STATEMENT OF ADDITIONAL INFORMATION
April 1, 2014
AR Capital Dividend and Value Fund
Class A Shares (DIVAX)
Class C Shares (DIVCX)
Advisor Class Shares (DIVVX)
AR Capital BDC Income Fund
Class A Shares (BDCAX)
Advisor Class Shares (BDCPX)
405 Park Avenue
15
th
Floor
New York, NY 10022
This Statement of Additional Information (SAI) is not a prospectus. This SAI should be read in conjunction with the current prospectus (each a Prospectus and together the Prospectuses) of each of the AR Capital Dividend and Value Fund and the AR Capital BDC Income Fund (each a Fund and together the Funds). The SAI is hereby incorporated by reference into each Prospectus (legally made a part of the Prospectus). This SAI does not include all information that a prospective investor should consider before purchasing the securities of either Fund. Defined terms used
herein, and not otherwise defined herein, have the same meanings as in each Prospectus.
You should obtain and read the corresponding Prospectus and any related Prospectus supplement prior to purchasing a Funds securities. A copy of each Prospectus may be obtained without charge by calling the Funds toll-free at 1-866-271-9244 or by visiting
www.arcincomefunds.com
. Information on this website is not incorporated herein by reference. The registration statement of which each Prospectus is a part can be reviewed and copied at the Public Reference Room of the U.S. Securities and Exchange Commission (the SEC) at 100 F Street NE, Washington, DC. You may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-202-551-8090. Each Funds filings with the SEC also are available to the public on the SECs Internet website at
www.sec.gov
. Copies of these filings may be obtained, after paying a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the SECs Public Reference Section, 100 F Street NE, Washington, DC 20549.
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THE FUNDS
Each of the AR Capital Dividend and Value Fund and AR Capital BDC Income Fund (each a Fund, and together, the Funds) is a newly organized, continuously offered, non-diversified, open-end management investment company. Each Fund is a series of the Realty Capital Income Funds Trust (the Trust). The Trust is a Delaware statutory trust organized under the laws of the State of Delaware on December 28, 2012. The Trusts principal office is located at 405 Park Avenue, 15
th
Floor, New York, NY 10022, and its telephone number is 1-866-271-9244. The investment objective and principal
investment strategies of each Fund, as well as the principal risks associated with each Funds investment strategies, are set forth in that Funds Prospectus. Certain additional investment information is set forth below.
INVESTMENT POLICIES
Fundamental Investment Policies
The following fundamental policies, which may be changed only by the affirmative vote of a majority of the outstanding voting securities of the respective Fund, apply to each of the Funds. Under the Investment Company Act of 1940, as amended (the 1940 Act), majority of the outstanding voting securities of the Fund means the vote, at an annual or special meeting of shareholders, duly called, of (a) 67% or more of the shares present at such meeting, if the holders of more than 50% of the outstanding shares are present or represented by proxy; or (b) more than 50% of the outstanding shares, whichever is
less.
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Borrowing.
Each Fund may not borrow money, except to the extent permitted by the 1940 Act, including the rules, regulations, and any exemptive orders obtained thereunder.
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Senior Securities.
Each Fund may not issue senior securities, except to the extent permitted under the 1940 Act, including the rules, regulations, and any exemptive orders obtained thereunder.
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Make Loans.
Each Fund may not make loans to other parties if, as a result, the aggregate value of such loans would exceed one-third of the Funds total assets. For the purposes of this limitation, a Fund is not considered to make loans by entering into repurchase agreements, lending securities, or acquiring any debt securities.
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Underwriting.
Each Fund may not underwrite securities of other issuers, except insofar as the Fund may be deemed an underwriter under the Securities Act of 1933, as amended (the Securities Act), in connection with the disposition of its portfolio securities. Each Fund may invest in restricted securities (those that must be registered under the Securities Act before they may be offered or sold to the public) to the extent permitted by the 1940 Act.
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Concentration.
The AR Capital BDC Income Fund will invest more than 25% of its assets in business development companies (BDCs) but otherwise may not invest more than 25% of its total assets in securities issued by companies or entities engaged in any one industry. The AR Capital Dividend and Value Fund may not invest more than 25% of its total assets in securities issued by companies or entities engaged in any one industry. The limitation on concentration does not apply to investments in securities issued by the U.S. Government or its agencies or instrumentalities.
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Real Estate.
Each Fund may not purchase or sell real estate or interests in real estate. This limitation is not applicable to investments in securities that are secured by or represent interests in real estate. This limitation does not preclude a Fund from investing in mortgage-related securities, such as commercial mortgage-backed securities (CMBS). Nor does this limitation preclude a Fund from investing in companies engaged in the real estate business or that have a significant portion of their assets in real estate, including real estate investment trusts (REITs).
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Commodities.
Each Fund may not purchase or sell commodities or commodity contracts, including commodity futures contracts, unless acquired as a result of ownership of securities or other investments, except that a Fund may invest in securities or other instruments backed by or linked to commodities, in companies that are engaged in a commodities business or have a significant portion of their assets in commodities, or in commodity pools and other entities that purchase and sell commodities and commodity contracts.
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If a restriction on a Funds investments is adhered to at the time an investment is made, a subsequent change in the percentage of Fund assets invested in certain securities or other instruments, or change in average duration of the Funds investment portfolio resulting from changes in the value of the Funds total assets, will not be considered a violation of the restriction; provided, however, that the asset coverage requirement applicable to borrowings shall be maintained in the manner contemplated by the 1940 Act, as described below. The 1940 Act generally prohibits the Funds from issuing senior securities,
although it does not treat certain transactions as senior securities, such as certain borrowings, reverse repurchase agreements, and firm commitment agreements, with appropriate segregation of assets to cover such obligation. As required by the 1940 Act, a Fund may only borrow from a bank and must maintain continuous asset coverage (total assets, including assets acquired with borrowed funds, less liabilities exclusive of borrowings) of 300% of all amounts borrowed. If, at any time, the value of the a Funds assets should fail to meet this 300% coverage test, the Fund will reduce the amount of the Funds borrowings to the extent necessary to meet this 300% coverage within three days (not including Saturdays, Sundays and holidays). Maintenance of this percentage limitation may result in the sale of portfolio securities at a time when investment considerations otherwise indicate that it would be disadvantageous to do so.
Non-Fundamental Investment Policies
The following is an additional investment limitation of the AR Capital BDC Income Fund and may be changed by the Trusts Board of Trustees (the Board) without shareholder approval.
AR Capital BDC Income Fund
1.
80% Investment Policy.
The Fund has adopted a policy to invest at least 80% of its assets (defined as net assets plus the amount of any borrowings for investment purposes) in common stock and other equity securities of BDCs that are traded on one or more nationally recognized securities exchanges, as discussed in the Prospectus. Shareholders of the Fund will be provided with at least 60 days prior notice of any change in the Funds 80% policy. The notice will be provided in a separate written document containing the following, or a similar statement, in boldface type: Important
Notice Regarding Change in Investment Policy. The statement will also appear on the envelope in which the notice is delivered, unless the notice is delivered separately from other communications to the shareholder.
If a restriction on the Funds investments is adhered to at the time an investment is made, a subsequent change in the percentage of Fund assets invested in certain securities or other instruments will not be considered a violation of the restriction.
ADDITIONAL INVESTMENT ACTIVITIES AND ASSOCIATED RISKS
Each Funds Prospectus identifies and summarizes the types of securities and assets in which the Fund may invest as part of its principal investment strategies, and the principal risks associated with such investments. This SAI identifies and summarizes other types of securities and assets in which each Fund may invest. Each of these securities and assets is subject to the same kinds of risks as are described in the Prospectuses. Certain additional risks associated with each type of investment are identified and described below and apply to each Fund.
Below Investment Grade Securities
The Funds may invest in securities that are rated below investment grade. Securities rated below investment grade are regarded as having predominately speculative characteristics with respect to the issuers capacity to pay interest and repay principal, and these bonds are commonly referred to as high yield or junk securities. These securities are subject to a greater risk of default. The prices of these lower-grade securities are more sensitive to negative developments, such as a decline in the issuers revenues or a general economic downturn, than are the prices of higher-grade securities.
Lower-grade securities tend to be less liquid than investment grade securities. The market values of lower-grade securities tend to be more volatile than investment grade securities. A security will be considered to be below investment grade if it is rated as such by one nationally recognized statistical rating organization (NRSRO) (for example, below Baa3 or BBB- by Moodys Investors Services, Inc. (Moodys) or Standard & Poors Ratings Services (S&P)) or, if unrated, are judged to be below investment grade by the Adviser or Sub-Adviser. Although a companys
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senior debt rating may be, for example, BBB , an underlying security issued by such company in which a Fund invests may have a lower rating. See Appendix A for a description of certain ratings.
Lower-rated securities, or equivalent unrated securities, may be considered speculative with respect to the issuers continuing ability to make principal and interest payments. Analysis of the creditworthiness of issuers of lower-rated securities may be more complex than for issuers of higher-quality debt securities, and a Funds ability to achieve its investment objective may, to the extent the Fund is invested in lower-rated securities, be more dependent upon such creditworthiness analysis than would be the case if the Fund were investing in higher-quality securities. An issuer of these securities has a currently
identifiable vulnerability to default and the issuer may be in default or there may be present elements of danger with respect to principal or interest.
The secondary markets in which lower-rated securities are traded may be less liquid than the market for higher-grade securities. Less liquidity in the secondary trading markets could adversely affect the price at which a Fund could sell a particular lower-rated security when necessary to meet liquidity needs or in response to a specific economic event, such as a deterioration in the creditworthiness of the issuer, and could adversely affect and cause large fluctuations in the net asset value of the Funds shares. Adverse publicity and investor perceptions may decrease the values and liquidity of high yield securities.
It is reasonable to expect that any adverse economic conditions could disrupt the market for lower-rated securities, have an adverse impact on the value of those securities, or adversely affect the ability of the issuers of those securities to repay principal or interest on those securities. New laws and proposed new laws may adversely impact the market for lower-rated securities.
Borrowing and Other Forms of Leverage
The Funds may borrow money to the extent permitted by their investment policies and applicable law. When a Fund borrows money or otherwise leverages its portfolio, the value of an investment in the Fund will be more volatile and other investment risks will tend to be compounded. This is because leverage tends to exaggerate the effect of any increase or decrease in the value of the Funds holdings. In addition to borrowing money from banks, the Funds may engage in certain other investment transactions that may be viewed as forms of financial leverage (
e.g.
, entering into reverse repurchase agreement and dollar
rolls; investing collateral from loans of portfolio securities; entering into when-issued, delayed-delivery, or forward commitment transactions; or using derivatives such as swaps, futures, forwards, and options).
Cash Reserves
The Funds cash reserves will be held to provide sufficient flexibility to take advantage of new opportunities for investments and for other cash needs. If the Adviser or Sub-Adviser has difficulty finding an adequate number of undervalued equity securities, all or any portion of the Funds assets may also be invested temporarily in money market instruments. Money market instruments in which the Funds may invest its cash reserves may consist of obligations issued or guaranteed by the U.S. Government or its agencies or instrumentalities, commercial paper rated by any NSRO (such as Moodys or S&P),
certificates of deposit, bankers acceptances issued by domestic banks having total assets in excess of one billion dollars, or money market mutual funds.
Collateralized Mortgage Obligations (CMOs) and Multiclass Pass-Through Securities
The Funds may invest in CMOs. CMOs are debt obligations collateralized by mortgage loans or mortgage pass-through securities. Typically, CMOs are collateralized by Government National Mortgage Association (Ginnie Mae), Federal National Mortgage Association (Fannie Mae), or Federal Home Loan Mortgage Corporation (Freddie Mac) certificates, but also may be collateralized by whole loans or private mortgage pass-through securities (such collateral is collectively hereinafter referred to as Mortgage Assets). Mortgage Assets may be collateralized by commercial or residential uses.
Multiclass pass-through securities are equity interests in a trust composed of Mortgage Assets. Payments of principal of and interest on the Mortgage Assets, and any reinvestment income thereon, may require the Funds to pay debt service on the CMOs or make scheduled distributions on the multiclass pass-through securities. CMOs may be issued by Federal Agencies, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks, and special purpose subsidiaries of the
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foregoing. The issuer of a series of mortgage pass-through securities may elect to be treated as a Real Estate Mortgage Investment Conduit (REMIC). REMICs include governmental and/or private entities that issue a fixed pool of mortgages secured by an interest in real property. REMICs are similar to CMOs in that they issue multiple classes of securities, but unlike CMOs, which are required to be structured as debt securities, REMICs may be structured as indirect ownership interests in the underlying assets of the REMICs themselves. Although CMOs and REMICs differ in certain respects, characteristics of CMOs described
below apply in most cases to REMICs as well.
In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMOs, often referred to as a tranche, is issued at a specific fixed or floating coupon rate and has a stated maturity or final distribution date. Principal prepayments on the Mortgage Assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution dates. Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly, or semiannual basis. Certain CMOs may have variable or floating interest rates and others may be Stripped Mortgage Securities. For more information
on Stripped Mortgage Securities, see Stripped Mortgage Securities below.
The principal of and interest on the Mortgage Assets may be allocated among the several classes of a CMO series in a number of different ways. Generally, the purpose of the allocation of the cash flow of a CMO to the various classes is to obtain a more predictable cash flow to certain of the individual tranches than exists with the underlying collateral of the CMO. As a general rule, the more predictable the cash flow is on a CMO tranche, the lower the anticipated yield will be on that tranche at the time of issuance relative to prevailing market yields on other mortgage-backed securities. As part of the process of creating
more predictable cash flows on most of the tranches in a series of CMOs, one or more tranches generally must be created that absorb most of the volatility in the cash flows on the underlying mortgage loans. The yields on these tranches are generally higher than prevailing market yields on mortgage-backed securities with similar maturities. As a result of the uncertainty of the cash flows of these tranches, the market prices of and yield on these tranches generally are more volatile.
CMBS
The Funds may invest in CMBS, which are bonds that evidence interests in, or are secured by, a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, the CMBS are subject to all the risks of the underlying mortgage loans. The value of CMBS may also change due to shifts in the markets perception of issuers and regulatory or tax changes adversely affecting the mortgage securities markets as a whole. In addition, CMBS are subject to the credit risk associated with the performance of the underlying mortgage properties, although this can sometimes be reduced by third-party guarantees or other
forms of credit support.
Derivatives Transactions
The Funds may purchase and sell financial futures contracts and options on such contracts. A financial futures contract is an agreement to buy or sell a specific security or financial instrument at a particular price on a stipulated future date. Although some financial futures contracts call for making or taking delivery of the underlying securities or instruments, in most cases these obligations are closed out before the settlement date. The closing of a contractual obligation may be accomplished by purchasing or selling an identical offsetting futures contract. Other financial futures contracts by their terms call for cash
settlements.
The Funds may also buy and sell index futures contracts with respect to any stock or bond index traded on a recognized stock exchange or board of trade. An index futures contract is a contract to buy or sell units of an index on a specified future date at a price agreed upon when the contract is made. The stock index futures contract specifies that no delivery of the actual stocks making up the index will take place. Instead, settlement in cash must occur upon the termination of the contract, with the settlement being the difference between the contract price and the actual level of the stock index at the expiration of the
contract. In addition, the Funds may enter into foreign currency futures contracts, as described below under Foreign Currency and Currency Hedging Transactions.
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When a Fund purchases a futures contract, an amount of cash or liquid portfolio securities generally equal to the settlement price less any margin deposit will be designated as segregated by the Funds custodian. When writing a futures contract, the Fund will maintain with its custodian similar liquid assets that, when added to the amounts deposited with a futures commission merchant or broker as margin, are equal to the market value of the instruments underlying the contract. Alternatively, the Fund may cover its position by owning the instruments underlying the contract (or, in the case of an index futures
contract, a portfolio with a volatility substantially similar to that of the index on which the futures contract is based), or holding a call option permitting the Fund to purchase the same futures contract at a price no higher than the price of the contract written by the Fund (or at a higher price if the difference is maintained in liquid assets with the Funds custodian).
Each Fund will be authorized to use financial futures contracts and related options for hedging and non-hedging purposes. The Funds may lose the expected benefit of transactions in financial contracts if currency exchange rates or securities prices change in an unanticipated manner. Such unanticipated changes in currency exchange rates or securities prices may also result in poorer overall performance than if the Funds had not entered into any futures transactions.
When purchasing stocks or bonds, the buyer acquires ownership in the security; however, buyers of futures contracts are not entitled to ownership of the underlying commodity until and unless they decide to accept delivery at expiration of the contract. In practice, delivery of the underlying commodity to satisfy a futures contract rarely occurs because most futures traders use the liquidity of the central marketplace to sell their futures contract before expiration.
Price Limits
. Some (not all exchanges have price change limits) commodity futures exchanges impose on each commodity futures contract traded on that exchange a maximum permissible price movement for each trading session. If the maximum permissible price movement is achieved on any trading day, no more trades may be executed above (or below, if the price has moved downward) that limit. If a Fund wishes to execute a trade outside the daily permissible price movement, it would be prevented from doing so by exchange rules, and would have to wait for another trading session to execute its transaction.
Price Volatility.
Despite the daily price limits on various futures exchanges, the price volatility of commodity futures contracts has been historically greater than that for traditional securities such as stocks and bonds. To the extent that a Fund invests in commodity futures contracts, the assets of the Fund, and therefore the prices of Fund shares, may be subject to greater volatility.
Marking-to-Market Futures Positions.
The futures clearinghouse marks every futures contract to market at the end of each trading day to ensure that the outstanding futures obligations are limited to the mark-to-market change in price from one day for any given futures contract. This process of marking-to-market is designed to prevent losses from accumulating in any futures account. Therefore, if a Funds futures positions have declined in value, the Fund may be required to post additional margin to cover this decline. Alternatively, if the Funds futures positions have increased in value,
this increase will be credited to the Funds account.
The Funds may also purchase and sell commodity futures contracts and can hold substantial positions in such contracts. The Funds investments in commodity futures contracts and related instruments may involve substantial risks. Some of the special characteristics and risks of these investments are described below.
Commodity futures contracts are agreements between two parties. One party agrees to buy a commodity from the other party at a later date at a price and quantity agreed-upon when the contract is made. Commodity futures contracts are traded on futures exchanges. These futures exchanges offer a central marketplace in which to transact futures contracts, a clearing corporation to process trades, a standardization of expiration dates and contract sizes, and the availability of a secondary market. Futures markets also specify the terms and conditions of delivery as well as the maximum permissible price movement during a trading
session. Additionally, the commodity futures exchanges may have position limit rules that limit the amount of futures contracts that any one party may hold in a particular commodity at any point in time. These position limit rules are designed to prevent any one participant from controlling a significant portion of the market.
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In the commodity futures markets, the exchange clearing corporation takes the other side in all transactions, either buying or selling directly to the market participants. The clearinghouse acts as the counterparty to all exchange-traded futures contracts. That is, the Funds obligation is to the clearinghouse, and the Fund will look to the clearinghouse to satisfy the Funds rights under the futures contract.
Options on Securities and Stock Indexes.
Each Fund may write covered call and put options and purchase call and put options on securities, stock indices, or futures contracts that are traded on U.S. exchanges. Each Fund may also enter into over-the-counter put and call options on securities and baskets of securities, indexes, and other financial instruments.
An option is a contract that gives the purchaser of the option, in return for the premium paid, the right to buy (in the case of a call option) a specified security or futures contract, as applicable, or to sell (in the case of a put option) a specified security from or to the writer of the option at a designated price during the term of the option. An option on a securities index gives the purchaser of the option, in return for the premium paid, the right to receive from the seller cash equal to the difference between the closing price of the index and the exercise price of the option.
Each Fund may write a call or put option only if the option is covered. A call option on a security written by a Fund is covered if the Fund owns the underlying security covered by the call or has an absolute and immediate right to acquire that security without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian) upon conversion or exchange of other securities held in its portfolio. A call option on a security is also covered if the Fund owns a call option on the same security and in the same principal amount as the call option written where the exercise
price of the call option held (a) is equal to or less than the exercise price of the call option written or (b) is greater than the exercise price of the call option written if the difference is maintained by the Fund in cash or liquid portfolio securities in a segregated account with its custodian. A put option on a security written by a Fund is covered if the Fund maintains similar liquid assets with a value equal to the exercise price designated as segregated at its custodian, or else owns a put option on the same security and in the same principal amount as the put option written where the exercise price of the put option held is equal to or greater than the exercise price of the put option written. The value of the underlying securities on which options may be written at any one time will not exceed 25% of the total assets of the Fund, and the Fund will not purchase put or call options if the aggregate premium paid for such options would exceed 5% of its total assets
at the time of purchase.
Each Fund will cover call options on stock indices by owning securities whose price changes, in the opinion of the Adviser or Sub-Adviser, are expected to be similar to those of the index, or in such other manner as may be in accordance with the rules of the exchange on which the option is traded and applicable laws and regulations. Nevertheless, where a Fund covers a call option on a stock index through ownership of securities, such securities may not match the composition of the index. In that event, the Fund will not be fully covered and could be subject to risk of loss in the event of adverse changes in the value of the
index. The Fund will cover put options on stock indices by segregating assets equal to the options exercise price, or in such other manner as may be in accordance with the rules of the exchange on which the option is traded and applicable laws and regulations.
Each Fund will receive a premium for writing a put or call option, which will increase the Funds gross income in the event the option expires unexercised or is closed out at a profit. If the value of a security or an index on which the Fund has written a call option falls or remains the same, the Fund will realize a profit in the form of the premium received (less transaction costs) that could offset all or a portion of any decline in the value of any portfolio securities underlying the option. A rise in the value of the security or index underlying a call option written by a Fund, exposes the Fund to possible loss or
loss of opportunity to realize appreciation in the value of any portfolio securities underlying or otherwise related to the call option. By writing a put option, the Fund assumes the risk of a decline in the underlying security or index. To the extent that the price changes of any portfolio securities being hedged correlate with changes in the value of the underlying security or index, writing put options on securities or indices will increase the Funds losses in the event of a market decline, although such losses will be offset in part by the premium received for writing the option.
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Each Fund may also purchase put options to hedge its investments against a decline in value. By purchasing a put option, the Fund will seek to offset a decline in the value of the portfolio securities being hedged through appreciation of the put option. If the value of the Funds investments does not decline as anticipated, the Funds loss will be limited to the premium paid for the option plus related transaction costs. The success of this strategy will depend, in part, on the accuracy of the correlation between the changes in value of the underlying security or index and the changes in value of the Funds
security holdings being hedged.
Each Fund may purchase call options on individual securities to hedge against an increase in the price of securities that the Fund anticipates purchasing in the future. Similarly, each Fund may purchase call options to attempt to reduce the risk of missing a broad market advance, or an advance in an industry or market segment, at a time when the Fund holds uninvested cash or short-term debt securities awaiting investment. When purchasing call options, the Fund will bear the risk of losing all or a portion of the premium paid if the value of the underlying security or index does not rise.
There can be no assurance that a liquid market will exist when the Fund seeks to close out an option position, and for certain options not on an exchange no market usually exists. Trading could be interrupted, for example, because of supply and demand imbalances arising from a lack of either buyers or sellers, or the options exchange could suspend trading after the price has risen or fallen more than the maximum specified by the exchange. Although the Fund may be able to offset to some extent any adverse effects of being unable to liquidate an option position, the Fund may experience losses in some cases as a result of such
inability.
Foreign Currency Transactions and Currency Hedging Transactions.
