STATEMENT OF ADDITIONAL INFORMATION
PART II
Part II of this SAI describes policies and practices that apply
to each of the J.P. Morgan Funds, for which Part I precedes this Part II. Part II is not a standalone document and must be read in conjunction with Part I. References in this Part II to a Fund mean each J.P. Morgan Fund, unless noted
otherwise. Capitalized terms used and not otherwise defined in this Part II have the meanings given to them in Part I of this SAI.
PART II
TABLE OF CONTENTS
Part II - i
Part II - ii
Part II - iii
INVESTMENT STRATEGIES AND POLICIES
As noted in the applicable Prospectuses for each of the Funds, in addition to the main investment strategy and the main investment risks
described in the Prospectuses, each Fund may employ other investment strategies and may be subject to other risks, which are described below. The Funds may engage in the practices described below to the extent consistent with their investment
objectives, strategies, polices and restrictions. However, no Fund is required to engage in any particular transaction or purchase any particular type of securities or investment even if to do so might benefit the Fund. Because the following is a
combined description of investment strategies of all of the Funds, certain matters described herein may not apply to particular Funds.
For a list of investment strategies and policies employed by each Fund, see INVESTMENT PRACTICES in Part I of this SAI.
Asset-Backed Securities
Asset-backed
securities consist of securities secured by company receivables, home equity loans, truck and auto loans, leases, or credit card receivables. Asset-backed securities also include other securities backed by other types of receivables or other assets,
including collateralized debt obligations (CDOs), which include collateralized bond obligations (CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. Such assets are generally
securitized through the use of trusts or special purpose corporations. Asset-backed securities are backed by a pool of assets representing the obligations often of a number of different parties. Certain of these securities may be illiquid.
Asset-backed securities are generally subject to the risks of the underlying assets. In addition, asset-backed securities, in
general, are subject to certain additional risks including depreciation, damage or loss of the collateral backing the security, failure of the collateral to generate the anticipated cash flow or in certain cases more rapid prepayment because of
events affecting the collateral, such as accelerated prepayment of loans backing these securities or destruction of equipment subject to equipment trust certificates. In addition, the underlying assets (for example, the underlying credit card debt)
may be refinanced or paid off prior to maturity during periods of declining interest rates. Changes in prepayment rates can result in greater price and yield volatility. If asset-backed securities are pre-paid, a Fund may have to reinvest the
proceeds from the securities at a lower rate. Potential market gains on a security subject to prepayment risk may be more limited than potential market gains on a comparable security that is not subject to prepayment risk. Under certain prepayment
rate scenarios, a Fund may fail to recover additional amounts paid (i.e., premiums) for securities with higher interest rates, resulting in an unexpected loss.
A CBO is a trust or other special purpose entity (SPE) which is typically backed by a diversified pool of fixed income securities (which may include high risk, below investment grade
securities). A CLO is a trust or other SPE that is typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans
that may be rated below investment grade or equivalent unrated loans. Although certain CDOs may receive credit enhancement in the form of a senior-subordinate structure, over-collateralization or bond insurance, such enhancement may not always be
present and may fail to protect a Fund against the risk of loss on default of the collateral. Certain CDOs may use derivatives contracts to create synthetic exposure to assets rather than holding such assets directly, which entails the
risks of derivative instruments described elsewhere in this SAI. CDOs may charge management fees and administrative expenses, which are in addition to those of a Fund.
For both CBOs and CLOs, the cash flows from the SPE are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the equity tranche, which bears the
first loss from defaults from the bonds or loans in the SPE and serves to protect the other, more senior tranches from default (though such protection is not complete). Since it is partially protected from defaults, a senior tranche from a CBO or
CLO typically has higher ratings and lower yields than its underlying securities, and may be rated investment grade. Despite the protection from the equity tranche, CBO or CLO tranches can experience substantial losses due to actual defaults,
downgrades of the underlying collateral by rating agencies, forced liquidation of the collateral pool due to a failure of coverage tests, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market
anticipation of defaults, as well as investor aversion to CBO or CLO securities as a class. Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash),
which involves continued exposure to default risk with respect to such payments.
The risks of an investment in a CDO depend
largely on the type of the collateral securities and the class of the CDO in which a Fund invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus are not registered under the securities laws. As a result, investments in
CDOs may be characterized by a Fund as illiquid
securities. However, an active dealer market may exist for CDOs, allowing a CDO to qualify for Rule 144A transactions. In addition to the normal risks associated with fixed income securities and
asset-backed securities generally discussed elsewhere in this SAI, CDOs carry additional risks including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other
payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization (NRSRO); (iii) a Fund may invest in tranches of CDOs that are
subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Fund
could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) risk of forced fire sale liquidation due to technical defaults such as coverage
test failures; and (viii) the CDOs manager may perform poorly.
Total Annual Fund Operating Expenses set forth in
the fee table and Financial Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment
company provided by Section
3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended (the 1940 Act).
Auction Rate
Securities
Auction rate securities consist of auction rate municipal securities and auction rate preferred securities sold
through an auction process issued by closed-end investment companies, municipalities and governmental agencies. For more information on risks associated with municipal securities, see Municipal Securities below.
Provided that the auction mechanism is successful, auction rate securities usually permit the holder to sell the securities in an auction
at par value at specified intervals. The dividend is reset by Dutch auction in which bids are made by broker-dealers and other institutions for a certain amount of securities at a specified minimum yield. The dividend rate set by the
auction is the lowest interest or dividend rate that covers all securities offered for sale. While this process is designed to permit auction rate securities to be traded at par value, there is the risk that an auction will fail due to insufficient
demand for the securities. Since February 2008, numerous auctions have failed due to insufficient demand for securities and have continued to fail for an extended period of time. Failed auctions may adversely impact the liquidity of auction rate
securities investments. Although some issuers of auction rate securities are redeeming or are considering redeeming such securities, such issuers are not obligated to do so and, therefore, there is no guarantee that a liquid market will exist for a
Funds investments in auction rate securities at a time when the Fund wishes to dispose of such securities.
Dividends on
auction rate preferred securities issued by a closed-end fund may be designated as exempt from federal income tax to the extent they are attributable to tax-exempt interest income earned by the closed-end fund on the securities in its portfolio and
distributed to holders of the preferred securities. However, such designation may be made only if the closed-end fund treats preferred securities as equity securities for federal income tax purposes and the closed-end fund complies with certain
requirements under the Internal Revenue Code of 1986, as amended (the Code).
A Funds investment in auction
rate preferred securities of closed-end funds is subject to limitations on investments in other U.S. registered investment companies, which limitations are prescribed under the 1940 Act. Except as permitted by rule or exemptive order (see
Investment Company Securities and Exchange Traded Funds below for more information), a Fund is generally prohibited from acquiring more than 3% of the voting securities of any other such investment company, and investing more than 5% of
a Funds total assets in securities of any one such investment company or more than 10% of its total assets in securities of all such investment companies. A Fund will indirectly bear its proportionate share of any management fees paid by such
closed-end funds in addition to the advisory fee payable directly by the Fund.
Bank Obligations
Bank obligations consist of bankers acceptances, certificates of deposit, and time deposits.
Bankers acceptances are negotiable drafts or bills of exchange typically drawn by an importer or exporter to pay for specific
merchandise, which are accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. To be eligible for purchase by a Fund, a bankers acceptance must be guaranteed
by a domestic or foreign bank or savings and loan association having, at the time of investment, total assets in excess of $1 billion (as of the date of its most recently published financial statements).
Part II - 2
Certificates of deposit are negotiable certificates issued against funds deposited in a
commercial bank or a savings and loan association for a definite period of time and earning a specified return. Certificates of deposit may also include those issued by foreign banks outside the United States (U.S.) with total assets at
the time of purchase in excess of the equivalent of $1 billion. Such certificates of deposit include Eurodollar and Yankee certificates of deposits. Eurodollar certificates of deposit are U.S. dollar-denominated certificates of deposit issued by
branches of foreign and domestic banks located outside the U.S. Yankee certificates of deposit are certificates of deposit issued by a U.S. branch of a foreign bank denominated in U.S. dollars and held in the U.S. Certain Funds may also invest in
obligations (including bankers acceptances and certificates of deposit) denominated in foreign currencies (see Foreign Investments (including Foreign Currencies)) herein. To be eligible for purchase by a Fund, a certificate of
deposit must be issued by (i) a domestic or foreign branch of a U.S. commercial bank which is a member of the Federal Reserve System or the deposits of which are insured by the Federal Deposit Insurance Corporation, or (ii) a domestic
savings and loan association, the deposits of which are insured by the Federal Deposit Insurance Corporation provided that, in each case, at the time of purchase, such institution has total assets in excess of $1 billion (as of the date of their
most recently published financial statements).
Time deposits are interest-bearing non-negotiable deposits at a bank or a
savings and loan association that have a specific maturity date. A time deposit earns a specific rate of interest over a definite period of time. Time deposits cannot be traded on the secondary market and those exceeding seven days and with a
withdrawal penalty are considered to be illiquid. Time deposits will be maintained only at banks and savings and loan associations from which a Fund could purchase certificates of deposit.
The Funds will not invest in obligations for which a Funds Adviser, or any of its affiliated persons, is the ultimate obligor or
accepting bank, provided, however, that the Funds maintain demand deposits at their affiliated custodian, JPMorgan Chase Bank.
Subject to the Funds limitations on concentration in a particular industry, there is no limitation on the amount of a Funds
assets which may be invested in obligations of banks which meet the conditions set forth herein.
Commercial
Paper
Commercial paper is defined as short-term obligations with maturities from 1 to 270 days issued by banks or bank
holding companies, corporations and finance companies. Although commercial paper is generally unsecured, the Funds may also purchase secured commercial paper. In the event of a default of an issuer of secured commercial paper, a Fund may hold the
securities and other investments that were pledged as collateral even if it does not invest in such securities or investments. In such a case, the Fund would take steps to dispose of such securities or investments in a commercially reasonable
manner. Commercial paper includes master demand obligations. See Variable and Floating Rate Instruments below.
Certain Funds may also invest in Canadian commercial paper, which is commercial paper issued by a Canadian corporation or a Canadian
counterpart of a U.S. corporation, and in Europaper, which is U.S. dollar denominated commercial paper of a foreign issuer. See Risk Factors of Foreign Investments below.
Convertible Securities
Certain Funds may
invest in convertible securities. Convertible securities include any debt securities or preferred stock which may be converted into common stock or which carry the right to purchase common stock. Generally, convertible securities entitle the holder
to exchange the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period of time.
The terms of any convertible security determine its ranking in a companys capital structure. In the case of subordinated convertible debentures, the holders claims on assets and earnings are
subordinated to the claims of other creditors, and are senior to the claims of preferred and common shareholders. In the case of convertible preferred stock, the holders claims on assets and earnings are subordinated to the claims of all
creditors and are senior to the claims of common shareholders.
Convertible securities have characteristics similar to both
debt and equity securities. Due to the conversion feature, the market value of convertible securities tends to move together with the market value of the underlying common stock. As a result, selection of convertible securities, to a great extent,
is based on the potential for capital appreciation that may exist in the underlying stock. The value of convertible securities is also affected by prevailing interest rates, the credit quality of the issuer, and any call provisions. In some cases,
the issuer may cause a convertible security to convert to common stock. In other situations, it may be advantageous for a Fund to cause the
Part II - 3
conversion of convertible securities to common stock. If a convertible security converts to common stock, a Fund may hold such common stock in its portfolio even if it does not ordinarily invest
in common stock.
Custodial Receipts
Certain Funds may acquire securities in the form of custodial receipts that evidence ownership of future interest payments, principal
payments or both on certain U.S. Treasury notes or bonds in connection with programs sponsored by banks and brokerage firms. These are not considered U.S. government securities and are not backed by the full faith and credit of the U.S. government.
These notes and bonds are held in custody by a bank on behalf of the owners of the receipts.
Debt Instruments
Below Investment Grade Securities.
Securities that were rated investment grade at the
time of purchase may subsequently be rated below investment grade (BB+ or lower by S&P and Bal or lower by Moodys). Certain Funds that do not invest in below investment grade securities as a main investment strategy may nonetheless
continue to hold such securities if the Adviser believes it is advantageous for the Fund to do so. The high degree of risk involved in these investments can result in substantial or total losses. These securities are subject to greater risk of loss,
greater sensitivity to interest rate and economic changes, valuation difficulties, and a potential lack of a secondary or public market for securities. The market price of these securities also can change suddenly and unexpectedly.
Corporate Debt Securities
.
Corporate debt securities may include bonds and other debt
securities of U.S. and non-U.S. issuers, including obligations of industrial, utility, banking and other corporate issuers. All debt securities are subject to the risk of an issuers inability to meet principal and interest payments on the
obligation and may also be subject to price volatility due to such factors as market interest rates, market perception of the creditworthiness of the issuer and general market liquidity.
High Yield/High Risk Securities/Junk Bonds
.
Certain Funds may invest in high yield securities,
to varying degrees. High yield, high risk bonds are securities that are generally rated below investment grade by the primary rating agencies (BB+ or lower by S&P and Bal or lower by Moodys) or unrated but determined by the Funds
Adviser to be of comparable quality. Other terms used to describe such securities include lower rated bonds, non-investment grade bonds, below investment grade bonds, and junk bonds. These securities
are considered to be high-risk investments.
High yield securities are regarded as predominately speculative. There is a
greater risk that issuers of lower rated securities will default than issuers of higher rated securities. Issuers of lower rated securities generally are less creditworthy and may be highly indebted, financially distressed, or bankrupt. These
issuers are more vulnerable to real or perceived economic changes, political changes or adverse industry developments. In addition, high yield securities are frequently subordinated to the prior payment of senior indebtedness. If an issuer fails to
pay principal or interest, a Fund would experience a decrease in income and a decline in the market value of its investments. A Fund may also incur additional expenses in seeking recovery from the issuer.
The income and market value of lower rated securities may fluctuate more than higher rated securities. Non-investment grade securities are
more sensitive to short-term corporate, economic and market developments. During periods of economic uncertainty and change, the market price of the investments in lower rated securities may be volatile. The default rate for high yield bonds tends
to be cyclical, with defaults rising in periods of economic downturn.
It is often more difficult to value lower rated
securities than higher rated securities. If an issuers financial condition deteriorates, accurate financial and business information may be limited or unavailable. The lower rated investments may be thinly traded and there may be no
established secondary market. Because of the lack of market pricing and current information for investments in lower rated securities, valuation of such investments is much more dependent on the judgment of the Adviser than is the case with higher
rated securities. In addition, relatively few institutional purchasers may hold a major portion of an issue of lower-rated securities at times. As a result, a Fund that invests in lower rated securities may be required to sell investments at
substantial losses or retain them indefinitely even where an issuers financial condition is deteriorating.
Credit
quality of non-investment grade securities can change suddenly and unexpectedly, and even recently issued credit ratings may not fully reflect the actual risks posed by a particular high-yield security.
Part II - 4
Future legislation may have a possible negative impact on the market for high yield, high
risk bonds. As an example, in the late 1980s, legislation required federally-insured savings and loan associations to divest their investments in high yield, high risk bonds. New legislation, if enacted, could have a material negative effect
on a Funds investments in lower rated securities.
Inflation-Linked Debt
Securities
.
Inflation-linked securities include fixed and floating rate debt securities of varying maturities issued by the U.S. government, its agencies and instrumentalities, such as Treasury Inflation-Protected Securities
(TIPS), as well as securities issued by other entities such as corporations, municipalities, foreign governments and foreign issuers, including foreign issuers from emerging markets. See also Foreign Investments (including Foreign
Currencies). Typically, such securities are structured as fixed income investments whose principal value is periodically adjusted according to the rate of inflation. The following two structures are common: (i) the U.S. Treasury and some
other issuers issue inflation-linked securities that accrue inflation into the principal value of the security and (ii) other issuers may pay out the Consumer Price Index (CPI) accruals as part of a semi-annual coupon. Other types
of inflation-linked securities exist which use an inflation index other than the CPI.
