the opposite side of the transaction from the options purchaser. In return for the receipt of the premium, a Fund assumes the
obligation to pay the strike price for the security underlying the option if the other party to the option chooses to exercise it. A Fund may seek to terminate its position in a put option it writes before exercise by purchasing an offsetting option
in the market at its current price. If the market is not liquid for a put option a Fund has written, however, it must continue to be prepared to pay the strike price while the option is outstanding, regardless of price changes, and must continue to
post margin as discussed below. If the market value of the underlying securities does not move to a level that would make exercise of the option profitable to its holder, the option will generally expire unexercised, and the Fund will realize as
profit the premium it received.
If the price of the underlying instrument rises, a put writer would generally expect to
profit, although its gain would be limited to the amount of the premium it received. If security prices remain the same over time, it is likely that the writer will also profit, because it should be able to close out the option at a lower price. If
security prices fall, the put writer would expect to suffer a loss. This loss should be less than the loss from purchasing and holding the underlying security directly, however, because the premium received for writing the option should offset a
portion of the decline.
Writing a call option obligates a Fund to sell or deliver the options underlying security in
return for the strike price upon exercise of the option. The characteristics of writing call options are similar to those of writing put options, except that writing calls generally is a profitable strategy if prices remain the same or fall. Through
receipt of the option premium a call writer offsets part of the effect of a price decline. At the same time, because a call writer must be prepared to deliver the underlying instrument in return for the strike price, even if its current value is
greater, a call writer gives up some ability to participate in security price increases.
In order to meet its asset coverage
requirements, when a Fund writes an exchange traded put or call option on a security, it will be required to deposit cash or securities or a letter of credit as margin and to make mark to market payments of variation margin as the position becomes
unprofitable.
Certain Funds will usually sell covered call options or cash-secured put options on securities. A call option is
covered if the writer either owns the underlying security (or comparable securities satisfying the cover requirements of the securities exchanges) or has the right to acquire such securities. A put option is cash-secured if the writer segregates
cash, high-grade short-term debt obligations, or other permissible collateral equal to the exercise price. As the writer of a covered call option, the Fund foregoes, during the options life, the opportunity to profit from increases in the
market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline. As the Fund writes covered calls over more of
its portfolio, its ability to benefit from capital appreciation becomes more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation, but may
Part II - 37
terminate its position by entering into an offsetting option. Once an option writer has received an exercise notice, it cannot effect an offsetting transaction in order to terminate its
obligation under the option and must deliver the underlying security at the exercise price.
When the Fund writes cash-secured
put options, it bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Fund could incur a loss if it is required to purchase the stock underlying the put
option at a price greater than the market price of the stock at the time of exercise plus the put premium the Fund received when it wrote the option. While the Funds potential gain in writing a cash-secured put option is limited to
distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Fund risks a loss equal to the entire exercise price of the option minus the put premium.
Engaging in Straddles and Spreads.
In a straddle transaction, a Fund either buys a call and a put or
sells a call and a put on the same security. In a spread, a Fund purchases and sells a call or a put. A Fund will sell a straddle when the Funds Adviser believes the price of a security will be stable. The Fund will receive a premium on the
sale of the put and the call. A spread permits a Fund to make a hedged investment that the price of a security will increase or decline.
Options on Indexes.
Certain Funds may purchase and sell options on securities indexes and other types of indexes. Options on indexes are similar to options on
securities, except that the exercise of index options may be settled by cash payments (or in some instances by a futures contract) and does not involve the actual purchase or sale of securities or the instruments in the index. In addition, these
options are designed to reflect price fluctuations in a group of securities or instruments or segment of the securities or instruments market rather than price fluctuations in a single security or instrument. A Fund, in purchasing or
selling index options, is subject to the risk that the value of its portfolio may not change as much as an index because a Funds investments generally will not match the composition of an index. Unlike call options on securities, index options
are cash settled, or settled with a futures contract in some instances, rather than settled by delivery of the underlying index securities or instruments.
Certain Funds purchase and sell credit options which are options on indexes of derivative instruments such as credit default swap indexes. Like other index options, credit options can be cash settled or
settled with a futures contract in some instances. In addition, credit options can also be settled in some instances by delivery of the underlying index instrument. Credit options may be used for a variety of purposes including hedging, risk
management such as positioning a portfolio for anticipated volatility or increasing income or gain to a Fund. There is no guarantee that the strategy of using options on indexes or credit options in particular will be successful.
For a number of reasons, a liquid market may not exist and thus a Fund may not be able to close out an option position that it has
previously entered into. When a Fund purchases an OTC option (as defined below), it will be relying on its counterparty to perform its obligations and the Fund may incur additional losses if the counterparty is unable to perform.
Exchange-Traded and OTC Options.
All options purchased or sold by a Fund will be traded on a
securities exchange or will be purchased or sold by securities dealers (OTC options) that meet the Funds creditworthiness standards. While exchange-traded options are obligations of the Options Clearing Corporation, in the case of
OTC options, a Fund relies on the dealer from which it purchased the option to perform if the option is exercised. Thus, when a Fund purchases an OTC option, it relies on the dealer from which it purchased the option to make or take delivery of the
underlying securities. Failure by the dealer to do so would result in the loss of the premium paid by a Fund as well as loss of the expected benefit of the transaction.
Provided that a Fund has arrangements with certain qualified dealers who agree that a Fund may repurchase any option it writes for a maximum price to be calculated by a predetermined formula, a Fund may
treat the underlying securities used to cover written OTC options as liquid. In these cases, the OTC option itself would only be considered illiquid to the extent that the maximum repurchase price under the formula exceeds the intrinsic value of the
option.
Futures Contracts
.
When a Fund purchases a futures contract, it agrees to
purchase a specified quantity of an underlying instrument at a specified future date or, in the case of an index futures contract, to make a cash payment based on the value of a securities index. When a Fund sells a futures contract, it agrees to
sell a specified quantity of the underlying instrument at a specified future date or, in the case of an index futures contract, to receive a cash payment based on the value of a securities index. The price at which the purchase and sale will take
place is fixed when a Fund enters into the contract. Futures can be held until their delivery dates or the position can be (and
Part II - 38
normally is) closed out before then. There is no assurance, however, that a liquid market will exist when the Fund wishes to close out a particular position.
When a Fund purchases a futures contract, the value of the futures contract tends to increase and decrease in tandem with the value of its
underlying instrument. Therefore, purchasing futures contracts will tend to increase a Funds exposure to positive and negative price fluctuations in the underlying instrument, much as if it had purchased the underlying instrument directly.
When a Fund sells a futures contract, by contrast, the value of its futures position will tend to move in a direction contrary to the value of the underlying instrument. Selling futures contracts, therefore, will tend to offset both positive and
negative market price changes, much as if the underlying instrument had been sold.
The purchaser or seller of a futures
contract is not required to deliver or pay for the underlying instrument unless the contract is held until the delivery date. However, when a Fund buys or sells a futures contract it will be required to deposit initial margin with a
futures commission merchant (FCM). Initial margin deposits are typically equal to a small percentage of the contracts value. If the value of either partys position declines, that party will be required to make additional
variation margin payments equal to the change in value on a daily basis. The party that has a gain may be entitled to receive all or a portion of this amount. A Fund may be obligated to make payments of variation margin at a time when it
is disadvantageous to do so. Furthermore, it may not always be possible for a Fund to close out its futures positions. Until it closes out a futures position, a Fund will be obligated to continue to pay variation margin. Initial and variation margin
payments do not constitute purchasing on margin for purposes of a Funds investment restrictions. In the event of the bankruptcy of an FCM that holds margin on behalf of a Fund, the Fund may be entitled to return of margin owed to it only in
proportion to the amount received by the FCMs other customers, potentially resulting in losses to the Fund. Each Fund will earmark and reserve Fund assets, in cash or liquid securities, in connection with its use of options and futures
contracts to the extent required by the staff of the SEC. Each Fund will earmark and reserve liquid assets in an amount equal to the current
mark-to-market
exposure, on
a daily basis, of a futures contract that is contractually required to cash settle. Such assets cannot be sold while the futures contract or option is outstanding unless they are replaced with other suitable assets. By setting aside assets equal
only to its net obligation under cash-settled futures, a Fund will have the ability to have exposure to such instruments to a greater extent than if a Fund were required to set aside assets equal to the full notional value of such contracts. There
is a possibility that earmarking and reservation of a large percentage of a Funds assets could impede portfolio management or a Funds ability to meet redemption requests or other current obligations.
The Funds only invest in futures contracts on securities to the extent they could invest in the underlying securities directly. Certain
Funds may also invest in indexes where the underlying securities or instruments are not available for direct investments by the Funds.
Cash Equitization.
The objective where equity futures are used to equitize cash is to match the notional value of all futures contracts to a Funds
cash balance. The notional values of the futures contracts and of the cash are monitored daily. As the cash is invested in securities and/or paid out to participants in redemptions, the Adviser simultaneously adjusts the futures positions. Through
such procedures, a Fund not only gains equity exposure from the use of futures, but also benefits from increased flexibility in responding to client cash flow needs. Additionally, because it can be less expensive to trade a list of securities as a
package or program trade rather than as a group of individual orders, futures provide a means through which transaction costs can be reduced. Such
non-hedging
risk management techniques involve leverage, and
thus present, as do all leveraged transactions, the possibility of losses as well as gains that are greater than if these techniques involved the purchase and sale of the securities themselves rather than their synthetic derivatives.
Options on Futures Contracts.
Futures contracts obligate the buyer to take and the seller to make
delivery at a future date of a specified quantity of a financial instrument or an amount of cash based on the value of a securities or other index. Currently, futures contracts are available on various types of securities, including but not limited
to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and on indexes of securities. Unlike a futures contract, which requires the parties to buy and sell a security or make a cash settlement payment based on changes in a
financial instrument or securities or other index on an agreed date, an option on a futures contract entitles its holder to decide on or before a future date whether to enter into such a contract. If the holder decides not to exercise its option,
the holder may close out the option position by entering into an offsetting transaction or may decide to let the option expire and forfeit the premium thereon. The purchaser of an option on a futures contract pays a premium for the option but makes
no initial margin payments or daily payments of cash in the nature of variation margin payments to reflect the change in the value of the underlying contract as does a purchaser or seller of a futures contract.
Part II - 39
The seller of an option on a futures contract receives the premium paid by the purchaser and
may be required to pay initial margin. Amounts equal to the initial margin and any additional collateral required on any options on futures contracts sold by a Fund are earmarked by a Fund and set aside by the Fund, as required by the 1940 Act and
the SECs interpretations thereunder.
Combined Positions.
Certain Funds may purchase
and write options in combination with futures or forward contracts, to adjust the risk and return characteristics of the overall position. For example, a Fund may purchase a put option and write a call option on the same underlying instrument, in
order to construct a combined position whose risk and return characteristics are similar to selling a futures contract. Another possible combined position would involve writing a call option at one strike price and buying a call option at a lower
price, in order to reduce the risk of the written call option in the event of a substantial price increase. Because combined options positions involve multiple trades, they result in higher transaction costs and may be more difficult to open and
close out.
Correlation of Price Changes.
Because there are a limited number of types of
exchange-traded options and futures contracts, it is likely that the standardized options and futures contracts available will not match a Funds current or anticipated investments exactly. A Fund may invest in options and futures contracts
based on securities or instruments with different issuers, maturities, or other characteristics from the securities in which it typically invests, which involves a risk that the options or futures position will not track the performance of a
Funds other investments.
Options and futures contracts prices can also diverge from the prices of their underlying
instruments, even if the underlying instruments match the Funds investments well. Options and futures contracts prices are affected by such factors as current and anticipated short term interest rates, changes in volatility of the underlying
instrument, and the time remaining until expiration of the contract, which may not affect security prices the same way. Imperfect correlation may also result from differing levels of demand in the options and futures markets and the securities
markets, from structural differences in how options and futures and securities are traded, or from imposition of daily price fluctuation limits or trading halts. A Fund may purchase or sell options and futures contracts with a greater or lesser
value than the securities it wishes to hedge or intends to purchase in order to attempt to compensate for differences in volatility between the contract and the securities, although this may not be successful in all cases. If price changes in a
Funds options or futures positions are poorly correlated with its other investments, the positions may fail to produce anticipated gains or result in losses that are not offset by gains in other investments.
Liquidity of Options and Futures Contracts.
There is no assurance that a liquid market will exist for
any particular option or futures contract at any particular time even if the contract is traded on an exchange. In addition, exchanges may establish daily price fluctuation limits for options and futures contracts and may halt trading if a
contracts price moves up or down more than the limit in a given day. On volatile trading days when the price fluctuation limit is reached or a trading halt is imposed, it may be impossible for a Fund to enter into new positions or close out
existing positions. If the market for a contract is not liquid because of price fluctuation limits or otherwise, it could prevent prompt liquidation of unfavorable positions, and could potentially require a Fund to continue to hold a position until
delivery or expiration regardless of changes in its value. As a result, a Funds access to other assets held to cover its options or futures positions could also be impaired. (See Exchange-Traded and OTC Options above for a
discussion of the liquidity of options not traded on an exchange.)
Position Limits.
Futures exchanges can limit the number of futures and options on futures contracts that can be held or controlled by an entity. If an adequate exemption cannot be obtained, a Fund or the Funds Adviser may be required to reduce the size of
its futures and options positions or may not be able to trade a certain futures or options contract in order to avoid exceeding such limits.
Asset Coverage for Futures Contracts and Options Positions.
A Fund will comply with guidelines established by the SEC with respect to coverage of options and futures
contracts by mutual funds, and if the guidelines so require, will set aside or earmark appropriate liquid assets in the amount prescribed. Such assets cannot be sold while the futures contract or option is outstanding, unless they are replaced with
other suitable assets. As a result, there is a possibility that the reservation of a large percentage of a Funds assets could impede portfolio management or a Funds ability to meet redemption requests or other current obligations.
Real Estate Investment Trusts (REITs)
Certain of the Funds may invest in equity interests or debt obligations issued by REITs. REITs are pooled investment vehicles which invest
primarily in income producing real estate or real estate related loans or interest.
Part II - 40
REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets directly in real property and derive
income primarily from the collection of rents. Equity REITs can also realize capital gains by selling property that has appreciated in value. Mortgage REITs invest the majority of their assets in real estate mortgages and derive income from the
collection of interest payments. Similar to investment companies, REITs are not taxed on income distributed to shareholders provided they comply with several requirements of the Code. A Fund will indirectly bear its proportionate share of expenses
incurred by REITs in which a Fund invests in addition to the expenses incurred directly by a Fund.
Investing in REITs involves
certain unique risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be
affected by the quality of any credit extended. REITs are dependent upon management skills and on cash flows, are not diversified, and are subject to default by borrowers and self-liquidation. REITs are also subject to the possibilities of failing
to qualify for tax free pass-through of income under the Code and failing to maintain their exemption from registration under the 1940 Act.
REITs (especially mortgage REITs) are also subject to interest rate risks. When interest rates decline, the value of a REITs investment in fixed rate obligations can be expected to rise. Conversely,
when interest rates rise, the value of a REITs investment in fixed rate obligations can be expected to decline. In contrast, as interest rates on adjustable rate mortgage loans are reset periodically, yields on a REITs investment in such
loans will gradually align themselves to fluctuate less dramatically in response to interest rate fluctuations than would investments in fixed rate obligations.
Investment in REITs involves risks similar to those associated with investing in small capitalization companies. These risks include:
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limited financial resources;
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infrequent or limited trading; and
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more abrupt or erratic price movements than larger company securities.
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In addition, small capitalization stocks, such as certain REITs, historically have been more volatile in price than the larger
capitalization stocks included in the S&P 500 Index.
Recent Events Relating to the Overall Economy
The U.S. Government, the Federal Reserve, the Treasury, the SEC, the Federal Deposit Insurance Corporation and other
governmental and regulatory bodies have recently taken or are considering taking actions to address the financial crisis. These actions include, but are not limited to, the enactment by the United States Congress of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, which was signed into law on July 21, 2010 and imposes a new regulatory framework over the U.S. financial services industry and the consumer credit markets in general, and proposed regulations by the
SEC. Given the broad scope, sweeping nature, and relatively recent enactment of some of these regulatory measures, the potential impact they could have on securities held by the Funds is unknown. There can be no assurance that these measures will
not have an adverse effect on the value or marketability of securities held by the Funds. Furthermore, no assurance can be made that the U.S. Government or any U.S. regulatory body (or other authority or regulatory body) will not continue to take
further legislative or regulatory action in response to the economic crisis or otherwise, and the effect of such actions, if taken, cannot be known.
Repurchase Agreements
Repurchase agreements
may be entered into with brokers, dealers or banks that meet the Advisers credit guidelines, including the Federal Reserve Bank of New York. A Fund will enter into repurchase agreements only with member banks of the Federal Reserve System and
securities dealers believed by the Adviser to be creditworthy. In a repurchase agreement, a Fund buys a security from a seller that has agreed to repurchase the same security at a mutually agreed upon date and price. The resale price normally is in
excess of the purchase price, reflecting an agreed upon interest rate. This interest rate is effective for the period of time a Fund is invested in the agreement and is not related to the coupon rate on the underlying security. A repurchase
agreement may also be viewed as a fully collateralized loan of money by a Fund to the seller. Except in the case of a
tri-party
agreement, the maximum maturity of a repurchase agreement will be seven days. In
the case of a
tri-party
agreement, the maximum maturity of a repurchase agreement will be 95 days, or as limited by the specific repurchase agreement. The securities which are subject to repurchase agreements,
however, may have maturity dates in excess of 95 days
Part II - 41
from the effective date of the repurchase agreement. Repurchase agreements maturing in more than seven days are treated as illiquid for purposes of a Funds restrictions on purchases of
illiquid securities. A Fund will always receive securities as collateral during the term of the agreement whose market value is at least equal to 100% of the dollar amount invested by the Fund in each agreement plus accrued interest. The repurchase
agreements further authorize the Fund to demand additional collateral in the event that the dollar value of the collateral falls below 100%. A Fund will make payment for such securities only upon physical delivery or upon evidence of book entry
transfer to the account of the custodian. Repurchase agreements are considered under the 1940 Act to be loans collateralized by the underlying securities.
All of the Funds that are permitted to invest in repurchase agreements may engage in repurchase agreement transactions that are collateralized fully as defined in Rule
5b-3
of the 1940 Act (except that Rule
5b-3(c)(1)(iv)(C)
or (D) of the 1940 Act shall not apply for the Money Market Funds), which has the effect of enabling a Fund
to look to the collateral, rather than the counterparty, for determining whether its assets are diversified for 1940 Act purposes. With respect to the Money Market Funds, in accordance with Rule
2a-7
under the 1940 Act, the Adviser evaluates the creditworthiness of each counterparty. Certain Funds may, in addition, engage in repurchase agreement transactions that are collateralized by money market
instruments, debt securities, loan participations, equity securities or other securities including securities that are rated below investment grade by the requisite NRSROs or unrated securities of comparable quality. For these types of repurchase
agreement transactions, the Fund would look to the counterparty, and not the collateral, for determining such diversification.
A repurchase agreement is subject to the risk that the seller may fail to repurchase the security. In the event of default by the seller
under a repurchase agreement construed to be a collateralized loan, the underlying securities would not be owned by the Fund, but would only constitute collateral for the sellers obligation to pay the repurchase price. Therefore, a Fund may
suffer time delays and incur costs in connection with the disposition of the collateral. The collateral underlying repurchase agreements may be more susceptible to claims of the sellers creditors than would be the case with securities owned by
the Fund.
Reverse Repurchase Agreements
In a reverse repurchase agreement, a Fund sells a security and agrees to repurchase the same security at a mutually
agreed upon date and price reflecting the interest rate effective for the term of the agreement. For purposes of the 1940 Act, a reverse repurchase agreement is considered borrowing by a Fund and, therefore, a form of leverage. Leverage may cause
any gains or losses for a Fund to be magnified. The Funds will invest the proceeds of borrowings under reverse repurchase agreements. In addition, except for liquidity purposes, a Fund will enter into a reverse repurchase agreement only when the
expected return from the investment of the proceeds is greater than the expense of the transaction. A Fund will not invest the proceeds of a reverse repurchase agreement for a period which exceeds the duration of the reverse repurchase agreement. A
Fund would be required to pay interest on amounts obtained through reverse repurchase agreements, which are considered borrowings under federal securities laws. The repurchase price is generally equal to the original sales price plus interest.
Reverse repurchase agreements are usually for seven days or less and cannot be repaid prior to their expiration dates. Each Fund will earmark and reserve Fund assets, in cash or liquid securities, in an amount at least equal to its purchase
obligations under its reverse repurchase agreements. Reverse repurchase agreements involve the risk that the market value of the portfolio securities transferred may decline below the price at which a Fund is obliged to purchase the securities. All
forms of borrowing (including reverse repurchase agreements) are limited in the aggregate and may not exceed 33
1
/
3
% of a Funds total assets, except as permitted by law.
Securities Lending
To generate additional income, certain Funds may lend up to 33
1
/
3
% of such Funds total assets pursuant to agreements requiring that the loan be continuously secured by collateral
equal to at least 100% of the market value plus accrued interest on the securities lent. Certain Funds (generally some of the Funds with an investment strategy of investing primarily in U.S. equity securities) use Goldman Sachs Bank USA (formerly
known as The Goldman Sachs Trust Company), doing business as Goldman Sachs Agency Lending (Goldman Sachs), as their securities lending agent. Pursuant to an agreement among Goldman Sachs, JPMorgan Chase Bank and certain Funds (the
Third Party Securities Lending Agreement), approved by the Board of Trustees, Goldman Sachs compensates JPMorgan Chase Bank for certain operational services, which may include processing transactions, termination of loans and
recordkeeping, provided by JPMorgan Chase Bank. The other Funds that engage in securities lending use JPMorgan Chase Bank as their securities lending agent.
Part II - 42
Pursuant to a securities lending agreement approved by the Board of Trustees between Goldman
Sachs and the Trusts on behalf of certain J.P. Morgan U.S. equity funds (the Goldman Sachs Agreement), collateral for loans will consist only of cash. Pursuant to a securities lending agreement approved by the Board of Trustees between
JPMorgan Chase Bank and certain Funds (the JPMorgan Agreement), collateral for loans will consist of cash. The Funds receive payments from the borrowers equivalent to the dividends and interest that would have been earned on the
securities lent. For loans secured by cash, the Funds seek to earn interest on the investment of cash collateral in investments permitted by the applicable securities lending agreement. Under both the Goldman Sachs Agreement and the JPMorgan
Agreement, cash collateral may be invested in Capital Shares of the JPMorgan Prime Money Market Fund.
Under the JPMorgan
Agreement, JPMorgan Chase Bank performs a daily mark to market of the loaned security and requests additional cash collateral if the amount of cash received from the borrower is less than 102% of the value of the loaned security in the case of
securities denominated in U.S. dollars and 105% of the value of the loaned security in the case of securities denominated in
non-U.S.
dollars subject to certain
de
minimis
guidelines. Such de
minimis guidelines provide that for a loan of U.S. dollar denominated securities, the aggregate value of cash collateral for such loan may be less than 102% but in no event less than 101.51% and for a loan of
non-U.S.
dollar denominated securities, the aggregate value of cash collateral held for such loan may be less than 105% but in no event less than 104.51%. Under the Goldman Sachs Agreement, Goldman Sachs marks
to market the loaned securities on a daily basis. In the event the cash received from the borrower is less than 102% of the value of the loaned securities, Goldman Sachs requests additional cash from the borrower so as to maintain a
collateralization level of at least 102% of the value of the loaned securities plus accrued interest. Loans are subject to termination by a Fund or the borrower at any time, and are therefore not considered to be illiquid investments. A Fund does
not have the right to vote proxies for securities on loan. However, a Funds Adviser may terminate a loan if the vote is considered material with respect to an investment.
Securities lending involves counterparty risk, including the risk that the loaned securities may not be returned or returned in a timely manner and/or a loss of rights in the collateral if the borrower or
the lending agent defaults or fails financially. This risk is increased when a Funds loans are concentrated with a single or limited number of borrowers. The earnings on the collateral invested may not be sufficient to pay fees incurred in
connection with the loan. Also, the principal value of the collateral invested may decline and may not be sufficient to pay back the borrower for the amount of collateral posted. There are no limits on the number of borrowers a Fund may use and a
Fund may lend securities to only one or a small group of borrowers. In addition, under the Goldman Sachs Agreement, loans may be made to affiliates of Goldman Sachs as identified in the Goldman Sachs Agreement. Funds participating in securities
lending bear the risk of loss in connection with investments of the cash collateral received from the borrowers, which do not trigger additional collateral requirements from the borrower.
To the extent that the value or return of a Funds investments of the cash collateral declines below the amount owed to a borrower,
the Fund may incur losses that exceed the amount it earned on lending the security. In situations where the Adviser does not believe that it is prudent to sell the cash collateral investments in the market, a Fund may borrow money to repay the
borrower the amount of cash collateral owed to the borrower upon return of the loaned securities. This will result in financial leverage, which may cause the Fund to be more volatile because financial leverage tends to exaggerate the effect of any
increase or decrease in the value of the Funds portfolio securities.
Short Selling
In short selling transactions, a Fund sells a security it does not own in anticipation of a decline in the market value of the security.
To complete the transaction, a Fund must borrow the security to make delivery to the buyer. A Fund is obligated to replace the security borrowed by purchasing it subsequently at the market price at the time of replacement. The price at such time may
be more or less than the price at which the security was sold by a Fund, which may result in a loss or gain, respectively. Unlike taking a long position in a security by purchasing the security, where potential losses are limited to the purchase
price, short sales have no cap on maximum losses, and gains are limited to the price of the security at the time of the short sale.
Short sales of forward commitments and derivatives do not involve borrowing a security. These types of short sales may include futures, options, contracts for differences, forward contracts on financial
instruments and options such as contracts, credit linked instruments, and swap contracts.
A Fund may not always be able to
borrow a security it wants to sell short. A Fund also may be unable to close out an established short position at an acceptable price and may have to sell long positions at disadvantageous times
Part II - 43
to cover its short positions. The value of your investment in a Fund will fluctuate in response to movements in the market. Fund performance also will depend on the effectiveness of the
Advisers research and the management teams investment decisions.
Short sales also involve other costs. A Fund must
repay to the lender an amount equal to any dividends or interest that accrues while the loan is outstanding. To borrow the security, a Fund may be required to pay a premium. A Fund also will incur transaction costs in effecting short sales. The
amount of any ultimate gain for a Fund resulting from a short sale will be decreased and the amount of any ultimate loss will be increased by the amount of premiums, interest or expenses a Fund may be required to pay in connection with the short
sale. Until a Fund closes the short position, it will earmark and reserve Fund assets, in cash or liquid securities, to offset a portion of the leverage risk. Realized gains from short sales are typically treated as short-term gains/losses.
Short-Term Funding Agreements
Short-term funding agreements issued by insurance companies are sometimes referred to as Guaranteed Investment Contracts (GICs), while those issued by banks are referred to as Bank Investment
Contracts (BICs). Pursuant to such agreements, a Fund makes cash contributions to a deposit account at a bank or insurance company. The bank or insurance company then credits to the Fund on a monthly basis guaranteed interest at either a
fixed, variable or floating rate. These contracts are general obligations of the issuing bank or insurance company (although they may be the obligations of an insurance company separate account) and are paid from the general assets of the issuing
entity.
A Fund will purchase short-term funding agreements only from banks and insurance companies which, at the time of
purchase, are rated in one of the three highest rating categories and have assets of $1 billion or more. Generally, there is no active secondary market in short-term funding agreements. Therefore, short-term funding agreements may be considered by a
Fund to be illiquid investments. To the extent that a short-term funding agreement is determined to be illiquid, such agreements will be acquired by a Fund only if, at the time of purchase, no more than 15% of the Funds net assets (5% of the
total assets for the Money Market Funds) will be invested in short-term funding agreements and other illiquid securities.
Structured Investments
A structured investment is a security having a return tied to an underlying index or other
security or asset class. Structured investments generally are individually negotiated agreements and may be traded
over-the-counter.
Structured investments are organized
and operated to restructure the investment characteristics of the underlying security. This restructuring involves the deposit with or purchase by an entity, such as a corporation or trust, or specified instruments (such as commercial bank loans)
and the issuance by that entity or one or more classes of securities (structured securities) backed by, or representing interests in, the underlying instruments. The cash flow on the underlying instruments may be apportioned among the
newly issued structured securities to create securities with different investment characteristics, such as varying maturities, payment priorities and interest rate provisions, and the extent of such payments made with respect to structured
securities is dependent on the extent of the cash flow on the underlying instruments. Because structured securities typically involve no credit enhancement, their credit risk generally will be equivalent to that of the underlying instruments.
Investments in structured securities are generally of a class of structured securities that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured securities typically have higher yields and
present greater risks than unsubordinated structured securities. Structured instruments include structured notes. In addition to the risks applicable to investments in structured investments and debt securities in general, structured notes bear the
risk that the issuer may not be required to pay interest on the structured note if the index rate rises above or falls below a certain level. Structured securities are typically sold in private placement transactions, and there currently is no
active trading market for structured securities. Investments in government and government-related restructured debt instruments are subject to special risks, including the inability or unwillingness to repay principal and interest, requests to
reschedule or restructure outstanding debt and requests to extend additional loan amounts. Structured investments include a wide variety of instruments including, without limitation, Collateralized Debt Obligations, credit linked notes, and
participation notes and participatory notes.
Structured instruments that are registered under the federal securities laws may
be treated as liquid. In addition, many structured instruments may not be registered under the federal securities laws. In that event, a Funds ability to resell such a structured instrument may be more limited than its ability to resell other
Fund securities. The Funds will treat such instruments as illiquid and will limit their investments in such instruments to no more than 15% of
Part II - 44
each Funds net assets (5% of the total assets for the Money Market Funds), when combined with all other illiquid investments of each Fund.
Total Annual Fund Operating Expenses set forth in the fee table and Financial Highlights section of each Funds Prospectuses do not
include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment company provided by section 3(c)(1) or 3(c)(7) of the 1940 Act.
Credit Linked Notes.
Certain Funds may invest in structured instruments known as credit linked
securities or credit linked notes (CLNs). CLNs are typically issued by a limited purpose trust or other vehicle (the CLN trust) that, in turn, invests in a derivative or basket of derivatives instruments, such as credit
default swaps, interest rate swaps and/or other securities, in order to provide exposure to certain high yield, sovereign debt, emerging markets, or other fixed income markets. Generally, investments in CLNs 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 CLN. However, these payments are conditioned on the CLN trusts receipt of payments from, and the CLN trusts potential obligations, to
the counterparties to the derivative instruments and other securities in which the CLN trust invests. For example, the CLN trust may sell one or more credit default swaps, under which the CLN 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 were to occur, the stream of payments may stop and the CLN trust would be obligated to pay
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 a Fund would receive as an investor in the CLN trust.
Certain Funds may enter into CLNs structured as
First-to-Default
CLNs. In a
First-to-Default
CLN, the CLN trust enters into a
credit default swap on a portfolio of a specified number of individual securities pursuant to which the CLN trust sells protection to a counterparty. The CLN trust uses the proceeds of issuing investments in the CLN trust to purchase securities,
which are selected by the counterparty and the total return of which is paid to the counterparty. Upon the occurrence of a default or credit event involving any one of the individual securities, the credit default swaps terminate and the Funds
investment in the CLN trust is redeemed for an amount equal to par minus the amount paid to the counterparty under the credit default swap.
Certain Funds may also enter in CLNs to gain access to sovereign debt and securities in emerging market particularly in markets where the Fund is not able to purchase securities directly due to domicile
restrictions or tax restrictions or tariffs. In such an instance, the issuer of the CLN may purchase the reference security directly and/or gain exposure through a credit default swap or other derivative.
A Funds investments in CLNs is subject to the risks associated with the underlying reference obligations and derivative instruments,
including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk.
Participation Notes and Participatory Notes.
Certain Funds may invest in instruments that have similar economic characteristics to equity securities, such as
participation notes (also known as participatory notes (P-notes)) or other structured instruments that may be developed from time to time (structured instruments). Structured instruments are notes that are issued by banks,
broker-dealers or their affiliates and are designed to offer a return linked to a particular underlying equity or market.
If
the structured instrument were held to maturity, the issuer would pay to the purchaser the underlying instruments value at maturity with any necessary adjustments. The holder of a structured instrument that is linked to a particular underlying
security or instrument may be entitled to receive dividends paid in connection with that underlying security or instrument, but typically does not receive voting rights as it would if it directly owned the underlying security or instrument.
Structured instruments have transaction costs. In addition, there can be no assurance that there will be a trading market for a structured instrument or that the trading price of a structured instrument will equal the underlying value of the
security, instrument or market that it seeks to replicate. Unlike a direct investment in equity securities, structured instruments typically involve a term or expiration date, potentially increasing the Funds turnover rate, transaction costs
and tax liability.
Due to transfer restrictions, the secondary markets on which a structured instrument is traded may be less
liquid than the market for other securities, or may be completely illiquid, which may expose the Fund to risks of mispricing or improper valuation. Structured instruments typically constitute general unsecured contractual obligations of the banks,
broker-dealers or their relevant affiliates that issue them, which subjects the Fund to
Part II - 45
counterparty risk (and this risk may be amplified if the Fund purchases structured instruments from only a small number of issuers). Structured instruments also have the same risks associated
with a direct investment in the underlying securities, instruments or markets that they seek to replicate.
Swaps and Related Swap Products
Swap transactions may include, but are not limited to, interest rate swaps, currency swaps, cross-currency interest rate swaps, forward rate agreements, contracts for differences, total return swaps,
index swaps, basket swaps, specific security swaps, fixed income sectors swaps, commodity swaps, asset-backed swaps (ABX), commercial mortgage-backed securities (CMBS) and indexes of CMBS (CMBX), credit default swaps, interest rate caps, price lock
swaps, floors and collars and swaptions (collectively defined as swap transactions).
A Fund may enter into swap
transactions for any legal purpose consistent with its investment objective and policies, such as for the purpose of attempting to obtain or preserve a particular return or spread at a lower cost than obtaining that return or spread through
purchases and/or sales of instruments in cash markets, to protect against currency fluctuations, to protect against any increase in the price of securities a Fund anticipates purchasing at a later date, or to gain exposure to certain markets in the
most economical way possible.
Swap agreements are
two-party
contracts entered into
primarily by institutional counterparties for periods ranging from a few weeks to several years. In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of return) that would be earned or realized on
specified notional investments or instruments. The gross returns to be exchanged or swapped between the parties are calculated by reference to a notional amount, i.e., the return on or increase in value of a particular dollar
amount invested at a particular interest rate, in a particular foreign currency or commodity, or in a basket of securities representing a particular index. The purchaser of an interest rate cap or floor, upon payment of a fee, has the
right to receive payments (and the seller of the cap or floor is obligated to make payments) to the extent a specified interest rate exceeds (in the case of a cap) or is less than (in the case of a floor) a specified level over a specified period of
time or at specified dates. The purchaser of an interest rate collar, upon payment of a fee, has the right to receive payments (and the seller of the collar is obligated to make payments) to the extent that a specified interest rate falls outside an
agreed upon range over a specified period of time or at specified dates. The purchaser of an option on an interest rate swap, also known as a swaption, upon payment of a fee (either at the time of purchase or in the form of higher
payments or lower receipts within an interest rate swap transaction) has the right, but not the obligation, to initiate a new swap transaction of a
pre-specified
notional amount with
pre-specified
terms with the seller of the swaption as the counterparty.