In order to hedge against foreign currency exchange rate risks from adverse changes in the relationship between the U.S. dollar and foreign currencies (including to hedge against anticipated future changes which otherwise might adversely affect the prices of securities that the Fund intends to purchase at a later date), each Fund may enter into forward foreign currency exchange contracts (forward contracts), foreign currency futures contracts (foreign currency futures), and foreign currency swap agreements (foreign currency swaps), as
well as purchase put or call options on foreign currencies, as described below.
A forward currency contract is an obligation to purchase or sell a specific currency for an agreed price on a future date that is individually negotiated and privately traded by currency traders and their customers. A foreign currency future is an exchange-traded contract for the purchase or sale of a specified foreign currency at a specified price at a future date. A foreign currency swap is an agreement between two parties to exchange principal and interest payments on a loan made in one currency for principal and interest payments of a loan of equal value in another currency. Each Fund may enter into a foreign currency
forward contract, foreign currency futures contract or foreign currency swap, or purchase a currency option, for example, when it enters into a contract for the purchase or sale of a security denominated in a foreign currency or expects to receive a dividend or interest payment on a portfolio holding, in order to lock in the U.S. dollar value of the security or payment. In addition, each Fund may enter into a foreign currency forward contract, futures contract or swap or purchase a currency option in respect of a currency which acts as a proxy for a currency in which the Funds portfolio holdings or anticipated holdings are denominated. This second investment practice is generally referred to as cross-hedging. Because in connection with the Funds foreign currency transactions an amount of the Funds assets equal to the amount of the Funds current commitment will be segregated to be used to pay for the commitment, the Fund will always have
cash or other liquid assets available that are sufficient to cover any commitments under these transactions. The segregated assets will be marked-to-market on a daily basis.
Each Fund may enter into a forward contract to attempt to minimize the risk to the Fund from adverse changes in the relationship between the U.S. dollar and foreign currencies. Forward contracts may limit potential gain from a positive change in the relationship between the U.S. dollar and foreign currencies. Unanticipated changes in currency prices may result in poorer overall performance for the Fund than if it had not engaged in such contracts.
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Each Fund may enter into exchange-traded foreign currency futures for the purchase or sale for future delivery of foreign currencies. U.S. exchange-traded futures are regulated by the Commodity Futures Trading Commission. This investment technique will be used only to hedge against anticipated future changes in exchange rates which otherwise might adversely affect the value of the Funds portfolio securities or adversely affect the prices of securities that the Fund intends to purchase at a later date.
Each Fund may enter into foreign currency swaps to shift its currency exposure from one currency to another currency. Each Fund may purchase and write put and call options on foreign currencies for the purpose of protecting against declines in the dollar value of foreign portfolio securities and against increases in the U.S. dollar cost of foreign securities to be acquired. As is the case with other kinds of options, however, the writing of an option on foreign currency will constitute only a partial hedge, up to the amount of the premium received, and the Fund could be required to purchase or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The purchase of an option on foreign currency may constitute an effective hedge against fluctuation in exchange rates although, in the event of rate movements adverse to the Funds position, the Fund may forfeit the entire amount of the premium plus related transaction costs.
The successful use of foreign currency transactions will usually depend on the Advisers or Sub-Advisers ability to forecast currency exchange rate movements correctly. Should exchange rates move in an unexpected manner, the Fund may not achieve the anticipated benefits of forward contracts, foreign currency futures or may realize losses.
Swap Transactions.
Swap agreements are two party over-the-counter contracts entered into primarily by institutional investors that agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments or instruments. The gross returns to be exchanged or swapped between the parties are generally calculated with respect to a notional amount,
i.e
., the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular foreign currency, or in a basket of
credit default swaps or securities representing a particular index. The notional amount of the swap agreement is only used as a basis upon which to calculate the obligations that the parties to a swap agreement have agreed to exchange.
Swap agreements will tend to shift investment exposure from one type of investment to another. For example, if a Fund agreed to exchange payments in U.S. dollars for payments in a foreign currency, the swap agreement would tend to decrease the Funds exposure to U.S. interest rates and increase its exposure to foreign currency and interest rates. Depending on how they are used, swap agreements may increase or decrease the overall volatility of the Funds investments and its share price and yield. Caps and floors have an effect similar to buying or writing options.
Most swap agreements entered into are cash settled and calculate the obligations of the parties to the agreement on a net basis. Thus, a Funds current obligations (or rights) under a swap agreement generally will be equal only to the net amount to be paid or received under the agreement based on the relative values of the positions held by each party to the agreement (the net amount). The Funds current obligations under a swap agreement will be accrued daily (offset against any amounts owed to the Fund) and any accrued but unpaid net amounts owed to a swap counterparty will be covered by the
segregation of permissible liquid assets of the Fund.
Specific swap agreements include foreign currency swaps; index swaps; interest rate swaps (including interest rate locks, caps, floors, and collars); credit default swaps; and total return swaps (including equity swaps).
Interest Rate Swap Transactions
. An interest rate swap agreement involves the exchange of cash flows based on interest rate specifications and a specified principal amount, often a fixed payment for a floating payment that is linked to an interest rate. In an interest rate cap one party receives payments at the end of each period in which a specified interest rate on a specified principal amount exceeds an agreed rate; conversely, in an interest rate floor one party may receive payments if a specified interest rate on a specified
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principal amount falls below an agreed rate. Interest rate collars involve selling a cap and purchasing a floor, or vice versa, to protect the Fund against interest rate movements exceeding given minimum or maximum levels.
Credit Default Swap Transactions
. Credit default swap agreements and similar agreements may have as reference obligations debt securities that are or are not currently held by either Fund. The protection buyer in a credit default contract may be obligated to pay the protection seller an up-front payment or a periodic stream of payments over the term of the contract provided generally that no credit event on a reference obligation has occurred. If a credit event occurs, the seller generally must pay the buyer the par value (full notional value) of the swap in exchange for an
equal face amount of deliverable obligations of the reference entity described in the swap, or the seller may be required to deliver the related net cash amount, if the swap is cash settled.
Total Return Swap Transactions
. In a total return or equity swap agreement one party makes payments based on a set rate, either fixed or variable, while the other party makes payments based on the return of an underlying asset, which includes both the income it generates and any capital gains. The underlying reference asset of a total return swap may include an individual security, an equity index, loans or bonds.
Commodity Swap Transactions
. Each Fund may invest in total return swaps to gain exposure to specific commodities or the overall commodity markets. A total return commodity swap is an agreement to make payments of the price appreciation from a specified commodity, basket of commodities, or commodity index during the specified period, in return for payments equal to a fixed or floating rate of interest or the price appreciation from another specified commodity, basket of commodities, or commodity index. Alternatively, a total return swap can be structured so that one party will make payments to the other party
if the value of the relevant commodity, basket of commodities, or commodity index increases, but receive payments from the other party if the value of that commodity, basket of commodities, or commodity index decreases. If the commodity swap is for one period, the Fund will pay a fixed fee, established at the outset of the swap. Each Fund may enter into exchanges for risk, in which a position in a futures contract is exchanged for an over-the-counter swap, (or an over-the-counter swap is exchanged for a futures contract) with a commodity broker in accordance with exchange rules.
Credit Derivatives.
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redit derivative transactions include those involving default price risk derivatives and market spread derivatives. Default price risk derivatives are linked to the price of reference securities or loans after a default by the issuer or borrower, respectively. Market spread derivatives are based on the risk that changes in market factors, such as credit spreads, can cause a decline in the value of a security, loan or index. There are three basic transactional forms for credit derivatives: swaps, options, and structured instruments. The use of credit derivatives is a highly
specialized activity which involves strategies and risks different from those associated with ordinary portfolio security transactions. The risk of loss in a credit derivative transaction varies with the form of the transaction. For example, if a Fund purchases a default option on a security, and if no default occurs with respect to the security, the Funds loss is limited to the premium it paid for the default option. In contrast, if there is a default by the grantor of a default option, the Funds loss will include both the premium it paid for the option and the decline in value of the underlying security that the default option hedged. If a Fund is a buyer in a credit default swap agreement and no credit event occurs, the Fund recovers nothing if the swap is held through its termination date. However, if a credit event occurs, the Fund may elect to receive the full notional value of the swap in exchange for an equal face amount of deliverable obligations of the reference
entity that may have little or no value. As a seller, a Fund generally receives an up-front payment or a fixed rate of income throughout the term of the swap, which typically is between six months and three years, provided that there is no credit event. If a credit event occurs, generally the seller must pay the buyer the full notional value of the swap in exchange for an equal face amount of deliverable obligations of the reference entity that may have little or no value.
Structured Notes.
Structured notes are privately negotiated debt obligations where the principal and/or interest is determined by reference to the performance of a benchmark asset, market, or interest rate (an embedded index), such as selected securities or commodities, an index of securities or commodities, or specified interest rates, or the differential performance of two assets or markets. When a Fund purchases a
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structured note, it will make a payment of principal to the counterparty. Some structured notes have a guaranteed repayment of principal while others place a portion (or all) of the principal at risk. The possibility of default by the counterparty or its credit provider may be greater for structured notes than for other types of money market instruments. The terms of such structured instruments normally provide that their principal and/or interest payments are to be adjusted upwards or downwards (but not ordinarily below zero) to reflect changes in the embedded index while the structured instruments are outstanding. As a
result, the interest and/or principal payments that may be made on a structured product may vary widely, depending upon a variety of factors, including the volatility of the embedded index and the effect of changes in the embedded index on principal and/or interest payments. The rate of return on structured notes may be determined by applying a multiplier to the performance or differential performance of the referenced index or indexes or other assets. Application of a multiplier involves leverage that will serve to magnify the potential for gain and the risk of loss. Structured notes may not have an active trading market.
Commodity Forward Contracts.
A commodity forward contract, which may be standardized and exchange-traded or customized and privately negotiated, is an agreement for one party to buy, and the other party to sell, a specific quantity of an underlying commodity or other tangible asset for an agreed-upon price at a future date. A forward contract generally is settled by physical delivery of the commodity or other tangible asset underlying the forward contract to an agreed upon location at a future date (rather than settled by cash) or will be rolled forward into a new forward contract. Non-deliverable
forwards (NDFs) specify a cash payment upon maturity. NDFs are normally used when the market for physical settlement of the currency is underdeveloped, heavily regulated or highly taxed.
Risks of Derivatives Transactions.
Derivatives transactions can be highly volatile and involve various types and degrees of risk, depending upon the characteristics of the particular derivative, including the imperfect correlation between the value of such instruments and the underlying assets, the possible default of the other party to the transaction and illiquidity of the derivative instruments. Derivatives transactions may entail investment exposures that are greater than their cost would suggest, meaning that a small investment in derivatives could have a large potential impact on the Funds
performance, effecting a form of investment leverage on the Funds portfolio. In certain types of derivatives transactions, the Fund could lose the entire amount of its investment; in other types of derivatives transactions the potential loss is theoretically unlimited.
The market for many derivatives is, or suddenly can become, illiquid. Changes in liquidity may result in significant, rapid and unpredictable changes in the prices for derivatives transactions. The Fund could experience severe losses if it were unable to liquidate its position because of an illiquid secondary market. Successful use of derivatives transactions also is subject to the ability of the Adviser or Sub-Adviser to predict correctly movements in the direction of the relevant market and, to the extent the transaction is entered into for hedging purposes, to ascertain the appropriate correlation between the transaction
being hedged and the price movements of the securities, currency, interest rate, or other reference asset underlying the derivatives transactions. Derivatives transactions entered into to seek to manage the risks of the Funds portfolio of securities may have the effect of limiting gains from otherwise favorable market movements. For example, the use of currency instruments for hedging purposes may limit gains from a change in the relationship between the U.S. dollar and foreign currencies. The use of derivatives transactions may result in losses greater than if they had not been used (and a loss on a derivatives transaction position may be larger than the gain in a portfolio position being hedged), may require the Fund to sell or purchase portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation the Fund can realize on an investment, or may cause the Fund to hold a security that it might otherwise sell. Amounts
paid by the Fund as premiums and cash or other assets held as collateral with respect to derivatives transactions may not otherwise be available to the Fund for investment purposes. To the extent derivatives transactions would be deemed to be illiquid, they will be included in the maximum limitation of 15% of net assets invested in restricted or illiquid securities.
The use of currency transactions can result in the Fund incurring losses as a result of the imposition of exchange controls, political developments, government intervention or failure to intervene, suspension of settlements, or the inability of the Fund to deliver or receive a specified currency.
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Structured notes and related instruments carry risks similar to those of more traditional derivatives such as futures, forward, and option contracts. However, structured instruments may entail a greater degree of market risk and volatility than other types of debt obligations. The Fund will be subject to credit risk with respect to the counterparties to certain Derivatives transactions entered into by the Fund. Derivatives may be purchased on established exchanges or, as described herein, through privately negotiated transactions referred to as over-the-counter (OTC) derivatives. Exchange-traded derivatives
generally are guaranteed by the clearing agency which is the issuer or counterparty to such derivatives. However, many futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single trading day and once the daily limit has been reached in a particular contract no trades may be made that day at a price beyond that limit or trading may be suspended. There also is no assurance that sufficient trading interest to create a liquid secondary market on an exchange will exist at any particular time and no such secondary market may exist or may cease to exist. Each party to an OTC derivative bears the risk that the counterparty will default. OTC derivatives are less liquid than exchange-traded derivatives because the other party to the transaction may be the only investor with sufficient understanding of the derivative to be interested in bidding for it. If a counterparty becomes bankrupt or otherwise fails to perform its obligations
under a derivative contract due to financial difficulties, the Fund may experience significant delays in obtaining any recovery under the derivative contract in bankruptcy or other reorganization proceeding. The Fund may obtain only a limited recovery or may obtain no recovery in such circumstances.
There is no limit on the amount of a Funds assets that can be put at risk through the use of futures contracts and the value of the Funds futures contracts and options thereon may equal or exceed 100% of the Funds total assets. No Fund has a current intention of entering into futures transactions other than for traditional hedging purposes.
Each Fund is subject to legal requirements that are designed to reduce the effects of any leverage created by the use of derivative instruments. Under these requirements, a Fund must identify liquid assets, or engage in other measures, with regard to its derivative transactions. Each Fund will cover its derivative obligations by segregating liquid assets or covering its obligations with an offsetting position, as determined by the Adviser or Sub-Adviser, in accordance with procedures approved by the Board.
Each Fund will be operated so that it will not be considered a commodity pool (i.e., a pooled investment vehicle which trades in commodity futures contracts and options thereon and the operator of which is registered with the Commodity Futures Trading Commission). In addition, each Fund has claimed an exclusion from the definition of commodity pool operator and, therefore, is not subject to registration or regulation as a pool operator under the Commodity Exchange Act.
Each Funds intention to qualify as a regulated investment company (RIC) under the Internal Revenue Code (the Code) will limit the extent to which the Fund can engage in certain derivatives transactions. With respect to purchases of derivatives, the Fund will comply with applicable law and guidance.
Exchange-Traded Notes (ETNs)
Each Fund may invest in ETNs. ETNs have many features of senior, unsecured, unsubordinated debt securities. Their returns are linked to the performance of a particular asset, such as a market index, less applicable fees, and expenses. ETNs are listed on an exchange and traded in the secondary market. A Fund may hold the ETN until maturity, at which time the issuer is obligated to pay a return linked to the performance of the relevant asset. ETNs do not typically make periodic interest payments and principal is not protected.
The market value of an ETN may be influenced by, among other things, time to maturity, level of supply, and demand of the ETN, volatility and lack of liquidity in the underlying assets, changes in the applicable interest rates, the current performance of the asset to which the ETN is linked, and the credit rating of the ETN issuer. The market value of an ETN may differ from the performance of the applicable asset and there may be times when an ETN trades at a premium or discount to the underlying assets value. This difference in price may be due to the fact that the supply and demand in the market for ETNs at any point
in time is not always identical to the supply and demand in the market for the assets on which the ETNs return is based. A change in the issuers credit rating may also impact the value of an ETN despite the underlying asset
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remaining unchanged. ETNs are also subject to tax risk. No assurance can be given that the Internal Revenue Service (IRS) will accept, or a court will uphold, how the Fund characterizes and treats ETNs, including the income it pays, for tax purposes.
An ETN that is tied to a specific market index may not be able to replicate and maintain exactly the composition and relative weighting of securities, commodities, or other components in the applicable market index. ETNs also incur certain expenses not incurred by their applicable market index, and the Fund would bear a proportionate share of any fees and expenses borne by the ETN in which it invests.
A Funds decision to sell its ETN holdings may be limited by the availability of a secondary market. In addition, although an ETN may be listed on an exchange, the issuer may not be required to maintain the listing and there can be no assurance that a secondary market will exist for an ETN. Some ETNs that use leverage in an effort to amplify the returns of an underlying market index can, at times, be relatively illiquid and may therefore be difficult to purchase or sell at a fair price. Leveraged ETNs may offer the potential for greater return, but the potential for loss and speed at which losses can be realized also are
greater.
Floating Rate and Variable Rate Demand Notes
Each Fund may purchase taxable or tax-exempt floating rate and variable rate demand notes for short-term cash management or other investment purposes. Floating rate and variable rate demand notes and bonds may have a stated maturity in excess of one year, but may have features that permit a holder to demand payment of principal plus accrued interest upon a specified number of days notice. Frequently, such obligations are secured by letters of credit or other credit support arrangements provided by banks. The issuer has a corresponding right, after a given period, to prepay in its discretion the outstanding principal of
the obligation plus accrued interest upon a specific number of days notice to the holders. The interest rate of a floating rate instrument may be based on a known lending rate, such as a banks prime rate, and is reset whenever such rate is adjusted. The interest rate on a variable rate demand note is reset at specified intervals at a market rate.
Foreign Currency Transactions
Each Fund may engage in currency exchange transactions to protect against uncertainty in the level of future foreign currency exchange rates and to increase current return. There can be no assurance that appropriate foreign currency transactions will be available for the Fund at any time or that the Fund will enter into such transactions at any time or under any circumstances even if appropriate transactions are available to it.
Each Fund may engage in both transaction hedging and position hedging. When it engages in transaction hedging, the Fund enters into foreign currency transactions with respect to specific receivables or payables of the Fund generally arising in connection with the purchase or sale of its portfolio securities. Each Fund may engage in transaction hedging when it desires to lock in the U.S. dollar price of a security it has agreed to purchase or sell, or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By transaction hedging, the Fund may attempt to protect
against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and the applicable foreign currency during the period between the date on which the security is purchased or sold or on which the dividend or interest payment is declared, and the date on which such payments are made or received.
Each Fund may purchase or sell a foreign currency on a spot (
i.e.
, cash) basis at the prevailing spot rate in connection with transaction hedging. Each Fund may also enter into contracts to purchase or sell foreign currencies at a future date (forward contracts) and purchase and sell foreign currency futures contracts. For transaction hedging purposes, each Fund may also purchase exchange-listed and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives the Fund the right to assume a short position in the futures
contract until expiration of the option. A put option on currency gives the Fund the right to sell a currency at a specified exercise price until the expiration of the option. A call option on a futures contract gives the Fund the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives the Fund the right to purchase a currency at the exercise price until the expiration of the option.
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When it engages in position hedging, the Fund enters into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which securities held by the Fund are denominated or are quoted in their principle trading markets or an increase in the value of currency for securities which the Fund expects to purchase. In connection with position hedging, each Fund may purchase put or call options on foreign currency and foreign currency futures contracts and buy or sell forward contracts and foreign currency futures contracts. Each Fund may also purchase or sell foreign currency on a spot
basis.
The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the values of those securities between the dates the currency exchange transactions are entered into and the dates they mature. It is impossible to forecast with precision the market value of each Funds portfolio securities at the expiration or maturity of a forward or futures contract. Accordingly, it may be necessary for a Fund to purchase
additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security or securities being hedged is less than the amount of foreign currency the Fund is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security or securities of the Fund if the market value of such security or securities exceeds the amount of foreign currency the Fund is obligated to deliver. To offset some of the costs of hedging against fluctuations in currency exchange rates, the Fund may write covered call options on those currencies.
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, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they tend to limit any potential gain which might result from the increase in the value of such currency.
Each Fund may also seek to increase its current return by purchasing and selling foreign currency on a spot basis, by purchasing and selling futures contracts on foreign currencies and options on foreign currencies and on foreign currency futures contracts, and by purchasing and selling foreign currency forward contracts. The value of any currency, including U.S. dollars and foreign currencies, may be affected by complex political and economic factors applicable to the issuing country. In addition, the exchange rates of foreign currencies (and therefore the values of foreign currency options, forward contracts, and futures
contracts) may be affected significantly, fixed, or supported directly or indirectly by U.S. and foreign government actions. Government intervention may increase risks involved in purchasing or selling foreign currency options, forward contracts, and futures contracts because exchange rates may not be free to fluctuate in response to other market forces. Foreign governmental restrictions or taxes could result in adverse changes in the cost of acquiring or disposing of foreign currencies.
Foreign Securities
Each Fund may invest in foreign (non-U.S.) securities. Investing in securities issued by foreign companies involves considerations and possible risks not typically associated with investing in securities issued by domestic corporations. The values of foreign investments are affected by changes in currency rates or exchange control regulations, application of foreign tax laws, including withholding taxes, changes in governmental administration or economic or monetary policy (in the United States or abroad), or changed circumstances in dealings between nations. Costs are incurred in connection with conversions between various
currencies. In addition, foreign brokerage commissions are generally higher than in the United States, and foreign securities markets may be less liquid, more volatile, and less subject to governmental supervision than in the United States. Investments in foreign countries could be affected by other factors not present in the United States, including expropriation, confiscatory taxation, lack of uniform accounting and auditing standards, and potential difficulties in enforcing contractual obligations which could extend settlement periods.
Investments in foreign securities, especially in emerging market countries, will expose the Fund to the direct or indirect consequences of political, social, or economic changes in the countries that issue the securities or in which the issuers are located. Certain countries in which a Fund may invest, especially
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emerging market countries, have historically experienced, and may continue to experience, high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of external debt, balance of payments and trade difficulties, and extreme poverty and unemployment. Many of these countries are also characterized by political uncertainty and instability. The cost of servicing external debt will generally be adversely affected by rising international interest rates because many external debt obligations bear interest at rates that are adjusted based upon international interest rates. In addition, with respect to
certain foreign countries, there is a risk of:
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the possibility of expropriation of assets;
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difficulty in obtaining or enforcing a court judgment;
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economic, political, or social instability; and
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diplomatic developments that could affect investments in those countries.
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Each Fund may invest in sponsored and unsponsored American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs), and similar depositary receipts. ADRs, typically issued by a financial institution (a depositary), evidence ownership interests in a security or a pool of securities issued by a foreign company and deposited with the depositary. Prices of ADRs are quoted in U.S. dollars, and ADRs are traded in the United States. GDRs are receipts issued outside the United States, typically by non-United States banks and trust companies, which evidence ownership of either foreign or domestic securities. Generally, GDRs, in
bearer form, are designated for use outside the United States. Ownership of ADRs and GDRs entails similar investment risks to direct ownership of foreign securities traded outside the U.S., including increased market liquidity, currency, political, information, and other risks. Income and gains earned by the Fund in respect of foreign securities may be subject to foreign withholding and other taxes, which will reduce the Funds return on such securities.