Inflation-linked securities issued by
the U.S. Treasury, such as TIPS, have maturities of approximately five, ten or thirty years, although it is possible that securities with other maturities will be issued in the future. Typically, TIPS pay interest on a semi-annual basis equal to a
fixed percentage of the inflation-adjusted principal amount. For example, if a Fund purchased an inflation-indexed bond with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5% semi-annually), and the rate of inflation over the
first six months was 1%, the mid-year par value of the bond would be $1,010 and the first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If inflation during the second half of the year resulted in the whole years inflation
of 3%, the end-of-year par value of the bond would be $1,030 and the second semi-annual interest payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal value of inflation-indexed bonds will be adjusted downward, and consequently the interest payable on these securities (calculated
with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of TIPS, even during a period of deflation, although the inflation-adjusted
principal received could be less than the inflation-adjusted principal that had accrued to the bond at the time of purchase. However, the current market value of the bonds is not guaranteed and will fluctuate. Other inflation-related bonds exist
which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal.
The value of inflation-linked securities is expected to change in response to changes in real interest rates. Real interest rates in turn
are tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if the rate of inflation rises at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of
inflation-linked securities.
While inflation-linked securities are expected to be protected from long-term inflationary
trends, short-term increases in inflation may lead to a decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the
extent that the increase is not reflected in the bonds inflation measure.
The periodic adjustment of U.S.
inflation-linked securities is tied to the Consumer Price Index for All Urban Consumers (CPI-U), which is not seasonably adjusted and which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of
changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-linked securities issued by a foreign government are generally adjusted to reflect a comparable inflation index calculated by that
government. There can be no assurance that the CPI-U or a foreign inflation index will accurately measure the real rate of inflation in the prices of goods and services. Moreover, there can be no assurance that the rate of inflation in a foreign
country will be correlated to the rate of inflation in the U.S.
Any increase in the principal amount of an inflation-linked
security will be considered taxable ordinary income, even though investors do not receive their principal until maturity.
Variable and Floating Rate Instruments
.
Certain obligations purchased by the Funds may carry variable or floating rates of interest, may involve a conditional or unconditional demand feature and may include variable amount master
demand notes. Variable and floating rate instruments are issued by a wide variety of issuers and may be issued for a wide variety of purposes, including as a method of reconstructing cash flows.
Part II - 5
Subject to their investment objective policies and restrictions, certain Funds may acquire
variable and floating rate instruments. A variable rate instrument is one whose terms provide for the adjustment of its interest rate on set dates and which, upon such adjustment, can reasonably be expected to have a market value that approximates
its par value. Certain Funds may purchase extendable commercial notes. Extendable commercial notes are variable rate notes which normally mature within a short period of time (e.g., 1 month) but which may be extended by the issuer for a maximum
maturity of thirteen months.
A floating rate instrument is one whose terms provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can reasonably be expected to have a market value that approximates its par value. Floating rate instruments are frequently not rated by credit rating agencies; however, unrated
variable and floating rate instruments purchased by a Fund will be determined by the Funds Adviser to be of comparable quality at the time of purchase to rated instruments eligible for purchase under the Funds investment policies. In
making such determinations, a Funds Adviser will consider the earning power, cash flow and other liquidity ratios of the issuers of such instruments (such issuers include financial, merchandising, bank holding and other companies) and will
continuously monitor their financial condition. There may be no active secondary market with respect to a particular variable or floating rate instrument purchased by a Fund. The absence of such an active secondary market could make it difficult for
the Fund to dispose of the variable or floating rate instrument involved in the event the issuer of the instrument defaulted on its payment obligations, and the Fund could, for this or other reasons, suffer a loss to the extent of the default.
Variable or floating rate instruments may be secured by bank letters of credit or other assets. A Fund may purchase a variable or floating rate instrument to facilitate portfolio liquidity or to permit investment of the Funds assets at a
favorable rate of return.
As a result of the floating and variable rate nature of these investments, the Funds yields
may decline, and they may forego the opportunity for capital appreciation during periods when interest rates decline; however, during periods when interest rates increase, the Funds yields may increase, and they may have reduced risk of
capital depreciation.
Past periods of high inflation, together with the fiscal measures adopted to attempt to deal with it,
have seen wide fluctuations in interest rates, particularly prime rates charged by banks. While the value of the underlying floating or variable rate securities may change with changes in interest rates generally, the nature of the
underlying floating or variable rate should minimize changes in value of the instruments. Accordingly, as interest rates decrease or increase, the potential for capital appreciation and the risk of potential capital depreciation is less than would
be the case with a portfolio of fixed rate securities. A Funds portfolio may contain floating or variable rate securities on which stated minimum or maximum rates, or maximum rates set by state law limit the degree to which interest on such
floating or variable rate securities may fluctuate; to the extent it does, increases or decreases in value may be somewhat greater than would be the case without such limits. Because the adjustment of interest rates on the floating or variable rate
securities is made in relation to movements of the applicable banks prime rates or other short-term rate securities adjustment indices, the floating or variable rate securities are not comparable to long-term fixed rate securities.
Accordingly, interest rates on the floating or variable rate securities may be higher or lower than current market rates for fixed rate obligations of comparable quality with similar maturities.
Variable Amount Master Notes.
Variable amount master notes are notes, which may possess a demand feature, that permit the
indebtedness to vary and provide for periodic adjustments in the interest rate according to the terms of the instrument. Variable amount master notes may not be secured by collateral. To the extent that variable amount master notes are secured by
collateral, they are subject to the risks described under the section Loan Assignments and Participations-Collateral and Subordination Risk.
Because master notes are direct lending arrangements between a Fund and the issuer of the notes, they are not normally traded. Although there is no secondary market in the notes, a Fund may demand payment
of principal and accrued interest. If the Fund is not repaid such principal and accrued interest, the Fund may not be able to dispose of the notes due to the lack of a secondary market.
While master notes are not typically rated by credit rating agencies, issuers of variable amount master notes (which are normally
manufacturing, retail, financial, brokerage, investment banking and other business concerns) must satisfy the same criteria as those set forth with respect to commercial paper, if any, in Part I of this SAI under the heading Diversification
and Quality Descriptions. A Funds Adviser will consider the credit risk of the issuers of such notes, including its earning power, cash flow, and other liquidity ratios of such issuers and will continuously monitor their financial status
and ability to meet payment on demand. In determining average weighted portfolio maturity, a variable amount master note will be deemed to have a maturity equal to the period of time remaining until the principal amount can be recovered from the
issuer.
Part II - 6
Variable Rate Instruments and Money Market Funds
. Variable or floating rate
instruments with stated maturities of more than 397 days may, under the SECs amortized cost rule applicable to money market funds, Rule 2a-7 under the 1940 Act, be deemed to have shorter maturities (other than in connection with the
calculation of dollar-weighted average life to maturity of a portfolio) as follows:
(1)
Adjustable Rate
Government Securities.
A Government Security which is a variable rate security where the variable rate of interest is readjusted no less frequently than every 397 days shall be deemed to have a maturity equal to the period remaining until the
next readjustment of the interest rate. A Government Security which is a floating rate security shall be deemed to have a remaining maturity of one day.
(2)
Short-Term Variable Rate Securities.
A variable rate security, the principal amount of which, in accordance with the terms of the security, must unconditionally be paid in 397 calendar days or
less shall be deemed to have maturity equal to the earlier of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand.
(3)
Long-Term Variable Rate Securities.
A variable rate security, the principal amount of which is scheduled to be
paid in more than 397 days, that is subject to a demand feature shall be deemed to have a maturity equal to the longer of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be
recovered through demand.
(4)
Short-Term Floating Rate Securities.
A floating rate security, the
principal amount of which, in accordance with the terms of the security, must unconditionally be paid in 397 calendar days or less shall be deemed to have a maturity of one day.
(5)
Long-Term Floating Rate Securities.
A floating rate security, the principal amount of which is scheduled to be
paid in more than 397 days, that is subject to a demand feature, shall be deemed to have a maturity equal to the period remaining until the principal amount can be recovered through demand.
As used above, a note is subject to a demand feature where the Fund is entitled to receive the principal amount of the note
either at any time on no more than 30 days notice or at specified intervals not exceeding 397 calendar days and upon no more than 30 days notice.
Limitations on the Use of Variable and Floating Rate Notes.
Variable and floating rate instruments for which no readily available market exists (e.g., illiquid securities) will be purchased in an
amount which, together with securities with legal or contractual restrictions on resale or for which no readily available market exists (including repurchase agreements providing for settlement more than seven days after notice), exceeds 15% of a
Funds net assets (5% of total assets for the J.P. Morgan Funds which are money market funds (the Money Market Funds)) only if such instruments are subject to a demand feature that will permit the Fund to demand payment of the
principal within seven days after demand by the Fund. There is no limit on the extent to which a Fund may purchase demand instruments that are not illiquid or deemed to be liquid in accordance with the Advisers liquidity determination
procedures (except, with regard to the Money Market Funds, as provided under Rule 2a-7). If not rated, such instruments must be found by the Funds Adviser to be of comparable quality to instruments in which a Fund may invest. A rating may be
relied upon only if it is provided by an NRSRO that is not affiliated with the issuer or guarantor of the instruments.
Zero-Coupon
,
Pay-in-Kind and Deferred Payment Securities
.
Zero-coupon securities are securities that are sold at a discount to par value and on which interest payments are not made during the life of the security. Upon
maturity, the holder is entitled to receive the par value of the security. Pay-in-kind securities are securities that have interest payable by delivery of additional securities. Upon maturity, the holder is entitled to receive the aggregate par
value of the securities. A Fund accrues income with respect to zero-coupon and pay-in-kind securities prior to the receipt of cash payments. Deferred payment securities are securities that remain zero-coupon securities until a predetermined date, at
which time the stated coupon rate becomes effective and interest becomes payable at regular intervals. While interest payments are not made on such securities, holders of such securities are deemed to have received phantom income.
Because a Fund will distribute phantom income to shareholders, to the extent that shareholders elect to receive dividends in cash rather than reinvesting such dividends in additional shares, the applicable Fund will have fewer assets
with which to purchase income-producing securities. Zero-coupon, pay-in-kind and deferred payment securities may be subject to greater fluctuation in value and lesser liquidity in the event of adverse market conditions than comparably rated
securities paying cash interest at regular interest payment periods.
Part II - 7
Demand Features
Certain Funds may acquire securities that are subject to puts and standby commitments (Demand Features) to purchase the
securities at their principal amount (usually with accrued interest) within a fixed period (usually seven days) following a demand by the Fund. The Demand Feature may be issued by the issuer of the underlying securities, a dealer in the securities
or by another third party and may not be transferred separately from the underlying security. The underlying securities subject to a put may be sold at any time at market rates. Applicable Funds expect that they will acquire puts only where the puts
are available without the payment of any direct or indirect consideration. However, if advisable or necessary, a premium may be paid for put features. A premium paid will have the effect of reducing the yield otherwise payable on the underlying
security. Demand Features provided by foreign banks involve certain risks associated with foreign investments. See Foreign Investments (including Foreign Currencies) for more information on these risks.
Under a stand-by commitment, a dealer would agree to purchase, at a Funds option, specified securities at a specified
price. A Fund will acquire these commitments solely to facilitate portfolio liquidity and does not intend to exercise its rights thereunder for trading purposes. Stand-by commitments may also be referred to as put options.
The purpose of engaging in transactions involving puts is to maintain flexibility and liquidity to permit a Fund to meet redemption
requests and remain as fully invested as possible.
Equity Securities, Warrants and Rights
Common Stock
.
Common stock represents a share of ownership in a company and usually carries
voting rights and may earn dividends. Unlike preferred stock, common stock dividends are not fixed but are declared at the discretion of the issuers board of directors. Common stock occupies the most junior position in a companys capital
structure. As with all equity securities, the price of common stock fluctuates based on changes in a companys financial condition and overall market and economic conditions.
Common Stock Warrants and Rights
.
Common stock warrants entitle the holder to buy common stock
from the issuer of the warrant at a specific price (the strike price) for a specific period of time. The market price of warrants may be substantially lower than the current market price of the underlying common stock, yet warrants are
subject to similar price fluctuations. As a result, warrants may be more volatile investments than the underlying common stock. If a warrant is exercised, a Fund may hold common stock in its portfolio even if it does not ordinarily invest in common
stock.
Rights are similar to warrants but normally have a shorter duration and are typically distributed directly by the
issuers to existing shareholders, while warrants are typically attached to new debt or preferred stock issuances.
Warrants and
rights generally do not entitle the holder to dividends or voting rights with respect to the underlying common stock and do not represent any rights in the assets of the issuer company. Warrants and rights will expire if not exercised on or prior to
the expiration date.
Preferred Stock
.
Preferred stock is a class of stock that
generally pays dividends at a specified rate and has preference over common stock in the payment of dividends and liquidation. Preferred stock generally does not carry voting rights. As with all equity securities, the price of preferred stock
fluctuates based on changes in a companys financial condition and on overall market and economic conditions.
Initial Public Offerings (IPOs
)
.
The Funds may purchase securities in IPOs. These securities are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs
have no trading history, and information about the companies may be available for very limited periods. The prices of securities sold in IPOs may be highly volatile. At any particular time or from time to time, a Fund may not be able to invest in
securities issued in IPOs, or invest to the extent desired, because, for example, only a small portion (if any) of the securities being offered in an IPO may be made available to the Fund. In addition, under certain market conditions, a relatively
small number of companies may issue securities in IPOs. Similarly, as the number of Funds to which IPO securities are allocated increases, the number of securities issued to any one Fund may decrease. The investment performance of a Fund during
periods when it is unable to invest significantly or at all in IPOs may be lower than during periods when the Fund is able to do so. In addition, as a Fund increases in size, the impact of IPOs on the Funds performance will generally decrease.
Foreign Investments (including Foreign Currencies)
Some of the Funds may invest in certain obligations or securities of foreign issuers. For purposes of a non-Money Market Funds
investment policies and unless described otherwise in a Funds prospectus, an issuer of a
Part II - 8
security will be deemed to be located in a particular country if: (i) the principal trading market for the security is in such country, (ii) the issuer is organized under the laws of
such country or (iii) the issuer derives at least 50% of its revenues or profits from such country or has at least 50% of its total assets situated in such country. Possible investments include equity securities and debt securities (e.g., bonds
and commercial paper) of foreign entities, obligations of foreign branches of U.S. banks and of foreign banks, including, without limitation, Eurodollar Certificates of Deposit, Eurodollar Time Deposits, Eurodollar Bankers Acceptances,
Canadian Time Deposits and Yankee Certificates of Deposit, and investments in Canadian Commercial Paper, and Europaper. Securities of foreign issuers may include sponsored and unsponsored American Depositary Receipts (ADRs), European
Depositary Receipts (EDRs), and Global Depositary Receipts (GDRs). Sponsored ADRs are listed on the New York Stock Exchange; unsponsored ADRs are not. Therefore, there may be less information available about the issuers of
unsponsored ADRs than the issuers of sponsored ADRs. Unsponsored ADRs are restricted securities. EDRs and GDRs are not listed on the New York Stock Exchange. As a result, it may be difficult to obtain information about EDRs and GDRs.
The Money Market Funds may only invest in U.S. dollar-denominated securities.
Risk Factors of Foreign Investments.
The following is a summary of certain risks associated with
foreign investments:
Political and Exchange Risks.
Foreign investments may subject a Fund to investment risks that
differ in some respects from those related to investments in obligations of U.S. domestic issuers. Such risks include potential future adverse political and economic developments, possible imposition of withholding taxes on interest or other income,
possible seizure, nationalization or expropriation of foreign deposits, possible establishment of exchange controls or taxation at the source, greater fluctuations in value due to changes in exchange rates, or the adoption of other foreign
governmental restrictions which might adversely affect the payment of principal and interest on such obligations.
Higher
Transaction Costs.
Foreign investments may entail higher custodial fees and sales commissions than domestic investments.
Accounting and Regulatory Differences.
Foreign issuers of securities or obligations are often subject to accounting treatment and
engage in business practices different from those of domestic issuers of similar securities or obligations. In addition, foreign issuers are usually not subject to the same degree of regulation as domestic issuers, and their securities may trade on
relatively small markets, causing their securities to experience potentially higher volatility and more limited liquidity than securities of domestic issuers. Foreign branches of U.S. banks and foreign banks are not regulated by U.S. banking
authorities and may be subject to less stringent reserve requirements than those applicable to domestic branches of U.S. banks. In addition, foreign banks generally are not bound by accounting, auditing, and financial reporting standards comparable
to those applicable to U.S. banks. Dividends and interest paid by foreign issuers may be subject to withholding and other foreign taxes which may decrease the net return on foreign investments as compared to dividends and interest paid to a Fund by
domestic companies.