The notional
amount of a swap transaction is the agreed upon basis for calculating the payments that the parties have agreed to exchange. For example, one swap counterparty may agree to pay a floating rate of interest (e.g., 3 month LIBOR) calculated based
on a $10 million notional amount on a quarterly basis in exchange for receipt of payments calculated based on the same notional amount and a fixed rate of interest on a semi-annual basis. In the event a Fund is obligated to make payments more
frequently than it receives payments from the other party, it will incur incremental credit exposure to that swap counterparty. This risk may be mitigated somewhat by the use of swap agreements which call for a net payment to be made by the party
with the larger payment obligation when the obligations of the parties fall due on the same date. Under most swap agreements entered into by a Fund, payments by the parties will be exchanged on a net basis, and a Fund will receive or
pay, as the case may be, only the net amount of the two payments.
The amount of a Funds potential gain or loss on any
swap transaction is not subject to any fixed limit. Nor is there any fixed limit on a Funds potential loss if it sells a cap or collar. If a Fund buys a cap, floor or collar, however, the Funds potential loss is limited to the amount of
the fee that it has paid. When measured against the initial amount of cash required to initiate the transaction, which is typically zero in the case of most conventional swap transactions, swaps, caps, floors and collars tend to be more volatile
than many other types of instruments.
The use of swap transactions, caps, floors and collars involves investment techniques
and risks that are different from those associated with portfolio security transactions. If a Funds Adviser is incorrect in its forecasts of market values, interest rates, and other applicable factors, the investment performance of the Fund
will be less favorable than if these techniques had not been used. These instruments are typically not traded on exchanges. Accordingly, there is a risk that the other party to certain of these instruments will not perform its obligations to a Fund
or that a Fund may be unable to enter into offsetting positions to terminate its exposure or liquidate its position under certain of these instruments when it wishes to do so. Such occurrences could result in losses to a Fund. A Funds Adviser
will consider such risks and will enter into swap and other derivatives transactions only when it believes that the risks are not unreasonable.
Part II - 46
A Fund will earmark and reserve Fund assets, in cash or liquid securities, in an amount
sufficient at all times to cover its current obligations under its swap transactions, caps, floors and collars. If a Fund enters into a swap agreement on a net basis, it will earmark and reserve assets with a daily value at least equal to the
excess, if any, of a Funds accrued obligations under the swap agreement over the accrued amount a Fund is entitled to receive under the agreement. If a Fund enters into a swap agreement on other than a net basis, or sells a cap, floor or
collar, it will earmark and reserve assets with a daily value at least equal to the full amount of a Funds accrued obligations under the agreement. A Fund will not enter into any swap transaction, cap, floor, or collar, unless the counterparty
to the transaction is deemed creditworthy by the Funds Adviser. If a counterparty defaults, a Fund may have contractual remedies pursuant to the agreements related to the transaction. The swap markets in which many types of swap transactions
are traded have grown substantially in recent years, with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the markets for certain types of swaps
(e.g., interest rate swaps) have become relatively liquid. The markets for some types of caps, floors and collars are less liquid.
The liquidity of swap transactions, caps, floors and collars will be as set forth in guidelines established by a Funds Adviser and approved by the Trustees which are based on various factors,
including: (1) the availability of dealer quotations and the estimated transaction volume for the instrument, (2) the number of dealers and end users for the instrument in the marketplace, (3) the level of market making by dealers in
the type of instrument, (4) the nature of the instrument (including any right of a party to terminate it on demand) and (5) the nature of the marketplace for trades (including the ability to assign or offset a Funds rights and
obligations relating to the instrument). Such determination will govern whether the instrument will be deemed within the applicable liquidity restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value of the instrument are recognized as unrealized gains or losses by
marking to market to reflect the market value of the instrument. When the instrument is terminated, a Fund will record a realized gain or loss equal to the difference, if any, between the proceeds from (or cost of) the closing transaction and a
Funds basis in the contract.
The federal income tax treatment with respect to swap transactions, caps, floors, and
collars may impose limitations on the extent to which a Fund may engage in such transactions.
Credit Default Swaps.
As described above, swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to more than one year. In the case of a credit default swap (CDS), the contract gives one party (the buyer) the right to recoup the economic value of a decline in
the value of debt securities of the reference issuer if the credit event (a downgrade or default) occurs. This value is obtained by delivering a debt security of the reference issuer to the party in return for a previously agreed payment from the
other party (frequently, the par value of the debt security). CDS include credit default swaps, which are contracts on individual securities, and CDX, which are contracts on baskets or indices of securities.
Credit default swaps may require initial premium (discount) payments as well as periodic payments (receipts) related to the interest leg
of the swap or to the default of a reference obligation. A Fund will earmark and reserve assets, in cash or liquid securities, to cover any accrued payment obligations when it is the buyer of a CDS. In cases where a Fund is a seller of a CDS
contract, the Fund will earmark and reserve assets, in cash or liquid securities, to cover its obligation (for credit default swaps on individual securities, such amount will be the notional amount of the CDS).
If a Fund is a seller of protection under a CDS contract, the Fund 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 or other credit event by the reference issuer, such as a U.S. or foreign corporate issuer, with respect to such debt obligations. 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, a Fund would keep the stream of payments and would have no payment obligations. As the seller, a Fund
would be subject to investment exposure on the notional amount of the swap.
If a Fund is a buyer of protection under a CDS
contract, the Fund would have the right to deliver a referenced debt obligation and receive the par (or other agreed-upon) value of such debt obligation from the counterparty in the event of a default or other credit event (such as a downgrade in
credit rating) by the reference issuer, such as a U.S. or foreign corporation, with respect to its debt obligations. In return, the Fund would pay 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, the counterparty would keep the stream of payments and would have no further obligations to the Fund.
The use of CDSs, like all swap agreements, is subject to certain risks. If a counterpartys creditworthiness declines, the value of the swap would likely decline. Moreover, there is no guarantee that
a Fund could eliminate its
Part II - 47
exposure under an outstanding swap agreement by entering into an offsetting swap agreement with the same or another party. In addition to general market risks, CDSs involve liquidity, credit and
counterparty risks. The recent increase in corporate defaults further raises these liquidity and credit risks, increasing the possibility that sellers will not have sufficient funds to make payments. As unregulated instruments, CDSs are difficult to
value and are therefore susceptible to liquidity and credit risks. Counterparty risks also stem from the lack of regulation of CDSs. Collateral posting requirements are individually negotiated between counterparties and there is no regulatory
requirement concerning the amount of collateral that a counterparty must post to secure its obligations under a CDS. Because they are unregulated, there is no requirement that parties to a contract be informed in advance when a CDS is sold. As a
result, investors may have difficulty identifying the party responsible for payment of their claims.
If a counterpartys
credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could increase the risk that the Fund may not receive adequate collateral. There is no readily available market for trading out of CDS
contracts. In order to eliminate a position it has taken in a CDS, the Fund must terminate the existing CDS contract or enter into an offsetting trade. The Fund may only exit its obligations under a CDS contract by terminating the contract and
paying applicable breakage fees, which could result in additional losses to the Fund. Furthermore, the cost of entering into an offsetting CDS position could cause the Fund to incur losses.
Synthetic Variable Rate Instruments
Synthetic variable rate instruments generally involve the deposit of a long-term tax exempt bond in a custody or trust arrangement and the
creation of a mechanism to adjust the long-term interest rate on the bond to a variable short-term rate and a right (subject to certain conditions) on the part of the purchaser to tender it periodically to a third party at par. A Funds Adviser
reviews the structure of synthetic variable rate instruments to identify credit and liquidity risks (including the conditions under which the right to tender the instrument would no longer be available) and will monitor those risks. In the event
that the right to tender the instrument is no longer available, the risk to the Fund will be that of holding the long-term bond. In the case of some types of instruments credit enhancement is not provided, and if certain events occur, which may
include (a) default in the payment of principal or interest on the underlying bond, (b) downgrading of the bond below investment grade or (c) a loss of the bonds tax exempt status, then the put will terminate and the risk to the
Fund will be that of holding a long-term bond.
Total Annual Fund Operating Expenses set forth in the fee table and Financial
Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment company provided by
section 3(c)(1) or 3(c)(7) of the 1940 Act.
Treasury Receipts
A Fund may purchase interests in separately traded interest and principal component parts of U.S. Treasury obligations that are issued by
banks or brokerage firms and are created by depositing U.S. Treasury notes and U.S. Treasury bonds into a special account at a custodian bank. Receipts include Treasury Receipts (TRs), Treasury Investment Growth Receipts
(TIGRs), and Certificates of Accrual on Treasury Securities (CATS). Receipts in which an entity other than the government separates the interest and principal components are not considered government securities unless such
securities are issued through the Treasury Separate Trading of Registered Interest and Principal of Securities (STRIPS) program.
Trust Preferred Securities
Certain Funds may purchase trust preferred securities, also known as trust preferreds, which are preferred stocks issued by a special purpose trust subsidiary backed by subordinated debt of
the corporate parent. An issuer creates trust preferred securities by creating a trust and issuing debt to the trust. The trust in turn issues trust preferred securities. Trust preferred securities are hybrid securities with characteristics of both
subordinated debt and preferred stock. Such characteristics include long maturities (typically 30 years or more), early redemption by the issuer, periodic fixed or variable interest payments, and maturities at face value. In addition, trust
preferred securities issued by a bank holding company may allow deferral of interest payments for up to 5 years. Holders of trust preferred securities have limited voting rights to control the activities of the trust and no voting rights with
respect to the parent company.
Part II - 48
U.S. Government Obligations
U.S. government obligations may include direct obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all of which
are backed as to principal and interest payments by the full faith and credit of the U.S., and separately traded principal and interest component parts of such obligations that are transferable through the Federal book-entry system known as STRIPS
and Coupon Under Book Entry Safekeeping (CUBES). The Funds may also invest in TIPS. U.S. government obligations are subject to market risk, interest rate risk and credit risk.
The principal and interest components of U.S. Treasury bonds with remaining maturities of longer than ten years are eligible to be traded
independently under the STRIPS program. Under the STRIPS program, the principal and interest components are separately issued by the U.S. Treasury at the request of depository financial institutions, which then trade the component parts separately.
The interest component of STRIPS may be more volatile than that of U.S. Treasury bills with comparable maturities.
Other
obligations include those issued or guaranteed by U.S. government agencies or instrumentalities. These obligations may or may not be backed by the full faith and credit of the U.S. Securities which are backed by the full faith and credit
of the U.S. include obligations of the Government National Mortgage Association, the Farmers Home Administration, and the Export-Import Bank. In the case of securities not backed by the full faith and credit of the U.S., the Funds must look
principally to the federal agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the U.S. itself in the event the agency or instrumentality does not meet its commitments. Securities in
which the Funds may invest that are not backed by the full faith and credit of the U.S. include, but are not limited to: (i) obligations of the Tennessee Valley Authority, the Federal Home Loan Banks and the U.S. Postal Service, each of which
has the right to borrow from the U.S. Treasury to meet its obligations; (ii) securities issued by Freddie Mac and Fannie Mae, which are supported only by the credit of such securities, but for which the Secretary of the Treasury has
discretionary authority to purchase limited amounts of the agencys obligations; and (iii) obligations of the Federal Farm Credit System and the Student Loan Marketing Association, each of whose obligations may be satisfied only by the
individual credits of the issuing agency.
The total public debt of the United States and other countries around the globe as a
percent of gross domestic product has grown rapidly since the beginning of the 2008 financial downturn. Although high debt levels do not necessarily indicate or cause economic problems, they may create certain systemic risks if sound debt management
practices are not implemented. A high national debt level may increase market pressures to meet government funding needs, which may drive debt cost higher and cause a country to sell additional debt, thereby increasing refinancing risk. A high
national debt also raises concerns that a government will not be able to make principal or interest payments when they are due. Unsustainable debt levels can cause devaluations of currency, prevent a government from implementing effective
counter-cyclical fiscal policy in economic downturns, and contribute to market volatility.
In the past, U.S. sovereign credit
has experienced downgrades and there can be no guarantee that it will not experience further downgrades in the future by rating agencies. The market prices and yields of securities supported by the full faith and credit of the U.S. Government may be
adversely affected by a rating agencys decision to downgrade the sovereign credit rating of the United States.
When-Issued Securities, Delayed Delivery Securities and Forward Commitments
Securities may be purchased on a
when-issued or delayed delivery basis. For example, delivery of and payment for these securities can take place a month or more after the date of the purchase commitment. The purchase price and the interest rate payable, if any, on the securities
are fixed on the purchase commitment date or at the time the settlement date is fixed. The value of such securities is subject to market fluctuation, and for money market instruments and other fixed income securities, no interest accrues to a Fund
until settlement takes place. At the time a Fund makes the commitment to purchase securities on a when-issued or delayed delivery basis, it will record the transaction, reflect the value each day of such securities in determining its NAV and, if
applicable, calculate the maturity for the purposes of average maturity from that date. At the time of settlement, a when-issued security may be valued at less than the purchase price. To facilitate such acquisitions, each Fund will earmark and
reserve Fund assets, in cash or liquid securities, in an amount at least equal to such commitments. On delivery dates for such transactions, each Fund will meet its obligations from maturities or sales of the securities earmarked and reserved for
such purpose and/or from cash flow. If a Fund chooses to dispose of the right to acquire a when-issued security prior to its acquisition, it could, as with the disposition of any other portfolio obligation, incur a gain or loss due to market
fluctuation. Also, a Fund may be disadvantaged if the other party to the transaction defaults.
Part II - 49
Forward Commitments
. Securities may be purchased for delivery at a future date, which
may increase their overall investment exposure and involves a risk of loss if the value of the securities declines prior to the settlement date. In order to invest a Funds assets immediately, while awaiting delivery of securities purchased on
a forward commitment basis, short-term obligations that offer
same-day
settlement and earnings will normally be purchased. When a Fund makes a commitment to purchase a security on a forward commitment basis,
cash or liquid securities equal to the amount of such Funds commitments will be reserved for payment of the commitment. For the purpose of determining the adequacy of the securities reserved for payment of commitments, the reserved securities
will be valued at market value. If the market value of such securities declines, additional cash, cash equivalents or highly liquid securities will be reserved for payment of the commitment so that the value of the Funds assets reserved for
payment of the commitments will equal the amount of such commitments purchased by the respective Fund.
Purchases of securities
on a forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in the respective Funds portfolio are subject to changes in value based upon the
publics perception of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place
may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the respective Fund will meet its obligations from then-available cash flow, sale of securities reserved for
payment of the commitment, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than such Funds payment obligations).
The sale of securities to meet such obligations may result in the realization of capital gains or losses. Purchasing securities on a forward commitment basis can also involve the risk of default by the other party on its obligation, delaying or
preventing the Fund from recovering the collateral or completing the transaction.
To the extent a Fund engages in forward
commitment transactions, it will do so for the purpose of acquiring securities consistent with its investment objective and policies and not for the purpose of investment leverage.
ADDITIONAL INFORMATION REGARDING FUND INVESTMENT PRACTICES
Investments in the China Region
Investing in China, Hong Kong and Taiwan (collectively, the China Region) involves a high degree of risk and special considerations not typically associated with investing in other more
established economies or securities markets. Such risks may include: (a) the risk of nationalization or expropriation of assets or confiscatory taxation; (b) greater social, economic and political uncertainty (including the risk of war);
(c) dependency on exports and the corresponding importance of international trade; (d) the increasing competition from Asias other
low-cost
emerging economies; (e) greater price volatility
and significantly smaller market capitalization of securities markets, particularly in China; (f) substantially less liquidity, particularly of certain share classes of Chinese securities; (g) currency exchange rate fluctuations and the
lack of available currency hedging instruments; (h) higher rates of inflation; (i) controls on foreign investment and limitations on repatriation of invested capital and on a Fund's ability to exchange local currencies for U.S. dollars;
(j) greater governmental involvement in and control over the economy; (k) the risk that the Chinese government may decide not to continue to support the economic reform programs implemented since 1978 and could return to the prior,
completely centrally planned, economy; (l) the fact that China region companies, particularly those located in China, may be smaller, less seasoned and newly-organized companies; (m) the difference in, or lack of, auditing and financial
reporting standards which may result in unavailability of material information about issuers, particularly in China; (n) the fact that statistical information regarding the economy of China may be inaccurate or not comparable to statistical
information regarding the U.S. or other economies; (o) the less extensive, and still developing, regulation of the securities markets, business entities and commercial transactions; (p) the fact that the settlement period of securities
transactions in foreign markets may be longer; (q) the willingness and ability of the Chinese government to support the Chinese and Hong Kong economies and markets is uncertain; (r) the risk that it may be more difficult, or impossible, to
obtain and/or enforce a judgment than in other countries; (s) the rapidity and erratic nature of growth, particularly in China, resulting in inefficiencies and dislocations; and (t) the risk that, because of the degree of interconnectivity
between the economies and financial markets of China, Hong Kong and Taiwan, any sizable reduction in the demand for goods from China, or an economic downturn in China, could negatively affect the economies and financial markets of Hong Kong and
Taiwan, as well.
Investment in the China Region is subject to certain political risks. Following the establishment of the
Peoples Republic of China by the Communist Party in 1949, the Chinese government renounced various debt obligations incurred by Chinas predecessor governments, which obligations remain in default, and expropriated assets without
Part II - 50
compensation. There can be no assurance that the Chinese government will not take similar action in the future. An investment in a Fund involves risk of a total loss. The political reunification
of China and Taiwan is a highly problematic issue and is unlikely to be settled in the near future. This situation poses a threat to Taiwans economy and could negatively affect its stock market. China has committed by treaty to preserve Hong
Kongs autonomy and its economic, political and social freedoms for fifty years from the July 1, 1997 transfer of sovereignty from Great Britain to China. However, if China would exert its authority so as to alter the economic, political
or legal structures or the existing social policy of Hong Kong, investor and business confidence in Hong Kong could be negatively affected, which in turn could negatively affect markets and business performance.
As with all transition economies, Chinas ability to develop and sustain a credible legal, regulatory, monetary, and socioeconomic
system could influence the course of outside investment. Hong Kong is closely tied to China, economically and through Chinas 1997 acquisition of the country as a Special Autonomous Region (SAR). Hong Kongs success depends, in large part,
on its ability to retain the legal, financial, and monetary systems that allow economic freedom and market expansion.
In
addition to the risks inherent in investing in the emerging markets, the risks of investing in China, Hong Kong, and Taiwan merit special consideration.
Peoples Republic of China.
The government of the Peoples Republic of China is dominated by the
one-party
rule of the Chinese Communist Party.
Chinas economy has transitioned from a rigidly central-planned
state-run
economy
to one that has been only partially reformed by more market-oriented policies. Although the Chinese government has implemented economic reform measures, reduced state ownership of companies and established better corporate governance practices, a
substantial portion of productive assets in China are still owned by the Chinese government. The government continues to exercise significant control over regulating industrial development and, ultimately, control over Chinas economic growth
through the allocation of resources, controlling payment of foreign currency denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.
Growth has also put a strain on Chinas economy. The government has attempted to slow down the pace of growth through monetary
tightening and administrative measures; however that policy started reversing in September 2008 in part due to the current global economic crisis, which has led to lower levels of economic growth and lower exports and foreign investments in the
country. The Chinese government has taken unprecedented steps to shore up economic growth, however, the results of these measures are unpredictable. Over the long term the countrys major challenges will be dealing with its aging
infrastructure, worsening environmental conditions and rapidly widening urban and rural income gap.
As with all transition
economies, Chinas ability to develop and sustain a credible legal, regulatory, monetary, and socioeconomic system could influence the course of outside investment. The Chinese legal system, in particular, constitutes a significant risk factor
for investors. The Chinese legal system is based on statutes. Over the past 25 years, Chinese legislative bodies have promulgated laws and regulations dealing with various economic matters such as foreign investment, corporate organization and
governance, commerce, taxation, and trade. However, these laws are relatively new and published court decisions based on these laws are limited and
non-binding.
The interpretation and enforcement of these laws
and regulations are uncertain.
Hong Kong.
In 1997, Great Britain handed over control of Hong Kong to the Chinese
mainland government. Since that time, Hong Kong has been governed by a semi-constitution known as the Basic Law, which guarantees a high degree of autonomy in certain matters until 2047, while defense and foreign affairs are the responsibility of
the central government in Beijing. The chief executive of Hong Kong is appointed by the Chinese government. Hong Kong is able to participate in international organizations and agreements and it continues to function as an international financial
center, with no exchange controls, free convertibility of the Hong Kong dollar and free inward and outward movement of capital. The Basic Law guarantees existing freedoms, including free speech and assembly, press, religion, and the right to strike
and travel. Business ownership, private property, the right of inheritance and foreign investment are also protected by law. China has committed by treaty to preserve Hong Kongs autonomy until 2047; however, if China were to exert its
authority so as to alter the economic, political, or legal structures or the existing social policy of Hong Kong, investor and business confidence in Hong Kong could be negatively affected, which in turn could negatively affect markets and business
performance. In addition, Hong Kongs economy has entered a recession as a result of the current global economic crisis. Near term improvement in its economy appears unlikely.
Taiwan.
For decades, a state of hostility has existed between Taiwan and the Peoples Republic of China. Beijing has long
deemed Taiwan a part of the one China and has made a nationalist cause of recovering it. In the
Part II - 51
past, China has staged frequent military provocations off the coast of Taiwan and made threats of full-scale military action. Foreign trade has been the engine of rapid growth in Taiwan and has
transformed the island into one of Asias great exporting nations. However, investing in Taiwan involves the possibility of the imposition of exchange controls, such as restrictions on the repatriation of fund investments or on the conversion
of local currency into foreign currencies. As an export-oriented economy, Taiwan depends on an open world trade regime and remains vulnerable to downturns in the world economy. Taiwanese companies continue to compete mostly on price, producing
generic products or branded merchandise on behalf of multinational companies. Accordingly, these businesses can be particularly vulnerable to currency volatility and increasing competition from neighboring lower-cost countries. Moreover, many
Taiwanese companies are heavily invested in mainland China and other countries throughout Southeast Asia, making them susceptible to political events and economic crises in these parts of the region. Although Taiwan has not yet suffered any major
economic setbacks due to the current global economic crisis, it is possible its economy could still be impacted.
The China
Region Fund may hold a significant weighting in securities listed on either the Shanghai and/or Shenzhen stock exchanges. Securities listed on these exchanges are divided into two classes, A shares, which are mostly limited to domestic investors,
and B shares, which are allocated for both international and domestic investors. The China Region Funds exposure to securities listed on either the Shanghai or Shenzhen exchanges will initially be through B shares. The government of China has
announced plans to exchange B shares for A shares and to merge the two markets. Such an event may produce greater liquidity and stability for the combined markets. However, it is uncertain whether or the extent to which these plans will be
implemented. In addition to B shares, the China Region Fund may also invest in Hong Kong listed H shares, Hong Kong listed Red chips (which are companies owned by mainland China enterprises, but are listed in Hong Kong), and companies that meet one
of the following categories: the company is organized under the laws of, or has a principal office in China (including Hong Kong and Macau) or Taiwan; the principal securities market for the issuer is China or Taiwan; the issuer derives at least 50%
of its total revenues or profits from goods that are produced or sold, investments made, or services performed in China or Taiwan; or at least 50% of the issuers assets are located in China or Taiwan.
Investments in India
Securities of many issuers in the Indian market may be less liquid and more volatile than securities of comparable domestic issuers, but may offer the potential for higher returns over the long term.
Indian securities will generally be denominated in foreign currency, mainly the rupee. Accordingly, the value of the Fund will fluctuate depending on the rate of exchange between the U.S. dollar and such foreign currency. India has less developed
clearance and settlement procedures, and there have been times when settlements have been unable to keep pace with the volume of securities and have been significantly delayed. The Indian stock exchanges have in the past been subject to closure,
broker defaults and broker strikes, and there can be no certainty that this will not recur. In addition, significant delays are common in registering transfers of securities and the Fund may be unable to sell securities until the registration
process is completed and may experience delays in receipt of dividends and other entitlements.
The value of investments in
Indian securities may also be affected by political and economic developments, social, religious or regional tensions, changes in government regulation and government intervention, high rates of inflation or interest rates and withholding tax
affecting India. The risk of loss may also be increased because there may be less information available about Indian issuers since they are not subject to the extensive accounting, auditing and financial reporting standards and practices which are
applicable in North America. There is also a lower level of regulation and monitoring of the Indian securities market and its participants than in other more developed markets.
Foreign investment in the securities of issuers in India is usually restricted or controlled to some degree. In addition, the availability of financial instruments with exposure to Indian financial
markets may be substantially limited by the restrictions on Foreign Institutional Investors (FIIs). Only registered FIIs and
non-Indian
mutual funds that comply with certain statutory conditions
may make direct portfolio investments in exchange-traded Indian securities. JPMIM is a registered FII. FIIs are required to observe certain investment restrictions which may limit the Funds ability to invest in issuers or to fully pursue its
investment objective. Income, gains and initial capital with respect to such investments are freely repatriable, subject to payment of applicable Indian taxes.
Indias guidelines under which foreign investors may invest in Indian securities are new and evolving. There can be no assurance that these investment control regimes will not change in a way that
makes it more difficult or impossible for a Fund to implement investment objective or repatriate its income, gains and initial capital from these countries. Similar risks and considerations will be applicable to the extent that a Fund invests in
other countries.
Part II - 52
Recently, certain policies have served to restrict foreign investment, and such policies may have the effect of reducing demand for such investments.
India may require withholding on dividends paid on portfolio securities and on realized capital gains. In the past, these taxes have
sometimes been substantial. There can be no assurance that restrictions on repatriation of a Funds income, gains or initial capital from India will not occur.
A high proportion of the shares of many issuers in India may be held by a limited number of persons and financial institutions, which may limit the number of shares available for investment. In addition,
further issuances, or the perception that such issuances may occur, of securities by Indian issuers in which a Fund has invested could dilute the earnings per share of a Funds investment and could adversely affect the market price of such
securities. Sales of securities by such issuers major shareholders, or the perception that such sales may occur, may also significantly and adversely affect the market price of such securities and, in turn, a Funds investment. The prices
at which investments may be acquired may be affected by trading by persons with material
non-public
information and by securities transactions by brokers in anticipation of transactions by a Fund in particular
securities. Similarly, volume and liquidity in the bond markets in India are less than in the United States and, at times, price volatility can be greater than in the United States. The limited liquidity of securities markets in India may also
affect a Funds ability to acquire or dispose of securities at the price and time it wishes to do so. In addition, Indias securities markets are susceptible to being influenced by large investors trading significant blocks of securities.
Indias stock market is undergoing a period of growth and change which may result in trading volatility and difficulties
in the settlement and recording of transactions, and in interpreting and applying the relevant law and regulations. The securities industry in India is comparatively underdeveloped. Stockbrokers and other intermediaries in India may not perform as
well as their counterparts in the United States and other more developed securities markets.
Political and economic structures
in India are undergoing significant evolution and rapid development, and may lack the social, political and economic stability characteristic of the United States. The risks described above, including the risks of nationalization or expropriation of
assets, may be heightened. In addition, unanticipated political or social developments may affect the values of investments in India and the availability of additional investments. The laws in India relating to limited liability of corporate
shareholders, fiduciary duties of officers and directors, and the bankruptcy of state enterprises are generally less well developed than or different from such laws in the United States. It may be more difficult to obtain or enforce a judgment in
the courts in India than it is in the United States. Monsoons and natural disasters also can affect the value of investments.
Religious and border disputes persist in India. Moreover, India has from time to time experienced civil unrest and hostilities with
neighboring countries such as Pakistan. The Indian government has confronted separatist movements in several Indian states. The longstanding dispute with Pakistan over the bordering Indian state of Jammu and Kashmir, a majority of whose population
is Muslim, remains unresolved. If the Indian government is unable to control the violence and disruption associated with these tensions, the results could destabilize the economy and consequently, adversely affect the Funds investments.
A Fund may use P-notes. Indian-based brokerages may buy Indian-based securities and then issue P-notes to foreign investors.
Any dividends or capital gains collected from the underlying securities may be remitted to the foreign investors. However, unlike ADRs, notes are subject to credit risk based on the uncertainty of the counterpartys (i.e., the Indian-based
brokerages) ability to meet its obligations.
Investments in Latin America
As an emerging market, Latin America has long suffered from political, economic, and social instability. For investors, this has meant
additional risk caused by periods of regional conflict, political corruption, totalitarianism, protectionist measures, nationalization, hyperinflation, debt crises, sudden and large currency devaluation, and intervention by the military in civilian
and economic spheres. However, much has changed in the past decade. Democracy is beginning to become well established in some countries. A move to a more mature and accountable political environment is well under way. Domestic economies have been
deregulated, privatization of state-owned companies is almost completed and foreign trade restrictions have been relaxed. Nonetheless, to the extent that events such as those listed above continue in the future, they could reverse favorable trends
toward market and economic reform, privatization, and removal of trade barriers, and result in significant disruption in securities markets in the region. Investors in the region continue to face a number of potential risks. Governments of many
Latin American countries have exercised and continue to exercise substantial influence over many aspects of the private sector. Governmental actions in the future could have a significant effect on economic conditions in Latin
Part II - 53
American countries, which could affect the companies in which the Latin America Fund invests and, therefore, the value of Fund shares.
Certain Latin American countries may experience sudden and large adjustments in their currency which, in turn, can have a disruptive and
negative effect on foreign investors. For example, in late 1994 the Mexican peso lost more than
one-third
of its value relative to the U.S. dollar. In 1999, the Brazilian real lost 30% of its value against the
U.S. dollar. Certain Latin American countries may impose restrictions on the free conversion of their currency into foreign currencies, including the U.S. dollar. There is no significant foreign exchange market for many currencies and it would, as a
result, be difficult for certain Funds to engage in foreign currency transactions designed to protect the value of the Funds interests in securities denominated in such currencies.
Almost all of the regions economies have become highly dependent upon foreign credit and loans from external sources to fuel their
state-sponsored economic plans. Government profligacy and
ill-conceived
plans for modernization have exhausted these resources with little benefit accruing to the economy and most countries have been forced to
restructure their loans or risk default on their debt obligations. In addition, interest on the debt is subject to market conditions and may reach levels that would impair economic activity and create a difficult and costly environment for
borrowers. Accordingly, these governments may be forced to reschedule or freeze their debt repayment, which could negatively affect the stock market. Latin American economies that depend on foreign credit and loans could fall into recession because
of tighter international credit supplies due to the current global economic crisis.
Substantial limitations may exist in
certain countries with respect to a Funds ability to repatriate investment income, capital or the proceeds of sales of securities. A Fund could be adversely affected by delays in, or a refusal to grant, any required governmental approval for
repatriation of capital, as well as by the application to the Fund of any restrictions on investments.
Certain Latin American
countries have entered into regional trade agreements that are designed to, among other things, reduce barriers between countries, increase competition among companies and reduce government subsidies in certain industries. No assurance can be given
that these changes will be successful in the long term, or that these changes will result in the economic stability intended. There is a possibility that these trade arrangements will not be fully implemented, or will be partially or completely
unwound. It is also possible that a significant participant could choose to abandon a trade agreement, which could diminish its credibility and influence. Any of these occurrences could have adverse effects on the markets of both participating and
non-participating
countries, including sharp appreciation or depreciation of participants national currencies and a significant increase in exchange rate volatility, a resurgence in economic protectionism, an
undermining of confidence in the Latin American markets, an undermining of Latin American economic stability, the collapse or slowdown of the drive towards Latin American economic unity, and/or reversion of the attempts to lower government debt and
inflation rates that were introduced in anticipation of such trade agreements. Such developments could have an adverse impact on a Funds investments in Latin America generally or in specific countries participating in such trade agreements.
Terrorism and related
geo-political
risks have led, and may in the future lead, to
increased short-term market volatility and may have adverse long-term effects on world economies and markets generally.
Investments in Russia
Investing in Russian securities is highly speculative and involves significant risks and special
considerations not typically associated with investing in the securities markets of the U.S. and most other developed countries.
Over the past century, Russia has experienced political, social and economic turbulence and has endured decades of communist rule under
which the property of tens of millions of its citizens was collectivized into state agricultural and industrial enterprises. Since the collapse of the Soviet Union, Russias government has been faced with the daunting task of stabilizing its
domestic economy, while transforming it into a modern and efficient structure able to compete in international markets and respond to the needs of its citizens. However, to date, many of the countrys economic reform initiatives have floundered
as the proceeds of International Monetary Fund and other economic assistance have been squandered or stolen. In this environment, there is always the risk that the nations government will abandon the current program of economic reform and
replace it with radically different political and economic policies that would be detrimental to the interests of foreign investors. This could entail a return to a centrally planned economy and nationalization of private enterprises similar to what
existed in the Soviet Union.
Many of Russias businesses have failed to mobilize the available factors of production
because the countrys privatization program virtually ensured the predominance of the old management teams that are largely
non-market-
Part II - 54
oriented in their management approach. Poor accounting standards, inept management, pervasive corruption, insider trading and crime, and inadequate regulatory protection for the rights of
investors all pose a significant risk, particularly to foreign investors. In addition, there is the risk that the Russian tax system will not be reformed to prevent inconsistent, retroactive, and/or exorbitant taxation, or, in the alternative, the
risk that a reformed tax system may result in the inconsistent and unpredictable enforcement of the new tax laws.
Compared to
most national stock markets, the Russian securities market suffers from a variety of problems not encountered in more developed markets. There is little long-term historical data on the Russian securities market because it is relatively new and a
substantial proportion of securities transactions in Russia are privately negotiated outside of stock exchanges. The inexperience of the Russian securities market and the limited volume of trading in securities in the market may make obtaining
accurate prices on portfolio securities from independent sources more difficult than in more developed markets. Additionally, because of less stringent auditing and financial reporting standards that apply to companies operating in Russia, there is
little solid corporate information available to investors. As a result, it may be difficult to assess the value or prospects of an investment in Russian companies. Stocks of Russian companies also may experience greater price volatility than stocks
of U.S. companies.
Settlement, clearing and registration of securities transactions in Russia are subject to additional risks
because of the recent formation of the Russian securities market, the underdeveloped state of the banking and telecommunications systems, and the overall legal and regulatory framework. Prior to 2013, there was no central registration system for
equity share registration in Russia and registration was carried out by either the issuers themselves or by registrars located throughout Russia. Such registrars were not necessarily subject to effective state supervision nor were they licensed with
any governmental entity, thereby increasing the risk that a Fund could lose ownership of its securities through fraud, negligence, or even mere oversight. With the implementation of the National Settlement Depository (NSD) in Russia as a
recognized central securities depository, title to Russian equities is now based on the records of the Depository and not the registrars. Although the implementation of the NSD is generally expected to decrease the risk of loss in connection with
recording and transferring title to securities, issues resulting in loss still might occur. In addition, issuers and registrars are still prominent in the validation and approval of documentation requirements for corporate action processing in
Russia. Because the documentation requirements and approval criteria vary between registrars and/or issuers, there remain unclear and inconsistent market standards in the Russian market with respect to the completion and submission of corporate
action elections. To the extent that a Fund suffers a loss relating to title or corporate actions relating to its portfolio securities, it may be difficult for the Fund to enforce its rights or otherwise remedy the loss.