Forward Commitments and Dollar Rolls
Each Fund may enter into contracts to purchase securities for a fixed price at a future date beyond customary settlement time (forward commitments) if the Fund sets aside on its books liquid assets in an amount sufficient to meet the purchase price, or if the Fund enters into offsetting contracts for the forward sale of other securities it owns. In the case of to-be-announced (TBA) purchase commitments, the unit price and the estimated principal amount are established when the Fund enters into a contract, with the actual principal amount being within a specified range of the estimate. Forward
commitments may be considered securities in themselves, and involve a risk of loss if the value of the security to be purchased declines prior to the settlement date, which risk is in addition to the risk of decline in the value of the Funds other assets. Where such purchases are made through dealers, the Fund relies on the dealer to consummate the sale. The dealers failure to do so may result in the loss to the Fund of an advantageous yield or price. Although the Fund will generally enter into forward commitments with the intention of acquiring securities for its portfolio or for delivery pursuant to options contracts it has entered into, the Fund may dispose of a commitment prior to settlement if the Adviser or Sub-Adviser deems it appropriate to do so. The Fund may realize short-term profits or losses upon the sale of forward commitments.
Each Fund may enter into TBA sale commitments to hedge its portfolio positions or to sell securities it owns under delayed delivery arrangements. Proceeds of TBA sale commitments are not received until the contractual settlement date. Unsettled TBA sale commitments are valued at current market value of the underlying securities. If the TBA sale commitment is closed through the acquisition of an offsetting purchase commitment, the Fund realizes a gain or loss on the commitment without regard to any unrealized gain or loss on the underlying security. If the Fund delivers securities under the commitment, the Fund realizes a gain
or loss from the sale of the securities based upon the unit price established at the date the commitment was entered into.
Each Fund may enter into dollar roll transactions (generally using TBAs) in which it sells a debt security for delivery in the current month and simultaneously contracts to purchase similar securities (for example, same type, coupon and maturity) at an agreed upon future time. By engaging in a dollar roll transaction, the
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Fund foregoes principal and interest paid on the security that is sold, but receives the difference between the current sales price and the forward price for the future purchase. The Fund would also be able to earn interest on the proceeds of the sale before they are reinvested. The Fund accounts for dollar rolls as purchases and sales. Dollar rolls may be used to create investment leverage and may increase the Funds risk and volatility.
The obligation to purchase securities on a specified future date involves the risk that the market value of the securities that the Fund is obligated to purchase may decline below the purchase price. In addition, in the event the other party to the transaction files for bankruptcy, becomes insolvent, or defaults on its obligation, the Fund may be adversely affected.
Government Mortgage Pass-Through Securities
Each Fund may invest in mortgage pass-through securities representing participation interests in pools of residential mortgage loans purchased from individual lenders by an agency, instrumentality, or sponsored corporation of the United States government (Federal Agency) or originated by private lenders and guaranteed, to the extent provided in such securities, by a Federal Agency. Such securities, which are ownership interests in the underlying mortgage loans, differ from conventional debt securities, which provide for periodic payment of interest in fixed amounts (usually semiannually) and principal payments at
payments (not necessarily in fixed amounts) that are a pass-through of the monthly interest and principal payments (including any prepayments) made by the individual borrowers on the pooled mortgage loans, net of any fees paid to the guarantor of such securities and the servicer of the underlying mortgage loans.
The government mortgage pass-through securities in which a Fund may invest include those issued or guaranteed by Ginnie Mae, Fannie Mae, and Freddie Mac. Ginnie Mae certificates are direct obligations of the U.S. Government and, as such, are backed by the full faith and credit of the United States. Fannie Mae is a federally chartered, privately owned corporation. Freddie Mac is a corporate instrumentality of the United States. Fannie Mae and Freddie Mac certificates are not backed by the full faith and credit of the United States, but the issuing agency or instrumentality has the right to borrow, to meet its
obligations, from an existing line of credit with the U.S. Treasury. The U.S. Treasury has no legal obligation to provide such line of credit and may choose not to do so.
Certificates for these types of mortgage-backed securities evidence an interest in a specific pool of mortgages. These certificates are, in most cases, modified pass-through instruments, wherein the issuing agency guarantees the payment of principal and interest on mortgages underlying the certificates, whether or not such amounts are collected by the issuer on the underlying mortgages. The Housing and Economic Recovery Act of 2008 (HERA) authorized the Secretary of the Treasury to support Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBs) (collectively, the GSEs)
by purchasing obligations and other securities from those government-sponsored enterprises. HERA gave the Secretary of the Treasury broad authority to determine the conditions and amounts of such purchases.
On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers, and privileges of Fannie Mae and Freddie Mac and of any stockholder, officer, or director of Fannie Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of Fannie Mae and Freddie Mac. FHFA selected a new chief executive officer and chairman of the board of directors for Fannie Mae and Freddie Mac.
In connection with the conservatorship, the U.S. Treasury, exercising powers granted to it under HERA, entered into a Senior Preferred Stock Purchase Agreement (SPA) with each of Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will purchase up to an aggregate of $100 billion of each of Fannie Mae and Freddie Mac to maintain a positive net worth in each enterprise. This agreement contains various covenants that severely limit each enterprises operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprises senior preferred stock and warrants to
purchase 79.9% of each enterprises common stock. On February 18, 2009, the U.S. Treasury announced that it was doubling the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasurys obligations under the Senior Preferred Stock Program are for an indefinite period of time for a maximum amount of $200 billion per enterprise. On December 24, 2009, the U.S. Treasury announced further amendments to the SPAs which included additional financial support for each GSE through the end of 2012
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and changes to the limits on their retained mortgage portfolios. It is difficult, if not impossible, to predict the future political, regulatory or economic changes that could impact the GSEs.
Fannie Mae and Freddie Mac are continuing to operate as going concerns while in conservatorship and each remain liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. The Senior Preferred Stock Purchase Agreement is intended to enhance each of Fannie Maes and Freddie Macs ability to meet its obligations. The FHFA has indicated that the conservatorship of each enterprise will end when the director of FHFA determines that FHFAs plan to restore the enterprise to a safe and solvent condition has been completed.
Hybrid Securities
Each Fund may acquire hybrid securities. A hybrid security combines an income-producing debt security (income producing component) and the right to receive payment based on the change in the price of an equity security (equity component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks, and money market instruments, which may be represented by derivative instruments. The equity component is achieved by investing in securities or instruments such as cash-settled warrants or options to receive a payment based on
whether the price of a common stock surpasses a certain exercise price or options on a stock index. A hybrid security comprises two or more separate securities, each with its own market value. Therefore, the market value of a hybrid security is the sum of the values of its income-producing component and its equity component.
A holder of a hybrid security faces the risk of a decline in the price of the security or the level of the index involved in the equity component, causing a decline in the value of the security or instrument, such as a call option or warrant, purchased to create the hybrid security. The equity component has risks typical to a purchased call option. Should the price of the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the call option or warrant would be lost. Because a hybrid security includes the income-producing component as well, the holder of a hybrid
security also faces risks typical to all debt securities.
Illiquid Securities
Each Fund may invest in illiquid securities. A Fund will not invest in illiquid securities if immediately after such investment more than 15% of the Funds net assets would be invested in such securities. For this purpose, illiquid securities include, among others, securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale. Securities that have legal or contractual restrictions on resale but have a readily available market are not deemed illiquid for purposes of this limitation.
Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act or which are otherwise not readily marketable. Securities which have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. The Funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have
an adverse effect on the marketability of portfolio securities, and the Funds might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. The Funds might also have to register such restricted securities in order to dispose of them, resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities.
In recent years, a large institutional market has developed for certain securities that are not registered under the Securities Act, including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuers ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments.
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Rule 144A under the Securities Act allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a safe harbor from the registration requirements of the Securities Act of resales of certain securities to qualified institutional buyers, which generally creates a more liquid market for securities eligible for resale under Rule 144A than other types of restricted securities.
The Adviser and Sub-Adviser will monitor the liquidity of restricted securities in the Funds portfolio, under the supervision of the Board. In reaching liquidity decisions, the Adviser and Sub-Adviser will consider, among other things, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security; and (4) the nature of the security and the nature of the marketplace trades (
e.g.
, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer).
Inflation-Protected Securities
Each Fund may invest in U.S. Treasury Inflation Protected Securities (U.S. TIPS), which are debt securities issued by the U.S. Department of Treasury, the principal amounts of which are adjusted daily based upon changes in the rate of inflation. Each Fund may also invest in other inflation-protected securities issued by non-U.S. governments or by private issuers. U.S. TIPS pay interest on a semi-annual basis, equal to a fixed percentage of the inflation-adjusted principal amount. The interest rate on these bonds is fixed at issuance, but over the life of the bond this interest may be paid on an increasing or
decreasing principal value that has been adjusted for inflation.
Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed for U.S. TIPS, even during a period of deflation. However, because the principal amount of U.S. TIPS would be adjusted downward during a period of deflation, the Fund will be subject to deflation risk with respect to its investments in these securities. In addition, the current market value of the bonds is not guaranteed, and will fluctuate. If a Fund purchases in the secondary market U.S. TIPS whose principal values have been adjusted upward due to inflation since issuance, the Fund may experience a loss if there is a subsequent
period of deflation. Each Fund may also invest in other inflation-related bonds which may or may not provide a guarantee of principal. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal amount.
The periodic adjustment of U.S. TIPS is currently tied to the CPI-U, which is calculated by the U.S. Department of Treasury. The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation, and energy. Inflation-protected bonds issued by a non-U.S. government are generally adjusted to reflect a comparable inflation index, calculated by that government. There can no assurance that the CPI-U or any non-U.S. inflation index will accurately measure the real rate of inflation in the prices of goods and services. If interest rates rise due to reasons other than inflation,
investors in these securities may not be protected to the extent that the increase is not reflected in the bonds inflation measure. In addition, there can be no assurance that the rate of inflation in a non-U.S. country will be correlated to the rate of inflation in the United States.
Infrastructure Investments
Each Fund may invest in securities and other obligations of U.S. and non-U.S. issuers providing exposure to infrastructure investment. Infrastructure investments may be related to physical structures and networks that provide necessary services to society, such as transportation and communications networks, water and energy utilities, and public service facilities. Securities, instruments, and obligations of infrastructure-related companies and projects are more susceptible to adverse economic or regulatory occurrences affecting their industries. Infrastructure companies may be subject to a variety of factors that may
adversely affect their business or operations, including high interest costs in connection with capital construction programs, high leverage, costs associated with environmental and other regulations, the effects of economic slowdown, surplus capacity, increased competition from other providers of services, uncertainties concerning the availability of fuel at reasonable prices, the effects of energy conservation policies, and other factors. Infrastructure companies and projects also may be affected by or subject to regulation by various government authorities, including rate regulation; service interruption due to environmental, operational or other mishaps;
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the imposition of special tariffs and changes in tax laws, regulatory policies and accounting standards; and general changes in market sentiment towards infrastructure and utilities assets.
Initial Public Offerings
Each Fund may purchase debt or equity securities in initial public offerings (IPOs). These securities, which are often issued by unseasoned companies, may be subject to many of the same risks of investing in companies with smaller market capitalizations. Securities issued in IPOs have no trading history, and information about the companies may be available for very limited periods. Securities issued in an IPO frequently are very volatile in price, and the Fund may hold securities purchased in an IPO for a very short period of time. As a result, the Funds investments in IPOs may increase portfolio turnover,
which increases brokerage and administrative costs and may result in taxable distributions to shareholders.
At any particular time, or from time to time, a Fund may not be able to invest in securities issued in IPOs, or invest to the extent desired because, for example, only a small portion (if any) of the securities being offered in an IPO may be made available to the Fund. In addition, under certain market conditions, a relatively small number of companies may issue securities in IPOs. There can be no assurance that investments in IPOs will improve the Funds performance.
Inverse Floaters
Inverse floaters constitute a class of CMOs with a coupon rate that moves inversely to a designated index, such as LIBOR (London Interbank Offered Rate). Inverse floaters have coupon rates that typically change at a multiple of the changes of the relevant index rate. Any rise in the index rate (as a consequence of an increase in interest rates) causes a drop in the coupon rate on an inverse floater while any drop in the index rate causes an increase in the coupon rate of an inverse floater. In some circumstances, the coupon on an inverse floater could decrease to zero. In addition, like most other debt securities, the value of
inverse floaters will decrease as interest rates increase and their average lives will extend. Inverse floaters exhibit greater price volatility than the majority of mortgage-backed securities. In addition, some inverse floaters display extreme sensitivity to changes in prepayments. As a result, the yield to maturity of an inverse floater is sensitive not only to changes in interest rates, but also to changes in prepayment rates on the related underlying mortgage assets. As described above, inverse floaters may be used alone or in tandem with interest-only stripped mortgage instruments.
Investment Companies
Each Fund may invest in securities of other open- or closed-end investment companies. Each Fund may purchase shares of closed-end funds that are managed by an affiliate of the Adviser or Sub-Adviser only to the extent that they are traded on a national exchange. Each Fund may also invest a portion of its assets in pooled investment vehicles other than registered investment companies. For example, some vehicles which are commonly referred to as exchanged traded funds may not be registered investment companies because of the nature of their underlying investments. As a stockholder in an investment company or other
pooled vehicle, the Fund will bear its ratable share of that investment companys or vehicles expenses, and would remain subject to payment of the funds advisory and administrative fees with respect to assets so invested. Shareholders would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies or vehicles. In addition, the securities of other investment companies or pooled vehicles may be leveraged and will therefore be subject to leverage risks (in addition to other risks of the investment companys or pooled vehicles strategy). The Fund will also incur brokerage costs when purchasing and selling shares of investment companies and other pooled vehicles.
An investment in the shares of another fund is subject to the risks associated with that funds portfolio securities. To the extent a Fund invests in shares of another fund, that Funds shareholders would indirectly pay a portion of that Funds expenses, including advisory fees, brokerage, and other distribution expenses. These fees and expenses are in addition to the direct expenses of the Funds own operations.
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Loan Participation and Assignments
Investment in secured or unsecured fixed or floating rate loans (Loans) arranged through private negotiations between a borrowing corporation, government, or other entity and one or more financial institutions (Lenders) may be in the form of participations in Loans (Participation) or assignments of all or a portion of Loans from third parties (Assignments). Participations typically result in the Fund having a contractual relationship only with the Lender, not with the borrower. The Fund has the right to receive payments of principal, interest, and any fees to which it is entitled
only from the Lender selling the Participation and only upon receipt by the Lender of the payments from the borrower. In connection with purchasing Participations, the Fund generally has no direct right to enforce compliance by the borrower with the terms of the loan agreement relating to the Loan, nor any rights of set-off against the borrower, and the Fund may not directly benefit from any collateral supporting the Loan in which it has purchased the Participation. As a result, the Fund assumes the credit risk of both the borrower and the Lender that is selling the Participation. In the event of the insolvency of the selling Lender, the Fund may be treated as a general creditor of that Lender and may not benefit from any set-off between the Lender and the borrower.
When a Fund purchases Assignments from Lenders, it acquires direct rights against the borrower on the Loan. In an Assignment, the Fund is entitled to receive payments directly from the borrower and, therefore, does not depend on the selling bank to pass these payments onto the Fund. However, because Assignments are arranged through private negotiations between potential assignees and assignors, the rights and obligations acquired by the Fund as the purchaser of an Assignment may differ from, and be more limited than, those held by the assigning Lender.
Assignments and Participations are generally not registered under the Securities Act, and thus may be subject to the Funds limitation on investment in illiquid securities. The lack of a liquid secondary market could have an adverse impact on the value of such securities and on the Funds ability to dispose of particular Assignments or Participations when necessary to meet the Funds liquidity needs or in response to a specific economic event, such as a deterioration in the creditworthiness of the borrower.
Money Market Instruments
Each Fund may invest, for defensive purposes or otherwise, some or all of their assets in high-quality fixed-income securities, money market instruments, and money market mutual funds, or hold cash or cash equivalents in such amounts as the Adviser or Sub-Adviser deems appropriate under the circumstances. In addition, each Fund may invest in these instruments pending allocation of its respective offering proceeds. Money market instruments are high-quality, short-term, fixed-income obligations, which generally have remaining maturities of one year or less and may include U.S. Government securities, commercial paper,
certificates of deposit, and bankers acceptances issued by domestic branches of U.S. banks that are members of the Federal Deposit Insurance Corporation (FDIC), and repurchase agreements.
Margin Payments
When a Fund purchases or sells a futures contract, it is required to deposit with its custodian an amount of cash, U.S. Treasury bills, or other permissible collateral equal to a small percentage of the amount of the futures contract. This amount is known as initial margin. Initial margin requirements are established by the exchanges on which futures contracts trade and may, from time to time, change. The nature of initial margin is different from that of margin in security transactions in that it does not involve borrowing money to finance transactions. Rather, initial margin is similar to a performance bond or
good faith deposit that is returned to the Fund upon termination of the contract, assuming the Fund satisfies its contractual obligations. In addition, brokers may establish margin deposit requirements in excess of those required by the exchanges.
Subsequent payments to and from the broker occur on a daily basis in a process known as marking to market. These payments are called variation margin and are made as the value of the underlying futures contract fluctuates. For example, when a Fund sells a futures contract and the price of the underlying index rises above the delivery price, the Funds position declines in value. The Fund then pays the broker a variation margin payment equal to the difference between the delivery price of the futures contract and the value of the index underlying the futures contract. Conversely, if the price of the
underlying index falls below the delivery
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price of the contract, the Funds futures position increases in value. The broker then must make a variation margin payment equal to the difference between the delivery price of the futures contract and the value of the index underlying the futures contract.
When a Fund terminates a position in a futures contract, a final determination of variation margin is made, additional cash is paid by or to the Fund, and the Fund realizes a loss or a gain. Such closing transactions involve additional commission costs.
Mortgage Dollar Rolls
Each Fund may enter into mortgage dollar rolls with a bank or a broker-dealer. A mortgage dollar roll is a transaction in which the Fund sells mortgage-related securities for immediate settlement and simultaneously purchases the same type of securities for forward settlement at a discount. While the Fund begins accruing interest on the newly purchased securities from the purchase or trade date, it is able to invest the proceeds from the sale of its previously owned securities, which will be used to pay for the new securities, in money market investments until future settlement date. The use of mortgage dollar rolls is a
speculative technique involving leverage, and can have an economic effect similar to borrowing money for investment purposes.
Mortgage-backed and Asset-backed Securities
Mortgage-backed securities, including collateralized mortgage obligations (CMOs) and certain stripped mortgage-backed securities, represent a participation in, or are secured by, mortgage loans. Asset-backed securities are structured like mortgage-backed securities, but instead of mortgage loans or interests in mortgage loans, the underlying assets may include such items as motor vehicle installment sales or installment loan contracts, leases of various types of real and personal property, and receivables from credit card agreements. The cash flow generated by the underlying assets is applied to make required
payments on the securities and to pay related administrative expenses. The amount of residual cash flow resulting from a particular issue of asset-backed or mortgage-backed securities depends on, among other things, the characteristics of the underlying assets, the coupon rates on the securities, prevailing interest rates, the amount of administrative expenses, and the actual prepayment experience on the underlying assets. Each Fund may invest in any such instruments or variations as may be developed, to the extent consistent with its investment objectives and policies and applicable regulatory requirements. In general, the collateral supporting asset-backed securities is of a shorter maturity than mortgage loans and is likely to experience substantial prepayments.
Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying assets. Unlike traditional debt securities, which may pay a fixed rate of interest until maturity, when the entire principal amount comes due, payments on certain mortgage-backed securities include both interest and a partial repayment of principal. Besides the scheduled repayment of principal, repayments of principal may result from the voluntary prepayment, refinancing, or foreclosure of the underlying mortgage loans. If property owners make unscheduled prepayments of their mortgage loans, these prepayments will result in early
payment of the applicable mortgage-backed securities. In that event a Fund may be unable to invest the proceeds from the early payment of the mortgage-backed securities in an investment that provides as high a yield as the mortgage-backed securities. Consequently, early payment associated with mortgage-backed securities may cause these securities to experience significantly greater price and yield volatility than that experienced by traditional debt securities. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage, and other social and demographic conditions. During periods of falling interest rates, the rate of mortgage prepayments tends to increase, thereby tending to decrease the life of mortgage-backed securities. During periods of rising interest rates, the rate of mortgage prepayments usually decreases, thereby tending to increase the life of mortgage-backed
securities. If the life of a mortgage-backed security is inaccurately predicted, the Fund may not be able to realize the rate of return it expected.
Adjustable rate mortgage securities (ARMs), like traditional mortgage-backed securities, are interests in pools of mortgage loans that provide investors with payments consisting of both principal and interest as mortgage loans in the underlying mortgage pool are paid off by the borrowers. Unlike fixed-rate mortgage-backed securities, ARMs are collateralized by or represent interests in mortgage loans with variable rates of interest. These interest rates are reset at periodic intervals, usually by reference to an interest rate
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index or market interest rate. Although the rate adjustment feature may act as a buffer to reduce sharp changes in the value of adjustable rate securities, these securities are still subject to changes in value based on, among other things, changes in market interest rates or changes in the issuers creditworthiness. Because the interest rates are reset only periodically, changes in the interest rate on ARMs may lag changes in prevailing market interest rates. Also, some ARMs (or the underlying mortgages) are subject to caps or floors that limit the maximum change in the interest rate during a specified period or over the
life of the security. As a result, changes in the interest rate on an ARM may not fully reflect changes in prevailing market interest rates during certain periods. Each Fund may also invest in hybrid ARMs, whose underlying mortgages combine fixed-rate and adjustable rate features.
Mortgage-backed and asset-backed securities are less effective than other types of securities as a means of locking in attractive long-term interest rates. One reason is the need to reinvest prepayments of principal; another is the possibility of significant unscheduled prepayments resulting from declines in interest rates. These prepayments would have to be reinvested at lower rates. The automatic interest rate adjustment feature of mortgages underlying ARMs likewise reduces the ability to lock-in attractive rates. As a result, mortgage-backed and asset-backed securities may have less potential for capital
appreciation during periods of declining interest rates than other securities of comparable maturities, although they may have a similar risk of decline in market value during periods of rising interest rates. Prepayments may also significantly shorten the effective maturities of these securities, especially during periods of declining interest rates. Conversely, during periods of rising interest rates, a reduction in prepayments may increase the effective maturities of these securities, subjecting them to a greater risk of decline in market value in response to rising interest rates than traditional debt securities, and, therefore, potentially increasing the volatility of the Fund.
At times, some mortgage-backed and asset-backed securities will have higher than market interest rates and therefore will be purchased at a premium above their par value. Prepayments may cause losses on securities purchased at a premium.
Asset-backed securities may be collateralized by the fees earned by service providers. The values of asset-backed securities may be substantially dependent on the servicing of the underlying asset and are therefore subject to risks associated with negligence by, or defalcation of, their servicers. In certain circumstances, the mishandling of related documentation may also affect the rights of the security holders in and to the underlying collateral. The insolvency of entities that generate receivables or that utilize the assets may result in added costs and delays in addition to losses associated with a decline in the value of
the underlying assets.
Preferred Securities
There are two basic types of preferred securities, traditional and hybrid-preferred securities. Traditional preferred securities consist of preferred stock issued by an entity taxable as a corporation. Preferred stocks, which may offer fixed or floating rate dividends, are perpetual instruments and considered equity securities. Preferred securities are subordinated to senior debt instruments in a companys capital structure, in terms of priority to corporate income and claim to corporate assets, and therefore will be subject to greater credit risk than debt instruments. Alternatively, hybrid-preferred securities may be
issued by corporations, generally in the form of interest-bearing notes with preferred securities characteristics, or by an affiliated trust or partnership of the corporation, generally in the form of preferred interests in subordinated debentures or similarly structured securities. The hybrid-preferred securities market consists of both fixed and adjustable coupon rate securities that are either perpetual in nature or have stated maturity dates. Hybrid-preferred securities are considered debt securities. Due to their similar attributes, the Adviser and Sub-Adviser also consider senior debt perpetual issues, certain securities with convertible features as well as exchange-listed senior debt issues that trade with attributes of exchange-listed perpetual and hybrid-preferred securities to be part of the broader preferred securities market.
