Equinox Institutional Asset Management, LP
This Statement of Additional Information (SAI) is not a prospectus. It is intended to provide additional information about the activities and
operations of Equinox Funds Trust (the Trust) and the Equinox EquityHedge U.S. Strategy Fund (the Fund), a series of the Trust, and should be read in conjunction with the Funds current prospectus, dated June 27, 2013,
as amended or supplemented from time to time (the Prospectus).
This SAI has been incorporated by reference in its entirety into the
Prospectus. A copy of the Prospectus and annual report to shareholders (when available) may be obtained without charge, upon request, by calling toll-free 1-888-643-3431.
TABLE OF CONTENTS
THE TRUST
The Trust is an open-end management investment company
established under Delaware law as a statutory trust, and was organized on June 2, 2010. The Fund is a newly established, separate series of the Trust. The Trust offers other mutual fund series in addition to the Fund. The Fund issues
Class A, Class C and Class I shares. The Trust is governed by its Board of Trustees (the Board or Trustees). The Fund is classified as a non-diversified investment company under the Investment Company Act of
1940, as amended (1940 Act), meaning it may invest in fewer companies than diversified investment companies. Each share of the Fund represents an equal proportionate interest in the Fund.
See
Capital Stock and Other
Securities.
DESCRIPTION OF PERMITTED INVESTMENTS
The Fund will only invest in any of the following
instruments or engage in any of the following investment practices if such investment or activity is consistent with the Funds investment objective and permitted by the Funds stated investment policies.
Common Stock.
Common stock represents an equity (ownership) interest in a company or other entity. This ownership interest often gives
the Fund the right to vote on measures affecting the companys organization and operations. Although common stocks generally have had a history of long-term growth in value, their prices are often volatile in the short-term and can be
influenced by both general market risk and specific corporate risks. Accordingly, the Fund can lose money through its stock investments.
Convertible
Securities.
The Fund may invest in convertible securities, which may offer higher income than the common stocks into which they are convertible. A convertible security is a bond, debenture, note, preferred stock, or other
security that entitles the holder to acquire common stock or other equity securities of the same or a different issuer. A convertible security generally entitles the holder to receive interest paid or accrued until the convertible security matures
or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to non-convertible debt or preferred securities, as applicable. Convertible securities rank senior to common stock in a corporations
capital structure and, therefore, generally entail less risk than the corporations common stock, although the extent to which such risk is reduced depends in large measure upon the degree to which the convertible security sells above its value
as a fixed income security. Convertible securities are subordinate in rank to any senior debt obligations of the issuer, and, therefore, an issuers convertible securities entail more risk than its debt obligations. Convertible securities
generally offer lower interest or dividend yields than non-convertible debt securities of similar credit quality because of the potential for capital appreciation. In addition, convertible securities are often lower-rated securities.
Because of the conversion feature, the price of the convertible security will normally fluctuate in some proportion to changes in the price of the underlying asset,
and as such is subject to risks relating to the activities of the issuer and/or general market and economic conditions. The income component of a convertible security may tend to cushion the security against declines in the price of the underlying
asset. However, the income component of convertible securities causes fluctuations based upon changes in interest rates and the credit quality of the issuer.
If the convertible securitys conversion value, which is the market value of the underlying common stock that would be obtained upon the conversion of the convertible security, is substantially
below the investment value, which is the value of a convertible security viewed without regard to its conversion feature (i.e., strictly on the basis of its yield), the price of the convertible security is governed principally by its
investment value. If the conversion value of a convertible security increases to a point that approximates or exceeds its investment value, the value of the security will be principally influenced by its conversion value. A convertible security will
sell at a premium over its conversion value to the extent investors place value on the right to acquire the underlying common stock while holding an income-producing security.
A convertible security may be subject to redemption at the option of the issuer at a predetermined price. If a convertible security held by the Fund is called for redemption, the Fund would be required to permit
the issuer to redeem the security and convert it to underlying common stock, or would sell the convertible security to a third party, which may have an adverse effect on the Funds ability to achieve its investment objective. The Fund generally
would invest in convertible securities for their favorable price characteristics and total return potential and would normally not exercise an option to convert unless the security is called or conversion is forced.
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Depositary Receipts.
American Depositary Receipts (ADRs) as well as other
hybrid forms of ADRs, including European Depositary Receipts (EDRs) and Global Depositary Receipts (GDRs), are certificates evidencing ownership of shares of a foreign issuer. These certificates are issued by
depository banks and generally trade on an established market in the United States or elsewhere. The underlying shares are held in trust by a custodian bank or similar financial institution. The depository bank may not have physical custody of the
underlying securities at all times and may charge fees for various services, including forwarding dividends interest and shareholder information regarding corporate actions. ADRs may be available through sponsored or
unsponsored facilities. A sponsored facility is established jointly by the issuer of the security underlying the receipt and a depositary. An unsponsored facility may be established by a depositary without participation by the issuer of
the underlying security. Holders of unsponsored depositary receipts generally bear all the costs of the unsponsored facility. The depositary of an unsponsored facility frequently is under no obligation to distribute shareholder communications
received from the issuer of the deposited security or to pass through, to the holders of the receipts, voting rights with respect to the deposited securities. ADRs are alternatives to directly purchasing the underlying foreign securities in their
national markets and currencies. However, ADRs continue to be subject to many of the risks associated with investing directly in foreign securities. These risks include foreign exchange risk as well as the political and economic risks of the
underlying issuers country.
Derivatives.
Derivatives are financial instruments whose value is based on an underlying
asset, such as a stock or a bond, or an underlying economic factor, such as an interest rate or a market benchmark. Unless otherwise stated in the Funds prospectus, the Fund may use derivatives to gain exposure to the asset class and for risk
management purposes, including to gain exposure to various markets in a cost efficient manner, to reduce transaction costs or to remain fully invested. The Fund may also invest in derivatives to protect from broad fluctuations in market prices,
interest rates or foreign currency exchange rates (a practice known as hedging). When hedging is successful, the Fund will have to offset any depreciation in the value of its portfolio securities by the appreciation in the value of the
derivative position. Although techniques other than the sale and purchase of derivatives could be used to control the exposure of the Fund to market fluctuations, the use of derivatives may be a more effective means of hedging this exposure. To the
extent that the Fund engages in hedging, there can be no assurance that any hedge will be effective or that there will be a hedge in place at any given time.
Because many derivatives have a leverage or borrowing component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount
invested in the derivative itself. Certain derivatives have the potential for unlimited loss, regardless of the size of the initial investment. Accordingly, certain derivative transactions may be considered to constitute borrowing transactions for
purposes of the 1940 Act. Such a derivative transaction will not be considered to constitute the issuance of a senior security by the Fund, and therefore such transaction will not be subject to the 300% asset coverage requirement
otherwise applicable to borrowings by the Fund, if the Fund covers the transaction or segregates sufficient liquid assets in accordance with the 1940 Act requirements or the rules and SEC interpretations thereunder.
Types of Derivatives:
Futures.
A futures contract is an agreement between two parties whereby one party sells and the other party agrees to buy a specified
amount of a commodity or a financial instrument at an agreed upon price and time. The financial instrument underlying a futures contract may be a stock, stock index, bond, bond index, interest rate, foreign exchange rate or other similar instrument.
Agreeing to buy the underlying commodity or financial instrument is called buying a futures contract or taking a long position in the contract. Likewise, agreeing to sell the underlying commodity or financial instrument is called selling a futures
contract or taking a short position in the contract.
Futures contracts are traded in the U.S. on commodity exchanges or boards of trade known as
contract markets approved for such trading and regulated by the Commodity Futures Trading Commission (CFTC). These contract markets standardize the terms, including the maturity date and underlying financial
instrument, of all futures contracts.
Unlike other securities or instruments, the parties to a futures contract do not have to pay for or deliver the
underlying commodity or financial instrument until some future date (the delivery date). Contract markets require both the purchaser and seller to deposit initial margin with a futures broker, known as a futures commission merchant or
custodian bank, when they enter into the contract. Initial margin deposits are typically equal to a percentage of the contracts value. After they open a futures contract, the parties to the transaction must compare the purchase price of the
contract to its daily market value. If the value of the futures contract changes in such a way that a partys position declines, that party must make additional variation margin payments so that the margin payment is adequate. On
the other hand, the value of the contract may change in such a way that there is excess margin on deposit, possibly entitling the party that has a gain to receive all or a portion of this amount. This process is known as marking to the
market.
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Although the actual terms of a futures contract calls for the actual delivery of and payment for the underlying
commodity or security, in many cases the parties may close the contract early by taking an opposite position in an identical contract. If the sale price upon closing out the contract is less than the original purchase price, the person closing out
the contract will realize a loss. If the sale price upon closing out the contract is more than the original purchase price, the person closing out the contract will realize a gain. If the purchase price upon closing out the contract is more than the
original sale price, the person closing out the contract will realize a loss. If the purchase price upon closing out the contract is less than the original sale price, the person closing out the contract will realize a gain.
The Fund may incur commission expenses when it opens or closes a futures position.
Options.
An option is a contract between two parties for the purchase and sale of a financial instrument for a specified price (known as the strike price or exercise
price) at any time during the option period. Unlike a futures contract, an option grants a right (not an obligation) to buy or sell a financial instrument. Generally, a seller of an option can grant a buyer two kinds of rights: a
call (the right to buy the security) or a put (the right to sell the security). Options have various types of underlying instruments, including specific securities, indices of securities prices, foreign currencies, interest
rates and futures contracts. Options may be traded on an exchange (exchange-traded-options) or may be customized agreements between the parties (over-the-counter or OTC options). Like futures, a financial intermediary, known as a
clearing corporation, financially backs exchange-traded options. However, OTC options have no such intermediary and are subject to the risk that the counterparty will not fulfill its obligations under the contract.
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Purchasing Put and Call Options
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When
the Fund purchases a put option, it buys the right to sell the instrument underlying the option at a fixed strike price. In return for this right, the Fund pays the current market price for the option (known as the option premium). The
Fund may purchase put options to offset or hedge against a decline in the market value of its securities (protective puts) or to benefit from a decline in the price of securities that it does not own. The Fund would ordinarily realize a
gain if, during the option period, the value of the underlying securities decreased below the exercise price sufficiently to cover the premium and transaction costs. However, if the price of the underlying instrument does not fall enough to offset
the cost of purchasing the option, a put buyer would lose the premium and related transaction costs.
Call options are similar to put options, except
that the Fund obtains the right to purchase, rather than sell, the underlying instrument at the options strike price. The Fund would normally purchase call options in anticipation of an increase in the market value of securities it owns or
wants to buy. The Fund would ordinarily realize a gain if, during the option period, the value of the underlying instrument exceeded the exercise price plus the premium paid and related transaction costs. Otherwise, the Fund would realize either no
gain or a loss on the purchase of the call option.
The purchaser of an option may terminate its position by:
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Allowing it to expire and losing its entire premium;
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Exercising the option and either selling (in the case of a put option) or buying (in the case of a call option) the underlying instrument at the strike price; or
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Closing it out in the secondary market at its current price.
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Selling (Writing) Put and Call Options
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When the Fund writes a call option, it assumes an obligation to sell specified securities to the holder of the option at a specified price if the option is
exercised at any time before the expiration date. Similarly, when the Fund writes a put option, it assumes an obligation to purchase specified securities from the option holder at a specified price if the option is exercised at any time before the
expiration date. The Fund may terminate its position in an exchange-traded put option before exercise by buying an option identical to the one it has written. Similarly, it may cancel an over-the-counter option by entering into an offsetting
transaction with the counterparty to the option.
The Fund could try to hedge against an increase in the value of securities it would like to acquire by
writing a put option on those securities. If security prices rise, the Fund would expect the put option to expire and the premium it received to offset the increase in the securitys value. If security prices remain the same over time, the Fund
would hope to profit by closing out the put option at a lower price. If security prices fall, the Fund may lose an amount of money equal to the difference between the value of the security and the premium it received. Writing covered put options may
deprive the Fund of the opportunity to profit from a decrease in the market price of the securities it would like to acquire.
The characteristics of
writing call options are similar to those of writing put options, except that call writers expect to profit if prices remain the same or fall. The Fund could try to hedge against a decline in the value of securities it already owns by writing a call
option. If the price of that security falls as expected, the Fund would expect the option to
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expire and the premium it received to offset the decline of the securitys value. However, the Fund must be prepared to deliver the underlying instrument in return for the strike price,
which may deprive it of the opportunity to profit from an increase in the market price of the securities it holds.
The Fund is permitted only to write
covered options. At the time of selling the call option, the Fund may cover the option by owning, among other things:
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The underlying security (or securities convertible into the underlying security without additional consideration) or index, interest rate, foreign currency or
futures contract;
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A call option on the same security or index with the same or lesser exercise price;
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A call option on the same security or index with a greater exercise price and segregating cash or liquid securities in an amount equal to the difference between
the exercise prices;
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Cash or liquid securities equal to at least the market value of the optioned securities, interest rate, foreign currency or futures contract; or
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In the case of an index, the portfolio of securities that corresponds to the index.
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At the time of selling a put option, the Fund may cover the put option by, among other things:
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Entering into a short position in the underlying security;
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Purchasing a put option on the same security, index, interest rate, foreign currency or futures contract with the same or greater exercise price;
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Purchasing a put option on the same security, index, interest rate, foreign currency or futures contract with a lesser exercise price and segregating cash or
liquid securities in an amount equal to the difference between the exercise prices; or
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Maintaining the entire exercise price in liquid securities.
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Options on Securities Indices
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Options
on securities indices are similar to options on securities, except that the exercise of securities index options requires cash settlement payments and does not involve the actual purchase or sale of securities. In addition, securities index options
are designed to reflect price fluctuations in a group of securities or segment of the securities market rather than price fluctuations in a single security.
An option on a
futures contract provides the holder with the right to buy a futures contract (in the case of a call option) or sell a futures contract (in the case of a put option) at a fixed time and price. Upon exercise of the option by the holder, the contract
market clearing house establishes a corresponding short position for the writer of the option (in the case of a call option) or a corresponding long position (in the case of a put option). If the option is exercised, the parties will be subject to
the futures contracts. In addition, the writer of an option on a futures contract is subject to initial and variation margin requirements on the option position. Options on futures contracts are traded on the same contract market as the underlying
futures contract.
The buyer or seller of an option on a futures contract may terminate the option early by purchasing or selling an option of the same
series (
i.e.,
the same exercise price and expiration date) as the option previously purchased or sold. The difference between the premiums paid and received represents the traders profit or loss on the transaction.
The Fund may purchase put and call options on futures contracts instead of selling or buying futures contracts. The Fund may buy a put option on a futures contract
for the same reasons it would sell a futures contract. It also may purchase such put options in order to hedge a long position in the underlying futures contract. The Fund may buy call options on futures contracts for the same purpose as the actual
purchase of the futures contracts, such as in anticipation of favorable market conditions.
The Fund may write a call option on a futures contract to
hedge against a decline in the prices of the instrument underlying the futures contracts. If the price of the futures contract at expiration were below the exercise price, the Fund would retain the option premium, which would offset, in part, any
decline in the value of its portfolio securities.
The writing of a put option on a futures contract is similar to the purchase of the futures contracts,
except that, if the market price declines, the Fund would pay more than the market price for the underlying instrument. The premium received on the sale of the put option, less any transaction costs, would reduce the net cost to the Fund.
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The Fund may
purchase and write options in combination with each other, or in combination with futures or forward contracts, to adjust the risk and return characteristics of the overall position. For example, the Fund could construct a combined position whose
risk and return characteristics are similar to selling a futures contract by purchasing a put option and writing a call option on the same underlying instrument. Alternatively, the Fund could write a call option at one strike price and buy a call
option at a lower price 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.
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Forward Foreign Currency Exchange Contracts
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A forward foreign currency contract involves an obligation to purchase or sell a specific amount of currency at a future date or date range at a specific price. 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. Forward foreign currency exchange contracts differ from foreign currency futures contracts in certain respects. Unlike futures contracts, forward
contracts:
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Do not have standard maturity dates or amounts (i.e., the parties to the contract may fix the maturity date and the amount).
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Are traded in the inter-bank markets conducted directly between currency traders (usually large commercial banks) and their customers, as opposed to futures
contracts which are traded only on exchanges regulated by the CFTC.
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Do not require an initial margin deposit.
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May be closed by entering into a closing transaction with the currency trader who is a party to the original forward contract, as opposed to a commodities
exchange.
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Foreign Currency Hedging Strategies.
A settlement hedge or transaction
hedge is designed to protect the Fund against an adverse change in foreign currency values between the date a security is purchased or sold and the date on which payment is made or received. Entering into a forward contract for the purchase or
sale of the amount of foreign currency involved in an underlying security transaction for a fixed amount of U.S. dollars locks in the U.S. dollar price of the security. The Fund may also use forward contracts to purchase or sell a
foreign currency when it anticipates purchasing or selling securities denominated in foreign currency, even if it has not yet selected the specific investments.