Currency Risk.
Foreign securities may be denominated in foreign currencies, although foreign
issuers may also issue securities denominated in U.S. dollars. The value of a Funds investments denominated in foreign currencies and any funds held in foreign currencies will be affected by changes in currency exchange rates, the relative
strength of those currencies and the U.S. dollar, and exchange-control regulations. Changes in the foreign currency exchange rates also may affect the value of dividends and interest earned, gains and losses realized on the sale of securities and
net investment income and gains, if any, to be distributed to shareholders by a Fund. The exchange rates between the U.S. dollar and other currencies are determined by the forces of supply and demand in foreign exchange markets. Accordingly, the
ability of a Fund that invests in foreign securities as part of its principal investment strategy to achieve its investment objective may depend, to a certain extent, on exchange rate movements. In addition, while the volume of transactions effected
on foreign stock exchanges has increased in recent years, in most cases it remains appreciably below that of domestic securities exchanges. Accordingly, a Funds foreign investments may be less liquid and their prices may be more volatile than
comparable investments in securities of U.S. companies. In buying and selling securities on foreign exchanges, purchasers normally pay fixed commissions that are generally higher than the negotiated commissions charged in the U.S. In addition, there
is generally less government supervision and regulation of securities exchanges, brokers and issuers located in foreign countries than in the U.S.
Settlement Risk.
The settlement periods for foreign securities and instruments are often longer than those for securities or obligations of U.S. issuers or instruments denominated in U.S. dollars.
Delayed settlement may affect
Part II - 9
the liquidity of a Funds holdings. Certain types of securities and other instruments are not traded delivery versus payment in certain markets (e.g., government bonds in Russia)
meaning that a Fund may deliver securities or instruments before payment is received from the counterparty. In such markets, the Fund may not receive timely payment for securities or other instruments it has delivered and may be subject to increased
risk that the counterparty will fail to make payments when due or default completely.
Brady
Bonds.
Brady bonds are securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings. Brady bonds have been issued since
1989. In light of the history of defaults of countries issuing Brady bonds on their commercial bank loans, investments in Brady bonds may be viewed as speculative and subject to the same risks as emerging market securities. Brady bonds may be fully
or partially collateralized or uncollateralized, are issued in various currencies (but primarily the U.S. dollar) and are actively traded in over-the-counter (OTC) secondary markets. Incomplete collateralization of interest or principal
payment obligations results in increased credit risk. Dollar-denominated collateralized Brady bonds, which may be either fixed-rate or floating rate bonds, are generally collateralized by U.S. Treasury securities.
Obligations of Supranational Entities.
Obligations of supranational entities include securities
designated or supported by governmental entities to promote economic reconstruction or development of international banking institutions and related government agencies. Examples include the International Bank for Reconstruction and Development (the
World Bank), the European Coal and Steel Community, the Asian Development Bank and the Inter-American Development Bank. Each supranational entitys lending activities are limited to a percentage of its total capital (including
callable capital contributed by its governmental members at the entitys call), reserves and net income. There is no assurance that participating governments will be able or willing to honor their commitments to make capital
contributions to a supranational entity.
Emerging Market Securities.
Investing in
companies domiciled in emerging market countries may be subject to potentially higher risks than investments in developed countries. These risks include: (i) less social, political, and economic stability; (ii) greater illiquidity and
price volatility due to smaller or limited local capital markets for such securities, or low non-existent trading volumes; (iii) less scrutiny and regulation by local authorities of the foreign exchanges and broker-dealers; (iv) the
seizure or confiscation by local governments of securities held by foreign investors, and the possible suspension or limiting by local governments of an issuers ability to make dividend or interest payments; (v) limiting or entirely
restricting repatriation of invested capital, profits, and dividends by local governments; (vi) possible local taxation of capital gains, including on a retroactive basis; (vii) the attempt by issuers facing restrictions on dollar or euro
payments imposed by local governments to make dividend or interest payments to foreign investors in the local currency; (viii) difficulty in enforcing legal claims related to the securities and/or local judges favoring the interests of the
issuer over those of foreign investors; (ix) bankruptcy judgments being paid in the local currency; (x) greater difficulty in determining market valuations of the securities due to limited public information regarding the issuer, and
(xi) difficulty of ascertaining the financial health of an issuer due to lax financial reporting on a regular basis, substandard disclosure and differences in accounting standards.
Emerging country securities markets are typically marked by a high concentration of market capitalization and trading volume in a small
number of issuers representing a limited number of industries, as well as a high concentration of ownership of such securities by a limited number of investors. Although some emerging markets have become more established and tend to issue securities
of higher credit quality, the markets for securities in other emerging countries are in the earliest stages of their development, and these countries issue securities across the credit spectrum. Even the markets for relatively widely traded
securities in emerging countries may not be able to absorb, without price disruptions, a significant increase in trading volume or trades of a size customarily undertaken by institutional investors in the securities markets of developed countries.
The limited size of many of these securities markets can cause prices to be erratic for reasons apart from factors that affect the soundness and competitiveness of the securities issuers. For example, prices may be unduly influenced by traders who
control large positions in these markets. Additionally, market making and arbitrage activities are generally less extensive in such markets, which may contribute to increased volatility and reduced liquidity of such markets. The limited liquidity of
emerging country securities may also affect a Funds ability to accurately value its portfolio securities or to acquire or dispose of securities at the price and time it wishes to do so or in order to meet redemption requests.
Many emerging market countries suffer from uncertainty and corruption in their legal frameworks. Legislation may be difficult to interpret
and laws may be too new to provide any precedential value. Laws regarding foreign investment and private property may be weak or non-existent. Sudden changes in governments may result in policies which are less favorable to investors, such as
policies designed to expropriate or nationalize sovereign assets.
Part II - 10
Certain emerging market countries in the past have expropriated large amounts of private property, in many cases with little or no compensation, and there can be no assurance that such
expropriation will not occur in the future.
Foreign investment in the securities markets of certain emerging countries is
restricted or controlled to varying degrees. These restrictions may limit a Funds investment in certain emerging countries and may increase the expenses of the Fund. Certain emerging countries require governmental approval prior to investments
by foreign persons or limit investment by foreign persons to only a specified percentage of an issuers outstanding securities or to a specific class of securities, which may have less advantageous terms (including price) than securities of the
company available for purchase by nationals.
Many developing countries lack the social, political, and economic stability
characteristic of the U.S. Political instability among emerging market countries can be common and may be caused by an uneven distribution of wealth, social unrest, labor strikes, civil wars, and religious oppression. Economic instability in
emerging market countries may take the form of: (i) high interest rates; (ii) high levels of inflation, including hyperinflation; (iii) high levels of unemployment or underemployment; (iv) changes in government economic and tax
policies, including confiscatory taxation; and (v) imposition of trade barriers.
Currencies of emerging market countries
are subject to significantly greater risks than currencies of developed countries. Many emerging market countries have experienced steady declines or even sudden devaluations of their currencies relative to the U.S. dollar. Some emerging market
currencies may not be internationally traded or may be subject to strict controls by local governments, resulting in undervalued or overvalued currencies.
Some emerging market countries have experienced balance of payment deficits and shortages in foreign exchange reserves. Governments have responded by restricting currency conversions. Future restrictive
exchange controls could prevent or restrict a companys ability to make dividend or interest payments in the original currency of the obligation (usually U.S. dollars). In addition, even though the currencies of some emerging market countries
may be convertible into U.S. dollars, the conversion rates may be artificial to their actual market values.
A Funds
income and, in some cases, capital gains from foreign stocks and securities will be subject to applicable taxation in certain of the countries in which it invests, and treaties between the U.S. and such countries may not be available in some cases
to reduce the otherwise applicable tax rates. Foreign markets also have different clearance and settlement procedures, and in certain markets there have been times when settlements have been unable to keep pace with the volume of securities
transactions, making it difficult to conduct such transactions. Such delays in settlement could result in temporary periods when a portion of the assets of a Fund remains uninvested and no return is earned on such assets. The inability of the Fund
to make intended security purchases or sales due to settlement problems could result either in losses to the Fund due to subsequent declines in value of the portfolio securities, in the Fund deeming those securities to be illiquid, or, if the Fund
has entered into a contract to sell the securities, in possible liability to the purchaser.
In the past, governments within
the emerging markets have become overly reliant on the international capital markets and other forms of foreign credit to finance large public spending programs which cause huge budget deficits. Often, interest payments have become too overwhelming
for a government to meet, representing a large percentage of total GDP. These foreign obligations have become the subject of political debate and have served as fuel for political parties of the opposition, which pressure the government not to make
payments to foreign creditors, but instead to use these funds for social programs. Either due to an inability to pay or submission to political pressure, foreign governments have been forced to seek a restructuring of their loan and/or bond
obligations, have declared a temporary suspension of interest payments or have defaulted. These events have adversely affected the values of securities issued by foreign governments and corporations domiciled in emerging market countries and have
negatively affected not only their cost of borrowing, but their ability to borrow in the future as well.
Risks of Particular Markets Russia.
Investing in Russian securities is highly speculative and
involves significant risks and special considerations not typically associated with investing in the securities markets of the U.S. and most other developed countries.
Over the past century, Russia has experienced political, social and economic turbulence and has endured decades of
communist rule under which the property of tens of millions of its citizens was collectivized into state agricultural and industrial enterprises. Since the collapse of the Soviet Union, Russias government has been faced with the daunting task
of stabilizing its domestic economy, while transforming it into a modern and efficient structure able to compete in international markets and respond to the needs of its citizens. However, to date, many of the countrys economic reform
initiatives have floundered as the proceeds of the International Monetary Fund and other economic assistance have been squandered or stolen. In this environment, there is always the risk that the nations government will abandon the current
program of economic reform and replace
Part II - 11
it with radically different political and economic policies that would be detrimental to the interests of foreign investors. This could entail a return to a centrally planned economy and
nationalization of private enterprises similar to what existed in the Soviet Union. Many of Russias businesses have failed to mobilize the available factors of production because the countrys privatization program virtually ensured the
predominance of the old management teams that are largely non-market oriented in their management approach. Poor accounting standards, inept management, pervasive corruption, insider trading and crime, and inadequate regulatory protection for the
rights of investors all pose a significant risk, particularly to foreign investors. In addition, there is the risk that the Russian tax system will not be reformed to prevent inconsistent, retroactive, and/or exorbitant taxation, or, in the
alternative, the risk that a reformed tax system may result in the inconsistent and unpredictable enforcement of the new tax laws.
Compared to most national stock markets, the Russian securities market suffers from a variety of problems not encountered in more developed markets. There is little long-term historical data on the
Russian securities market because it is relatively new and a substantial proportion of securities transactions in Russia are privately negotiated outside of stock exchanges. The inexperience of the Russian securities market and the limited volume of
trading in securities in the market may make obtaining accurate prices on portfolio securities from independent sources more difficult than in more developed markets. Additionally, because of less stringent auditing and financial reporting standards
that apply to U.S. companies, there is little solid corporate information available to investors. As a result, it may be difficult to assess the value or prospects of an investment in Russian companies. Stocks of Russian companies also may
experience greater price volatility than stocks of U.S. companies.
Because of the recent formation of the
Russian securities market as well as the underdeveloped state of the banking and telecommunications systems, settlement, clearing and registration of securities transactions are subject to significant risks. Ownership of shares (except where shares
are held through depositories that meet the requirements of the 1940 Act) is defined according to entries in a companys share register and is normally evidenced by extracts from the register or by formal share certificates. However, there is
no central registration system for shareholders and these services are carried out by the companies themselves or by registrars located throughout Russia. These registrars are not necessarily subject to effective state supervision nor are they
licensed with any governmental entity and it is possible for a Fund to lose ownership of its securities through fraud, negligence, or even mere oversight. While the Fund will endeavor to ensure that its interest continues to be appropriately
recorded either itself or through a custodian or other agent inspecting the share register and by obtaining extracts of share registers through regular confirmations, these extracts have no legal enforceability and it is possible that subsequent
illegal amendment or other fraudulent act may deprive the Fund of its ownership rights or improperly dilute its interests. In addition, while applicable Russian regulations impose liability on registrars for losses resulting from their errors, it
may be difficult for the Fund to enforce any rights it may have against the registrar or issuer of the securities in the event of loss of share registration. Furthermore, significant delays or problems may occur in registering the transfer of
securities, which could cause a Fund to incur losses due to a counterpartys failure to pay for securities the Fund has delivered or the Funds inability to complete its contractual obligations because of theft or other reasons. A Fund
also may experience difficulty in obtaining and/or enforcing judgments in Russia.
The Russian economy is
heavily dependent upon the export of a range of commodities including most industrial metals, forestry products, oil, and gas. Accordingly, it is strongly affected by international commodity prices and is particularly vulnerable to any weakening in
global demand for these products.
Foreign investors also face a high degree of currency risk when investing in
Russian securities and a lack of available currency hedging instruments. In a surprise move in August 1998, Russia devalued the ruble, defaulted on short-term domestic bonds, and imposed a moratorium on the repayment of its international debt and
the restructuring of the repayment terms. These actions have negatively affected Russian borrowers ability to access international capital markets and have had a damaging impact on the Russian economy. In light of these and other government
actions, foreign investors face the possibility of further devaluations. In addition, there is a risk that the government may impose capital controls on foreign portfolio investments in the event of extreme financial or political crisis. Such
capital controls would prevent the sale of a portfolio of foreign assets and the repatriation of investment income and capital. The current economic turmoil in Russia and the effects on the current global economic crisis on the Russian economy may
cause flight from the Russian ruble into U.S. dollars and other currencies, which could force the Russian central bank to spend reserves to maintain the value of the ruble. If the Russian central bank falters in its defense of the ruble, there could
be additional pressure on Russias banks and its currency.
Part II - 12
Terrorism and related geo-political risks have led, and may in the future
lead, to increased short-term market volatility and may have adverse long-term effects on world economies and markets generally.
Sovereign Obligations.
Sovereign debt includes investments in securities issued or guaranteed by a
foreign sovereign government or its agencies, authorities or political subdivisions. An investment in sovereign debt obligations involves special risks not present in corporate debt obligations. The issuer of the sovereign debt or the governmental
authorities that control the repayment of the debt may be unable or unwilling to repay principal or interest when due, and a Fund may have limited recourse in the event of a default. During periods of economic uncertainty, the market prices of
sovereign debt, and the Funds NAV, may be more volatile than prices of U.S. debt obligations. In the past, certain emerging markets have encountered difficulties in servicing their debt obligations, withheld payments of principal and interest
and declared moratoria on the payment of principal and interest on their sovereign debts.
A sovereign debtors
willingness or ability to repay principal and pay interest in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign currency reserves, the availability of sufficient foreign exchange, the
relative size of the debt service burden, the sovereign debtors policy toward principal international lenders and local political constraints. Sovereign debtors may also be dependent on expected disbursements from foreign governments,
multilateral agencies and other entities to reduce principal and interest arrearages on their debt. The failure of a sovereign debtor to implement economic reforms, achieve specified levels of economic performance or repay principal or interest when
due may result in the cancellation of third-party commitments to lend funds to the sovereign debtor, which may further impair such debtors ability or willingness to service its debts.
Foreign Currency Transactions.
Certain Funds may engage in foreign currency transactions which
include the following, some of which also have been described elsewhere in this SAI: options on currencies, currency futures, options on such futures, forward foreign currency transactions, forward rate agreements and currency swaps, caps and
floors. Certain Funds may engage in such transactions in both U.S. and non-U.S. markets. To the extent a Fund enters into such transactions in markets other than in the U.S., the Fund may be subject to certain currency, settlement, liquidity,
trading and other risks similar to those described above with respect to the Funds investments in foreign securities including emerging markets securities. Certain Funds may engage in such transactions to hedge against currency risks, as a
substitute for securities in which the Fund invests, to increase or decrease exposure to a foreign currency, to shift exposure from one foreign currency to another, for risk management purposes or to increase income or gain to the Fund. To the
extent that a Fund uses foreign currency transactions for hedging purposes, the Fund may hedge either specific transactions or portfolio positions.
While a Funds use of hedging strategies is intended to reduce the volatility of the net asset value of Fund shares, the net asset value of the Fund will fluctuate. There can be no assurance that a
Funds hedging transactions will be effective. Furthermore, a Fund may only engage in hedging activities from time to time and may not necessarily be engaging in hedging activities when movements in currency exchange rates occur.