Traditional Preferred Securities.
Traditional preferred securities pay fixed or floating dividends to investors and have preference over common stock in the payment of dividends and the liquidation of a companys assets. This means that a company must pay dividends on preferred stock before paying any dividends on its common stock. In order to be payable, distributions on such preferred securities must be declared by the issuers board of directors. Income payments on preferred securities may be cumulative,
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causing dividends and distributions to accumulate even if not declared by the board of directors or otherwise made payable. In such a case, all accumulated dividends must be paid before any dividend on the common stock can be paid. However, many traditional preferred stocks are non-cumulative, in which case dividends do not accumulate and need not ever be paid. Each Fund may invest in non-cumulative preferred securities, whereby the issuer does not have an obligation to make up any missed payments to its stockholders. There is no assurance that dividends or distributions on the traditional preferred securities in which a Fund
invests will be declared or otherwise made payable. Preferred securities may also contain provisions under which payments must be stopped (
i.e.
, stoppage is compulsory, not discretionary). The conditions under which this occurs may relate to, for instance, capitalization levels. Hence, if a company incurs significant losses that deplete retained earnings automatic payment stoppage could occur. In some cases the terms of the preferred securities provide that the issuer would be obligated to attempt to issue common shares to raise funds for the purpose of making the preferred payments. However, there is no guarantee that the issuer would be successful in placing common shares.
Preferred stockholders usually have no right to vote for corporate directors or on other matters. Shares of traditional preferred securities have a liquidation preference that generally equals the original purchase price at the date of issuance. The market value of preferred securities may be affected by, among other factors, favorable and unfavorable changes impacting the issuer or industries in which they operate, movements in interest rates and inflation, and the broader economic and credit environments, and by actual and anticipated changes in tax laws, such as changes in corporate and individual income tax rates. Because
the claim on an issuers earnings represented by traditional preferred securities may become onerous when interest rates fall below the rate payable on such securities, the issuer may redeem the securities. Thus, in declining interest rate environments in particular, a Funds holdings of higher rate-paying fixed rate preferred securities may be reduced, and the Fund may be unable to acquire securities of comparable credit quality paying comparable rates with the redemption proceeds.
Hybrid-preferred Securities.
Hybrid-preferred securities are typically junior and fully subordinated liabilities of an issuer or the beneficiary of a guarantee that is junior and fully subordinated to the other liabilities of the guarantor. In addition, hybrid-preferred securities typically permit an issuer to defer the payment of income for eighteen months or more without triggering an event of default. Generally, the maximum deferral period is five years. Because of their subordinated position in the capital structure of an issuer, the ability to defer payments for extended periods of time without
default consequences to the issuer, and certain other features (such as restrictions on common dividend payments by the issuer or ultimate guarantor when full cumulative payments on the hybrid preferred securities have not been made), these hybrid-preferred securities are often treated as close substitutes for traditional preferred securities, both by issuers and investors. Hybrid-preferred securities have many of the key characteristics of equity due to their subordinated position in an issuers capital structure and because their quality and value are heavily dependent on the profitability of the issuer rather than on any legal claims to specific assets or cash flows. Hybrid-preferred securities are typically issued with a final maturity date. In certain instances, a final maturity date may be extended and/or the final payment of principal may be deferred at the issuers option for a specified time without default. No redemption can typically take place unless all
cumulative payment obligations have been met, although issuers may be able to engage in open-market repurchases without regard to whether all payments have been paid.
Many hybrid-preferred securities are issued by trusts or other special purpose entities established by operating companies and are not a direct obligation of an operating company. At the time the trust or special purpose entity sells such preferred securities to investors, it purchases debt of the operating company (with terms comparable to those of the trust or special purpose entity securities), which enables the operating company to deduct for tax purposes the interest paid on the debt held by the trust or special purpose entity. The trust or special purpose entity is generally required to be treated as transparent for U.S.
federal income tax purposes such that the holders of the trust preferred securities are treated as owning beneficial interests in the underlying debt of the operating company. Accordingly, payments on the hybrid-preferred securities are generally treated as interest rather than dividends for U.S. federal income tax purposes and, as such, are not eligible for the DRD or the reduced rates of tax that apply to qualified dividend income. The trust or special purpose entity in turn would be a holder of the operating companys debt and would have priority with respect
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to the operating companys earnings and profits over the operating companys common stockholders, but would typically be subordinated to other classes of the operating companys debt. Typically a preferred security has a credit rating that is lower than that of its corresponding operating companys senior debt securities.
Within the category of hybrid-preferred securities are senior debt instruments that trade in the broader preferred securities market. These debt instruments, which are sources of long-term capital for the issuers, have structural features similar to other preferred securities such as maturities ranging from 30 years to perpetuity, call features, quarterly payments, exchange listings and the inclusion of accrued interest in the trading price.
In some cases traditional and hybrid securities may include loss absorption provisions that make the securities more equity like. This is particularly true in the financial sector, the largest preferred issuer segment. Events in global financial markets in recent periods have caused regulators to review the function and structure of preferred securities more closely. While loss absorption language is relatively rare in the preferred market today, it may become much more prevalent.
In one version of a preferred security with loss absorption characteristics, the liquidation value of the security may be adjusted downward to below the original par value under certain circumstances. This may occur, for instance, in the event that business losses have eroded capital to a substantial extent. The write down of the par value would occur automatically and would not entitle the holders to seek bankruptcy of the company. Such securities may provide for circumstances under which the liquidation value may be adjusted back up to par, such as an improvement in capitalization and/or earnings.
Another preferred structure with loss absorption characteristics is the contingent capital security (sometimes referred to as CoCos). These securities provide for mandatory conversion into common shares of the issuer under certain circumstances. The mandatory conversion might relate, for instance, to maintenance of a capital minimum, whereby falling below the minimum would trigger automatic conversion. Since the common stock of the issuer may not pay a dividend, investors in these instruments could experience a reduced income rate, potentially to zero; and conversion would deepen the subordination of the
investor, hence worsening standing in a bankruptcy. In addition, some such instruments have a set stock conversion rate that would cause an automatic write-down of capital if the price of the stock is below the conversion price on the conversion date.
Preferred securities may be subject to changes in regulations and there can be no assurance that the current regulatory treatment of preferred securities will continue.
Convertible Preferred Securities.
Some preferred securities, generally known as convertible preferred securities, provide for an investor option to convert their holdings into common shares of the issuer. These securities may have lower rates of income than other preferred securities, and the conversion option may cause them to trade more like equities than typical fixed income instruments.
Floating Rate Securities.
Each Fund may invest in floating rate preferred securities, which provide for a periodic adjustment in the interest rate paid on the securities. The terms of such securities provide that interest rates are adjusted periodically based upon an interest rate adjustment index. The adjustment intervals may be regular, and range from daily up to annually, or may be event-based, such as a change in the prime rate. Because of the interest rate reset feature, floating rate securities provide the Fund with a certain degree of protection against rises in interest rates, although the
interest rates of floating rate securities will participate in any declines in interest rates as well.
Private Funds
Each Fund may also invest in private investment funds, vehicles, or structures such as hedge funds or private equity funds. Private funds may utilize leverage without limit and, to the extent a Fund invests in private funds that utilize leverage, the Fund will indirectly be exposed to the risks associated with that leverage and the values of its shares may be more volatile as a result. If a fund or investment pool in which a Fund invests is not publicly offered or there is no public market for its shares, the Fund may be prohibited by the terms of its investment from selling its shares in the fund or pool, or may
not be able to find a buyer for those shares at an acceptable price. Securities issued by private funds are generally issued in private
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placements and are restricted securities. An investment in a Private fund may be highly volatile and difficult to value. The Fund would bear its pro rata share of the expenses of any Private fund in which it invests.
Real Estate Companies
Each Fund may invest in real estate securities, including securities issued by domestic REITs, foreign REITs, REIT-like entities and other issuers in the real estate industry. Such investments will be affected by factors generally affecting the value of real estate and the earnings of companies engaged in the real estate industry. These include, among others: (1) changes in general economic and market conditions; (2) risks related to local economic conditions, overbuilding and increased competition; (3) increases in property taxes and operating expenses; (4) changes in zoning laws; (5) casualty and condemnation losses; (6)
variations in rental income, neighborhood values or the appeal of property to tenants; (7) the availability of financing; and (8) changes in interest rates. The value of investments in the real estate industry may go through cycles of relative under-performance and over-performance in comparison to the broader securities markets in general. Other factors may contribute to the risk of investing, directly or indirectly, in the commercial real estate industry.
Current Adverse Economic Conditions.
The volatility in the broader credit markets over the past several years has caused the global financial markets to become more volatile. The real estate industry has been dramatically impacted as a result. The confluence of the dislocation in the credit markets generally, along with the broad-based stress in the United States real estate industry, has created a difficult operating environment for owners and investors in real estate and investors should be aware that the general risks of investing in real estate may be magnified.
In addition, recent instability in the United States, European and other credit markets has at times made it more difficult for borrowers to obtain financing or refinancing on attractive terms or at all. In particular, because of conditions in the credit markets, borrowers may be subject to increased interest expenses for borrowed money and tightening underwriting standards. There is also a risk that a general lack of liquidity or other adverse events in the credit markets may adversely affect the ability of real estate companies to finance real estate developments and projects or to refinance completed projects.
For example, adverse developments relating to sub-prime mortgages in the United States have adversely affected the willingness of some lenders to extend credit, which may make it more difficult for real estate companies to obtain financing, on attractive terms or at all, so that they may commence or complete real estate development projects, refinance completed projects or purchase real estate. It also may adversely affect the price at which companies can sell real estate, because purchasers may not be able to obtain financing on attractive terms or at all. These developments also may adversely affect the broader economy,
which in turn may adversely affect the real estate markets. Such developments could, in turn, reduce the number of real estate funds publicly-traded during the investment period and reduce a Funds investment opportunities in the real estate industry.
Development Risks.
Certain commercial real estate companies engage in the development or construction of real estate properties. To the extent a Fund directly or indirectly invests in such companies, the Fund will be exposed to a variety of risks inherent in real estate development and construction. These include the risk that there will be insufficient tenant or consumer demand to occupy newly developed properties or produce the revenues needed to make the development project successful, the risk that prices of construction materials or construction labor may rise materially during the development,
and the risk that other legal, regulatory, economic or other factors beyond the real estate companys control will adversely affect the viability of a development project.
Lack of Insurance.
Certain issuers of real estate securities in which a Fund may directly or indirectly invest may fail to carry comprehensive liability, fire, flood, earthquake, extended coverage and rental loss insurance, or the insurance that is in place may be insufficient or subject to various policy specifications, limits and deductibles. Should any type of uninsured loss occur, a real estate company could lose its investment in, and anticipated profits and cash flows from, a number of properties. As a result, the Funds investment performance may be adversely affected.
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Financial Leverage.
Many real estate companies utilize a high degree of financial leverage, which increases investment risk and could adversely affect a companys operations and market value in periods of rising interest rates. In addition, the financial covenants associated with borrowings may limit a real estate companys flexibility and adversely affect its ability to operate effectively.
Environmental Issues.
In connection with the ownership (direct or indirect), operation, management, and development of real properties that may contain hazardous or toxic substances, a real estate company may be considered an owner, operator, or responsible party of such properties, and may therefore be potentially liable for environmental issues, including removal or remediation costs, governmental fines, and liabilities for injuries to persons and property, as well as other costs. The existence of any such material environmental liability could have a material adverse effect on the results of
operations and cash flow of any such real estate company and, as a result, the amount available to make distributions on shares of a Fund could be reduced.
There are also special risks associated with the particular commercial real estate sectors in which a Fund may invest. These include:
Retail Properties.
Retail properties are affected by the overall health of the economy and may be adversely affected by, among other things, the growth of alternative forms of retailing, bankruptcy, departure or cessation of operations of a tenant, a shift in consumer demand due to demographic changes, changes in spending patterns and lease terminations.
Office Properties.
Office properties are affected by the overall health of the economy, and other factors such as a downturn in the businesses operated by their tenants, obsolescence and non-competitiveness.
Industrial Properties.
Industrial properties are affected by the overall health of the economy and other factors such as downturns in the manufacturing, processing, and shipping of goods.
Hotel Properties.
The risks of hotel properties include, among other things, the necessity of a high level of continuing capital expenditures, competition, increases in operating costs that may not be offset by increases in revenues, dependence on business and commercial travelers and tourism, increases in fuel costs and other expenses of travel, and adverse effects of general and local economic conditions. Hotel properties tend to be more sensitive to adverse economic conditions and competition than many other commercial properties.
Healthcare Properties.
Healthcare properties and healthcare providers are affected by several significant factors, including federal, state, and local laws governing licenses, certification, adequacy of care, pharmaceutical distribution, rates, equipment, personnel, and other factors regarding operations, continued availability of revenue from government reimbursement programs and competition on a local and regional basis. The failure of any healthcare operator to comply with governmental laws and regulations may affect its ability to operate its facility or receive government reimbursements.
Multifamily Properties.
The value and successful operation of a multifamily property may be affected by a number of factors, such as the location of the property, the ability of the management team, the level of mortgage interest rates, the presence of competing properties, adverse economic conditions in the locale, oversupply, and rent control laws or other laws affecting such properties.
Shopping Centers.
Shopping center properties are dependent upon the successful operations and financial condition of their tenants, particularly certain of their major tenants, and could be adversely affected by bankruptcy of those tenants. In some cases a tenant may lease a significant portion of the space in one center, and the filing of bankruptcy could cause significant revenue loss, including the loss of revenue from smaller tenants with co-tenancy rights. Like others in the commercial real estate industry, shopping centers are subject to environmental risks and interest rate risk. They also face
the need to enter into new leases or renew leases on favorable terms to generate rental revenues. Shopping center properties could be adversely affected by changes in the local markets where their properties are located, as well as by adverse changes in national economic and market conditions.
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Self-Storage Properties.
The value and successful operation of a self-storage property may be affected by a number of factors, such as the ability of the management team, the location of the property, the presence of competing properties, changes in traffic patterns, and effects of general and local economic conditions with respect to rental rates and occupancy levels.
REITs
Each Fund may invest in REITs, including domestic and foreign REITs and REIT-like entities. REITs are pooled investment vehicles that invest primarily in either real estate or real estate related loans. In addition to the general risks associated with investments in real estate, investing in REITs will subject a Fund to various risks, including:
Dependence on Tenants.
The value of a Funds investments in REITs and the ability to make distributions to its shareholders depend upon the ability of the tenants of the properties in which such REITs invest to generate enough income in excess of their operating expenses to make their lease payments. Changes beyond the control of a REITs portfolio companies may adversely affect their tenants ability to make their lease payments and, in such event, would substantially reduce both their income from operations and ability to make distributions to such REITs portfolio companies and,
consequently, the Fund.
Risks of Investing in Net-Leased Real Estate.
Where REITs invest in properties with net leases, in addition to satisfying their rent obligations, tenants in such properties are responsible for the payment of real estate taxes, insurance, and ordinary maintenance and repairs. However, under the provisions of future leases with such tenants, the REITs may be required to pay some expenses, such as the costs of environmental liabilities, roof and structural repairs, insurance, certain non-structural repairs, and maintenance. If such properties incur significant expenses that must be paid by such REITs
under the terms of these leases, the REITs business, financial condition, and results of operations will be adversely affected and the amount of cash available to meet expenses and to make distributions to holders of their common stock may be reduced.
Tax Risk.
Qualification as a REIT under the Code in any particular year is a complex analysis that depends on a number of factors. There can be no assurance that the entities in which a Fund invests with the expectation that they will be taxed as a REIT will qualify as a REIT. An entity that fails to qualify as a REIT would be subject to a corporate level tax, would not be entitled to a deduction for dividends paid to its shareholders, and would not pass through to its shareholders the character of income earned by the entity. If a Fund were to invest in an entity that failed to qualify as a REIT, such
failure could significantly reduce the Funds yield on that investment.
Dividends paid by REITs will not generally qualify for the reduced U.S. federal income tax rates applicable to qualified dividends under the Code. A Funds investments in REITs may include an additional risk to shareholders. Some or all of a REITs annual distributions to its investors may constitute a non-taxable return of capital. Any such return of capital will generally reduce a Funds basis in the REIT investment, but not below zero. To the extent that the distributions from a particular REIT exceed the Funds basis in such REIT, the Fund will generally recognize gain. In part because REIT
distributions often include a non-taxable return of capital, Fund distributions to shareholders may also include a non-taxable return of capital. Shareholders that receive such a distribution will also reduce their tax basis in their shares of such Fund, but not below zero. To the extent that the distribution exceeds a shareholders basis in the Funds shares, such shareholder will generally recognize a capital gain.
Key Personnel Risk.
Where investments are made in REITs, success may depend to a significant degree upon the contributions of certain of executive officers and other key personnel who may be difficult to replace. There can be no guarantee that all, or any particular one of such key personnel, will remain affiliated with the REITs adviser. If any of such key personnel were to cease their affiliation with the REITs adviser, operating results could suffer. Further, separate key person life insurance may not be maintained on such key personnel. The future success of such REITs depends, in large
part, upon their advisers ability to hire and retain highly skilled managerial, operational, and marketing personnel. Competition for such personnel is intense, and there can be no assurance of success in attracting and retaining such skilled personnel. If such key personnel are lost or their services are unable to obtain, the ability to implement investment strategies could be delayed or hindered, and the value of the Funds investment may decline.
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Non-Traded REITs.
A Fund may invest in any Non-Traded REITs that are consistent with the Funds investment objective and strategy and that, in the Advisers or Sub-Advisers judgment, offer attractive investment opportunities for the Fund. However, no Fund will invest in any Non-Traded REITs that are sponsored by or distributed by affiliates of the Adviser (or any Sub-Adviser). By their very nature, Non-Traded REITs are illiquid investments, and it is unlikely that a Fund would be able to sell any of its investments in Non-Traded REITs promptly or at all. Even if a Fund is able to sell
its shares in a Non-Traded REIT, it is likely that the Fund would have to sell them at a substantial discount to the price it paid for the shares. If a Fund invests in Non-Traded REITs, there is an increased risk that the Fund may be forced to dispose of other investments at unfavorable times or prices in order to satisfy its obligations.
Unlike Listed REITs, which typically construct their investment portfolios before offering shares to the public, Non-Traded REITs typically commence offering shares before or concurrently with the process of constructing their investment portfolios. As such, while a Fund may be able to evaluate any information about a Non-Traded REIT existing portfolio that is publicly available before making an investment, the Fund will not be able to evaluate or approve any future acquisitions to be made by such Non-Traded REIT after the Fund makes its investment. Instead, the Fund must rely on the management of a Non-Traded REIT to
implement the REITs investment strategies effectively. A Non-Traded REITs ability to achieve its investment objectives will also depend on the amount raised in its offering, which may not be known at the time the Fund makes its investment.
A Non-Traded REITs ability to achieve its investment objectives and to pay distributions is dependent upon the performance of its adviser in acquiring of investments, selecting tenants for properties and securing independent financing arrangements. The Fund will have no opportunity to evaluate the terms of transactions or other economic or financial data concerning a REITs investments. The Fund must rely entirely on the management ability of the REITs board of directors. Neither the Adviser nor the Sub-Adviser can be sure that such advisers will be successful in obtaining suitable investments on financially
attractive terms or that, if such investments are made, that the Funds goals and objectives will be achieved.
A Non-Traded REIT could suffer from delays in locating suitable investments, particularly as a result of its reliance on its adviser at times when management of its adviser is simultaneously seeking to locate suitable investments for other affiliated programs. Delays encountered in the selection, acquisition and/or development of income-producing properties, likely would adversely affect such REITs ability to make distributions and the value of overall returns. Generally, such REITs may fund distributions of unlimited amounts from any source, including borrowing funds, using proceeds from this offering, issuing
additional securities or selling assets in order to fund distributions if they are unable to make distributions with cash flows from operations. If such delays are encountered, all or a substantial portion of distributions may be paid from offering proceeds or from borrowings in anticipation of future cash flow, which may constitute a return of the Funds capital. In particular, where properties are acquired prior to the start of construction or during the early stages of construction, it typically will take several months to complete construction and rent available space.
In the case of Non-Traded REITs, there are many factors that can affect the availability and timing of cash distributions to shareholders. Distributions will be based principally on cash available from such REITs operations. The amount of cash available for distributions is affected by many factors, such as ability to buy properties as offering proceeds become available, rental income from such properties and operating expense levels, as well as many other variables. Actual cash available for distributions may vary substantially from estimates. In the case of REITs with no prior operating history, there can be no
assurance of the ability to pay or maintain current level of distributions or that distributions will increase over time. There can be no assurance that rents from the properties will increase, that the securities such REITs buy will increase in value or provide constant or increased distributions over time, or that future acquisitions of real properties, mortgage, bridge or mezzanine loans or any investments in securities will increase cash available for distributions to shareholders. Actual results may differ significantly from the assumptions used by the REITs board of directors in establishing the distribution rate to shareholders. Such REITs may not have sufficient cash from operations to make a distribution required to qualify for or maintain REIT status. Such REITs may pay distributions from unlimited amounts of any source, including borrowing funds, offering proceeds, issuing additional securities or selling assets.
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Repurchase Agreements
Repurchase agreements, which may be viewed as a type of secured lending by a Fund, typically involve the acquisition by the Fund of debt securities from a selling financial institution such as a bank, savings and loan association, or broker-dealer. The repurchase agreements will provide that the Fund will sell back to the institution, and that the institution will repurchase, the underlying security (collateral) at a specified price and at a fixed time in the future, usually not more than seven days from the date of purchase. The collateral will be maintained in a segregated account and, with respect to repurchase
agreements, will be marked to market daily to ensure that the full value of the collateral, as specified in the repurchase agreement, does not decrease below the repurchase price plus accrued interest. If such a decrease occurs, additional collateral will be requested and, when received, added to the account to maintain full collateralization. The Fund will accrue interest from the institution until the date the repurchase occurs. Although this date is deemed by the Fund to be the maturity date of a repurchase agreement, the maturities of the collateral securities are not subject to any limits and may exceed one year.
Reverse Repurchase Agreements
Reverse repurchase agreements involve sales by a Fund of portfolio securities concurrently with an agreement by the Fund to repurchase the same securities at a later date at a fixed price. Reverse repurchase agreements are speculative techniques involving leverage. Reverse repurchase agreements involve the risk that the market value of the securities the Fund is obligated to repurchase under the agreement may decline below the repurchase price. Reverse repurchase agreements involve the risk that the buyer of the securities sold might be unable to deliver them when the Fund seeks to repurchase the securities. If the buyer files
for bankruptcy or becomes insolvent, the Fund may be delayed or prevented from recovering the security that it sold.
Securities Loans
Each Fund may make secured loans of its portfolio securities, on either a short-term or long-term basis, amounting to not more than one third of its total assets, thereby potentially realizing additional income. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delay in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. If a borrower defaults, the value of the collateral may decline before the Fund can dispose of it.
Short Sales
Short sales are transactions in which a Fund sells a security it does not own, in anticipation of a decline in the market value of that security. 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 it at the market price at or prior to the time of 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 repay the lender any dividends or interest that accrue during the period of the loan. To borrow
the security, the Fund also may be required to pay a premium, which would increase the cost of the security sold. The net proceeds of the short sale will be retained by the broker (or by the Funds custodian in a special custody account), to the extent necessary to meet margin requirements, until the short position is closed out. The Fund also will incur transaction costs in effecting short sales.