The Fund may use forward contracts to hedge against a decline in the value of existing investments denominated in foreign currency. Such a hedge, sometimes referred to as a position hedge, would tend to
offset both positive and negative currency fluctuations, but would not offset changes in security values caused by other factors. The Fund could also hedge the position by selling another currency expected to perform similarly to the currency in
which the Funds investment is denominated. This type of hedge, sometimes referred to as a proxy hedge, could offer advantages in terms of cost, yield, or efficiency, but generally would not hedge currency exposure as effectively as
a direct hedge into U.S. dollars. Proxy hedges may result in losses if the currency used to hedge does not perform similarly to the currency in which the hedged securities are denominated.
Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities that the Fund owns or intends to purchase or sell. They simply establish a rate of exchange that one can
achieve at some future point in time. Additionally, these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency and to limit any potential gain that might result from the increase in value of such
currency.
The Fund may enter into forward contracts to shift its investment exposure from one currency into another. Such transactions may call for the
delivery of one foreign currency in exchange for another foreign currency, including currencies in which its securities are not then denominated. This may include shifting exposure from U.S. dollars to a foreign currency, or from one foreign
currency to another foreign currency. This type of strategy, sometimes known as a cross-hedge, will tend to reduce or eliminate exposure to the currency that is sold, and increase exposure to the currency that is purchased. Cross-hedges
may protect against losses resulting from a decline in the hedged currency, but will cause the Fund to assume the risk of fluctuations in the value of the currency it purchases. Cross hedging transactions also involve the risk of imperfect
correlation between changes in the values of the currencies involved.
It is difficult to forecast with precision the market value of portfolio
securities at the expiration or maturity of a forward or futures contract. Accordingly, the Fund may have to purchase additional foreign currency on the spot market if the market value of a security it is hedging is less than the amount of foreign
currency it is obligated to deliver. Conversely, the Fund may have to sell on the spot market some of the foreign currency it received upon the sale of a security if the market value of such security exceeds the amount of foreign currency it is
obligated to deliver.
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To the extent that the Fund engages in foreign currency hedging, there can be no assurance that any hedge will be
effective or that there will be a hedge in place at any given time.
Swaps, Caps, Collars and Floors
Swap Agreements.
A swap is a financial instrument that typically involves the exchange of cash flows between two parties on specified
dates (settlement dates), where the cash flows are based on agreed-upon prices, rates, indices, etc. The nominal amount on which the cash flows are calculated is called the notional amount. Swaps are individually negotiated and structured to include
exposure to a variety of different types of investments or market factors, such as interest rates, foreign currency rates, mortgage securities, corporate borrowing rates, security prices or inflation rates.
Swap agreements may increase or decrease the overall volatility of the investments of the Fund and its share price. The performance of swap agreements may be
affected by a change in the specific interest rate, currency, or other factors that determine the amounts of payments due to and from the Fund. If a swap agreement calls for payments by the Fund, the Fund must be prepared to make such payments when
due. In addition, if the counterpartys creditworthiness declined, the value of a swap agreement would be likely to decline, potentially resulting in losses.
Generally, swap agreements have a fixed maturity date that will be agreed upon by the parties. The agreement can be terminated before the maturity date under certain circumstances, such as default by one of the
parties or insolvency, among others, and can be transferred by a party only with the prior written consent of the other party. The Fund may be able to eliminate its exposure under a swap agreement either by assignment or by other disposition, or by
entering into an offsetting swap agreement with the same party or a similarly creditworthy party. If the counterparty is unable to meet its obligations under the contract, declares bankruptcy, defaults or becomes insolvent, the Fund may not be able
to recover the money it expected to receive under the contract.
A swap agreement can be a form of leverage, which can magnify the Funds gains or
losses. In order to reduce the risk associated with leveraging, the Fund may cover its current obligations under swap agreements according to guidelines established by the U.S. Securities and Exchange Commission (SEC). If the Fund enters
into a swap agreement on a net basis, it will maintain coverage with a daily value at least equal to the excess, if any, of the Funds accrued obligations under the swap agreement over the accrued amount the Fund is entitled to receive under
the agreement. If the Fund enters into a swap agreement on other than a net basis, it will maintain coverage with a value equal to the full amount of the Funds accrued obligations under the agreement.
Total return swaps
are contracts in which one party agrees to make payments of the total return from the underlying asset during the specified period, in return for payments equal to a fixed or floating rate of interest or the total return from another underlying
asset. The total return includes appreciation or depreciation on the underlying asset, plus any interest or dividend payments. Payments under the swap are based upon an agreed upon principal amount but since the principal amount is not exchanged, it
represents neither an asset nor a liability to either counterparty, and is referred to as notional. Total return swaps are marked to market daily using different sources, including quotations from counterparties, pricing services, brokers or market
makers. The unrealized appreciation (depreciation) related to the change in the valuation of the notional amount of the swap is combined with the amount due to the Fund at termination or settlement. The primary risks associated with total returns
swaps are credit risks (if the counterparty fails to meet its obligations) and market risk (if there is no liquid market for the agreement or unfavorable changes occur to the underlying asset).
In a typical equity swap,
one party agrees to pay another party the return on a stock, stock index or basket of stocks in return for a specified interest rate. By entering into an equity index swap, for example, the index receiver can gain exposure to stocks making up the
index of securities without actually purchasing those stocks. Equity index swaps involve not only the risk associated with investment in the securities represented in the index, but also the risk that the performance of such securities, including
dividends, will not exceed the return on the interest rate that the Fund will be committed to pay.
Interest rate swaps
are financial instruments that involve the exchange of one type of interest rate for another type of interest rate cash flow on specified dates in the future. Some of the different types of interest rate swaps are fixed-for floating rate
swaps, termed basis swaps and index amortizing swaps. Fixed-for floating rate swaps involve the exchange of fixed interest rate cash flows for floating rate cash flows. Termed basis swaps entail cash flows to both
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parties based on floating interest rates, where the interest rate indices are different. Index amortizing swaps are typically fixed-for floating swaps where the notional amount changes if certain
conditions are met.
Like a traditional investment in a debt security, the Fund could lose money by investing in an interest rate swap if interest rates
change adversely. For example, if the Fund enters into a swap where it agrees to exchange a floating rate of interest for a fixed rate of interest, the Fund may have to pay more money than it receives. Similarly, if the Fund enters into a swap where
it agrees to exchange a fixed rate of interest for a floating rate of interest, the Fund may receive less money than it has agreed to pay.
A currency swap is an
agreement between two parties in which one party agrees to make interest rate payments in one currency and the other promises to make interest rate payments in another currency. The Fund may enter into a currency swap when it has one currency and
desires a different currency. Typically the interest rates that determine the currency swap payments are fixed, although occasionally one or both parties may pay a floating rate of interest. Unlike an interest rate swap, however, the principal
amounts are exchanged at the beginning of the contract and returned at the end of the contract. Changes in foreign exchange rates and changes in interest rates, as described above may negatively affect currency swaps.
Caps, Collars and Floors.
Caps and floors have an effect similar to buying or writing options. In a typical cap or floor agreement,
one party agrees to make payments only under specified circumstances, usually in return for payment of a fee by the other party. For example, the buyer of an interest rate cap obtains the right to receive payments to the extent that a specified
interest rate exceeds an agreed-upon level. The seller of an interest rate floor is obligated to make payments to the extent that a specified interest rate falls below an agreed-upon level. An interest rate collar combines elements of buying a cap
and selling a floor.
Risks of Derivatives:
While transactions in derivatives may reduce certain risks, these transactions themselves entail certain other risks. For example, unanticipated changes in interest
rates, securities prices or currency exchange rates may result in a poorer overall performance of the Fund than if it had not entered into any derivatives transactions. Derivatives may magnify the Funds gains or losses, causing it to make or
lose substantially more than it invested.
When used for hedging purposes, increases in the value of the securities the Fund holds or intends to acquire
should offset any losses incurred with a derivative. Purchasing derivatives for purposes other than hedging could expose the Fund to greater risks.
Correlation of Prices.
The Funds ability to hedge its securities through derivatives depends on the degree to which price
movements in the underlying index or instrument correlate with price movements in the relevant securities. In the case of poor correlation, the price of the securities the Fund is hedging may not move in the same amount, or even in the same
direction as the hedging instrument. The Adviser or the Sub-Adviser, as the case may be, will try to minimize this risk by investing only in those contracts whose behavior it expects to resemble with the portfolio securities it is trying to hedge.
However, if the Funds prediction of interest and currency rates, market value, volatility or other economic factors is incorrect, the Fund may lose money, or may not make as much money as it expected.
Derivative prices can diverge from the prices of their underlying instruments, even if the characteristics of the underlying instruments are very similar to the
derivative. Listed below are some of the factors that may cause such a divergence:
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current and anticipated short-term interest rates, changes in volatility of the underlying instrument, and the time remaining until expiration of the contract;
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a difference between the derivatives and securities markets, including different levels of demand, how the instruments are traded, the imposition of daily price
fluctuation limits or trading of an instrument stops; and
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differences between the derivatives, such as different margin requirements, different liquidity of such markets and the participation of speculators in such
markets.
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Derivatives based upon a narrow index of securities, such as those of a particular industry group, may present greater risk
than derivatives based on a broad market index. Since narrower indices are made up of a smaller number of securities, they are more susceptible to rapid and extreme price fluctuations because of changes in the value of those securities.
While currency futures and options values are expected to correlate with exchange rates, they may not reflect other factors that affect the value of the investments
of the Fund. A currency hedge, for example, should protect a
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yen-denominated security from a decline in the yen, but will not protect the Fund against a price decline resulting from deterioration in the issuers creditworthiness. Because the value of
the Funds foreign-denominated investments changes in response to many factors other than exchange rates, it may not be possible to match the amount of currency options and futures to the value of the Funds investments precisely over
time.
Lack of Liquidity.
Before a futures contract or option is exercised or expires, the Fund can terminate it only by
entering into a closing purchase or sale transaction. Moreover, the Fund may close out a futures contract only on the exchange on which the contract was initially traded. If there is no secondary market for the contract, or the market is illiquid,
the Fund may not be able to close out its position. In an illiquid market, the Fund may:
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have to sell securities to meet its daily margin requirements at a time when it is disadvantageous to do so;
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have to purchase or sell the instrument underlying the contract;
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not be able to hedge its investments; and
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not be able to realize profits or limit its losses.
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Derivatives may become illiquid (i.e., difficult to sell at a desired time and price) under a variety of market conditions. For example:
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an exchange may suspend or limit trading in a particular derivative instrument, an entire category of derivatives or all derivatives, which sometimes occurs
because of increased market volatility;
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unusual or unforeseen circumstances may interrupt normal operations of an exchange;
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the facilities of the exchange may not be adequate to handle current trading volume;
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equipment failures, government intervention, insolvency of a brokerage firm or clearing house or other occurrences may disrupt normal trading activity; or
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investors may lose interest in a particular derivative or category of derivatives.
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Equity-Linked Securities.
The Fund may invest in equity-linked securities. Equity-linked securities are privately issued securities whose investment results are designed to correspond
generally to the performance of a specified stock index or basket of stocks, or sometimes a single stock. To the extent that the Fund invests in an equity-linked security whose return corresponds to the performance of a foreign
securities index or one or more foreign stocks, investing in equity-linked securities will involve risks similar to the risks of investing in foreign equity securities. See Foreign Securities below. In addition, the Fund bears the risk
that the issuer of an equity-linked security may default on its obligations under the security. Equity-linked securities are often used for many of the same purposes as, and share many of the same risks with derivative instruments such as index
futures on stock indexes, zero-strike options and warrants and swap agreements. See Derivatives above. Equity-linked securities may be considered illiquid and thus subject to the Funds restriction on investments in illiquid
securities.
Foreign Securities.
The Fund may invest in foreign securities either directly by purchasing foreign securities
or indirectly by purchasing depositary receipts or depositary shares of foreign securities. (See Depositary Receipts above.) Foreign securities include equity or debt securities issued by issuers outside the United States, and include
securities in the form of ADRs and EDRs (see Depositary Receipts). Direct investments in foreign securities may be made either on foreign securities exchanges or in the over-the-counter markets.
Foreign investments may be affected favorably or unfavorably by changes in currency rates and exchange control regulations. There may be less information available
about a foreign company than about a U.S. company, and foreign companies may not be subject to reporting standards and requirements comparable to those applicable to U.S. companies. Foreign securities may not be as liquid as U.S. securities.
Securities of foreign companies may involve greater market risk than securities of U.S. companies, and foreign brokerage commissions and custody fees are generally higher than in the United States. Investments in foreign securities may also be
subject to local economic or political risks, political instability and possible nationalization of issuers.
To date, the market values of securities of
issuers located in different countries have moved relatively independently of each other. During certain periods, the return on equity investments in some countries has exceeded the return on similar investments in the United States. A decline in
the value of the Funds investments in one country may offset potential gains from investments in another country.
Investments in securities of
foreign issuers may involve risks that are not associated with domestic investments. Foreign issuers may lack uniform accounting, auditing and financial reporting standards, practices and requirements, and there is generally less publicly available
information about foreign issuers than there is about domestic issuers. Gov-
8
ernmental regulation and supervision of foreign stock exchanges, brokers and listed companies may be less pervasive than is customary in the United States.
Securities of some foreign issuers are less liquid and their prices are more volatile than securities of comparable domestic issuers. Foreign securities settlements
may in some instances be subject to delays and related administrative uncertainties that could result in temporary periods when assets of the Fund are uninvested and no return is earned thereon and may involve a risk of loss to the Fund. Foreign
securities markets may have substantially less volume than U.S. markets and far fewer traded issues. Fixed brokerage commissions on foreign securities exchanges are generally higher than in the United States, and transaction costs with respect to
smaller capitalization companies may be higher than those of larger capitalization companies. Income from foreign securities may be reduced by a withholding tax at the source or other foreign taxes. In some countries, there may also be the
possibility of nationalization, expropriation or confiscatory taxation (in which case the Fund could lose its entire investment in a certain market), limitations on the removal of monies or other assets of the Fund, higher rates of inflation,
political or social instability or revolution, or diplomatic developments that could affect investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside the United States.
Some of the risks described in the preceding paragraph may be more severe for investments in emerging or developing countries. By comparison with the United States
and other developed countries, emerging or developing countries may have relatively unstable governments, economies based on a less diversified industrial base and securities markets that trade a smaller number of securities. Companies in emerging
markets may generally be smaller, less experienced and more recently organized than many domestic companies. Prices of securities traded in the securities markets of emerging or developing countries tend to be volatile. Furthermore, foreign
investors are subject to many restrictions in emerging or developing countries. These restrictions may require, among other things, governmental approval prior to making investments or repatriating income or capital, or may impose limits on the
amount or type of securities held by foreigners or on the companies in which the foreigners may invest.
The economies of individual emerging countries
may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rates of inflation, currency depreciation, capital reinvestment, resource self-sufficiency and balance of payment position and may be
based on a substantially less diversified industrial base. Further, the economies of developing countries generally are heavily dependent upon international trade and, accordingly, have been, and may continue to be, adversely affected by trade
barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, adversely affected by
economic conditions in the countries with which they trade.
Investments in foreign securities will usually be denominated in foreign currencies and
therefore, the Fund may temporarily hold cash in foreign currencies. The value of the Funds investments denominated in foreign currencies may be affected, favorably or unfavorably, by the relative strength of the U.S. dollar, changes in
foreign currency and U.S. dollar exchange rates and exchange control regulations. The Fund may incur costs in connection with conversions between various currencies. The Funds value could be affected by changes in currency exchange rates.
Changes in foreign currency exchange rates may also affect the value of dividends and interest earned, and gains and losses realized on the sale of securities. The rate of exchange between the U.S. dollar and other currencies is determined by the
forces of supply and demand in the foreign exchange markets (which in turn are affected by interest rates, trade flows and numerous other factors, including, in some countries, local governmental intervention).
Management Risk.
If the Adviser or a sub-adviser, as the case may be, incorrectly predicts stock market and interest rate trends, the
Fund may lose money by investing in derivatives. For example, if the Fund were to write a call option based on the Advisers or a sub-advisers, as the case may be, expectation that the price of the underlying security would fall, but the
price were to rise instead, the Fund could be required to sell the security upon exercise at a price below the current market price. Similarly, if the Fund were to write a put option based on the Advisers or a sub-advisers expectation
that the price of the underlying security would rise, but the price were to fall instead, the Fund could be required to purchase the security upon exercise at a price higher than the current market price.
Pricing Risk.
At times, market conditions might make it hard to value some investments. For example, if the Fund has valued its
securities too highly, you may end up paying too much for Fund shares when you buy into the Fund. If the Fund underestimates its price, you may not receive the full market value for your Fund shares when you sell.
Margin.
Because of the low margin deposits required upon the opening of a derivative position, such transactions involve an extremely
high degree of leverage. Consequently, a relatively small price movement in a derivative may result in an immediate and substantial loss (as well as gain) to the Fund and it may lose more than it originally invested in the derivative.
9
If the price of a futures contract changes adversely, the Fund may have to sell securities at a time when it is
disadvantageous to do so to meet its minimum daily margin requirement. The Fund may lose its margin deposits if a broker with whom it has an open futures contract or related option becomes insolvent or declares bankruptcy.
Volatility and Leverage.
The prices of derivatives are volatile (i.e., they may change rapidly, substantially and unpredictably) and
are influenced by a variety of factors, including:
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actual and anticipated changes in interest rates;
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fiscal and monetary policies; and
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national and international political events.