The Russian economy is heavily dependent upon the export of a range of commodities including most industrial metals, forestry products,
oil, and gas. Accordingly, it is strongly affected by international commodity prices and is particularly vulnerable to any weakening in global demand for these products.
Foreign investors also face a high degree of currency risk when investing in Russian securities and a lack of available currency hedging instruments. In a surprise move in August 1998, Russia devalued the
ruble, defaulted on short-term domestic bonds, and imposed a moratorium on the repayment of its international debt and the restructuring of the repayment terms. These actions have negatively affected Russian borrowers ability to access
international capital markets and have had a damaging impact on the Russian economy. In light of these and other government actions, foreign investors face the possibility of further devaluations. In addition, there is a risk that the government may
impose capital controls on foreign portfolio investments in the event of extreme financial or political crisis. Such capital controls would prevent the sale of a portfolio of foreign assets and the repatriation of investment income and capital. The
current economic turmoil in Russia and the effects on the current global economic crisis on the Russian economy may cause flight from the Russian ruble into U.S. dollars and other currencies, which could force the Russian central bank to spend
reserves to maintain the value of the ruble. If the Russian central bank falters in its defense of the ruble, there could be additional pressure on Russias banks and its currency.
Terrorism and related
geo-political
risks have led, and may in the future lead, to increased
short-term market volatility and may have adverse long-term effects on world economies and markets generally.
RISK MANAGEMENT
Each Fund may employ
non-hedging
risk management techniques.
Risk management strategies are used to keep the Funds fully invested and to reduce the transaction costs associated with cash flows into and out of a Fund. The Funds use a wide variety of instruments and strategies for risk management and the
examples below are not meant to be exhaustive.
Part II - 55
Examples of risk management strategies include synthetically altering the duration of a
portfolio or the mix of securities in a portfolio. For example, if the Adviser wishes to extend maturities in a fixed income portfolio in order to take advantage of an anticipated decline in interest rates, but does not wish to purchase the
underlying long-term securities, it might cause a Fund to purchase futures contracts on long term debt securities. Likewise, if the Adviser wishes to gain exposure to an instrument but does not wish to purchase the instrument it may use swaps and
related instruments. Similarly, if the Adviser wishes to decrease exposure to fixed income securities or purchase equities, it could cause the Fund to sell futures contracts on debt securities and purchase futures contracts on a stock index. Such
non-hedging
risk management techniques involve leverage, and thus, present, as do all leveraged transactions, the possibility of losses as well as gains that are greater than if these techniques involved the
purchase and sale of the securities themselves rather than their synthetic derivatives.
SPECIAL FACTORS AFFECTING CERTAIN FUNDS
In addition to the investment strategies and policies described above, certain Funds may employ other investment strategies and policies,
or similar strategies and policies to a greater extent, and, therefore, may be subject to additional risks or similar risks to a greater extent. For instance, certain Funds which invest in certain state specific securities may be subject to special
considerations regarding such investments. For a description of such additional investment strategies and policies as well as corresponding risks for such Funds, see Part I of this SAI.
DIVERSIFICATION
Certain Funds are diversified funds and as such intend to meet the diversification requirements of the 1940 Act. Please refer to the Funds Prospectuses for information about whether a Fund is a
diversified or
non-diversified
Fund. Current 1940 Act diversification requirements require that with respect to 75% of the assets of a Fund, the Fund may not invest more than 5% of its total assets in the
securities of any one issuer or own more than 10% of the outstanding voting securities of any one issuer, except cash or cash items, obligations of the U.S. government, its agencies and instrumentalities, and securities of other investment
companies. As for the other 25% of a Funds assets not subject to the limitation described above, there is no limitation on investment of these assets under the 1940 Act, so that all of such assets may be invested in securities of any one
issuer. Investments not subject to the limitations described above could involve an increased risk to a Fund should an issuer be unable to make interest or principal payments or should the market value of such securities decline.
Each of the Money Market Funds intends to comply with the diversification requirements imposed by Rule
2a-7
of the 1940 Act.
Certain other Funds are registered as
non-diversified
investment companies. A Fund is considered non-diversified because a relatively high percentage of the Funds assets may be invested in the securities of a single issuer or a limited
number of issuers, primarily within the same economic sector. A
non-diversified
Funds portfolio securities, therefore, may be more susceptible to any single economic, political, or regulatory occurrence
than the portfolio securities of a more diversified investment company.
Regardless of whether a Fund is diversified under the
1940 Act, all of the Funds will comply with the diversification requirements imposed by the Code for qualification as a regulated investment company. See Distributions and Tax Matters.
DISTRIBUTIONS AND TAX MATTERS
The following discussion is a brief summary of some of the important federal (and, where noted, state) income tax consequences affecting
each Fund and its shareholders. There may be other tax considerations applicable to particular shareholders. Except as otherwise noted in a Funds Prospectus, the Funds are not intended for foreign shareholders. As a result, this section does
not address in detail the tax consequences affecting any shareholder who, as to the U.S., is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership. This section is based on the Code, the regulations
thereunder, published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. The following tax discussion is very general; therefore, prospective investors are urged to consult
their tax advisors about the impact an investment in a Fund may have on their own tax situations and the possible application of foreign, state and local law.
Each Fund generally will be treated as a separate entity for federal income tax purposes, and thus the provisions of the Code generally will be applied to each Fund separately. Net long-term and
short-term capital gain, net income and operating expenses therefore will be determined separately for each Fund.
Part II - 56
Special tax rules apply to investments held through defined contribution plans and other
tax-qualified
plans. Shareholders should consult their tax advisors to determine the suitability of shares of the Fund as an investment through such plans.
Qualification as a Regulated Investment Company
Each Fund intends to elect to be treated and qualify each year as a regulated investment company under Subchapter M of the Code. In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, each Fund must, among other things:
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(a)
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derive at least 90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gain from the
sale or other disposition of stock, securities, or foreign currencies, or other income (including, but not limited to, gain from options, swaps, futures, or forward contracts) derived with respect to its business of investing in such stock,
securities, or currencies and (ii) net income derived from interests in qualified publicly traded partnerships (QPTPs, defined below);
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(b)
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diversify its holdings so that, at the end of each quarter of the Funds taxable year, (i) at least 50% of the market value of the Funds total assets is
represented by cash and cash items, U.S. government securities, securities of other regulated investment companies, and other securities, limited in respect of any one issuer to an amount not greater than 5% of the value of the Funds total
assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets is invested (x) in the securities (other than cash or cash items, or securities
issued by the U.S. government or other regulated investment companies) of any one issuer or of two or more issuers that the Fund controls and that are engaged in the same, similar, or related trades or businesses, or (y) in the securities of
one or more QPTPs. In the case of a Funds investments in loan participations, the Fund shall treat both the financial intermediary and the issuer of the underlying loan as an issuer for the purposes of meeting this diversification requirement;
and
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(c)
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distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code, without regard to
the deduction for dividends paid generally, taxable ordinary income and any excess of net short-term capital gain over net long-term capital loss) and net
tax-exempt
interest income, for such year.
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In general, for purposes of the 90% gross income requirement described in paragraph (a) above, income
derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying income if realized by the regulated investment company. However, 100% of
the net income derived from an interest in a qualified publicly traded partnership (defined as a partnership (x) interests in which are traded on an established securities markets or readily tradable on a secondary market as the
substantial equivalents thereof, (y) that derives at least 90% of its income from passive income sources defined in Code section 7704(d), and (z) that derives less than 90% of its income from the qualifying income described in (a)(i)
above) will be treated as qualifying income. Although income from a QPTP is qualifying income, as discussed above, investments in QPTPs cannot exceed 25% of the Funds assets. In addition, although in general the passive loss rules of the Code
do not apply to regulated investment companies, such rules do apply to a regulated investment company with respect to items attributable to an interest in a QPTP.
Gains from foreign currencies (including foreign currency options, foreign currency swaps, foreign currency futures and foreign currency forward contracts) currently constitute qualifying income for
purposes of the 90% test, described in paragraph (a) above. However, the Treasury Department has the authority to issue regulations (possibly with retroactive effect) excluding from the definition of qualifying income a funds
foreign currency gains to the extent that such income is not directly related to the funds principal business of investing in stock or securities.
For purposes of paragraph (b) above, the term outstanding voting securities of such issuer will include the equity securities of a QPTP. A Funds investment in MLPs may qualify as an
investment in (1) a QPTP, (2) a regular partnership, (3) a passive foreign investment company (a PFIC) or (4) a corporation for U.S. federal income tax purposes. The treatment of particular
MLPs for U.S. federal income tax purposes will affect the extent to which a Fund can invest in MLPs. The U.S. federal income tax consequences of a Funds investments in PFICs and regular partnerships are discussed in
greater detail below.
If a Fund qualifies for a taxable year as a regulated investment company that is accorded special tax
treatment, the Fund will not be subject to federal income tax on income distributed in a timely manner to its shareholders in the
Part II - 57
form of dividends (including Capital Gain Dividends, defined below). If a Fund were to fail to qualify as a regulated investment company accorded special tax treatment in any taxable year, the
Fund would be subject to taxation on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net
tax-exempt
income and net long-term capital gain,
would be taxable to shareholders as ordinary income. Some portions of such distributions may be eligible for the dividends-received deduction in the case of corporate shareholders and for treatment as qualified dividend income in the case of
individual shareholders. In addition, the Fund could be required to recognize unrealized gain, pay substantial taxes and interest, and make substantial distributions before
re-qualifying
as a regulated
investment company that is accorded special tax treatment.
Each Fund intends to distribute at least annually to its
shareholders all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction) and may distribute its net capital gain (that is the excess of net long-term capital gain over net short-term
capital loss). Investment company taxable income which is retained by a Fund will be subject to tax at regular corporate tax rates. A Fund might also retain for investment its net capital gain. If a Fund does retain such net capital gain, such gain
will be subject to tax at regular corporate rates on the amount retained, but the Fund may designate the retained amount as undistributed capital gain in a notice to its shareholders who (i) will be required to include in income for federal
income tax purposes, as long-term capital gain, their respective shares of the undistributed amount, and (ii) will be entitled to credit their respective shares of the tax paid by the Fund on such undistributed amount against their federal
income tax liabilities, if any, and to claim refunds to the extent the credit exceeds such liabilities. For federal income tax purposes, the tax basis of shares owned by a shareholder of a Fund will be increased by an amount equal under current law
to the difference between the amount of undistributed capital gain included in the shareholders gross income and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence.
In determining its net capital gain, including in connection with determining the amount available to support a Capital Gain Dividend, its
taxable income and its earnings and profits, a Fund may elect to treat part or all of any post-October capital loss (defined as the greatest of net capital loss, net long-term capital loss, or net short-term capital loss, in each case attributable
to the portion of the taxable year after October 31) or late-year ordinary loss (generally, (i) net ordinary loss from the sale, exchange or other taxable disposition of property, attributable to the portion of the taxable year after
October 31, plus (ii) other net ordinary loss attributable to the portion of the taxable year after December 31) as if incurred in the succeeding taxable year.
Excise Tax on Regulated Investment Companies
If a Fund fails to distribute in a calendar year an amount equal to the sum of 98% of its ordinary income for such year and 98.2% of its
capital gain net income for the
one-year
period ending October 31 (or later if the Fund is permitted to elect and so elects), plus any retained amount from the prior year, the Fund will be subject to a
nondeductible 4% excise tax on the undistributed amounts. The Funds intend to make distributions sufficient to avoid imposition of the 4% excise tax, although each Fund reserves the right to pay an excise tax rather than make an additional
distribution when circumstances warrant (e.g., the excise tax amount is deemed by a Fund to be
de minimis
). Certain derivative instruments give rise to ordinary income and loss. If a Fund has a taxable year that begins in one calendar year
and ends in the next calendar year, the Fund will be required to make this excise tax distribution during its taxable year. There is a risk that a Fund could recognize income prior to making this excise tax distribution and could recognize losses
after making this distribution. As a result, an excise tax distribution could constitute a return of capital (see discussion below).
Fund Distributions
The Funds anticipate distributing substantially all of their net investment income for each taxable
year. Distributions are taxable to shareholders even if they are paid from income or gain earned by the Fund before a shareholders investment (and thus were included in the price the shareholder paid). Distributions are taxable whether
shareholders receive them in cash or reinvest them in additional shares. A shareholder whose distributions are reinvested in shares will be treated as having received a dividend equal to the fair market value of the new shares issued.
Dividends and distributions on a Funds shares generally are subject to federal income tax as described herein to the extent they do
not exceed the Funds realized income and gains, even though such dividends and distributions may represent economically a return of a particular shareholders investment. Such dividends and distributions are
likely to occur in respect of shares purchased at a time when the Funds net asset value reflects gains that are either (i) unrealized, or
(ii) realized but not distributed.
Part II - 58
For federal income tax purposes, distributions of net investment income generally are
taxable as ordinary income. Taxes on distributions of capital gain are determined by how long a Fund owned the investment that generated it, rather than how long a shareholder may have owned shares in the Fund. Distributions of net capital gain from
the sale of investments that a Fund owned for more than one year and that are properly designated by the Fund as capital gain dividends (Capital Gain Dividends) will be taxable as long-term capital gain. Distributions of capital gain
generally are made after applying any available capital loss carryovers. For taxable years beginning after December 31, 2012, the maximum individual rate applicable to long-term capital gains is either 15% or 20%, depending on whether the
individuals income exceeds certain threshold amounts. A distribution of gain from the sale of investments that a Fund owned for one year or less will be taxable as ordinary income. Distributions attributable to gain from the sale of MLPs that
is characterized as ordinary income under the Codes recapture provisions will be taxable as ordinary income.
Distributions of investment income designated by a Fund as derived from qualified dividend income will be taxed in the hands
of individuals at the rates applicable to long-term capital gain. In order for some portion of the dividends received by a Fund shareholder to be qualified dividend income, the Fund must meet certain holding-period and other requirements with
respect to some portion of the dividend-paying stocks in its portfolio, and the shareholder must meet certain holding-period and other requirements with respect to the Funds shares. A dividend will not be treated as qualified dividend income
(at either the Fund or shareholder level) (i) if the dividend is received with respect to any share of stock held for fewer than 61 days during the
121-day
period beginning on the date which is 60 days
before the date on which such share becomes
ex-dividend
with respect to such dividend (or, in the case of certain preferred stock, 91 days during the
181-day
period
beginning 90 days before such date), (ii) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property,
(iii) if the recipient elects to have the dividend income treated as investment interest for purposes of the limitation on deductibility of investment interest, or (iv) if the dividend is received from a foreign corporation that is
(a) not eligible for the benefits of a comprehensive income tax treaty with the U.S. (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the U.S.) or
(b) treated as a PFIC.
In general, distributions of investment income designated by a Fund as derived from qualified
dividend income will be treated as qualified dividend income by a
non-corporate
taxable shareholder so long as the shareholder meets the holding period and other requirements described above with respect to
the Funds shares. In any event, if the qualified dividend income received by each Fund during any taxable year is equal to or greater than 95% of its gross income, then 100% of the Funds dividends (other than dividends that
are properly designated as Capital Gain Dividends) will be eligible to be treated as qualified dividend income. For this purpose, the only gain included in the term gross income is the excess of net short-term capital gain over net
long-term capital loss.
If a Fund receives dividends from an underlying fund, and the underlying fund designates such
dividends as qualified dividend income, then the Fund may, in turn, designate a portion of its distributions as qualified dividend income as well, provided the Fund meets the holding-period and other requirements with respect
to shares of the underlying fund.
Any loss realized upon a taxable disposition of shares held for six months or less will be
treated as long-term capital loss to the extent of any Capital Gain Dividends received by the shareholder with respect to those shares. All or a portion of any loss realized upon a taxable disposition of Fund shares will be disallowed if other
shares of such Fund are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
A distribution paid to shareholders by a Fund in January of a year generally is deemed to have been received by shareholders on
December 31 of the preceding year, if the distribution was declared and payable to shareholders of record on a date in October, November, or December of that preceding year. The Funds will provide federal tax information annually, including
information about dividends and distributions paid during the preceding year to taxable investors and others requesting such information.
If a Fund makes a distribution to its shareholders in excess of its current and accumulated earnings and profits in any taxable year, the excess distribution will be treated as a return of
capital to the extent of each shareholders basis (for tax purposes) in its shares, and any distribution in excess of basis will be treated as capital gain. A return of capital is not taxable, but it reduces the shareholders basis in its
shares, which reduces the loss (or increases the gain) on a subsequent taxable disposition by such shareholder of the shares.
Dividends of net investment income received by corporate shareholders (other than shareholders that are S corporations) of a Fund
will qualify for the 70% dividends-received deduction generally available to corporations
Part II - 59
to the extent of the amount of qualifying dividends received by the Fund from domestic corporations for the taxable year. A dividend received by a Fund will not be treated as a qualifying
dividend (1) if the stock on which the dividend is paid is considered to be debt-financed (generally, acquired with borrowed funds), (2) if it has been received with respect to any share of stock that the Fund has held less
than 46 days (91 days in the case of certain preferred stock) during the
91-day
period beginning on the date which is 45 days before the date on which such share becomes
ex-dividend
with respect to such dividend (during the
181-day
period beginning 90 days before such date in the case of certain preferred stock) or (3) to the extent
that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends-received deduction may be disallowed or reduced
(1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of a Fund or (2) by application of the Code. However, any distributions received by a Fund from REITs and PFICs will not qualify for
the corporate dividends-received deduction.
For taxable years beginning after December 31, 2012, an additional 3.8%
Medicare tax will be imposed on certain net investment income (including ordinary dividends and capital gain distributions received from a Fund and net gains from redemptions or other taxable dispositions of Fund shares, but excluding any exempt
interest dividends from a Fund) of U.S. individuals, estates and trusts to the extent that such persons modified adjusted gross income (in the case of an individual) or adjusted gross income (in the case of an estate or
trust) exceeds certain threshold amounts.
Sale or Redemption of Shares
The sale, exchange, or redemption of Fund shares may give rise to a gain or loss. In general, any gain or loss arising from (or treated as
arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for more than one year. However, any capital loss arising from the sale or
redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on (or undistributed capital gains credited with respect to) such shares. Additionally, any
loss realized upon the sale or exchange of Fund shares with a tax holding period of six months or less may be disallowed to the extent of any distributions treated as exempt interest dividends with respect to such shares. For taxable years beginning
after December 31, 2012, the maximum individual rate applicable to long-term capital gains is either 15% or 20%, depending on whether the individuals income exceeds certain threshold amounts. Capital gain of a corporate shareholder is
taxed at the same rate as ordinary income. Depending on a shareholders percentage ownership in the Fund, a partial redemption of Fund shares could cause the shareholder to be treated as receiving a dividend, taxable as ordinary income in an
amount equal to the full amount of the distribution, rather than capital gain income.
Fund Investments
Certain investments of the Funds, including transactions in options, swaptions, futures contracts, forward contracts,
straddles, swaps, short sales, foreign currencies, inflation-linked securities and foreign securities, including for hedging purposes, will be subject to special tax rules (including
mark-to-market,
constructive sale, straddle, wash sale and short sale rules). In a given case, these rules may accelerate income to a Fund, defer losses to a Fund, cause
adjustments in the holding periods of a Funds securities, convert long-term capital gain into short-term capital gain, convert short-term capital losses into long-term capital loss, or otherwise affect the character of a Funds income.
These rules could therefore affect the amount, timing and character of distributions to shareholders and cause differences between a Funds book income and its taxable income. If a Funds book income exceeds its taxable income, the
distribution (if any) of such excess generally will be treated as (i) a dividend to the extent of the Funds remaining earnings and profits (including earnings and profits arising from
tax-exempt
income), (ii) thereafter, as a return of capital to the extent of the recipients basis in its shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset. If a Funds book income is less than taxable
income, the Fund could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment. Income earned as a result of these transactions would, in general, not be eligible
for the dividends-received deduction or for treatment as exempt-interest dividends when distributed to shareholders. The Funds will endeavor to make any available elections pertaining to such transactions in a manner believed to be in the best
interest of each Fund and its shareholders.
The Funds participation in loans of securities may affect the amount,
timing, and character of distributions to shareholders. With respect to any security subject to a securities loan, any (i) amounts received by the Fund in place of dividends earned on the security during the period that such security was not
directly held by the Fund will not
Part II - 60
give rise to qualified dividend income and (ii) withholding taxes accrued on dividends during the period that such security was not directly held by the Fund will not qualify as a foreign
tax paid by the Fund and therefore cannot be passed through to shareholders even if the Fund meets the requirements described in Foreign Taxes, below.
Certain debt securities purchased by the Funds are sold at an original issue discount and thus do not make periodic cash interest payments. Similarly, zero-coupon bonds do not make periodic interest
payments. Generally, the amount of the original issue discount is treated as interest income and is included in taxable income (and required to be distributed) over the term of the debt security even though payment of that amount is not received
until a later time, usually when the debt security matures. In addition,
payment-in-kind
securities will give rise to income that is required to be distributed and is
taxable even though the Fund holding the security receives no interest payment in cash on the security during the year. Because each Fund distributes substantially all of its net investment income to its shareholders (including such imputed
interest), a Fund may have to sell portfolio securities in order to generate the cash necessary for the required distributions. Such sales may occur at a time when the Adviser would not otherwise have chosen to sell such securities and may result in
a taxable gain or loss. Some of the Funds may invest in inflation-linked debt securities. Any increase in the principal amount of an inflation-linked debt security will be original issue discount, which is taxable as ordinary income and is required
to be distributed, even though the Fund will not receive the principal, including any increase thereto, until maturity. A Fund investing in such securities may be required to liquidate other investments, including at times when it is not
advantageous to do so, in order to satisfy its distribution requirements and to eliminate any possible taxation at the Fund level.
A Fund may invest to a significant extent in debt obligations that are in the lowest rated categories (or are unrated), including debt obligations of issuers that are not currently paying interest or that
are in default. Investments in debt obligations that are at risk of being in default (or are presently in default) present special tax issues for a Fund. Tax rules are not entirely clear about issues such as when a Fund may cease to accrue interest,
original issue discount or market discount, when and to what extent deductions may be taken for bad debts or worthless securities and how payments received on obligations in default should be allocated between principal and income. These and other
related issues will be addressed by each Fund when, as and if it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company and does not become subject to
U.S. federal income taxation or any excise tax.
Transactions of certain Funds in foreign currencies, foreign currency
denominated debt securities and certain foreign currency options, future contracts and forward contracts (and similar instruments) may accelerate income recognition and result in ordinary income or loss to a Fund for federal income tax purposes
which will be taxable to the shareholders as such when it is distributed to them.
Special tax considerations apply if a Fund
invests in investment companies that are taxable as partnerships for federal income tax purposes. In general, the Fund will not recognize income earned by such an investment company until the close of the investment companys taxable year. But
the Fund will recognize such income as it is earned by the investment company for purposes of determining whether it is subject to the 4% excise tax. Therefore, if the Fund and such an investment company have different taxable years, the Fund may be
compelled to make distributions in excess of the income recognized from such an investment company in order to avoid the imposition of the 4% excise tax. A Funds receipt of a
non-liquidating
cash
distribution from an investment company taxable as a partnership generally will result in recognized gain (but not loss) only to the extent that the amount of the distribution exceeds the Funds adjusted basis in shares of such investment
company before the distribution. A Fund that receives a liquidating cash distribution from an investment company taxable as a partnership will recognize capital gain or loss to the extent of the difference between the proceeds received by the Fund
and the Funds adjusted tax basis in shares of such investment company; however, the Fund will recognize ordinary income, rather than capital gain, to the extent that the Funds allocable share of unrealized receivables
(including any accrued but untaxed market discount) exceeds the shareholders share of the basis in those unrealized receivables.
Some amounts received by each Fund with respect to its investments in MLPs will likely be treated as a return of capital because of accelerated deductions available with respect to the activities of such
MLPs. On the disposition of an investment in such an MLP, the Fund will likely realize taxable income in excess of economic gain with respect to that asset (or, if the Fund does not dispose of the MLP, the Fund likely will realize taxable income in
excess of cash flow with respect to the MLP in a later period), and the Fund must take such income into account in determining whether the Fund has satisfied its distribution requirements. The Fund may have to borrow or liquidate securities to
satisfy its distribution requirements and to meet its redemption requests, even though investment considerations might otherwise make it undesirable for the Fund to sell securities or borrow money at such time.
Part II - 61
Some of the Funds may invest in REITs. Such investments in REIT equity securities may
require a Fund to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio (including when it is not advantageous to do so)
that it otherwise would have continued to hold. A Funds investments in REIT equity securities may at other times result in the Funds receipt of cash in excess of the REITs earnings; if the Fund distributes such amounts, such
distribution could constitute a return of capital to Fund shareholders for federal income tax purposes. Dividends received by a Fund from a REIT generally will not constitute qualified dividend income.
A Fund might invest directly or indirectly in residual interests in real estate mortgage investment conduits (REMICs) or
equity interests in taxable mortgage pools (TMPS). Under a notice issued by the IRS in October 2006 and Treasury regulations that have not yet been issued (but may apply with retroactive effect) a portion of a Funds income from a
REIT that is attributable to the REITs residual interest in a REMIC or a TMP (referred to in the Code as an excess inclusion) will be subject to federal income taxation in all events. This notice also provides, and the regulations
are expected to provide, that excess inclusion income of a regulated investment company, such as each of the Funds, will generally be allocated to shareholders of the regulated investment company in proportion to the dividends received by such
shareholders, with the same consequences as if the shareholders held the related REMIC or TMP residual interest directly.
In
general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions) and (ii) will constitute unrelated business taxable income
(UBTI) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other
tax-exempt
entity) subject to tax on UBTI, thereby potentially
requiring such an entity that is allocated excess inclusion income, and otherwise might not be required to file a tax return, to file a tax return and pay tax on such income. In addition, because the Code provides that excess inclusion income is
ineligible for treaty benefits, a regulated investment company must withhold tax on excess inclusions attributable to its foreign shareholders at a 30% rate of withholding, regardless of any treaty benefits for which a shareholder is otherwise
eligible.
Any investment in residual interests of a CMO that has elected to be treated as a REMIC can create complex tax
problems, especially if the Fund has state or local governments or other
tax-exempt
organizations as shareholders. Under current law, the Fund serves to block unrelated business taxable income
(UBTI) from being realized by its
tax-exempt
shareholders. Notwithstanding the foregoing, a
tax-exempt
shareholder will recognize UBTI by virtue of its
investment in the Fund if shares in the Fund constitute debt-financed property in the hands of the
tax-exempt
shareholder within the meaning of Code Section 514(b). Furthermore, a
tax-exempt
shareholder may recognize UBTI if the Fund recognizes excess inclusion income derived from direct or indirect investments in REMIC residual interests or TMPs if the amount of such income
recognized by the Fund exceeds the Funds investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in regulated investment companies that invest directly or indirectly in residual interests in
REMICs or in TMPs. Under legislation enacted in December 2006, a CRT, as defined in section 664 of the Code, that realizes UBTI for a taxable year must pay an excise tax annually of an amount equal to such UBTI. Under IRS guidance issued in October
2006, a CRT will not recognize UBTI solely as a result of investing in a Fund that recognizes excess inclusion income. Rather, if at any time during any taxable year a CRT (or one of certain other
tax-exempt
shareholders, such as the U.S., a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a share in a Fund that recognizes
excess inclusion income, then the Fund will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The
extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the 1940 Act, each Fund may elect to specially allocate any such tax to the applicable CRT, or other
shareholder, and thus reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the Fund. The Funds have not yet determined whether such an election will be made. CRTs are
urged to consult their tax advisors concerning the consequences of investing in a Fund.
If a Fund invests in PFICs, certain
special tax consequences may apply. A PFIC is any foreign corporation in which (i) 75% or more of the gross income for the taxable year is passive income, or (ii) the average percentage of the assets (generally by value, but by adjusted
tax basis in certain cases) that produce or are held for the production of passive income is at least 50%. Generally, passive income for this purpose means dividends, interest (including income equivalent to interest), royalties, rents, annuities,
the excess of gains over losses from certain property
Part II - 62
transactions and commodities transactions, and foreign currency gains. Passive income for this purpose does not include rents and royalties received by the foreign corporation from active
business and certain income received from related persons. A Funds investments in certain PFICs could subject the Fund to a U.S. federal income tax (including interest charges) on distributions received from the company or on proceeds received
from the disposition of shares in the company. This tax cannot be eliminated by making distributions to Fund shareholders. In addition, certain interest charges may be imposed on the Fund as a result of such distributions.
If a Fund is in a position to treat a PFIC as a qualified electing fund (QEF), the Fund will be required to
include its share of the companys income and net capital gain annually, regardless of whether it receives any distributions from the company. Alternately, a Fund may make an election to mark the gains (and to a limited extent losses) in such
holdings to the market as though it had sold and repurchased its holdings in those PFICs on the last day of the Funds taxable year. Such gain and loss are treated as ordinary income and loss. The QEF and
mark-to-market
elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed by
the Fund to avoid taxation. Making either of these elections, therefore, may require the Fund to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the
recognition of gain and affect the Funds total return. A fund that invests indirectly in PFICs by virtue of the funds investment in other investment companies that qualify as U.S. persons within the meaning of the Code may
not make such elections; rather, such underlying investment companies investing directly in the PFICs would decide whether to make such elections. Dividends paid by PFICs will not be eligible to be treated as qualified dividend income.
Certain Funds have wholly-owned subsidiaries organized under the laws of the Cayman Islands, which are classified as
corporations for U.S. federal income tax purposes (each, a Subsidiary). With respect to such Funds, a Fund may invest a portion of its assets in its Subsidiary. A foreign corporation, such as a Subsidiary, will generally not be subject
to U.S. federal income taxation unless it is deemed to be engaged in a U.S. trade or business. It is expected that each Subsidiary will conduct its activities in a manner so as to meet the requirements of a safe harbor provided under
Section 864(b)(2) of the Code under which the Subsidiary may engage in trading in stocks or securities or certain commodities without being deemed to be engaged in a U.S. trade or business. However, if certain of a Subsidiarys activities
were determined not to be of the type described in the safe harbor (which is not expected), then the activities of the Subsidiary may constitute a U.S. trade or business, and subject to U.S. taxation as such.
In general, a foreign corporation, such as a Subsidiary, that does not conduct a U.S. trade or business is nonetheless subject to tax at a
flat rate of 30 percent (or lower tax treaty rate), generally payable through withholding, on the gross amount of certain U.S.-source income that is not effectively connected with a U.S. trade or business. There is presently no tax treaty in force
between the U.S. and the Cayman Islands that would reduce this rate of withholding tax. It is not expected that a Subsidiary will derive meaningful income subject to such withholding tax.
Each Subsidiary will be treated as a controlled foreign corporation (CFC) and the Fund investing in its Subsidiary will be
treated as a U.S. shareholder of that Subsidiary. As a result, a Fund will be required to include in gross income for U.S. federal income tax purposes all of its Subsidiarys subpart F income, whether or not such income
is distributed by the Subsidiary. It is expected that all of the Subsidiarys income will be subpart F income. A Funds recognition of its Subsidiarys subpart F income will increase the Funds tax basis
in the Subsidiary. Distributions by the Subsidiary to a Fund will be tax-free, to the extent of its previously undistributed subpart F income, and will correspondingly reduce the Funds tax basis in the Subsidiary. Subpart F
income is generally treated as ordinary income, regardless of the character of the Subsidiarys underlying income. If a net loss is realized by the Subsidiary, such loss is not generally available to offset the income earned by a Fund.
The ability of a Fund to invest directly in commodities, and in certain commodity-related securities and other instruments, is
subject to significant limitations in order to enable a Fund to maintain its status as a regulated investment company under the Code.
Investment in Other Funds
If a Fund invests in shares of other mutual funds, ETFs or other companies that are taxable
as regulated investment companies, as well as certain investments in REITs (collectively, underlying funds), its distributable income and gains will normally consist, in part, of distributions from the underlying funds and gains and
losses on the disposition of shares of the underlying funds. To the extent that an underlying fund realizes net losses on its investments for a given taxable year, the Fund will not be able to recognize its share of those losses (so as to offset
Part II - 63
distributions of net income or capital gains from other underlying funds) until it disposes of shares of the underlying fund. Moreover, even when the Fund does make such a disposition, a portion
of its loss may be recognized as a long-term capital loss, which will not be treated as favorably for federal income tax purposes as a short-term capital loss or an ordinary deduction. In particular, the Fund will not be able to offset any capital
losses from its dispositions of underlying fund shares against its ordinary income (including distributions of any net short-term capital gain realized by an underlying fund).
In addition, in certain circumstances, the wash sale rules under Section 1091 of the Code may apply to a Funds sales of underlying fund shares that have generated losses. A wash
sale occurs if shares of an underlying fund are sold by the Fund at a loss and the Fund acquires substantially identical shares of that same underlying fund 30 days before or after the date of the sale. The wash-sale rules could defer losses in the
Funds hands on sales of underlying fund shares (to the extent such sales are wash sales) for extended (and, in certain cases, potentially indefinite) periods of time.
As a result of the foregoing rules, and certain other special rules, the amount of net investment income and net capital gain that each Fund will be required to distribute to shareholders may be greater
than what such amounts would have been had the Fund directly invested in the securities held by the underlying funds, rather than investing in shares of the underlying funds. For similar reasons, the character of distributions from the Fund (e.g.,
long-term capital gain, exempt interest, eligibility for dividends-received deduction, etc.) will not necessarily be the same as it would have been had the Fund invested directly in the securities held by the underlying funds.
If a Fund received dividends from an underlying fund that qualifies as a regulated investment company, and the underlying fund designates
such dividends as qualified dividend income, then the Fund is permitted in turn to designate a portion of its distributions as qualified dividend income, provided the Fund meets holding period and other requirements with
respect to shares of the underlying fund.
Depending on a Funds percentage ownership in an underlying fund, both before
and after a redemption, a redemption of shares of an underlying fund by a Fund may cause the Fund to be treated as receiving a Section 301 distribution taxable as a dividend to the extent of its allocable shares of earnings and profits, on the
full amount of the distribution instead of receiving capital gain income on the shares of the underlying fund. Such a distribution may be treated as qualified dividend income and thus eligible to be taxed at the rates applicable to long-term capital
gain. If qualified dividend income treatment is not available, the distribution may be taxed as ordinary income. This could cause shareholders of the Fund to recognize higher amounts of ordinary income than if the shareholders had held the shares of
the underlying funds directly.
For taxable years beginning on or before December 22, 2010, a Fund cannot pass through to
shareholders foreign tax credits borne in respect of foreign securities income or exempt interest dividends in respect of tax-exempt obligations, in each case, earned by an underlying fund. For taxable years beginning after December 22, 2010, a
Fund may elect to pass through to shareholders foreign tax credits from an underlying fund and exempt-interest dividends from an underlying fund, provided that at least 50% of the Funds total assets are invested in other regulated investment
companies at the end of each quarter of the taxable year.