The Fund will incur a loss as a result of the short sale if the price of the security increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund will generally realize a gain if the security declines in price between those dates. The amount of any gain will be decreased, and the amount of any loss increased, by the amount of the premium, dividends, interest, or expenses the Fund may be required to pay in connection with a short sale. An increase in the value of a security sold short by the Fund over the price at which it was sold short will result in a loss to the Fund.
There can be no assurance that the Fund will be able to close out the position at any particular time or at an acceptable price. The Funds ability to engage in short sales may from time to time be limited or prohibited because of the inability to borrow certain securities in the market, legal restrictions on short sales, or other reasons.
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Special Purpose Acquisition Companies
Each Fund may invest in stock, warrants, and other securities of special purpose acquisition companies (SPACs) or similar special purpose entities that pool funds to seek potential acquisition opportunities. Unless and until an acquisition meeting the SPACs requirements is completed, a SPAC generally invests its assets (less a portion retained to cover expenses) in U.S. Government securities, money market securities, and cash; if an acquisition that meets the requirements for the SPAC is not completed within a pre-established period of time, the invested funds are returned to the entitys shareholders.
Because SPACs and similar entities have no operating history or ongoing business other than seeking acquisitions, the value of their securities is particularly dependent on the ability of the entitys management to identify and complete a profitable acquisition. Some SPACs may pursue acquisitions only within certain industries or regions, which may increase the volatility of their prices. In addition, these securities, which are typically traded in the over-the-counter market, may be considered illiquid and/or be subject to restrictions on resale. Each Funds affiliates may create a SPAC for purchase by the Fund to assist the Fund in purchasing certain assets not otherwise available to the Fund.
Stripped Mortgage Securities
Stripped Mortgage Securities may be issued by Federal Agencies, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose subsidiaries of the foregoing. Stripped Mortgage Securities usually are structured with two classes that receive different proportions of the interest and principal distribution of a pool of mortgage assets. A common type of Stripped Mortgage Security will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most
of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the interest-only or IO class), while the other class will receive all of the principal (the principal-only or PO class). PO classes generate income through the accretion of the deep discount at which such securities are purchased, and, while PO classes do not receive periodic payments of interest, they receive monthly payments associated with scheduled amortization and principal prepayment from the mortgage assets underlying the PO class. The yield to maturity on a PO or an IO class security is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets. A slower than expected rate of principal payments may have an adverse effect on a PO class securitys yield to maturity. If the underlying mortgage assets experience slower than anticipated principal repayment, the Fund may
fail to fully recoup its initial investment in these securities. Conversely, a rapid rate of principal payments may have a material adverse effect on an IO class securitys yield to maturity. If the underlying mortgage assets experience greater than anticipated prepayments or principal, the Fund may fail to fully recoup its initial investment in these securities.
Structured Investments
A structured investment is a security having a return tied to an underlying index or other security or asset class. Structured investments generally are individually negotiated agreements and may be traded over-the-counter. Structured investments are organized and operated to restructure the investment characteristics of the underlying security. This restructuring involves the deposit with or purchase by an entity, such as a corporation or trust, or specified instruments (such as commercial bank loans) and the issuance by that entity or one or more classes of securities (structured securities) backed by, or
representing interests in, the underlying instruments. The cash flow on the underlying instruments may be apportioned among the newly issued structured securities to create securities with different investment characteristics, such as varying maturities, payment priorities and interest rate provisions, and the extent of such payments made with respect to structured securities is dependent on the extent of the cash flow on the underlying instruments. Because structured securities typically involve no credit enhancement, their credit risk generally will be equivalent to that of the underlying instruments. Investments in structured securities are generally of a class of structured securities that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured securities typically have higher yields and present greater risks than unsubordinated structured securities. Investments in government and government-related and restructured debt
instruments are subject to special risks, including the inability or unwillingness to repay principal and interest, requests to reschedule or restructure outstanding debt, and requests to extend additional loan amounts.
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Warrants
Each Fund may invest in warrants, which are instruments that give the Fund the right to purchase certain securities from an issuer at a specific price (the strike price) for a limited period of time. The strike price of warrants typically is much lower than the current market price of the underlying securities, yet they are subject to similar price fluctuations. As a result, warrants may be more volatile investments than the underlying securities and may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the
underlying securities and do not represent any rights in the assets of the issuing company. Also, the value of the warrant does not necessarily change with the value of the underlying securities and a warrant ceases to have value if it is not exercised prior to the expiration date. These factors can make warrants more speculative than other types of investments.
In addition to warrants on securities, each Fund may purchase put warrants and call warrants whose values vary depending on the change in the value of one or more specified securities indices (index warrants). Index warrants are generally issued by banks or other financial institutions and give the holder the right, at any time during the term of the warrant, to receive upon exercise of the warrant a cash payment from the issuer based on the value of the underlying index at the time of exercise. In general, if the value of the underlying index rises above the exercise price of the index warrant, the holder of a
call warrant will be entitled to receive a cash payment from the issuer upon exercise based on the difference between the value of the index and the exercise price of the warrant; if the value of the underlying index falls, the holder of a put warrant will be entitled to receive a cash payment from the issuer upon exercise based on the difference between the exercise price of the warrant and the value of the index. The holder of a warrant would not be entitled to any payments from the issuer at any time when, in the case of a call warrant, the exercise price is greater than the value of the underlying index, or, in the case of a put warrant, the exercise price is less than the value of the underlying index. If the Fund were not to exercise an index warrant prior to its expiration, then the Fund would lose the amount of the purchase price paid by it for the warrant.
Each Fund will normally use index warrants in a manner similar to its use of options on securities indices. The risks of the Funds use of index warrants are generally similar to those relating to its use of index options. Unlike most index options, however, index warrants are issued in limited amounts and are not obligations of a regulated clearing agency, but are backed only by the credit of the bank or other institution which issues the warrant. Also, index warrants generally have longer terms than index options. Index warrants are not likely to be as liquid as certain index options backed by a recognized clearing
agency. In addition, the terms of index warrants may limit the Funds ability to exercise the warrants at such time, or in such quantities, as the Fund would otherwise wish to do.
When, As and If Issued Securities
Each Fund may purchase securities on a when, as and if issued basis under which the issuance of the security depends upon the occurrence of a subsequent event, such as approval of a merger, corporate reorganization, leveraged buyout, or debt restructuring. An increase in the percentage of the Funds assets committed to the purchase of securities on a when, as and if issued basis may create investment leverage and increase the volatility of the Funds net asset value. The Fund may also sell securities on a when, as and if issued basis provided that the issuance of the security will
result automatically from the exchange or conversion of a security owned by the Fund at the time of the sale.
When-Issued, Delayed Delivery and Forward Commitment Securities
To reduce the risk of changes in securities prices and interest rates, a Fund may purchase securities on a forward commitment, when-issued or delayed delivery basis. This means that delivery and payment occur a number of days after the date of the commitment to purchase. The payment obligation and the interest rate receivable with respect to such purchases are determined when the Fund enters into the commitment, but the Fund does not make payment until it receives delivery from the counterparty. The Fund may, if it is deemed advisable, sell the securities after it commits to a purchase but before delivery and settlement takes
place.
Securities purchased on a forward commitment, when-issued or delayed delivery basis are subject to changes in value based upon the publics perception of the creditworthiness of the issuer and changes (either
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real or anticipated) in the level of interest rates. Purchasing securities on a when-issued or delayed delivery basis can present the risk that the yield available in the market when the delivery takes place may be higher than that obtained in the transaction itself. Purchasing securities on a forward commitment, when-issued or delayed delivery basis when the Fund is fully, or almost fully invested, results in a form of leverage and may cause greater fluctuation in the value of the net assets of the Fund. In addition, there is a risk that securities purchased on a when-issued or delayed delivery basis may not be delivered, and
that the purchaser of securities sold by the Fund on a forward basis will not honor its purchase obligation. In such cases, the Fund may incur a loss.
Zero-Coupon and Payment-in-Kind Bonds
Each Fund may invest in so-called zero-coupon bonds and payment-in-kind bonds. Zero-coupon bonds are issued at a significant discount from their principal amount in lieu of paying interest periodically. Payment-in-kind bonds allow the issuer, at its option, to make current interest payments on the bonds either in cash or in additional bonds. Because zero-coupon and payment-in-kind bonds do not pay current interest in cash, their value is subject to greater fluctuation in response to changes in market interest rates than bonds that pay interest currently. Both zero-coupon and payment-in-kind bonds allow
an issuer to avoid the need to generate cash to meet current interest payments. Accordingly, such bonds may involve greater credit risks than bonds paying interest currently in cash. Each Fund is required to accrue interest income on such investments and to distribute such amounts at least annually to shareholders even though the investments do not make any current interest payments. Thus, it may be necessary at times for the Funds to liquidate other investments in order to satisfy its distribution requirements under the Code.
DISCLOSURE OF PORTFOLIO HOLDINGS
The Trust has adopted policies and procedures with respect to the disclosure of each Funds portfolio holdings and ongoing arrangements to make available such information to the general public and to certain persons on a selective basis. Except as noted below, the Trust does not provide portfolio holdings to any third party until they are made available on the Trusts website or through some other means of public dissemination. The Funds full portfolio holdings are published semi-annually in reports sent to shareholders and such reports are made available on the Trusts website, within 60 days after the
end of each semi-annual period. These semi-annual holdings are also filed with the SEC within 70 days of the end of each semi-annual period, as part of Form N-CSR. Quarterly holdings reports are filed with the SEC within 60 days at the end of the first and third fiscal quarters, as part of Form N-Q. In addition, pursuant to policies and procedures approved by the Board, a Fund may post an uncertified whole or partial list of portfolio holdings on its website at
www.arcincomefunds.com
quarterly, no earlier than 15 days after the end of each calendar quarter. One day after the full holdings have been published, employees of the Adviser or a Funds Sub-Adviser may freely distribute them to third-parties. This information remains available until the Trust files a report on Form N-Q or Form N-CSR for the period that includes the date as of which the information is current. In addition to information on portfolio holdings, other Fund statistical information may be found on the
Trusts website.
Pursuant to the Trusts portfolio holdings disclosure policies and procedures, the following are exceptions to the general rule that holdings are not disclosed to third parties until posted to the website:
1. Each Funds portfolio holdings may be disclosed prior to public release to certain third parties (
e.g.
, rating and ranking organizations, financial printers, pricing information vendors, and other research firms) for legitimate business purposes. Disclosure is conditioned on receipt of a written confidentiality agreement, including an agreement not to trade on the basis of the information disclosed. The portfolio holdings may be disclosed to such third parties on an as-needed basis and such disclosure must be authorized by an officer of the Fund.
2. Each Funds portfolio holdings may also be disclosed between and among the Funds Adviser, Sub-Adviser, Distributor, Transfer Agent, Administrator, independent registered public accounting firm, and outside legal counsel for legitimate business purposes within the scope of their official duties and responsibilities, subject to their continuing duty of confidentiality and duty not to trade on the basis of any material nonpublic information, as such duties are imposed under the Code of Ethics and the Inside
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Information Policies and Procedures applicable to the Adviser, Sub-Adviser, Distributor, and Administrator, and as imposed on the other parties by agreement or under applicable laws, rules and regulations.
3. Each Funds Adviser, Sub-Adviser, Distributor, Transfer Agent, and Administrator may for legitimate business purposes within the scope of their official duties and responsibilities disclose portfolio holdings to one or more broker-dealers during the course of, or in connection with, normal day-to-day securities transactions with such broker-dealers, subject to the broker-dealers legal obligation not to use or disclose material nonpublic information concerning the each Funds portfolio holdings.
4. Each Fund may provide certain information (other than complete portfolio holdings) related to its portfolio holdings or derived from its portfolio holdings to the media so long as the Funds chief compliance officer, or his or her designated representative, determines that the Fund has a legitimate business purpose for disclosing the information and the dissemination cannot be reasonably seen to give the recipient of such information an advantage in trading Fund shares or in any other way harm the Fund or its shareholders. Such information may include a small number of portfolio holdings (including information that the
Fund no longer holds a particular security) or general information about the Funds portfolio holdings that cannot be used to determine the Funds portfolio holdings or any portion thereof. Information about a security may not be released if it could reasonably be seen to interfere with the current or future purchase or sale activities of the Fund or is contrary to applicable law.
5. Fund portfolio holdings may also be disclosed to any person as required by applicable laws, rules, and regulations. Examples of such required disclosure include, but are not limited to, disclosure (1) in a filing or submission with the SEC or another regulatory body, (2) in connection with a lawsuit, or (3) as required by court order. A Fund may from time to time post portfolio holdings on the Trusts website on a more-timely basis than 15 days after calendar quarter-end if warranted by market conditions or other circumstances.
Occasions may arise where the Adviser, a Sub-Adviser, a Fund or an affiliate of a Fund may have a conflict of interest in connection with a recipients request for disclosure of portfolio holdings information. In order to protect the interests of shareholders and the Fund and to ensure no adverse effect on the shareholders or the Fund, in the limited instances where a designated person is considering making non-public portfolio holdings information, the designated person will disclose the conflict to the chief compliance officer. If the chief compliance officer of the Trust determines, to the best of his/her knowledge
following appropriate due diligence, that the disclosure of non-public portfolio holdings information would be in the best interests of shareholders and the Fund and will not adversely affect the shareholders or the Fund, the chief compliance officer may approve the disclosure. The chief compliance officer will document in writing any such exception (which identifies the legitimate business purpose for the disclosure) and will provide a report to the Board for its review at a subsequent Board meeting. Any such exceptions log shall be retained in the Funds records.
PORTFOLIO TURNOVER
Although the Funds generally will not invest for short-term trading purposes, portfolio securities may be sold without regard to the length of time they have been held when, in the opinion of the Adviser or Sub-Adviser, investment considerations warrant such action. Portfolio turnover rate is calculated by dividing (1) the lesser of purchases or sales of portfolio securities for the fiscal year by (2) the monthly average of the value of portfolio securities owned during the fiscal year. A 100% turnover rate would occur if all the securities in a Funds portfolio, with the exception of securities whose maturities at the
time of acquisition were one year or less, were sold and either repurchased or replaced within one year. A high rate of portfolio turnover (100% or more) generally leads to higher transaction costs and may result in a greater number of taxable transactions.
MANAGEMENT OF THE FUNDS
The Board has overall responsibility to oversee the business affairs of the Funds, including the complete and exclusive authority to oversee and to establish policies regarding the management, conduct, and operation of the Funds business. The business of the Trust is managed under the supervision of the Board in accordance with the Declaration of Trust, as may be amended from time to time, which has been filed with the SEC and is available upon request. The Board consists of four individuals, three of whom are not interested persons (as defined under the 1940 Act) of the Trust, the Adviser, and each
Funds Sub-Adviser. Pursuant to the
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Declaration of Trust, the trustees shall elect officers including a President, a Secretary, and a Treasurer, and shall appoint a Chief Compliance Officer. The Board has the power to incur and pay any expenses, which, in the opinion of the Board, are necessary or incidental to carry out any of the Trusts purposes. The trustees, officers, employees, and agents of the Trust, when acting in such capacities, shall not be subject to any personal liability except for his or her own bad faith, willful misfeasance, gross negligence, or reckless disregard of his or her duties.
Board Leadership Structure
The Board currently is comprised of four Trustees, three of which are not interested persons (as that term is defined in the 1940 Act) of the Trust (the Independent Trustees). Nicholas Schorsch, who, among other things, serves as Chairman of the Board, is an interested person of the Trust. The Board has not selected a lead independent trustee, although it may do so in the future. The Independent Trustees regularly meet outside the presence of management, both in-person and by telephone.
The Board has established a committee structure that includes an Audit Committee. All Independent Trustees are members of the Audit Committee, which allows all of the Independent Trustees to participate in the full range of the Boards oversight responsibilities. The Board reviews its structure regularly and believes that its leadership structure is appropriate given the recent formation of the Trust, the number of Trustees overseeing the Trust and the Boards oversight responsibilities, as well as the Trusts business activities.
Board Risk Oversight
The Board is comprised of four individuals, three of whom are Independent Trustees, with a standing independent Audit Committee with a separate chair. The Board is responsible for overseeing risk management, and the full Board regularly engages in discussions of risk management and receives compliance reports that inform its oversight of risk management from its Chief Compliance Officer at quarterly meetings and on an ad hoc basis, when and if necessary. The Audit Committee considers financial and reporting risk within its area of responsibilities. Generally, the Board believes that its oversight of material risks is
adequately maintained through the compliance-reporting chain where the Chief Compliance Officer is the primary recipient and communicator of such risk-related information.
Trustees and Officers
Following is a list of the trustees and executive officers of the Trust and their principal occupations over the last five years.
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Name, Address,
and Age
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Position Held
and
Length of
Time Served
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Principal Occupation During Past
5 Years
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Number of
Portfolios
Overseen by
Trustee
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Other Directorships Held by
Trustee During Past 5 Years
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Non-Interested Trustees
(1)
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Robert H. Burns
405 Park Avenue
15
th
Floor
New York,
NY 10022
(82)
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Trustee since
2013
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Hotelier, Villa Feltrinelli on Lago di Garda (a small, luxury hotel in Northern Italy), as well as developing hotel projects in Asia, focusing on Vietnam and Chine, from 2009 to present
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3
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American Realty Capital Trust, Inc. from January 2008 to January 2013 (a real estate investment trust); American Realty Capital New York Recovery REIT, Inc. from October 2009 to present; American Realty Capital Healthcare Trust, Inc. from March 2012 to present; American Realty Capital Trust V, Inc. from January 2013 to present
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Name, Address,
and Age
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Position Held
and
Length of
Time Served
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Principal Occupation During Past
5 Years
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Number of
Portfolios
Overseen by
Trustee
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Other Directorships Held by
Trustee During Past 5 Years
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Dr. Robert
J. Froehlich
c/o 405 Park Avenue
15
th
Floor
New York,
NY 10022
(60)
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Trustee since
2013
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Retired. Board of Directors and Co-Owner of Kane County Cougars Professional Baseball Team from January 2013 to present; Owner and Operator, 5/3 Bank Ballpark from January 2013 to present
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3
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American Realty Capital Daily Net Asset Value Trust, Inc. from November 2012 to present (a publicly registered, non-traded real estate investment program); Davidson Investment Advisors from July 2009 to present; American Sports Enterprise, Inc. from January 2013 to present; American Realty Capital Healthcare Trust II, Inc. from January 2013 to present; Highland Capital Management, L.P. from December 2013 to present
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Leslie D. Michelson
c/o 405 Park Avenue
15
th
Floor
New York,
NY 10022
(62)
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Trustee since
2013
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Chairman & Chief Executive Officer, Private Health Management (healthcare company) from April 2007 to present
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3
|
|
American Realty Capital Properties, Inc. from October 2012 to present; American Realty Capital Healthcare Trust, Inc. director from January 2011 to July 2012, lead independent director from July 2012 to present; Business Development Corporation of America from January 2011 to present; Molecular Insight Pharmaceuticals, Inc. from November 2011 to January 2013 (a biotechnology company); American Realty Capital Retail Centers of America, Inc. from March 2012 to October 2012; American Realty Capital New York Recovery REIT, Inc. from October 2009 to August 2011; American Realty Capital Trust, Inc. from January 2008 to July 2012, lead independent director from July 2012 to January 2013; American Realty Capital Daily Net Asset Value Trust, Inc. from August 2011 to February 2012; ARC Realty Finance Trust, Inc. lead independent director from January 2013 to present; Highlands Acquisition Company from 2007 to 2009
(special purpose acquisition company); Landmark Imaging from 2007 to 2010 (privately-held diagnostic imaging and treatment company); ALS-TDI from June 2004 to present (also vice chairman; philanthropy dedicated to curing Lou Gehrigs disease)
|
34
|
|
|
|
|
|
|
|
|
Name, Address,
and Age
|
|
Position Held
and
Length of
Time Served
|
|
Principal Occupation During Past
5 Years
|
|
Number of
Portfolios
Overseen by
Trustee
|
|
Other Directorships Held by
Trustee During Past 5 Years
|
Interested Trustees and Officers
|
Nicholas
S. Schorsch
(2)
405 Park Avenue
15
th
Floor
New York,
NY 10022
(52)
|
|
Trustee,
Chairman and
Chief
Executive
Officer since
2013
|
|
Chairman and Chief Executive Officer, Business Development Corporation of America from May 2010 to present; Chief Executive Officer, American Realty Capital Trust, Inc. from August 2007 to March 2012; Chairman and Chief Executive Officer, American Realty Capital New York Recovery REIT, Inc. from October 2009 to present; Chief Executive Officer, Adviser of Phillips Edison ARC Shopping Center REIT, Inc. from December 2009 to present: Chairman and Chief Executive Officer, American Realty Capital Retail Centers of America, Inc. from July 2010 to present; Chairman and Chief Executive Officer, American Realty Capital Healthcare Trust, Inc. from August 2010 to present; Chairman and Chief Executive Officer, American Realty Capital Daily Net Asset Value Trust, Inc. from September 2010 to present; Chairman and Chief Executive Officer, American Realty Capital Properties, Inc. from December 2010 to
present; Chairman and Chief Executive Officer, ARCT III from October 2010 to February 2013; Chairman and Chief Executive Officer, American Realty Capital Global Trust, Inc. from July 2011 to present; Chief Executive Officer, American Realty Capital Trust IV, Inc. from February 2012 to present; Chief Executive Officer, ARC Realty Finance Trust, Inc. from November 2012 to present; Chief Executive Officer, American Realty Capital Trust V, Inc. from January 2013 to present; Chief Executive Officer, American Realty Capital PECO II Advisors, LLC from July 2013 to present
|
|
3
|
|
Business Development Corporation of America from May 2010 to present; American Realty Capital Trust, Inc. from August 2007 to January 2013; American Realty Capital Trust IV, Inc. from February 2012 to present; American Realty Capital Healthcare Trust II, Inc. from October 2012 to present; ARC Realty Finance Trust, Inc. from November 2012 to present; American Realty Capital Trust V, Inc. from January 2013 to present; American Energy Capital Partners GP, LLC from October 2013 to present; ARCT V since January 2013 to present; American Realty Capital Hospitality Trust, Inc. since August 2013 to present
|
Officers
|
John H. Grady
405 Park Avenue
15
th
Floor
New York,
NY 10022
(51)
|
|
President and
Secretary since
2013
|
|
President, National Fund Advisors, LLC from October 2012 to present; President, American National Stock Transfer, LLC from October 2012 to present; Chief Operating Officer, Realty Capital Securities from October 2012 to present; Executive Vice President, RCS Advisory Services, LLC from October 2012 to present; Chief Operating Officer, American Realty Capital from October 2012 to present; General Counsel and Chief Operating Officer, Steben & Company (firm focused on the operation and distribution of managed futures funds) from February 2008 to September 2012
|
|
N/A
|
|
N/A
|
35
|
|
|
|
|
|
|
|
|
Name, Address,
and Age
|
|
Position Held
and
Length of
Time Served
|
|
Principal Occupation During Past
5 Years
|
|
Number of
Portfolios
Overseen by
Trustee
|
|
Other Directorships Held by
Trustee During Past 5 Years
|
Nicholas Radesca
405 Park Avenue
15
th
Floor
New York,
NY 10022
(47)
|
|
Executive Vice
President since
2013
|
|
Executive Vice President and Chief Financial Officer, National Fund Advisors, LLC from December 2012 to present; Chief Financial Officer and Treasurer, Business Development Corporation of America from February 2013 to present; Chief Financial Officer and Treasurer, BDCA Adviser, LLC from February 2013 to present; Chief Financial Officer and Treasurer, ARC Realty Finance Trust, Inc. from January 2013 to present; Chief Financial Officer and Treasurer, ARC Realty Finance Advisors, LLC from January 2013 to present; Chief Financial Officer, American Realty Capital from December 2012 to present; Solar Senior Capital Management, LLC from March 2008 to May 2012 serving as Chief Financial Officer and Corporate Secretary for Solar Capital Ltd. and its predecessor company Solar Senior Capital Ltd. (both publicly traded business development companies)
|
|
N/A
|
|
N/A
|
Christopher Pike
405 Park Avenue
15
th
Floor
New York,
NY 10022
(45)
|
|
Vice President
since 2013
|
|
Vice President and Chief Investment Officer, National Fund Advisors, LLC from May 2012 to present; Director of Investment Research, American Realty Capital and Realty Capital Securities from August 2011 to May 2012; Equity Research Analyst, Fagenson & Company, Inc. from December 2009 to August 2011; Equity Research Analyst, Merrill Lynch from March 2006 to December 2008
|
|
N/A
|
|
N/A
|
Gerard Scarpati
Brandywine Two
5 Christy Drive
Suite 209
Chadds Ford,
PA 19317
(57)
|
|
Treasurer and
Chief Financial
Officer since
2013
|
|
President, Vigilant Compliance, LLC (an investment management services company) from August 15, 2004 to present
|
|
N/A
|
|
N/A
|
Robert Amweg
Brandywine Two
5 Christy Drive
Suite 209
Chadds Ford,
PA 19317
(60)
|
|
Chief
Compliance
Officer since
2014
|
|
Compliance Director, Vigilant Compliance, LLC (an investment management services company) from August 2013 to present; Consultant to the financial services industry from September 2012 to present; and Chief Financial Officer and Chief Accounting Officer, Turner Investments, LP from February 2007 to August 2012.
|
|
N/A
|
|
N/A
|
Erik Naviloff
80 Arkay
Drive Suite
110 Hauppauge,
NY 11788
(44)
|
|
Assistant
Treasurer since
2013
|
|
Vice President of Gemini Fund Services, LLC from 2011 to present; Assistant Vice President, Gemini Fund Services, LLC from 2007 to 2012; Senior Accounting Manager, Fixed Income, Dreyfus Corporation from 2002 to 2007
|
|
N/A
|
|
N/A
|
36
|
|
|
|
|
|
|
|
|
Name, Address,
and Age
|
|
Position Held
and
Length of
Time Served
|
|
Principal Occupation During Past
5 Years
|
|
Number of
Portfolios
Overseen by
Trustee
|
|
Other Directorships Held by
Trustee During Past 5 Years
|
James Ash
80 Arkay
Drive Suite
110 Hauppauge,
NY 11788
(36)
|
|
Assistant
Secretary since
2013
|
|
Senior Vice President, Gemini Fund Services, LLC from 2012 to present; Vice President, Gemini Fund Services, LLC from 2011 to 2012; Director of Legal Administration, Gemini Fund Services LLC from 2009 to 2011; Assistant Vice President of Legal Administration, Gemini Fund Services, LLC from 2008 to 2011
|
|
N/A
|
|
N/A
|
|
(1)
|
The Trustees of the Trust who are not Independent Trustees.
|
|
(2)
|
Affiliated with the Adviser and/or the Distributor.
|
Qualifications and Experience of the Trustees
In addition to the information set forth in the table above, the following sets forth additional information about the qualifications and experience of each of the Trustees.