Certain Funds are authorized to deal in forward foreign exchange between currencies of the different countries in which the Fund will
invest and multi-national currency units as a hedge against possible variations in the foreign exchange rate between these currencies. This is accomplished through contractual agreements entered into in the interbank market to purchase or sell one
specified currency for another currency at a specified future date (up to one year) and price at the time of the contract.
Transaction Hedging.
Generally, when a Fund engages in transaction hedging, it enters into foreign currency transactions with
respect to specific receivables or payables of the Fund generally arising in connection with the purchase or sale of its portfolio securities. A Fund may engage in transaction hedging when it desires to lock in the U.S. dollar price (or
a non-U.S. dollar currency (reference currency)) of a security it has agreed to purchase or sell, or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By transaction hedging, a Fund attempts to protect
itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar or other reference currency and the applicable foreign currency during the period between the date on which the security is purchased or
sold, or on which the dividend or interest payment is declared, and the date on which such payments are made or received.
A
Fund may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in that foreign currency. Certain Funds reserve the right to
purchase and sell foreign currency futures contracts traded in the U.S. and subject to regulation by the Commodity Futures Trading Commission (CFTC).
Part II - 13
For transaction hedging purposes, a Fund may also purchase U.S. exchange-listed call and put
options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives a Fund the right to assume a short position in the foreign currency futures contract until expiration of the option. A put option on
currency gives a Fund the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Fund the right to assume a long position in the futures contract until the expiration of the
option. A call option on currency gives a Fund the right to purchase a currency at the exercise price until the expiration of the option.
Position Hedging.
When engaging in position hedging, a Fund will enter into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which
their portfolio securities are denominated or an increase in the value of currency for securities which a Funds Adviser expects to purchase. In connection with the position hedging, the Fund may purchase or sell foreign currency forward
contracts or foreign currency on a spot basis. A Fund may purchase U.S. exchange-listed put or call options on foreign currency and foreign currency futures contracts and buy or sell foreign currency futures contracts traded in the U.S. and subject
to regulation by the CFTC.
The precise matching of the amounts of foreign currency exchange transactions and the value of the
portfolio securities involved will not generally be possible because the future value of such securities in foreign currencies will change as a consequence of market movements in the value of those securities between the dates the currency exchange
transactions are entered into and the dates they mature.
Forward Foreign Currency Exchange Contracts.
Certain
Funds may purchase forward foreign currency exchange contracts, sometimes referred to as currency forwards (Forward Contracts), which involve an obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days from the date of the contract as agreed by the parties in an amount and at a price set at the time of the contract. In the case of a cancelable Forward Contract, the holder has the unilateral right to cancel the contract
at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers, so no intermediary is required. A Forward Contract generally
has no deposit requirement, and no commissions are charged at any stage for trades.
At the maturity of a Forward Contract, a
Fund may either accept or make delivery of the currency specified in the contract or, at or prior to maturity, enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the original forward contract. Certain Funds may also engage in non-deliverable forwards which are cash settled and which do not involve delivery of the currency specified in
the contract. For more information on Non-Deliverable Forwards, see Non-Deliverable Forwards below.
Foreign
Currency Futures Contracts.
Certain Funds may purchase foreign currency futures contracts. Foreign currency futures contracts traded in the U.S. are designed by and traded on exchanges regulated by the CFTC, such as the New York Mercantile
Exchange. A Fund may enter into foreign currency futures contracts for hedging purposes and other risk management purposes as defined in CFTC regulations. Certain Funds may also enter into foreign currency futures transactions to increase exposure
to a foreign currency, to shift exposure from one foreign currency to another or to increase income or gain to the Fund.
At
the maturity of a futures contract, the Fund may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing
transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts.
Positions in the foreign currency futures contracts may be closed out only on an exchange or board of trade which provides a secondary
market in such contracts. There is no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or at any particular time. In such event, it may not be possible to close a futures position; in the
event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin.
For
more information on futures contacts, see Futures Contracts under the heading Options and Futures Transactions below.
Foreign Currency Options.
Certain Funds may purchase and sell U.S. exchange-listed and over the counter call and put options on foreign currencies. Such options on foreign currencies operate
similarly to options on securities. When a Fund purchases a put option, the Fund has the right but not the obligation to exchange money denominated
Part II - 14
in one currency into another currency at a pre-agreed exchange rate on a specified date. When a Fund sells or writes a call option, the Fund has the obligation to exchange money denominated in
one currency into another currency at a pre-agreed exchange rate if the buyer exercises option. Some of the Funds may also purchase and sell non-deliverable currency options (Non-Deliverable Options). Non-Deliverable Options are
cash-settled, options on foreign currencies (each a Option Reference Currency) that are non-convertible and that may be thinly traded or illiquid. Non-Deliverable Options involve an obligation to pay an amount in a deliverable currency
(such as U.S. Dollars, Euros, Japanese Yen, or British Pounds Sterling) equal to the difference between the prevailing market exchange rate for the Option Reference Currency and the agreed upon exchange rate (the Non-Deliverable Option
Rate), with respect to an agreed notional amount. Options on foreign currencies are affected by all of those factors which influence foreign exchange rates and investments generally.
A Fund is authorized to purchase or sell listed foreign currency options and currency swap contracts as a short or long hedge against
possible variations in foreign exchange rates, as a substitute for securities in which a Fund may invest, and for risk management purposes. Such transactions may be effected with respect to hedges on non-U.S. dollar denominated securities (including
securities denominated in the Euro) owned by the Fund, sold by the Fund but not yet delivered, committed or anticipated to be purchased by the Fund, or in transaction or cross-hedging strategies. As an illustration, a Fund may use such techniques to
hedge the stated value in U.S. dollars of an investment in a Japanese yen-dominated security. In such circumstances, the Fund may purchase a foreign currency put option enabling it to sell a specified amount of yen for dollars at a specified price
by a future date. To the extent the hedge is successful, a loss in the value of the dollar relative to the yen will tend to be offset by an increase in the value of the put option. To offset, in whole or in part, the cost of acquiring such a put
option, the Fund also may sell a call option which, if exercised, requires it to sell a specified amount of yen for dollars at a specified price by a future date (a technique called a collar). By selling the call option in this
illustration, the Fund gives up the opportunity to profit without limit from increases in the relative value of the yen to the dollar. Certain Funds may also enter into foreign currency futures transactions for non-hedging purposes including to
increase or decrease exposure to a foreign currency, to shift exposure from one foreign currency to another or to increase income or gain to the Fund.
Certain differences exist among these foreign currency instruments. Foreign currency options provide the holder thereof the right to buy or to sell a currency at a fixed price on a future date. Listed
options are third-party contracts (i.e., performance of the parties obligations is guaranteed by an exchange or clearing corporation) which are issued by a clearing corporation, traded on an exchange and have standardized strike prices and
expiration dates. OTC options are two-party contracts and have negotiated strike prices and expiration dates. Options on futures contracts are traded on boards of trade or futures exchanges. Currency swap contracts are negotiated two-party
agreements entered into in the interbank market whereby the parties exchange two foreign currencies at the inception of the contract and agree to reverse the exchange at a specified future time and at a specified exchange rate.
The JPMorgan Emerging Markets Debt Fund may also purchase and sell barrier/touch options (Barrier Options),
including knock-in options (Knock-In Options) and knock-out options (Knock-Out Options). A Barrier Option is a type of exotic option that gives an investor a payout once the price of the underlying currency reaches or
surpasses (or falls below) a predetermined barrier. This type of option allows the buyer of the option to set the position of the barrier, the length of time until expiration and the payout to be received once the barrier is broken. There are two
kinds of Knock-In Options, (i) up and in and (ii) down and in. With Knock-In Options, if the buyer has selected an upper price barrier, and the currency hits that level, the Knock-In Option turns into a more
traditional option (Vanilla Option) whereby the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. This type of Knock-In
Option is called up and in. The down and in Knock-In Option is the same as the up and in, except the currency has to reach a lower barrier. Upon hitting the chosen lower price level, the down and in
Knock-In Option turns into a Vanilla Option. As in the Knock-In Option, there are two kinds of Knock-Out Options, ( i) up and out and (ii) down and out. However, in a Knock-Out Option, the buyer begins with a Vanilla
Option, and if the predetermined price barrier is hit, the Vanilla Option is cancelled and the seller has no further obligation. If the option hits the upper barrier, the option is cancelled and the investor loses the premium paid, thus, up
and out. If the option hits the lower price barrier, the option is cancelled, thus, down and out. Barrier Options usually call for delivery of the underlying currency.
The value of a foreign currency option is dependent upon the value of the foreign currency and the U.S. dollar and may have no
relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of
Part II - 15
foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than those for round lots.
There is no systematic reporting of last sale
information for foreign currencies and there is no regulatory requirement that quotations available through dealer or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very
large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the
extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the options market.
In addition to writing call options on currencies when a Fund owns the underlying currency, the Funds may also write call options on
currencies even if they do not own the underlying currency as long as the Fund segregates cash or liquid assets that, when added to the amounts deposited with a futures commission merchant or a broker as margin, equal the market value of the
currency underlying the call option (but not less than the strike price of the call option). The Funds may also cover a written call option by owning a separate call option permitting the Fund to purchase the reference currency at a price no higher
than the strike price of the call option sold by the Fund. In addition, a Fund may write a non-deliverable call option if the Fund segregates an amount equal to the current notional value (amount obligated to pay). Netting is generally permitted of
long and short positions of a specific country (assuming long and short contracts are similar). If there are securities or currency held in that specific country at least equal to the current notional value of the net currency positions, no
segregation is required.
Non-Deliverable Forwards.
Some of the Funds may also invest in non-deliverable
forwards (NDFs). NDFs are cash-settled, short-term forward contracts on foreign currencies (each a Reference Currency) that are non-convertible and that may be thinly traded or illiquid. NDFs involve an obligation to pay
an amount (the Settlement Amount) equal to the difference between the prevailing market exchange rate for the Reference Currency and the agreed upon exchange rate (the NDF Rate), with respect to an agreed notional amount.
NDFs have a fixing date and a settlement (delivery) date. The fixing date is the date and time at which the difference between the prevailing market exchange rate and the agreed upon exchange rate is calculated. The settlement (delivery) date
is the date by which the payment of the Settlement Amount is due to the party receiving payment.
Although NDFs are similar to
forward foreign currency exchange contracts, NDFs do not require physical delivery of the Reference Currency on the settlement date. Rather, on the settlement date, the only transfer between the counterparties is the monetary settlement amount
representing the difference between the NDF Rate and the prevailing market exchange rate. NDFs typically may have terms from one month up to two years and are settled in U.S. dollars.
NDFs are subject to many of the risks associated with derivatives in general and forward currency transactions including risks associated
with fluctuations in foreign currency and the risk that the counterparty will fail to fulfill its obligations. The Funds will segregate or earmark liquid assets in an amount equal to the marked to market, on a daily basis, of the NDF.
The Funds will typically use NDFs for hedging purposes, but may also, use such instruments to increase income or gain. The use of NDFs for
hedging or to increase income or gain may not be successful, resulting in losses to the Fund, and the cost of such strategies may reduce the Funds respective returns.
Foreign Currency Conversion.
Although foreign exchange dealers do not charge a fee for currency conversion, they do realize a profit based on the difference (the spread) between prices
at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to a Fund at one rate while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer.
Other Foreign Currency Hedging Strategies.
New options and futures contracts and other financial products, and various combinations
thereof, continue to be developed, and certain Funds may invest in any such options, contracts and products as may be developed to the extent consistent with the Funds investment objective and the regulatory requirements applicable to
investment companies, and subject to the supervision of the Trusts Board of Trustees.
Risk Factors in Foreign
Currency Transactions.
The following is a summary of certain risks associated with foreign currency transactions:
Imperfect Correlation.
Foreign currency transactions present certain risks. In particular, the variable degree of correlation
between price movements of the instruments used in hedging strategies and price movements in a security being hedged creates the possibility that losses on the hedging transaction may be greater than gains in the value of a Funds securities.
Part II - 16
Liquidity.
Hedging instruments may not be liquid in all circumstances. As a result,
in volatile markets, the Funds may not be able to dispose of or offset a transaction without incurring losses. Although foreign currency transactions used for hedging purposes may reduce the risk of loss due to a decline in the value of the hedged
security, at the same time the use of these instruments could tend to limit any potential gain which might result from an increase in the value of such security.
Leverage and Volatility Risk
. Derivative instruments, including foreign currency derivatives, may sometimes increase or leverage a Funds exposure to a particular market risk. Leverage
enhances the price volatility of derivative instruments held by a Fund.
Strategy Risk.
Certain Funds may use foreign
currency derivatives for hedging as well as non-hedging purposes including to gain or adjust exposure to currencies and securities markets or to increase income or gain to a Fund. There is no guarantee that these strategies will succeed and their
use may subject a Fund to greater volatility and loss. Foreign currency transactions involve complex securities transactions that involve risks in addition to direct investments in securities including leverage risk and the risks associated with
derivatives in general, currencies, and investments in foreign and emerging markets.
Judgment of the Adviser.
Successful use of foreign currency transactions by a Fund depends upon the ability of the applicable Adviser to predict correctly movements in the direction of interest and currency rates and other factors affecting markets for securities. If
the expectations of the applicable Adviser are not met, a Fund would be in a worse position than if a foreign currency transaction had not been pursued. For example, if a Fund has hedged against the possibility of an increase in interest rates which
would adversely affect the price of securities in its portfolio and the price of such securities increases instead, the Fund will lose part or all of the benefit of the increased value of its securities because it will have offsetting losses in its
hedging positions. In addition, when utilizing instruments that require variation margin payments, if the Fund has insufficient cash to meet daily variation margin requirements, it may have to sell securities to meet such requirements.
Other Risks
. Such sales of securities may, but will not necessarily, be at increased prices which reflect the rising market. Thus,
a Fund may have to sell securities at a time when it is disadvantageous to do so.
It is impossible to forecast with precision
the market value of portfolio securities at the expiration or maturity of a forward contract or futures contract. Accordingly, a Fund may have to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the
market value of the security or securities being hedged is less than the amount of foreign currency a Fund is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it
may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security or securities if the market value of such security or securities exceeds the amount of foreign currency the Fund is obligated
to deliver.
Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which a
Fund owns or expects to purchase or sell. Rather, an Adviser may employ these techniques in an effort to maintain an investment portfolio that is relatively neutral to fluctuations in the value of the U.S. dollar relative to major foreign currencies
and establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they also tend to limit any
potential gain which might result from the increase in the value of such currency. Moreover, it may not be possible for a Fund to hedge against a devaluation that is so generally anticipated that the Fund is not able to contract to sell the currency
at a price above the anticipated devaluation level.
Inverse Floaters and Interest Rate Caps
Inverse floaters are instruments whose interest rates bear an inverse relationship to the interest rate on another security or the value
of an index. The market value of an inverse floater will vary inversely with changes in market interest rates and will be more volatile in response to interest rate changes than that of a fixed rate obligation. Interest rate caps are financial
instruments under which payments occur if an interest rate index exceeds a certain predetermined interest rate level, known as the cap rate, which is tied to a specific index. These financial products will be more volatile in price than securities
which do not include such a structure.
Investment Company Securities and Exchange Traded Funds
Investment Company Securities.
A Fund may acquire the securities of other investment
companies (acquired funds) to the extent permitted under the 1940 Act and consistent with its investment objective and strategies. As a shareholder of another investment company, a Fund would bear, along with other shareholders, its
Part II - 17
pro rata portion of the other investment companys expenses, including advisory fees. These expenses would be in addition to the advisory and other expenses that a Fund bears directly in
connection with its own operations. Except as described below, the 1940 Act currently requires that, as determined immediately after a purchase is made, (i) not more than 5% of the value of a funds total assets will be invested in the
securities of any one investment company, (ii) not more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group and (iii) not more than 3% of the outstanding voting stock
of any one investment company will be owned by a fund.
In addition, Section 17 of the 1940 Act prohibits a Fund from investing
in another J.P. Morgan Fund except as permitted by Section 12 of the 1940 Act, by rule, or by exemptive order.
The limitations
described above do not apply to investments in money market funds subject to certain conditions. All of the J.P. Morgan Funds may invest in affiliated and unaffiliated money market funds without limit under Rule 12d1-1 of the 1940 Act subject to the
acquiring funds investment policies and restrictions and the conditions of the Rule.