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Most exchanges limit the amount by which the price of a derivative can change during a single trading day. Daily trading limits establish the maximum amount that
the price of a derivative may vary from the settlement price of that derivative at the end of trading on the previous day. Once the price of a derivative reaches this value, the Fund may not trade that derivative at a price beyond that limit. The
daily limit governs only price movements during a given day and does not limit potential gains or losses. Derivative prices have occasionally moved to the daily limit for several consecutive trading days, preventing prompt liquidation of the
derivative.
Because of the low margin deposits required upon the opening of a derivative position, such transactions involve an extremely high degree of
leverage. Consequently, a relatively small price movement in a derivative may result in an immediate and substantial loss (as well as gain) to the Fund and it may lose more than it originally invested in the derivative.
If the price of a futures contract changes adversely, the Fund may have to sell securities at a time when it is disadvantageous to do so to meet its minimum daily
margin requirement. The Fund may lose its margin deposits if a broker-dealer with whom it has an open futures contract or related option becomes insolvent or declares bankruptcy.
Tax Risk.
The Fund intends to qualify annually to be treated as a RIC under the Internal Revenue Code of 1986, as amended (the IRC). To qualify as a RIC under the IRC, the
Fund must invest in assets which produce the types of income specified in the IRC and the Treasury regulations (Qualifying Income). Whether the income from certain derivatives securities and swap agreements is Qualifying Income is
unclear. If the Fund invests in these types of securities and the income is determined to not be Qualifying Income, it may cause the Fund to fail to qualify as a RIC under the IRC. See
Taxes
below for additional information
related to these restrictions.
Exchange-Traded Funds
(ETFs). ETFs are investment
companies or grantor trusts whose shares are bought and sold on a securities exchange. An ETF holds a portfolio of securities designed to track a particular market segment or index. Some examples of ETFs are SPDRs
®
, streetTRACKS, DIAMONDS
SM
, NASDAQ 100 Index Tracking Stock
SM
(QQQs
SM
), and iShares
®
. The Fund could purchase an ETF to temporarily gain exposure to a portion of the U.S. or foreign market while awaiting an opportunity to purchase securities directly.
The risks of owning an ETF generally reflect the risks of owning the underlying securities they are designed to track, although lack of liquidity in an ETF could result in it being more volatile than the underlying portfolio of securities, and ETFs
have management fees that increase their costs versus the costs of owning the underlying securities directly. See also Investment Company Shares below.
Fixed Income Securities.
Fixed income securities include bonds, notes, debentures and other interest-bearing securities that represent indebtedness. The market value of the fixed
income investments in which the Fund invests will change in response to interest rate changes and other factors. During periods of falling interest rates, the values of outstanding fixed income securities generally rise. Conversely, during periods
of rising interest rates, the values of such securities generally decline. Moreover, while securities with longer maturities tend to produce higher yields, the prices of longer maturity securities are also subject to greater market fluctuations as a
result of changes in interest rates. Changes by recognized agencies in the rating of any fixed income security and in the ability of an issuer to make payments of interest and principal also affect the value of these investments. Changes in the
value of these securities will not necessarily affect cash income derived from these securities but will affect the Funds net asset value.
Investment Company Shares.
The Fund may invest in shares of other investment companies. Such investments are subject to limitations
prescribed by the 1940 Act, the rules thereunder and applicable SEC staff interpretations thereof, or applicable exemptive relief granted by the SEC. These investment companies typically incur fees that are separate from those fees incurred directly
by the Fund. The Funds purchases of such investment company securities results in the layering of expenses, such that shareholders would indirectly bear a proportionate share of the operating expenses of such investment companies, including
advisory fees, in addition to paying the Funds expenses. Under the 1940 Act, unless an exception is available, the Fund is prohibited from acquiring the securities of another investment company if, as a result of such acquisition: (1) the
Fund owns more than 3% of the total voting stock of the other
10
company; (2) securities issued by any one investment company represent more than 5% of the Funds total assets; or (3) securities (other than treasury stock) issued by all
investment companies represent more than 10% of the total assets of the Fund.
For hedging or other purposes, the Fund may invest in
investment companies that seek to track the composition and/or performance of specific indexes or portions of specific indexes. Certain of these investment companies, known as ETFs, are traded on a securities exchange. (See Exchange-Traded
Funds above). The market prices of index-based investments will fluctuate in accordance with changes in the underlying portfolio securities of the investment company and also due to supply and demand of the investment companys shares on
the exchange upon which the shares are traded. Index-based investments may not replicate or otherwise match the composition or performance of their specified index due to transaction costs, among other things. Pursuant to an order issued by the SEC
to iShares
®
Funds and procedures approved by the Board, the Fund may invest in iShares
®
Funds in excess of the 5% and 10% limits described above, provided that the Fund has described ETF investments in its
prospectus and otherwise complies with the conditions of the SEC, as it may be amended, and any other applicable investment limitations. iShares
®
is a registered trademark of BlackRock, Inc. (BR). Neither BR nor the iShares
®
Funds makes any representations regarding the advisability of investing in the iShares
®
Funds.
Money Market Securities.
Money
market securities include short-term U.S. government securities; custodial receipts evidencing separately traded interest and principal components of securities issued by the U.S. Treasury; commercial paper rated in the highest short-term rating
category by a nationally recognized statistical ratings organization (NRSRO), such as Standard & Poors or Moodys, or determined by the Adviser to be of comparable quality at the time of purchase; short-term bank
obligations (certificates of deposit, time deposits and bankers acceptances) of U.S. commercial banks with assets of at least $1 billion as of the end of their most recent fiscal year; and repurchase agreements involving such securities. Each
of these money market securities are described below. For a description of ratings, see Appendix A Ratings to this SAI.
Preferred
Stock.
The Fund may invest in preferred stocks. Preferred stock has a preference over common stock in liquidation (and generally dividends as well) but is subordinated to the liabilities of the issuer in all respects. As a
general rule, the market value of preferred stock with a fixed dividend rate and no conversion element varies inversely with interest rates and perceived credit risk, while the market price of convertible preferred stock generally also reflects some
element of conversion value. Because preferred stock is junior to debt securities and other obligations of the issuer, deterioration in the credit quality of the issuer will cause greater changes in the value of a preferred stock than in a more
senior debt security with similar stated yield characteristics. Unlike interest payments on debt securities, preferred stock dividends are payable only if declared by the issuers board of directors. Preferred stock also may be subject to
optional or mandatory redemption provisions.
U.S. Government Securities.
Examples of types of U.S. government obligations
in which the Fund may invest include U.S. Treasury Obligations and the obligations of U.S. government agencies such as Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business Administration, Federal National Mortgage Association, Government National Mortgage Association, General Services Administration, Student Loan Marketing Association, Central
Bank for Cooperatives, Freddie Mac (formerly Federal Home Loan Mortgage Corporation), Federal Intermediate Credit Banks, Maritime Administration, and other similar agencies. Whether backed by the full faith and credit of the U.S. Treasury or not,
U.S. government securities are not guaranteed against price movements due to fluctuating interest rates.
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U.S. Treasury Obligations.
U.S. Treasury obligations consist of bills, notes and bonds issued by the U.S. Treasury and separately
traded interest and principal component parts of such obligations that are transferable through the federal book-entry system known as Separately Traded Registered Interest and Principal Securities (STRIPS) and Treasury Receipts
(TRs).
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Receipts.
Interests in separately traded interest and principal component parts of U.S. government obligations that are issued by
banks or brokerage firms and are created by depositing U.S. government obligations into a special account at a custodian bank. The custodian holds the interest and principal payments for the benefit of the registered owners of the certificates or
receipts. The custodian arranges for the issuance of the certificates or receipts evidencing ownership and maintains the register. TRs and STRIPS are interests in accounts sponsored by the U.S. Treasury. Receipts are sold as zero coupon securities.
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U.S. Government Zero Coupon Securities.
STRIPS and receipts are sold as zero coupon securities, that is, fixed income securities
that have been stripped of their unmatured interest coupons. Zero coupon securities are sold at a (usually substantial) discount and redeemed at face value at their maturity date without interim cash payments of interest or principal. The amount of
this discount is accreted over the life of the security, and the accretion
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constitutes the income earned on the security for both accounting and tax purposes. Because of these features, the market prices of zero coupon securities are generally more volatile than the
market prices of securities that have similar maturity but that pay interest periodically. Zero coupon securities are likely to respond to a greater degree to interest rate changes than are non-zero coupon securities with similar maturity and credit
qualities.
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U.S. Government Agencies.
Some obligations issued or guaranteed by agencies of the U.S. government are supported by the full faith
and credit of the U.S. Treasury, others are supported by the right of the issuer to borrow from the Treasury, while still others are supported only by the credit of the instrumentality. Guarantees of principal by agencies or instrumentalities of the
U.S. government may be a guarantee of payment at the maturity of the obligation, so that in the event of a default prior to maturity, there might not be a market and thus no means of realizing on the obligation prior to maturity. Guarantees as to
the timely payment of principal and interest do not extend to the value or yield of these securities nor to the value of the Funds shares.
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Commercial Paper.
Commercial paper is the term used to designate unsecured short-term promissory notes issued by corporations and other entities. Maturities on these issues vary from a
few to 270 days.
Obligations of Domestic Banks, Foreign Banks and Foreign Branches of U.S. Banks.
The Fund may invest in
obligations issued by banks and other savings institutions. Investments in bank obligations include obligations of domestic branches of foreign banks and foreign branches of domestic banks. Such investments in domestic branches of foreign banks and
foreign branches of domestic banks may involve risks that are different from investments in securities of domestic branches of U.S. banks. These risks may include future unfavorable political and economic developments, possible withholding taxes on
interest income, seizure or nationalization of foreign deposits, currency controls, interest limitations, or other governmental restrictions which might affect the payment of principal or interest on the securities held by the Fund. Additionally,
these institutions may be subject to less stringent reserve requirements and to different accounting, auditing, reporting and recordkeeping requirements than those applicable to domestic branches of U.S. banks. Bank obligations include the
following:
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Bankers Acceptances.
Bankers acceptances are bills of exchange or time drafts drawn on and accepted by a commercial
bank. Corporations use bankers acceptances to finance the shipment and storage of goods and to furnish dollar exchange. Maturities are generally six months or less.
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Certificates of Deposit.
Certificates of deposit are interest-bearing instruments with a specific maturity. They are issued by
banks and savings and loan institutions in exchange for the deposit of funds and normally can be traded in the secondary market prior to maturity. Certificates of deposit with penalties for early withdrawal will be considered illiquid.
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Time Deposits.
Time deposits are non-negotiable receipts issued by a bank in exchange for the deposit of funds. Like a certificate
of deposit, it earns a specified rate of interest over a definite period of time; however, it cannot be traded in the secondary market. Time deposits with a withdrawal penalty or that mature in more than seven days are considered to be illiquid
securities.
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Repurchase Agreements.
The Fund may enter into repurchase agreements with financial
institutions. The Fund follows certain procedures designed to minimize the risks inherent in such agreements. These procedures include effecting repurchase transactions only with creditworthy financial institutions whose condition will be
continually monitored by the Adviser. The repurchase agreements entered into by the Fund will provide that the underlying collateral at all times shall have a value at least equal to 102% of the resale price stated in the agreement (the Adviser
monitors compliance with this requirement). Under all repurchase agreements entered into by the Fund, the custodian or its agent must take possession of the underlying collateral. In the event of a default or bankruptcy by a selling financial
institution, the Fund will seek to liquidate such collateral. However, the exercising of the Funds right to liquidate such collateral could involve certain costs or delays and, to the extent that proceeds from any sale upon a default of the
obligation to repurchase were less than the repurchase price, the Fund could suffer a loss. It is the current policy of the Fund, not to invest in repurchase agreements that do not mature within seven days if any such investment, together with any
other illiquid assets held by the Fund, amounts to more than 15% of the Funds total assets. The investments of the Fund in repurchase agreements, at times, may be substantial when, in the view of the Adviser, liquidity or other considerations
so warrant.
Securities Lending.
The Fund may lend portfolio securities to brokers, dealers and other financial
organizations that meet capital and other credit requirements or other criteria established by the Funds Board of Trustees. These loans, if and when made, may not exceed 33 1/3% of the total asset value of the Fund (including the loan
collateral). The Fund will not lend portfolio securities to its investment adviser or affiliates unless they have applied for and received specific authority to do so from the SEC. Loans of portfolio securities will be fully collateralized by cash,
letters of credit or U.S. government securities, and the collateral will be maintained in an amount equal to at least 100% of the
12
current market value of the loaned securities by marking to market daily. Any gain or loss in the market price of the securities loaned that might occur during the term of the loan would be for
the account of the Fund.
The Fund may pay a part of the interest earned from the investment of collateral, or other fee, to an unaffiliated third party
for acting as the Funds securities lending agent.
By lending its securities, the Fund may increase its income by receiving payments from the
borrower that reflect the amount of any interest or any dividends payable on the loaned securities as well as by either investing cash collateral received from the borrower in short-term instruments or obtaining a fee from the borrower when U.S.
government securities or letters of credit are used as collateral. The Fund will adhere to the following conditions whenever its portfolio securities are loaned: (i) the Fund must receive at least 100% cash collateral or equivalent securities
of the type discussed in the preceding paragraph from the borrower; (ii) the borrower must increase such collateral whenever the market value of the securities rises above the level of such collateral; (iii) the Fund must be able to
terminate the loan on demand; (iv) the Fund must receive reasonable interest on the loan, as well as any dividends, interest or other distributions on the loaned securities and any increase in market value; (v) the Fund may pay only
reasonable fees in connection with the loan (which fees may include fees payable to the lending agent, the borrower, the Funds administrator and the custodian); and (vi) voting rights on the loaned securities may pass to the borrower,
provided, however, that if a material event adversely affecting the investment occurs, the Fund must terminate the loan and regain the right to vote the securities. The Board has adopted procedures reasonably designed to ensure that the foregoing
criteria will be met. Loan agreements involve certain risks in the event of default or insolvency of the borrower, including possible delays or restrictions upon the Funds ability to recover the loaned securities or dispose of the collateral
for the loan, which could give rise to loss because of adverse market action, expenses and/or delays in connection with the disposition of the underlying securities.
Illiquid Securities.
Illiquid securities are securities that cannot be sold or disposed of in the ordinary course of business (within seven days) at approximately the prices at which
they are valued. Because of their illiquid nature, illiquid securities must be priced at fair value as determined in good faith pursuant to procedures approved by the Trusts Board of Trustees. Despite such good faith efforts to determine fair
value prices, the Funds illiquid securities are subject to the risk that the securitys fair value price may differ from the actual price which the Fund may ultimately realize upon their sale or disposition. Difficulty in selling illiquid
securities may result in a loss or may be costly to the Fund. Under the supervision of the Trusts Board of Trustees, the Adviser or a sub-adviser, as the case may be, determines the liquidity of the Funds investments. In determining the
liquidity of the Funds investments, the Adviser or a sub-adviser, as the case may be, may consider various factors, including (1) the frequency and volume of trades and quotations, (2) the number of dealers and prospective purchasers
in the marketplace, (3) dealer undertakings to make a market, and (4) the nature of the security and the market in which it trades (including any demand, put or tender features, the mechanics and other requirements for transfer, any
letters of credit or other credit enhancement features, any ratings, the number of holders, the method of soliciting offers, the time required to dispose of the security, and the ability to assign or offset the rights and obligations of the
security). The Fund will not invest more than 15% of its net assets in illiquid securities.
Restricted
Securities.
Restricted securities are securities that may not be sold freely to the public absent registration under the Securities Act of 1933, as amended (1933 Act) or an exemption from registration. As
consistent with the Funds investment objectives, the Fund may invest in Section 4(2) commercial paper. Section 4(2) commercial paper is issued in reliance on an exemption from registration under Section 4(2) of the Act and is
generally sold to institutional investors who purchase for investment. Any resale of such commercial paper must be in an exempt transaction, usually to an institutional investor through the issuer or investment dealers who make a market in such
commercial paper. The Trust believes that Section 4(2) commercial paper is liquid to the extent it meets the criteria established by the Board of Trustees of the Trust. The Trust intends to treat such commercial paper as liquid and not subject
to the investment limitations applicable to illiquid securities or restricted securities.
Short Sales.
As consistent with
the Funds investment objective, the Fund may engage in short sales that are either uncovered or against the box. A short sale is against the box if at all times during which the short position is open, the
Fund owns at least an equal amount of the securities or securities convertible into, or exchangeable without further consideration for, securities of the same issue as the securities that are sold short. A short sale against the box is a taxable
transaction to the Fund with respect to the securities that are sold short.
Uncovered short sales are transactions under which the Fund sells a security
it does not own. To complete such a transaction, the Fund must borrow the security to make delivery to the buyer. The Fund then is obligated to replace the security borrowed by purchasing the security at the market price at the time of the
replacement. The price at such time may be more or less than the price at which the security was sold by the Fund. Until the security is replaced, the Fund is required to pay the lender amounts equal to any dividends or interest that accrue during
the period of the loan. To
13
borrow the security, the Fund also may be required to pay a premium, which would increase the cost of the security sold. The proceeds of the short sale will be retained by the broker, to the
extent necessary to meet margin requirements, until the short position is closed out.