Roberts H. Burns
Mr. Burns is a hotel industry veteran who has over thirty years of experience in real estate development and senior management positions. In addition to the directorships set forth in the chart above, Mr. Burns served as the chairman and chief executive officer of Regent International Hotels, where he was personally involved in all strategic and major operating decisions, from 1970 to 1992. Mr. Burns also chairs the Robert H. Burns Foundation, founded in 1992, which funds the education of Asian students in American schools. Mr. Burns frequently lectures at Stanford Business
School and served as a faculty member at the University of Hawaii from 1963 to 1994. In addition, Mr. Burns was the president of the Hawaii Hotel Association from 1968 to 1970. Mr. Burns experience serving on other boards of directors and his experience in the hotel industry, specifically his expertise in management, make him well qualified to serve as a Trustee.
Dr. Robert J. Froehlich
Dr. Froehlich is a global strategist who has spoken in 107 countries and an accomplished author, having written six books on investing. Prior to his retirement, Dr. Froehlich spent three years as head investment strategist and chair of investment strategy committees for multiple global asset management companies. Dr. Froehlichs experience serving on other boards of directors and his investment expertise and experience as a financial expert make him well qualified to serve as a Trustee.
Leslie D. Michelson
As set forth in the chart above, Mr. Michelsons more than twenty years of senior management experiences at various corporations, his service on the board of directors of other public companies in the past, and his legal education make him well qualified to serve as a Trustee. In addition to the directorships set forth in the chart above, Mr. Michelson has also held and/or holds the following directorships and/or executive officer positions: Mr. Michelson served as vice chairman and chief executive officer of the Prostate Cancer Foundation, the worlds largest
private source of prostate cancer research funding, from April 2002 until December 2006 and currently serves on its board of directors. Mr. Michelson served on the board of directors of Catellus Development Corp. from 1997 until 2004 when the company was sold to ProLogis. Mr. Michelson was a member of the Audit Committee of the board of directors for 5 years and served at various times as the chairman of the Audit Committee and the Compensation Committee. From April 2001 to April 2002, he was an investor in, and served as an adviser or director of, a portfolio of entrepreneurial healthcare, technology and real estate companies. From March 2000 to August 2001, he served as chief executive officer and as a director of Acurian, Inc., an Internet company that accelerates clinical trials for new prescription drugs. From 1999 to March 2000, Mr. Michelson served as an adviser of Saybrook Capital, LLC, an investment bank specializing in the real estate and health care industries. From June
1998 to February 1999, Mr. Michelson served as chairman and co-chief executive officer of Protocare, Inc., a manager of clinical trials for the pharmaceutical industry and disease management firm. From 1988 to 1998, he served as chairman and chief executive officer of Value Health Sciences, Inc., an applied health services research firm he co-founded. Mr. Michelson has been a director of Nastech Pharmaceutical Company Inc., a NASDAQ-traded biotechnology company focused on innovative drug delivery technology, from 2004 to 2008,
37
and of G&L Realty Corp., a NYSE-traded medical office building REIT from 1995 to 2001. Mr. Michelson has served as chairman and chief executive officer of Private Health Management, a retainer-based primary care medical practice management company from April 2007 to present.
Nicholas S. Schorsch
Mr. Schorschs current experience as chairman and chief executive officer of various entities and his significant real estate acquisition experience, make him well qualified to serve as a Trustee and Chairman of the Board.
The Board has determined that each Trustee on an individual basis and in combination with the other Trustees is qualified to serve, and should serve, on the Board. To make this determination the Board considered a variety of criteria, none of which in isolation was controlling. Among other things, the Board considered each Trustees experience, qualifications, attributes and skills.
Board Committees
Audit Committee.
The Board has an Audit Committee that consists of the trustees who are not Independent Trustees. The Audit Committees responsibilities include: (1) recommending to the Board the selection, retention or termination of the Trusts independent auditors; (2) reviewing with the independent auditors the scope, performance and anticipated cost of their audit; (3) discussing with the independent auditors certain matters relating to the Trusts financial statements, including any adjustment to such financial statements recommended by such independent auditors, or any other
results of any audit; (4) reviewing on a periodic basis a formal written statement from the independent auditors with respect to their independence, discussing with the independent auditors any relationships or services disclosed in the statement that may impact the objectivity and independence of the Trusts independent auditors and recommending that the Board take appropriate action in response thereto to satisfy itself of the auditors independence; and (5) considering the comments of the independent auditors and managements responses thereto with respect to the quality and adequacy of the Trusts accounting and financial reporting policies and practices and internal controls. The Audit Committee operates pursuant to an Audit Committee Charter. The Audit Committee is responsible for seeking and reviewing nominee candidates for consideration as Independent Trustees as is from time to time considered necessary or appropriate. The Audit Committee will consider
shareholder nominations. The Audit Committee is also responsible for reviewing and setting Independent Trustee compensation from time to time when considered necessary or appropriate. In the year ended December 31, 2013, the Audit Committee held 1 meeting.
38
Trustee Ownership
The following table indicates the dollar range of equity securities that each Trustee beneficially owned in the Funds as of the date of this SAI.
|
|
|
|
|
|
|
Name of Trustee
|
|
Dollar Range of Equity Securities in the AR Capital
BDC Income Fund
|
|
Dollar Range of Equity Securities in the AR Capital Dividend and
Value Fund
|
|
Aggregate Dollar Range of Equity Securities in All Registered Investment Companies Overseen by Trustee in Family of Investment Companies
|
Non-Interested Trustees
|
|
|
|
|
|
|
Robert H. Burns
|
|
None
|
|
None
|
|
None
|
Dr. Robert J. Froehlich
|
|
None
|
|
None
|
|
None
|
Leslie D. Michelson
|
|
None
|
|
None
|
|
None
|
Interested Trustees and Officers
|
|
|
|
|
|
|
Nicholas S. Schorsch
|
|
None
|
|
None
|
|
None
|
Compensation
The Non-Interested Trustees were elected to the Board effective April 2013, and prior to that date had not received any compensation from the Trust. Effective April 2013, each Non-Interested Trustee receives from the Trust an annual fee of $10,000 representing the payment of an annual retainer plus $1,000 for each regular or special meeting attended. All Trustees are reimbursed for their travel expenses and other reasonable out-of-pocket expenses incurred in connection with attending Board meetings. The Board currently holds (1) four regularly scheduled Board meetings and (2) two regularly scheduled Audit Committee meetings.
The Board may also hold special Board meetings and special meetings of its Audit Committee throughout the year. The interested Trustees receive no compensation directly from the Trust.
The table below details the amount of compensation the trustees are expected to receive from the Trust during the fiscal period ended March 31, 2014. The Trust does not have a bonus, profit sharing, pension or retirement plan.
|
|
|
|
|
|
|
|
|
Name of Person,
Position
|
|
Aggregate Compensation from the Trust
|
|
Pension or Retirement Benefits Accrued as Part of the Fund
|
|
Estimated Annual Benefits Upon Retirement
|
|
Total Compensation from Fund Complex Paid to Trustees
|
Non-Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert H. Burns
|
|
$
|
12,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
12,000
|
|
Dr. Robert J. Froehlich
|
|
$
|
16,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
16,000
|
|
Leslie D. Michelson
|
|
$
|
16,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
16,000
|
|
Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nicholas S. Schorsch
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
39
CODES OF ETHICS
The Trust, the Adviser, each Funds Sub-Adviser, and the Distributor have adopted a code of ethics under Rule 17j-1 of the 1940 Act (collectively, the Ethics Codes). Rule 17j-1 and the Ethics Codes are designed to prevent unlawful practices in connection with the purchase or sale of securities by covered personnel (Access Persons). The Ethics Codes permit Access Persons, subject to certain restrictions, to invest in securities, including securities that may be purchased or held by the Fund. Under the Ethics Codes, Access Persons may engage in personal securities transactions, but are required to
report their personal securities transactions for monitoring purposes. In addition, certain Access Persons are required to obtain approval before investing in initial public offerings or private placements. The Ethics Codes can be reviewed and copied at the SECs Public Reference Room in Washington, DC. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-202-551-8090. The codes are available on the EDGAR database on the SECs website at
www.sec.gov
, and also may be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SECs Public Reference Section, Washington, DC 20549.
DISTRIBUTOR
The Distributor for the Funds, Realty Capital Securities, LLC, is located at 405 Park Avenue, New York, NY 10022. The Distributor is not obligated to sell any specific amount of shares of each Fund and will sell shares, as agent for the Funds, on a continuous basis only against orders to purchase shares. The Distributor is an affiliated person of the Adviser, which is itself an affiliated person of the Funds.
CUSTODIAN
Union Bank, N.A. (Union Bank), Institutional Custody Services, 350 California Street, 6
th
Floor, San Francisco, CA 94104 serves as custodian of the Trusts portfolio securities and other assets. Under the terms of the custody agreement between the Trust and Union Bank, Union Bank maintains cash, securities and other assets of the Fund. Union Bank is also required, upon the order of the Trust, to deliver securities held by Union Bank, and to make payments for securities purchased by the Trust.
TRANSFER AGENT
American National Stock Transfer, LLC (ANST), located at 405 Park Avenue, New York, NY 10022, serves as the transfer agent for the Trust. ANST has entered into an agreement with Gemini Fund Services to serve as sub-transfer agent to the Trust.
PROXY VOTING POLICIES AND PROCEDURES
The Board has delegated to the Adviser the responsibility to vote proxies related to the securities held in each Funds portfolio. The Adviser has further delegated the responsibility to vote proxies to each Funds Sub-Adviser. Under this authority, the Sub-Adviser is required by the Board to vote proxies related to portfolio securities in the best interests of the Fund and its shareholders. Each Sub-Adviser will vote such proxies in accordance with its proxy policies and procedures, which are included in Appendix B to this SAI. The Board will periodically review each Funds proxy voting record.
The Trust will annually disclose its complete proxy voting record on Form N-PX. The Trusts most recent Form N-PX will available without charge, upon request by calling 1-866-271-9244. The Trusts Form N-PX also is available on the SECs web site at
www.sec.gov
.
CONTROL PERSONS AND PRINCIPAL HOLDERS
AR Capital, LLC (ARC), an affiliate of the Adviser, owns all of the initial shares issued by the Funds prior to the commencement of investment operations and the public launch of the Funds. No other person owns of record or is known by the Funds to own beneficially 5% or more of the Funds outstanding equity securities.
40
INVESTMENT ADVISORY AND OTHER SERVICES
The Adviser
National Fund Advisors, LLC, located at 405 Park Avenue, Suite C, New York, NY 10022, serves as each Funds investment adviser. The Adviser is an indirect, wholly-owned subsidiary of ARC. ARC is primarily an investment adviser to REITs. ARC is a full-service investment banking, asset management and real estate advisory firm that serves both institutions and individual investors. ARC, which directly and through its wholly-owned subsidiaries, sponsors a variety of securities offerings, including publicly registered non-traded real estate investment trusts, a publicly-registered non-traded BDC a non-traded oil and gas
limited partnership and additional other funds registered under the 1940 Act. ARC was formed by Nicholas S. Schorsch and William M. Kahane in 2007. Both Mr. Schorsch and Mr. Kahane have extensive backgrounds in real estate and capital markets, with expertise in transaction structure and execution. Collectively, ARCs executive team has acquired and managed over $10 billion of real estate since 2001. The Adviser is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended. The Adviser is a Delaware limited liability company formed in June 2011. As of December 31, 2013, the Adviser managed approximately $105 million in assets. Under the general supervision of the Board, the Adviser will supervise each Funds Sub-Adviser. In addition, the Adviser will supervise and provide oversight of the Funds service providers. The Adviser will furnish to the Fund necessary personnel for servicing the management of the Fund. The Adviser will
compensate all Adviser personnel who provide services to the Funds (other than the Chief Financial Officer and the Chief Compliance Officer).
The Sub-Advisers
SEL Asset Management
SEL Asset Management, LLC (SEL), located at 1235 Westlakes Dr. Berwyn, PA 19312 is the AR Capital Dividend and Value Funds investment sub-adviser. SEL is a Delaware LLC formed in April 2013. As of the date of this SAI, SEL has no assets under management. SEL will carry out the investment and reinvestment of the net assets of the Fund, furnish a continuous investment program with respect to the Fund and determine which securities should be purchased, sold or exchanged.
The Advisers annual advisory fee is 0.70% of the AR Capital Dividend and Value Funds average daily net assets. The Adviser pays SEL an annual sub-advisory fee equal to 0.55% of the AR Capital Dividend and Value Funds average daily net assets.
BDCA Adviser, LLC
BDCA Adviser, LLC (BDCA), is the AR Capital BDC Income Funds investment sub-adviser. As of December 31, 2013, the BDCA Adviser managed approximately $1.085 billion in assets.
The Advisers annual management fee is 0.90% of the AR Capital BDC Income Funds average daily net assets. The Adviser pays BDCA an annual sub-advisory fee equal to 0.75% of the AR Capital BDC Income Funds average daily net assets.
The Administrator
RCS Advisory Services, LLC (the Administrator), located at 405 Park Avenue, 15
th
Floor, New York, NY 10022, serves as the Funds administrator. Pursuant to an administrative agreement, the Administrator provides the Funds with necessary administrative services. The Administrator has entered into a contract with Gemini Fund Services, LLC (Gemini), pursuant to which Gemini serves as sub-administrator and performs many of the administrative services for the Trust. In addition, the Administrator makes available the office space, equipment, personnel and facilities required to provide such
administrative services to the Funds. For these administrative services, the Funds pays the Administrator a base annual fee (per Fund) as follows: 0.26% on the first $250 million of net assets; 0.245% on net assets from $250 million to $500 million; 0.23% on net assets from $500 million to $1 billion; and 0.22% on net assets greater than $1 billion. The base annual fee is subject to a $30,000 minimum annual fee per Fund. Because the Funds are new, no information is available regarding fees paid to the Administrator for administrative services.
41
PORTFOLIO MANAGERS
AR Capital Dividend and Value Fund
Bradford Stanley and Mark Painter serve as co-Portfolio Managers to the AR Capital Dividend and Value Fund. They are primarily responsible for overseeing the overall allocation of the Funds portfolio. They each receive a salary, retirement plan, benefits and discretionary bonuses from SEL. Because the Portfolio Managers may manage assets for other pooled investment vehicles and/or other accounts (including institutional clients, pension plans and certain high net worth individuals) (collectively, Client Accounts), or may be affiliated with such Client Accounts, there may be an incentive to favor one Client
Account over another, resulting in a conflict of interest. For example, SEL or its affiliates may, directly or indirectly, receive fees from Client Accounts that are higher than the fee it receives from the Fund, or it may, directly or indirectly, receive a performance-based fee on a Client Account. In those instances, a Portfolio Manager may have an incentive to not favor the Fund over the Client Accounts. SEL has adopted policies and procedures that it believes are reasonably designed to address these and other conflicts of interest.
Brad Stanley.
Mr. Stanley serves as a Portfolio Manager of the Fund, with primary responsibility for overseeing the allocation of the Funds assets and security selection. In addition to his responsibilities at SEL, Mr. Stanley is a Portfolio Manager at the Stanley Laman Group (SLG). In that capacity, Mr. Stanley oversees approximately $600 million in managed securities. Mr. Stanley began his career with SLG in 2003. He has been the co-manager on SLG High Growth and Fixed Income since February of 2005, SLG High Dividend and Value since February 2010, SLG Micro-Cap since December 2010, SLG
International Opportunities LP since February 2012 and SLG Risk Managed since March 2013. Mr. Stanley graduated from Carnegie Mellon University in 2003 with a degree in Computer Science. He has been a Chartered Financial Analyst since 2009.
Mark Painter.
Mr. Painter has over nine years of experience in the financial services industry, including more than five years analyzing and investing in securities. However, he has no prior experience managing an open-end investment company. Mr. Painter is a Portfolio Manager at SLG. In that capacity, Mr. Painter oversees approximately $600 million in managed securities. Mr. Painter began his career with SLG in 2004. He has been the co-manager for SLG High Growth and Fixed Income since February 2005, SLG High Dividend and Value since February 2010, SLG Micro-Cap since December 2010, SLG International
Opportunities LP since February 2012 and SLG Risk Managed since March 2013. Mr. Painter graduated from Carnegie Mellon University in 2004 with a degree in Business Administration, with a concentration in finance. As of the date of this SAI, Mr. Painter owned no Fund shares.
The following table provides information about the other accounts for which the Portfolio Managers are primarily responsible. The reporting information is provided as of March 11, 2014:
|
|
|
|
|
|
|
Bradford Stanley
|
|
Mark Painter
|
Registered Investment Companies
|
|
|
|
|
|
|
|
|
Number of Accounts
|
|
|
557
|
|
|
|
0
|
|
Total Assets (in millions)
|
|
$
|
620
|
|
|
$
|
0
|
|
Number of Accounts Subject to a Performance Fee
|
|
|
0
|
|
|
|
0
|
|
Total Assets Subject to a Performance Fee (in millions)
|
|
$
|
0
|
|
|
$
|
0
|
|
Other Pooled Investment Vehicles
|
|
|
|
|
|
|
|
|
Number of Accounts
|
|
|
1
|
|
|
|
1
|
|
Total Assets (in millions)
|
|
$
|
75
|
|
|
$
|
70
|
|
Number of Accounts Subject to a Performance Fee
|
|
|
0
|
|
|
|
0
|
|
Total Assets Subject to a Performance Fee (in millions)
|
|
$
|
0
|
|
|
$
|
0
|
|
Other Accounts
|
|
|
|
|
|
|
|
|
Number of Accounts
|
|
|
556
|
|
|
|
800
|
|
Total Assets (in millions)
|
|
$
|
545
|
|
|
$
|
600
|
|
Number of Accounts Subject to a Performance Fee
|
|
|
0
|
|
|
|
0
|
|
Total Assets Subject to a Performance Fee (in millions)
|
|
$
|
0
|
|
|
$
|
0
|
|
42
AR Capital BDC Income Fund
Robert K. Grunewald.
Mr. Grunewald is the Funds Portfolio Manager, and has served the Fund in this capacity since inception in 2014. Mr. Grunewald has served as the chief investment officer of BDCA since September 2011. Since April 2012, Mr. Grunewald has also served as the chief investment officer of Business Development Corporation of America, a public, non-traded BDC for which BDCA acts as investment adviser. Mr. Grunewald has over 25 years of experience with middle-market finance, BDCs and asset management. Within the finance industry, he has participated as a lender, investment banker, M&A
advisor, portfolio manager and hedge fund operator. Prior to joining BDCA, Mr. Grunewald served from 2006 to 2009 as the head of the Financial Services Investment Practice at what became Wachovia Securities. At Wachovia, Mr. Grunewald managed a number of high profile transactions, including initial public offerings and secondary offerings for some of the largest publicly-traded BDCs and finance companies. Mr. Grunewald receives a salary, retirement plan, benefits and discretionary bonuses from BDCA.
The following table provides information about the other accounts for which the portfolio manager is primarily responsible for. The reporting information is provided as of March 11, 2014:
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Robert K. Grunewald
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Registered Investment Companies
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Number of Accounts
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0
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Total Assets (in millions)
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$
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0
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Number of Accounts Subject to a Performance Fee
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0
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Total Assets Subject to a Performance Fee (in millions)
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$
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0
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Other Pooled Investment Vehicles
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Number of Accounts
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1
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Total Assets (in millions)
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$
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842
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Number of Accounts Subject to a Performance Fee
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1
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Total Assets Subject to a Performance Fee (in millions)
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$
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842
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Other Accounts
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Number of Accounts
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0
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Total Assets (in millions)
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$
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0
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Number of Accounts Subject to a Performance Fee
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0
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Total Assets Subject to a Performance Fee (in millions)
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$
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0
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Potential Conflicts of Interest
The portfolio managers management of other accounts may give rise to potential conflicts of interest in connection with their management of the respective Funds investments, on the one hand, and the investments of the other accounts, on the other. The other accounts may have the same investment objective as a Fund. Therefore, a potential conflict of interest may arise as a result of the identical investment objectives, whereby the portfolio manager could favor one account over another. Another potential conflict could include the portfolio managers knowledge about the size, timing and possible
market impact of Fund trades, whereby the portfolio manager could use this information to the advantage of other accounts and to the disadvantage of a Fund. However, the Adviser and each Funds Sub-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. There can be no assurance that these policies and procedures will be effective, however.