Backup Withholding
Each Fund generally is required to backup withhold and remit to the U.S. Treasury a percentage of the taxable dividends and other
distributions paid to, and the proceeds of share sales, exchanges, or redemptions made by, any individual shareholder who fails to properly furnish the Fund with a correct taxpayer identification number (TIN), who has under-reported
dividend or interest income, or who fails to certify to the Fund that he or she is not subject to backup withholding. The backup withholding rules may also apply to distributions that are properly designated as exempt-interest dividends. The backup
withholding tax rate is 28%.
Foreign Shareholders
Shares of the Funds have not been registered for sale outside of the United States. This SAI is not intended for distribution to
prospective investors outside of the United States. The Funds generally do not market or sell shares to investors domiciled outside of the United States, even, with regard to individuals, if they are citizens or lawful permanent residents of the
United States.
Distributions properly designated as Capital Gain Dividends and exempt-interest dividends generally will not be
subject to withholding of federal income tax. However, exempt-interest dividends may be subject to backup withholding (as discussed above). In general, dividends other than Capital Gain Dividends and exempt-interest
Part II - 64
dividends paid by a Fund to a shareholder that is not a U.S. person within the meaning of the Code (a foreign person) are subject to withholding of U.S. federal income tax
at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio interest, short-term capital gains, or foreign-source dividend and interest income) that, if paid to a foreign person directly, would
not be subject to withholding. However, effective for taxable years of a Fund beginning before January 1, 2014 (or a later date if extended by the U.S. Congress as discussed below), the Fund will not be required to withhold any amounts
(i) with respect to distributions (other than distributions to a foreign person (w) that has not provided a satisfactory statement that the beneficial owner is not a U.S. person, (x) to the extent that the dividend is attributable to
certain interest on an obligation if the foreign person is the issuer or is a 10% shareholder of the issuer, (y) that is within certain foreign countries that have inadequate information exchange with the United States, or (z) to the
extent the dividend is attributable to interest paid by a person that is a related person of the foreign person and the foreign person is a controlled foreign corporation) from U.S.-source interest income of types similar to those not subject to
U.S. federal income tax if earned directly by an individual foreign person, to the extent such distributions are properly designated by the Fund (interest-related dividends), and (ii) with respect to distributions (other than
(a) distributions to an individual foreign person who is present in the United States for a period or periods aggregating 183 days or more during the year of the distribution and (b) distributions subject to special rules regarding the
disposition of U.S. real property interests (as described below) of net short-term capital gains in excess of net long-term capital losses to the extent such distributions are properly designated by the Fund (short-term capital gain
dividends). Depending on the circumstances, a Fund may make designations of interest-related and/or short-term capital gain dividends with respect to all, some or none of its potentially eligible dividends and/or treat such dividends, in whole
or in part, as ineligible for these exemptions from withholding. In the case of shares held through an intermediary, the intermediary may withhold even if a Fund makes a designation with respect to a payment. Foreign persons should contact their
intermediaries regarding the application of these rules to their accounts. Absent legislation extending these exemptions for taxable years beginning on or after January 1, 2014, these special withholding exemptions for interest-related and
short-term capital gain dividends will expire and these dividends generally will be subject to withholding as described above.
A beneficial holder of shares who is a foreign person is not, in general, subject to U.S. federal income tax on gains (and is not allowed
a deduction for losses) realized on the sale of shares of the Fund or on Capital Gain Dividends or exempt-interest dividends unless (i) such gain or dividend is effectively connected with the conduct of a trade or business carried on by such
holder within the United States or (ii) in the case of an individual holder, the holder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale or the receipt of the Capital Gain Dividend
and certain other conditions are met or (iii) the shares constitute U.S. real property interests (USRPIs) or the Capital Gain Dividends are attributable to gains from the sale or exchange of USRPIs in accordance with the
rules set forth below.
Special rules apply to distributions to foreign shareholders from a Fund that is either a U.S.
real property holding corporation (USRPHC) or would be a USRPHC but for the operation of the exceptions to the definition thereof described below. Additionally, special rules apply to the sale of shares in a Fund that is a USRPHC.
Very generally, a USRPHC is a domestic corporation that holds U.S. real property interests (USRPIs) USRPIs are defined as any interest in U.S. real property or any equity interest in a USRPHC the fair market value of which
equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests in real property located outside the United States and other assets. A Fund that holds (directly or indirectly) significant interests in REITs may
be a USRPHC. The special rules discussed in the next paragraph will also apply to distributions from a Fund that would be a USRPHC absent exclusions from USRPI treatment for interests in domestically controlled REITs or regulated investment
companies and
not-greater-than-5%
interests in publicly traded classes of stock in REITs or regulated investment companies.
In the case of a Fund that is a USRPHC or would be a USRPHC but for the exceptions from the definition of USRPI (described immediately
above), distributions by the Fund that are attributable to (a) gains realized on the disposition of USRPIs by the Fund and (b) distributions received by the Fund from a lower-tier regulated investment company or REIT that the Fund is
required to treat as USRPI gain in its hands will retain their character as gains realized from USRPIs in the hands of the Funds foreign shareholders. (However, absent legislation, after December 31, 2013, this look-through
treatment for distributions by the Fund to foreign shareholders will apply only to such distributions that, in turn, are attributable to distributions received by the Fund from a lower-tier REIT and required to be treated as USRPI gain in the
Funds hands.) If the foreign shareholder holds (or has held in the prior year) more than a 5% interest in the Fund, such distributions will be treated as gains effectively connected with the conduct of a U.S. trade or
business, and subject to tax at graduated rates. Moreover, such shareholders will be required to file a U.S. income tax return for the year in which the gain was recognized and the Fund will be
Part II - 65
required to withhold 35% of the amount of such distribution. In the case of all other foreign shareholders (i.e., those whose interest in the Fund did not exceed 5% at any time during the prior
year), the USRPI distribution will be treated as ordinary income (regardless of any designation by the Fund that such distribution is a short-term capital gain dividend or a Capital Gain Dividend), and the Fund must withhold 30% (or a lower
applicable treaty rate) of the amount of the distribution paid to such foreign shareholder. Foreign shareholders of a Fund are also subject to wash sale rules to prevent the avoidance of the
tax-filing
and
-payment
obligations discussed above through the sale and repurchase of Fund shares.
In addition, with respect to
open-end
funds, a Fund that is a USRPHC must typically withhold 10%
of the amount realized in a redemption by a
greater-than-5%
foreign shareholder, and that shareholder must file a U.S. income tax return for the year of the disposition of the USRPI and pay any additional tax
due on the gain. On or before December 31, 2013, no withholding is generally required with respect to amounts paid in redemption of shares of a Fund if the Fund is a domestically controlled USRPHC or, in certain limited cases, if the Fund
(whether or not domestically controlled) holds substantial investments in regulated investment companies that are domestically controlled USRPHCs. Absent legislation extending this exemption from withholding beyond December 31, 2013, it will
expire at that time and any previously exempt Fund will be required to withhold with respect to amounts paid in redemption of its shares as described above.
In order to qualify for any exemptions from withholding described above or for lower withholding tax rates under income tax treaties, or to establish an exemption from backup withholding, the foreign
investor must comply with special certification and filing requirements relating to its
non-US
status (including, in general, furnishing an IRS Form
W-8BEN
or substitute
form). Foreign investors in a Fund should consult their tax advisers in this regard.
If a shareholder is eligible for the
benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable to a permanent establishment maintained by the shareholder in the United States.
A beneficial holder of shares who is a foreign person may be subject to state and local tax and to the U.S. federal estate tax
in addition to the federal tax on income referred to above. Foreign shareholders in a Fund should consult their tax advisors with respect to the potential application of the above rules.
Effective January 1, 2014, a Fund will be required to withhold U.S. tax (at a 30% rate) on payments of taxable dividends and
(effective January 1, 2017) redemption proceeds made to certain
non-U.S.
entities that fail to comply (or be deemed compliant) with extensive new reporting and withholding requirements designed to inform
the U.S. Department of the Treasury of U.S.-owned foreign investment accounts. Shareholders may be requested to provide additional information to a Fund to enable the Fund to determine whether withholding is required.
Foreign Taxes
Certain Funds may be subject to foreign withholding taxes or other foreign taxes with respect to income (possibly including, in some cases, capital gain) received from sources within foreign countries.
Tax conventions between certain countries and the U.S. may reduce or eliminate such taxes. If more than 50% of a Funds assets at year end consists of the securities of foreign corporations, the Fund may elect to permit shareholders to claim a
credit or deduction on their income tax returns for their pro rata portion of qualified taxes paid by the Fund to foreign countries in respect of foreign securities the Fund has held for at least the minimum period specified in the Code. In such a
case, shareholders will include in gross income from foreign sources their pro rata shares of such taxes. A shareholders ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by a Fund may be subject to certain
limitations imposed by the Code and the Treasury Regulations issued thereunder, as a result of which a shareholder may not get a full credit or deduction for the amount of such taxes. In particular, shareholders must hold their Fund shares (without
protection from risk of loss) on the
ex-dividend
date and for at least 15 additional days during the
30-day
period surrounding the
ex-dividend
date to be eligible to claim a foreign tax credit with respect to a given dividend. Shareholders who do not itemize on their federal income tax returns may claim a credit (but no deduction) for
such foreign taxes.
If a Fund does not make the above election or if more than 50% of its assets at the end of the year do not
consist of securities of foreign corporations, the Funds net income will be reduced by the foreign taxes paid or withheld. In such cases, shareholders will not be entitled to claim a credit or deduction with respect to foreign taxes.
The foregoing is only a general description of the treatment of foreign source income or foreign taxes under the U.S. federal
income tax laws. Because the availability of a credit or deduction depends on the particular circumstances of each shareholder, shareholders are advised to consult their own tax advisors.
Part II - 66
Exempt-Interest Dividends
Some of the Funds intend to qualify to pay exempt-interest dividends to their respective shareholders. In order to qualify to pay
exempt-interest dividends, at least 50% of the value of a Funds total assets must consist of
tax-exempt
municipal bonds at the close of each quarter of the Funds taxable year. An exempt-interest
dividend is that part of a dividend that is properly designated as an exempt-interest dividend and that consists of interest received by a Fund on such
tax-exempt
securities. Shareholders of Funds that pay
exempt-interest dividends would not incur any regular federal income tax on the amount of exempt-interest dividends received by them from a Fund, but an investment in such a Fund may result in liability for federal and state alternative minimum
taxation and may be subject to state and local taxes.
Interest on indebtedness incurred or continued by a shareholder, whether
a corporation or an individual, to purchase or carry shares of a Fund is not deductible to the extent it relates to exempt-interest dividends received by the shareholder from that Fund. Any loss incurred on the sale or redemption of a Funds
shares held for six months or less will be disallowed to the extent of exempt-interest dividends received with respect to such shares.
Interest on certain
tax-exempt
bonds that are private activity bonds within the meaning of the Code is treated as a tax preference item for purposes of the
alternative minimum tax, and any such interest received by a Fund and distributed to shareholders will be so treated for purposes of any alternative minimum tax liability of shareholders to the extent of the dividends proportionate share of a
Funds income consisting of such interest. All exempt-interest dividends are subject to the corporate alternative minimum tax.
The exemption from federal income tax for exempt-interest dividends does not necessarily result in exemption for such dividends under the income or other tax laws of any state or local authority.
Shareholders that receive social security or railroad retirement benefits should consult their tax advisors to determine what effect, if any, an investment in a Fund may have on the federal taxation of their benefits.
From time to time legislation may be introduced or litigation may arise that would change the tax treatment of exempt-interest dividends.
Such legislation or litigation may have the effect of raising the state or other taxes payable by shareholders on such dividends. Shareholders should consult their tax advisors for the current federal, state and local law on exempt-interest
dividends.
State and Local Tax Matters
Depending on the residence of the shareholders for tax purposes, distributions may also be subject to state and local taxation. Rules of
state and local taxation regarding qualified dividend income, ordinary income dividends and capital gain dividends from regulated investment companies may differ from the rules of U.S. federal income tax in many respects. Shareholders are urged to
consult their tax advisors as to the consequences of these and other state and local tax rules affecting investment in the Funds.
Most states provide that a regulated investment company may pass through (without restriction) to its shareholders state and local income tax exemptions available to direct owners of certain types of U.S.
government securities (such as U.S. Treasury obligations). Thus, for residents of these states, distributions derived from a Funds investment in certain types of U.S. government securities should be free from state and local income taxation to
the extent that the interest income from such investments would have been exempt from state and local taxes if such securities had been held directly by the respective shareholders. Certain states, however, do not allow a regulated investment
company to pass through to its shareholders the state and local income tax exemptions available to direct owners of certain types of U.S. government securities unless a Fund holds at least a required amount of U.S. government securities.
Accordingly, for residents of these states, distributions derived from a Funds investment in certain types of U.S. government securities may not be entitled to the exemptions from state and local income taxes that would be available if the
shareholders had purchased U.S. government securities directly. The exemption from state and local income taxes does not preclude states from asserting other taxes on the ownership of U.S. government securities. To the extent that a Fund invests to
a substantial degree in U.S. government securities which are subject to favorable state and local tax treatment, shareholders of the Fund will be notified as to the extent to which distributions from the Fund are attributable to interest on such
securities.
Tax Shelter Reporting Regulations
If a shareholder realizes a loss on disposition of a Funds shares of $2 million or more for an individual shareholder or $10 million
or more for a corporate shareholder, the shareholder must file with the Internal Revenue Service a disclosure statement on Form 8886. Direct shareholders of portfolio securities are in many cases excepted
Part II - 67
from this reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. Future guidance may extend the current exception from this reporting
requirement to shareholders of most or all regulated investment companies. The fact that a loss is reportable under these regulations does not affect the legal determination whether the taxpayers treatment of the loss is proper. Shareholders
should consult their tax advisers to determine the applicability of these regulations in light of their individual circumstances.
General Considerations
The federal income tax discussion set forth above is for general information only. Prospective
investors should consult their tax advisers regarding the specific federal tax consequences of purchasing, holding, and disposing of shares of each of the Funds, as well as the effects of state, local and foreign tax law and any proposed tax law
changes.
TRUSTEES
The names of the Trustees of the Trusts, together with information regarding their year of birth, the year each Trustee became a Board
member of the Trusts, the year each Trustee first became a Board member of any of the heritage J.P. Morgan Funds or heritage One Group Mutual Funds, principal occupations and other board memberships, including those in any company with a class of
securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the Securities Exchange Act) or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company
registered as an investment company under the 1940 Act, are shown below. The contact address for each of the Trustees is 270 Park Avenue, New York, NY 10017.
|
|
|
|
|
|
|
|
|
Name (Year of Birth; Positions with
the Funds since)
|
|
Principal Occupation
During Past 5 Years
|
|
Number of Funds
in Fund Complex
Overseen by
Trustee
(1)
|
|
|
Other Directorships Held
During the Past 5 Years
|
Independent Trustees
|
|
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|
|
|
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John F. Finn
(1947); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1998.
|
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Chairman (1985present), President and Chief Executive Officer, Gardner, Inc. (supply chain management company serving industrial and consumer markets)
(1974present).
|
|
|
165
|
|
|
Director, Cardinal Health, Inc (CAH) (1994present); Director, Greif, Inc. (GEF) (industrial package products and services) (2007present); Trustee, Columbus Association
for the Performing Arts (1988present).
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Dr. Matthew Goldstein
(1941); Chairman since 2013; Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2003.
|
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Professor, City University of New York (2013present); Chancellor, City University of New York (19992013); President, Adelphi University (New York)
(19981999).
|
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165
|
|
|
Trustee, Museum of Jewish Heritage (2011present).
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|
|
Robert J. Higgins
(1945); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2002.
|
|
Retired; Director of Administration of the State of Rhode Island (20032004); President Consumer Banking and Investment Services, Fleet Boston Financial
(19712002).
|
|
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165
|
|
|
None
|
|
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|
Peter C. Marshall
(1942); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1985.
|
|
Self-employed business consultant (2002present).
|
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165
|
|
|
None
|
Part II - 68
|
|
|
|
|
|
|
|
|
Name (Year of Birth; Positions with
the Funds since)
|
|
Principal Occupation
During Past 5 Years
|
|
Number of Funds
in Fund Complex
Overseen by
Trustee
(1)
|
|
|
Other Directorships Held
During the Past 5 Years
|
|
|
|
|
Mary E. Martinez
(1960); Trustee of Trusts since 2013
|
|
Associate, Special Properties, a Christies International Real Estate Affiliate (2010present); Managing Director, Bank of America (Asset Management) (20072008);
Chief Operating Officer, U.S. Trust Asset Management; U.S. Trust Company (asset management) (20032007); President, Excelsior Funds (registered investment companies) (20042005).
|
|
|
165
|
|
|
None
|
|
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|
Marilyn McCoy*
(1948); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1999.
|
|
Vice President of Administration and Planning, Northwestern University (1985present).
|
|
|
165
|
|
|
Trustee, Carleton College
(2003present).
|
|
|
|
|
Mitchell M. Merin
(1953); Trustee of Trusts since 2013
|
|
Retired (2005present); President and Chief Operating Officer, Morgan Stanley Investment Management, Member Morgan Stanley & Co. Management Committee (registered investment
adviser) (19852005).
|
|
|
165
|
|
|
Director, Sun Life Financial (SLF) (20072013) (financial services and insurance); Trustee, Trinity College, Hartford, CT (20022010)
|
|
|
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William G. Morton, Jr.
(1937); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2003.
|
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Retired; Chairman Emeritus (20012002), and Chairman and Chief Executive Officer, Boston Stock Exchange (19852001).
|
|
|
165
|
|
|
Director, Radio Shack Corp. (electronics) (19872008); Director, National Organization of Investment Professionals (2010present); Trustee, Stratton Mountain School
(2001present).
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|
|
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Dr. Robert A. Oden, Jr.
(1946); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1997.
|
|
Retired; President, Carleton College (2002present); President, Kenyon College
(19952002).
|
|
|
165
|
|
|
Trustee, American University in Cairo (1999present); Chairman, Dartmouth-Hitchcock Medical Center (2011present); Trustee, American Schools of Oriental Research
(2011present); Trustee, American Museum of Fly Fishing (2013present).
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Marian U. Pardo
**
(1946); Trustee of Trusts effective February 1, 2013
|
|
Managing Director and Founder, Virtual Capital Management LLC (Investment Consulting) (2007present); Managing Director, Credit Suisse Asset Management (portfolio manager)
(20032006).
|
|
|
165
|
|
|
Member, Board of Governors, Columbus Citizens Foundation (not-for-profit supporting philanthropic and cultural programs)
(2006present).
|
Part II - 69
|
|
|
|
|
|
|
|
|
Name (Year of Birth; Positions with
the Funds since)
|
|
Principal Occupation
During Past 5 Years
|
|
Number of Funds
in Fund Complex
Overseen by
Trustee
(1)
|
|
|
Other Directorships Held
During the Past 5 Years
|
|
|
|
|
Frederick W. Ruebeck
(1939); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1994.
|
|
Consultant (2000present); Advisor, JP Greene & Associates, LLC (broker-dealer) (20002009); Chief Investment Officer,
Wabash College (2004present); Director of Investments, Eli Lilly and Company (pharmaceuticals) (19881999).
|
|
|
165
|
|
|
Trustee, Wabash College (1988present); Chairman, Indianapolis Symphony Foundation (1994present).
|
|
|
|
|
James J. Schonbachler
(1943); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2001.
|
|
Retired; Managing Director of
Bankers Trust Company
(financial services)
(1968
1998).
|
|
|
165
|
|
|
None
|
Interested Trustee Not Affiliated with the Adviser
|
|
|
|
|
|
|
|
|
|
|
Frankie D. Hughes
***
(1952); Trustee of Trusts since 2008.
|
|
President and Chief Investment Officer, Hughes Capital Management, Inc. (fixed income asset management) (1993present).
|
|
|
165
|
|
|
Trustee, The Victory Portfolios (2000-2008) (investment companies)
|
(1)
|
A Fund Complex means two or more registered investment companies that hold themselves out to investors as related companies for purposes of investment and investor
services or have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other registered investment companies. The J.P. Morgan Funds Complex for which the Board of Trustees
serves currently includes twelve registered investment companies (165 funds), including JPMMFG which liquidated effective November 29, 2012, and is in the process of winding up its affairs.
|
*
|
Two members of the Board of Trustees of Northwestern University are executive officers of registered investment advisers (not affiliated with JPMorgan) that are under
common control with sub-advisers to certain J.P. Morgan Funds.
|
**
|
In connection with prior employment with JPMorgan Chase, Ms. Pardo was the recipient of
non-qualified
pension plan payments
from JPMorgan Chase in the amount of approximately $2,055 per month, which she irrevocably waived effective January 1, 2013, and deferred compensation payments from JPMorgan Chase in the amount of approximately $7,294 per year, which ended in
January 2013. In addition, Ms. Pardo receives payments from a fully-funded qualified plan, which is not an obligation of JPMorgan Chase.
|
***
|
Ms. Hughes is treated as an interested person based on the portfolio holdings of clients of Hughes Capital Management, Inc.
|
The Trustees serve for an indefinite term, subject to the Trusts current retirement policy, which is age 75 for all Trustees, except
that the Board has determined Mr. Morton should continue to serve until December 31, 2014. The Board of Trustees decides upon general policies and is responsible for overseeing the business affairs of the Trusts.
Qualifications of Trustees
The Governance Committee and the Board considered the commitment that each Trustee has demonstrated in serving on the Board including the significant time each Trustee has devoted to preparing for
meetings and the active engagement and participation of each Trustee at Board meetings. The Governance Committee and the Board also considered the character of each Trustee noting that each Trustee is committed to executing his or her duties as
a trustee with diligence, honesty and integrity. The Governance Committee and the Board also considered the contributions that each Trustee has made to the Board in terms of experience, leadership, independence and the ability to work
effectively and collaboratively with other Board members.
The Governance Committee also considered the significant and
relevant experience and knowledge that each Trustee has with respect to registered investment companies and asset management. The Governance Committee and the Board noted the additional experience that each of the Trustees has gained with respect to
registered investment companies as a result of his or her service on the J.P. Morgan Funds Board. The J.P. Morgan Funds overseen by the J.P. Morgan Funds Board represent almost every asset class including (1) fixed income funds including
traditional bond funds, municipal bond funds, high yield funds, government funds, and emerging markets
Part II - 70
debt funds, (2) money market funds, (3) international, emerging markets and country/region funds, (4) equity funds including small, mid and large capitalization funds and value and
growth funds, (5) index funds, (6) funds of funds, including target date funds, and (7) specialty funds including market neutral funds, long/short funds and funds that invest in real estate securities and commodity-related securities
and derivatives. The Governance Committee and the Board also considered the experience that each Trustee had with respect to reviewing agreements with the Funds service providers in connection with their broader service to the J.P. Morgan
Funds including the Funds investment advisers, custodian, and fund accountant.
The Governance Committee and the Board
also considered the experience and contribution of each Trustee in the context of the Boards leadership and committee structure. Prior to August 22, 2013, the Board had four committees: the Investments Committee, the Audit and Valuation
Committee, the Compliance Committee and the Governance Committee. The Investments Committee had three sub-committees: an Equity Sub-Committee, a Money Market and Alternative Products Sub-Committee and a Fixed Income Sub-Committee. Effective
August 22, 2013, the Investments Sub-Committees were reorganized into three separate investment committees: the Equity Committee, the Fixed Income Committee and the Money Market Funds/Alternative Products Committee. The Board has six committees
including the Audit and Valuation Committee, the Compliance Committee, the Governance Committee, the Equity Committee, the Money Market Funds/Alternative Products Committee, and a Fixed Income Committee. Different members of the Board serve on these
three investment committees with respect to each asset type thereby allowing the J.P. Morgan Funds Board to effectively evaluate information for the Funds in the complex in a focused, disciplined manner.
The Governance Committee also considered the operational efficiencies achieved by having a single Board for the Funds and the other
registered investment companies overseen by the Advisers and its affiliates as well as the extensive experience of certain Trustees in serving on Boards for registered investment companies advised by subsidiaries or affiliates of JPMorgan
Chase & Co. and/or Bank One Corporation (known as heritage J.P. Morgan Funds or heritage One Group Mutual Funds).
In reaching its conclusion that each Trustee should serve as a Trustee of the Trust, the Board also considered the following additional specific qualifications, contributions and experience of the
following trustee:
John F. Finn.
Mr. Finn has served on the J.P. Morgan Funds Board since 2005 and was a member of
the heritage One Group Mutual Funds Board since 1998. Until February 2013, Mr. Finn served on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, Mr. Finn has participated in the appointment of the
Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the
valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds, and acting as a liaison between the Funds independent registered
public accounting firm and the full Board. Mr. Finn currently serves as a member of the Equity Committee and the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for
election or appointment as Trustees, periodic review of the compensation payable to the Trustees, review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the
non-interested Trustees, oversight of regulatory issues or deficiencies affecting the Funds, oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. In addition,
Mr. Finn is also the head of the Strategic Planning Working Group, comprised of independent Trustees. The Strategic Planning Working Group works with the administrator to the Trust on initiatives related to efficiency and effectiveness of Board
materials and meetings.
Dr. Matthew Goldstein.
Dr. Goldstein has served as the Chairman of the Board since
January 2013 and on the J.P. Morgan Funds Board since 2005. Dr. Goldstein was a member of the heritage J.P. Morgan Funds Board since 2003. Dr. Goldstein serves as the Chairman of the Governance Committee. As a member of the Governance
Committee, he has participated in the selection and nomination of persons for election or appointment as Trustees, periodic review of the compensation payable to the Trustees, review and evaluation of the functioning of the Board and its committees,
oversight of any ongoing litigation affecting the Funds, the Advisers or the non-interested Trustees, oversight of regulatory issues or deficiencies affecting the Funds, oversight of the Funds risk management processes and oversight and review
of matters with respect to service providers to the Funds. Dr. Goldstein previously served as the Chairman of the Money Market and Alternative Products Sub-Committee.
Robert J. Higgins.
Mr. Higgins has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2002. Mr. Higgins serves as the Chairman
of the Equity Committee.
Part II - 71
Until February 2013, Mr. Higgins served on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, Mr. Higgins has participated in the appointment of the
Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the
valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds and acting as a liaison between the Funds independent registered
public accounting firm and the full Board. Mr. Higgins currently serves on the Compliance Committee. As a member of the Compliance Committee, he has participated in the oversight of the Funds compliance with legal and regulatory and
contractual requirements and compliance policies and procedures, as well as the appointment and compensation of the Funds Chief Compliance Officer. The members of the Compliance Committee also oversee the investigation and resolution of any
significant compliance incidents.
Frankie D. Hughes.
Ms. Hughes has served on the J.P. Morgan Funds Board since
2008. Until February 2013, Ms. Hughes was a member of the Fixed Income Sub-Committee. Ms. Hughes is also a member of the Compliance Committee. As a member of the Compliance Committee, she has participated in the oversight of the
Funds compliance with legal, regulatory and contractual requirements and compliance policies and procedures, as well as the appointment and compensation of the Funds Chief Compliance Officer. The members of the Compliance Committee also
oversee the investigation and resolution of any significant compliance incidents. Ms. Hughes also serves as a member of the Money Market Funds/Alternative Products Committee.
Peter C. Marshall.
Mr. Marshall has served on the J.P. Morgan Funds Board since 2005 and is currently Vice Chairman.
Mr. Marshall was also the Chairman of the heritage One Group Mutual Funds Board, serving as a member of such Board since 1985. Mr. Marshall was also an Audit Committee Financial Expert for the heritage One Group Mutual Funds.
Mr. Marshall serves as a member of the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or appointment as Directors, periodic review of the compensation
payable to the Directors, review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the non-interested Directors, oversight of regulatory issues or deficiencies
affecting the Funds, oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. Mr. Marshall also serves as a member of the Money Market Funds/ Alternative
Products Committee.
Mary E. Martinez.
Ms. Martinez has served on the J.P. Morgan Funds Board since January 2013.
In addition to the experience that Ms. Martinez has gained through her service on the J.P. Morgan Funds Board, Ms. Martinez is a senior financial services executive with over 25 years of experience in asset management, wealth management
and private banking services. She has extensive experience with respect to registered investment companies and asset management products as a result of serving as president to other registered investment companies and as a chief operating officer of
an asset management firm with responsibility for product development, management, infrastructure and operating oversight, including experience with respect to: (1) diversified product offerings including fundamental, quantitative, traditional
and alternative asset classes; (2) asset and portfolio management analytics; (3) risk management and governance; and (4) regulatory and financial reporting. Ms. Martinez also serves on the Audit and Valuation Committee. As a
member of the Audit and Valuation Committee, she has participated in the appointment of the Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and
internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements
of the Funds, and acting as a liaison between the Funds independent registered public accounting firm and the full Board. Ms. Martinez also serves as a member of the Fixed Income Committee.
Marilyn McCoy.
Ms. McCoy has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage One Group
Mutual Funds Board since 1999. Ms. McCoy is the Chairman of the Compliance Committee. As a member of the Compliance Committee, she has participated in the oversight of the Funds compliance with legal, regulatory and contractual
requirements and compliance policies and procedures, as well as the appointment and compensation of the Funds Chief Compliance Officer. The members of the Compliance Committee also oversee the investigation and resolution of any significant
compliance incidents. Ms. McCoy also serves as a member of the Equity Committee.
Mitchell M. Merin.
Mr. Merin
has served on the J.P. Morgan Funds Board since January 2013 and is the Chairman of the Money Market Funds/Alternative Products Committee. In addition to the experience that Mr. Merin has gained through his service on the J.P. Morgan Funds
Board, Mr. Merin has been in the securities and
Part II - 72
asset management business for over 25 years and has served as both a board member and president of other registered investment companies and has extensive experience with respect to
(1) taxable fixed income products and derivatives; (2) investment oversight; and (3) board governance of registered investment companies and other public companies. Mr. Merin has held leadership positions within the investment
company industry including serving as a member of the Executive Committee of the Board of Governors of the Investment Company Institute and the Chair of the Fixed Income Securities and Investment Company Committees of NASDR. Mr. Merin also
serves on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, he has participated in the appointment of the Funds independent accountants, the oversight of the performance of the Funds audit, accounting
and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds
independent audit and the financial statements of the Funds, and acting as a liaison between the Funds independent registered public accounting firm and the full Board.
William G. Morton, Jr.
Mr. Morton has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2003. Mr. Morton also serves as a
member of the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or appointment as Directors, periodic review of the compensation payable to the Directors,
review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the non-interested Directors, oversight of regulatory issues or deficiencies affecting the Funds,
oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. Mr. Morton also serves as a member of the Equity Committee.
Dr. Robert A. Oden Jr.
Dr. Oden has served on the J.P. Morgan Funds Board since 2005 and was a member of the
heritage One Group Mutual Funds Board since 1997. Until February 2013, Dr. Oden was a member of the Compliance Committee. As a member of the Compliance Committee, he has participated in the oversight of the Funds compliance with legal,
regulatory and contractual requirements and compliance policies and procedures, as well as the appointment and compensation of the Funds Chief Compliance Officer. The members of the Compliance Committee also oversee the investigation and
resolution of any significant compliance incidents. Dr. Oden currently serves as a member of the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or
appointment as Trustees, periodic review of the compensation payable to the Trustees, review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the
non-interested Trustees, oversight of regulatory issues or deficiencies affecting the Funds, oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. Dr. Oden
also serves as a member of the Fixed Income Committee.
Marian U. Pardo.
Ms. Pardo has served on the J.P. Morgan
Funds Board since February 2013. In addition to the experience that Ms. Pardo has gained through her service on the J.P. Morgan Funds Board, Ms. Pardo has been in the financial services industry since 1968, with experience in banking,
lending, and investment management, and has specific experience with respect to (1) portfolio management, (2) the J.P. Morgan Funds investment advisory business, and (3) banking and investment management. She served as a
portfolio manager for equity funds across the capitalization spectrum including, prior to 2002, small cap US equity funds advised by JPMIM. Ms. Pardo is also a member of the Compliance Committee. As a member of the Compliance Committee, she has
participated in the oversight of the Funds compliance with legal, regulatory and contractual requirements and compliance policies and procedures, as well as the appointment and compensation of the Funds Chief Compliance Officer. The
members of the Compliance Committee also oversee the investigation and resolution of any significant compliance incidents. Ms. Pardo also serves as a member of the Money Market Funds/Alternative Products Committee.
Frederick W. Ruebeck.
Mr. Ruebeck has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage One
Group Mutual Funds Board since 1994. Mr. Ruebeck is the Chairman of the Fixed Income Committee. Mr. Ruebeck also serves on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, Mr. Ruebeck has
participated in the appointment of the Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the
Board in its oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds, and acting as a liaison between the
Funds independent registered public accounting firm and the full Board.
James J. Schonbachler.
Mr.
Schonbachler has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2001. Mr. Schonbachler serves as Chairman of the Audit
Part II - 73
and Valuation Committee. In connection with his duties to the Audit and Valuation Committee, Mr. Schonbachler has participated in the appointment of the Funds independent accountants,
the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by
the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements, and acting as a liaison between the Funds independent registered public accounting firm and the full Board.
Mr. Schonbachler also serves as a member of the Fixed Income Committee.
Board Leadership Structure and
Oversight
The Board has structured itself in a manner that allows it to effectively perform its oversight function. The
Chairman of the Board is an independent Trustee, which allows him to carry out his leadership duties as Chairman with objectivity.
The Board has adopted a committee structure that allows it to effectively perform its oversight function for all of the Funds in the complex. As described under Qualifications of Trustees and
Standing Committees, the Board has six committees: the Audit and Valuation Committee, the Compliance Committee, the Governance Committee, the Equity Committee, the Fixed Income Committee and the Money Market Funds/Alternative Products
Committee. The Board has determined that the leadership and committee structure is appropriate for the Funds and allows the Board to effectively and efficiently evaluate issues that impact the J.P. Morgan Funds as a whole as well as issues that are
unique to each Fund.
The Board and the Committees take an active role in risk oversight including the
risks associated with registered investment companies including investment risk, compliance and valuation. The Governance Committee oversees and reports to the Board on the risk management processes for the Funds. In addition, in connection with its
oversight, the Board receives regular reports from the Chief Compliance Officer (CCO), the Advisers, the Administrator, and the internal audit department of JPMorgan Chase & Co. The Board also receives periodic reports from the
Chief Risk Officer of J.P. Morgan Asset Management
1
(JPMAM) including reports concerning operational controls that are designed to address market risk, credit risk, and liquidity risk among others. The Board also receives regular reports from personnel responsible for JPMAMs
business resiliency and disaster recovery.
In addition, the Board and its Committees work on an ongoing basis in fulfilling
the oversight function. At each quarterly meeting, each of the Equity Committee, the Fixed Income Committee, and the Money Market Funds/Alternative Products Committee meets with representatives of the Advisers as well as an independent consultant to
review and evaluate the ongoing performance of the Funds. Each of these three Committees reports these reviews to the full Board. The Audit and Valuation Committee is responsible for oversight of the performance of the Funds audit, accounting
and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds
independent audit and the financial statements of the Funds, and acting as a liaison between the Funds independent registered public accounting firm and the full Board. The Compliance Committee is responsible for oversight of the Funds
compliance with legal, regulatory and contractual requirements and compliance with policy and procedures. The Governance Committee is responsible for, among other things, oversight of matters relating to the Funds corporate governance
obligations and risk management processes, Fund service providers and litigation. At each quarterly meeting, each of the Governance Committee, the Audit and Valuation Committee and the Compliance Committee report their committee proceedings to the
full Board. This Committee structure allows the Board to efficiently evaluate a large amount of material and effectively fulfill its oversight function. Annually, the Board considers the efficiency of this committee structure.