Until the Fund closes its short position or replaces the borrowed
security, the Fund will: (a) maintain a segregated account containing cash or liquid securities at such a level that (i) the amount deposited in the account plus the amount deposited with the broker as collateral will equal the current
value of the security sold short; and (ii) the amount deposited in the segregated account plus the amount deposited with the broker as collateral will not be less than the market value of the security at the time the security was sold short, or
(b) otherwise cover the Funds short position.
Rights Offerings and Warrants to Purchase Securities.
The Fund
may participate in rights offerings and may purchase warrants, which are privileges issued by corporations enabling the owners to subscribe to and purchase a specified number of shares of the corporation at a specified price during a specified
period of time. Subscription rights normally have a short life span to expiration. The purchase of rights or warrants involves the risk that the Fund could lose the purchase value of a right or warrant if the right to subscribe to additional shares
is not exercised prior to the rights and warrants expiration. Also, the purchase of rights and/or warrants involves the risk that the effective price paid for the right and/or warrant added to the subscription price of the related
security may exceed the value of the subscribed securitys market price such as when there is no movement in the level of the underlying security. Buying a warrant does not make the Fund a shareholder of the underlying stock. The warrant holder
has no voting or dividend rights with respect to the underlying stock. A warrant does not carry any right to assets of the issuer, and for this reason investment in warrants may be more speculative than other equity-based investments.
INVESTMENT LIMITATIONS
The following investment limitations are in addition to
those described in the Prospectus. These investment limitations are fundamental and may be changed with respect to the Fund only with the approval of the holders of a majority of the Funds outstanding voting securities
as defined in the 1940 Act. Except with respect to the asset coverage requirement under Section 18(f)(1) of the 1940 Act with respect to borrowing, if a percentage limitation is adhered to at the time of investment, a later increase or decrease
in percentage resulting from a change in value of portfolio securities or amount of net assets will not be considered a violation of the investment limitation. In the case of borrowing, however, the Fund will promptly take action to reduce the
amount of the Funds borrowings outstanding if, because of changes in the net asset value of the Fund due to market action, the amount of such borrowings exceeds one-third of the value of the Funds net assets.
The Fund will not:
1.
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Invest 25% or more of the value of the Funds total assets in the securities of one or more issuers conducting their principal business activities in the same industry or
group of industries. This limit does not apply to securities issued or guaranteed by the U.S. government, its agencies or instrumentalities.
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2.
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Borrow money or issue senior securities (as defined under the 1940 Act), except to the extent permitted under the 1940 Act, the rules and regulations thereunder or any exemption
therefrom, as such statute, rules or regulations may be amended or interpreted from time to time.
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3.
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Make loans, except to the extent permitted under the 1940 Act, the rules and regulations thereunder or any exemption therefrom, as such statute, rules or regulations may be
amended or interpreted from time to time.
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4.
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Purchase or sell commodities or real estate, except to the extent permitted under the 1940 Act, the rules and regulations thereunder or any exemption therefrom, as such statute,
rules or regulations may be amended or interpreted from time to time.
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5.
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Underwrite securities issued by other persons, except to the extent permitted under the 1940 Act, the rules and regulations thereunder or any exemption therefrom, as such
statute, rules or regulations may be amended or interpreted from time to time.
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When engaging in options, futures and forward currency
contract strategies, the Fund will either: (1) earmark or set aside cash or liquid securities in a segregated account with the custodian in the prescribed amount; or (2) hold securities or other options or futures contracts whose values
are expected to offset (cover) its obligations thereunder. Securities, currencies or other options or futures contracts used for cover cannot be sold or closed out while the strategy is outstanding, unless they are replaced with similar
assets.
14
THE ADVISER
General.
Equinox
Institutional Asset Management, LP, a Delaware limited partnership formed in 2003, serves as the investment adviser to the Fund. It has been registered with the SEC as an investment adviser since 2005 and registered with the Commodity Futures
Trading Commission as a commodity pool operator since 2010. The Advisers principal place of business is located at 47 Hulfish Street, Suite 510, Princeton, NJ 08542. The Adviser is controlled by Equinox Financial Group, LLC through such
entitys ownership interest in the Adviser. As of December 31, 2012, the Adviser had approximately $261 million in assets under management.
Advisory Agreement with the Trust.
The Trust and the Adviser have entered into an investment advisory agreement with respect to the
Fund (the Advisory Agreement). Under the Advisory Agreement, the Adviser serves as the investment adviser and makes the investment decisions for the Fund and continuously reviews, supervises and administers the Funds investment
program, subject to the supervision of, and policies established by, the Trustees of the Trust. The Adviser may at any time, upon approval by the Board of Trustees, enter into one or more sub-advisory agreements with a sub-adviser pursuant to which
the Adviser delegates any or all of its duties as set forth in the Advisory Agreement. The Adviser is responsible for the ongoing performance evaluation and monitoring of each sub-adviser.
After its initial two-year term, the continuance of the Advisory Agreement must be specifically approved at least annually (i) by the vote of the Trustees or by a vote of the shareholders of the Fund and
(ii) by the vote of a majority of the Trustees who are not parties to the Advisory Agreement or interested persons of any party thereto, cast in person at a meeting called for the purpose of voting on such approval.
The Advisory Agreement will terminate automatically in the event of its assignment, and is terminable at any time without penalty by the Trustees of the Trust or,
with respect to the Fund, by a majority of the outstanding shares of the Fund, on not less than 60 days written notice to the Adviser, or by the Adviser on 60 days written notice to the Trust. The Advisory Agreement provides that the Adviser shall
not be protected against any liability to the Trust or its shareholders by reason of willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless disregard of its obligations or duties thereunder.
Advisory Fees Paid to the Adviser.
For its services, the Adviser is entitled to an investment advisory fee, which is
calculated daily and paid monthly, at an annual rate of 1.95% the Funds average daily net assets. The Adviser has contractually agreed that from commencement of the Funds operations through July 31, 2014, it will reduce its
compensation and/or reimburse certain expenses for the Fund, to the extent necessary to ensure that the Funds total operating expenses, excluding taxes, any class-specific fees and expenses (such as Rule 12b-1 distribution fees, shareholder
service fees, or transfer agency fees), interest, extraordinary items, Acquired Fund fees and expenses and brokerage commissions, do not exceed, 2.24% (on an annual basis) of the Funds average daily net assets. The Adviser shall be
entitled to recover, subject to approval by the Board of Trustees of the Trust, such waived or reimbursed amounts for a period of up to three (3) years from the year in which the Adviser reduced its compensation and/or assumed expenses for the
Fund.
THE SUB-ADVISERS
Confluence Investment Management, LLC, Equity Investment
Corporation, Logan Capital Management, Inc., Polen Capital Management, LLC, Quantum Capital Management Co. and Turner Investments, L.P. are the sub-advisers to the Fund. It is the Advisers responsibility to select sub-advisers for the Fund and
to review each sub-advisers performance. The Adviser determines the Funds asset allocation among the different sub-advisers.
The Adviser
provides investment management evaluation services by performing initial due diligence on each sub-adviser and thereafter monitoring the sub-advisers performance for compliance with the Funds investment objective and strategies, as well
as adherence to its investment style. The Adviser also conducts performance evaluations through in-person, telephonic and written consultations. In evaluating the sub-advisers, the Adviser considers, among other factors: their level of expertise;
relative performance and consistency of performance over a minimum period of time; level of adherence to investment discipline or philosophy; personnel, facilities and financial strength; and quality of service and client communications.
While each sub-adviser is subject to the oversight of the Adviser, the Adviser will not attempt to coordinate or manage the day-to-day investments of the
sub-advisers. Each sub-adviser has complete discretion to invest its portion of the
15
Funds assets as it deems appropriate within the constraints of the Funds investment objective, strategies and restrictions.
Not all of the sub-advisers listed for the Fund may be actively managing assets for the Fund at all times. Subject to the oversight of the Board of Trustees, the Adviser may allocate Fund assets away from a
sub-advisor. Situations in which the Adviser may make such a determination include, but are not limited to, the level of assets in the Fund, changes in a sub-advisers personnel or a sub-advisers adherence to an investment strategy.
Equity Investment Corporation
The Adviser has
entered into a sub-advisory agreement with Equity Investment Corporation (EIC) to manage a portion of the Funds assets in accordance with EICs All-Cap Value strategy. EIC is located at 3007 Piedmont Road NE, Suite 200,
Atlanta, GA 30305, and is a registered investment adviser. EIC, which was established in 1986, offers investment advisory services to investors based upon a value-oriented investment approach. As of December 31, 2012, EIC had approximately
$2,300 million in assets under management.
Confluence Investment Management, LLC
The Adviser has entered into a sub-advisory agreement with Confluence Investment Management, LLC (Confluence) to manage a portion of the Funds assets in accordance with Confluences Large Cap
Value strategy. Confluence is located at 349 Marshall Avenue, Suite 302, St. Louis, MO 63119, and is a registered investment adviser. Confluence, which was established in 2007, offers professional portfolio management and advisory services to
institutional and individual clients. It employs investment strategies based upon independent, fundamental research that integrates its evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, fundamental
company-specific approach. As of December 31, 2012, Confluence had approximately $1,270 million in assets under management.
Logan Capital
Management, Inc.
The Adviser has entered into a sub-advisory agreement with Logan Capital Management, Inc. (Logan) to manage a portion
of the Funds assets in accordance with Logans Growth strategy. Logan is located at Six Coulter Avenue, Suite 2000, Ardmore, Pennsylvania 19003, and is a registered investment adviser. Logan, which was established in 1993, offers advisory
services in respect of equity and fixed income investments to institutional clients, strategic partners and individual clients. As of December 31, 2012, Logan had approximately $1,932 million in assets under management.
Polen Capital Management, LLC
The Adviser has entered into
a sub-advisory agreement with Polen Capital Management, LLC (Polen) to manage a portion of the Funds assets in accordance with Polens Large Cap Growth strategy. Polen is located at 2700 N. Military Trail, Suite 230, Boca
Raton, FL 33431-6394, and is a registered investment adviser. Polen, which was established in 1979, offers advisory services focused on identifying high quality large cap growth companies that are able to deliver sustainable above average growth in
earnings. As of December 31, 2012, Polen had approximately $4,527 million in assets under management.
Quantum Capital Management Co.
The Adviser has entered into a sub-advisory agreement with Quantum Capital Management Co (Quantum) to manage a portion of the
Funds assets in accordance with Quantums Mid Cap Growth strategy. Quantum is located at 770 Tamalpais Drive, Suite 204, Corte Madera, CA 94925, and is a registered investment adviser. Quantum, which was established in 1996, offers
financial planning, consulting, and investment management services to institutional and individual clients. As of December 31, 2012, Quantum had approximately $450 million in assets under management.
Turner Investments, L.P.
The Adviser has entered into a
sub-advisory agreement with Turner Investments, L.P. (Turner) to manage a portion of the Funds assets in accordance with Tuners Small Cap Growth strategy. Turner is located at 1205 Westlakes Drive, Suite 100, Berwyn, PA
19312, and is a registered investment adviser. Turner, which was established in 1990, offers investment advisory services to investors based upon a growth-oriented investment approach. As of December 31, 2012, Turner had approximately $10,700
million in assets under management.
Sub-Advisory Agreements.
The Adviser and each sub-adviser have entered into a
sub-advisory agreement with respect to the Fund (each a Sub-Advisory Agreement and collectively, the Sub-Advisory Agreements). Each Sub-Advisory Agreement provides that the sub-adviser has discretionary investment authority
with respect to the portion of the Funds assets allocated to it by the Adviser, subject to the restrictions of the 1940 Act, the Internal Revenue Code
16
of 1986, as amended, applicable state securities laws, applicable statutes and regulations of foreign jurisdictions, the Funds investment objective, policies and restrictions and the
instructions of the Board of Trustees and the Adviser.
After its initial two-year term, the continuance of each Sub-Advisory Agreement must be
specifically approved at least annually (i) by the vote of the Trustees or by a vote of the shareholders of the Fund and (ii) by the vote of a majority of the Trustees who are not parties to the Sub-Advisory Agreement or interested
persons of any party thereto, cast in person at a meeting called for the purpose of voting on such approval. Each Sub-Advisory Agreement will terminate automatically in the event of its assignment, and is terminable at any time without penalty
by the Trustees of the Trust or, with respect to the Fund, by a majority of the outstanding shares of the Fund, on not less than 60 days written notice to the sub-adviser, or by the sub-adviser on 60 days written notice to the Adviser and the Trust.
Each Sub-Advisory Agreement provides that the sub-adviser shall not be protected against any liability to the Trust or its shareholders by reason of willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or
from reckless disregard of its obligations or duties thereunder.
Sub-Advisory Fees Paid to the Sub-Adviser.
The Adviser
pays sub-advisory fees to each sub-adviser from its advisory fee. Each sub-advisers base fee is accrued daily and paid monthly, based on the Funds average net assets allocated to the sub-adviser during the current month. The compensation
of any officer, director, or employee of each sub-adviser who is rendering services to the Fund is paid by such sub-adviser.
PORTFOLIO MANAGERS
This section
supplements the information provided in the Prospectus under the heading Portfolio Managers, and includes information about other accounts managed by, the dollar range of Fund shares owned by and compensation of the Funds portfolio
managers. The Advisers portfolio managers are Afroz Qadeer, Sue Osborne, Ajay Dravid and Rufus Rankin.
Equinox Institutional Asset
Management, LP, Adviser
Compensation (as of December 31, 2012).
Mr. Qadeer, Ms. Osborne,
Dr. Dravid and Mr. Rankin are each paid a fixed salary and discretionary bonus by the Adviser, which is contingent upon the overall performance of the Adviser and each individuals contribution to the Advisers performance, and
is not directly contingent upon the performance of the Fund.
Fund Shares Owned by the Portfolio Managers.
As of
December 31, 2012, Mr. Qadeer, Ms. Osborne, Dr. Dravid and Mr. Rankin did not own shares of the Fund.
Other
Accounts.
In addition to the Fund, Mr. Qadeer, Ms. Osborne, Dr. Dravid and Mr. Rankin are responsible for the day-to-day management of certain other accounts, as listed below. The information below is
provided as of December 31, 2012.
Afroz Qadeer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account Type
|
|
Number of
Accounts by
Account Type
|
|
|
Total Assets By
Account Type
|
|
|
Number of
Accounts by Type
Subject to a
Performance Fee
|
|
|
Total Assets By
Account Type
Subject to a
Performance Fee
|
|
Registered Investment Companies
|
|
|
0
|
|
|
$
|
0
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Pooled Investment Vehicles
|
|
|
0
|
|
|
$
|
0
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Accounts
|
|
|
2
|
|
|
$
|
261,000,000
|
|
|
|
2
|
|
|
$
|
261,000,000
|
|
Sue Osborne
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account Type
|
|
Number of
Accounts by
Account Type
|
|
|
Total Assets By
Account Type
|
|
|
Number of
Accounts by Type
Subject to a
Performance Fee
|
|
|
Total Assets By
Account Type
Subject to a
Performance Fee
|
|
Registered Investment Companies
|
|
|
0
|
|
|
$
|
0
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Pooled Investment Vehicles
|
|
|
0
|
|
|
$
|
0
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Accounts
|
|
|
2
|
|
|
$
|
261,000,000
|
|
|
|
2
|
|
|
$
|
261,000,000
|
|
17
Ajay Dravid
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account Type
|
|
Number of
Accounts by
Account Type
|
|
|
Total Assets By
Account Type
|
|
|
Number of
Accounts by Type
Subject to a
Performance Fee
|
|
|
Total Assets By
Account Type
Subject to a
Performance Fee
|
|
Registered Investment Companies
|
|
|
10
|
|
|
$
|
845,106,000
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Pooled Investment Vehicles
|
|
|
1
|
|
|
$
|
312,972,049
|
|
|
|
1
|
|
|
$
|
312,972,049
|
|
Other Accounts
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Rufus Rankin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account Type
|
|
Number of
Accounts by
Account Type
|
|
|
Total Assets By
Account Type
|
|
|
Number of
Accounts by Type
Subject to a
Performance Fee
|
|
|
Total Assets By
Account Type
Subject to a
Performance Fee
|
|
Registered Investment Companies
|
|
|
10
|
|
|
$
|
845,106,000
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Other Pooled Investment Vehicles
|
|
|
1
|
|
|
$
|
312,972,049
|
|
|
|
1
|
|
|
$
|
312,972,049
|
|
Other Accounts
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
Conflicts of Interests (as of December 31, 2012).
The portfolio managers management of
other accounts may give rise to potential conflicts of interest in connection with their management of the Funds investments, on the one hand, and the investments of the other accounts referenced above, on the other. The other
accounts may have the same investment objective as the Fund. Therefore, a potential conflict of interest may arise as a result of the identical investment objectives, whereby the portfolio managers could favor one account over another. Another
potential conflict could include the portfolio managers knowledge about the size, timing and possible market impact of the Funds trade, whereby the portfolio managers could use this information to the advantage of other accounts and to
the disadvantage of the Fund. However, the Adviser has established policies and procedures to ensure that the purchase and sale of securities among all accounts it manages are fairly and equitably allocated.