Compensation
The portfolio managers annual compensation will be comprised of a base salary plus discretionary bonus, which may be delivered in cash, shares of the Fund managed, or common stock of an affiliated publically traded company. The discretionary bonus is based on several factors, including: (1) the success of the Fund managed in relation to the investment mandate set forth herein; (2) the success of the Adviser, Sub-Adviser and/or affiliates; and (3) the success of other accounts managed by the Adviser or Sub-Adviser.
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ALLOCATION OF BROKERAGE
Specific decisions to purchase or sell securities for a Fund are made by that Funds portfolio manager(s), who is an employee of a Sub-Adviser. Each Sub-Adviser is authorized by the trustees to allocate the orders placed on behalf of each Fund to brokers or dealers who may, but need not, provide research or statistical material or other services to the Funds, the Adviser or Sub-Advisers for the Funds use. Such allocation is to be in such amounts and proportions as the Sub-Adviser may determine.
In selecting a broker or dealer to execute each particular transaction, a Sub-Adviser will take the following into consideration:
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the best net price available;
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the reliability, integrity, and financial condition of the broker or dealer;
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the size of and difficulty in executing the order; and
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the value of the expected contribution of the broker or dealer to the investment performance of the Fund on a continuing basis
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Brokers or dealers executing a portfolio transaction on behalf of a Fund may receive a commission in excess of the amount of commission another broker or dealer would have charged for executing the transaction if the Sub-Adviser determines in good faith that such commission is reasonable in relation to the value of brokerage and research services provided to the Fund. In allocating portfolio brokerage, the Sub-Adviser may select brokers or dealers who also provide brokerage, research, and other services to other accounts over which the Sub-Adviser exercises investment discretion. Some of the services received as the result of
Fund transactions may primarily benefit accounts other than the Fund, while services received as the result of portfolio transactions effected on behalf of those other accounts may primarily benefit the Fund.
Affiliated Party Brokerage.
The Adviser, the Sub-Advisers and the affiliates of the Adviser and each Sub-Adviser will not purchase securities or other property from, or sell securities or other property to, the Funds, except that a Fund may in accordance with rules under the 1940 Act engage in transactions with accounts that are affiliated with a Fund as a result of common officers, directors, advisers, members, managing general partners or common control. These transactions would be effected in circumstances in which the Adviser or Sub-Adviser determined that it would be appropriate for a Fund to
purchase and another client to sell, or a Fund to sell and another client to purchase, the same security or instrument each on the same day.
The Adviser and each Sub-Adviser places its trades under a policy adopted by the trustees pursuant to Section 17(e) and Rule 17(e)(1) under the 1940 Act, which place limitations on the securities transactions effected through affiliated brokers. The policy of the Funds with respect to brokerage is reviewed by the trustees from time to time. Because of the possibility of further regulatory developments affecting the securities exchanges and brokerage practices generally, the foregoing practices may be modified.
DISTRIBUTION AND SHAREHOLDER SERVICE PLANS
Rule 12b-1
Rule 12b-1 permits an investment company to pay expenses associated with the distribution of its shares in accordance with a plan adopted by its board of directors and approved by its shareholders. Pursuant to such rule, the Funds Board has approved and entered into the Class A Plan and the Class C Plan for the AR Capital Dividend and Value Fund, and the Class A Plan for the AR Capital BDC Income Fund. The plans are described below.
In adopting the plans, the Board (including a majority of trustees who are not interested persons of the Fund, hereafter referred to as the independent trustees) determined that there was a reasonable likelihood that the plans would benefit the Funds and the affected class of the respective Funds shareholders. Some of the anticipated benefits include improved name recognition of a Fund generally and growing assets in the Fund, which helps retain and attract investment management talent, provides a better environment for improving Fund performance, and can lower the total expense ratio for that Fund. Pursuant to Rule
12b-1, information about revenues and expenses under the plans is presented to the Board quarterly.
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Continuance of the plans must be approved by the Board, including a majority of the independent trustees, annually. The plans may be amended by a vote of the Board, including a majority of the independent trustees, except that the plans may not be amended to materially increase the amount spent for distribution without majority approval of the shareholders of the affected class. The plans terminate automatically in the event of an assignment and may be terminated upon a vote of a majority of the independent trustees or by a majority of the outstanding shareholder votes of the affected class.
All fees paid under the plans will be made in accordance with Section 2830 of the Conduct Rules of the Financial Industry Regulatory Authority, Inc. (FINRA).
The Share Class Plans
Class A and C shares of the AR Capital Dividend and Value Fund and Class A shares of the AR Capital BDC Income Fund are made available to persons purchasing through broker-dealers and other financial intermediaries that provide various administrative, shareholder and distribution services. The Funds Distributor enters into contracts with various broker-dealers and other financial intermediaries, with respect to the sale of the Funds shares and/or the use of the Funds shares in various investment products or in connection with various financial services.
Certain recordkeeping and administrative services that would otherwise be performed by the Funds transfer agent may be performed by a financial intermediary for Class A and C investors in the AR Capital Dividend and Value Fund, and Class A investors in the AR Capital BDC Income Fund. In addition to such services, the financial intermediaries provide various individual shareholder and distribution services.
To enable the Funds shares to be made available through such financial intermediaries, and to compensate them for such services, the Funds Board has adopted the Class A and C Plans for the AR Capital Dividend and Value Fund, and the Class A Plan for the AR Capital BDC Income Fund. Pursuant to the plans, the following fees are paid and described further below.
AR Capital Dividend and Value Fund
Class A
. Class A pays the Funds Distributor 0.25% annually of the average daily net asset value of the Class A shares, which is paid for certain ongoing individual shareholder, administrative services and distribution services, including past distribution services. This payment is fixed at 0.25% and is not based on expenses incurred by the Distributor.
Class C
. Class C pays the Funds Distributor 1.00% annually of the average daily net asset value of the Funds Class C shares, 0.25% of which is paid for certain ongoing individual shareholder and administrative services and 0.75% of which is paid for distribution services, including past distribution services. This payment is fixed at 1.00% and is not based on expenses incurred by the Distributor.
AR Capital BDC Income Fund
Class A
. Class A pays the Funds Distributor 0.25% annually of the average daily net asset value of the Class A shares, which is paid for certain ongoing individual shareholder, administrative services and distribution services, including past distribution services. This payment is fixed at 0.25% and is not based on expenses incurred by the Distributor.
The Distributor then makes these payments to the financial intermediaries (including underwriters and broker-dealers, who may use some of the proceeds to compensate sales personnel) who offer the Class A and Class C shares of the AR Capital Dividend and Value Fund, and Class A shares of the AR Capital BDC Income Fund for the services described below. No portion of these payments is used by the Distributor to pay for advertising, printing costs or interest expenses.
Payments may be made for a variety of individual shareholder services, including, but not limited to:
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1.
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providing individualized and customized investment advisory services, including the consideration of shareholder profiles and specific goals;
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2.
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creating investment models and asset allocation models for use by shareholders in selecting appropriate investment options, including the Funds;
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3.
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conducting proprietary research about investment choices and the market in general;
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4.
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periodic rebalancing of shareholder accounts to ensure compliance with the selected asset allocation;
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5.
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consolidating shareholder accounts in one place;
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6.
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paying service fees for providing personal, continuing services to investors, as contemplated by the Conduct Rules of FINRA; and
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7.
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other individual services.
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Individual shareholder services do not include those activities and expenses that are primarily intended to result in the sale of additional shares of the Fund.
Distribution services include any activity undertaken or expense incurred that is primarily intended to result in the sale of Class A and/or Class C shares of the AR Capital Dividend and Value Fund, and Class A shares of the AR Capital BDC Income Fund, which services may include but are not limited to:
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1.
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paying sales commissions, on-going commissions and other payments to brokers, dealers, financial institutions or others who sell these shares pursuant to selling agreements;
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2.
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compensating registered representatives or other employees of the Distributor who engage in or support distribution of the Funds shares;
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3.
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compensating and paying expenses (including overhead and telephone expenses) of the Distributor;
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4.
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printing prospectuses, statements of additional information and reports for other-than-existing shareholders;
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5.
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preparing, printing and distributing sales literature and advertising materials provided to the Funds shareholders and prospective shareholders;
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6.
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receiving and answering correspondence from prospective shareholders, including distributing prospectuses, statements of additional information, and shareholder reports;
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providing facilities to answer questions from prospective shareholders about Fund shares;
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8.
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complying with federal and state securities laws pertaining to the sale of Fund shares;
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9.
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assisting shareholders in completing application forms and selecting dividend and other account options;
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10.
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providing other reasonable assistance in connection with the distribution of Fund shares;
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11.
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organizing and conducting sales seminars and payments in the form of transactional and compensation or promotional incentives;
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12.
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profit on the foregoing; and
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13.
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such other distribution and services activities as the NFA determines may be paid for by the Fund pursuant to the terms of the agreement between the corporation and the Funds Distributor and in accordance with Rule 12b-1 of the 1940 Act.
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REDUCING SALES CHARGE ON CLASS A SHARES
As discussed in the Prospectus, the size of your total investment in a Funds Class A shares will affect your sales charge. Described below are several methods to reduce the applicable sales charge. Importantly, an investment in a Funds Class A shares will not reduce the sales charge applicable to the Class A shares of the other Fund or other series of the Trust. In order to obtain a reduction in the sales charge, an investor must notify, at the time of purchase, his or her dealer, the Transfer Agent, or the Distributor of the applicability of one of the following:
Rights of Aggregation
The size of the total investment in a Funds Class A shares applies to the total amount being invested by any person, which term includes an individual, his or her spouse; his or her children under the age of 21; a trustee or other fiduciary purchasing for a single trust, estate, or single fiduciary account (including a pension, profit-sharing or other employee benefit trust created pursuant to a plan qualified under the Code although more than one beneficiary may be involved); or any U.S. bank or investment adviser purchasing shares for its investment advisory clients or customers. Any such person purchasing
for several accounts at the same time may combine these investments into a single transaction in order to reduce the applicable sales charge.
Rights of Accumulation
A Funds Class A shares may be purchased at a reduced sales charge by a person (as defined above) who is already a shareholder of the Funds Class A shares by taking into account not only the amount then being invested, but also the current NAV of the Class A shares already held by such person. If the current NAV of the qualifying shares already held plus the NAV of the current purchase exceeds a point in the schedule of sales charges at which the charge is reduced to a lower percentage, the entire current purchase is eligible for the reduced charge. To be entitled to a reduced sales charge pursuant to
the Rights of Accumulation, the investor must notify his or her dealer, the Transfer Agent, or the Distributor at the time of purchase that he or she wishes to take advantage of such entitlement, and give the numbers of his or her account, and those accounts held in the name of his or her spouse or for a child, and the specific relationship of each such other person to the investor.
Letter of Intention
An investor may also qualify for a reduced sales charge by completing a Letter of Intention (the Letter) set forth in the Subscription Agreement or on a separate form for this purpose provided by the Trust. This enables the investor to aggregate purchases of shares of the Trust during a 12-month period for purposes of calculating the applicable sales charge. All shares of the Trust currently owned by the investor will be credited as purchases toward the completion of the Letter at the greater of their NAV on the date the Letter is executed or their cost. No retroactive adjustment will be made if purchases exceed the amount
indicated in the Letter. For each investment made, the investor must notify his or her dealer, the Transfer Agent, or the Distributor that a Letter is on file along with all account numbers associated with the Letter.
The Letter is not a binding obligation on the investor. However, 5% of the amount specified in the Letter will be held in escrow, and if the investors purchases are less than the amount specified, the investor will be requested to remit to the Trust an amount equal to the difference between the sales charge paid and the sales charge applicable to the aggregate purchases actually made. If not remitted within 20 days after written request, an appropriate number of escrowed shares will be redeemed in order to realize the difference. However, the sales charge applicable to the investment will in no event be higher than if
the shareholder had not submitted a Letter.
Sales at Net Asset Value
Class A shares of each Fund may be sold at NAV (
i.e.,
without a sales charge) (1) to registered representatives or employees (and their immediate families) of authorized dealers, or to any trust, pension, profit-sharing or other benefit plan for only such persons; (2) to banks or trust companies or their affiliates when the bank, trust company, or affiliate is authorized to make investment decisions on behalf of a client; (3) to investment advisers and financial planners who place trades for their own accounts or the accounts of their clients and who charge a management, consulting or other fee for their services; (4)
to clients of such
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investment advisers and financial planners who place trades for their own accounts if the accounts are linked to the master account of such investment adviser or financial planner on the books and records of the broker, agent, investment adviser or financial institution; and (5) to retirement and deferred compensation plans including, but not limited to those defined in Section 401(a), 403(b) or 457 of the Code and rabbi trusts. Investors may be charged a fee if they effect transactions in Fund shares through a broker or agent. Class A shares of a Fund may also be sold at NAV to current officers, directors, and
employees (and their immediate families) of the Trust; the Adviser and its affiliates; the Distributor; employees (and their immediate families) of certain firms providing services to the Trust (such as the Transfer Agent); and to any trust, pension, profit-sharing or other benefit plan for only such persons.
CONTINGENT DEFERRED SALES CHARGE
Class A Shares
With respect to purchases of $1,000,000 or more, Class A shares redeemed on or before the one year anniversary date of their purchase will be subject to a contingent deferred sales charge equal to 1% of the lesser of the cost of the shares being redeemed or their NAV at the time of redemption. Accordingly, no sales charge will be imposed on increases in NAV above the initial purchase price. The contingent deferred sales charge on Class A shares will be waived on certain redemptions, as described below. In addition, no charge will be assessed on shares derived from reinvestment of dividends or capital gains distributions. In
determining the contingent deferred sales charge applicable to a redemption of Class A shares, it will be assumed that the redemption is, first, of any shares that are not subject to a contingent deferred sales charge (for example, because an initial sales charge was paid with respect to the shares, or they have been held beyond the period during which the charge applies or were acquired upon the reinvestment of dividends and distributions) and, second, of shares held longest during the time they are subject to the sales charge.
Proceeds from the contingent deferred sales charge on Class A shares are paid to the Distributor and are used by the Distributor to defray expenses of the Distributor related to providing distribution-related services to the Fund in connection with the sales of Class A shares, such as the payment of compensation to selected dealers or financial intermediaries for selling Class A shares.
Class C Shares
Regardless of the amount invested, Class C shares redeemed on or before the one year anniversary date of their purchase will be subject to a contingent deferred sales charge equal to 1% of the lesser of the cost of the shares being redeemed or their NAV at the time of redemption. Accordingly, no sales charge will be imposed on increases in NAV above the initial purchase price. The contingent deferred sales charge on Class C shares will be waived on certain redemptions, as described below. In addition, no charge will be assessed on shares derived from reinvestment of dividends or capital gains distributions. In determining the
contingent deferred sales charge applicable to a redemption of Class C shares, it will be assumed that the redemption is, first, of any shares that are not subject to a contingent deferred sales charge (for example, because an initial sales charge was paid with respect to the shares, or they have been held beyond the period during which the charge applies or were acquired upon the reinvestment of dividends and distributions) and, second, of shares held longest during the time they are subject to the sales charge.
Proceeds from the contingent deferred sales charge on Class C shares are paid to the Distributor and are used by the Distributor to defray expenses of the Distributor related to providing distribution-related services to the Fund in connection with the sales of Class C shares, such as the payment of compensation to selected dealers or financial intermediaries for selling Class C shares.
Advisor Class Shares
Advisor Class shares are not subject to a contingent deferred sales charge.
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Waiver
The contingent deferred sales charge is waived on redemptions of shares (1) following the death or disability, as defined in the Code, of a shareholder; (2) to the extent that the redemption represents a minimum required distribution from an individual retirement account or other retirement plan to a shareholder who has attained the age of 70½; or (3) that had been purchased by present or former Trustees of a Fund, by the relative of any such person, by any trust, individual retirement account or retirement plan account for the benefit of any such person or relative, or by the estate of any such person or relative.
PURCHASES AND REDEMPTIONS IN KIND
Purchases In Kind
Each Fund may, at the sole discretion of the Adviser, in consultation with the applicable Sub-Adviser, accept securities in exchange for shares of the Fund. Securities which may be accepted in exchange for shares of a Fund must: (1) be consistent with the investment objectives and policies of the Fund; (2) be acquired for investment and not for resale; (3) be liquid securities which are not restricted as to transfer either by law or liquidity of market (determined by reference to liquidity policies established by the Board); and (4) have a value which is readily ascertainable as evidenced by, for example, a listing on a
recognized stock exchange.
Redemptions In Kind
If a Fund determines that it would be detrimental to the best interests of the remaining shareholders of the Fund to make a redemption payment wholly in cash (for example, if the amount of such a request is large enough to affect operations such as being greater than $250,000 or 1% of the Funds assets), the Fund may pay, consistent with applicable law, any portion of a redemption by a distribution in kind of readily marketable portfolio securities in lieu of cash. The securities will be chosen by the Fund and valued at the Funds net asset value. Shareholders receiving distributions in kind may
incur brokerage commissions or other costs, such as transaction expenses in converting securities to cash, when subsequently disposing of those securities.
TAX STATUS
The following discussion is a general summary of the material United States federal income tax considerations applicable to us and to an investment in a Funds shares. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, this discussion does not describe tax consequences that are generally known by investors or certain considerations that may be relevant to certain types of holders subject to special treatment under United States federal income tax laws, including shareholders subject to the alternative minimum tax, tax-exempt
organizations, insurance companies, dealers in securities, pension plans and trusts, and financial institutions. This summary assumes that investors hold a Funds common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as in effect as of the date of this prospectus and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. Neither Fund has sought nor will seek any ruling from the Internal Revenue Service regarding the offering. This summary does not discuss any aspects of United States estate or gift tax or foreign, state or local tax. It does not discuss the special treatment under United States federal income tax laws that could result if the Fund invested in tax-exempt securities or certain other investment assets in which the Fund does not currently intend to invest.
A U.S. shareholder generally is a beneficial owner of shares of a Funds common stock who is for United States federal income tax purposes:
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A citizen or individual resident of the United States including an alien individual who is a lawful permanent resident of the United States or meets the substantial presence test under Section 7701(b) of the Code;
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A corporation or other entity taxable as a corporation, for United States federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof;
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A trust if: (i) a court in the United States has primary supervision over its administration and one or more U.S. persons have authority to control all substantial decisions of such trust, or (ii) such trust validly elects to be treated as a U.S. person for federal income tax purposes; or
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An estate, the income of which is subject to United States federal income taxation regardless of its source.
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A non-U.S. shareholder is a beneficial owner of shares of our common stock that is not a U.S. shareholder.
If a partnership (including an entity treated as a partnership for United States federal income tax purposes) holds shares of a Funds common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A prospective shareholder who is a partner of a partnership holding shares of a Funds common stock should consult his, her or its tax advisors with respect to the purchase, ownership and disposition of shares of a Funds common stock.
Tax matters are very complicated and the tax consequences to an investor of an investment in a Funds shares will depend on the facts of his, her or its particular situation. Investors are encouraged to consult their own tax advisors regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of federal, state, local and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws.
Taxation of the Fund
Each Fund has elected or intends to elect to be treated as, and intends to qualify annually as, a RIC under subchapter M of the Code. If the Fund qualifies as a RIC, the Fund generally will not be subject to U.S. federal income tax on its investment company taxable income (which includes among other items, dividends, interest and net short-term capital gains in excess of net long-term capital losses, but determined without regard to the deduction for dividend paid) and net capital gains (the excess of net long-term capital gains over net short-term capital losses), if any, that it distributes to shareholders, provided that it
distributes at least 90% of the sum of its investment company taxable income and any net tax-exempt income for such taxable year (the annual distribution requirement). Each Fund intends to distribute to its shareholders, at least annually, substantially all of its investment company taxable income, net tax-exempt income and net capital gains.
Qualification as a Regulated Investment Company.
To qualify for the favorable U.S. federal income tax treatment generally accorded to a RIC, the Fund must, among other things, (1) derive in each taxable year at least 90% of its gross income from:(a) dividends, interest, payments with respect to certain 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 foreign currencies; and (b)
net income derived from interests in certain qualified publicly traded partnerships (as defined below); and (2) diversify its holdings so that, at the end of each quarter of each taxable year: (a) at least 50% of the value of the Funds total assets is represented by (I) cash and cash items, U.S. government securities, the securities of other regulated investment companies and (II) other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the value of the Funds total assets and not more than 10% of the outstanding voting securities of such issuer and (b) not more than 25% of the value of the Funds total assets is invested in the securities (other than U.S. government securities and the securities of other regulated investment companies) of (I) any one issuer, (II) any two or more issuers that the Fund controls and that are determined to be engaged in the same or similar trades or businesses or
related trades or businesses or (III) any one or more qualified publicly traded partnerships.
In general, for purposes of the 90% gross income requirement described in (1) 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 that would be qualifying income if realized directly by the RIC. However, 100% of the net income derived from an interest in a qualified publicly traded partnership (a partnership (a) 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 (b) that derives less than 90% of its income from
the qualifying
50
income described in (1) above) will be treated as qualifying income. In general, such entities will be treated as partnerships for U.S. federal income tax purposes because they meet the passive income requirement under Code Section 7704(c)(2). In addition, although in general the passive loss rules of the Code 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 test described in (2) above, the term outstanding voting securities of such issuer will include the equity securities of a qualified publicly traded partnership. Also, for purposes of the diversification test in (2) above, the identification of the issuer (or, in some cases, issuers) of a particular investment can depend on the terms and conditions of that investment. In some cases, identification of the issuer (or issuers) is uncertain under current law, and an adverse determination or future guidance by the IRS with respect to issuer identification for a particular type of
investment may adversely affect the Funds ability to meet the diversification test in (2) above.
The Funds intention to qualify for treatment as a RIC may negatively affect each Funds return by limiting its ability to acquire or continue to hold positions that would otherwise be consistent with its investment strategy or by requiring it to engage in transactions it would otherwise not engage in, resulting in additional transaction costs.
If the Fund does retain any investment company taxable income, it will be subject to tax at regular corporate rates on the amount retained. If the Fund retains any net capital gain, it will also be subject to tax at regular corporate rates on the amount retained, but may designate the retained amount as undistributed capital gain in a notice to its shareholders who would then (1) be required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amount, and (2) be entitled to credit their proportionate shares of the tax paid by the Fund on such undistributed
amount against their U.S. federal income tax liabilities, if any, and to claim such refunds on a properly filed U.S. tax return to the extent the credit exceeds such liabilities. If the Fund makes this designation, for U.S. federal income tax purposes, the tax basis of a shareholders Fund shares will be increased by an amount equal under current law to the difference between the amount of undistributed capital gains included in the shareholders gross income under clause (1) of the preceding sentence and the tax deemed paid by the shareholder under clause (2) of the preceding sentence. The Fund is not required to, and there can be no assurance that the Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year.
In determining its net capital gain, including in connection with determining the amount available to support a Capital Gain Dividend (as defined below), its taxable income and its earnings and profits, a RIC generally may elect to treat part or all of any post-October capital loss (defined as the greatest of net capital loss, net long-term capital loss, or net short-term capital loss, in each case attributable to the portion of the taxable year after October 31 (or a later date, if the Fund makes the election referred to in the following paragraph)) or late-year ordinary loss (generally, (1) net ordinary loss from the sale,
exchange or other taxable disposition of property, attributable to the portion of the taxable year after October 31 (or a later date, if the Fund makes the election referred to in the following paragraph)), plus (2) other net ordinary loss attributable to the portion of the taxable year after December 31) as if incurred in the succeeding taxable year.