In addition, the 1940 Acts
limits and restrictions summarized above do not apply to J.P. Morgan Funds that invest in other J.P. Morgan Funds in reliance on Section 12(d)(1)(G) of the 1940 Act, SEC rule, or an exemptive order issued by the SEC (each, a Fund of
Funds; collectively, Funds of Funds). Such Funds of Funds include JPMorgan Investor Funds (the Investor Funds), the JPMorgan SmartRetirement Funds and the JPMorgan SmartRetirement Blend Funds (collectively, the
JPMorgan SmartRetirement Funds), JPMorgan Diversified Real Return Fund, JPMorgan Access Funds, JPMorgan Alternative Strategies Fund, JPMorgan Diversified Fund, and such other J.P. Morgan Funds that invest in other J.P. Morgan Funds in
reliance on Section 12(d)(G) of the 1940 Act or the rules issued Section 12.
Section 12(d)(1)(G) of the 1940 Act permits a
fund to invest in acquired funds in the same group of investment companies (affiliated funds), government securities and short-term paper. In addition to the investments permitted by Section 12(d)(1)(G), Rule 12d1-2 permits
funds of funds to make investments in addition to affiliated funds under certain circumstances including: (1) unaffiliated investment companies (subject to certain limits), (2) other types of securities (such as stocks, bonds and other securities)
not issued by an investment company that are consistent with the fund of funds investment policies and (3) affiliated and unaffiliated money market funds. In order to be an eligible investment under Section 12(d)(1)(G), an affiliated fund must
have a policy prohibiting it from investing in other funds under Section 12(d)(1)(F) or (G) of the 1940 Act.
In addition to
investments permitted by Section 12(d)(1)(G) and Rule 12d1-2, the J.P. Morgan Funds may invest in derivatives pursuant to an exemptive order issued by the SEC. Under the exemptive order, the Funds of Funds are permitted to invest in financial
instruments that may not be considered securities for purposes of Rule 12d-1 subject to certain conditions, including a finding of the Board of Trustees that the advisory fees charged by the Adviser to the Funds of Funds are for services
that are in addition to, and not duplicative of, the advisory services provided to an underlying fund.
Exchange Traded Funds (ETFs).
ETFs are pooled investment vehicles whose ownership interests are purchased and sold on a securities exchange. ETFs may be structured investment companies, depositary receipts or other pooled
investment vehicles. As shareholders of an ETF, the Funds will bear their pro rata portion of any fees and expenses of the ETFs. Although shares of ETFs are traded on an exchange, shares of certain ETFs may not be redeemable by the ETF. In addition,
ETFs may trade at a price below their net asset value (also known as a discount).
Certain Funds may use ETFs to gain exposure
to various asset classes and markets or types of strategies and investments By way of example, ETFs may be structured as broad based ETFs that invest in a broad group of stocks from different industries and market sectors; select sector or market
ETFs that invest in debt securities from a select sector of the economy, a single industry or related industries; or ETFs that invest in foreign and emerging markets securities. Other types of ETFs continue to be developed and the Fund may invest in
them to the extent consistent with such Funds investment objectives, policies and restrictions. The ETFs in which the Funds invest are subject to the risks applicable to the types of securities and investments used by the ETFs (e.g., debt
securities are subject to risks like credit and interest rate risks; emerging markets securities are subject risks like currency risks and foreign and emerging markets risk; derivatives are subject to leverage and counterparty risk).
ETFs may be actively managed or index-based. Actively managed ETFs are subject to management risk and may not achieve their objective if
the ETFs managers expectations regarding particular securities or markets are not met. An index based ETFs objective is to track the performance of a specified index. Index based ETFs invest in a securities portfolio that includes
substantially all of the securities (in substantially the same amount as the
Part II - 18
securities included in the designated index. Because passively managed ETFs are designed to track an index, securities may be purchased, retained and sold at times when an actively managed ETF
would not do so. As a result, shareholders of a Fund that invest in such an ETF can expect greater risk of loss (and a correspondingly greater prospect of gain) from changes in the value of securities that are heavily weighted in the index than
would be the case if ETF were not fully invested in such securities. This risk is increased if a few component securities represent a highly concentrated weighting in the designated index.
Unless permitted by the 1940 Act or an order or rule issued by the SEC (see Investment Company Securities above for more
information), the Funds investments in unaffiliated ETFs that are structured as investment companies as defined in the 1940 Act are subject to certain percentage limitations of the 1940 Act regarding investments in other investment companies.
As a general matter, these percentage limitations currently require a Fund to limit its investments in any one issue of ETFs to 5% of the Funds total assets and 3% of the outstanding voting securities of the ETF issue. Moreover, a Funds
investments in all ETFs may not currently exceed 10% of the Funds total assets under the 1940 Act, when aggregated with all other investments in investment companies. ETFs that are not structured as investment companies as defined in the 1940
Act are not subject to these percentage limitations.
SEC exemptive orders granted to various iShares funds (which are ETFs)
and other ETFs and their investment advisers permit the Funds to invest beyond the 1940 Act limits, subject to certain terms and conditions, including a finding of the Board of Trustees that the advisory fees charged by the Adviser to the Fund are
for services that are in addition to, and not duplicative of, the advisory services provided to those ETFs.
Loans.
Some of the Funds may invest in fixed and floating rate loans (Loans). Loans may include senior floating rate loans (Senior Loans) and secured and unsecured loans, second lien or
more junior loans (Junior Loans) and bridge loans or bridge facilities (Bridge Loans). Loans are typically arranged through private negotiations between borrowers in the U.S. or in foreign or emerging markets which may be
corporate issuers or issuers of sovereign debt obligations (Obligors) and one or more financial institutions and other lenders (Lenders). Generally, the Funds invest in Loans by purchasing assignments of all or a portion of
Loans (Assignments) or Loan participations (Participations) from third parties.
A Fund has direct
rights against the Obligor on the Loan when it purchases an Assignment. Because Assignments are arranged through private negotiations between potential assignees and potential assignors, however, the rights and obligations acquired by a Fund as the
purchaser of an Assignment may differ from, and be more limited than, those held by the assigning Lender. With respect to Participations, typically, a Fund will have a contractual relationship only with the Lender and not with the Obligor. The
agreement governing Participations may limit the rights of a Fund to vote on certain changes which may be made to the Loan agreement, such as waiving a breach of a covenant. However, the holder of a Participation will generally have the right to
vote on certain fundamental issues such as changes in principal amount, payment dates and interest rate. Participations may entail certain risks relating to the creditworthiness of the parties from which the participations are obtained.
A Loan is typically originated, negotiated and structured by a U.S. or foreign commercial bank, insurance company, finance company or
other financial institution (the Agent) for a group of Loan investors. The Agent typically administers and enforces the Loan on behalf of the other Loan investors in the syndicate. The Agents duties may include responsibility for
the collection of principal and interest payments from the Obligor and the apportionment of these payments to the credit of all Loan investors. The Agent is also typically responsible for monitoring compliance with the covenants contained in the
Loan agreement based upon reports prepared by the Obligor. In addition, an institution, typically but not always the Agent, holds any collateral on behalf of the Loan investors. In the event of a default by the Obligor, it is possible, though
unlikely, that the Fund could receive a portion of the borrowers collateral. If the Fund receives collateral other than cash, any proceeds received from liquidation of such collateral will be available for investment as part of the Funds
portfolio.
In the process of buying, selling and holding Loans, a Fund may receive and/or pay certain fees. These fees are in
addition to interest payments received and may include facility fees, commitment fees, commissions and prepayment penalty fees. When a Fund buys or sells a Loan it may pay a fee. In certain circumstances, a Fund may receive a prepayment penalty fee
upon prepayment of a Loan.
Additional Information concerning Senior Loans.
Senior Loans typically hold the most senior
position in the capital structure of the Obligor, are typically secured with specific collateral and have a claim on the assets and/or
Part II - 19
stock of the Obligor that is senior to that held by subordinated debtholders and shareholders of the Obligor. Collateral for Senior Loans may include (i) working capital assets, such as
accounts receivable and inventory; (ii) tangible fixed assets, such as real property, buildings and equipment; (iii) intangible assets, such as trademarks and patent rights; and/or (iv) security interests in shares of stock of
subsidiaries or affiliates.
Additional Information concerning Junior Loans.
Junior Loans include secured and unsecured
loans including subordinated loans, second lien and more junior loans, and bridge loans. Second lien and more junior loans (Junior Lien Loans) are generally second or further in line in terms of repayment priority. In addition, Junior
Lien Loans may have a claim on the same collateral pool as the first lien or other more senior liens or may be secured by a separate set of assets. Junior Loans generally give investors priority over general unsecured creditors in the event of an
asset sale.
Additional Information concerning Bridge Loans.
Bridge Loans are short-term loan arrangements (e.g., 12 to
18 months) typically made by an Obligor in anticipation of intermediate-term or long-term permanent financing. Most Bridge Loans are structured as floating-rate debt with step-up provisions under which the interest rate on the Bridge Loan rises the
longer the Loan remains outstanding. In addition, Bridge Loans commonly contain a conversion feature that allows the Bridge Loan investor to convert its Loan interest to senior exchange notes if the Loan has not been prepaid in full on or prior to
its maturity date. Bridge Loans typically are structured as Senior Loans but may be structured as Junior Loans.
Additional
Information concerning Unfunded Commitments.
Unfunded commitments are contractual obligations pursuant to which the Fund agrees to invest in a Loan at a future date. Typically, the Fund receives a commitment fee for entering into the Unfunded
Commitment.
Additional Information concerning Synthetic Letters of Credit.
Loans include synthetic letters of credit.
In a synthetic letter of credit transaction, the Lender typically creates a special purpose entity or a credit-linked deposit account for the purpose of funding a letter of credit to the borrower. When a Fund invests in a synthetic letter of credit,
the Fund is typically paid a rate based on the Lenders borrowing costs and the terms of the synthetic letter of credit. Synthetic letters of credit are typically structured as Assignments with the Fund acquiring direct rights against the
Obligor.
Additional Information concerning Loan Originations.
In addition to investing in loan assignments and
participations, the Strategic Income Opportunities Fund may originate Loans in which the Fund would lend money directly to a borrower by investing in limited liability companies or corporations that make loans directly to borrowers. The terms
of the Loans are negotiated with borrowers in private transactions. Such Loans would be collateralized, typically with tangible fixed assets such as real property or interests in real property. Such Loans may also include mezzanine loans.
Unlike Loans secured by a mortgage on real property, mezzanine loans are collateralized by an equity interest in a special purpose vehicle that owns the real property.
Limitations on Investments in Loan Assignments and Participations
. If a government entity is a borrower on a Loan, the Fund will consider the government to be the issuer of an Assignment or
Participation for purposes of a Funds fundamental investment policy that it will not invest 25% or more of its total assets in securities of issuers conducting their principal business activities in the same industry (i.e., foreign
government).
Risk Factors of Loans
. Loans are subject to the risks associated with debt obligations in general
including interest rate risk, credit risk and market risk. When a Loan is acquired from a Lender, the risk includes the credit risk associated with the Obligor of the underlying Loan. The Fund may incur additional credit risk when the Fund acquires
a participation in a Loan from another lender because the Fund must assume the risk of insolvency or bankruptcy of the other lender from which the Loan was acquired. To the extent that Loans involve Obligors in foreign or emerging markets, such
Loans are subject to the risks associated with foreign investments or investments in emerging markets in general. The following outlines some of the additional risks associated with Loans.
High Yield Securities Risk.
The Loans that a Fund invests in may not be rated by an NRSRO, will not be registered
with the SEC or any state securities commission and will not be listed on any national securities exchange. To the extent that such high yield Loans are rated, they typically will be rated below investment grade and are subject to an increased risk
of default in the payment of principal and interest as well as the other risks described under
High Yield/High Risk Securities/Junk Bonds.
Loans are vulnerable to market sentiment such that economic conditions or other events may
reduce the demand for Loans and cause their value to decline rapidly and unpredictably.
Part II - 20
Liquidity Risk.
Although the Funds limit their investments in
illiquid securities to no more than 15% of a Funds net assets (5% of the total assets for the Money Market Funds) at the time of purchase, Loans that are deemed to be liquid at the time of purchase may become illiquid or less liquid. No active
trading market may exist for certain Loans and certain Loans may be subject to restrictions on resale or have a limited secondary market. Certain Loans may be subject to irregular trading activity, wide bid/ask spreads and extended trade settlement
periods. The inability to dispose of certain Loans in a timely fashion or at a favorable price could result in losses to a Fund.
Collateral and Subordination Risk.
With respect to Loans that are secured, a Fund is subject to the risk that collateral securing the Loan will decline in value or have no value or that the
Funds lien is or will become junior in payment to other liens. A decline in value of the collateral, whether as a result of market value declines, bankruptcy proceedings or otherwise, could cause the Loan to be under collateralized or
unsecured. In such event, the Fund may have the ability to require that the Obligor pledge additional collateral. The Fund, however, is subject to the risk that the Obligor may not pledge such additional collateral or a sufficient amount of
collateral. In some cases, there may be no formal requirement for the Obligor to pledge additional collateral. In addition, collateral may consist of assets that may not be readily liquidated, and there is no assurance that the liquidation of such
assets would satisfy an Obligors obligation on a Loan. If the Fund were unable to obtain sufficient proceeds upon a liquidation of such assets, this could negatively affect Fund performance.
If an Obligor becomes involved in bankruptcy proceedings, a court may restrict the ability of the Fund to demand immediate
repayment of the Loan by Obligor or otherwise liquidate the collateral. A court may also invalidate the Loan or the Funds security interest in collateral or subordinate the Funds rights under a Senior Loan or Junior Loan to the interest
of the Obligors other creditors, including unsecured creditors, or cause interest or principal previously paid to be refunded to the Obligor. If a court required interest or principal to be refunded, it could negatively affect Fund
performance. Such action by a court could be based, for example, on a fraudulent conveyance claim to the effect that the Obligor did not receive fair consideration for granting the security interest in the Loan collateral to a Fund. For
Senior Loans made in connection with a highly leveraged transaction, consideration for granting a security interest may be deemed inadequate if the proceeds of the Loan were not received or retained by the Obligor, but were instead paid to other
persons (such as shareholders of the Obligor) in an amount which left the Obligor insolvent or without sufficient working capital. There are also other events, such as the failure to perfect a security interest due to faulty documentation or faulty
official filings, which could lead to the invalidation of a Funds security interest in Loan collateral. If the Funds security interest in Loan collateral is invalidated or a Senior Loan were subordinated to other debt of an Obligor in
bankruptcy or other proceedings, the Fund would have substantially lower recovery, and perhaps no recovery on the full amount of the principal and interest due on the Loan, or the Fund could have to refund interest. Lenders and investors in Loans
can be sued by other creditors and shareholders of the Obligors. Losses can be greater than the original Loan amount and occur years after the principal and interest on the Loan have been repaid.
Agent Risk.
Selling Lenders, Agents and other entities who may be positioned between a Fund and the Obligor will
likely conduct their principal business activities in the banking, finance and financial services industries. Investments in Loans may be more impacted by a single economic, political or regulatory occurrence affecting such industries than other
types of investments. Entities engaged in such industries may be more susceptible to, among other things, fluctuations in interest rates, changes in the Federal Open Market Committees monetary policy, government regulations concerning such
industries and concerning capital raising activities generally and fluctuations in the financial markets generally. An Agent, Lender or other entity positioned between a Fund and the Obligor may become insolvent or enter FDIC receivership or
bankruptcy. The Fund might incur certain costs and delays in realizing payment on a Loan or suffer a loss of principal and/or interest if assets or interests held by the Agent, Lender or other party positioned between the Fund and the Obligor are
determined to be subject to the claims of the Agents, Lenders or such other partys creditors.
Regulatory Changes.
To the extent that legislation or state or federal regulators that regulate certain financial
institutions impose additional requirements or restrictions with respect to the ability of such institutions to make Loans, particularly in connection with highly leveraged transactions, the availability of Loans for investment may be adversely
affected. Furthermore, such legislation or regulation could depress the market value of Loans held by the Fund.
Part II - 21
Inventory Risk.
Affiliates of the Adviser may participate in the
primary and secondary market for Loans. Because of limitations imposed by applicable law, the presence of the Advisers affiliates in the Loan market may restrict a Funds ability to acquire some Loans, affect the timing of such
acquisition or affect the price at which the Loan is acquired.