Proxy Voting Policies.
The Board has adopted Proxy Voting Policies and Procedures (Policies) on behalf of the Trust, which
delegate the responsibility for voting proxies of securities held by the Fund to the Adviser, subject to the Boards continuing oversight. The Policies require that the Adviser vote proxies received in a manner consistent with the best interest
of the Fund and its shareholders. The Policies also require the Adviser to present to the Board, at least annually, the Advisers Proxy Policies and a record of each proxy voted by the Adviser on behalf of the Fund, including a report on the
resolution of all proxies identified by the Adviser as involving a conflict of interest. A copy of the Advisers Proxy Voting Policies is attached hereto as Appendix B.
More information.
Information regarding how the Fund voted proxies relating to portfolio securities held by the Fund during the most recent 12-month period ending June 30th will
be available (1) without charge, upon request, by calling the Fund at 1-888-643-3431; and (2) on the SECs website at http://www.sec.gov. In addition, a copy of the Funds proxy voting policies and procedures are attached
herewith as Appendix B.
THE DISTRIBUTOR
Northern Lights Distributors, LLC, located at 17605 Wright
Street, Omaha, NE 68130 (the Distributor) serves as the principal underwriter and national distributor for the shares of the Fund pursuant to an Underwriting Agreement with the Trust (the Underwriting Agreement). The
Distributor is registered as a broker-dealer under the Securities Exchange Act of 1934 and each states securities laws and is a member of the Financial Industry Regulatory Authority, Inc. (FINRA). The offering of the Funds
shares is continuous. The Underwriting Agreement provides that the Distributor, as agent in connection with the distribution of Fund shares, will use its best efforts to distribute the Funds shares.
The Underwriting Agreement provides that, unless sooner terminated, it will continue in effect for two years initially and thereafter shall continue from year to
year, subject to annual approval by (a) the Board or a vote of a majority of the outstanding shares, and (b) by a majority of the Trustees who are not interested persons of the Trust or of the Distributor by vote cast in person at a
meeting called for the purpose of voting on such approval.
18
The Underwriting Agreement may be terminated by the Fund at any time, without the payment of any penalty, by vote of a
majority of the entire Board of the Trust or by vote of a majority of the outstanding shares of the Fund on 60 days written notice to the Distributor, or by the Distributor at any time, without the payment of any penalty, on 60 days written notice
to the Fund. The Underwriting Agreement will automatically terminate in the event of its assignment.
The Distributor may enter into selling agreements
with broker-dealers that solicit orders for the sale of shares of the Fund and may allow concessions to dealers that sell shares of the Fund. If a class of the Fund charges a sales charge, the Distributor receives the portion of the sales charge on
all direct initial investments in the Fund and on all investments in accounts with no designed dealer of record. If a class of the Fund has a contingent deferred sales charge, the Distributor retains the contingent deferred sales charge on
redemptions of shares of the Fund that are subject to a contingent deferred sales charge. The Distributor will be compensated for distribution services according to the Rule 12b-1 Plan (defined below) applicable to a specific class regardless
of the Distributors expenses. If such compensation exceeds the Distributors expenses, the Distributor may realize a profit from these arrangements.
Rule 12b-1 Plan and Agreement
.
The Trust has adopted a distribution plan and related agreement pursuant to Rule 12b-1 under the 1940 Act for the Fund (the Rule 12b-1
Plan) pursuant to which the Fund is authorized to pay fees to the Distributor for providing distribution and other services to the Fund such as public relations services, telephone services, sales presentations, media charges, preparation,
printing and mailing advertising and sales literature, data processing necessary to support a distribution effort and printing and mailing of prospectuses to prospective shareholders. Additionally, the Distributor may pay certain financial
institutions such as banks or broker-dealers who have entered into servicing agreements with the Distributor and other financial institutions for distribution and shareholder servicing activities.
With respect to Class A shares, the Rule 12b-1 Plan allows for the payment of a distribution fee up to 0.25% of average daily net assets of the Class A
shares of the Fund to pay for distribution activities and expenses primarily intended to result in the sale of Class A shares. With respect to Class C shares, the Rule 12b-1 Plan allows for the payment of a distribution and service fee up to
0.75% of average daily net assets of the Class C shares of the Fund to pay for distribution activities and expenses primarily intended to result in the sale of Class C shares and a shareholder servicing fee of 0.25% of average daily net assets for
personal services and/or the maintenance of shareholder accounts of shareholders of Class C shares.
Under the Rule 12b-1 Plan, if any payments made by
the Adviser out of its advisory fee, not to exceed the amount of that fee, to any third parties (including banks), including payments for shareholder servicing and transfer agent functions, were deemed to be indirect financing by the Fund of the
distribution of its Class A shares and Class C shares, such payments are authorized. The Fund may execute portfolio transactions with and purchase securities issued by depository institutions that receive payments under the Rule 12b-1 Plan. No
preference for instruments issued by such depository institutions is shown in the selection of investments.
Dealer
Reallowances
.
Class A shares of the Fund are sold subject to a front-end sales charge as described in the prospectus. Selling dealers are normally reallowed a portion of the sales charge by the Distributor. The
following table shows the amount of the front-end sales charge that is reallowed to dealers as a percentage of the offering price of Class A Shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount Invested
|
|
Sales Charge as a %
of Offering Price
|
|
|
Sales Charge as a %
of Amount Invested
|
|
|
Dealer Reallowance
|
|
Under $25,000
|
|
|
5.75
|
%
|
|
|
6.10
|
%
|
|
|
5.00
|
%
|
$25,000 to $49,999
|
|
|
5.00
|
%
|
|
|
5.26
|
%
|
|
|
4.25
|
%
|
$50,000 to $99,999
|
|
|
4.75
|
%
|
|
|
4.99
|
%
|
|
|
4.00
|
%
|
$100,000 to $249,999
|
|
|
3.75
|
%
|
|
|
3.90
|
%
|
|
|
3.25
|
%
|
$250,000 to $499,999
|
|
|
2.50
|
%
|
|
|
2.56
|
%
|
|
|
2.00
|
%
|
$500,000 to $999,999
|
|
|
2.00
|
%
|
|
|
2.04
|
%
|
|
|
1.75
|
%
|
$1,000,000 and above
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
See Below
|
|
Authorized broker-dealers may receive commissions on purchases of Class A shares over $1 million calculated as follows: For
sales of $1 million or more, payments may be made to those broker-dealers having at least $1 million of assets invested in the Fund, a fee of up to 1% of the offering price of such shares up to $2.5 million, 0.5% of the offering price from $2.5
million to $5 million, and 0.25% of the offering price over $5 million. The commission rate is determined based on the purchase amount combined with the current market value of existing investments in Class A shares.
19
PAYMENTS TO FINANCIAL INTERMEDIARIES
The Adviser and/or its affiliates, at their discretion,
may make payments from their own resources and not from Fund assets to affiliated or unaffiliated brokers, dealers, banks (including bank trust departments), trust companies, registered investment advisers, financial planners, retirement plan
administrators, insurance companies, and any other institution having a service, administration, or any similar arrangement with the Fund, its service providers or their respective affiliates, as incentives to help market and promote the Fund and/or
in recognition of their distribution, marketing, administrative services, and/or processing support.
These additional payments may be made to financial
intermediaries that sell Fund shares or provide services to the Fund, the Distributor or shareholders of the Fund through the financial intermediarys retail distribution channel and/or fund supermarkets. Payments may also be made through the
financial intermediarys retirement, qualified tuition, fee-based advisory, wrap fee bank trust, or insurance (e.g., individual or group annuity) programs. These payments may include, but are not limited to, placing the Fund in a financial
intermediarys retail distribution channel or on a preferred or recommended fund list; providing business or shareholder financial planning assistance; educating financial intermediary personnel about the Fund; providing access to sales and
management representatives of the financial intermediary; promoting sales of Fund shares; providing marketing and educational support; maintaining share balances and/or for sub-accounting, administrative or shareholder transaction processing
services. A financial intermediary may perform the services itself or may arrange with a third party to perform the services.
The Adviser and/or its
affiliates may also make payments from their own resources to financial intermediaries for costs associated with the purchase of products or services used in connection with sales and marketing, participation in and/or presentation at conferences or
seminars, sales or training programs, client and investor entertainment and other sponsored events. The costs and expenses associated with these efforts may include travel, lodging, sponsorship at educational seminars and conferences, entertainment
and meals to the extent permitted by law.
Revenue sharing payments may be negotiated based on a variety of factors, including the level of sales, the
amount of Fund assets attributable to investments in the Fund by financial intermediaries customers, a flat fee or other measures as determined from time to time by the Adviser and/or its affiliates. A significant purpose of these payments is
to increase the sales of Fund shares, which in turn may benefit the Adviser through increased fees as Fund assets grow.
THE ADMINISTRATOR
The Administrator for the Fund is Gemini Fund Services,
LLC, (GFS), which has its principal office at 450 Wireless Blvd., Hauppauge, New York 11788, and is primarily in the business of providing administrative, fund accounting and transfer agent services to retail and institutional mutual
funds. GFS is an affiliate of the Distributor.
Pursuant to the Fund Services Agreement with the Trust, GFS provides administrative services to the Fund,
subject to the supervision of the Board. GFS may provide persons to serve as officers of the Fund. Such officers may be directors, officers or employees of the Administrator or its affiliates.
The Fund Services Agreement was initially approved by the Board at a meeting held on December 20, 2010. The Agreement shall remain in effect for two years from the effective date of the Fund, and subject to
annual approval of the Board for one-year periods thereafter. The Fund Services Agreement is terminable at the end of the initial term or subsequent renewal period by the Board or GFS on ninety days written notice. The Fund Services Agreement
provides that, in the absence of GFS lack of good faith, negligence, willful misconduct or reckless disregard of its duties with respect to GFSs performance under or in connection with this Agreement, GFS shall be without liability for
any action taken or omitted pursuant to this Agreement.
Under the Fund Services Agreement, the GFS provides facilitating administrative services,
including: (i) providing services of persons competent to perform such administrative and clerical functions as are necessary to provide effective administration of the Fund; (ii) facilitating the performance of administrative and
professional services to the Fund by others, including the Funds Custodian; (iii) preparing, but not paying for, the periodic updating of the Funds Registration Statement, Prospectuses and Statement of Additional Information in
conjunction with Fund counsel, including the printing of such documents for the purpose of filings with the SEC and state securities administrators, and preparing reports to the Funds shareholders and the SEC; (iv) preparing in
conjunction with Fund counsel, but not paying for, all filings under the securities or Blue Sky laws of such states or countries as are designated by the Distributor, which
20
may be required to register or qualify, or continue the registration or qualification, of the Fund and/or its shares under such laws; (v) preparing notices and agendas for meetings of the
Board and minutes of such meetings in all matters required by the 1940 Act to be acted upon by the Board; and (vi) monitoring daily and periodic compliance with respect to all requirements and restrictions of the 1940 Act, the IRC and the
Prospectus.
For the services rendered to the Fund by GFS, the Fund pays GFS an asset based fee for fund administration services. The Fund also pays GFS
for any out-of-pocket expenses.
FUND ACCOUNTING
GFS pursuant to the Fund Services Agreement, provides the
Fund with accounting services, including: (i) daily computation of net asset value; (ii) maintenance of security ledgers and books and records as required by the 1940 Act; (iii) production of the Funds listing of portfolio
securities and general ledger reports; (iv) reconciliation of accounting records; (v) calculation of yield and total return for the Fund; (vi) maintaining certain books and records described in Rule 31a-1 under the 1940 Act, and
reconciling account information and balances among the Funds custodian or Adviser; and (vii) monitoring and evaluating daily income and expense accruals, and sales and redemptions of shares of the Fund.
For the services rendered to the Fund by the Fund Services Agreement, the Fund pays GFS, an asset based fee for fund accounting services. The Fund also pays GFS for
any out-of-pocket expenses.
TRANSFER AGENT
GFS, 17605 Wright Street, Suite 2, Omaha, NE 68130, acts
as transfer, dividend disbursing, and shareholder servicing agent for the Fund pursuant to a written agreement with the Fund. Under the agreement, GFS is responsible for administering and performing transfer agent functions, dividend distribution,
shareholder administration, and maintaining necessary records in accordance with applicable rules and regulations.
THE
CUSTODIAN
U.S. Bank, 950 17th
Street, 5th Floor, Denver, CO 80202, acts as custodian (the Custodian) of the Fund. The Custodian holds cash, securities and other assets of the Fund as required by the 1940 Act.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
McGladrey LLP, located at 555 Seventeenth Street, Suite 1000, Denver, CO 80202-3910 serves as independent registered public accounting firm for the Fund. McGladrey
LLP performs annual audits of the Funds financial statements and provides other audit, tax and related services for the Fund.
LEGAL COUNSEL
Pepper Hamilton LLP,
3000 Two Logan Square 18th & Arch Streets, Philadelphia, PA 19103-2799 serves as the Trusts legal counsel.
21
COMPLIANCE SERVICES
Northern Lights Compliance Services, LLC
(NLCS), an affiliate of GFS and the Distributor, provides a Chief Compliance Officer to the Trust as well as related compliance services pursuant to a consulting agreement between NLCS and the Trust. The Fund pays a compliance service
fee to NLCS.
PURCHASE, REDEMPTION AND PRICING OF SHARES
Calculation of Share
Price
. The following information supplements and should be read in conjunction with the section in the Prospectus entitled How Shares are Priced. The NAV of the Fund serves as the basis for the purchase and
redemption price of the Funds shares. The NAV of the Fund is calculated by dividing the market value of the Funds securities plus the value of the Funds other assets, less all liabilities, by the number of outstanding shares of the
Fund. If market quotations are not readily available for any security in the Funds portfolio, the security will be valued at fair value by the Adviser using methods established or ratified by the Board.
Options on securities and indices purchased by the Fund generally are valued at their last bid price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter (OTC) market, the average of the last bid price as obtained from two or more dealers unless there is only one dealer, in which case that dealers price is used. Futures contracts and options on
futures contracts are valued at the last trade price prior to the end of the Funds pricing cycle.
The Fund will regularly value its investments in
structured notes at fair value and other investments at market prices.
OTC securities, if any, held by the Fund shall be valued at the NASDAQ Official
Closing Price (NOCP) on the valuation date or, if no NOCP is reported, the last reported bid price is used, and quotations shall be taken from the market/exchange where the security is primarily traded. Securities listed on the Nasdaq
Global Select Market and Nasdaq Global Market shall be valued at the NOCP; which may differ from the last sales price reported. The portfolio securities of the Fund that are listed on national exchanges, if any, are taken at the last sales price of
such securities on such exchange; if no sales price is reported, the last reported bid price is used. For valuation purposes, all assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at
the rate at which local currencies can be sold to buy U.S. Dollars as last quoted by any recognized dealer. If these quotations are not available, the rate of exchange will be determined in good faith by the Adviser based on guidelines adopted by
the Board. Dividend income and other distributions are recorded on the ex-dividend date, except for certain dividends from foreign securities which are recorded as soon as the Trust is informed after the ex-dividend date.
The value of domestic equity index and credit default swap agreements entered into by the Fund are accounted for using the unrealized gain or loss on the agreements
that is determined by marking the agreements to the last quoted value of the index that the swap pertains to at the close of the NYSE, usually 4:00 p.m., Eastern Time. The swaps market value is then adjusted to include dividends accrued,
financing charges and/or interest associated with the swap agreement. The value of foreign equity index and currency index swap agreements entered into by the Fund are accounted for using the unrealized gain or loss on the agreements that is
determined by marking the agreements to the price at which orders are being filled at the close of the NYSE, usually 4:00 p.m., Eastern Time. In the event that no order is filled at 4:00 p.m., Eastern Time, the Fund values a swap based on a quote
provided by a dealer in accordance with the Funds pricing procedures. The swaps market value is then adjusted to include dividends accrued, financing charges and/or interest associated with the swap agreements.
Illiquid securities, securities for which reliable quotations or pricing services are not readily available, and all other assets will be valued either at the
average of the last bid price of the securities obtained from two or more dealers or otherwise at their respective fair value as determined in good faith by, or under procedures established by the Board. The Board has adopted fair valuation
procedures for the Fund and has delegated responsibility for fair value determinations to the Fair Valuation Committee. The members of the Fair Valuation Committee report, as necessary, to the Board regarding portfolio valuation determination. The
Board, from time to time, will review these methods of valuation and will recommend changes which may be necessary to assure that the investments of the Fund are valued at a fair value.
The Trust expects that the holidays upon which the New York Stock Exchange will be closed are as follows: New Years Day, Martin Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Purchase of Shares
. Orders for shares received by the
Fund in good order prior to the close of business on the NYSE on each day during such periods that the NYSE is open for trading are priced at NAV per share or offering price (NAV plus a sales charge, if applicable) computed as of the close of the
regular session of trading on the NYSE. Orders received in good order after the close of the NYSE, or on a day it is not open for trading, are priced at the close of such NYSE on the next day on which it is open for trading at the next determined
NAV or offering price per share.