Capital losses in excess of capital gains (net capital losses) are not permitted to be deducted against the Funds net investment income. Instead, potentially subject to certain limitations, the Fund may carry net capital losses from any taxable year forward to subsequent taxable years to offset capital gains, if any, realized during such subsequent taxable years. Capital loss carryforwards are reduced to the extent they offset current-year net realized capital gains, whether the Fund retains or distributes such gains. Those losses will be carried forward to one or more subsequent taxable years without
expiration. Any such carryforward losses will retain their character as short-term or long-term; this may well result in larger distributions of short-term gains to shareholders (taxable to individual shareholders as ordinary income) than would have resulted under the previous regime described above. The Funds available capital loss carryforwards, if any, will be set forth in its annual shareholder report for each fiscal year.
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Excise Tax on Undistributed Earnings.
Amounts not distributed on a timely basis in accordance with a calendar year distribution requirement, described below, are subject to a nondeductible 4% excise tax. To prevent imposition of the excise tax, the Fund must distribute during each calendar year an amount at least equal to the sum of (1) 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year, (2) 98.2% of its capital gains in excess of its capital losses (adjusted for certain ordinary losses) for the one-year period ending on October 31 (or a later date if the
Fund is eligible to elect and so elects), and (3) any ordinary income and capital gain net income for previous years that was not distributed during those years. For purposes of the required excise tax distribution, a RICs ordinary gains and losses from the sale, exchange, or other taxable disposition of property that would otherwise be taken into account after October 31(or a later date, if a RIC makes the election referred to above) generally are treated as arising on January 1 of the following calendar year. Also, for purposes of the excise tax, the Fund will be treated as having distributed any amount on which it is subject to corporate income tax for the taxable year ending within the calendar year. Each Fund intends to make distributions sufficient to avoid imposition of the excise tax, although there can be no assurance that it will be able to do so.
Investments with Original Issue Discount.
For federal income tax purposes, each Fund may be required to recognize taxable income in circumstances in which it does not receive a corresponding payment in cash. For example, if a Fund holds debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with payment-in-kind interest or, in certain cases, increasing interest rates or debt instruments that were issued with warrants), the Fund must include in income each year a portion of the original issue discount that accrues over the life of the
obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of the accrual, the Fund may be required to make a distribution to our shareholders in order to satisfy the annual 90% distribution requirement discussed above, even though it will not have received any corresponding cash amount. As a result, the Fund may have difficulty meeting the annual distribution requirement necessary to obtain and maintain RIC tax treatment under the Code. The Fund may have to sell some of our investments at times and/or at prices it would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If Fund is not able to obtain cash from other sources, it may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax. Our ability to
dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If the Fund dispose of assets in order to meet the annual distribution requirement, it may make such dispositions at times that, from an investment standpoint, are not advantageous.
Special Rules.
Certain of each Funds investment practices may be subject to special and complex federal income tax provisions that may, among other things, (1) treat dividends that would otherwise constitute qualified dividend income as non-qualified dividend income, (2) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (3) convert lower-taxed long-term capital gain into higher-taxed short-term capital gain or ordinary income, (4) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (5) cause us to recognize income or
gain without receipt of a corresponding distribution of cash, (6) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (7) adversely alter the characterization of certain complex financial transactions and (8) produce income that will not be qualifying income for purposes of the 90% gross income test. Each Fund intends to monitor its transactions and may make certain tax elections to mitigate the potential adverse effect of these provisions, but there can be no assurance that any adverse effects of these provisions will be mitigated.
Investments in REITs.
Any investment by a Fund in equity securities of REITs qualifying as such under Subchapter M of the Code may result in the Funds receipt of cash in excess of the REITs earnings. If the Fund distributes these amounts, these distributions could constitute a return of capital to Fund shareholders for U.S. federal income tax purposes. Investments in REIT equity securities also may require a Fund to accrue and distribute income not yet received. In such an event, to generate sufficient cash to make the requisite distributions, a Fund may be required to sell securities in its
portfolio (including when it is not advantageous
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to do so) that it otherwise would have continued to hold. Dividends received by the Fund from a REIT will not qualify for the corporate dividends-received deduction and generally will not constitute qualified dividend income.
Investments in REMICs and Other Mortgage-Backed Securities.
Each Fund may invest directly or indirectly in residual interests in REMICs (including by investing in residual interests in CMOs with respect to which an election to be treated as a REMIC is in effect) or equity interests in taxable mortgage pools (TMPs). Under a notice issued by the IRS in October 2006 and Treasury regulations that have yet to be issued but may apply retroactively, a portion of a Funds income (including income allocated to the Fund from a REIT or other pass-through entity) that is attributable to a residual
interest in a REMIC or an equity interest in a TMP (referred to in the Code as an excess inclusion) will be subject to U.S. federal income tax in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion income of a RIC will be allocated to shareholders of the RIC in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related interest directly. In general, excess inclusion income allocated to shareholders (1) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (2) will constitute unrelated business taxable income (UBTI) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess inclusion income, and otherwise might not be
required to file a tax return, to file a tax return and pay tax on such income, and (3) in the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding tax. A shareholder will be subject to U.S. federal income tax on such inclusions not withstanding any exemption from such income tax otherwise available under the Code. As a result, a Fund investing in such interests may not be a suitable investment for charitable remainder trusts. See Tax-Exempt Shareholders below.
Passive Foreign Investment Companies.
If a Fund purchases shares in a passive foreign investment company (a PFIC), it may be subject to federal income tax on its allocable share of a portion of any excess distribution received on, or any gain from the disposition of, such shares even if our allocable share of such income is distributed as a taxable dividend to its shareholders. Additional charges in the nature of interest generally will be imposed on us in respect of deferred taxes arising from any such excess distribution or gain. If the Fund invest in a PFIC and elect to
treat the PFIC as a qualified electing fund under the Code (a QEF), in lieu of the foregoing requirements, it will be required to include in income each year our proportionate share of the ordinary earnings and net capital gain of the QEF, even if such income is not distributed by the QEF. Alternatively, the Fund may be able to elect to mark-to-market at the end of each taxable year its shares in a PFIC; in this case, it will recognize as ordinary income our allocable share of any increase in the value of such shares, and as ordinary loss our allocable share of any decrease in such value to the extent that any such decrease does not exceed prior increases included in its income. Under either election, the Fund may be required to recognize in a year income in excess of distributions from PFICs and proceeds from dispositions of PFIC stock during that year, and such income will nevertheless be subject to the annual distribution requirement discussed above and will
be taken into account for purposes of the 4% excise tax.
Failure to Qualify.
In certain circumstances, it may be difficult for the Funds to meet the 90% gross income test and the diversification test described above. If a Fund were to fail to meet either of these tests, or the distribution test described above, the Fund could in some cases cure such failure, including: in the case of a gross income test failure, by paying the Fund-level tax, paying interest, making additional distributions or disposing of certain assets. If the Fund were ineligible to or otherwise did not cure such failure for any year, or if the Fund were otherwise to fail to qualify as a RIC
accorded special tax treatment for such year, the Fund would be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as dividend income. Some portions of such distributions may be eligible for the dividends received deduction in the case of corporate shareholders and to be treated as qualified dividend income in the case of individuals, provided, in both cases, that the shareholder meets certain holding period and other requirements in respect of Fund shares (as described below). In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before
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re-qualifying as a RIC that is accorded special tax treatment. Thus failure to qualify as a RIC would likely materially reduce the Funds investment return to its shareholders.
Taxation of U.S. Shareholders
Distributions.
Dividends paid out of each Funds current and accumulated earnings and profits will, except in the case of distributions of qualified dividend income and capital gain dividends described below, be taxable to a U.S. shareholder as ordinary income.
Taxes on distributions of capital gains are determined by how long the Fund owned the investments that generated the gains, rather than how long a shareholder has owned his or her shares. In general, the Fund will recognize long-term capital gain or loss on investments it has owned for more than one year, and short-term capital gain or loss on investments it has owned for one year or less. Tax rules can alter the Funds holding period in its investments and thereby affect the tax treatment of gain or loss on such investments. Distributions of net capital gain (that is, the excess of net long-term capital gain over net
short-term capital loss, in each case determined with reference to any loss carryforwards) that are properly reported by the Fund as capital gain dividends (Capital Gain Dividends) will be taxable to shareholders as long-term capital gains. Distributions of net short-term capital gain (as reduced by any net long-term capital loss for the taxable year) will be taxable to shareholders as ordinary income.
Each Fund may report certain dividends as derived from qualified dividend income which, when received by non-corporate shareholders, will be taxed at the rates applicable to long-term capital gain, provided holding period and other requirements are met at both the shareholder and Fund levels. In order for some portion of the dividends received by the Fund shareholder to be qualified dividend income that is eligible for taxation at long-term capital gain rates, the Fund must meet holding period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder must
meet holding period and other requirements with respect to the Funds shares. A dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (1) if the dividend is received with respect to any share of stock held for fewer than 61 days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90 days before such date), (2) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (3) if the recipient elects to have the dividend income treated as investment income for purposes of the limitation on deductibility of investment interest, or (4) if the dividend is received from a foreign corporation that is (a) not eligible for
the benefits of a comprehensive income tax treaty with the United States (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the United States) or (b) treated as a passive foreign investment company. Dividends paid by REITs will generally not qualify as qualified dividend income.
If the aggregate qualified dividends received by the Fund during a taxable year are 95% or more of its gross income (excluding net long-term capital gain over net short-term capital loss), then 100% of the Funds dividends (other than dividends properly reported as Capital Gain Dividends) will be eligible to be treated as qualified dividend income. In general, distributions of investment income reported by the Fund as derived from qualified dividend income will be treated as qualified dividend income in the hands of a shareholder taxed as an individual, provided the shareholder meets the holding period and other
requirements described above with respect to the Funds shares.
Dividends received by corporate shareholders of a Fund may qualify for the 70% dividends-received deduction to the extent of the amount of qualifying dividends received by the Fund from domestic corporations (other than REITs) and to the extent, if any, that a portion of interest paid or accrued on certain high yield discount obligations owned by the Fund is treated as a dividend. A dividend received by a Fund will not be treated as a dividend eligible for the dividends-received deduction (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain
preferred stock) during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days before such date in the case of certain preferred stock) or (2) to the extent that the Fund is under an obligation
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(pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends received deduction may otherwise be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the Fund or (2) by application of various provisions of the Code (for instance, the dividends-received deduction is reduced in the case of a dividend received on debt-financed portfolio stock (generally, stock acquired with borrowed funds)).
Any distribution of income that is attributable to (1) income received by a Fund in lieu of dividends with respect to securities on loan pursuant to a securities lending transaction or (2) dividend income received by a Fund on securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by the Fund, will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders.
Dividends and distributions on Fund shares are generally subject to federal income tax as described herein to the extent they do not exceed the Funds realized income and gains, even though such dividends and distributions may economically represent a return of a particular shareholders investment. Such distributions are likely to occur in respect of shares purchased at a time when the Funds net asset value reflects unrealized gains or income or gains that are realized but not yet distributed. Such realized income and gains may be required to be distributed even when the Funds net asset value also
reflects unrealized losses.
A distribution will be treated as paid on December 31 of the current calendar year if it is declared by the Fund in October, November or December with a record date in such a month and paid by the Fund during January of the following calendar year. Such distributions will be taxable to shareholders in the calendar year in which the distributions are declared, rather than the calendar year in which the distributions are received.
A distribution of an amount in excess of the Funds current and accumulated earnings and profits in any taxable year will be treated as a return of capital to the extent of a shareholders tax basis in his or her shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders basis in his or her shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of such shares.
Distributions will be treated in the manner described above regardless of whether such distributions are paid in cash or invested in additional shares of the Fund. Distributions may also be subject to additional state, local and foreign taxes depending on a U.S. shareholders particular situation.
Each Fund or, in the case of shares purchased through a financial intermediary, the financial intermediary will report to you and the IRS annually as to the U.S. federal tax status of distributions.
Sales and Redemptions.
A shareholder generally will recognize taxable gain or loss if the shareholder sells, redeems, or otherwise disposes of his, her or its shares of our common stock. The amount of gain or loss will be measured by the difference between such shareholders adjusted tax basis in the common stock sold, redeemed, or otherwise disposed and the amount of the proceeds received in exchange. Any gain arising from such sale, redemption, or disposition generally will be treated as long-term capital gain or loss if the shareholder has held his, her or its shares for more than one year. Otherwise,
it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale, redemption, or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition.
In general, individual U.S. shareholders currently are subject to a maximum federal income tax rate of 20% on their net capital gain (i.e., the excess of realized net long-term capital gains over realized net short-term capital losses), including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Individuals with income in excess of $200,000 ($250,000 in the case of married individuals filing jointly) and certain estates and trusts are subject to an additional 3.8% tax on their net investment income,
which generally includes
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net income from interest, dividends, annuities, royalties, and rents, and net capital gains (other than certain amounts earned from trades or businesses). Corporate U.S. shareholders currently are subject to federal income tax on net capital gain at the maximum 35% rate also applied to ordinary income. Non-corporate shareholders with net capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year; any net capital losses of a non-corporate shareholder in excess of $3,000 generally may be carried forward and used in subsequent
years as provided in the Code. Corporate shareholders generally may not deduct any net capital losses for a year, but may carry back such losses for three years or carry forward such losses for five years.
Upon the redemption or exchange of Fund shares, the Fund or, in the case of shares purchased through a financial intermediary, the financial intermediary may be required to provide you and the IRS with cost basis and certain other related tax information about the Fund shares you redeemed or exchanged. See each Funds Prospectus for more information.
Certain Losses.
If a shareholder recognizes a loss with respect to shares of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder (or a greater loss over a combination of years), the shareholder must file with the Internal Revenue Service (IRS) a disclosure statement on Form 8886. Significant penalties may be imposed upon a failure to comply with this requirement. Direct shareholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, shareholders of a RIC are not excepted. Future guidance may extend the
current exception from this reporting requirement to shareholders of most or all regulated investment companies. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Backup Withholding.
The Funds may be required to withhold federal income tax, or backup withholding from all payments to any non-corporate U.S. shareholder (1) who fails to furnish us with a correct taxpayer identification number or a certificate that such shareholder is exempt from backup withholding or (2) with respect to whom the IRS notifies us that such shareholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individuals taxpayer identification number is his or her social security number. Any amount withheld under backup
withholding is allowed as a credit against the U.S. shareholders federal income tax liability, provided that proper information is provided to the IRS.
Tax-Exempt Shareholders
Income of a RIC that would be UBTI if earned directly by a tax-exempt entity will not generally be attributed as UBTI to a tax-exempt shareholder of the RIC. Notwithstanding this blocking effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in a Fund if shares in the Fund constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of Code Section 514(b).
A tax-exempt shareholder may also recognize UBTI if a Fund recognizes excess inclusion income derived from direct or indirect investments in residual interests in REMICs or equity interests in TMPs as described above, if the amount of such income recognized by a Fund exceeds the Funds investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in RICs that invest directly or indirectly in residual interests in REMICs or equity interests in TMPs. Under legislation enacted in December 2006, a CRT (as defined in section 664 of the Code) that realizes any UBTI for a taxable year must pay an excise tax annually of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI as a result of investing in a Fund that recognizes excess inclusion income. Rather, if at any time during any taxable year a CRT (or one of
certain other tax-exempt shareholders, such as the United States, a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a share in a Fund that recognizes excess inclusion income, then the Fund will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To
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the extent permitted under the 1940 Act, each Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the Fund.
CRTs and other tax-exempt investors are urged to consult their tax advisors concerning the consequences of investing in a Fund.
Taxation of Non-U.S. Shareholders
Whether an investment in a Funds shares is appropriate for a non-U.S. shareholder will depend upon that persons particular circumstances. An investment in a Funds shares by a non-U.S. shareholder may have adverse tax consequences. Non-U.S. shareholders should consult their tax advisers before investing in our common stock. Non-U.S. persons should consult their own tax advisers with respect to the U.S. federal income tax and withholding tax, and state, local and foreign tax consequences of an investment in the shares.
General Rules Applicable to Non-U.S. Shareholders.
Distributions of a Funds investment company taxable income to non-U.S. shareholders (including interest income and realized net short-term capital gains in excess of realized long-term capital losses, which generally would be free of withholding if paid to non-U.S. shareholders directly) will be subject to withholding of federal tax at a 30% rate (or lower rate provided by an applicable treaty) to the extent of the Funds current and accumulated earnings and profits unless an applicable exception applies. If the distributions are effectively
connected with a U.S. trade or business of the non-U.S. shareholder, and, if an income tax treaty applies, attributable to a permanent establishment in the United States, we will not be required to withhold federal tax if the non-U.S. shareholder complies with applicable certification and disclosure requirements, although the distributions will be subject to federal income tax at the rates applicable to U.S. persons. (Special certification requirements apply to a non-U.S. shareholder that is a foreign partnership or a foreign trust, and such entities are urged to consult their own tax advisers.)
In addition, with respect to certain distributions made to non-U.S. shareholders in a Funds taxable years beginning before January 1, 2014, no withholding was required and the distributions generally were not subject to federal income tax if (1) the distributions were properly reported in a notice timely delivered to the Funds shareholders as interest-related dividends or short-term capital gain dividends, (2) the distributions were derived from sources specified in the Code for such dividends and (3) certain other requirements were satisfied. Although this exemption has been subject to
previous extensions, no assurance can be provided that this exemption will be extended for taxable years beginning on or after January 1, 2014. In addition, no assurance can be given that any of the Funds distributions would be eligible for this exemption even it is extended. In the case of shares held through an intermediary, the intermediary may withhold even if the Fund reports all or a portion of a payment as an interest-related or short-term capital gain dividend to shareholders. Non-U.S. shareholders should contact their intermediaries regarding the application of these rules to their accounts.
Actual or deemed distributions of a Funds net capital gains to a non-U.S. shareholder, and gains realized by a non-U.S. shareholder upon the sale or redemption of our common stock, will not be subject to federal withholding tax and generally will not be subject to federal income tax unless (1) the distributions or gains, as the case may be, are effectively connected with a U.S. trade or business of the non-U.S. shareholder and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the non-U.S. shareholder in the United States, (2) the non-U.S. shareholder is an individual that is
present in the United States for more than 183 days during the taxable year, or (3) the special rules applicable U.S. real property interests discuss below apply to the sale or redemption of our common stock.
If the Fund distributes its net capital gains in the form of deemed rather than actual distributions, a non-U.S. shareholder will be entitled to a federal income tax credit or tax refund equal to the shareholders allocable share of the tax the Fund pays on the capital gains deemed to have been distributed. In order to obtain the refund, the non-U.S. shareholder must obtain a U.S. taxpayer identification number and file a federal income tax return even if the non-U.S. shareholder would not otherwise be required to obtain a U.S. taxpayer identification number or file a federal income tax return.
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For a corporate non-U.S. shareholder, distributions (both actual and deemed), and gains realized upon the sale of our common stock that are effectively connected to a U.S. trade or business may, under certain circumstances, be subject to an additional branch profits tax at a 30% rate (or at a lower rate if provided for by an applicable treaty). Accordingly, investment in the shares may not be appropriate for a non-U.S. shareholder.
Special Rules Applicable to U.S. Real Property Interests.
Special rules will apply if a Fund is either a U.S. real property holding corporation (USRPHC) or would be a USRPHC but for the operation of certain exceptions to the definition thereof. Very generally, a USRPHC is a domestic corporation that holds USRPIs the fair market value of which equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests in real property located outside the United States, and other trade or business assets. USRPIs are generally defined as any interest in U.S.
real property and any interest (other than solely as a creditor) in a USRPHC or former USRPHC.
If a Fund is a USRPHC or would be a USRPHC but for the exceptions referred to above, under a special look-through rule, any distributions by the Fund to a foreign shareholder (including, in certain cases, distributions made by the Fund in redemption of its shares) attributable to gains realized by the Fund on the disposition of USRPIs or to distributions received by the Fund from a lower-tier RIC or REIT that the Fund is required to treat as USRPI gain in its hands, generally would be subject to U.S. tax withholding. In addition, such distributions could result in the foreign shareholder being required to file a
U.S. tax return and pay tax on the distributions at regular U.S. federal income tax rates. The consequences to a foreign shareholder, including the rate of such withholding and character of such distributions (e.g., as ordinary income or USRPI gain), would vary depending upon the extent of the foreign shareholders current and past ownership of the Fund. On and after January 1, 2014, the look-through rule described above for distributions by the Fund (which treatment applies only if the Fund is either a USRPHC or would be a USRPHC but for the operation of the exceptions referred to above) applies only to those distributions that, in turn, are attributable directly or indirectly to distributions received by the Fund from a lower-tier REIT, unless Congress enacts legislation providing otherwise.
In addition, if a Fund is a USRPHC or former USRPHC, it could be required to withhold U.S. tax on the proceeds of a share redemption by a greater-than-5% foreign shareholder, in which case such foreign shareholder generally would also be required to file U.S. tax returns and pay any additional taxes due in connection with the redemption.
Foreign shareholders of the Funds also may be subject to special wash sale rules to prevent the avoidance of the tax-filing and payment obligations discussed above through the sale and repurchase of Fund shares.
FATCA.
Under the Foreign Account Tax Compliance Act, a 30% withholding tax is imposed on payments of certain types of income to foreign financial institutions that fail to enter into an agreement with the United States Treasury to report certain required information with respect to accounts held by United States persons (or held by foreign entities that have United States persons as substantial owners). The types of income subject to the tax include U.S. source interest and dividends paid after June 30, 2014, and the gross proceeds from the sale of any property that could produce U.S.-source interest or
dividends paid after December 31, 2016. The information required to be reported includes the identity and taxpayer identification number of each account holder that is a U.S. person and transaction activity within the holders account. In addition, subject to certain exceptions, this legislation also imposes a 30% withholding on payments to foreign entities that are not financial institutions unless the foreign entity certifies that it does not have a 10% or greater U.S. owner or provides the withholding agent with identifying information on each 10% or greater U.S. owner. When these provisions become effective, depending on the status of a non-U.S. Holder and the status of the intermediaries through which they hold their units, non-U.S. Holders could be subject to this 30% withholding tax with respect to distributions on their units and proceeds from the sale of their units. Under certain circumstances, a non-U.S. Holder might be eligible for refunds or credits of such taxes.
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Certification of Non-U.S. Status.
A non-U.S. shareholder who is a non-resident alien individual, and who is otherwise subject to withholding of federal tax, may be subject to information reporting and backup withholding of federal income tax on dividends unless the non-U.S. shareholder provides us or the dividend paying agent with an IRS Form W-8BEN (or an acceptable substitute form) or otherwise meets documentary evidence requirements for establishing that it is a non-U.S. shareholder or otherwise establishes an exemption from backup withholding.
OTHER INFORMATION
Each share represents a proportional interest in the assets of the respective Fund. Each shareholder shall be entitled to one vote for each dollar (and fractional vote for each fractional dollar) of net asset value standing in such shareholders name on the books of the respective Fund for matters submitted to the vote of shareholders. There are no cumulative voting rights. Shares do not have pre-emptive or conversion or redemption provisions. In the event of a liquidation of a Fund, shareholders are entitled to share pro rata in the net assets of that Fund available for distribution to shareholders after all expenses and
debts have been paid.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
BBD, LLP, serves as each Funds independent registered public accounting firm. The independent registered public accounting firm is responsible for auditing each Funds annual financial statements.
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