Information Risk
. There is typically
less publicly available information concerning Loans than other types of fixed income investments. As a result, a Fund generally will be dependent on reports and other information provided by the Obligor, either directly or through an Agent, to
evaluate the Obligors creditworthiness or to determine the Obligors compliance with the covenants and other terms of the Loan Agreement. Such reliance may make investments in Loans more susceptible to fraud than other types of
investments. In addition, because the Adviser may wish to invest in the publicly traded securities of an Obligor, it may not have access to material non-public information regarding the Obligor to which other Loan investors have access.
Junior Loan Risk.
Junior Loans are subject to the same general risks inherent to any Loan investment. Due to their
lower place in the Obligors capital structure and possible unsecured status, Junior Loans involve a higher degree of overall risk than Senior Loans of the same Obligor. Junior Loans that are Bridge Loans generally carry the expectation that
the Obligor will be able to obtain permanent financing in the near future. Any delay in obtaining permanent financing subjects the Bridge Loan investor to increased risk. An Obligors use of Bridge Loans also involves the risk that the Obligor
may be unable to locate permanent financing to replace the Bridge Loan, which may impair the Obligors perceived creditworthiness.
Mezzanine Loan Risk.
In addition to the risk factors described above, mezzanine loans are subject to additional risks. Unlike conventional mortgage loans, mezzanine loans are not secured by a
mortgage on the underlying real property but rather by a pledge of equity interests (such as a partnership or limited liability company membership) in the property owner or another company in the ownership structures that has control over the
property. Such companies are typically structured as special purpose entities. Generally, mezzanine loans may be more highly leveraged than other types of Loans and subordinate in the capital structure of the Obligor. While foreclosure of a
mezzanine loan generally takes substantially less time than foreclosure of a traditional mortgage, the holders of a mezzanine loan have different remedies available versus the holder of a first lien mortgage loan. In addition, a sale of the
underlying real property would not be unencumbered, and thus would be subject to encumbrances by more senior mortgages and liens of other creditors. Upon foreclosure of a mezzanine loan, the holder of the mezzanine loan acquires an equity interest
in the Obligor. However, because of the subordinate nature of a mezzanine loan, the real property continues to be subject to the lien of the mortgage and other liens encumbering the real estate. In the event the holder of a mezzanine loan forecloses
on its equity collateral, the holder may need to cure the Obligors existing mortgage defaults or, to the extent permissible under the governing agreements, sell the property to pay off other creditors. To the extent that the amount of
mortgages and senior indebtedness and liens exceed the value of the real estate, the collateral underlying the mezzanine loan may have little or no value.
Foreclosure Risk.
There may be additional costs associated with enforcing a Funds remedies under a Loan including additional legal costs and payment of real property transfer taxes upon
foreclosure in certain jurisdictions. As a result of these additional costs, the Fund may determine that pursuing foreclosure on the Loan collateral is not worth the associated costs. In addition, if the Fund incurs costs and the collateral loses
value or is not recovered by the Fund in foreclosure, the Fund could lose more than its original investment in the Loan. Foreclosure risk is heightened for Junior Loans, including certain mezzanine loans.
Miscellaneous Investment Strategies and Risks
Borrowings
.
A Fund may borrow for temporary purposes and/or for
investment purposes. Such a practice will result in leveraging of a Funds assets and may cause a Fund to liquidate portfolio positions when it would not be advantageous to do so. This borrowing may be secured or unsecured. If a Fund utilizes
borrowings, for investment purposes or otherwise, it may pledge up to 33
1
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3
% of its total assets to secure such borrowings. Provisions of the 1940 Act require a Fund to maintain continuous asset
coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed, with an exception for borrowings not in excess of 5% of the Funds total assets made for temporary administrative or
emergency purposes. Any borrowings for temporary administrative purposes in excess of 5% of the Funds total assets must maintain continuous asset coverage. If the 300% asset coverage should decline as a result of market fluctuations or other
reasons, a Fund may be required to sell some of its portfolio holdings within three days to reduce the debt and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell securities at that time.
Part II - 22
Borrowing will tend to exaggerate the effect on net asset value of any increase or decrease in the market value of a Funds portfolio. Money borrowed will be subject to interest costs which
may or may not be recovered by appreciation of the securities purchased. A Fund also may be required to maintain minimum average balances in connection with such borrowing or to pay a commitment or other fee to maintain a line of credit; either of
these requirements would increase the cost of borrowing over the stated interest rate.
Certain types of investments are
considered to be borrowings under precedents issued by the SEC. Such investments are subject to the limitations as well as asset segregation requirements. In addition, each Fund may enter into Interfund Lending Arrangements. Please see
Interfund Lending.
Commodity-Linked Derivatives
.
Commodity-linked
derivatives are derivative instruments the value of which is linked to the value of a commodity, commodity index or commodity futures contract. A Funds investment in commodity-linked derivative instruments may subject the Fund to greater
volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes
in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked
derivatives creates the possibility for greater loss (including the likelihood of greater volatility of the Funds net asset value), and there can be no assurance that a Funds use of leverage will be successful. Tax considerations may
limit a Funds ability to pursue investments in commodity-linked derivatives.
Exchange-Traded Notes (ETNs)
are senior, unsecured notes linked to an index. Like ETFs,
they may be bought and sold like shares of stock on an exchange. However, ETNs have a different underlying structure. While ETF shares represent an interest in a portfolio of securities, ETNs are structured products that are an obligation of the
issuing bank, whereby the bank agrees to pay a return based on the target index less any fees. Essentially, these notes allow individual investors to have access to derivatives linked to commodities and assets such as oil, currencies and foreign
stock indexes. ETNs combine certain aspects of bonds and ETFs. Similar to ETFs, ETNs are traded on a major exchange (e.g., the New York Stock Exchange) during normal trading hours. However, investors can also hold the ETN until maturity. At
maturity, the issuer pays to the investor a cash amount equal to principal amount, subject to the days index factor. ETN returns are based upon the performance of a market index minus applicable fees. ETNs do not make periodic coupon payments
and provide no principal protection. The value of an ETN may be influenced by time to maturity, level of supply and demand for the ETN, volatility and lack of liquidity in underlying commodities markets, changes in the applicable interest rates,
changes in the issuers credit rating and economic, legal, political or geographic events that affect the referenced commodity. The value of the ETN may drop due to a downgrade in the issuers credit rating, despite the underlying index
remaining unchanged. The timing and character of income and gains derived from ETNs is under consideration by the U.S. Treasury and Internal Revenue Service and may also be affected by future legislation.
Impact of Large Redemptions and Purchases of Fund Shares
From time to time, shareholders of a Fund
(which may include the Adviser or affiliates of the Adviser or accounts for which the Adviser or its affiliates serve as investment adviser or trustee or, for certain Funds, affiliated and/or non-affiliated registered investment companies that
invest in a Fund) may make relatively large redemptions or purchases of Fund shares. These transactions may cause the Fund to have to sell securities, or invest additional cash, as the case may be. While it is impossible to predict the overall
impact of these transactions over time, there could be adverse effects on the Funds performance to the extent that the Fund is required to sell securities or invest cash at times when it would not otherwise do so, which may result in a loss to
the Fund. These transactions may result in higher portfolio turnover, accelerate the realization of taxable income if sales of securities resulted in capital gains or other income and increase transaction costs, which may impact the Funds
expense ratio. To the extent that such transactions result in short-term capital gains, such gains will generally be taxed at the ordinary income tax rate.
Government Intervention in Financial Markets.
Events in the financial sector over the past several years have resulted in reduced liquidity in credit and fixed income
markets and in an unusually high degree of volatility in the financial markets, both domestically and internationally. While entire markets have been impacted, issuers that have exposure to the real estate, mortgage and credit markets have been
particularly affected. These events and the potential for continuing market turbulence may have an adverse effect on the Funds investments. It is uncertain how long these conditions will continue.
Recent instability in the financial markets has led governments and regulators around the world to take a number of unprecedented actions
designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Governments, their
Part II - 23
regulatory agencies, or self regulatory organizations may take actions that affect the regulation of the instruments in which the Funds invest, or the issuers of such instruments, in ways that
are unforeseeable. Legislation or regulation may also change the way in which the Funds themselves are regulated. Such legislation or regulation could limit or preclude a Funds ability to achieve its investment objective.
Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those
institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of a Funds portfolio holdings.
Furthermore, volatile financial markets can expose the Funds to greater market and liquidity risk and potential difficulty in valuing portfolio instruments held by the Funds.
Interfund Lending
.
To satisfy redemption requests or to cover unanticipated cash shortfalls, a Fund may enter into lending agreements (Interfund Lending
Agreements) under which the Fund would lend money and borrow money for temporary purposes directly to and from another J.P. Morgan Fund through a credit facility (Interfund Loan), subject to meeting the conditions of an SEC
exemptive order granted to the Funds permitting such interfund lending. No Fund may borrow more than the lesser of the amount permitted by Section 18 of the 1940 Act or the amount permitted by its investment limitations. All Interfund Loans
will consist only of uninvested cash reserves that the Fund otherwise would invest in short-term repurchase agreements or other short-term instruments.
If a Fund has outstanding borrowings, any Interfund Loans to the Fund (a) will be at an interest rate equal to or lower than any outstanding bank loan, (b) will be secured at least on an equal
priority basis with at least an equivalent percentage of collateral to loan value as any outstanding bank loan that requires collateral, (c) will have a maturity no longer than any outstanding bank loan (and in any event not over seven days)
and (d) will provide that, if an event of default occurs under any agreement evidencing an outstanding bank loan to the Fund, the event of default will automatically (without need for action or notice by the lending Fund) constitute an
immediate event of default under the Interfund Lending Agreement entitling the lending Fund to call the Interfund Loan (and exercise all rights with respect to any collateral) and that such call will be made if the lending bank exercises its right
to call its loan under its agreement with the borrowing Fund.
A Fund may make an unsecured borrowing through the credit
facility if its outstanding borrowings from all sources immediately after the interfund borrowing total 10% or less of its total assets; provided, that if the Fund has a secured loan outstanding from any other lender, including but not limited to
another J.P. Morgan Fund, the Funds interfund borrowing will be secured on at least an equal priority basis with at least an equivalent percentage of collateral to loan value as any outstanding loan that requires collateral. If a Funds
total outstanding borrowings immediately after an interfund borrowing would be greater than 10% of its total assets, the Fund may borrow through the credit facility on a secured basis only. A Fund may not borrow through the credit facility nor from
any other source if its total outstanding borrowings immediately after the interfund borrowing would exceed the limits imposed by Section 18 of the 1940 Act.
No Fund may lend to another Fund through the interfund lending credit facility if the loan would cause its aggregate outstanding loans through the credit facility to exceed 15% of the lending Funds
net assets at the time of the loan. A Funds Interfund Loans to any one Fund shall not exceed 5% of the lending Funds net assets. The duration of Interfund Loans is limited to the time required to receive payment for securities sold, but
in no event may the duration exceed seven days. Loans effected within seven days of each other will be treated as separate loan transactions for purposes of this condition. Each Interfund Loan may be called on one business days notice by a
lending Fund and may be repaid on any day by a borrowing Fund.
The limitations detailed above and the other conditions of the
SEC exemptive order permitting interfund lending are designed to minimize the risks associated with interfund lending for both the lending fund and the borrowing fund. However, no borrowing or lending activity is without risk. When a Fund borrows
money from another Fund, there is a risk that the loan could be called on one days notice or not renewed, in which case the Fund may have to borrow from a bank at higher rates if an Interfund Loan were not available from another Fund. A delay
in repayment to a lending Fund could result in a lost opportunity or additional lending costs.
Master Limited Partnerships
.
Certain companies are organized as master limited partnerships
(MLPs) in which ownership interests are publicly traded. MLPs often own several properties or businesses (or directly own interests) that are related to real estate development and oil and gas industries, but they also may finance motion
pictures, research and development and other projects or provide financial services. Generally, an MLP is operated under the supervision of one or more managing general partners. Limited partners (like a Fund that invests in an MLP) are not involved
in the day-to-day management of the partnership. They are allocated income and capital gains associated with the partnership project in accordance with the terms established in the partnership agreement.
Part II - 24
The risks of investing in an MLP are generally those inherent in investing in a partnership
as opposed to a corporation. For example, state law governing partnerships is often less restrictive than state law governing corporations. Accordingly, there may be fewer protections afforded investors in an MLP than investors in a corporation.
Additional risks involved with investing in an MLP are risks associated with the specific industry or industries in which the partnership invests, such as the risks of investing in real estate, or oil and gas industries.
New Financial Products
.
New options and futures contracts and other financial products, and
various combinations thereof, including over-the-counter products, continue to be developed. These various products may be used to adjust the risk and return characteristics of certain Funds investments. These various products may increase or
decrease exposure to security prices, interest rates, commodity prices, or other factors that affect security values, regardless of the issuers credit risk. If market conditions do not perform as expected, the performance of a Fund would be
less favorable than it would have been if these products were not used. In addition, losses may occur if counterparties involved in transactions do not perform as promised. These products may expose the Fund to potentially greater return as well as
potentially greater risk of loss than more traditional fixed income investments.
Private
Placements, Restricted Securities and Other Unregistered Securities.
Subject to its policy limitation, a Fund may acquire investments that are illiquid or have limited liquidity, such as commercial obligations issued in reliance on the so-called
private placement exemption from registration afforded by Section 4(2) under the Securities Act of 1933, as amended (the 1933 Act), and cannot be offered for public sale in the U.S. without first being registered under
the 1933 Act. An illiquid investment is any investment that cannot be disposed of within seven days in the normal course of business at approximately the amount at which it is valued by a Fund. The price a Fund pays for illiquid securities or
receives upon resale may be lower than the price paid or received for similar securities with a more liquid market. Accordingly the valuation of these securities will reflect any limitations on their liquidity.
A Fund is subject to a risk that should the Fund decide to sell illiquid securities when a ready buyer is not available at a price the
Fund deems representative of their value, the value of the Funds net assets could be adversely affected. Where an illiquid security must be registered under the 1933 Act before it may be sold, a Fund may be obligated to pay all or part of the
registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Fund may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market
conditions were to develop, a Fund might obtain a less favorable price than prevailed when it decided to sell.
The Funds may
invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(2) of the 1933 Act and other restricted securities (i.e., other securities subject to restrictions on resale). Section 4(2) commercial
paper (4(2) paper) is restricted as to disposition under federal securities law and is generally sold to institutional investors, such as the Funds, that agree that they are purchasing the paper for investment purposes and not with a
view to public distribution. Any resale by the purchaser must be in an exempt transaction. 4(2) paper is normally resold to other institutional investors through or with the assistance of the issuer or investment dealers who make a market in 4(2)
paper, thus providing liquidity. The Funds believe that 4(2) paper and possibly certain other restricted securities which meet the criteria for liquidity established by the Trustees are quite liquid. The Funds intend, therefore, to treat restricted
securities that meet the liquidity criteria established by the Board of Trustees, including 4(2) paper and Rule 144A Securities, as determined by the Funds Adviser, as liquid and not subject to the investment limitation applicable to illiquid
securities.
The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under an SEC
Staff position set forth in the adopting release for Rule 144A under the 1933 Act (Rule 144A). Rule 144A is a nonexclusive safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under
federal securities laws. Rule 144A provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. Rule 144A was expected to further enhance the liquidity of the secondary market for
securities eligible for resale. The Funds believe that the Staff of the SEC has left the question of determining the liquidity of all restricted securities to the Trustees. The Trustees have directed each Funds Adviser to consider the
following criteria in determining the liquidity of certain restricted securities:
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the frequency of trades and quotes for the security;
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the number of dealers willing to purchase or sell the security and the number of other potential buyers;
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dealer undertakings to make a market in the security; and
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the nature of the security and the nature of the marketplace trades.