Redemption of Shares
. The Fund will redeem all or any portion of a shareholders
shares in the Fund when requested in accordance with the procedures set forth in the Redemptions section of the Prospectus. Under the 1940 Act, a shareholders right to redeem shares and to receive payment therefore may be suspended
at times:
(a)
|
when the NYSE is closed, other than customary weekend and holiday closings;
|
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(b)
|
when trading on that exchange is restricted for any reason;
|
(c)
|
when an emergency exists as a result of which disposal by the Fund of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Fund
fairly to determine the value of its net assets, provided that applicable rules and regulations of the SEC (or any succeeding governmental authority) will govern as to whether the conditions prescribed in (b) or (c) exist; or
|
(d)
|
when the SEC by order permits a suspension of the right to redemption or a postponement of the date of payment on redemption.
|
In case of suspension of the right of redemption, payment of a redemption request will be made based on the NAV next determined after the termination of the
suspension.
Supporting documents in addition to those listed under Redemptions in the Prospectus will be required from executors,
administrators, Trustees, or if redemption is requested by someone other than the shareholder of record. Such documents include, but are not restricted to, stock powers, Trust instruments, certificates of death, appointments as executor,
certificates of corporate authority and waiver of tax required in some states when settling estates.
The Trust reserves the right to honor requests for
redemption or repurchase orders by making payment in whole or in part in readily marketable securities (redemption in kind) if the amount is greater than (the lesser of) $250,000 or 1% of the Funds assets. The securities will be
chosen by the Fund and valued under the Funds net asset value procedures. A shareholder will be exposed to market risk until these securities are converted to cash and may incur transaction expenses in converting these securities to cash.
Use of Third-Party Independent Pricing Agents.
Pursuant to contracts with the Administrator, market prices for most
securities held by the Fund are provided daily by third-party independent pricing agents that are approved by the Board. The valuations provided by third-party independent pricing agents are reviewed daily by the Administrator.
TAXES
The following discussion summarizes certain U.S. federal income tax considerations affecting the Fund and its shareholders. This discussion is for general
information only and does not purport to consider all aspects of U.S. federal income taxation that might be relevant to beneficial owners of shares of the Fund. Therefore, the summary discussion that follows may not be considered to be individual
tax advice and may not be relied upon by any shareholder. The summary is based upon current provisions of the IRC, applicable U.S. Treasury Regulations promulgated thereunder (the Regulations), and administrative and judicial
interpretations thereof, all of which are subject to change, which change could be retroactive, and may affect the conclusions expressed herein. The summary applies only to beneficial owners of the Funds shares in whose hands such shares are
capital assets within the meaning of Section 1221 of the IRC, and may not apply to certain types of beneficial owners of the Funds shares, including, but not limited to insurance companies, tax-exempt organizations, shareholders holding
the Funds shares through tax-advantaged accounts (such as an individual retirement account (an IRA), a 401(k) plan account, or other qualified retirement account), financial institutions, pass-through entities, broker-dealers,
entities that are not organized under the laws of the United States or a political subdivision thereof, persons who are neither a citizen nor resident of the United States, shareholders holding the Funds shares as part of a hedge, straddle or
conversion transaction, and shareholders who are subject to the alternative minimum tax. Persons who may be subject to tax in more than one country should consult the provisions of any applicable tax treaty to determine the potential tax
consequences to them.
The Fund has not requested nor will the Fund request an advance ruling from the Internal Revenue Service (the IRS) as
to the federal income tax matters described below. The IRS could adopt positions contrary to those discussed below and such positions could be sustained. In addition, the following discussion applicable to shareholders of the Fund addresses only
some of the federal income tax considerations generally affecting investments in the Fund.
Shareholders are urged and advised to consult their own tax adviser with respect to the tax consequences of the ownership, purchase and disposition of an
investment in the Fund including, but not limited to, the applicability of state, local, foreign and other tax laws affecting the particular shareholder and to possible effects of changes in federal or other tax laws.
GENERAL.
For federal tax purposes, the Fund is treated as a separate corporation. The Fund has elected, and intends to continue
to qualify for, taxation as a regulated investment company (RIC) under the IRC. By qualifying as a RIC, the Fund (but not the shareholders) will not be subject to federal income tax on that portion of its investment company taxable
income and net realized capital gains that it distributes to its shareholders.
28
Shareholders should be aware that investments made by the Fund, some of which are described below, may involve complex
tax rules some of which may result in income or gain recognition by a shareholder without the concurrent receipt of cash. Although the Fund seeks to avoid significant noncash income, such noncash income could be recognized by the Fund, in which case
it may distribute cash derived from other sources in order to meet the minimum distribution requirements described below. Cash to make the required minimum distributions may be obtained from sales proceeds of securities held by the Fund (even if
such sales are not advantageous) or, if permitted by its governing documents and other regulatory restrictions, through borrowing the amounts required to be distributed.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY.
Qualification as a RIC under the IRC requires, among other things, that the Fund: (a) derive at least 90% of its gross income for
each taxable year from dividends, interest, payments with respect to securities loans and gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gains from options, futures
and forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the Qualifying Income Requirement), and net income from certain qualified publicly traded partnerships; (b) diversify
its holdings so that, at the close of each quarter of the taxable year: (i) at least 50% of the value of its assets is comprised of cash, cash items (including receivables), U.S. government securities, securities of other RICs and other
securities, with those other securities limited, in respect of any one issuer, to an amount that does not exceed 5% of the value of its total assets and that does not represent more than 10% of the outstanding voting securities of such issuer; and
(ii) not more than 25% of the value of its assets is invested in the securities (other than U.S. government securities or securities of other RICs) of any one issuer or the securities (other than the securities of other RICs) of two or more
issuers controlled by it and engaged in the same, similar or related trades or businesses, or one or more qualified publicly traded partnerships (together with (i) the Diversification Requirement); and
(c) distribute for each taxable year the sum of (i) at least 90% of its investment company taxable income (which includes dividends, taxable interest, taxable original issue discount income, market discount income, income from securities
lending, net short-term capital gain in excess of net long-term capital loss, certain net realized foreign currency exchange gains, and any other taxable income other than net capital gain as defined below and is reduced by deductible
expenses all determined without regard to any deduction for dividend paid); and (ii) 90% of its tax-exempt interest, if any, net of certain expenses allocable thereto (net tax-exempt interest).
The Treasury Department is authorized to promulgate regulations under which gains from foreign currencies (and options, futures, and forward contracts on foreign
currency) would constitute qualifying income for purposes of the Qualifying Income Requirement only if such gains are directly related to the principal business of the Fund in investing in stock or securities or options and futures with respect to
stock or securities. To date, such regulations have not been issued.
As a RIC, the Fund generally will not be subject to U.S. federal income tax on the
portion of its income and capital gains that it distributes to its shareholders in any taxable year for which it distributes, in compliance with the IRCs timing and other requirements at least 90% of its investment company taxable income and
at least 90% of its net tax-exempt interest). The Fund may retain for investment all or a portion of its net capital gain (i.e., the excess of its net long-term capital gain over its net short-term capital loss). If the Fund retains any investment
company taxable income or net capital gain, it will be subject to tax at regular corporate rates on the amount retained. If the Fund retains any net capital gain, it may designate the retained amount as undistributed net capital gain in a notice to
its shareholders, who will be (i) required to include in income for federal income tax purposes, as long-term capital gain, their shares of such undistributed amount; and (ii) entitled to credit their proportionate shares of tax paid by
the Fund 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 the shares owned by a shareholder of the Fund will be increased
by the amount of undistributed net capital gain included in the shareholders gross income and decreased by the federal income tax paid by the Fund on that amount of capital gain.
In general, for purposes of the Qualifying Income Requirement described 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 directly by the RIC. However, all of the net income of a RIC derived from an interest in a qualified publicly traded partnership (defined as a partnership (x) the interests
in which are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent thereof, and (y) that derives less than 90% of its income from the qualifying income described in clause
(i) of the Qualifying Income Requirement described above) will be treated as qualifying income. In general, such entities will be treated as partnerships for federal income tax purposes if they meet the passive income requirement under
Section 7704(c)(2) of the IRC. In addition, although in general the passive loss rules of the IRC do not apply to RICs, such rules do apply to a RIC with respect to items attributable to an interest in a qualified publicly traded partnership.
For purposes of the Diversification Requirement described above, the term outstanding voting securities of such issuer will include the equity securities of a qualified publicly traded partnership.
29
The qualifying income and asset requirements that must be met under the IRC in order for the Fund to qualify as a RIC,
as described above, may limit the extent to which the Fund will be able to engage in derivative transactions. Rules governing the federal income tax aspects of derivatives, including swap agreements, are not entirely clear in certain respects,
particularly in light of two IRS revenue rulings issued in 2006. Revenue Ruling 2006-1 held that income from a derivative contract with respect to a commodity index is not qualifying income for a RIC. Accordingly, the Funds ability to invest
in certain commodity related derivatives is limited to a maximum of 10% of its gross income. This limitation, however, will not protect the Fund against the risk of losing its RIC status should any other income be reclassified as non-qualifying
income. In Revenue Ruling 2006-31, the IRS stated that the holding in Revenue Ruling 2006-1 was not intended to preclude a conclusion that the income from certain instruments (such as certain structured notes) that create a commodity exposure
for the holder is qualifying income.
If the Fund fails to satisfy the Qualifying Income Requirement or the Diversification Requirement in any
taxable year, the Fund may be eligible for relief provisions if the failures are due to reasonable cause and not willful neglect and if a penalty tax is paid with respect to each failure to satisfy the applicable requirements. Additionally, relief
is provided for certain de minimis failures to satisfy the Diversification Requirements where the Fund corrects the failure within a specified period of time. If the applicable relief provisions are not available or cannot be met, the Fund will be
subject to tax in the same manner as an ordinary corporation subject to tax on a graduated basis with a maximum tax rate of 35% and all distributions from earnings and profits (as determined under the U.S. federal income tax principles) to its
shareholders will be taxable as ordinary dividend income eligible for the dividends received deduction for corporate shareholders and the 15% non-corporate long-term capital gain shareholder rate (for taxable years beginning prior to January 1,
2013. After January 1, 2013, the long-term capital gain rate is 20% for non-corporate shareholders with taxable income in excess of $400,000 ($450,000 if married and filing jointly) and 15% (0% for non-corporate shareholders in lower income tax
brackets) for non-corporate shareholders with taxable income of less than the threshold amounts.
EXCISE TAX.
If the Fund
fails to distribute by December 31 of each calendar year an amount equal to the sum of (1) at least 98% of its taxable ordinary income (excluding capital gains and losses) for such year, (2) at least 98.2% of the excess of its capital
gains over its capital losses (as adjusted for certain ordinary losses) for the twelve month period ending on October 31 of such year, and (3) all taxable ordinary income and the excess of capital gains over capital losses for the prior
year that were not distributed during such year and on which it did not pay federal income tax, the Fund will be subject to a nondeductible 4% excise tax (the Excise Tax) on the undistributed amounts. A distribution will be treated as
paid on December 31 of the calendar year if it is declared by the Fund in October, November, or December of that year to shareholders of record on a date in such month and paid by it during January of the following year. Such distributions will
be taxable to shareholders (other than those not subject to federal income tax) in the calendar year in which the distributions are declared, rather than the calendar year in which the distributions are received. The Fund generally intends to
actually distribute or be deemed to have distributed substantially all of its net income and gain, if any, by the end of each calendar year in compliance with these requirements so that it will generally not be required to pay the Excise Tax. The
Fund may in certain circumstances be required to liquidate its investments in order to make sufficient distributions to avoid the Excise Tax liability at a time when its Adviser might not otherwise have chosen to do so. Liquidation of investments in
such circumstances may affect the ability of the Fund to satisfy the requirements for qualification as a RIC. However, no assurances can be given that the Fund will not be subject to the Excise Tax and, in fact, in certain instances if warranted,
the Fund may choose to pay the Excise Tax as opposed to making an additional distribution.
CAPITAL LOSS CARRYFORWARDS.
The
Fund may carry forward capital losses indefinitely. The excess of the Funds net short-term capital losses over its net long-term capital gain is treated as short-term capital losses arising on the first day of the Funds next taxable year
and the excess of the Funds net long-term capital losses over its net short-term capital gain is treated as long-term capital losses arising on the first day of the Funds net taxable year. Capital gains arising in subsequent years are
offset by carried forward capital losses and are not subject to Fund-level federal income taxation, regardless of whether they are distributed to shareholders. The Fund cannot carry back or carry forward any net operating losses.
ORIGINAL ISSUE DISCOUNT AND MARKET DISCOUNT.
The Fund may acquire debt securities that are treated as having original issue
discount (OID) (generally a debt obligation with a purchase price less than its principal amount). Generally, the Fund will be required to include the OID in income over the term of the debt security, even though it will not receive cash
payments for such OID until a later time, usually when the debt security matures. The Fund may make one or more of the elections applicable to debt securities having OID which could affect the character and timing of recognition of income.
Inflation-protected bonds generally can be expected to produce OID income as their principal amounts are adjusted upward for inflation. A portion of the OID includible in income with respect to certain high-yield corporate debt securities may be
treated as a dividend for federal income tax purposes if the securities are characterized as equity for federal income tax purposes.
30
A debt security acquired in the secondary market by the Fund may be treated as having market discount if acquired at a
price below redemption value or adjusted issue price if issued with original issue discount. Market discount generally is accrued ratably, on a daily basis, over the period from the date of acquisition to the date of maturity even though no cash
will be received. Absent an election by the Fund to include the market discount in income as it accrues, gain on its disposition of such an obligation will be treated as ordinary income rather than capital gain to the extent of the accrued market
discount.
In addition, pay-in-kind securities will give rise to income which is required to be distributed and is taxable even though the Fund holding
such securities receives no interest payments in cash on such securities during the year.
The Fund generally will be required to make distributions to
shareholders representing the income accruing on the debt securities, described above, that is currently includable in income, even though cash representing such income may not have been received by the Fund. Cash to pay these distributions may be
obtained from sales proceeds of securities held by the Fund (even if such sales are not advantageous) or, if permitted by the Funds governing documents, through borrowing the amounts required to be distributed. In the event the Fund realizes
net capital gains from such transactions, its shareholders may receive a larger capital gain distribution, if any, than they would have in the absence of such transactions. Borrowing to fund any distribution also has tax implications, such as
potentially creating unrelated business taxable income (UBTI).
OPTIONS, FUTURES AND FORWARD CONTRACTS.
The
writing (selling) and purchasing of options and futures contracts and entering into forward currency contracts, involves complex rules that will determine for income tax purposes the amount, character and timing of recognition of the gains and
losses the Fund realizes in connection with such transactions.
Gains and losses on the sale, lapse, or other termination of options and futures
contracts, options thereon and certain forward contracts (except certain foreign currency options, forward contracts and futures contracts) will generally be treated as capital gains and losses. Some regulated futures contracts, certain foreign
currency contracts, and certain non-equity options (such as certain listed options or options on broad based securities indexes) held by the Fund (Section 1256 contracts), other than contracts on which it has made a mixed-straddle
election, will be required to be marked-to-market for federal income tax purposes, that is, treated as having been sold at their market value on the last day of the Funds taxable year. These provisions may require the Fund to
recognize income or gains without a concurrent receipt of cash. Any gain or loss recognized on actual or deemed sales of Section 1256 contracts will be treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss,
although certain foreign currency gains and losses from such contracts may be treated as ordinary income or loss as described below. Transactions that qualify as designated hedges are exempt from the mark-to-market rule, but may require the Fund to
defer the recognition of losses on futures contracts, foreign currency contracts and certain options to the extent of any unrecognized gains on related positions held by it.
The tax provisions described above applicable to options, futures and forward contracts may affect the amount, timing, and character of the Funds distributions to its shareholders. For example, the
Section 1256 rules described above may operate to increase the amount the Fund must distribute to satisfy the minimum distribution requirement for the portion treated as short-term capital gain which will be taxable to its shareholders as
ordinary income, and to increase the net capital gain it recognizes, without, in either case, increasing the cash available to the Fund. The Fund may elect to exclude certain transactions from the operation of Section 1256, although doing so
may have the effect of increasing the relative proportion of net short-term capital gain (taxable as ordinary income) and thus increasing the amount of dividends it must distribute. Section 1256 contracts also may be marked-to-market for
purposes of the Excise Tax.
When a covered call option written (sold) by the Fund expires the Fund will realize a short-term capital gain equal to the
amount of the premium it received for writing the option. When the Fund terminates its obligations under such an option by entering into a closing transaction, it will realize a short-term capital gain (or loss), depending on whether the cost of the
closing transaction is less than (or exceeds) the premium received when it wrote the option. When a covered call option written by the Fund is exercised, the Fund will be treated as having sold the underlying security, producing long-term or
short-term capital gain or loss, depending upon the holding period of the underlying security and whether the sum of the option price received upon the exercise plus the premium received when it wrote the option is more or less than the basis of the
underlying security.
STRADDLES.