Additional information about each of the Committees is included below in Standing Committees.
Standing Committees
The Board of Trustees has six standing committees
2
: the Audit and Valuation Committee, the Compliance Committee, the Governance Committee, the Equity Committee, the Fixed Income Committee, and the Money Market Funds/Alternative Products Committee
2
. The members of each Committee are set forth below:
|
|
|
|
|
Name of Committee
|
|
Members
|
|
Committee Chair
|
Audit and Valuation Committee
|
|
Mr. Schonbachler
Ms.
Martinez
Mr. Merin
Mr.
Ruebeck
|
|
Mr. Schonbachler
|
Part II - 74
|
|
|
|
|
Name of Committee
|
|
Members
|
|
Committee Chair
|
|
|
|
Compliance Committee
|
|
Ms. McCoy
Mr.
Higgins
Ms. Hughes
Ms.
Pardo
|
|
Ms. McCoy
|
Governance Committee
|
|
Dr. Goldstein
Mr.
Finn
Mr. Marshall
Mr.
Morton
Dr. Oden
|
|
Dr. Goldstein
|
Fixed Income Committee
|
|
Mr. Ruebeck
Ms.
Martinez
Dr. Oden
Mr.
Schonbachler
|
|
Mr. Ruebeck
|
Equity Committee
|
|
Mr. Higgins
Mr.
Finn
Ms. McCoy
Mr.
Morton
|
|
Mr. Higgins
|
Money Market Funds/Alternative Products Committee
|
|
Mr. Merin
Ms.
Hughes
Mr. Marshall
Ms.
Pardo
|
|
Mr. Merin
|
Audit and Valuation Committee.
The purposes of the Audit and Valuation Committee are to:
(i) appoint and determine compensation of the Funds independent accountants; (ii) evaluate the independence of the Funds independent accountants; (iii) oversee the performance of the Funds audit, accounting and
financial reporting policies, practices and internal controls and valuation policies; (iv) approve
non-audit
services, as required by the statutes and regulations administered by the SEC, including the
1940 Act and the Sarbanes-Oxley Act of 2002; (v) assist the Board in its oversight of the valuation of the Funds securities by the Adviser, as well as any
sub-adviser;
(vi) oversee the quality
and objectivity of the Funds independent audit and the financial statements of the Funds; and (vii) act as a liaison between the Funds independent registered public accounting firm and the full Board. The Audit and Valuation
Committee has delegated valuation responsibilities to any member of the Committee to respond to inquiries on valuation matters and participate in fair valuation determinations when the Funds valuation procedures require Board action, but it is
impracticable or impossible to hold a meeting of the entire Board. Prior to November 18, 2009, the Board delegated these valuation responsibilities to a Valuation
Sub-Committee
of the Audit Committee.
Compliance Committee.
The primary purposes of the Compliance Committee are to (i) oversee the Funds
compliance with legal and regulatory and contractual requirements and the Funds compliance policies and procedures; and (ii) consider the appointment, compensation and removal of the Funds Chief Compliance Officer.
Governance Committee.
The members of the Governance Committee are each Independent Trustees of the J.P. Morgan Funds. The
duties of the Governance Committee include, but are not limited to, (i) selection and nomination of persons for election or appointment as Trustees; (ii) periodic review of the compensation payable to the
non-interested
Trustees; (iii) establishment of
non-interested
Trustee expense policies; (iv) periodic review and evaluation of the functioning of the Board
and its committees; (v) with respect to the JPMT II Funds, appointment and removal of the Funds Senior Officer, and approval of compensation for the Funds Senior Officer and retention and compensation of the Senior Officers
staff and consultants; (vi) selection of independent legal counsel to the
non-interested
Trustees and legal counsel to the Funds; (vii) oversight of ongoing litigation affecting the Funds, the
Adviser or the
non-interested
Trustees; (viii) oversight of regulatory issues or deficiencies affecting the Funds (except financial matters considered by the Audit Committee); (ix) oversight of the
risk management processes for Funds; and (x) oversight and review of matters with respect to service providers to the Funds (except the Funds independent registered public accounting firm). When evaluating a person as a potential nominee
to serve as an
1
|
J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but
are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.
|
2
|
Prior to August 22, 2013, the Equity Committee, the Fixed Income Committee and the Money Market Funds/Alternative Products Committee were
sub-committees of the Investments Committee.
|
Part II - 75
Independent Trustee, the Governance Committee may consider, among other factors, (i) whether or not the person is independent and whether the person is otherwise qualified under
applicable laws and regulations to serve as a Trustee; (ii) whether or not the person is willing to serve, and willing and able to commit the time necessary for the performance of the duties of an Independent Trustee; (iii) the
contribution that the person can make to the Board and the J.P. Morgan Funds, with consideration being given to the persons business experience, education and such other factors as the Committee may consider relevant; (iv) the character
and integrity of the person; (v) the desirable personality traits, including independence, leadership and the ability to work with the other members of the Board; and (vi) to the extent consistent with the 1940 Act, such recommendations
from management as are deemed appropriate. The process of identifying nominees involves the consideration of candidates recommended by one or more of the following: current Independent Trustees, officers, shareholders and other sources that the
Governance Committee deems appropriate. The Governance Committee will review nominees recommended to the Board by shareholders and will evaluate such nominees in the same manner as it evaluates nominees identified by the Governance Committee.
Nominee recommendations may be submitted to the Secretary of the Trusts at each Trusts principal business address.
Equity Committee, Fixed Income Committee and Money Market Funds/Alternative Products Committee.
Each member of the
Board, other than Dr. Goldstein, serves on one of the following committees: the Equity Committee, the Fixed Income Committee and Money Market Funds/Alternative Products Committee. These three Committees are divided by asset type and different
members of the Board serve on each committee with respect to each asset type. The function of the Committees is to assist the Board in the oversight of the investment management services provided by the Adviser to the Funds, as well as any
sub-adviser
to the Funds. The primary purpose of each Committee is to (i) assist the Board in its oversight of the investment management services provided by the Adviser to the Funds designated for review by
each Committee; and (ii) review and make recommendations to the Board concerning the approval of proposed new or continued advisory and distribution arrangements for the Funds or for new funds. The full Board may delegate to the applicable
Committee from time to time the authority to make Board level decisions on an interim basis when it is impractical to convene a meeting of the full Board. Each of the Committees receives reports concerning investment management topics, concerns or
exceptions with respect to particular Funds that the Committee is assigned to oversee, and work to facilitate the understanding by the Board of particular issues related to investment management of Funds reviewed by the applicable Committee.
For details of the number of times each of the four standing committees met during the most recent fiscal year, see
TRUSTEES Standing Committees in Part I of this SAI.
For details of the dollar range of equity
securities owned by each Trustee in the Funds, see TRUSTEES Ownership of Securities in Part I of this SAI.
Trustee Compensation
The Trustees instituted a Deferred Compensation Plan for Eligible Trustees (the Deferred
Compensation Plan) pursuant to which the Trustees are permitted to defer part or all of their compensation. Amounts deferred are deemed invested in shares of one or more series of JPMT I, JPMT II, Undiscovered Managers Funds, JPMFMFG, and
JPMMFIT, as selected by the Trustee from time to time, to be used to measure the performance of a Trustees deferred compensation account. Amounts deferred under the Deferred Compensation Plan will be deemed to be invested in Select Class
Shares of the identified funds, unless Select Class Shares are not available, in which case the amounts will be deemed to be invested in Class A Shares. A Trustees deferred compensation account will be paid at such times as elected by the
Trustee, subject to certain mandatory payment provisions in the Deferred Compensation Plan (e.g., death of a Trustee). Deferral and payment elections under the Deferred Compensation Plan are subject to strict requirements for modification.
Each Declaration of Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses
incurred in connection with litigation in which they may be involved because of their offices with the Trust, unless, as to liability to the Trust or its shareholders, it is finally adjudicated that they engaged in willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in their offices or with respect to any matter unless it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interest
of the Trust. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or disposition, or by a reasonable determination based upon a review of readily
available facts, by vote of a majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their
duties.
Part II - 76
For details of Trustee compensation paid by the Funds, including deferred compensation,
see TRUSTEES Trustee Compensation in Part I of this SAI.
OFFICERS
The Trusts executive officers (listed below) generally are employees of the Adviser or one of its affiliates. The
officers conduct and supervise the business operations of the Trusts. The officers hold office until a successor has been elected and duly qualified. The Trusts have no employees. The names of the officers of the Funds, together with their year of
birth, information regarding their positions held with the Trusts and principal occupations are shown below. The contact address for each of the officers, unless otherwise noted, is 270 Park Avenue, New York, NY 10017.
|
|
|
Name (Year of Birth),
Positions Held with
the Trusts
(Since)
|
|
Principal Occupations During Past 5 Years
|
Robert L. Young (1963),
President and Principal Executive Officer (2013)**
|
|
Chief Operating Officer and Director, J.P. Morgan Investment Management Inc. since 2010; Senior Vice President, J.P. Morgan Funds (2005-2010), Chief Operating Officer, J.P.
Morgan Funds (2005-2010); Director and various officer positions for JPMorgan Funds Management, Inc. (formerly One Group Administrative Services) and JPMorgan Distribution Services, Inc. (formerly One Group Dealer Services, Inc.) from 1999 to
present. Mr. Young has been with JPMorgan Chase & Co. (formerly Bank One Corporation) since 1997.
|
Laura M. Del Prato (1964), Treasurer and Principal Financial Officer (2014)
|
|
Managing Director, JPMorgan Funds Management, Inc. (since 2014); Partner, Cohen Fund Audit Services, Ltd. (2012-2013); Partner
(2004-2012) and various other titles (1990-2004) at KPMG, LLP.
|
Frank J. Nasta (1964),
Secretary (2008)
|
|
Managing Director and Associate General Counsel, JPMorgan Chase since 2008; Previously, Director, Managing Director, General Counsel and Corporate Secretary, J. & W. Seligman
& Co. Incorporated; Secretary of each of the investment companies of the Seligman Group of Funds and Seligman Data Corp.; Director and Corporate Secretary, Seligman Advisors, Inc. and Seligman Services, Inc.
|
Stephen M. Ungerman (1953),
Chief Compliance Officer (2005)
|
|
Managing Director, JPMorgan Chase & Co.; Mr. Ungerman has been with JPMorgan Chase & Co. since 2000.
|
Kathryn A. Jackson (1962),
AML Compliance Officer (2012)*
|
|
Vice President and AML Compliance Manager for JPMorgan Asset Management Compliance since 2011; Senior
On-Boarding
Specialist for JPMorgan Distribution Services, Inc. in Global Liquidity from 2008 to 2011; prior to joining JPMorgan, Ms. Jackson was a Financial Services Analyst responsible for
on-boarding,
compliance and training with Nationwide Securities LLC and 1717 Capital Management Company, both registered broker-dealers, from 2005 until 2008.
|
Elizabeth A. Davin (1964),
Assistant Secretary (2005)**
|
|
Executive Director and Assistant General Counsel, JPMorgan Chase since February 2012; formerly Vice President and Assistant General Counsel, JPMorgan Chase from 2005 until
February 2012; Senior Counsel, JPMorgan Chase (formerly Bank One Corporation) from 2004 to 2005.
|
Jessica K. Ditullio (1962),
Assistant Secretary (2005)**
|
|
Executive Director and Assistant General Counsel, JPMorgan Chase since February 2011; Ms. Ditullio has served as an attorney with various titles for JPMorgan Chase (formerly Bank
One Corporation) since 1990.
|
John T. Fitzgerald (1975),
Assistant Secretary (2008)
|
|
Executive Director and Assistant General Counsel, JPMorgan Chase since February 2011; formerly, Vice President and Assistant General Counsel, JPMorgan Chase from 2005 until
February 2011.
|
Carmine Lekstutis (1980),
Assistant Secretary (2011)
|
|
Vice President and Assistant General Counsel, JPMorgan Chase since 2011; Associate, Skadden, Arps, Slate, Meagher & Flom LLP (law firm) from 2006 to
2011.
|
Part II - 77
|
|
|
Name (Year of Birth),
Positions Held with
the Trusts
(Since)
|
|
Principal Occupations During Past 5 Years
|
Gregory S. Samuels (1980)
Assistant Secretary (2010)
|
|
Executive Director and Assistant General Counsel, JPMorgan Chase since February 2014; formerly Vice President and Assistant General Counsel, JPMorgan Chase from 2010 to February
2014; Associate, Ropes & Gray (law firm) from 2008 to 2010; Associate, Clifford Chance LLP (law firm) from 2005 to 2008.
|
Pamela L. Woodley (1971),
Assistant Secretary (2012)
|
|
Vice President and Assistant General Counsel, JPMorgan Chase since November 2004.
|
Michael M. DAmbrosio (1969),
Assistant Treasurer (2012)
|
|
Executive Director, JPMorgan Funds Management, Inc. from July 2012; prior to joining JPMorgan Chase, Mr. DAmbrosio was a Tax Director at PricewaterhouseCoopers LLP since
2006.
|
Joseph Parascondola (1963),
Assistant Treasurer (2011)
|
|
Vice President, JPMorgan Funds Management, Inc. since August 2006.
|
Matthew J. Plastina (1970),
Assistant Treasurer (2011)
|
|
Vice President, JPMorgan Funds Management, Inc. since August 2010; prior to August 2010, Vice President and Controller, Legg Mason Global Asset Management.
|
Julie A. Roach (1971),
Assistant Treasurer (2012)**
|
|
Vice President, JPMorgan Funds Management, Inc. from August 2012; prior to joining JPMorgan Chase, Ms. Roach was a Senior Manager with Deloitte since 2001.
|
Gillian I. Sands (1969),
Assistant Treasurer (2012)
|
|
Vice President, JPMorgan Funds Management, Inc. from September 2012; Assistant Treasurer, Wells Fargo Funds Management (20072009)
|
*
|
The contact address for the officer is 500 Stanton Christiana Road, Ops 1, Floor 02, Newark, DE 19173-2107.
|
**
|
The contact address for the officer is 460 Polaris Parkway, Westerville, OH 43082.
|
For details of the percentage of shares of any class of each Fund owned by the officers and Trustees, as a group, see SHARE
OWNERSHIP Trustees and Officers in Part I of this SAI.
INVESTMENT ADVISERS
AND
SUB-ADVISERS
Pursuant to investment advisory agreements, JPMIM serves as
investment adviser to the Funds, except for U.S. Core Real Estate Securities Fund. SCR&M serves as investment adviser for the U.S. Core Real Estate Securities Fund pursuant to an agreement with JPMT I. JFIMI serves as
sub-adviser
to certain funds pursuant to an investment
sub-advisory
agreement with JPMIM.
The Trusts Shares are not sponsored, endorsed or guaranteed by, and do not constitute obligations or deposits of JPMorgan Chase, any bank affiliate of JPMIM or any other bank, and are not insured by
the FDIC or issued or guaranteed by the U.S. government or any of its agencies.
For details of the investment advisory fees
paid under an applicable advisory agreement, see INVESTMENT ADVISERS Investment Advisory Fees in Part I of the SAI for the respective Fund.
For details of the dollar range of shares of each Fund (excluding Money Market Funds) beneficially owned by the portfolio managers who serve on a team that manages such Fund, see PORTFOLIO
MANAGERS Portfolio Managers Other Accounts Managed in Part I of this SAI.
J.P. Morgan Investment Management Inc
(JPMIM).
JPMIM serves as investment adviser to certain Funds pursuant to the investment advisory agreements between JPMIM and certain of the Trusts (the JPMIM Advisory
Agreements). Effective October 1, 2003, JPMIM became a wholly-owned subsidiary of JPMorgan Asset Management Holdings Inc., which is a wholly-owned subsidiary of JPMorgan Chase & Co. (JPMorgan Chase). Prior to
October 1, 2003, JPMIM was a wholly-owned subsidiary of JPMorgan Chase, a bank holding company organized under the laws of the State of Delaware which was formed from the merger of J.P. Morgan & Co. Incorporated with and into The Chase
Manhattan Corporation.
JPMIM is a registered investment adviser under the Investment Advisers Act of 1940, as amended. JPMIM
is located at 270 Park Avenue, New York, NY 10017.
Under the JPMIM Advisory Agreements, JPMIM provides investment advisory
services to certain Funds, which include managing the purchase, retention and disposition of such Funds investments. JPMIM may delegate
Part II - 78
its responsibilities to a
sub-adviser.
Any subadvisory agreements must be approved by the applicable Trusts Board of Trustees and the applicable
Funds shareholders, as required by the 1940 Act.
Under separate agreements, JPMorgan Chase Bank, JPMorgan Funds
Management, Inc. (formerly One Group Administrative Services, Inc.) (JPMFM), and JPMorgan Distribution Services, Inc. (JPMDS) provide certain custodial, fund accounting, recordkeeping and administrative services to the Trusts
and the Funds and shareholder services for the Trusts. JPMDS is the shareholder servicing agent and the distributor for certain Funds. JPMorgan Chase Bank, JPMFM and JPMDS are each affiliates of JPMIM. See the Custodian,
Administrator, Shareholder Servicing and Distributor sections.
Under the terms of the
JPMIM Advisory Agreements, the investment advisory services JPMIM provides to certain Funds are not exclusive. JPMIM is free to and does render similar investment advisory services to others. JPMIM serves as investment adviser to personal investors
and other investment companies and acts as fiduciary for trusts, estates and employee benefit plans. Certain of the assets of trusts and estates under management are invested in common trust funds for which JPMIM serves as trustee. The accounts
which are managed or advised by JPMIM have varying investment objectives, and JPMIM invests assets of such accounts in investments substantially similar to, or the same as, those which are expected to constitute the principal investments of certain
Funds. Such accounts are supervised by employees of JPMIM who may also be acting in similar capacities for the Funds. See Portfolio Transactions.
The Funds are managed by employees of JPMIM who, in acting for their customers, including the Funds, do not discuss their investment decisions with any personnel of JPMorgan Chase or any personnel of
other divisions of JPMIM or with any of their affiliated persons, with the exception of certain other investment management affiliates of JPMorgan Chase which execute transactions on behalf of the Funds.
As compensation for the services rendered and related expenses, such as salaries of advisory personnel borne by JPMIM or a predecessor,
under the JPMIM Advisory Agreements, the applicable Trusts, on behalf of the Funds, have agreed to pay JPMIM a fee, which is computed daily and may be paid monthly, equal to the annual rate of each Funds average daily net assets as described
in the applicable Prospectuses.
The JPMIM Advisory Agreements continue in effect for annual periods beyond October 31 of
each year only if specifically approved thereafter annually in the same manner as the Distribution Agreement; except that for new funds, the initial approval will continue for up to two years, after which annual approvals are required. See the
Distributor section. The JPMIM Advisory Agreements will terminate automatically if assigned and are terminable at any time without penalty by a vote of a majority of the Trustees, or by a vote of the holders of a majority of a
Funds outstanding voting securities (as defined in the 1940 Act), on 60 days written notice to JPMIM and by JPMIM on 90 days written notice to the Trusts (60 days with respect to the International Equity Index Fund, Mid Cap Value
Fund and Growth Advantage Fund). The continuation of the JPMIM Advisory Agreements was last approved by the Board of Trustees at its meeting in August 2013.
The JPMIM Advisory Agreements provide that the Adviser shall not be liable for any error of judgment or mistake of law or for any loss suffered by the Trust in connection with the performance of the
respective investment advisory agreement, except a loss resulting from willful misfeasance, bad faith, or gross negligence on the part of the Adviser in the performance of its duties, or from reckless disregard by it of its duties and obligations
thereunder, or, with respect to all such Funds except the Mid Cap Value Fund, a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services.
Prior to January 1, 2010, JPMIA served as investment adviser to certain JPMT II Funds pursuant to the Amended and Restated Investment
Advisory Agreement between JPMIA and JPMT II dated August 12, 2004 (the JPMIA Advisory Agreement). On July 1, 2004, Bank One Corporation, the former indirect corporate parent of JPMIA, merged into J.P. Morgan Chase &
Co. (now officially known as JPMorgan Chase & Co.). On that date, JPMIA became an indirect, wholly-owned subsidiary of JPMorgan Chase. JPMIA is a registered investment adviser under the Investment Advisers Act of 1940, as amended. Effective
January 1, 2010 (the Effective Date), the investment advisory business of JPMIA was transferred to JPMIM and JPMIM became the investment adviser for the applicable Funds under the JPMIA Advisory Agreement. The appointment of JPMIM
did not change the portfolio management team, the investment strategies, the investment advisory fees charged to the Funds or the terms of the JPMIA Advisory Agreement (other than the identity of the investment adviser). Shareholder approval was not
required for the replacement of JPMIA by JPMIM.
Subject to the supervision of a Trusts Board of Trustees, JPMIM provides
or will cause to be provided a continuous investment program for certain Funds, including investment research and management with respect to all securities and investments and cash equivalents in those Funds. JPMIM may delegate its responsibilities
to a
Part II - 79
sub-adviser.
Any subadvisory agreements must be approved by the Trusts Board of Trustees and the applicable Funds shareholders, as required by
the 1940 Act.
The JPMIA Advisory Agreement continues in effect for annual periods beyond October 31 of each year, if such
continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund (as defined under Additional Information in this SAI), and a majority of the Trustees who are
not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective investment advisory agreements by votes cast in person at a meeting called for such purpose. The
continuation of the JPMIA Advisory Agreement was approved by the Trusts Board of Trustees at its meeting held in August 2009.
The JPMIA Advisory Agreement may be terminated as to a particular Fund at any time on 60 days written notice without penalty by the Trustees, by vote of a majority of the outstanding Shares of that
Fund, or by the Funds Adviser as the case may be. The JPMIA Advisory Agreement also terminates automatically in the event of any assignment, as defined in the 1940 Act.
As compensation for the services rendered and related expenses, such as salaries of advisory personnel borne by JPMIM, under the JPMIA Advisory Agreement, the applicable Trusts, on behalf of the Funds,
have agreed to pay JPMIM a fee, which is computed daily and may be paid monthly, equal to the annual rate of each Funds average daily net assets as described in the applicable Prospectuses.
The JPMIA Advisory Agreement provides that the Adviser shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Trust in connection with the performance of the respective investment advisory agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from
willful misfeasance, bad faith, or gross negligence on the part of the Adviser in the performance of its duties, or from reckless disregard by it of its duties and obligations thereunder.
JPMorgan Chase Bank, JPMFM and JPMDS are each subsidiaries of JPMorgan Chase and affiliates of JPMIM. See the Custodian,
Administrator, Shareholder Servicing and Distributor sections.
Security Capital Research & Management Incorporated (SCR&M).
SCR&M serves as investment adviser to the U.S. Core Real Estate Securities Fund pursuant to an agreement with JPMT I, on behalf of the U.S. Core Real
Estate Securities Fund (the Core Real Estate Securities Fund Investment Advisory Agreement). SCR&M was formed in January 1995 to provide investment advisory services related to real estate assets to various clients. SCR&M is a
direct, wholly-owned subsidiary of JPMorgan Asset Management Holdings Inc.
SCR&M makes the investment decisions for the
assets of the U.S. Core Real Estate Securities Fund. SCR&M also reviews, supervises and administers each such Funds investment program, subject to the supervision of, and policies established by, the Trustees. SCR&M is located at 10
South Dearborn Street, Suite 1400, Chicago, IL 60603.
The Core Real Estate Securities Fund Investment Advisory Agreement
provides that it will continue in effect for successive twelve month periods beyond October 31 of each year if not terminated or approved at least annually by the Trusts Board of Trustees. The Core Real Estate Securities Fund Investment
Advisory Agreement was initially approved by the Trusts Board of Trustees at their quarterly meeting on May 17, 2011 and may be terminated as to the U.S. Core Real Estate Securities Fund at any time on 60 days written notice without
penalty by the Trustees, by vote of a majority of the outstanding Shares of that Fund, or by the Funds Adviser. The Core Real Estate Securities Fund Investment Advisory Agreement also terminates automatically in the event of any assignment, as
defined in the 1940 Act.
The Core Real Estate Securities Fund Investment Advisory Agreement provide that the Adviser shall not
be liable for any error of judgment or mistake of law or for any loss suffered by the respective Trust in connection with the performance under the agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad faith, or gross negligence on the part of the Adviser in the performance of its duties, or from reckless disregard by it of its duties and obligations thereunder.
JF International Management Inc. (JFIMI).
JPMIM has entered into two
investment
sub-advisory
agreements with JFIMI, one agreement with respect to the China Region Fund and one with respect to the Asia Pacific Fund (the JFIMI
Sub-Advisory
Agreements) pursuant to which JFIMI serves as investment
sub-adviser
to such Funds. JFIMI is registered as a registered investment adviser under the
Investment Advisers Act and the Hong Kong Securities and Futures Commission. JFIMI is a
wholly-owned
subsidiary of J.P. Morgan Asset Management
Part II - 80
(Asia) Inc., which is wholly-owned by JPMorgan Asset Management Holdings Inc. (JPMAMH). JFIMI is located at 21F, Charter House, 8 Connaught Road, Central Hong Kong.
JFIMI may, in its discretion, provide such services through its own employees or the employees of one or more affiliated companies that
are qualified to act as an investment adviser to a Fund under applicable laws and that are under the common control of JPMIM; provided that (i) all persons, when providing services under the JFIMI
Sub-Advisory
Agreements, are functioning as part of an organized group of persons, and (ii) such organized group of persons is managed at all times by authorized officers of JFIMI. This arrangement will
not result in the payment of additional fees by a Fund.
Pursuant to the terms of the applicable JPMIM Advisory Agreement and
the JFIMI
Sub-Advisory
Agreements, the Adviser and
Sub-Adviser
are permitted to render services to others. Each such agreement is terminable without penalty by the
applicable Trusts, on behalf of the Funds, on not more than 60 days, nor less than 30 days, written notice when authorized either by a majority vote of a Funds shareholders or by a vote of a majority of the Boards of Trustees of
the Trusts, or by JPMIM or JFIMI on not more than 60 days, nor less than 30 days, written notice, and will automatically terminate in the event of its assignment (as defined in the 1940 Act). The applicable JPMIM Advisory
Agreement provides that JPMIM or JFIMI shall not be liable for any error of judgment or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of portfolio transactions for a Fund, except for willful
misfeasance, bad faith or gross negligence in the performance of its duties, or by reason of reckless disregard of its obligations and duties thereunder.
As compensation for the services rendered and related expenses borne by JFIMI, under the applicable JFIMI
Sub-Advisory
Agreement, JPMIM has agreed to pay JFIMI a
fee, which is computed daily and may be paid monthly, at the rate of 0.60% per annum on the average daily net asset value of the assets of the China Region Fund and at the rate of 0.40% per annum on the average daily net asset value of the
assets of the Asia Pacific Fund.
The JFIMI
Sub-Advisory
Agreement applicable to the
Asia Pacific Fund provides that it will continue in effect, if not terminated, from year to year, if such continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund
(as defined under Additional Information in this SAI), and a majority of the Trustees who are not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective
investment advisory agreements by votes cast in person at a meeting called for such purpose. The continuation of the JFIMI
Sub-Advisory
Agreement applicable to the Asia Pacific Fund was approved by the
Trusts Board of Trustees at its meeting held in August 2011.
The JFIMI
Sub-Advisory
Agreement applicable to the China Region Fund provides that it will continue in effect for an initial
two-year
period and thereafter, if not terminated,
from year to year, if such continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund (as defined under Additional Information in this SAI), and a
majority of the Trustees who are not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective investment advisory agreements by votes cast in person at a meeting
called for such purpose. The continuation of the JFIMI
Sub-Advisory
Agreement applicable to the China Region Fund was approved by the Trusts Board of Trustees at its meeting held in August 2009.
Each JFIMI
Sub-Advisory
Agreement provides that the
Sub-Adviser
shall not be liable for any error of judgment or for any loss suffered by the Trust in connection with the performance under the agreement, except a loss resulting from willful misfeasance, bad
faith, or gross negligence on the part of the
Sub-Adviser
in the performance of its duties, or from reckless disregard by it of its duties and obligations thereunder.
J.P. Morgan Private Investments, Inc. (JPMPI).
JPMPI has been engaged by JPMIM to serve
as investment
sub-adviser
to the JPMorgan Access Balanced Fund and JPMorgan Access Growth Fund (the JPMPI
Sub-Advisory
Agreement). JPMPI is a wholly owned
subsidiary of JPMorgan Chase & Co. JPMPI is located at 270 Park Avenue, New York, NY 10017.
JPMPI is paid monthly by
JPMIM a fee equal to a percentage of the average daily net assets of the JPMorgan Access Balanced Fund and JPMorgan Access Growth Fund. The aggregate annual rate of the fees payable by JPMIM to JPMPI is 0.95% of the portion of each of the JPMorgan
Access Balanced Funds and JPMorgan Access Growth Funds average daily net assets managed by JPMPI.
The JPMPI
Sub-Advisory
Agreement will continue in effect for a period of two years from the date of its execution, unless terminated sooner. It may be renewed from year to year thereafter, so long as continuance is
specifically approved at least annually in accordance with the requirements of the 1940 Act.
Part II - 81
The JPMPI
Sub-Advisory
Agreement provides that it
will terminate in the event of an assignment (as defined in the 1940 Act), and may be terminated without penalty at any time by either party upon 60 days written notice, or upon termination of the JPMIM Advisory Agreement. Under
the terms of the JPMPI
Sub-Advisory
Agreement, JPMPI is not liable to JPMIM, the JPMorgan Access Balanced Fund or the JPMorgan Access Growth Fund, or their shareholders, for any error of judgment or mistake of
law or for any losses sustained by JPMIM, the JPMorgan Access Balanced Fund or the JPMorgan Access Growth Fund or their shareholders, except in the case of JPMPIs willful misfeasance, bad faith, gross negligence or reckless disregard of
obligations or duties under the JPMPI
Sub-Advisory
Agreement.
POTENTIAL CONFLICTS OF INTEREST
The chart in Part I of this SAI (excluding the Money Market Funds) entitled
Portfolio Managers Other Accounts Managed shows the number, type and market value as of a specified date of the accounts other than the Funds that are managed by the Funds portfolio managers. The potential for conflicts of
interest exists when portfolio managers manage other accounts with similar investment objectives and strategies as the Funds (Similar Accounts). Potential conflicts may include, for example, conflicts between investment strategies and
conflicts in the allocation of investment opportunities. Responsibility for managing the Advisers and its affiliates clients portfolios is organized according to investment strategies within asset classes. Generally, client
portfolios with similar strategies are managed by portfolio managers in the same portfolio management group using the same objectives, approach and philosophy. Underlying sectors or strategy allocations within a larger portfolio are likewise managed
by portfolio managers who use the same approach and philosophy as similarly managed portfolios. Therefore, portfolio holdings, relative position sizes and industry and sector exposures tend to be similar across similar portfolios and strategies,
which minimizes the potential for conflicts of interest.
The Advisers and/or their affiliates (together, JPMorgan)
perform investment services, including rendering investment advice, to varied clients. The Advisers, JPMorgan and their directors, officers, agents, and/or employees may render similar or differing investment advisory services to clients, including
the Funds, and may give advice or exercise investment responsibility and take such other action with respect to any of their other clients that differs from the advice given or the timing or nature of action taken with respect to another client or
group of clients, including the Funds. It is the Advisers policy to the extent practicable, to allocate, within their reasonable discretion, investment opportunities among clients, including the Funds, over a period of time on a fair and
equitable basis. One or more of the Advisers other client accounts may at any time hold, acquire, increase, decrease, dispose, or otherwise deal with positions in the investments in which another client account, including the Funds, may have
an interest from time-to-time.
The Advisers, JPMorgan, JPMorgan Chase and any of their directors, partners, officers, agents
or employees, may also buy, sell, or trade securities for their own accounts or the proprietary accounts of an Adviser, JPMorgan and/or JPMorgan Chase. The Advisers, JPMorgan and/or JPMorgan Chase, within their discretion, may make different
investment decisions and other actions with respect to their own proprietary accounts than those made for client accounts, including the Funds, including the timing or nature of such investment decisions or actions. Further, the Advisers are not
required to purchase or sell for any client accounts, including the Funds, securities that they, JPMorgan, JPMorgan Chase and/or any of their employees, principals, or agents may purchase or sell for their own accounts or the proprietary accounts of
the Advisers, JPMorgan or JPMorgan chase or their clients.
The Adviser and/or its affiliates may receive more compensation
with respect to certain Similar Accounts than that received with respect to the Funds or may receive compensation based in part on the performance of certain Similar Accounts. This may create a potential conflict of interest for the Adviser and its
affiliates or the portfolio managers by providing an incentive to favor these Similar Accounts when, for example, placing securities transactions. In addition, the Adviser or its affiliates could be viewed as having a conflict of interest to the
extent that the Adviser or an affiliate has a proprietary investment in Similar Accounts, the portfolio managers have personal investments in Similar Accounts or the Similar Accounts are investment options in the Advisers or its
affiliates employee benefit plans. Potential conflicts of interest may arise with both the aggregation and allocation of securities transactions and allocation of investment opportunities because of market factors or investment restrictions
imposed upon the Adviser and its affiliates by law, regulation, contract or internal policies. Allocations of aggregated trades, particularly trade orders that were only partially completed due to limited availability and allocation of investment
opportunities generally, could raise a potential conflict of interest, as the Adviser or its affiliates may have an incentive to allocate securities that are expected to increase in value to favored accounts. Initial public offerings, in particular,
are frequently of very limited availability. The Adviser and its affiliates may be perceived as causing accounts they manage to participate in an offering to increase the Advisers and its affiliates
Part II - 82
overall allocation of securities in that offering. A potential conflict of interest also may be perceived to arise if transactions in one account closely follow related transactions in a
different account, such as when a purchase increases the value of securities previously purchased by another account, or when a sale in one account lowers the sale price received in a sale by a second account. If the Adviser or its affiliates manage
accounts that engage in short sales of securities of the type in which the Fund invests, the Adviser or its affiliates could be seen as harming the performance of the Fund for the benefit of the accounts engaging in short sales if the short sales
cause the market value of the securities to fall.
As an internal policy matter, the Adviser or its affiliates may from time to
time maintain certain overall investment limitations on the securities positions or positions in other financial instruments the Adviser or its affiliates will take on behalf of its various clients due to, among other things, liquidity concerns and
regulatory restrictions. Such policies may preclude a Fund from purchasing particular securities or financial instruments, even if such securities or financial instruments would otherwise meet the Funds objectives.
The Adviser and/or its affiliates serve as adviser to the Funds as well as certain Funds of Funds. The Funds of Funds may invest in shares
of the Funds (other than the Funds of Funds). Because the Adviser and/or its affiliates is the adviser to the Funds and it or its affiliates is adviser to the Funds of Funds, it may be subject to certain potential conflicts of interest when
allocating the assets of the Funds of Funds among the Funds. Purchases and redemptions of Fund shares by a Fund of Funds due to reallocations or rebalancings may result in a Fund having to sell securities or invest cash when it otherwise would not
do so. Such transactions could accelerate the realization of taxable income if sales of securities resulted in gains and could also increase a Funds transaction costs. Large redemptions by a Fund of Funds may cause a Funds expense ratio
to increase due to a resulting smaller asset base. To the extent that the portfolio managers for the Funds of Funds also serve as portfolio managers for any of the Funds, the portfolio managers may have regular and continuous access to the holdings
of such Funds. In addition, the portfolio managers of the Funds of Funds may have access to the holdings of some of the Funds as well as knowledge of and a potential impact on investment strategies and techniques of the Funds.