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Part II - 25
Certain 4(2) paper programs cannot rely on Rule 144A because, among other things, they were
established before the adoption of the rule. However, the Trustees may determine for purposes of the Trusts liquidity requirements that an issue of 4(2) paper is liquid if the following conditions, which are set forth in a 1994 SEC no-action
letter, are met:
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The 4(2) paper must not be traded flat or in default as to principal or interest;
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The 4(2) paper must be rated in one of the two highest rating categories by at least two NRSROs, or if only one NRSRO rates the security, by that
NRSRO, or if unrated, is determined by a Funds Adviser to be of equivalent quality;
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The Funds Adviser must consider the trading market for the specific security, taking into account all relevant factors, including but not limited
to, whether the paper is the subject of a commercial paper program that is administered by an issuing and paying agent bank and for which there exists a dealer willing to make a market in that paper, or whether the paper is administered by a direct
issuer pursuant to a direct placement program;
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The Funds Adviser shall monitor the liquidity of the 4(2) paper purchased and shall report to the Board of Trustees promptly if any such
securities are no longer determined to be liquid if such determination causes a Fund to hold more than 10% of its net assets in illiquid securities in order for the Board of Trustees to consider what action, if any, should be taken on behalf of the
Trust, unless the Funds Adviser is able to dispose of illiquid assets in an orderly manner in an amount that reduces the Funds holdings of illiquid assets to less than 10% of its net assets; and
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The Funds Adviser shall report to the Board of Trustees on the appropriateness of the purchase and retention of liquid restricted securities
under these guidelines no less frequently than quarterly.
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Securities Issued
in Connection with Reorganizations and Corporate Restructuring
.
Debt securities may be downgraded and issuers of debt securities including investment grade securities may default in the payment of principal or interest or be subject to
bankruptcy proceedings. In connection with reorganizing or restructuring of an issuer, an issuer may issue common stock or other securities to holders of its debt securities. A Fund may hold such common stock and other securities even though it does
not ordinarily invest in such securities.
Temporary Defensive Positions.
To respond to
unusual market conditions, all of the Funds may invest their assets in cash or cash equivalents. Cash equivalents are highly liquid, high quality instruments with maturities of three months or less on the date they are purchased (Cash
Equivalents) for temporary defensive purposes. These investments may result in a lower yield than lower-quality or longer term investments and may prevent the Funds from meeting their investment objectives. The percentage of Funds total
assets that a Fund may invest in cash or cash equivalents is described in the applicable Funds Prospectuses. They include securities issued by the U.S. government, its agencies and instrumentalities, repurchase agreements with maturities of 7
days or less (other than equity repurchase agreements), certificates of deposit, bankers acceptances, commercial paper (rated in one of the two highest rating categories), variable rate master demand notes, money market mutual funds, and bank
money market deposit accounts.
Mortgage-Related Securities
Mortgages (Directly Held)
.
Mortgages are debt instruments secured by real property. Unlike
mortgage-backed securities, which generally represent an interest in a pool of mortgages, direct investments in mortgages involve prepayment and credit risks of an individual issuer and real property. Consequently, these investments require
different investment and credit analysis by a Funds Adviser.
Directly placed mortgages may include residential
mortgages, multifamily mortgages, mortgages on cooperative apartment buildings, commercial mortgages, and sale-leasebacks. These investments are backed by assets such as office buildings, shopping centers, retail stores, warehouses, apartment
buildings and single-family dwellings. In the event that a Fund forecloses on any non-performing mortgage, and acquires a direct interest in the real property, such Fund will be subject to the risks generally associated with the ownership of real
property. There may be fluctuations in the market value of the foreclosed property and its occupancy rates, rent schedules and operating expenses. There may also be adverse changes in local, regional or general economic conditions, deterioration of
the real estate market and the financial circumstances of tenants and sellers, unfavorable changes in zoning, building, environmental and other laws, increased real property taxes, rising interest rates, reduced availability and increased cost of
mortgage borrowings, the need for unanticipated renovations, unexpected
Part II - 26
increases in the cost of energy, environmental factors, acts of God and other factors which are beyond the control of a Fund or the Funds Adviser. Hazardous or toxic substances may be
present on, at or under the mortgaged property and adversely affect the value of the property. In addition, the owners of property containing such substances may be held responsible, under various laws, for containing, monitoring, removing or
cleaning up such substances. The presence of such substances may also provide a basis for other claims by third parties. Costs of clean up or of liabilities to third parties may exceed the value of the property. In addition, these risks may be
uninsurable. In light of these and similar risks, it may be impossible to dispose profitably of properties in foreclosure.
Mortgage-Backed Securities (CMOs and REMICs)
.
Mortgage-backed securities include collateralized mortgage obligations (CMOs) and Real Estate Mortgage Investment Conduits (REMICs). A REMIC is a CMO that
qualifies for special tax treatment under the Code and invests in certain mortgages principally secured by interests in real property and other permitted investments.
Mortgage-backed securities represent pools of mortgage loans assembled for sale to investors by:
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various governmental agencies such as the Government National Mortgage Association (Ginnie Mae);
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organizations such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac); and
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non-governmental issuers such as commercial banks, savings and loan institutions, mortgage bankers, and private mortgage insurance companies
(non-governmental mortgage securities cannot be treated as U.S. government securities for purposes of investment policies).
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There are a number of important differences among the agencies and instrumentalities of the U.S. government that issue mortgage-related securities and among the securities that they issue.
Ginnie Mae Securities
. Mortgage-related securities issued by Ginnie Mae include Ginnie Mae Mortgage Pass-Through
Certificates which are guaranteed as to the timely payment of principal and interest by Ginnie Mae. Ginnie Maes guarantee is backed by the full faith and credit of the U.S. Ginnie Mae is a wholly-owned U.S. government corporation within the
Department of Housing and Urban Development. Ginnie Mae certificates also are supported by the authority of Ginnie Mae to borrow funds from the U.S. Treasury to make payments under its guarantee.
Fannie Mae Securities.
Mortgage-related securities issued by Fannie Mae include Fannie Mae Guaranteed Mortgage
Pass-Through Certificates which are solely the obligations of Fannie Mae and are not backed by or entitled to the full faith and credit of the U.S. Fannie Mae is a government-sponsored organization owned entirely by private stockholders. Fannie Mae
Certificates are guaranteed as to timely payment of the principal and interest by Fannie Mae.
Freddie Mac
Securities.
Mortgage-related securities issued by Freddie Mac include Freddie Mac Mortgage Participation Certificates. Freddie Mac is a corporate instrumentality of the U.S., created pursuant to an Act of Congress, which is owned by private
stockholders. Freddie Mac Certificates are not guaranteed by the U.S. or by any Federal Home Loan Bank and do not constitute a debt or obligation of the U.S. or of any Federal Home Loan Bank. Freddie Mac Certificates entitle the holder to timely
payment of interest, which is guaranteed by Freddie Mac. Freddie Mac guarantees either ultimate collection or timely payment of all principal payments on the underlying mortgage loans. When Freddie Mac does not guarantee timely payment of principal,
Freddie Mac may remit the amount due on account of its guarantee of ultimate payment of principal at any time after default on an underlying mortgage, but in no event later than one year after it becomes payable.
For more information on recent events impacting Fannie Mae and Freddie Mac securities, see
Recent Events Regarding Fannie Mae and
Freddie Mac Securities
under the heading Risk Factors of Mortgage-Related Securities below.
CMOs and
guaranteed REMIC pass-through certificates (REMIC Certificates) issued by Fannie Mae, Freddie Mac, Ginnie Mae and private issuers are types of multiple class pass-through securities. Investors may purchase beneficial interests in REMICs,
which are known as regular interests or residual interests. The Funds do not currently intend to purchase residual interests in REMICs. The REMIC Certificates represent beneficial ownership interests in a REMIC Trust,
generally consisting of mortgage loans or Fannie Mae, Freddie Mac or Ginnie Mae guaranteed mortgage pass-through certificates (the Mortgage Assets). The obligations of Fannie Mae, Freddie Mac or Ginnie Mae under their respective guaranty
of the REMIC Certificates are obligations solely of Fannie Mae, Freddie Mac or Ginnie Mae, respectively.
Part II - 27
Fannie Mae REMIC Certificates.
Fannie Mae REMIC Certificates are
issued and guaranteed as to timely distribution of principal and interest by Fannie Mae. In addition, Fannie Mae will be obligated to distribute the principal balance of each class of REMIC Certificates in full, whether or not sufficient funds are
otherwise available.
Freddie Mac REMIC Certificates.
Freddie Mac guarantees the timely payment of
interest, and also guarantees the payment of principal as payments are required to be made on the underlying mortgage participation certificates (PCs). PCs represent undivided interests in specified residential mortgages or participation
therein purchased by Freddie Mac and placed in a PC pool. With respect to principal payments on PCs, Freddie Mac generally guarantees ultimate collection of all principal of the related mortgage loans without offset or deduction. Freddie Mac also
guarantees timely payment of principal on certain PCs referred to as Gold PCs.
Ginnie Mae REMIC
Certificates.
Ginnie Mae guarantees the full and timely payment of interest and principal on each class of securities (in accordance with the terms of those classes as specified in the related offering circular supplement). The Ginnie Mae
guarantee is backed by the full faith and credit of the U.S.
REMIC Certificates issued by Fannie Mae, Freddie Mac and Ginnie
Mae are treated as U.S. Government securities for purposes of investment policies.
CMOs and REMIC Certificates provide for the
redistribution of cash flow to multiple classes. Each class of CMOs or REMIC Certificates, often referred to as a tranche, is issued at a specific adjustable or fixed interest rate and must be fully retired no later than its final
distribution date. This reallocation of interest and principal results in the redistribution of prepayment risk across different classes. This allows for the creation of bonds with more or less risk than the underlying collateral exhibits. Principal
prepayments on the mortgage loans or the Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all of the classes of CMOs or REMIC Certificates to be retired substantially earlier than their final distribution dates. Generally,
interest is paid or accrues on all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest on
the Mortgage Assets may be allocated among the several classes of CMOs or REMIC Certificates in various ways. In certain structures (known as sequential pay CMOs or REMIC Certificates), payments of principal, including any principal
prepayments, on the Mortgage Assets generally are applied to the classes of CMOs or REMIC Certificates in the order of their respective final distribution dates. Thus, no payment of principal will be made on any class of sequential pay CMOs or REMIC
Certificates until all other classes having an earlier final distribution date have been paid in full.
Additional structures
of CMOs and REMIC Certificates include, among others, principal only structures, interest only structures, inverse floaters and parallel pay CMOs and REMIC Certificates. Certain of these structures may be more volatile than other types
of CMO and REMIC structures. Parallel pay CMOs or REMIC Certificates are those which are structured to apply principal payments and prepayments of the Mortgage Assets to two or more classes concurrently on a proportionate or disproportionate basis.
These simultaneous payments are taken into account in calculating the final distribution date of each class.
A wide variety of
REMIC Certificates may be issued in the parallel pay or sequential pay structures. These securities include accrual certificates (also known as Z-Bonds), which only accrue interest at a specified rate until all other certificates having
an earlier final distribution date have been retired and are converted thereafter to an interest-paying security, and planned amortization class (PAC) certificates, which are parallel pay REMIC Certificates which generally require that
specified amounts of principal be applied on each payment date to one or more classes of REMIC Certificates (the PAC Certificates), even though all other principal payments and prepayments of the Mortgage Assets are then required to be
applied to one or more other classes of the certificates. The scheduled principal payments for the PAC Certificates generally have the highest priority on each payment date after interest due has been paid to all classes entitled to receive interest
currently. Shortfalls, if any, are added to the amount of principal payable on the next payment date. The PAC Certificate payment schedule is taken into account in calculating the final distribution date of each class of PAC. In order to create PAC
tranches, one or more tranches generally must be created that absorb most of the volatility in the underlying Mortgage Assets. These tranches tend to have market prices and yields that are much more volatile than the PAC classes. The Z-Bonds in
which the Funds may invest may bear the same non-credit-related risks as do other types of Z-Bonds. Z-Bonds in which the Fund may invest will not include residual interest.
Part II - 28
Total Annual Fund Operating Expenses set forth in the fee table and Financial Highlights
section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment company provided by section
3(c)(1) or 3(c)(7) of the 1940 Act.
Mortgage TBAs.
The Fund may invest in mortgage
pass-through securities eligible to be sold in the to-be-announced or TBA market (Mortgage TBAs). Mortgage TBAs provide for the forward or delayed delivery of the underlying instrument with settlement up to 180 days. The term TBA comes
from the fact that the actual mortgage-backed security that will be delivered to fulfill a TBA trade is not designated at the time the trade is made, but rather is generally announced 48 hours before the settlement date. Mortgage TBAs are subject to
the risks described in the When-Issued Securities, Delayed Delivery Securities and Forward Commitments section.
Mortgage Dollar Rolls.
In a mortgage dollar roll transaction, one party sells mortgage-backed
securities, principally Mortgage TBAs, for delivery in the current month and simultaneously contracts with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities on a specified future date. When a
Fund enters into mortgage dollar rolls, the Fund will earmark and reserve until the settlement date Fund assets, in cash or liquid securities, in an amount equal to the forward purchase price. During the period between the sale and repurchase in a
mortgage dollar roll transaction, the Fund will not be entitled to receive interest and principal payments on securities sold. Losses may arise due to changes in the value of the securities or if the counterparty does not perform under the terms of
the agreement. If the counterparty files for bankruptcy or becomes insolvent, the Funds right to repurchase or sell securities may be limited. Mortgage dollar rolls may be subject to leverage risks. In addition, mortgage dollar rolls may
increase interest rate risk and result in an increased portfolio turnover rate which increases costs and may increase taxable gains. The benefits of mortgage dollar rolls may depend upon a Funds Advisers ability to predict mortgage
prepayments and interest rates. There is no assurance that mortgage dollar rolls can be successfully employed. For purposes of diversification and investment limitations, mortgage dollar rolls are considered to be mortgage-backed securities.
Stripped Mortgage-Backed Securities.
Stripped Mortgage-Backed Securities
(SMBS) are derivative multi-class mortgage securities issued outside the REMIC or CMO structure. SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions from a pool of
mortgage assets. A common type of SMBS will have one class receiving all of the interest from the mortgage assets (IOs), while the other class will receive all of the principal (POs). Mortgage IOs receive monthly interest
payments based upon a notional amount that declines over time as a result of the normal monthly amortization and unscheduled prepayments of principal on the associated mortgage POs.
In addition to the risks applicable to Mortgage-Related Securities in general, SMBS are subject to the following additional risks:
Prepayment/Interest Rate Sensitivity.
SMBS are extremely sensitive to changes in prepayments and
interest rates. Even though these securities have been guaranteed by an agency or instrumentality of the U.S. government, under certain interest rate or prepayment rate scenarios, the Funds may lose money on investments in SMBS.
Interest Only SMBS.
Changes in prepayment rates can cause the return on investment in IOs to be highly volatile.
Under extremely high prepayment conditions, IOs can incur significant losses.
Principal Only SMBS.
POs
are bought at a discount to the ultimate principal repayment value. The rate of return on a PO will vary with prepayments, rising as prepayments increase and falling as prepayments decrease. Generally, the market value of these securities is
unusually volatile in response to changes in interest rates.
Yield Characteristics.
Although SMBS may
yield more than other mortgage-backed securities, their cash flow patterns are more volatile and there is a greater risk that any premium paid will not be fully recouped. A Funds Adviser will seek to manage these risks (and potential benefits)
by investing in a variety of such securities and by using certain analytical and hedging techniques.
Adjustable Rate Mortgage Loans
.
Certain Funds may invest in adjustable rate mortgage loans (ARMs). ARMs eligible for inclusion in a mortgage pool will generally provide for a fixed initial mortgage interest rate for a
specified period of time. Thereafter, the interest rates (the Mortgage Interest Rates) may be subject to periodic adjustment based on changes in the applicable index rate (the Index Rate). The adjusted rate would be equal to
the Index Rate plus a gross margin, which is a fixed percentage spread over the Index Rate established for each ARM at the time of its origination.