Section 1092 deals with the taxation of straddles which also may affect the taxation
of options in which the Fund may invest. Offsetting positions held by the Fund involving certain derivative instruments, such as options, futures and forward currency contracts, may be considered, for federal income tax purposes, to constitute
straddles. Straddles are defined to include offsetting positions in actively traded personal property. In certain circumstances, the rules governing straddles override or modify the provisions of Section 1256, described above. If
31
the Fund is treated as entering into a straddle and at least one (but not all) of its positions in derivative contracts comprising a part of such straddle is governed by Section 1256, then
such straddle could be characterized as a mixed straddle. The Fund may make one or more elections with respect to mixed straddles. Depending on which election is made, if any, the results with respect to the Fund may differ. Generally,
to the extent the straddle rules apply to positions established by the Fund, losses realized by it may be deferred to the extent of unrealized gain in any offsetting positions. Moreover, as a result of the straddle rules, short-term capital loss on
straddle positions may be characterized as long-term capital loss, and long-term capital gain may be characterized as short-term capital gain. In addition, the existence of a straddle may affect the holding period of the offsetting positions and
cause such sales to be subject to the wash sale and short sale rules. As a result, the straddle rules could cause distributions that would otherwise constitute qualified dividend income to fail to satisfy the
applicable holding period requirements, described below, and therefore to be taxed as ordinary income. Further, the Fund may be required to capitalize, rather than deduct currently, any interest expense and carrying charges applicable to a position
that is part of a straddle. Because the application of the straddle rules may affect the character and timing of gains and losses from affected straddle positions, the amount which must be distributed to shareholders, and which will be taxed to
shareholders as ordinary income or long-term capital gain, may be increased or decreased substantially as compared to the situation where the Fund had not engaged in such transactions.
In circumstances where the Fund has invested in certain pass-through entities, the amount of long-term capital gain that it may recognize from certain derivative transactions with respect to interests in such
pass-through entities is limited under the IRCs constructive ownership rules. The amount of long-term capital gain is limited to the amount of such gain the Fund would have had if it directly invested in the pass-through entity during the term
of the derivative contract. Any gain in excess of this amount is treated as ordinary income. An interest charge is imposed on the amount of gain that is treated as ordinary income.
CONSTRUCTIVE SALES.
Certain rules may affect the timing and character of gain if the Fund engages in transactions that reduce or eliminate its risk of loss with respect to appreciated
financial positions. If the Fund enters into certain transactions (including a short sale, an offsetting notional principal contract, a futures or forward contract, or other transactions identified in Treasury regulations) in property while holding
an appreciated financial position in substantially identical property, it will be treated as if it had sold and immediately repurchased the appreciated financial position and will be taxed on any gain (but not loss) from the constructive sale. The
character of gain from a constructive sale will depend upon the Funds holding period in the appreciated financial position. Loss from a constructive sale would be recognized when the position was subsequently disposed of, and its character
would depend on the Funds holding period and the application of various loss deferral provisions of the IRC.
In addition, if the appreciated
financial position is itself a short sale or such a contract, acquisition of the underlying property or substantially identical property by the Fund will be deemed a constructive sale. The foregoing will not apply, however, to the Funds
transaction during any taxable year that otherwise would be treated as a constructive sale if the transaction is closed within 30 days after the end of that year and the Fund holds the appreciated financial position unhedged for 60 days after that
closing (i.e., at no time during that 60-day period is the Funds risk of loss regarding the position reduced by reason of certain specified transactions with respect to substantially identical or related property, such as having an option to
sell, being contractually obligated to sell, making a short sale or granting an option to buy substantially identical stock or securities).
WASH
SALES.
The Fund may in certain circumstances be impacted by special rules relating to wash sales. In general, the wash sale rules prevent the recognition of a loss by the Fund from the disposition of stock or
securities at a loss in a case in which identical or substantially identical stock or securities (or an option to acquire such property) is or has been acquired by it within 30 days before or 30 days after the sale.
SHORT SALES.
The Fund may make short sales of securities. Short sales may increase the amount of short-term capital gain realized by
the Fund, which is taxed as ordinary income when distributed to its shareholders. Short sales also may be subject to the Constructive Sales rules, discussed above.
SWAPS AND DERIVATIVES.
As a result of entering into swap or derivative agreements, the Fund may make or receive periodic net payments. The Fund may also make or receive a payment when
a swap or derivative is terminated prior to maturity through an assignment of the swap, derivative or other closing transaction. Periodic net payments will generally constitute ordinary income or deductions, while termination of a swap or derivative
will generally result in capital gain or loss (which will be a long-term capital gain or loss if the Fund has been a party to a swap or derivative for more than one year). The Funds transactions in swaps or other derivatives may be subject to
one or more of the special tax rules (e.g., notional principal contract, straddle, constructive sales, wash sales, and short sale rules). These rules may affect whether gains and losses recognized by the Fund are treated as ordinary or capital or as
short-term or long-term, accelerate the recognition of income or gains to the Fund, defer losses to the Fund, and cause
32
adjustments in the holding periods of the Funds securities. These rules could therefore affect the amount, timing and/or character of distributions to shareholders.
With respect to certain types of swap agreements or derivative securities, the Fund may be required to currently recognize income or loss with respect to future
payments on such swaps or derivatives or may elect under certain circumstances to mark to market such swaps or derivatives annually for tax purposes as ordinary income or loss.
The applicability of these rules to swap agreements or other derivative securities is not entirely clear in certain respects under current law. In addition, whether income generated from swaps and other derivatives
is Qualifying Income is not certain or clear. Accordingly, while the Fund intends to account for such transactions in a manner it deems appropriate, the IRS might not accept such treatment. If the IRS did not accept such treatment, the status of the
Fund as a RIC might be adversely affected. The Fund intends to monitor developments in this area. Certain requirements that must be met under the IRC in order for the Fund to qualify as a RIC may limit the extent to which the Fund will be able to
engage in swap agreements and certain other derivatives securities.
PASSIVE FOREIGN INVESTMENT COMPANIES.
The Fund may
invest in a non-U.S. corporation, which could be treated as a passive foreign investment company (PFIC) or become a PFIC under the IRC. A PFIC is generally defined as a foreign corporation that meets either of the following tests:
(1) at least 75% of its gross income for its taxable year is income from passive sources (such as interest, dividends, certain rents and royalties, or capital gains); or (2) an average of at least 50% of its assets produce, or are held for
the production of, such passive income. If the Fund acquires any equity interest in a PFIC, the Fund could be subject to federal income tax and interest charges on excess distributions received with respect to such PFIC stock or on any
gain from the sale of such PFIC stock (collectively PFIC income), plus interest thereon even if the Fund distributes the PFIC income as a taxable dividend to its shareholders. The balance of the PFIC income will be included in the
Funds investment company taxable income and, accordingly, will not be taxable to it to the extent it distributes that income to its shareholders. The Funds distributions of PFIC income will be taxable as ordinary income even though,
absent the application of the PFIC rules, some portion of the distributions may have been classified as capital gain.
The Fund will not be permitted to
pass through to its shareholders any credit or deduction for taxes and interest charges incurred with respect to a PFIC. Payment of this tax would therefore reduce the Funds economic return from its investment in PFIC shares. To the extent the
Fund invests in a PFIC, it may elect to treat the PFIC as a qualified electing fund (QEF), then instead of the tax and interest obligation described above on excess distributions, the Fund would be required to include in
income each taxable year its pro rata share of the QEFs annual ordinary earnings and net capital gain. As a result of a QEF election, the Fund would likely have to distribute to its shareholders an amount equal to the QEFs annual
ordinary earnings and net capital gain to satisfy the IRCs minimum distribution requirement described herein and avoid imposition of the Excise Tax even if the QEF did not distribute those earnings and gain to the Fund. In most instances it
will be very difficult, if not impossible, to make this election because of certain requirements in making the election.
The Fund may elect to
mark-to-market its stock in any PFIC. Marking-to-market, in this context, means including in ordinary income each taxable year the excess, if any, of the fair market value of the PFIC stock over the Funds adjusted basis
therein as of the end of that year. Pursuant to the election, the Fund also may deduct (as an ordinary, not capital, loss) the excess, if any, of its adjusted basis in the PFIC stock over the fair market value thereof as of the taxable year-end, but
only to the extent of any net mark-to-market gains with respect to that stock it included in income for prior taxable years under the election. The Funds adjusted basis in its PFIC stock subject to the election would be adjusted to reflect the
amounts of income included and deductions taken thereunder. In either case, the Fund may be required to recognize taxable income or gain without the concurrent receipt of cash.
FOREIGN CURRENCY TRANSACTIONS.
Foreign currency gains and losses realized by the Fund in connection with certain transactions involving foreign currency-denominated debt instruments,
certain options, futures contracts, forward contracts, and similar instruments relating to foreign currency, foreign currencies, and foreign currency-denominated payables and receivables are subject to Section 988 of the IRC, which causes such
gains and losses to be treated as ordinary income or loss and may affect the amount and timing of recognition of the Funds income. In some cases elections may be available that would alter this treatment, but such elections could be
detrimental to the Fund by creating current recognition of income without the concurrent recognition of cash. If a foreign currency loss treated as an ordinary loss under Section 988 were to exceed the Funds investment company taxable
income (computed without regard to such loss) for a taxable year the resulting loss would not be deductible by it or its shareholders in future years. The foreign currency income or loss will also increase or decrease the Funds investment
company income distributable to its shareholders.
FOREIGN TAXATION.
Income received by the Fund from sources within
foreign countries may be subject to foreign withholding and other taxes. Tax conventions between certain countries and the United States may reduce or eliminate
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such taxes. If more than 50% of the Funds total assets at the close of any taxable year consist of stock or securities of foreign corporations and it meets the distribution requirements
described above, the Fund may file an election (the pass-through election) with the IRS pursuant to which shareholders of the Fund would be required to (i) include in gross income (in addition to taxable dividends actually received)
their pro rata shares of foreign income taxes paid by the Fund even though not actually received by such shareholders; and (ii) treat such respective pro rata portions as foreign income taxes paid by them. The Fund will furnish its shareholders
with a written statement providing the amount of foreign taxes paid by the Fund that will pass-through for the year, if any.
Generally, a
credit for foreign taxes is subject to the limitation that it may not exceed the shareholders U.S. tax attributable to his or her total foreign source taxable income. For this purpose, if the pass-through election is made, the source of the
Funds income will flow through to shareholders. The limitation on the foreign tax credit is applied separately to foreign source passive income, and to certain other types of income. Shareholders may be unable to claim a credit for the full
amount of their proportionate share of the foreign taxes paid by the Fund. Various limitations, including a minimum holding period requirement, apply to limit the credit and deduction for foreign taxes for purposes of regular federal tax and
alternative minimum tax.
DISTRIBUTIONS.
Distributions paid out of the Funds current and accumulated earnings and
profits (as determined at the end of the year), whether reinvested in additional shares or paid in cash, are generally taxable and must be reported by each shareholder who is required to file a federal income tax return. Distributions in excess of
the Funds current and accumulated earnings and profits, as computed for federal income tax purposes, will first be treated as a return of capital up to the amount of a shareholders tax basis in his or her Fund shares and then as capital
gain.
For federal income tax purposes, distributions of investment company taxable income are generally taxable as ordinary income, and distributions of
gains from the sale of investments that the Fund owned for one year or less will be taxable as ordinary income. Distributions designated by the Fund as capital gain dividends (distributions from the excess of net long-term capital gain
over short-term capital losses) will be taxable to shareholders as long-term capital gain regardless of the length of time they have held their shares of the Fund. Such dividends do not qualify as dividends for purposes of the dividends received
deduction described below.
Noncorporate shareholders of the Fund may be eligible for the 15% long-term capital gain rate applicable to distributions of
qualified dividend income received by such noncorporate shareholders in taxable years beginning before January 1, 2013. After January 1, 2013, the long-term capital gain rate is 20% for non-corporate shareholders with taxable
income in excess of $400,000 ($450,000 if married and filing jointly) and 15% (0% for non-corporate shareholders in lower tax brackets)_for non-corporate shareholders with taxable income of less than the threshold amounts. The Funds
distribution will be treated as qualified dividend income and therefore eligible for the long term capital gain rate to the extent it receives dividend income from taxable domestic corporations and certain qualified foreign corporations, provided
that certain holding periods and other requirements are met. A corporate shareholder of the Fund may be eligible for the dividends received deduction on the Funds distributions attributable to dividends received by the Fund from domestic
corporations, which, if received directly by the corporate shareholder, would qualify for such a deduction. For eligible corporate shareholders, the dividends received deduction may be subject to certain reductions, and a distribution by the Fund
attributable to dividends of a domestic corporation will be eligible for the deduction only if certain holding period and other requirements are met.
Under current law, beginning in 2013, a new 3.8% Medicare contribution tax on net investment income including interest, dividends, and capital gains of U.S.
individuals with income exceeding $200,000 ($250,000 if married and filing jointly) and of estates and trusts.
The Fund will furnish a statement to
shareholders providing the federal income tax status of its dividends and distributions including the portion of such dividends, if any, that qualifies as long-term capital gain.
Different tax treatment, including penalties on certain excess contributions and deferrals, certain pre-retirement and post-retirement distributions, and certain prohibited transactions, is accorded to accounts
maintained as qualified retirement plans.
Shareholders are urged and advised to consult their own tax advisors for more information.
PURCHASES
OF FUND SHARES.
Prior to purchasing shares in the Fund, the impact of dividends or distributions which are expected to be or have been declared, but not paid, should be carefully considered. Any dividend or distribution
declared shortly after a purchase of shares of the Fund prior to the record date will have the effect of reducing the per share net asset value by the per share amount of the dividend or distribution, and to the extent the distribution consists of
the Funds taxable income, the purchasing shareholder will be taxed on the taxable portion of the dividend or distribution received even though some or all of the amount distributed is effectively a return of capital.
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SALES, EXCHANGES OR REDEMPTIONS.
Upon the disposition of shares of the Fund (whether by
redemption, sale or exchange), a shareholder may realize a capital gain or loss. Such capital gain or loss will be long-term or short-term depending upon the shareholders holding period for the shares. The capital gain will be long-term if the
shares were held for more than 12 months and short-term if held for 12 months or less.
If a shareholder sells or exchanges Fund shares within 90 days of
having acquired such shares and if, before January 31 of the calendar year following the calendar year of the sale or exchange, as a result of having initially acquired those shares, the shareholder subsequently pays a reduced sales charge on a
new purchase of shares of the Fund or another Fund, the sales charge previously incurred in acquiring the Funds shares generally shall not be taken into account (to the extent the previous sales charges do not exceed the reduction in sales
charges on the new purchase) for the purpose of determining the amount of gain or loss on the disposition, but generally will be treated as having been incurred in the new purchase. Any loss realized on a disposition will be disallowed under the
wash sale rules to the extent that the shares disposed of by the shareholder are replaced by the shareholder within a period of 61 days beginning 30 days before and ending 30 days after the date of disposition. In such a case, the basis
of the shares acquired will be adjusted to reflect the disallowed loss. Any loss realized by a shareholder on a disposition of shares held by the shareholder for six months or less will be treated as a long-term capital loss to the extent of any
distributions of capital gain dividends received by the shareholder and disallowed to the extent of any distributions of exempt-interest dividends received by the shareholder with respect to such shares. Capital losses are generally deductible only
against capital gains except that individuals may deduct up to $3,000 of capital losses against ordinary income.
The 3.8% Medicare contribution tax
(described above) will apply to gains from the sale or exchange of the Funds shares.
BACKUP WITHHOLDING.
The Fund
generally is required to withhold, and remit to the U.S. Treasury, subject to certain exemptions, an amount equal to 28% of all distributions and redemption proceeds paid or credited to a shareholder of the Fund if (i) the shareholder fails to
furnish the Fund with the correct taxpayer identification number (TIN) certified under penalties of perjury, (ii) the shareholder fails to provide a certified statement that the shareholder is not subject to backup withholding, or
(iii) the IRS or a broker has notified the Fund that the number furnished by the shareholder is incorrect or that the shareholder is subject to backup withholding as a result of failure to report interest or dividend income. If the backup
withholding provisions are applicable, any such distributions or proceeds, whether taken in cash or reinvested in shares, will be reduced by the amounts required to be withheld. Backup withholding is not an additional tax. Any amounts withheld may
be credited against a shareholders U.S. federal income tax liability.
STATE AND LOCAL TAXES.
State and local laws
often differ from federal income tax laws with respect to the treatment of specific items of income, gain, loss, deduction and credit.
Shareholders are
urged and advised to consult their own tax advisors as to the state and local tax rules affecting investments in the Fund.
NON-U.S.
SHAREHOLDERS.
Distributions made to non-U.S. shareholders attributable to net investment income generally are subject to U.S. federal income tax withholding at a 30% rate (or such lower rate provided under an applicable
income tax treaty). Notwithstanding the foregoing, if a distribution described above is effectively connected with the conduct of a trade or business carried on by a non-U.S. shareholder within the United States (or, if an income tax treaty applies,
is attributable to a permanent establishment in the United States), federal income tax withholding and exemptions attributable to foreign persons will not apply and such distribution will be subject to the federal income tax, reporting and
withholding requirements generally applicable to U.S. persons described above.