The goal of the Adviser and its affiliates is to meet their fiduciary obligation with respect to all clients. The Adviser and its
affiliates have policies and procedures that seek to manage conflicts. The Adviser and its affiliates monitor a variety of areas, including compliance with fund guidelines, review of allocation decisions and compliance with the Advisers Codes
of Ethics and JPMorgan Chase and Co.s Code of Conduct. With respect to the allocation of investment opportunities, the Adviser and its affiliates also have certain policies designed to achieve fair and equitable allocation of investment
opportunities among its clients over time. For example:
Orders for the same equity security traded through a single trading
desk or system are aggregated on a continual basis throughout each trading day consistent with the Advisers and its affiliates duty of best execution for its clients. If aggregated trades are fully executed, accounts participating in the
trade will be allocated their pro rata share on an average price basis. Partially completed orders generally will be allocated among the participating accounts on a
pro-rata
average price basis, subject to
certain limited exceptions. For example, accounts that would receive a
de minimis
allocation relative to their size may be excluded from the order. Another exception may occur when thin markets or price volatility require that an aggregated
order be completed in multiple executions over several days. If partial completion of the order would result in an uneconomic allocation to an account due to fixed transaction or custody costs, the Adviser and its affiliates may exclude small orders
until 50% of the total order is completed. Then the small orders will be executed. Following this procedure, small orders will lag in the early execution of the order, but will be completed before completion of the total order.
Purchases of money market instruments and fixed income securities cannot always be allocated
pro-rata
across the accounts with the same investment strategy and objective. However, the Adviser and its affiliates attempt to mitigate any potential unfairness by basing
non-pro
rata allocations traded through a single trading desk or system upon objective predetermined criteria for the selection of investments and a disciplined process for allocating securities with similar
duration, credit quality and liquidity in the good faith judgment of the Adviser or its affiliates so that fair and equitable allocation will occur over time.
Fees earned by JPMPI for managing certain accounts may vary, particularly because for multiple accounts, JPMPI is paid based upon the performance results for those accounts. In addition, some of the
portfolio managers have personal investments in other accounts. This could create a conflict of interest because the portfolio managers could have an incentive to favor certain accounts over others, resulting in other accounts outperforming the
Fund. JPMPI believes that such conflicts are mitigated in part because the Fund will be investing predominantly in mutual funds and structured notes, the prices of which are fixed at the close of the trading day for all investors. With respect to
other securities, JPMPI utilizes JPMIMs trading desk and systems in order to participate in JPMIMs policies
Part II - 83
designed to achieve fair and equitable allocation of investment opportunities. JPMPI also has policies and procedures that seek to manage conflicts and monitors a variety of areas, including
compliance with fund guidelines, review of allocation decisions and compliance with its Code of Ethics and JPMCs Code of Conduct.
For details of the dollar range of shares of each Fund (excluding the Money Market Funds) beneficially owned by the portfolio managers, see PORTFOLIO MANAGERS Ownership of Securities
in Part I of this SAI.
PORTFOLIO MANAGER COMPENSATION
Each Advisers portfolio managers participate in a competitive compensation program that is designed to attract and retain
outstanding people and closely link the performance of investment professionals to client investment objectives. The total compensation program includes a base salary fixed from year to year and a variable performance bonus consisting of cash
incentives and restricted stock and may include mandatory notional investments (as described below) in selected mutual funds advised by the Adviser or its affiliates. These elements reflect individual performance and the performance of the
Advisers business as a whole.
Each portfolio managers performance is formally evaluated annually based on a
variety of factors including the aggregate size and blended performance of the portfolios such portfolio manager manages. Individual contribution relative to client goals carries the highest impact. Portfolio manager compensation is primarily driven
by meeting or exceeding clients risk and return objectives, relative performance to competitors or competitive indices and compliance with firm policies and regulatory requirements. In evaluating each portfolio managers performance with
respect to the mutual funds he or she manages, the Funds
pre-tax
performance is compared to the appropriate market peer group and to each Funds benchmark index listed in the Funds
prospectuses over one, three and five year periods (or such shorter time as the portfolio manager has managed the Fund). Investment performance is generally more heavily weighted to the long-term.
Awards of restricted stock are granted as part of an employees annual performance bonus and comprise from 0% to 40% of a portfolio
managers total bonus. As the level of incentive compensation increases, the percentage of compensation awarded in restricted stock also increases. Up to 50% of the restricted stock portion of a portfolio managers bonus may instead be
subject to mandatory notional investment in selected mutual funds advised by the Adviser or its affiliates. When these awards vest over time, the portfolio manager receives cash equal to the market value of the notional investment in the selected
mutual funds.
CODES OF ETHICS
The Trusts, the Advisers and JPMDS have each adopted codes of ethics pursuant to Rule
17j-1
under
the 1940 Act (and pursuant to Rule
204A-1
under the Advisers Act with respect to the Advisers).
The Trusts code of ethics includes policies which require access persons (as defined in Rule
17j-1)
to: (i) place the interest of Trust
shareholders first; (ii) conduct personal securities transactions in a manner that avoids any actual or potential conflict of interest or any abuse of a position of trust and responsibility; and (iii) refrain from taking inappropriate
advantage of his or her position with the Trusts or a Fund. The Trusts code of ethics prohibits any access person from: (i) employing any device, scheme or artifice to defraud the Trusts or a Fund; (ii) making to the Trusts or a Fund
any untrue statement of a material fact or omit to state to the Trusts or a Fund a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading; (iii) engaging in any act,
practice, or course of business which operates or would operate as a fraud or deceit upon the Trusts or a Fund; or (iv) engaging in any manipulative practice with respect to the Trusts or a Fund. The Trusts code of ethics permits
personnel subject to the code to invest in securities, including securities that may be purchased or held by a Fund so long as such investment transactions are not in contravention of the above noted policies and prohibitions.
The code of ethics adopted by the Advisers requires that all employees must: (i) place the interest of the accounts which are managed
by the Adviser first; (ii) conduct all personal securities transactions in a manner that is consistent with the code of ethics and the individual employees position of trust and responsibility; and (iii) refrain from taking
inappropriate advantage of their position. Employees of each Adviser are also prohibited from certain mutual fund trading activity including excessive trading of shares of a mutual fund as described in the applicable Funds Prospectuses or SAI
and effecting or facilitating a mutual fund transaction to engage in market timing. The Advisers code of ethics permits personnel subject to the code to invest in securities, including securities that may be purchased or held by a Fund subject
to certain restrictions. However, all employees are required to preclear securities
Part II - 84
trades (except for certain types of securities such as
non-proprietary
mutual fund shares and U.S. government securities). Each of the Advisers
affiliated
sub-advisers
has also adopted the code of ethics described above.
JPMDSs code of ethics requires that all employees of JPMDS must: (i) place the interest of the accounts which are managed by
affiliates of JPMDS first; (ii) conduct all personal securities transactions in a manner that is consistent with the code of ethics and the individual employees position of trust and responsibility; and (iii) refrain from taking
inappropriate advantage of their positions. Employees of JPMDS are also prohibited from certain mutual fund trading activity, including excessive trading of shares of a mutual fund as such term is defined in the applicable Funds Prospectuses
or SAI, or effecting or facilitating a mutual fund transaction to engage in market timing. JPMDSs code of ethics permits personnel subject to the code to invest in securities, including securities that may be purchased or held by the Funds
subject to the policies and restrictions in such code of ethics.
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions.
Pursuant to the Advisory and
sub-advisory
Agreements, the Advisers determine, subject to the general supervision of the Board of Trustees of the Trusts and in accordance with each Funds investment objective and restrictions, which
securities are to be purchased and sold by each such Fund and which brokers are to be eligible to execute its portfolio transactions. The Advisers operate independently in providing services to their respective clients. Investment decisions are the
product of many factors in addition to basic suitability for the particular client involved. Thus, for example, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the
same time. Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In some instances, one client may sell a particular security to another client. It also happens that two or
more clients may simultaneously buy or sell the same security, in which event each days transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in the opinion of the
Adviser is equitable to each and in accordance with the amount being purchased or sold by each. There may be circumstances when purchases or sales of portfolio securities for one or more clients will have an adverse effect on other clients.
Brokerage and Research Services.
On behalf of the Funds, a Funds Adviser places
orders for all purchases and sales of portfolio securities, enters into repurchase agreements, and may enter into reverse repurchase agreements and execute loans of portfolio securities on behalf of a Fund unless otherwise prohibited. See
Investment Strategies and Policies.
Fixed income and debt securities and municipal bonds and notes are generally
traded at a net price with dealers acting as principal for their own accounts without a stated commission. The price of the security usually includes profit to the dealers. In underwritten offerings, securities are purchased at a fixed price, which
includes an amount of compensation to the underwriter, generally referred to as the underwriters concession or discount. Transactions on stock exchanges (other than foreign stock exchanges) involve the payment of negotiated brokerage
commissions. Such commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign securities generally involve
payment of fixed brokerage commissions, which are generally higher than those in the U.S. On occasion, certain securities may be purchased directly from an issuer, in which case no commissions or discounts are paid.
In connection with portfolio transactions, the overriding objective is to obtain the best execution of purchase and sales orders. In
making this determination, the Adviser considers a number of factors including, but not limited to: the price per unit of the security, the brokers execution capabilities, the commissions charged, the brokers reliability for prompt,
accurate confirmations and
on-time
delivery of securities, the broker-dealer firms financial condition, the brokers ability to provide access to public offerings, as well as the quality of research
services provided. As permitted by Section 28(e) of the Securities Exchange Act, the Adviser may cause the Funds to pay a
broker-dealer
which provides brokerage and research services to the Adviser, or
the Funds and/or other accounts for which the Adviser exercises investment discretion an amount of commission for effecting a securities transaction for a Fund in excess of the amount other broker-dealers would have charged for the transaction if
the Adviser determines in good faith that the greater commission is reasonable in relation to the value of the brokerage and research services provided by the executing broker-dealer viewed in terms of either a particular transaction or the
Advisers overall responsibilities to accounts over which it exercises investment discretion. Not all such services are useful or of value in advising the Funds. The Adviser reports to the Board of Trustees regarding overall commissions paid by
the Funds and their reasonableness in relation to the benefits to the Funds. In accordance with Section 28(e) of the Securities Exchange Act and consistent with applicable SEC guidance and interpretation, the term brokerage and research
services includes (i) advice as to the value of securities; (ii) the advisability of
Part II - 85
investing in, purchasing or selling securities; (iii) the availability of securities or of purchasers or sellers of securities; (iv) furnishing analyses and reports concerning issues,
industries, securities, economic factors and trends, portfolio strategy and the performance of accounts; and (v) effecting securities transactions and performing functions incidental thereto (such as clearance, settlement, and custody) or
required by rule or regulation in connection with such transactions.
Brokerage and research services received from such
broker-dealers will be in addition to, and not in lieu of, the services required to be performed by an Adviser under the Advisory Agreement (or with respect to a
Sub-Adviser,
under the
sub-advisory
agreement). The fees that the Funds pay to the Adviser are not reduced as a consequence of the Advisers receipt of brokerage and research services. To the extent the Funds portfolio
transactions are used to obtain such services, the brokerage commissions paid by the Funds may exceed those that might otherwise be paid by an amount that cannot be presently determined. Such services generally would be useful and of value to the
Adviser in serving one or more of its other clients and, conversely, such services obtained by the placement of brokerage business of other clients generally would be useful to the Adviser in carrying out its obligations to the Funds. While such
services are not expected to reduce the expenses of the Adviser, the Adviser would, through use of the services, avoid the additional expenses that would be incurred if it should attempt to develop comparable information through its own staff.
Subject to the overriding objective of obtaining the best execution of orders, the Adviser may allocate a portion of a
Funds brokerage transactions to affiliates of the Adviser. Under the 1940 Act, persons affiliated with a Fund and persons who are affiliated with such persons are prohibited from dealing with the Fund as principal in the purchase and sale of
securities unless an exemptive order allowing such transactions is obtained from the SEC. The SEC has granted exemptive orders permitting each Fund to engage in principal transactions with J.P. Morgan Securities LLC, an affiliated broker, involving
taxable and tax exempt money market instruments (including commercial paper, banker acceptances and medium term notes) and repurchase agreements. The orders are subject to certain conditions. An affiliated person of a Fund may serve as its broker in
listed or
over-the-counter
transactions conducted on an agency basis provided that, among other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by
non-affiliated
brokers in connection with comparable transactions.
In addition, a Fund may not purchase securities during the existence of any underwriting syndicate for such securities of which JPMorgan Chase Bank or an affiliate is a member or in a private placement in
which JPMorgan Chase Bank or an affiliate serves as placement agent, except pursuant to procedures adopted by the Board of Trustees that either comply with rules adopted by the SEC or with interpretations of the SECs staff. Each Fund expects
to purchase securities from underwriting syndicates of which certain affiliates of JPMorgan Chase act as a member or manager. Such purchases will be effected in accordance with the conditions set forth in Rule
10f-3
under the 1940 Act and related procedures adopted by the Trustees, including a majority of the Trustees who are not interested persons of a Fund. Among the conditions are that the issuer of
any purchased securities will have been in operation for at least three years, that not more than 25% of the underwriting will be purchased by a Fund and all other accounts over which the same investment adviser has discretion, and that no shares
will be purchased from JPMDS or any of its affiliates.
On those occasions when the Adviser deems the purchase or sale of a
security to be in the best interests of a Fund as well as other customers, including other Funds, the Adviser, to the extent permitted by applicable laws and regulations, may, but is not obligated to, aggregate the securities to be sold or purchased
for a Fund with those to be sold or purchased for other customers in order to obtain best execution, including lower brokerage commissions if appropriate. In such event, allocation of the securities so purchased or sold as well as any expenses
incurred in the transaction will be made by the Adviser in the manner it considers to be most equitable and consistent with its fiduciary obligations to its customers, including the Funds. In some instances, the allocation procedure might not permit
a Fund to participate in the benefits of the aggregated trade.
If a Fund that writes options effects a closing purchase
transaction with respect to an option written by it, normally such transaction will be executed by the same broker-dealer who executed the sale of the option. The writing of options by a Fund will be subject to limitations established by each of the
exchanges governing the maximum number of options in each class which may be written by a single investor or group of investors acting in concert, regardless of whether the options are written on the same or different exchanges or are held or
written in one or more accounts or through one or more brokers. The number of options that a Fund may write may be affected by options written by the Adviser for other investment advisory clients. An exchange may order the liquidation of positions
found to be in excess of these limits, and it may impose certain other sanctions.
Part II - 86
Allocation of transactions, including their frequency, to various broker-dealers is
determined by a Funds Adviser based on its best judgment and in a manner deemed fair and reasonable to Shareholders and consistent with the Advisers obligation to obtain the best execution of purchase and sales orders. In making this
determination, the Adviser considers the same factors for the best execution of purchase and sales orders listed above. Accordingly, in selecting broker-dealers to execute a particular transaction, and in evaluating the best overall terms available,
a Funds Adviser is authorized to consider the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act) provided to the Funds and/or other accounts over which a Funds Adviser
exercises investment discretion. A Funds Adviser may cause a Fund to pay a broker-dealer that furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same
transaction, provided that a Funds Adviser determines in good faith that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either the particular
transaction or the overall responsibilities of a Funds Adviser to the Funds. To the extent such services are permissible under the safe harbor requirements of Section 28(e) of the Securities Exchange Act and consistent with applicable SEC
guidance and interpretation, such brokerage and research services might consist of advice as to the value of securities, the advisability of investing in, purchasing, or selling securities, the availability of securities or purchasers or sellers of
securities; analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and the performance of accounts, market data, stock quotes, last sale prices, and trading volumes. Shareholders of the
Funds should understand that the services provided by such brokers may be useful to a Funds Adviser in connection with its services to other clients and not all the services may be used by the Adviser in connection with the Fund.
Under the policy for JPMIM, soft dollar services refer to arrangements that fall within the safe harbor requirements of
Section 28(e) of the Securities Exchange Act, as amended, which allow JPMIM to allocate client brokerage transactions to a broker-dealer in exchange for products or services that are research and brokerage-related and provide lawful and
appropriate assistance in the performance of the investment decision-making process. These services include third party research, market data services, and proprietary broker-dealer research. The Funds receive proprietary research where
broker-dealers typically incorporate the cost of such research into their commission structure. Many brokers do not assign a hard dollar value to the research they provide, but rather bundle the cost of such research into their commission structure.
It is noted in this regard that some research that is available only under a bundled commission structure is particularly important to the investment process. However, the Funds, other than the U.S. Equity Funds and JPMorgan Research Market Neutral
Fund, do not participate in soft dollar arrangements for market data services and third-party research.
The U.S. Equity Funds
(except the JPMorgan Equity Index Fund and JPMorgan Market Expansion Enhanced Index Fund), JPMorgan Research Market Neutral Fund, JPMorgan Realty Income Fund, JPMorgan Research Equity Long/Short Fund, and JPMorgan Tax Aware Equity Fund participate
in soft dollar arrangements whereby a broker-dealer provides market data services and third-party research in addition to proprietary research. In order to obtain such research, the Adviser may utilize a Client Commission Arrangement
(CCA). CCAs are agreements between an investment adviser and executing broker whereby the investment adviser and the broker agree to allocate a portion of commissions to a pool of credits maintained by the broker that are used to pay for
eligible brokerage and research services. The Adviser will only enter into and utilize CCAs to the extent permitted by Section 28(e) of the Securities Exchange Act. As required by interpretive guidance issued by the SEC, any CCAs entered into
by the Adviser with respect to commissions generated by the U.S. Equity Funds will provide that: (1) the broker-dealer pay the research preparer directly; and (2) the broker-dealer take steps to assure itself that the client commissions
that the Adviser directs it to use to pay for such services are only for eligible research under Section 28(e).
SCR&M
does not enter into soft dollar arrangements whereby a broker pays for research services such as Bloomberg, Reuters or Factset. From time to time, SCR&M may receive or have access to research generally provided by a broker to the brokers
institutional clients that trade with the broker in the sector of the securities markets in which SCR&M is active, namely in the case of real estate securities. In addition, SCR&M may consider the value-added quality of proprietary broker
research received from brokers in allocating trades to brokers subject always to the objective of obtaining best execution.
Investment decisions for each Fund are made independently from those for the other Funds or any other investment company or account
managed by an Adviser. Any such other investment company or account may also invest in the same securities as the Trusts. When a purchase or sale of the same security is made at substantially the same time on behalf of a given Fund and another Fund,
investment company or account, the transaction will be averaged as to price, and available investments allocated as to amount, in a manner which the Adviser of the given Fund believes to be equitable to the Fund(s) and such other investment company
or account. In some instances, this
Part II - 87
procedure may adversely affect the price paid or received by a Fund or the size of the position obtained by a Fund. To the extent permitted by law, the Adviser may aggregate the securities to be
sold or purchased by it for a Fund with those to be sold or purchased by it for other Funds or for other investment companies or accounts in order to obtain best execution. In making investment recommendations for the Trusts, the Adviser will not
inquire or take into consideration whether an issuer of securities proposed for purchase or sale by the Trusts is a customer of the Adviser or their parents or subsidiaries or affiliates and in dealing with its commercial customers, the Adviser and
their respective parent, subsidiaries, and affiliates will not inquire or take into consideration whether securities of such customers are held by the Trusts.
For details of brokerage commissions paid by the Funds, see BROKERAGE AND RESEARCH SERVICES Brokerage Commissions in Part I of this SAI.
For details of the Funds ownership of securities of the Funds regular broker dealers, see BROKERAGE AND RESEARCH
SERVICES Securities of Regular Broker-Dealers in Part I of this SAI.
OVERVIEW OF SERVICE PROVIDER AGREEMENTS
The following sections provide an overview of the J.P. Morgan Funds agreements with various service providers including the
Administrator, Distributor, Securities Lending Agent, Custodian, Transfer Agent, and Shareholder Servicing Agent. As indicated below, some of the service agreements for the JPMorgan SmartRetirement Blend Funds and other J.P. Morgan Funds are
different than the services agreements for the other JPMorgan SmartRetirement Funds. For purposes of distinguishing between the agreements and expenses, the JPMorgan SmartRetirement Funds other than the JPMorgan SmartRetirement Blend Funds are
referred to in the following as the JPMorgan SR Funds.
ADMINISTRATOR
JPMorgan Funds Management, Inc. (JPMFM or the Administrator) serves as the administrator to the
Funds, pursuant to an Administration Agreement dated February 19, 2005 (the Administration Agreement), between the Trusts, on behalf of the Funds, and JPMFM. Additionally, JPMFM serves as the administrator to the JPMorgan SR Funds
pursuant to an agreement effective May 5, 2006 (the SR Administration Agreement), between JPMT I, on behalf of the JPMorgan SR Funds, and JPMFM. JPMFM is an affiliate of JPMorgan Chase Bank and an indirect, wholly-owned subsidiary
of JPMorgan Chase; it has its principal place of business at 460 Polaris Parkway, Westerville, OH 43082.
Pursuant to the
Administration Agreement and the SR Administration Agreement, JPMFM performs or supervises all operations of each Fund for which it serves (other than those performed under the advisory agreement, any
sub-advisory
agreements, the custodian and fund accounting agreement, and the transfer agency agreement for that Fund). Under the Administration Agreement and the SR Administration Agreement, JPMFM has agreed
to maintain the necessary office space for the Funds, and to furnish certain other services required by the Funds with respect to each Fund. The Administrator prepares annual and semi-annual reports to the SEC, prepares federal and state tax returns
and generally assists in all aspects of the Funds operations other than those performed under the advisory agreement, any
sub-advisory
agreements, the custodian and fund accounting agreement, and the
transfer agency agreement. JPMFM may, at its expense, subcontract with any entity or person concerning the provision of services under the Administration Agreement and the SR Administration Agreement. JPMorgan Chase Bank serves as the Funds
sub-administrator
(the Sub-administrator). The Administrator pays JPMorgan Chase Bank a fee for its services as the Funds
Sub-administrator.
If not terminated, the Administration Agreement and the SR Administration Agreement continue in effect for annual periods beyond
October 31 of each year, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees who are not parties to the Administration Agreement or SR Administration
Agreement or interested persons of any such party. The Administration Agreement and the SR Administration Agreement may be terminated without penalty, on not less than 60 days prior written notice, by the Board of Trustees of each Trust or by
JPMFM. The termination of the Administration Agreement or the SR Administration Agreement with respect to one Fund will not result in the termination of the Administration Agreement with respect to any other Fund.
The Administration Agreement and the SR Administration Agreement provide that JPMFM shall not be liable for any error of judgment or
mistake of law or any loss suffered by the Funds in connection with the matters to
Part II - 88
which the Administration Agreement relates, except a loss resulting from willful misfeasance, bad faith or negligence in the performance of its duties, or from the reckless disregard by it of its
obligations and duties thereunder.
In consideration of the services to be provided by JPMFM pursuant to the Administration
Agreement, JPMFM receives from each Fund a pro rata portion of a fee computed daily and paid monthly at an annual rate equal to 0.15% of the first $25 billion of average daily net assets of all funds in the J.P. Morgan Funds Complex (excluding
certain funds of funds and the series of J.P. Morgan Funds Complex that operate as money market funds (each a Money Market Fund)) and 0.075% of average daily net assets of all funds in the J.P. Morgan Funds Complex (excluding certain
funds of funds and the Money Market Funds) over $25 billion of such assets. For purposes of this paragraph, the J.P. Morgan Funds Complex includes most of the
open-end
investment companies in the
J.P. Morgan Funds Complex, including the series of the former One Group Mutual Funds.
With respect to the Money Market Funds,
in consideration of the services provided by JPMFM pursuant to the Administration Agreement, JPMFM will receive from each Fund a
pro-rata
portion of a fee computed daily and paid monthly at an annual rate of
0.10% on the first $100 billion of the average daily net assets of all the money market funds in the J.P. Morgan Funds Complex and 0.05% of the average daily net assets of the money market funds in the J.P. Morgan Funds Complex over $100 billion.
For purposes of this paragraph, the J.P. Morgan Funds Complex includes most of the
open-end
investment companies in the J.P. Morgan Funds Complex including the series of the former One Group Mutual
Funds.
With respect to the Investor Funds and JPMorgan Diversified Real Return Fund, in consideration of the services provided
by JPMFM pursuant to the Administration Agreement, JPMFM will receive from each Fund a pro rata portion of a fee computed daily and paid monthly at an annual rate of 0.10% of the first $500 million of average daily net assets of all the Investor
Funds and JPMorgan Diversified Real Return Fund in the J.P. Morgan Funds Complex, 0.075% of certain Funds of Funds average daily net assets between $500 million and $1 billion and 0.05% of certain Funds of Funds average daily net
assets in excess of $1 billion.
JPMFM does not charge a fee for providing administrative services to the JPMorgan SR Funds
under the SR Administration Agreement, but does receive fees for its services to the acquired funds.
For details of
the administration and administrative services fees paid or accrued, see ADMINISTRATOR Administration Fees in Part I of this SAI.
DISTRIBUTOR
Since February 19, 2005,
JPMDS has served as the distributor for all the Trusts and holds itself available to receive purchase orders for shares of each of the Funds. In that capacity, JPMDS has been granted the right, as agent of each Trust, to solicit and accept orders
for the purchase of shares of each of the Funds in accordance with the terms of the Distribution Agreement between each Trust and JPMDS. JPMDS began serving as JPMT IIs distributor pursuant to a Distribution Agreement dated as of April 1,
2002. JPMDS is an affiliate of JPMIM and JPMorgan Chase Bank and is a direct, wholly-owned subsidiary of JPMorgan Chase. The principal offices of JPMDS are located at 460 Polaris Parkway, Westerville, OH 43082.
Unless otherwise terminated, the Distribution Agreement with JPMDS will continue in effect for successive one-year terms if approved at
least annually by: (a) the vote of the Board of Trustees, including the vote of a majority of those members of the Board of Trustees who are not parties to the Distribution Agreement or interested persons of any such party, cast in person at a
meeting for the purpose of voting on such approval, or (b) the vote of a majority of the outstanding voting securities of the Fund. The Distribution Agreement may be terminated without penalty on not less than 60 days prior written notice
by the Board of Trustees, by vote of majority of the outstanding voting securities of the Fund or by JPMDS. The termination of the Distribution Agreement with respect to one Fund will not result in the termination of the Distribution Agreement with
respect to any other Fund. The Distribution Agreement may also be terminated in the event of its assignment, as defined in the 1940 Act. JPMDS is a broker-dealer registered with the SEC and is a member of the Financial Industry Regulatory Authority
(FINRA).
For details of the compensation paid to the principal underwriter, JPMDS, see DISTRIBUTOR
Compensation paid to JPMDS in Part I of this SAI.
Part II - 89
DISTRIBUTION PLAN
Certain Funds have adopted a plan of distribution pursuant to Rule 12b-1 under the 1940 Act (the Distribution Plan) on behalf
of the Class A Shares, Class B Shares, Class C Shares, Class R2 Shares, Cash Management Shares, Morgan Shares, Reserve Shares, Service Shares, Eagle Shares and E*TRADE Class Shares of the applicable Funds, which provides that each of such
classes shall pay for distribution services a distribution fee (the Distribution Fee) to JPMDS, at annual rates not to exceed the amounts set forth in each applicable Funds prospectuses. The Institutional Class Shares, Select Class
Shares, Class R5 Shares, Investor Shares, Class R6 Shares, IM Shares, Premier Shares, Capital Shares, Direct Shares and Agency Shares of the Funds have no Distribution Plan.
The Distribution Fees are paid by the Funds to JPMDS as compensation for its services and expenses in connection with the sale and distribution of Fund shares. JPMDS in turn pays all or part of these
Distribution Fees to Financial Intermediaries that have agreements with JPMDS to sell shares of the Funds. In addition, JPMDS may use the Distribution Fees payable under the Distribution Plan to finance any other activity that is primarily intended
to result in the sale of Shares, including, but not limited to, (i) the development, formulation and implementation of marketing and promotional activities, including direct mail promotions and television, radio, magazine, newspaper, electronic
and media advertising; (ii) the preparation, printing and distribution of prospectuses, statements of additional information and reports and any supplements thereto (other than prospectuses, statements of additional information and reports and
any supplements thereto used for regulatory purposes or distributed to existing shareholders of each Fund); (iii) the preparation, printing and distribution of sales and promotional materials and sales literature which is provided to various
entities and individuals, including brokers, dealers, financial institutions, financial intermediaries, shareholders, and prospective investors in each Fund; (iv) expenditures for sales or distribution support services, including meetings with
and assistance to brokers, dealers, financial institutions, and financial intermediaries and in-house telemarketing support services and expenses; (v) preparation of information, analyses, surveys, and opinions with respect to marketing and
promotional activities, including those based on meetings with and feedback from JPMDSs sales force and others including potential investors, shareholders and financial intermediaries; (vi) commissions, incentive compensation,
finders fees, or other compensation paid to, and expenses of employees of JPMDS, brokers, dealers, and other financial institutions and financial intermediaries that are attributable to any distribution and/or sales support activities,
including interest expenses and other costs associated with financing of such commissions, incentive compensation, other compensation, fees, and expenses; (vii) travel, promotional materials, equipment, printing, delivery and mailing costs,
overhead and other office expenses of JPMDS and its sales force attributable to any distribution and/or sales support activities, including meetings with brokers, dealers, financial institutions and financial intermediaries in order to provide them
with information regarding the Funds and their investment process and management; (viii) the costs of administering the Distribution Plan; (ix) expenses of organizing and conducting sales seminars; and (x) any other costs and expenses
relating to any distribution and/or sales support activities. Activities intended to promote one class of shares of a Fund may also benefit the Funds other shares and other Funds. Anticipated benefits to the Funds that may result from the
adoption of the Distribution Plan are economic advantages achieved through economies of scale and enhanced viability if the Funds accumulate a critical mass.
Class A, Class B, Class C and Class R2 Shares
. Class A Shares of the Funds pay a Distribution Fee of 0.25% of average daily net assets. Class R2 Shares of the Funds pay a Distribution Fee
of 0.50% of average daily net assets. Class B and Class C Shares of the Funds pay a Distribution Fee of 0.75% of average daily net assets. JPMDS currently expects to pay sales commissions to a dealer at the time of sale of Class C Shares of the
Funds of up to 1.00% of the purchase price of the shares sold by such dealer. JPMDS will use its own funds (which may be borrowed or otherwise financed) to pay such commissions and generally recoups such amounts through collection of the
Distribution and Shareholder Servicing Fee and any contingent deferred sales charge (CDSC) for the first year following the purchase of such shares. Distribution Fees paid to JPMDS under the Distribution Plan may be paid by JPMDS to
broker-dealers as distribution fees in an amount not to exceed 0.25% annualized of the average daily net asset value of the Class A Shares or 0.75% annualized of the average daily net asset value of the Class B and Class C Shares or 0.50%
annualized of the average daily net asset value of the Class R2 Shares maintained in a Fund by such broker-dealers customers. Such payments on Class A and Class R2 Shares will be paid to broker- dealers promptly after the shares are
purchased. Such payments on Class B and Class C Shares will be paid to broker-dealers beginning in the 13th month following the purchase of such shares, except certain broker/dealers who have sold Class C Shares to certain defined contribution plans
and who have waived the 1.00% sales commission shall be paid distribution and shareholder servicing fees promptly after the shares are purchased.
Since the Distribution Fee is not directly tied to expenses, the amount of Distribution Fees paid by a class of a Fund during any year may be more or less than actual expenses incurred pursuant to the
Distribution Plan. For this
Part II - 90
reason, this type of distribution fee arrangement is characterized by the staff of the SEC as being of the compensation variety (in contrast to reimbursement arrangements
by which a distributors payments are directly linked to its expenses). With respect to Class B and Class C Shares of the Funds, because of the 0.75% annual limitation on the compensation paid to JPMDS during a fiscal year, compensation
relating to a large portion of the commissions attributable to sales of Class B or Class C Shares in any one year will be accrued and paid by a Fund to JPMDS in fiscal years subsequent. However, the shares are not liable for any distribution
expenses incurred in excess of the Distribution Fee paid.
Money Market Funds
. Distribution Fees paid to JPMDS under the
Distribution Plans adopted by the Money Market Funds may be paid by JPMDS to broker-dealers as distributions fees in an amount not to exceed 0.75% annualized of the average daily net asset value of the Class B and Class C Shares, 0.50% annualized of
the average daily net asset value of the Cash Management Shares, 0.25% annualized of the average daily net asset value of the Reserve and Eagle Shares, 0.10% annualized of the average daily net asset value of the Morgan Shares (except for Morgan
Shares of the Prime Money Market Fund), 0.60% annualized of the average daily net asset value of the E*TRADE and Service Shares, maintained in a Fund by such broker-dealers customers. For Class B and Class C Shares, distribution fees will be
paid to broker-dealers beginning in the 13th month following the purchase of such shares. Since the distribution fees are not directly tied to expenses, the amount of Distribution Fees paid by a class of a Fund during any year may be more or less
than actual expenses incurred pursuant to the Distribution Plan. For this reason, this type of distribution fee arrangement is characterized by the staff of the SEC as being of the compensation variety (in contrast to
reimbursement arrangements by which a distributors payments are directly linked to its expenses). No class of shares of a Fund will make payments or be liable for any distribution expenses incurred by other classes of shares of any
Fund.
JPMDS, JPMIM or their affiliates may from time to time, at its or their own expense, out of compensation retained by
them from the Funds or from other sources available to them, make additional payments to certain Financial Intermediaries for their marketing support services. Such compensation does not represent an additional expense to the Funds or to their
shareholders, since it will be paid by JPMDS, JPMIM or their affiliates. See
ADDITIONAL COMPENSATION TO FINANCIAL INTERMEDIARIES
below.
The Distribution Plan provides that it will continue in effect indefinitely if such continuance is specifically approved at least annually by a vote of both a majority of the Trustees and a majority of
the Trustees who are not interested persons (as defined in the 1940 Act) of the Trusts and who have no direct or indirect financial interest in the operation of the Distribution Plan or in any agreement related to such plan
(Qualified Trustees). The Distribution Plan may be terminated, with respect to any class of a Fund, at any time by a vote of a majority of the Qualified Trustees or by vote of a majority of the outstanding voting shares of the class of
such Fund to which it applies (as defined in the 1940 Act and the rules thereunder). The Distribution Plan may not be amended to increase materially the amount of permitted expenses thereunder without the approval of the affected shareholders and
may not be materially amended in any case without a vote of the majority of both the Trustees and the Qualified Trustees. Each of the Funds will preserve copies of any plan, agreement or report made pursuant to Rule 12b-1 for a period of not less
than six years from the date of such plan, agreement or report, and for the first two years such copies will be preserved in an easily accessible place. The Board of Trustees will review at least on a quarterly basis written reports of the amounts
expended under the Distribution Plan indicating the purposes for which such expenditures were made. The selection and nomination of Qualified Trustees shall be committed to the discretion of the disinterested Trustees (as defined in the 1940 Act)
then in office.