Under U.S. federal tax law, a non-U.S. shareholder is not, in general,
subject to federal income tax or withholding tax on capital gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund, capital gains dividends, and, with respect to taxable years beginning before January 1,
2012, short-term capital gains dividends, provided that the Fund obtains a properly completed and signed certificate of foreign status, unless (i) such gains or distributions are effectively connected with the conduct of a trade or business
carried on by the non-U.S. shareholder within the United States (or, if an income tax treaty applies, are attributable to a permanent establishment in the United States of the non-U.S. shareholder); (ii) in the case of an individual non-U.S.
shareholder, the shareholder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale and certain other conditions are met; or (iii) the shares of the Fund constitute U.S. real property
interests (USRPIs).
Distributions from the Fund when at least 50% of its assets are USRPIs, as defined in the IRC and Treasury regulations, to the
extent the distributions are attributable to gains from sales or exchanges of USRPIs (including gains on the sale or exchange of shares in certain U.S. real property holding corporations, which may include certain REITS, among other
entities, and certain REIT capital gain dividends) generally will cause a non-U.S. shareholder to treat such
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gain as income effectively connected to a trade or business within the United States subject to tax at the graduated rates applicable to U.S. shareholders. Such distributions may be subject to
U.S. withholding tax and may require the non-U.S. shareholders to file a federal income tax return.
Subject to the additional rules described herein,
federal income tax withholding will apply to distributions attributable to dividends and other investment income distributed by the Fund. The federal income tax withholding rate may be reduced (and, in some cases, eliminated) under an applicable tax
treaty between the United States and the non-U.S. shareholders country of residence or incorporation. In order to qualify for treaty benefits, a non-U.S. shareholder must comply with applicable certification requirements relating to its
foreign status (generally by providing the Fund with a properly completed Form W-8BEN).
All non-U.S. shareholders are urged and advised to consult their own tax advisers as to the tax consequences of an investment in the Fund.
Recently enacted rules require the reporting to the IRS of direct and indirect ownership of foreign financial accounts and foreign entities by U.S. persons. The IRS
has issued final guidance with respect to these new rules. However, since they have been recently promulgated, all aspects of their application and scope are not yet clear as to their implementation. Pursuant to that guidance, a 30% withholding tax
will be imposed on dividends paid after December 31, 2013 and redemption proceeds paid after December 31, 2014, to (i) foreign financial institutions including non-U.S. investment funds unless they agree to collect and disclose to the
IRS information regarding their direct and indirect U.S. account holders and (ii) certain other foreign entities unless they certify certain information regarding their direct and indirect U.S. owners. To avoid withholding, a foreign financial
institution will need to enter into agreements with the IRS regarding providing the IRS information including the name, address and taxpayer identification number of direct and indirect U.S. account holders, to comply with due diligence procedures
with respect to the identification of U.S. accounts, to report to the IRS certain information with respect to U.S. accounts maintained, to agree to withhold tax on certain payments made to non-compliant foreign financial institutions or to account
holders who fail to provide the required information, and to determine certain other information as to their account holders. Other foreign entities will need to provide the name, address, and TIN of each substantial U.S. owner or certifications of
no substantial U.S. ownership unless certain exceptions apply. Shareholders are urged and advised to consult their own tax adviser regarding the application of this new reporting and withholding regime to their own tax situation.
FOREIGN BANK AND FINANCIAL ACCOUNTS AND FOREIGN FINANCIAL ASSETS REPORTING REQUIREMENTS.
A shareholder that owns directly or
indirectly more than 50% by vote or value of the Fund, is urged and advised to consult its own tax adviser regarding its filing obligations with respect to IRS Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts.
Also, under recently enacted rules, subject to exceptions, individuals (and, to the extent provided in forthcoming future U.S. Treasury regulations, certain
domestic entities) must report annually their interests in specified foreign financial assets on their U.S. federal income tax returns. It is currently unclear whether and under what circumstances shareholders would be required to report
their indirect interests in the Funds specified foreign financial assets (if any) under these new rules.
Shareholders may be subject
to substantial penalties for failure to comply with these reporting requirements.
Shareholders are urged and advised to consult their own tax advisers to determine whether these reporting requirements are applicable to them.
TAX-EXEMPT SHAREHOLDERS.
A tax-exempt shareholder could realize UBTI by virtue of its investment in the Fund as a result of the
Funds investments and if shares in the Fund constitute debt financed property in the hands of the tax-exempt shareholder within the meaning of IRC Section 514(b).
Any investment in a residual interest of a CMO that has elected to be treated as a REMIC can create complex tax consequences, especially if the Fund has state or local governments or other tax-exempt organizations
as shareholders.
All tax-exempt shareholders are urged to consult their tax advisers as to the tax consequences of an investment in the Fund.
TAX SHELTER REPORTING REGULATIONS.
Under Treasury regulations, if a shareholder recognizes a loss of $2 million or
more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. The fact that a loss is reportable under these regulations does not affect the legal
determination of whether the taxpayers treatment of the loss is proper. Shareholders are urged and advised to consult their own tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Shareholders are urged and advised to consult their own tax adviser with respect to the tax consequences of an investment in the Fund including, but
not limited to, the applicability of state, local, foreign and other tax laws affecting the particular shareholder and to possible effects of changes in federal or other tax laws.
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BROKERAGE ALLOCATION AND OTHER FUND BROKERAGE PRACTICES
Brokerage
Transactions.
Generally, equity securities are bought and sold through brokerage transactions for which commissions are payable. Purchases from underwriters will include the underwriting commission or concession, and
purchases from dealers serving as market makers will include a dealers mark-up or reflect a dealers mark-down. The purchase price for securities bought from dealers serving as market makers will similarly include the dealers mark
up or reflect a dealers mark down. When the Fund executes transactions in the over-the-counter market, it will generally deal with primary market makers unless prices that are more favorable are otherwise obtainable.
In addition, the Adviser may place a combined order for two or more accounts it manages, including the Fund, engaged in the purchase or sale of the same security
if, in its judgment, joint execution is in the best interest of each participant and will result in best price and execution. Transactions involving commingled orders are allocated in a manner deemed equitable to each account or the Fund. Although
it is recognized that, in some cases, the joint execution of orders could adversely affect the price or volume of the security that a particular account or the Fund may obtain, it is the opinion of the Adviser that the advantages of combined orders
outweigh the possible disadvantages of separate transactions. Nonetheless, the Adviser believes that the ability of the Fund to participate in higher volume transactions will generally be beneficial to the Fund.
Brokerage Selection.
The Trust does not expect to use one particular broker or dealer, and when one or more brokers is believed
capable of providing the best combination of price and execution, the Funds Adviser may select a broker based upon brokerage or research services provided to the Adviser. The Adviser may pay a higher commission than otherwise obtainable from
other brokers in return for such services only if a good faith determination is made that the commission is reasonable in relation to the services provided.
Section 28(e) of the Securities Exchange Act of 1934 (the 1934 Act) permits the Adviser, under certain circumstances, to cause the Fund to pay a broker or dealer a commission for effecting a
transaction in excess of the amount of commission another broker or dealer would have charged for effecting the transaction in recognition of the value of brokerage and research services provided by the broker or dealer. In addition to agency
transactions, the Adviser may receive brokerage and research services in connection with certain riskless principal transactions, in accordance with applicable SEC guidance. Brokerage and research services include: (1) furnishing advice as to
the value of securities, the advisability of investing in, purchasing or selling securities, and the availability of securities or purchasers or sellers of securities; (2) furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, Fund strategy, and the performance of accounts; and (3) effecting securities transactions and performing functions incidental thereto (such as clearance, settlement, and custody). In the case of research
services, the Adviser believes that access to independent investment research is beneficial to its investment decision-making processes and, therefore, to the Fund.
To the extent that research services may be a factor in selecting brokers, such services may be in written form or through direct contact with individuals and may include information as to particular companies and
securities as well as market, economic, or institutional areas and information which assists in the valuation and pricing of investments. Examples of research-oriented services for which the Adviser might utilize Fund commissions include research
reports and other information on the economy, industries, sectors, groups of securities, individual companies, statistical information, political developments, technical market action, pricing and appraisal services, credit analysis, risk
measurement analysis, performance and other analysis. The Adviser may use research services furnished by brokers in servicing all client accounts and not all services may necessarily be used in connection with the account that paid commissions to
the broker providing such services. Information so received by the Adviser will be in addition to and not in lieu of the services required to be performed by the Funds Adviser under the Advisory Agreement. Any advisory or other fees paid to
the Adviser are not reduced as a result of the receipt of research services.
In some cases the Adviser may receive a service from a broker that has both
a research and a non-research use. When this occurs, the Adviser makes a good faith allocation, under all the circumstances, between the research and non-research uses of the service. The percentage of the service that is
used for research purposes may be paid for with client commissions, while the Adviser will use its own funds to pay for the percentage of the service that is used for non-research purposes. In making this good faith allocation, the Adviser faces a
potential conflict of interest, but the Adviser believes that its allocation procedures are reasonably designed to ensure that it appropriately allocates the anticipated use of such services to their research and non-research uses.
From time to time, the Fund may purchase new issues of securities in a fixed price offering. In these situations, the seller may be a member of the selling group
that will, in addition to selling securities, provide the Adviser with research services. FINRA has adopted rules expressly permitting these types of arrangements under certain circumstances.
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Generally, the seller will provide research credits in these situations at a rate that is higher than that which is available for typical secondary market transactions. These
arrangements may not fall within the safe harbor of Section 28(e).
Brokerage with Fund Affiliates.
The Fund may
execute brokerage or other agency transactions through registered broker-dealer affiliates of either the Fund, the Adviser, the sub-advisers or the Distributor for a commission in conformity with the 1940 Act, the 1934 Act and rules promulgated by
the SEC. These rules further require that commissions paid to the affiliate by the Fund for exchange transactions not exceed usual and customary brokerage commissions. The rules define usual and customary commissions to
include amounts which are reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities being purchased or sold on
a securities exchange during a comparable period of time. The Trustees, including those who are not interested persons of the Fund, have adopted procedures for evaluating the reasonableness of commissions paid to affiliates and
review these procedures periodically.
Portfolio Turnover.
The Funds portfolio turnover rate is calculated by
dividing the lesser of purchases or sales of portfolio securities for the fiscal year by the monthly average of the value of the portfolio securities owned by the Fund during the fiscal year. The calculation excludes from both the numerator and the
denominator securities with maturities at the time of acquisition of one year or less. High portfolio turnover involves correspondingly greater brokerage commissions and other transaction costs, which will be borne directly by the Fund. A 100%
turnover rate would occur if all of the Funds portfolio securities were replaced once within a one-year period.
PORTFOLIO HOLDINGS DISCLOSURE
The Trust has adopted policies and procedures that govern
the disclosure of the Funds portfolio holdings. These policies and procedures are designed to ensure that such disclosure is in the best interests of Fund shareholders.
The Fund will disclose its portfolio holdings by mailing its annual and semi-annual reports to shareholders approximately two months after the end of the fiscal year and semi-annual period. The Fund may also
disclose its portfolio holdings by mailing a quarterly report to its shareholders. In addition, the Fund will disclose its portfolio holdings in reports filed with the Securities and Exchange Commission (SEC) on Forms N-CSR and N-Q two
months after the end of each quarter/semi-annual period.
The Fund may, but is not required to, post a schedule of its 10 largest portfolio holdings on a
website at regular intervals or from time to time at the discretion of the Fund. Such schedule shall be published as of the most recent calendar month-end on such website, generally within 10 business days after the end of the calendar month. This
information will remain on the website until new information for the next month is posted, or at least until the Fund files its Form N-Q or Form N-CSR for the period that includes the dates of the posted holdings. A website is not currently
operated for the Fund.
The Fund may choose to make its holdings available to rating agencies such as Lipper, Morningstar or Bloomberg more frequently on
a confidential basis.
Under limited circumstances, as described below, the Funds portfolio holdings may be disclosed to, or known by, certain
third parties in advance of their filing with the SEC on Form N-CSR or Form N-Q. In each case, a determination has been made that such advance disclosure is supported by a legitimate business purpose and that the recipient is subject to a duty to
keep the information confidential.
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The Adviser and Sub-Advisers
. Personnel of the Adviser and sub-advisers, including personnel responsible for managing the
Funds portfolio, may have full daily access to Fund portfolio holdings since that information is necessary in order for the Adviser and sub-advisers to provide management, administrative, and investment services to the Fund. As required for
purposes of analyzing the impact of existing and future market changes on the prices, availability, demand and liquidity of such securities, as well as for the assistance of portfolio managers in the trading of such securities, Adviser and
sub-advisers personnel may also release and discuss certain portfolio holdings with various broker-dealers.
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Gemini Fund Services, LLC.
Gemini Fund Services, LLC is the transfer agent, fund accountant and administrator for the Fund;
therefore, its personnel have full daily access to the Funds portfolio holdings since that information is necessary in order for them to provide the agreed-upon services for the Fund.
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U.S. Bank.
U.S. Bank is the custodian for the Fund; therefore, its personnel have full daily access to the
Funds portfolio holdings since that information is necessary in order for them to provide the agreed-upon services for the Fund.
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Independent Registered Public Accounting Firm.
McGladrey LLP is the Funds registered independent public accounting firm;
therefore, its personnel have access to the Funds portfolio holdings in connection with auditing of the Funds annual financial statements and providing assistance and consultation in connection with SEC filings.
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Counsel. Pepper Hamilton, LLP
is counsel to the Fund; therefore its personnel have access to the Funds portfolio holdings in connection with the
review of the Funds annual and semi-annual shareholder reports and SEC filings.
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Additions to List of Approved
Recipients.
The Trusts Chief Compliance Officer is the person responsible, and whose prior approval is required, for any disclosure of the Funds portfolio securities at any time or to any persons other than
those described above. In such cases, the recipient must have a legitimate business need for the information and must be subject to a duty to keep the information confidential. There are no ongoing arrangements in place with respect to the
disclosure of portfolio holdings. In no event shall the Fund, the Adviser, the sub-advisers or any other party receive any direct or indirect compensation in connection with the disclosure of information about the Funds portfolio holdings.
Compliance with Portfolio Holdings Disclosure Procedures.
The Trusts Chief Compliance Officer will report
periodically to the Board with respect to compliance with the portfolio holdings disclosure procedures, and from time to time will provide the Board any updates to the portfolio holdings disclosure policies and procedures.
There is no assurance that the Trusts policies on disclosure of portfolio holdings will protect the Fund from the potential misuse of holdings information by
individuals or firms in possession of that information.
CAPITAL STOCK AND OTHER SECURITIES
The Trust issues and offers separate classes of shares of
the Fund: Class A, Class C and Class I shares. The shares of the Fund, when issued and paid for in accordance with the Prospectus, will be fully paid and non-assessable shares, with equal voting rights and no preferences as to conversion,
exchange, dividends, redemption or any other feature.
The separate classes of shares of the Fund represent interests in the same portfolio of
investments, have the same rights and are identical in all respects, except that Class A and Class C shares bear distribution and/or service fees and have exclusive voting rights with respect to their respective Rule 12b-1 Plan pursuant to
which the distribution fee may be paid.
The net income attributable to a class of shares and the dividends payable on such shares will be reduced by the
amount of any applicable shareholder service or Rule 12b-1 distribution fees. Accordingly, the NAV of the Class A and Class C shares will be reduced by such amount to the extent the Fund has undistributed net income.
Shares of the Fund entitle holders to one vote per share and fractional votes for fractional shares held. Shares have non-cumulative voting rights, do not have
preemptive or subscription rights and are transferable. Each class takes separate votes on matters affecting only that class.
The Trust does not hold
annual meetings of shareholders. The Trustees are required to call a meeting of shareholders for the purpose of voting upon the question of removal of any Trustee when requested in writing to do so by the shareholders of record owning not less than
10% of the Funds outstanding shares.
ANTI-MONEY LAUNDERING PROGRAM
The Trust has established an Anti-Money Laundering
Compliance Program (the AML Program) as required by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act). To ensure compliance with
this law, the Trusts AML Program provides for the development of internal practices, procedures and controls, designation of anti-money laundering compliance officers, an ongoing training program and an independent audit function to determine
the effectiveness of the AML Program. The Trusts Secretary serves as its Anti-Money Laundering compliance officer.
Procedures to implement the AML
Program include, but are not limited to, determining that the Funds Distributor and Transfer Agent have established proper anti-money laundering procedures, reported suspicious and/or fraudulent activity and a complete and thorough review of
all new opening account applications. The Trust will not transact business with any person or entity whose identity cannot be adequately verified under the provisions of the USA PATRIOT Act.
39
As a result of the AML Program, the Trust may be required to freeze the account of a shareholder if the
shareholder appears to be involved in suspicious activity or if certain account information matches information on government lists of known terrorists or other suspicious persons, or the Trust may be required to transfer the account or proceeds of
the account to a governmental agency.
LIMITATION OF TRUSTEES LIABILITY
The Trusts Declaration of Trust provides that a
Trustee shall be liable only for his or her 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 Declaration of Trust also provides that the Fund will indemnify its Trustees 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
the Trust unless it is determined in the manner provided in the Declaration of Trust that they have not acted in good faith in the reasonable belief that their actions were in the best interests of the Trust. However, nothing in the Declaration of
Trust shall protect or indemnify a Trustee against any liability for his or her willful misfeasance, bad faith, gross negligence or reckless disregard of his or her duties. Nothing contained in this section attempts to disclaim a Trustees
individual liability in any manner inconsistent with the federal securities laws.