For details of the Distribution Fees that the Funds paid to or that were accrued by JPMDS, see
DISTRIBUTOR Distribution Fees in Part I of this SAI.
SECURITIES
LENDING AGENT
To generate additional income, certain Funds may lend up to 33
1
/
3
% of their total assets pursuant to agreements (Borrower Agreements) requiring that the loan be continuously secured by cash or U.S. Treasury securities. JPMorgan Chase Bank, an affiliate of
the Funds, and Goldman Sachs serve as lending agents pursuant to the JPMorgan Agreement and the Goldman Sachs Agreement, respectively.
Under the Goldman Sachs Agreement and the JPMorgan Agreement, Goldman Sachs and JPMorgan Chase Bank, respectively, acting as agents for certain of the Funds, loan securities to approved borrowers pursuant
to Borrower Agreements substantially in the form approved by the Board of Trustees in exchange for collateral. During the term of the loan, the Fund receives payments from borrowers equivalent to the dividends and interest that would have been
earned on securities lent while simultaneously seeking to earn income on the investment of
Part II - 91
cash collateral in accordance with investment guidelines contained in the JPMorgan Agreement or the Goldman Sachs Agreement. The Fund retains the interest on cash collateral investments but is
required to pay the borrower a rebate for the use of cash collateral. The net income earned on the securities lending (after payment of rebates and the lending agents fee) is included in the Statement of Operations as income from securities
lending (net in the Funds financial statements). Information on the investment of cash collateral is shown in the Schedule of Portfolio Investments (in the Funds financial statements).
Under the Goldman Sachs Agreement, Goldman Sachs is entitled to a fee equal to a percentage of the earnings on loans of securities. For
purposes of this calculation, earnings shall mean: (a) the earnings on investments of cash collateral including waivers and reimbursements made by the Funds adviser or its affiliates for the benefit of the Fund that are related solely to
investments of cash collateral less (b) the cash collateral fees paid to borrowers in connection with cash collateral. Pursuant to the Third Party Securities Lending Agreement, JPMorgan Chase Banks compensation is paid by Goldman Sachs.
Under the JPMorgan Agreement, JPMorgan Chase Bank is entitled to a fee, monthly in arrears, equal to (i) 0.03% of the average dollar value of loans of U.S. securities outstanding during a given month; and (ii) 0.09% of the average dollar
value of loans of
non-U.S.
securities outstanding during a given month. The purpose of these fees under the JPMorgan Agreement is to cover the custodial, administrative and related costs of securities lending
including securities movement, settlement of trades involving cash received as collateral, custody of collateral and marking to market loans.
CUSTODIAN
Pursuant to the Amended and
Restated Global Custody and Fund Accounting Agreement with JPMorgan Chase Bank, 270 Park Avenue, New York, New York 10017 (the JPMorgan Custody Agreement), JPMorgan Chase Bank serves as the custodian and fund accounting agent for each of
the Funds, other than the JPMorgan SR Funds. Pursuant to the JPMorgan Custody Agreement, JPMorgan Chase Bank is responsible for holding portfolio securities and cash and maintaining the books of account and records of portfolio transactions.
JPMorgan Chase Bank is an affiliate of the Advisers.
With respect to the JPMorgan SR Funds, pursuant to the Amended and
Restated Global Custody and Fund Accounting Agreement between JPMFM, JPMT I on behalf of the JPMorgan SR Funds, and JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017, effective September 1, 2010 (the SR Custody Agreement),
JPMorgan Chase Bank serves as the custodian and funds accounting agent and is responsible for holding portfolio securities and cash and maintaining the books of account and records of portfolio transactions. The fees and expenses under the SR
Custody Agreement for custody and fund accounting are paid by JPMFM.
CUSTODY AND FUND
ACCOUNTING FEES AND EXPENSES
For custodian services, each Fund (other than the JPMorgan SR Funds, as defined below) pays
to JPMorgan Chase Bank annual safekeeping fees of between 0.0006% and 0.35% of assets held by JPMorgan Chase Bank (depending on the domicile in which the asset is held), calculated monthly in arrears and fees between $2.50 and $80 for securities
trades (depending on the domicile in which the trade is settled), as well as transaction fees on certain activities of $2.50 to $20 per transaction. JPMorgan Chase Bank is also reimbursed for its reasonable out-of-pocket or incidental expenses,
including, but not limited to, registration and transfer fees and related legal fees.
For custodian services for the JPMorgan
SmartRetirement Funds other than the JPMorgan SmartRetirement Blend Funds (the JPMorgan SR Funds), JPMFM pays to JPMorgan Chase Bank annual safekeeping fees of between 0.0006% and 0.35% of assets held by JPMorgan Chase Bank (depending on
the domicile in which the asset is held) calculated monthly in arrears. JPMFM also pays JPMorgan Chase Bank fees between $2.50 and $80 for securities trades (depending on the domicile in which the trade is settled), as well as transaction fees on
certain activities of $2.50 to $20 per transaction. JPMFM shall also pay JPMorgan Chase Banks reasonable out-of-pocket or incidental expenses including, but not limited to, registration and transfer fees and related legal fees.
JPMorgan Chase Bank may also be paid $15, $35 or $60 per proxy (depending on the country where the issuer is located) for its service
which helps facilitate the voting of proxies throughout the world. For securities in the U.S. market, this fee is waived if the Adviser votes the proxies directly.
With respect to fund accounting services, the following schedule shall be employed in the calculation of the fees payable for the services provided under the JPMorgan Custody Agreement and the SR Custody
Agreement. For purposes of determining the asset levels at which a tier applies, assets for that fund type across the entire J.P. Morgan Funds Complex shall be used.
Part II - 92
|
|
|
|
|
|
|
Money Market Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $250 billion
|
|
|
0.0013
|
%
|
Tier Two
|
|
Over $250 billion
|
|
|
0.0010
|
%
|
All Other Funds (other than Funds of Funds subject to a flat fee described below):
|
|
|
|
|
|
|
Tier One
|
|
First $75 billion
|
|
|
0.0025
|
%
|
Tier Two
|
|
Next $75 billion
|
|
|
0.0020
|
%
|
Tier Three
|
|
Over $150 billion
|
|
|
0.0015
|
%
|
Other Fees:
|
|
|
|
|
|
|
Multi-Managed Funds (per manager)
|
|
|
|
|
$10,000
|
|
Fund of Funds (for a Fund of Funds that invests in J.P. Morgan Funds only)
|
|
|
|
|
$15,000
|
|
Additional Share Classes (this additional class expense applies after the third class)
|
|
|
|
|
$2,000
|
|
Daily Market-based Net Asset Value Calculation for Money Market Funds
|
|
|
|
|
$15,000 per Fund
|
|
Hourly Net Asset Value Calculation for Money Market Funds
|
|
|
|
|
$5,000 per Fund
|
|
The Funds will also pay a per transaction fee of $8 with respect to servicing of exchange traded derivatives and with respect to bank loans, a per transaction fee of $20 and an annual servicing fee of
0.0040% on the amount of each bank loan.
|
|
|
|
|
|
|
Minimums:
|
|
|
|
|
|
|
(except for certain Funds of Funds which are subject to the fee described above)
|
|
Money Market Funds
|
|
|
|
$
|
15,000
|
|
All Other Funds
|
|
|
|
$
|
20,000
|
|
In addition, JPMorgan Chase Bank provides derivative servicing, including, with respect to swaps,
swaptions and bond and currency options. The fees for these services include a transaction fee of $25 or $150 per new contract (depending on whether the transaction is electronic or manual), a fee of up to $25 or $150 per contract amendment
(including transactions such as trade amendments, cancellations, terminations, novations, option exercises, option expiries, maturities or credit events) and a daily fee of $0.40 per contract for position management services. In addition a Fund will
pay a fee of $2.00 to $5.30 per day for the valuation of the derivative positions covered by these services.
TRANSFER AGENT
Boston Financial Data Services, Inc. (BFDS or Transfer Agent), 2000 Crown
Colony Drive, Quincy, MA 02169, serves as each Funds transfer and dividend disbursing agent. As transfer agent and dividend disbursing agent, BFDS is responsible for maintaining account records, detailing the ownership of Fund shares and for
crediting income, capital gains and other changes in share ownership to shareholder accounts.
SHAREHOLDER SERVICING
The Trusts, on behalf of the Funds, have entered into a shareholder servicing agreement, effective February 19, 2005, with JPMDS (Shareholder Servicing Agreement). The Shareholder
Servicing Agreement for Institutional Class Shares of JPMT II became effective on August 12, 2004. Under the Shareholder Servicing Agreement, JPMDS will provide, or cause its agents to provide, any combination of the (i) personal
shareholder liaison services and shareholder account information services (Shareholder Services) described below and/or (ii) other related services (Other Related Services) as also described below.
Shareholder Services include (a) answering shareholder inquiries (through electronic and other means) regarding account
status and history, the manner in which purchases and redemptions of Fund shares may be effected, and certain other matters pertaining to the Funds; (b) providing shareholders with information through electronic means; (c) assisting
shareholders in completing application forms, designating and changing dividend options, account designations and addresses; (d) arranging for or assisting shareholders with respect to the wiring of the funds to and from shareholder accounts in
connection with shareholder orders to purchase, redeem or exchange shares; (e) verifying shareholder requests for changes to account information; (f) handling correspondence from shareholders about their accounts; (g) assisting in
establishing and maintaining shareholder accounts with the Trusts; and (h) providing other shareholder services as the Trusts or a shareholder may reasonably request, to the extent permitted by applicable law.
Other Related Services include (a) aggregating and processing purchase and redemption orders for shares;
(b) providing shareholders with account statements showing their purchases, sales, and positions in the applicable Fund; (c) processing dividend payments for the applicable Fund; (d) providing sub-accounting services to the Trusts
Part II - 93
for shares held for the benefit of shareholders; (e) forwarding communications from the Trusts to shareholders, including proxy statements and proxy solicitation materials, shareholder
reports, dividend and tax notices, and updated Prospectuses and SAIs; (f) receiving, tabulating and transmitting proxies executed by shareholders; (g) facilitating the transmission and receipt of funds in connection with shareholder orders
to purchase, redeem or exchange shares; (h) developing and maintaining the Trusts website; (i) developing and maintaining facilities to enable transmission of share transactions by electronic and non-electronic means;
(j) providing support and related services to Financial Intermediaries in order to facilitate their processing of orders and communications with shareholders; (k) providing transmission and other functionalities for shares included in
investment, retirement, asset allocation, cash management or sweep programs or similar programs or services; and (l) developing and maintaining check writing functionality.
For details of fees paid by the Funds to JPMDS for Shareholder Services and Other Related Services under the Shareholder Servicing
Agreement, see SHAREHOLDER SERVICING Shareholder Services Fees in Part I of this SAI.
To the extent it
is not otherwise required by its contractual agreement to limit a Funds expenses as described in the Prospectuses for the Funds, JPMDS may voluntarily agree from time to time to waive a portion of the fees payable to it under the Shareholder
Servicing Agreement with respect to each Fund on a month-to-month basis.
If not terminated, the Shareholder Servicing
Agreement will continue for successive one year terms beyond October 31 of each year, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees of the Trusts
who are not parties to the Shareholder Servicing Agreement or interested persons (as defined in the 1940 Act) of any such party. The Shareholder Servicing Agreement may be terminated without penalty, on not less than 60 days prior written
notice, by the Board of Trustees of the Trusts or by JPMDS. The Shareholder Servicing Agreement will also terminate automatically in the event of its assignment.
JPMDS may enter into service agreements with Financial Intermediaries under which it will pay all or a portion of such fees received from the Funds to such entities for performing Shareholder Services
and/or Other Related Services, as described above, for shareholders. Such Financial Intermediaries may include affiliates of JPMDS.
JPMDS, JPMIM or their affiliates may from time to time, at its or their own expense, out of compensation retained by them from the Funds or from other sources available to them, make additional payments
to certain Financial Intermediaries for performing: Other Related Services for their customers. These services include the services listed in paragraph beginning Other Related Services above. Such compensation does not
represent an additional expense to the Funds or to their shareholders, since it will be paid by JPMDS, JPMIM or their affiliates.
For shareholders that bank with JPMorgan Chase Bank, JPMorgan Chase Bank may aggregate investments in the Funds with balances held in JPMorgan Chase Bank accounts for purposes of determining eligibility
for certain bank privileges that are based on specified minimum balance requirements, such as reduced or no fees for certain banking services or preferred rates on loans and deposits.
JPMDS, the Funds and their affiliates, agents and subagents may share certain information about shareholders and their accounts, as
permitted by law and as described in the J.P. Morgan Funds Privacy Policy provided with your shareholder report, and also available on the J.P. Morgan Funds website at www.jpmorganfunds.com.
EXPENSES
Except for the JPMorgan SR Funds, the Funds pay the expenses incurred in their operations, including their
pro-rata
share of expenses of the Trusts. These expenses
include: investment advisory and administrative fees; the compensation of the Trustees; registration fees; interest charges; taxes; expenses connected with the execution, recording and settlement of security transactions; fees and expenses of the
Funds custodian for all services to the Funds, including safekeeping of funds and securities and maintaining required books and accounts; expenses of preparing and mailing reports to investors and to government offices and commissions;
expenses of meetings of investors; fees and expenses of independent accountants, legal counsel and any transfer agent, registrar or dividend disbursing agent of the Trusts; insurance premiums; and expenses of calculating the NAV of, and the net
income on, shares of the Funds. Shareholder servicing and distribution fees are all allocated to specific classes of the Funds. In addition, the Funds may allocate transfer agency and certain other expenses by class. Service providers to a Fund may,
from time to time, voluntarily waive all or a portion of any fees to which they are entitled.
Part II - 94
With respect to the JPMorgan SR Funds, the Administrator pays many of the ordinary expenses
incurred by the Funds in their operations including organization costs, taxes, ordinary fees and expenses for legal and auditing services, fees and expenses of pricing services, the expenses of preparing (including typesetting), printing and mailing
reports, prospectuses, statements of additional information, proxy solicitation material and notices to existing shareholders, all expenses incurred in connection with issuing and redeeming shares, the cost of custodial and fund accounting services,
and the cost of initial and ongoing registration of the shares under Federal and state securities laws. The Funds pay the following fees and expenses, including their
pro-rata
share of the following fees and
expenses of the Trust: (1) transfer agency, (2) shareholder servicing, (3) distribution fees, (4) brokerage costs, (5) all fees and expenses of Trustees, (6) the portion of the compensation of the Trusts Chief
Compliance Officer (CCO) attributable to the Funds on the basis of relative net assets, (7) costs of the Trusts CCO Program, (8) insurance, including fidelity bond and D&O insurance, (9) interest, (10) litigation and
(11) other extraordinary or nonrecurring expenses. Shareholder servicing and distribution fees are allocated to specific classes of the Funds. Service providers to the Funds may, from time to time, voluntarily waive all or a portion of any fees
to which they are entitled.
JPMIM, JPMFM and JPMDS have agreed that they will waive fees or reimburse the Funds as described
in the Prospectuses.
FINANCIAL INTERMEDIARIES
As described in
SHAREHOLDER SERVICING
in this SAI, JPMDS may enter into service agreements with Financial
Intermediaries under which it will pay all or a portion of the shareholder servicing fees it receives from the Funds to such Financial Intermediaries for performing Shareholder Services and/or Other Related Services for Financial
Intermediaries customers who are shareholders of the Funds. In addition, as described in
DISTRIBUTION PLAN
in this SAI, JPMDS may enter into Mutual Fund Sales Agreements with Financial Intermediaries under which it will pay
all or a portion of the Distribution Fees it receives from the Funds to such Financial Intermediaries for providing distribution services and marketing support.
In addition, the Funds may enter into agreements with Financial Intermediaries pursuant to which the Funds will pay the Financial Intermediary for services such as networking, or sub-transfer agency
and/or omnibus sub-accounting (collectively, Omnibus Sub-Accounting) or networking. Payments made pursuant to such agreements are generally based on either (1) a percentage of the average daily net assets of clients serviced by such
Financial Intermediary up to a set maximum dollar amount per shareholder account serviced, or (2) the number of accounts serviced by such Financial Intermediary. Any payments made pursuant to such agreements are in addition to, rather than in
lieu of, Rule 12b-1 fees and shareholder servicing fees the Financial Intermediary may also be receiving pursuant to agreements with the Distributor and shareholder servicing agent, respectively. From time to time, JPMDS, JPMIM or their affiliates
may pay a portion of the fees for networking or Omnibus Sub-Accounting at its or their own expense out of its or their own resources.
Financial Intermediaries may offer additional services to their customers, including specialized procedures and payment for the purchase and redemption of Fund shares, such as pre-authorized or systematic
purchase and redemption programs, sweep programs, cash advances and redemption checks. Certain Financial Intermediaries may (although they are not required by the Trusts to do so) credit to the accounts of their customers from whom they
are already receiving other fees amounts not exceeding such other fees or the fees for their services as Financial Intermediaries.
Financial Intermediaries may establish their own terms and conditions for providing their services and may charge investors a transaction-based or other fee for their services. Such charges may vary among
Financial Intermediaries, but in all cases will be retained by the Financial Intermediary and will not be remitted to a Fund or JPMDS.
Certain Funds have authorized one or more Financial Intermediaries to accept purchase and redemption orders on their behalf. Such Financial Intermediaries are authorized to designate other intermediaries
to accept purchase and redemption orders on a Funds behalf. Such Funds will be deemed to have received a purchase or redemption order when a Financial Intermediary or, if applicable, that Financial Intermediarys authorized designee
accepts the order. These orders will be priced at the Funds NAV next calculated after they are so accepted.
Part II - 95
ADDITIONAL COMPENSATION TO FINANCIAL INTERMEDIARIES
JPMDS and JPMIM, at their own expense out of their own resources, may provide additional compensation (Additional
Compensation) to Financial Intermediaries. Additional Compensation may also be paid by other affiliates of JPMDS and JPMIM from time to time. These Additional Compensation payments are over and above any sales charges (including Rule 12b-1
fees), shareholder servicing, Omnibus Sub-Accounting or networking fees which are charged directly to the Funds and which are disclosed elsewhere in the Funds prospectuses or in this SAI. The categories of Additional Compensation are described
below. These categories are not mutually exclusive and JPMDS, JPMIM and/or their affiliates may pay additional types of Additional Compensation in the future. The same Financial Intermediaries may receive payments under more than one or all
categories. Not all Financial Intermediaries receive Additional Compensation payments and such payments may be different for different Financial Intermediaries or different types of funds (e.g., equity fund or fixed income fund). These payments may
be significant to a Financial Intermediary and may be an important factor in a Financial Intermediarys willingness to support the sale of the Funds through its distribution system. Additional Compensation payments are always made only to the
firm, never to individuals other than occasional gifts and entertainment that are permitted by FINRA rules.
JPMIM, JPMDS
and/or their affiliates may be motivated to pay Additional Compensation to promote the sale of Fund shares to clients of Financial Intermediaries and the retention of those investments by those clients. To the extent Financial Intermediaries sell
more shares of the Funds or retain shares of the Funds in their clients accounts, JPMIM and JPMDS benefit from the incremental management and other fees paid by the Funds with respect to those assets.
The provision of Additional Compensation, the varying fee structure and the basis on which a Financial Intermediary compensates its
registered representatives or salespersons may create an incentive for a particular Financial Intermediary, registered representative or salesperson to highlight, feature or recommend funds, including the Funds, or other investments based, at least
in part, on the level of compensation paid. Additionally, if one mutual fund sponsor makes greater distribution payments than another, a Financial Intermediary may have an incentive to recommend that sponsors mutual fund over other mutual
funds. Similarly, if a Financial Intermediary receives greater compensation for one share class versus another, that Financial Intermediary may have an incentive to recommend that share class. Shareholders should consider whether such incentives
exist when evaluating any recommendations from a Financial Intermediary to purchase or sell shares of the Funds and when considering which share class is most appropriate. Shareholders should ask their salesperson or visit their Financial
Intermediarys website for more information.
Sales and Marketing Support
.
Additional Compensation
may be paid to Financial Intermediaries for sales and marketing support. Marketing support may include access to a Financial Intermediarys sales representatives and management representatives. Additional Compensation may also be paid to
Financial Intermediaries for inclusion of the Funds on a firms list of offered products including a preferred or select sales list, in other sales programs or as an expense reimbursement. Additional Compensation may be calculated in basis
points based on average net Fund assets attributable to the Financial Intermediary or sales of the Funds by the Financial Intermediary. Additional Compensation may also be fixed dollar amounts.
From time to time, JPMIM, JPMDS and their affiliates may provide, out of their own resources, financial assistance to Financial
Intermediaries that enable JPMDS to sponsor and/or participate in and/or present at meeting, conferences or seminars, sales, training or educational programs, client and investor events, client prospecting retention, and due diligence events and
other firm-sponsored events or other programs for the Financial Intermediaries registered representatives and employees. These payments may vary depending upon the nature of the event, and may include travel expenses, such as lodging incurred
by registered representatives of the Financial Intermediaries. In addition, JPMIM, JPMDS and their affiliates may pay or reimburse sales representatives of Financial Intermediaries in the form of occasional gifts and occasional meals or
entertainment events that JPMIM, JPMDS or their affiliates deem appropriate, subject to applicable law and regulations. Other compensation may be offered to the extent not prohibited by federal or state laws or any self-regulatory agency, such as
FINRA. These payments may vary depending upon the nature of the event or the relationship.
Administrative and Processing
Support.
JPMIM and/or JPMDS may also pay Additional Compensation to Financial Intermediaries for their administrative and processing support, including (i) record keeping, Omnibus Sub-Accounting and networking, to the extent that the
Funds do not pay for these costs directly; (ii) reimbursement for ticket processing charges applied to Fund shares and (iii) one time payments for ancillary services such as setting up Funds on the Financial Intermediarys mutual fund
trading system/platform.
Part II - 96
Identification of Financial Intermediaries
The following is a list of FINRA member firms that received Additional Compensation for the period ending December 31, 2013. This
list includes FINRA members: (1) who have entered into to written agreements with the Funds Adviser to receive Additional Compensation (excluding payments made for Omnibus Sub-Accounting services); and/or (2) who have received
Additional Compensation for events and meetings that were sponsored in whole or in part by JPMDS.
|
2.
|
Ameriprise Financial Services, Inc.
|
|
3.
|
Apex Clearing Corporation
|
|
4.
|
Banc of America Securities LLC
|
|
7.
|
Cadaret Grant & Co Inc.
|
|
8.
|
Cambridge Investment Research
|
|
9.
|
Cetera Advisor Networks LLC
|
|
11.
|
Cetera Financial Specialists LLC
|
|
12.
|
Cetera Investment Services LLC
|
|
13.
|
Charles Schwab & Co Inc.
|
|
14.
|
Citigroup Global Markets, Inc.
|
|
15.
|
Comerica Securities, Inc.
|
|
16.
|
Commonfund Securities, Inc.
|
|
17.
|
Commonwealth Financial Network
|
|
18.
|
Credit Suisse Securities (USA) LLC
|
|
20.
|
Deutsche Bank Securities Inc
|
|
21.
|
Edward D Jones & Co LP
|
|
22.
|
E*Trade Clearing, LLC
|
|
23.
|
Eagle Fund Distributors, Inc.
|
|
25.
|
First Command Financial Planning
|
|
26.
|
FSC Securities Corp.Royal Alliance AssociatesSagePoint Financial, IncWoodbury Financial Services, Inc.
|
|
27.
|
ING Financial Partners, Inc.
|
|
28.
|
Ingalls & Snyder, LLC
|
|
29.
|
ING Financial Partners, Inc.
|
|
30.
|
Investacorp, Inc.Securities America Inc.Triad Advisors Inc.
|
|
31.
|
JJB Hilliard WL Lyons LLC
|
|
32.
|
J.P. Morgan Clearing Corp
|
|
33.
|
J.P. Morgan Securities LLC
|
Part II - 97
|
34.
|
Janney Montgomery Scott LLC
|
|
35.
|
JPMorgan Institutional Investments
|
|
36.
|
Lazard Capital Markets, LLC
|
|
37.
|
Lincoln Financial Advisors Corp
|
|
38.
|
Lincoln Financial Securities Corporation
|
|
40.
|
Merrill Lynch, Pierce, Fenner & Smith Inc.
|
|
42.
|
Morgan Stanley Smith Barney LLC
|
|
43.
|
MSCS Financial Services LLC
|
|
44.
|
National Planning Corporation/National Planning Holdings Inc.
|
|
45.
|
New York Life Investments
|
|
47.
|
Oppenheimer & Co., Inc.
|
|
49.
|
PFS Investments, Inc.
|
|
50.
|
PNC Capital Markets LLC
|
|
51.
|
Raymond James & Associates, Inc.Raymond James Financial Services, Inc
|
|
52.
|
RBC Capital Markets, LLC
|
|
53.
|
Robert W. Baird & Co. Incorporated
|
|
54.
|
Securities America Inc
|
|
55.
|
Southwest Securities, Inc.
|
|
56.
|
State Street Global Markets, LLC
|
|
57.
|
Sterne Agee & Leach Inc.
|
|
58.
|
Stifel Nicholaus & Co Inc
|
|
59.
|
SunTrust Robinson Humphrey, Inc.
|
|
62.
|
Transamerica Capital Inc.
|
|
63.
|
U.S. Bancorp Investments Inc
|
|
64.
|
UBS Financial Services
|
|
65.
|
Wells Fargo Advisors, LLC
|
|
66.
|
Wells Fargo Securities LLC
|
Other Financial Intermediaries, which are not members of FINRA, also may receive Additional Compensation.
For details of the amounts of Additional Compensation paid by the Funds Adviser to Financial Intermediaries (including both FINRA
and Non-FINRA members) pursuant to written agreements including agreements for networking and Omnibus Sub-Accounting for all of the Funds,
s
ee FINANCIAL INTERMEDIARIES Other Cash Compensation in Part I of this SAI.
Part II - 98
For details of finders fee paid to Financial Intermediaries, see FINANCIAL
INTERMEDIARIES Finders Fee Commissions in Part I of this SAI.
TRUST
COUNSEL
The law firm of Dechert LLP, 1095 Avenue of the Americas, New York, NY 10036-6797, is counsel to the Trusts.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered public accounting firm for the Trusts and the Funds is PricewaterhouseCoopers LLP, 300 Madison Avenue, New
York, NY 10017. PricewaterhouseCoopers LLP conducts an annual audit of the financial statements of each of the Funds and assists in the preparation and/or review of each Funds federal and state income tax returns.
DIVIDENDS AND DISTRIBUTIONS
Each Fund declares and pays dividends and distributions as described under Distribution and Tax Matters in the Prospectuses. Dividends may differ between classes as a result of differences in
distribution expenses or other class-specific expenses.
Dividends and capital gains distributions paid by a Fund are
automatically reinvested in additional shares of the Fund unless the shareholder has elected to have them paid in cash. Dividends and distributions to be paid in cash are credited to the shareholders
pre-assigned
bank account or are mailed by check in accordance with the customers instructions. The Funds reserve the right to discontinue, alter or limit the automatic reinvestment privilege at any
time.
If a shareholder has elected to receive dividends and/or capital gain distributions in cash and the postal or other
delivery service is unable to deliver checks to the shareholders address of record, such shareholders distribution option will automatically be converted to having all dividend and other distributions reinvested in additional shares. No
interest will accrue on amounts represented by uncashed distribution or redemption checks. With regard to Funds that accrue dividends daily, dividends will only begin to accrue after a Fund receives payment for shares. Once a Fund distributes
proceeds from a redemption, shares are no longer entitled to receive any dividends that are declared.
NET ASSET VALUE
Shares are sold at NAV per share, plus a sales charge, if any. This is also known as the offering
price. Shares are also redeemed at NAV, minus any applicable deferred sales charges. Each class of shares in each Fund has a different NAV. This is primarily because each class has class specific expenses such as distribution and shareholder
servicing fees.
The NAV per share of a class of a Fund is equal to the value of all the assets attributable to that class,
minus the liabilities attributable to that class, divided by the number of outstanding shares of that class. The following is a discussion of the procedures used by the Funds in valuing their assets.
Securities for which market quotations are readily available are generally valued at their current market value. Other securities and
assets, including securities for which market quotations are not readily available; market quotations are determined not to be reliable; or, their value has been materially affected by events occurring after the close of trading on the exchange or
market on which the security is principally traded (for example, a natural disaster affecting an entire country or region, or an event that affects an individual company) but before a Funds NAV is calculated, may be valued at its fair value in
accordance with policies and procedures adopted by the J.P. Morgan Funds Board of Trustees. Fair value represents a good faith determination of the value of a security or other asset based upon specifically applied procedures. Fair valuation
determinations may require subjective determinations. There can be no assurance that the fair value of an asset is the price at which the asset could have been sold during the period in which the particular fair value was used in determining the
Funds NAV.
Equity securities listed on a North American, Central American, South American or Caribbean
(Americas) securities exchange are generally valued at the last sale price on the exchange on which the security is principally traded that is reported before the time when the net assets of the Funds are valued. The value of securities
listed on the NASDAQ Stock Market, Inc. is generally the NASDAQ official closing price.
Part II - 99
Generally, trading of foreign securities on most foreign markets is completed before the
close in trading in U.S. markets. The Funds have implemented fair value pricing on a daily basis for all equity securities other than Americas equity securities. The fair value pricing utilizes the quotations of an independent pricing service.
Trading on foreign markets may also take place on days on which the U.S. markets and the Funds are closed.
Shares of
open-end
investment companies are valued at their NAVs.
Fixed income securities with a
remaining maturity of 61 days or more are valued using market quotations supplied by approved independent third party pricing services, affiliated pricing services or broker/dealers. In determining security prices, pricing services and
broker/dealers may consider a variety of inputs and factors, including, but not limited to proprietary models that may take into account market transactions in securities with comparable characteristics, yield curves, option-adjusted spreads, credit
spreads, estimated default rates, coupon rates, underlying collateral and estimated cash flows.
Generally, short-term
securities which mature in 60 days or less are valued at amortized cost if their maturity at acquisition was 60 days or less, or by amortizing their value on the 61st day prior to maturity, if their maturity when acquired by a Fund was more than 60
days.
Assets and liabilities initially expressed in foreign currencies will be converted into U.S. dollars at the prevailing
market rates from an approved independent pricing service as of 4:00 PM ET.
Options (e.g., on stock indices or equity
securities) traded on U.S. equity securities exchanges are valued at the composite mean price, using the National Best Bid and Offer quotes at the close of options trading on such exchanges.
Options traded on foreign exchanges or U.S. commodity exchanges are valued at the settled price, or if no settled price is available, at
the last sale price available prior to the calculation of a Funds NAV.
Exchange traded futures (e.g., on stock indices,
debt securities or commodities) are valued at the settled price, or if no settled price is available, at the last sale price as of the close of the exchanges on which they trade.
Non-listed
over-the-counter
options and futures are valued at the evaluated price provided by a counterparty or broker/dealer.
Swaps and structured notes are priced generally by an approved independent third party or affiliated pricing service or at an evaluated
price provided by a counterparty or broker/dealer.
Certain fixed income securities and swaps may be valued using market
quotations or valuations provided by pricing services affiliated with the Adviser. Valuations received by the Funds from affiliated pricing services are the same as those provided to other affiliated and unaffiliated entities by these affiliated
pricing services.
The Money Market Funds portfolio securities are valued at their amortized cost. The purpose of this
method of calculation is to attempt to maintain a constant NAV per share of each Fund of $1.00. No assurances can be given that this goal can be attained. The amortized cost method of valuation values a security at its cost at the time of purchase
and thereafter assumes an amortization that would produce a constant yield to maturity of any discount or premium, regardless of the impact of fluctuating interest rates on the market value of the instrument. The Board of Trustees has established
procedures and directed certain officers of the Funds to monitor the differences between the NAVs calculated based on amortized cost and market value at predetermined intervals but no less frequently than weekly, and to report to the Board of
Trustees such differences. If a difference of more than 1/2 of 1% occurs between valuation based on the amortized cost method and valuation based on market value, the Board of Trustees may take steps necessary to reduce such deviation if it believes
that such deviation will result in material dilution or any unfair results to investors or existing shareholders. Actions that may be taken by the Board of Trustees include (i) redeeming shares in kind, (ii) selling portfolio instruments
prior to maturity to realize capital gains or losses or to shorten the average maturity of portfolio securities, (iii) withholding or supplementing dividends (iv) utilizing a net asset value per share as determined by using available
market quotations, or (v) reducing the number of outstanding Fund shares. Any reduction of outstanding shares will be accomplished by having each shareholder contribute to a Funds capital the necessary shares on a pro rata basis. Each
shareholder will be deemed to have agreed to such contribution in these circumstances by his or her investment in the Funds. In its discretion, the Board of Trustees of the Money Market Funds may elect to calculate the price of a Funds shares
once per day. Further, with regard to the Money Market Funds, the Board of Trustees has empowered management to temporarily suspend one or more cut-off times for a Fund, other than the last cut-off time of the day.
Part II - 100
With respect to all Funds, securities or other assets for which market quotations are not
readily available or for which market quotations do not represent the value at the time of pricing (including certain illiquid securities) are fair valued in accordance with policies and procedures (Policies) established by and under the
supervision and responsibility of the Trustees. The Board of Trustees has established an Audit and Valuation Committee to assist the Board of Trustees in its oversight of the valuation of the Funds securities and delegated to JPMorgan Funds
Management, Inc., an indirect, wholly-owned subsidiary of JPMorgan Chase & Co. (the Administrator or JPMFM), the responsibility for implementing the day-to-day operational aspects of the valuation process. The
Administrator has created the J.P. Morgan Asset Management (JPMAM) Americas Valuation Committee (VC) to oversee and carry out the Policies for the valuation of investments held in the Funds. The VC is comprised of senior
representatives from JPMFM, J.P. Morgan Investment Management Inc. (JPMIM or the Adviser), JPMAM Legal, Compliance and Risk Management and the Funds Chief Compliance Officer. Fair value situations could include, but are
not limited to: (1) a significant event that affects the value of a Funds securities (e.g., news relating to natural disasters affecting an issuers operations or earnings announcements); (2) illiquid securities;
(3) securities that may be defaulted or
de-listed
from an exchange and are no longer trading; or (4) any other circumstance in which the VC believes that market quotations do not accurately reflect
the value of a security.
From time to time, there may be errors in the calculation of the NAV of a Fund or the processing of
purchases and redemptions. Shareholders will generally not be notified of the occurrence of an error or the resolution thereof.
DELAWARE TRUSTS
JPMT I and JPMT II.
JPMT I and JPMT II were each formed as Delaware statutory trusts on November 12, 2004 pursuant to separate Declarations of Trust dated November 5, 2004. JPMT I assumed
JPMMFS registration pursuant to the 1933 Act and the 1940 Act effective after the close of business on February 18, 2005, and JPMT II assumed One Group Mutual Funds registration pursuant to the 1933 Act and the 1940 Act
effective after the close of business on February 18, 2005.
Under Delaware law, shareholders of a statutory trust shall
have the same limitation of personal liability that is extended to stockholders of private corporations for profit organized under Delaware law, unless otherwise provided in the trusts governing trust instrument. JPMT Is and JPMT
IIs Declarations of Trust each provides that shareholders of JPMT I and JPMT II shall not be personally liable for the debts, liabilities, obligations and expenses incurred by, contracted for, or otherwise existing with respect to JPMT I or
JPMT II or any series or class thereof. In addition, the Declarations of Trust each provides that neither JPMT I or JPMT II, nor the Trustees, officers, employees, nor agents thereof shall have any power to bind personally any shareholders nor to
call upon any shareholder for payment of any sum of money or assessment other than such as the shareholder may personally agree to pay. Moreover, Declarations of Trust for JPMT I and JPMT II each expressly provide that the shareholders shall have
the same limitation of personal liability that is extended to shareholders of a private corporation for profit incorporated in the State of Delaware.
The Declarations of Trust of JPMT I and JPMT II each provides for the indemnification out of the assets held with respect to a particular series of shares of any shareholder or former shareholder held
personally liable solely by reason of a claim or demand relating to the person being or having been a shareholder and not because of the shareholders acts or omissions. The Declarations of Trust of JPMT I and JPMT II each also provide that
JPMT I and JPMT II, on behalf of the applicable series, may, at its option with prior written notice, assume the defense of any claim made against a shareholder.
JPMT Is and JPMT IIs Declarations of Trust each provides that JPMT I and JPMT II will indemnify their respective Trustees and officers against liabilities and expenses incurred in connection
with any proceeding in which they may be involved because of their offices with JPMT I or JPMT II, unless, as to liability to JPMT I or JPMT II or the shareholders thereof, the Trustees engaged in willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of their offices. In addition, the Declarations of Trust each provides that any Trustee who has been determined to be an audit committee financial expert shall not be subject to a
greater liability or duty of care because of such determination.
JPMT I and JPMT II shall continue without limitation of time
subject to the provisions in the Declarations of Trust concerning termination by action of the shareholders or by action of the Trustees upon written notice to the shareholders.
JPMT I is party to an Agreement and Plan of Investment and Transfer of Assets dated January 17, 2006 pursuant to which it has agreed,
out of the assets and property of certain Funds, to indemnify and hold harmless
Part II - 101
JPMorgan Chase Bank, in its corporate capacity and as trustee of certain common trust funds, and each of its directors and officers, for any breach by JPMT I of its representations, warranties,
covenants or agreements under such Agreement or any act, error, omission, neglect, misstatement, materially misleading statement, breach of duty or other act wrongfully done or attempted to be committed by JPMT I or its Board of Trustees or
officers, related to the transfer of assets from certain common trust funds to the respective Funds and other related transactions.
MASSACHUSETTS TRUSTS
JPMMFG and JPMMFIT.
JPMMFG and JPMMFIT are each organized as a Massachusetts business trust. The Growth Advantage Fund is a separate and distinct series of JPMMFIT. Copies of the Declarations of Trust of each of JPMMFG and JPMMFIT are on file in the office of the
Secretary of The Commonwealth of Massachusetts. The Declarations of Trust and
By-laws
of JPMMFG and JPMMFIT are designed to make JPMMFG and JPMMFIT similar in most respects to a Massachusetts business
corporation. The principal distinction between the two forms concerns shareholder liability as described below.
Under
Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable as partners for the obligations of the trust, which is not the case for a corporation. However, JPMMFGs and JPMMFITs Declarations
of Trust provide that the shareholders shall not be subject to any personal liability for the acts or obligations of the Funds and that every written agreement, obligation, instrument or undertaking made on behalf of the Funds shall contain a
provision to the effect that the shareholders are not personally liable thereunder.
No personal liability will attach to the
shareholders under any undertaking containing such provision when adequate notice of such provision is given, except possibly in a few jurisdictions. With respect to all types of claims in the latter jurisdictions, (i) tort claims,
(ii) contract claims where the provision referred to is omitted from the undertaking, (iii) claims for taxes, and (iv) certain statutory liabilities in other jurisdictions, a shareholder may be held personally liable to the extent
that claims are not satisfied by the Funds. However, upon payment of such liability, the shareholder will be entitled to reimbursement from the general assets of the Funds. The Boards of Trustees intend to conduct the operations of JPMMFG and
JPMMFIT in such a way so as to avoid, as far as possible, ultimate liability of the shareholders for liabilities of the Funds.
JPMMFGs and JPMMITs Declarations of Trust each provides that JPMMFG and JPMMFIT will each indemnify their respective Trustees
and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with JPMMFG or JPMMFIT, unless, as to liability to JPMMFG or JPMMFIT or their shareholders, it is finally
adjudicated that the Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices or with respect to any matter unless it is finally adjudicated that they did not act in good
faith in the reasonable belief that their actions were in the best interests of JPMMFG or JPMMFIT. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement
or other disposition, or by a reasonable determination based upon a review of readily available facts, by vote of a majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have not engaged in
willful misfeasance, bad faith, gross negligence or reckless disregard of their duties.
JPMMFIT shall continue without
limitation of time subject to the provisions in its Declarations of Trust concerning termination by action of the shareholders or by action of the Trustees upon notice to the shareholders. JPMMFG liquidated effective November 29, 2012, and is
in the process of winding up its affairs.
MARYLAND CORPORATION
JPMFMFG.
JPMFMFG is a diversified
open-end
management
investment company which was organized as a Maryland corporation, on August 19, 1997. Effective April 30, 2003, the name of JPMFMFG was changed from Fleming Mutual Fund Group, Inc. to J.P. Morgan Fleming Mutual Fund Group, Inc.
The Articles of Incorporation of JPMFMFG provide that a Director shall be liable only for his own willful defaults and, if reasonable care
has been exercised in the selection of officers, agents, employees or investment advisers, shall not be liable for any neglect or wrongdoing of any such person. The Articles of Incorporation also provide that JPMFMFG will indemnify its Directors and
officers against liabilities and expenses incurred in connection with actual or threatened litigation in which they may be involved because of their offices with JPMFMFG to the fullest extent permitted by law. However, nothing in the Articles of
Incorporation shall protect or indemnify a Director against any liability for his willful misfeasance, bad faith, gross negligence or reckless disregard of his duties.
Part II - 102
DESCRIPTION OF SHARES
Shares of JPMT I and JPMT II.
JPMT I and JPMT II are open-end, management investment companies
organized as Delaware statutory trusts. Each Fund represents a separate series of shares of beneficial interest. See Delaware Trusts.
The Declarations of Trust of JPMT I and JPMT II each permits the Trustees to issue an unlimited number of full and fractional shares ($0.0001 par value) of one or more series and classes within any series
and to divide or combine the shares of any series or class without materially changing the proportionate beneficial interest of such shares of such series or class in the assets held with respect to that series. Each share represents an equal
beneficial interest in the net assets of a Fund with each other share of that Fund. The Trustees of JPMT I and JPMT II may authorize the issuance of shares of additional series and the creation of classes of shares within any series with such
preferences, voting powers, rights, duties and privileges as the Trustees may determine; however, the Trustees may not classify or change outstanding shares in a manner materially adverse to shareholders of each share. Upon liquidation of a Fund,
shareholders are entitled to share pro rata in the net assets of a Fund available for distribution to such shareholders. The rights of redemption and exchange are described in the Prospectuses and elsewhere in this SAI.
The shareholders of each Fund are entitled to one vote for each dollar of NAV (or a proportionate fractional vote with respect to the
remainder of the NAV of shares, if any), on matters on which shares of a Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees themselves have the power to alter the number and the terms of office of the Trustees, to lengthen their
own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided, however, that immediately after such appointment the requisite majority of the Trustees have been elected by
the shareholders of JPMT I or JPMT II, respectively. The voting rights of shareholders are not cumulative with respect to the election of Trustees. It is the intention of JPMT I and JPMT II not to hold meetings of shareholders annually. The Trustees
may call meetings of shareholders for action by shareholder vote as may be required by either the 1940 Act or the Declarations of Trust of JPMT I and JPMT II.
Each share of a series or class represents an equal proportionate interest in the assets in that series or class with each other share of that series or class. The shares of each series or class
participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMTI and JPMT II which are not attributable to a specific series or class are allocated among all of their series in a manner deemed by the
Trustees to be fair and equitable. Shares have no
pre-emptive
or conversion rights, and when issued, are fully paid and
non-assessable.
Shares of each series or class
generally vote together, except when required under federal securities laws to vote separately on matters that may affect a particular class, such as the approval of distribution plans for a particular class.
The Trustees of JPMT I and JPMT II may, without shareholder approval (unless otherwise required by applicable law): (i) cause JPMT I
or JPMT II to merge or consolidate with or into one or more trusts (or series thereof to the extent permitted by law, partnerships, associations, corporations or other business entities (including trusts, partnerships, associations, corporations, or
other business entities created by the Trustees to accomplish such merger or consolidation) so long as the surviving or resulting entity is an investment company as defined in the 1940 Act, or is a series thereof, that will succeed to or assume JPMT
I or JPMT IIs registration under the 1940 Act and that is formed, organized, or existing under the laws of the U.S. or of a state, commonwealth, possession or territory of the U.S., unless otherwise permitted under the 1940 Act;
(ii) cause any one or more series or classes of JPMT I or JPMT II to merge or consolidate with or into any one or more other series or classes of JPMT I or JPMT II, one or more trusts (or series or classes thereof to the extent permitted by
law), partnerships, associations, corporations; (iii) cause the shares to be exchanged under or pursuant to any state or federal statute to the extent permitted by law; or (iv) cause JPMT I or JPMT II to reorganize as a corporation,
limited liability company or limited liability partnership under the laws of Delaware or any other state or jurisdiction. However, the exercise of such authority may be subject to certain restrictions under the 1940 Act.
The Trustees may, without shareholder vote, generally restate, amend or otherwise supplement JPMT I or JPMT IIs governing
instruments, including the Declarations of Trust and the
By-Laws,
without the approval of shareholders, subject to limited exceptions, such as the right to elect Trustees.
The Trustees, without obtaining any authorization or vote of shareholders, may change the name of any series or class or dissolve or
terminate any series or class of shares.
Part II - 103
Shares have no subscription or preemptive rights and only such conversion or exchange rights
as the Board may grant in its discretion. When issued for payment as described in the Prospectus and this SAI, JPMT Is and JPMT IIs Shares will be fully paid and
non-assessable.
In the event of a
liquidation or dissolution of JPMT I or JPMT II, Shares of a Fund are entitled to receive the assets available for distribution belonging to the Fund, and a proportionate distribution, based upon the relative asset values of the respective Funds, of
any general assets not belonging to any particular Fund which are available for distribution.
Rule
18f-2
under the 1940 Act provides that any matter required to be submitted to the holders of the outstanding voting securities of an investment company such as JPMT I or JPMT II shall not be deemed to have been
effectively acted upon unless approved by the holders of a majority of the outstanding Shares of each Fund affected by the matter. For purposes of determining whether the approval of a majority of the outstanding Shares of a Fund will be required in
connection with a matter, a Fund will be deemed to be affected by a matter unless it is clear that the interests of each Fund in the matter are identical, or that the matter does not affect any interest of the Fund. Under Rule
18f-2,
the approval of an investment advisory agreement or any change in investment policy would be effectively acted upon with respect to a Fund only if approved by a majority of the outstanding Shares of such
Fund. However, Rule
18f-2
also provides that the ratification of independent public accountants, the approval of principal underwriting contracts, and the election of Trustees may be effectively acted upon by
Shareholders of the Trust voting without regard to series.
Each share class of a Fund has exclusive voting rights with respect
to matters pertaining to the Funds Distribution and Shareholder Services Plans, Distribution Plans or Shareholder Services Plan applicable to those classes.
Shares of JPMMFIT.
JPMMFIT is an open-end, management investment company which is organized as a Massachusetts business trust. The Growth Advantage Fund represents a
separate series of shares of beneficial interest of JPMMFIT. See Massachusetts Trust.
The Declaration of Trust of
JPMMFIT permits the Trustees to issue an unlimited number of full and fractional shares ($0.001 par value) of one or more series and classes within any series and to divide or combine the shares (of any series, if applicable) without changing the
proportionate beneficial interest of each shareholder in the Fund (or in the assets of other series, if applicable). Each share represents an equal proportional interest in the Fund with each other share. Upon liquidation of the Fund, holders are
entitled to share
pro-rata
in the net assets of the Fund available for distribution to such shareholders. See Massachusetts Trusts. The rights of redemption and exchange are described in the
Prospectuses and elsewhere in this SAI.
The shareholders of the Fund are entitled to one vote for each whole share (with
fractional shares entitled to a proportionate fractional vote) on matters on which shares of the Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees themselves have the power to alter the number and the terms of office of the
Trustees, to lengthen their own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided, however, that immediately after such appointment the requisite majority of the
Trustees have been elected by the shareholders of JPMMFIT. The voting rights of shareholders are not cumulative so that holders of more than 50% of the shares voting can, if they choose, elect all Trustees being selected while the shareholders of
the remaining shares would be unable to elect any Trustees. It is the intention of JPMMFIT not to hold meetings of shareholders annually. The Trustees may call meetings of shareholders for action by shareholder vote as may be required by either the
1940 Act or the Declarations of Trust.
Each share of a series or class represents an equal proportionate interest in that
series or class with each other share of that series or class. The shares of each series or class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMMFIT which are not attributable to a
specific series or class are allocated among all of its series in a manner believed by management of JPMMFIT to be fair and equitable. Shares have no
pre-emptive
or conversion rights. Shares when issued are
fully paid and
non-assessable,
except as set forth below. Shares of each series or class generally vote together, except when required under federal securities laws to vote separately on matters that may
affect a particular class, such as the approval of distribution plans for a particular class.
The Trustees may, however,
authorize the issuance of shares of additional series and the creation of classes of shares within any series with such preferences, privileges, limitations and voting and dividend rights as the Trustees may determine. The proceeds from the issuance
of any additional series would be invested in separate, independently managed Funds with distinct investment objectives, policies and restrictions, and share purchase, redemption and net asset valuation procedures. Any additional classes would be
used to distinguish among the rights
Part II - 104
of different categories of shareholders, as might be required by future regulations or other unforeseen circumstances. All consideration received by the Fund for shares of any additional series
or class, and all assets in which such consideration is invested, would belong to that series or class, subject only to the rights of creditors of the Fund and would be subject to the liabilities related thereto. Shareholders of any additional
series or class will approve the adoption of any management contract or distribution plan relating to such series or class and of any changes in the investment policies related thereto, to the extent required by the 1940 Act.
Shareholders of the Fund have the right, upon the declaration in writing or vote of more than
two-thirds
of its outstanding shares, to remove a Trustee. The Trustees will call a meeting of shareholders to vote on removal of a Trustee upon the written request of the record holders of 10% of the
Funds shares. In addition, whenever ten or more shareholders of record who have been such for at least six months preceding the date of application, and who hold in the aggregate either shares having a NAV of at least $25,000 or at least 1% of
JPMMFITs outstanding shares, whichever is less, shall apply to the Trustees in writing, stating that they wish to communicate with other shareholders with a view to obtaining signatures to request a meeting for the purpose of voting upon the
question of removal of the Trustee or Trustees and accompanied by a form of communication and request which they wish to transmit, the Trustees shall within five business days after receipt of such application either: (1) afford to such
applicants access to a list of the names and addresses of all shareholders as recorded on the books of the Trust; or (2) inform such applicants as to the approximate number of shareholders of record, and the approximate cost of mailing to them
the proposed communication and form of request. If the Trustees elect to follow the latter course, the Trustees, upon the written request of such applicants, accompanied by a tender of the material to be mailed and of the reasonable expenses of
mailing, shall, with reasonable promptness, mail such material to all shareholders of record at their addresses as recorded on the books, unless within five business days after such tender the Trustees shall mail to such applicants and file with the
SEC, together with a copy of the material to be mailed, a written statement signed by at least a majority of the Trustees to the effect that in their opinion either such material contains untrue statements of fact or omits to state facts necessary
to make the statements contained therein not misleading, or would be in violation of applicable law, and specifying the basis of such opinion. After opportunity for hearing upon the objections specified in the written statements filed, the SEC may,
and if demanded by the Trustees or by such applicants shall, enter an order either sustaining one or more of such objections or refusing to sustain any of them. If the SEC shall enter an order refusing to sustain any of such objections, or if, after
the entry of an order sustaining one or more of such objections, the SEC shall find, after notice and opportunity for hearing, that all objections so sustained have been met, and shall enter an order so declaring, the Trustees shall mail copies of
such material to all shareholders with reasonable promptness after the entry of such order and the renewal of such tender.
For
information relating to mandatory redemption of Fund shares or their redemption at the option of JPMMFIT under certain circumstances, see Purchases, Redemptions and Exchanges.
Shares of JPMFMFG.
The Articles of Incorporation of JPMFMFG permit the classes of JPMFMFG to offer
812,500,000 shares of common stock, with $.001 par value per share. Pursuant to JPMFMFGs Articles of Incorporation, the Board may increase the number of shares that the classes of JPMFMFG are authorized to issue without the approval of the
shareholders of each class of JPMFMFG. The Board of Directors has the power to designate and redesignate any authorized but unissued shares of capital stock into one or more classes of shares and separate series within each such class, to fix the
number of shares in any such class or series and to classify or reclassify any unissued shares with respect to such class or series.
Each share of a series in JPMFMFG represents an equal proportionate interest in that series with each other share. Shares are entitled upon liquidation to a pro rata share in the net assets of the series.
Shareholders have no preemptive rights. All consideration received by JPMFMFG for shares of any series and all assets in which such consideration is invested would belong to that series and would be subject to the liabilities related thereto. Share
certificates representing shares will not be issued.
Under Maryland law, JPMFMFG is not required to hold an annual meeting of
its shareholders unless required to do so under the 1940 Act.
Each share in each series of the Fund represents an equal
proportionate interest in that series of the Fund with each other share of that series of the Fund. The shares of each series and class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMFMFG
which are not attributable to a specific series or class are allocated among all the series and classes in a manner believed by management of JPMFMFG to be fair and equitable. Shares of each series or class generally vote together, except when
required by federal securities laws to vote separately on matters that may affect a particular series or class differently, such as approval of a distribution plan.
Part II - 105
PORTFOLIO HOLDINGS DISCLOSURE
As described in the Prospectuses and pursuant to the procedures approved by the Trustees, each business day, a Fund will make available to
the public upon request to J.P. Morgan Funds Services or the J.P. Morgan Institutional Funds Service Center
(1-800-480-4111
or
1-800-766-7722,
as applicable) a complete, uncertified schedule of its portfolio holdings as of the prior business day for the Money
Market Funds and as of the last day of that prior month for all other Funds. In addition, from time to time, each Fund may post portfolio holdings on the J.P. Morgan Funds website on a more timely basis.
The Funds publicly available uncertified, complete list of portfolio holdings information, as described above, may also be provided
regularly pursuant to a standing request, such as on a monthly or quarterly basis, to (i) third party service providers, rating and ranking agencies, financial intermediaries, and affiliated persons of the Funds and (ii) clients of the
Funds Adviser or its affiliates that invest in the Funds or such clients consultants. No compensation or other consideration is received by a Fund or the Funds Adviser, or any other person for these disclosures.
For a list of the entities that receive the Funds portfolio holdings information, the frequency with which it is provided and the
length of the lag between the date of the information and the date it is disclosed, see PORTFOLIO HOLDINGS DISCLOSURE in Part I of this SAI.
In addition, certain service providers to the Funds or the Adviser, Administrator, Shareholder Servicing Agent or Distributor may for legitimate business purposes receive the Funds portfolio
holdings information earlier than the time period specified in the applicable prospectus, such as
sub-advisers,
rating and ranking agencies, pricing services, proxy voting service providers, accountants,
attorneys, custodians, securities lending agents, consultants retained to assist in the drafting of management discussion of fund performance in shareholder reports, brokers in connection with Fund transactions and in providing pricing quotations,
transfer agents and entities providing CDSC financing (released weekly one day after trade date). When a Fund redeems a shareholder in kind, the shareholder generally receives its proportionate share of the Funds portfolio holdings and,
therefore, the shareholder and its agent may receive such information earlier than the time period specified in the Prospectuses. Such holdings are released on conditions of confidentiality, which include appropriate trading prohibitions.
Conditions of confidentiality include confidentiality terms included in written agreements, implied by the nature of the relationship (e.g., attorneyclient relationship), or required by fiduciary or regulatory principles (e.g.,
custody services provided by financial institutions).
Disclosure of a Funds portfolio securities as an exception to the
Funds normal business practice requires the business unit proposing such exception to identify a legitimate business purpose for the disclosure and to submit the proposal to the Funds Treasurer for approval following business and legal
review. Additionally, no compensation or other consideration is received by a Fund or the Funds Adviser, or any other person for these disclosures. The Funds Trustees will review annually a list of such entities that have received such
information, the frequency of such disclosures and the business purpose therefor. These procedures are designed to address conflicts of interest between the Funds shareholders on the one hand and the Funds Adviser or any affiliated
person of the Fund or such entities on the other hand by creating a structured review and approval process which seeks to ensure that disclosure of information about the Funds portfolio securities is in the best interests of the Funds
shareholders. There can be no assurance, however, that a Funds policies and procedures with respect to the disclosure of portfolio holdings information will prevent the misuse of such information by individuals or firms in possession of such
information.
In addition to the foregoing, the portfolio holdings of certain of the Advisers separately managed account
investment strategies, which are the same or substantially similar to certain of the J.P. Morgan Funds, are made available on a more timely basis than the time period specified in the applicable prospectus. It is possible that any such recipient of
these holdings could trade ahead of or against a Fund based on the information received.
Finally, the Funds release
information concerning any and all portfolio holdings when required by law. Such releases may include providing information concerning holdings of a specific security to the issuer of such security. With regard to the Money Market Funds, not later
than five business days after the end of each calendar month, each Fund will post detailed information regarding its portfolio holdings, as well as its dollar-weighted average maturity and dollar-weighted average life, as of the last day of that
month on the J.P. Morgan Funds website and provide a link to the SEC website where the most recent twelve months of publicly available information filed by the Fund may be obtained. In addition, not later than five business days after the
end of each calendar month, each Money Market Fund will file a schedule of detailed information regarding its portfolio holdings as of the last day of that
Part II - 106
month with the SEC. These filings will be publicly available on a delayed basis on the J.P. Morgan Funds website at www.jpmorganfunds.com and the SECs website 60 days after the end of
each calendar month. Each business day, each money market will make available upon request an uncertified complete schedule of its portfolio holdings as of the prior business day. In addition, each money market fund may post portfolio holdings on
the J.P. Morgan Funds website or on other external websites. In addition, on each business day, all money market funds will post their level of weekly liquid assets as of the prior business day and the money market funds (other than tax
free and municipal money market funds) will post their level of daily liquid assets as of the prior business day on the J.P. Morgan Funds website at www.jpmorganfunds.com. In addition to information on portfolio holdings, no sooner than
10 days after month end, the Funds may post a portfolio characteristics summary to the J.P. Morgan Funds website at www.jpmorganfunds.com. In addition, other fund statistical information may be found on the J.P. Morgan Funds
website from time to time.
PROXY VOTING PROCEDURES AND GUIDELINES
The Board of Trustees has delegated to the Advisers and their affiliated advisers, proxy voting authority with respect to the Funds
portfolio securities. To ensure that the proxies of portfolio companies are voted in the best interests of the Funds, the Funds Board of Trustees has adopted the Advisers detailed proxy voting procedures (the Procedures) that
incorporate guidelines (Guidelines) for voting proxies on specific types of issues.
The Adviser and its affiliated
advisers are part of a global asset management organization with the capability to invest in securities of issuers located around the globe. Because the regulatory framework and the business cultures and practices vary from region to region, the
Guidelines are customized for each region to take into account such variations. Separate Guidelines cover the regions of (1) North America, (2) Europe, Middle East, Africa, Central America and South America, (3) Asia
(ex-Japan)
and (4) Japan, respectively.
Notwithstanding the variations among the
Guidelines, all of the Guidelines have been designed with the uniform objective of encouraging corporate action that enhances shareholder value. As a general rule, in voting proxies of a particular security, the Adviser and its affiliated advisers
will apply the Guidelines of the region in which the issuer of such security is organized. Except as noted below, proxy voting decisions will be made in accordance with the Guidelines covering a multitude of both routine and
non-routine
matters that the Adviser and its affiliated advisers have encountered globally, based on many years of collective investment management experience.
To oversee and monitor the proxy-voting process, the Adviser has established a proxy committee and appointed a proxy administrator in each
global location where proxies are voted. The primary function of each proxy committee is to review periodically general proxy-voting matters, review and approve the Guidelines annually, and provide advice and recommendations on general proxy-voting
matters as well as on specific voting issues. The procedures permit an independent voting service to perform certain services otherwise carried out or coordinated by the proxy administrator.
Although for many matters the Guidelines specify the votes to be cast, for many others, the Guidelines contemplate
case-by-case
determinations. In addition, there will undoubtedly be proxy matters that are not contemplated by the Guidelines. For both of these categories of matters and to
override the Guidelines, the Procedures require a certification and review process to be completed before the vote is cast. That process is designed to identify actual or potential material conflicts of interest (between the Fund on the one hand,
and the Funds investment adviser, principal underwriter or an affiliate of any of the foregoing, on the other hand) and ensure that the proxy vote is cast in the best interests of the Fund. A conflict is deemed to exist when the proxy is for
JPMorgan Chase & Co. stock or for J.P. Morgan Funds, or when the proxy administrator has actual knowledge indicating that a JPMorgan affiliate is an investment banker or rendered a fairness opinion with respect to the matter that is the subject
of the proxy vote. When such conflicts are identified, the proxy will be voted by an independent third party either in accordance with JPMorgan proxy voting guidelines or by the third party using its own guidelines.
When other types of potential material conflicts of interest are identified, the proxy administrator and JPMAMs Chief Fiduciary
Officer will evaluate the potential conflict of interest and determine whether such conflict actually exists, and if so, will recommend how the Adviser will vote the proxy. In addressing any material conflict, the Adviser may take one or more of the
following measures (or other appropriate action): removing or walling off from the proxy voting process certain Adviser personnel with knowledge of the conflict, voting in accordance with any applicable Guideline if the application of
the Guideline would objectively result in the casting of a proxy vote in a predetermined manner, or deferring the vote to or obtaining a recommendation from an third
Part II - 107
independent party, in which case the proxy will be voted by, or in accordance with the recommendation of, the independent third party.
The following summarizes some of the more noteworthy types of proxy voting policies of the
non-U.S.
Guidelines:
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Corporate governance procedures differ among the countries. Because of time constraints and local customs, it is not always possible for the Adviser to
receive and review all proxy materials in connection with each item submitted for a vote. Many proxy statements are in foreign languages. Proxy materials are generally mailed by the issuer to the
sub-custodian
which holds the securities for the client in the country where the portfolio company is organized, and there may not be sufficient time for such materials to be transmitted to the Adviser in time for a vote to be cast. In some countries, proxy
statements are not mailed at all, and in some locations, the deadline for voting is two to four days after the initial announcement that a vote is to be solicited and it may not always be possible to obtain sufficient information to make an informed
decision in good time to vote.
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Certain markets require that shares being tendered for voting purposes are temporarily immobilized from trading until after the shareholder meeting has
taken place. Elsewhere, notably emerging markets, it may not always be possible to obtain sufficient information to make an informed decision in good time to vote. Some markets require a local representative to be hired in order to attend the
meeting and vote in person on our behalf, which can result in considerable cost.
The Adviser also considers the cost of voting in light of the expected benefit of the vote. In certain instances, it may sometimes be in the
Funds best interests to intentionally refrain from voting in certain overseas markets from time to time.
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Where proxy issues concern corporate governance, takeover defense measures, compensation plans, capital structure changes and so forth, the Adviser
pays particular attention to managements arguments for promoting the prospective change. The Advisers sole criterion in determining its voting stance is whether such changes will be to the economic benefit of the beneficial owners of the
shares.
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The Adviser is in favor of a unitary board structure of the type found in the United Kingdom as opposed to tiered board structures. Thus, the Adviser
will generally vote to encourage the gradual phasing out of tiered board structures, in favor of unitary boards. However, since tiered boards are still very prevalent in markets outside of the United Kingdom, local market practice will always be
taken into account.
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The Adviser will use its voting powers to encourage appropriate levels of board independence, taking into account local market practice.
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The Adviser will usually vote against discharging the board from responsibility in cases of pending litigation, or if there is evidence of wrongdoing
for which the board must be held accountable.
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The Adviser will vote in favor of increases in capital which enhance a companys long-term prospects. The Adviser will also vote in favor of the
partial suspension of preemptive rights if they are for purely technical reasons (e.g., rights offers which may not be legally offered to shareholders in certain jurisdictions). However, the Adviser will vote against increases in capital which would
allow the company to adopt poison pill takeover defense tactics, or where the increase in authorized capital would dilute shareholder value in the long term.
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The Adviser will vote in favor of proposals which will enhance a companys long-term prospects. The Adviser will vote against an increase in bank
borrowing powers which would result in the company reaching an unacceptable level of financial leverage, where such borrowing is expressly intended as part of a takeover defense, or where there is a material reduction in shareholder value.
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The Adviser will generally vote against anti-takeover devices.
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Where social or environmental issues are the subject of a proxy vote, the Adviser will consider the issue on a
case-by-case
basis, keeping in mind at all times the best economic interests of its clients.
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The following summarizes some of the more noteworthy types of proxy voting policies of the U.S. Guidelines:
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The Adviser considers votes on director nominees on a
case-by-case
basis. Votes generally will be withheld from directors who: (a) attend less than 75% of board and committee meetings without a valid excuse; (b) implement or renew a dead-hand poison pill; (c) are affiliated directors who serve on
audit, compensation or nominating committees or are affiliated directors and the full board serves on such
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Part II - 108
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committees or the company does not have such committees; or (d) ignore a shareholder proposal that is approved for two consecutive years by a majority of either the shares outstanding or the
votes cast.
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The Adviser votes proposals to classify boards on a
case-by-case
basis,
but normally will vote in favor of such proposal if the issuers governing documents contain each of eight enumerated safeguards (for example, a majority of the board is composed of independent directors and the nominating committee is composed
solely of such directors).
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The Adviser also considers management poison pill proposals on a
case-by-case
basis, looking for shareholder-friendly provisions before voting in favor.
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The Adviser votes against proposals for a super-majority vote to approve a merger.
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The Adviser considers proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan on a
case-by-case
basis, taking into account such factors as the extent of dilution and whether the transaction will result in a change in control.
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The Adviser votes proposals on a stock option plan based primarily on a detailed, quantitative analysis that takes into account factors such as
estimated dilution to shareholders equity and dilution to voting power. The Adviser generally considers other management compensation proposals on a
case-by-case
basis.
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The Adviser also considers on a
case-by-case
basis proposals to change
an issuers state of incorporation, mergers and acquisitions and other corporate restructuring proposals and certain social and environmental issue proposals.
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The Adviser reviews Say on Pay proposals on a case by case basis with additional review of proposals where the issuers previous years
proposal received a low level of support.
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In accordance with regulations of the SEC, the Funds proxy
voting records for the most recent
12-month
period ended June 30 are on file with the SEC and are available on the J.P. Morgan Funds website at www.jpmorganfunds.com and are on the SECs
website at www.sec.gov.
ADDITIONAL INFORMATION
A Trust is not required to hold a meeting of Shareholders for the purpose of electing Trustees except that (i) a Trust is required to
hold a Shareholders meeting for the election of Trustees at such time as less than a majority of the Trustees holding office have been elected by Shareholders and (ii) if, as a result of a vacancy on the Board of Trustees, less than
two-thirds
of the Trustees holding office have been elected by the Shareholders, that vacancy may only be filled by a vote of the Shareholders. In addition, Trustees may be removed from office by a written consent
signed by the holders of Shares representing
two-thirds
of the outstanding Shares of a Trust at a meeting duly called for the purpose, which meeting shall be called and held in accordance with the bylaws of
the applicable Trust. Except as set forth above, the Trustees may continue to hold office and may appoint successor Trustees.
As used in a Trusts Prospectuses and in this SAI, assets belonging to a Fund means the consideration received by a Trust
upon the issuance or sale of Shares in that Fund, together with all income, earnings, profits, and proceeds derived from the investment thereof, including any proceeds from the sale, exchange, or liquidation of such investments, and any funds or
payments derived from any reinvestment of such proceeds, and any general assets of a Trust not readily identified as belonging to a particular Fund that are allocated to that Fund by a Trusts Board of Trustees. The Board of Trustees may
allocate such general assets in any manner it deems fair and equitable. It is anticipated that the factor that will be used by the Board of Trustees in making allocations of general assets to particular Funds will be the relative net asset values of
the respective Funds at the time of allocation. Assets belonging to a particular Fund are charged with the direct liabilities and expenses in respect of that Fund, and with a share of the general liabilities and expenses of a Trust not readily
identified as belonging to a particular Fund that are allocated to that Fund in proportion to the relative net asset values of the respective Funds at the time of allocation. The timing of allocations of general assets and general liabilities and
expenses of a Trust to particular Funds will be determined by the Board of Trustees of a Trust and will be in accordance with generally accepted accounting principles. Determinations by the Board of Trustees of a Trust as to the timing of the
allocation of general liabilities and expenses and as to the timing and allocable portion of any general assets with respect to a particular Fund are conclusive.
As used in this SAI and the Prospectuses, the term majority of the outstanding voting securities of the Trust, a particular Fund or a particular class of a Fund means the following when the
1940 Act governs the required
Part II - 109
approval: the affirmative vote of the lesser of (a) more than 50% of the outstanding shares of the Trust, such Fund or such class of such Fund, or (b) 67% or more of the shares of the
Trust, such Fund or such class of such Fund present at a meeting at which the holders of more than 50% of the outstanding shares of the Trust, such Fund or such class of such Fund are represented in person or by proxy. Otherwise, the declaration of
trust, articles of incorporation or
by-laws
usually govern the needed approval and generally require that if a quorum is present at a meeting, the vote of a majority of the shares of the Trust, such Fund or
such class of such Fund, as applicable, shall decide the question.
Telephone calls to the Funds, the Funds service
providers or a Financial Intermediary as Financial Intermediary may be recorded. With respect to the securities offered hereby, this SAI and the Prospectuses do not contain all the information included in the Registration Statements of the Trusts
filed with the SEC under the 1933 Act and the 1940 Act. Pursuant to the rules and regulations of the SEC, certain portions have been omitted. The Registration Statement including the exhibits filed therewith may be examined at the office of the SEC
in Washington, D.C.
Statements contained in this SAI and the Prospectuses concerning the contents of any contract or other
document are not necessarily complete, and in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statements of the Trusts. Each such statement is qualified in all respects by such
reference.
No dealer, salesman or any other person has been authorized to give any information or to make any representations,
other than those contained in the Prospectuses and this SAI, in connection with the offer contained therein and, if given or made, such other information or representations must not be relied upon as having been authorized by any of the Trusts, the
Funds or JPMDS. The Prospectuses and this SAI do not constitute an offer by any Fund or by JPMDS to sell or solicit any offer to buy any of the securities offered hereby in any jurisdiction to any person to whom it is unlawful for the Funds or JPMDS
to make such offer in such jurisdictions.
Part II - 110