Part II - 29
Adjustable interest rates can cause payment increases that some borrowers may find difficult
to make. However, certain ARMs may provide that the Mortgage Interest Rate may not be adjusted to a rate above an applicable lifetime maximum rate or below an applicable lifetime minimum rate for such ARM. Certain ARMs may also be subject to
limitations on the maximum amount by which the Mortgage Interest Rate may adjust for any single adjustment period (the Maximum Adjustment). Other ARMs (Negatively Amortizing ARMs) may provide instead or as well for
limitations on changes in the monthly payment on such ARMs. Limitations on monthly payments can result in monthly payments which are greater or less than the amount necessary to amortize a Negatively Amortizing ARM by its maturity at the Mortgage
Interest Rate in effect in any particular month. In the event that a monthly payment is not sufficient to pay the interest accruing on a Negatively Amortizing ARM, any such excess interest is added to the principal balance of the loan, causing
negative amortization and will be repaid through future monthly payments. It may take borrowers under Negatively Amortizing ARMs longer periods of time to achieve equity and may increase the likelihood of default by such borrowers. In the event that
a monthly payment exceeds the sum of the interest accrued at the applicable Mortgage Interest Rate and the principal payment which would have been necessary to amortize the outstanding principal balance over the remaining term of the loan, the
excess (or accelerated amortization) further reduces the principal balance of the ARM. Negatively Amortizing ARMs do not provide for the extension of their original maturity to accommodate changes in their Mortgage Interest Rate. As a
result, unless there is a periodic recalculation of the payment amount (which there generally is), the final payment may be substantially larger than the other payments. These limitations on periodic increases in interest rates and on changes in
monthly payments protect borrowers from unlimited interest rate and payment increases.
Certain ARMs may provide for periodic
adjustments of scheduled payments in order to amortize fully the mortgage loan by its stated maturity. Other ARMs may permit their stated maturity to be extended or shortened in accordance with the portion of each payment that is applied to interest
as affected by the periodic interest rate adjustments.
There are two main categories of indices which provide the basis for
rate adjustments on ARMs: those based on U.S. Treasury securities and those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the one-year, three-year and
five-year constant maturity Treasury bill rates, the three-month Treasury bill rate, the 180-day Treasury bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds, the National Median Cost of Funds,
the one-month, three-month, six-month or one-year London InterBank Offered Rate (LIBOR), the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant maturity Treasury rate, closely mirror
changes in market interest rate levels. Others, such as the 11th District Federal Home Loan Bank Cost of Funds index, tend to lag behind changes in market rate levels and tend to be somewhat less volatile. The degree of volatility in the market
value of the Funds portfolio and therefore in the net asset value of the Funds shares will be a function of the length of the interest rate reset periods and the degree of volatility in the applicable indices.
In general, changes in both prepayment rates and interest rates will change the yield on Mortgage-Backed Securities. The rate of principal
prepayments with respect to ARMs has fluctuated in recent years. As is the case with fixed mortgage loans, ARMs may be subject to a greater rate of principal prepayments in a declining interest rate environment. For example, if prevailing interest
rates fall significantly, ARMs could be subject to higher prepayment rates than if prevailing interest rates remain constant because the availability of fixed rate mortgage loans at competitive interest rates may encourage mortgagors to refinance
their ARMs to lock-in a lower fixed interest rate. Conversely, if prevailing interest rates rise significantly, ARMs may prepay at lower rates than if prevailing rates remain at or below those in effect at the time such ARMs were
originated. As with fixed rate mortgages, there can be no certainty as to the rate of prepayments on the ARMs in either stable or changing interest rate environments. In addition, there can be no certainty as to whether increases in the principal
balances of the ARMs due to the addition of deferred interest may result in a default rate higher than that on ARMs that do not provide for negative amortization.
Other factors affecting prepayment of ARMs include changes in mortgagors housing needs, job transfers, unemployment, mortgagors net equity in the mortgage properties and servicing decisions.
Risk Factors of Mortgage-Related Securities
.
The following is a summary of certain
risks associated with Mortgage-Related Securities:
Guarantor Risk.
There can be no assurance that the U.S. government
would provide financial support to Fannie Mae or Freddie Mac if necessary in the future. Although certain mortgage-related securities are guaranteed by a third party or otherwise similarly secured, the market value of the security, which may
fluctuate, is not so secured.
Part II - 30
Interest Rate Sensitivity.
If a Fund purchases a mortgage-related security at a
premium, that portion may be lost if there is a decline in the market value of the security whether resulting from changes in interest rates or prepayments in the underlying mortgage collateral. As with other interest-bearing securities, the prices
of such securities are inversely affected by changes in interest rates. Although the value of a mortgage-related security may decline when interest rates rise, the converse is not necessarily true since in periods of declining interest rates the
mortgages underlying the securities are prone to prepayment. For this and other reasons, a mortgage-related securitys stated maturity may be shortened by unscheduled prepayments on the underlying mortgages and, therefore, it is not possible to
predict accurately the securitys return to the Fund. In addition, regular payments received in respect of mortgage-related securities include both interest and principal. No assurance can be given as to the return the Fund will receive when
these amounts are reinvested.
Market Value.
The market value of the Funds adjustable rate Mortgage-Backed
Securities may be adversely affected if interest rates increase faster than the rates of interest payable on such securities or by the adjustable rate mortgage loans underlying such securities. Furthermore, adjustable rate Mortgage-Backed Securities
or the mortgage loans underlying such securities may contain provisions limiting the amount by which rates may be adjusted upward and downward and may limit the amount by which monthly payments may be increased or decreased to accommodate upward and
downward adjustments in interest rates. When the market value of the properties underlying the Mortgage-Backed Securities suffer broad declines on a regional or national level, the values of the corresponding Mortgage-Backed Securities or
Mortgage-Backed Securities as a whole, may be adversely affected as well.
Prepayments.
Adjustable rate Mortgage-Backed
Securities have less potential for capital appreciation than fixed rate Mortgage-Backed Securities because their coupon rates will decline in response to market interest rate declines. The market value of fixed rate Mortgage-Backed Securities may be
adversely affected as a result of increases in interest rates and, because of the risk of unscheduled principal prepayments, may benefit less than other fixed rate securities of similar maturity from declining interest rates. Finally, to the extent
Mortgage-Backed Securities are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments may result in some loss of the Funds principal investment to the extent of the premium paid. On the other hand, if such
securities are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the recognition of income.
Yield Characteristics.
The yield characteristics of Mortgage-Backed Securities differ from those of traditional fixed income
securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possibility that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current
interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. As with fixed rate mortgage loans, adjustable rate mortgage loans may be subject to a greater prepayment rate in a declining
interest rate environment. The yields to maturity of the Mortgage-Backed Securities in which the Funds invest will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans. The mortgage loans
underlying such securities generally may be prepaid at any time without penalty. In a fluctuating interest rate environment, a predominant factor affecting the prepayment rate on a pool of mortgage loans is the difference between the interest rates
on the mortgage loans and prevailing mortgage loan interest rates taking into account the cost of any refinancing. In general, if mortgage loan interest rates fall sufficiently below the interest rates on fixed rate mortgage loans underlying
mortgage pass-through securities, the rate of prepayment would be expected to increase. Conversely, if mortgage loan interest rates rise above the interest rates on the fixed rate mortgage loans underlying the mortgage pass-through securities, the
rate of prepayment may be expected to decrease.
Recent Events Regarding Fannie Mae and Freddie Mac Securities
. On
September 6, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of Fannie Mae and Freddie Mac and
of any stockholder, officer or director of Fannie Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of Fannie Mae and Freddie Mac. FHFA selected a new chief executive officer and chairman of the board of directors for
each of Fannie Mae and Freddie Mac. On September 7, 2008, the U.S. Treasury announced three additional steps taken by it in connection with the conservatorship. First, the U.S. Treasury entered into a Senior Preferred Stock Purchase Agreement
with each of Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will purchase up to an aggregate of $100 billion of each of Fannie Mae and Freddie Mac to maintain a positive net worth in each enterprise. This agreement contains various
covenants, discussed below, that severely limit each enterprises operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprises senior preferred stock and warrants to purchase 79.9%
of each enterprises common stock. Second, the
Part II - 31
U.S. Treasury announced the creation of a new secured lending facility which is available to each of Fannie Mae and Freddie Mac as a liquidity backstop. Third, the U.S. Treasury announced the
creation of a temporary program to purchase mortgage-backed securities issued by each of Fannie Mae and Freddie Mac. Both the liquidity backstop and the mortgage-backed securities purchase program expired in December 2009. 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 liquidity backstop and the Senior
Preferred Stock Purchase Agreement were both intended to enhance each of Fannie Maes and Freddie Macs ability to meet its obligations.
Under the Federal Housing Finance Regulatory Reform Act of 2008 (the
Reform Act), which was included as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or
receiver, has the power to repudiate any contract entered into by Fannie Mae or Freddie Mac prior to FHFAs appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is
burdensome and that repudiation of the contract promotes the orderly administration of Fannie Maes or Freddie Macs affairs. The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time
after its appointment as conservator or receiver. FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of Fannie Mae or Freddie Mac because FHFA views repudiation as incompatible with the
goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for Fannie Mae or Freddie Mac, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as
applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of Fannie Maes or Freddie Macs assets available therefor. In
the event of repudiation, the payments of interest to holders of Fannie Mae or Freddie Mac mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such mortgage-backed
securities are not made by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security
holders. Further, in its capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of Fannie Mae or Freddie Mac without any approval, assignment or consent. Although FHFA has stated that it has no present
intention to do so, if FHFA, as conservator or receiver, were to transfer any such guaranty obligation to another party, holders of Fannie Mae or Freddie Mac mortgage-backed securities would have to rely on that party for satisfaction of the
guaranty obligation and would be exposed to the credit risk of that party.
In addition, certain rights provided to holders of
mortgage-backed securities issued by Fannie Mae and Freddie Mac under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or any future
receivership. The operative documents for Fannie Mae and Freddie Mac mortgage-backed securities may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided) that upon the occurrence of
an event of default on the part of Fannie Mae or Freddie Mac, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right to replace Fannie Mae or Freddie Mac
as trustee if the requisite percentage of mortgage-backed securities holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has
been appointed. The Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which Fannie Mae or Freddie Mac is a party, or obtain possession of or
exercise control over any property of Fannie Mae or Freddie Mac, or affect any contractual rights of Fannie Mae or Freddie Mac, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days following the appointment of FHFA
as conservator or receiver, respectively.
The conditions attached to the financial contribution made by the Treasury to
Freddie Mac and Fannie Mae and the issuance of senior preferred stock place significant restrictions on the activities of Freddie Mac and Fannie Mae. Freddie Mac and Fannie Mae must obtain the consent of the Treasury to, among other things, (i) make
any payment to purchase or redeem its capital stock or pay any dividend other than in respect of the senior preferred stock, (ii) issue capital stock of any kind, (iii) terminate the conservatorship of the FHFA except in connection with a
receivership, or (iv) increase its debt beyond certain specified levels. In addition, significant restrictions are placed on the maximum size of each of Freddie Macs and Fannie Maes respective portfolios of mortgages and mortgage-backed
securities, and the purchase agreements entered into by Freddie Mac and Fannie Mae provide that the maximum size of their portfolios of these assets must decrease by a specified percentage each year. The future status and role of Freddie Mac and
Fannie Mae could be impacted by (among other things) the actions taken and restrictions placed on Freddie Mac and Fannie Mae by the FHFA in is role as conservator, the restrictions placed on
Part II - 32
Freddie Macs and Fannie Maes operations and activities as a result of the senior preferred stock investment made by the U.S. Treasury, market responses to developments at Freddie Mac
and Fannie Mac, and future legislative and regulatory action that alters the operations, ownership, structure and/or mission of these institutions, each of which may, in turn, impact the value of, and cash flows on, any mortgage-backed securities
guaranteed by Freddie Mac and Fannie Mae, including any such mortgage-backed securities held by a Fund.
Municipal Securities
Municipal Securities are issued to obtain funds for a wide variety of reasons. For example, municipal securities may be issued to obtain funding for the construction of a wide range of public facilities
such as:
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5.
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waterworks and sewer systems; and
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Other public
purposes for which Municipal Securities may be issued include:
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1.
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refunding outstanding obligations;
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2.
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obtaining funds for general operating expenses; and
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3.
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obtaining funds to lend to other public institutions and facilities.
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In addition, certain debt obligations known as Private Activity Bonds may be issued by or on behalf of municipalities and public authorities to obtain funds to provide:
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1.
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water, sewage and solid waste facilities;
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2.
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qualified residential rental projects;
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3.
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certain local electric, gas and other heating or cooling facilities;
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4.
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qualified hazardous waste facilities;
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5.
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high-speed intercity rail facilities;
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6.
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governmentally-owned airports, docks and wharves and mass transportation facilities;
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8.
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student loan and redevelopment bonds; and
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9.
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bonds used for certain organizations exempt from Federal income taxation.
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Certain debt obligations known as Industrial Development Bonds under prior Federal tax law may have been issued by or on behalf of public authorities to obtain funds to provide:
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1.
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privately operated housing facilities;
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4.
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convention or trade show facilities;
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5.
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airport, mass transit, port or parking facilities;
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6.
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air or water pollution control facilities;
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7.
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sewage or solid waste disposal facilities; and
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8.
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facilities for water supply.
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Other private activity bonds and industrial development bonds issued to fund the construction, improvement, equipment or repair of
privately-operated industrial, distribution, research, or commercial facilities may also be
Part II - 33
Municipal Securities, however the size of such issues is limited under current and prior Federal tax law. The aggregate amount of most private activity bonds and industrial development bonds is
limited (except in the case of certain types of facilities) under Federal tax law by an annual volume cap. The volume cap limits the annual aggregate principal amount of such obligations issued by or on behalf of all governmental
instrumentalities in the state.
The two principal classifications of Municipal Securities consist of general
obligation and limited (or revenue) issues. General obligation bonds are obligations involving the credit of an issuer possessing taxing power and are payable from the issuers general unrestricted revenues and not from any
particular fund or source. The characteristics and method of enforcement of general obligation bonds vary according to the law applicable to the particular issuer, and payment may be dependent upon appropriation by the issuers legislative
body. Limited obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Private activity bonds and
industrial development bonds generally are revenue bonds and thus not payable from the unrestricted revenues of the issuer. The credit and quality of such bonds is generally related to the credit of the bank selected to provide the letter of credit
underlying the bond. Payment of principal of and interest on industrial development revenue bonds is the responsibility of the corporate user (and any guarantor).
The Funds may also acquire moral obligation issues, which are normally issued by special purpose authorities, and in other tax-exempt investments including pollution control bonds and
tax-exempt commercial paper. Each Fund that may purchase municipal bonds may purchase:
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1.
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Short-term tax-exempt General Obligations Notes;
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2.
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Tax Anticipation Notes;
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3.
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Bond Anticipation Notes;
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4.
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Revenue Anticipation Notes;
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6.
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Other forms of short-term tax-exempt loans.
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Such notes are issued with a short-term maturity in anticipation of the receipt of tax funds, the proceeds of bond placements, or other revenues. Project Notes are issued by a state or local housing
agency and are sold by the Department of Housing and Urban Development. While the issuing agency has the primary obligation with respect to its Project Notes, they are also secured by the full faith and credit of the U.S. through agreements with the
issuing authority which provide that, if required, the Federal government will lend the issuer an amount equal to the principal of and interest on the Project Notes.
There are, of course, variations in the quality of Municipal Securities, both within a particular classification and between classifications. Also, the yields on Municipal Securities depend upon a variety
of factors, including:
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1.
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general money market conditions;
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3.
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the financial condition of the issuer;
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4.
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general conditions of the municipal bond market;
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5.
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the size of a particular offering;
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6.
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the maturity of the obligations; and
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7.
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the rating of the issue.
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The
ratings of Moodys and S&P represent their opinions as to the quality of Municipal Securities. However, ratings are general and are not absolute standards of quality. Municipal Securities with the same maturity, interest rate and rating may
have different yields while Municipal Securities of the same maturity and interest rate with different ratings may have the same yield. Subsequent to its purchase by a Fund, an issue of Municipal Securities may cease to be rated or its rating may be
reduced below the minimum rating required for purchase by the Fund. The Adviser will consider such an event in determining whether the Fund should continue to hold the obligations.
Municipal Securities may include obligations of municipal housing authorities and single-family mortgage revenue bonds. Weaknesses in
Federal housing subsidy programs and their administration may result in a decrease
Part II - 34
of subsidies available for payment of principal and interest on housing authority bonds. Economic developments, including fluctuations in interest rates and increasing construction and operating
costs, may also adversely impact revenues of housing authorities. In the case of some housing authorities, inability to obtain additional financing could also reduce revenues available to pay existing obligations.
Single-family mortgage revenue bonds are subject to extraordinary mandatory redemption at par in whole or in part from the proceeds
derived from prepayments of underlying mortgage loans and also from the unused proceeds of the issue within a stated period which may be within a year from the date of issue.
Municipal leases are obligations issued by state and local governments or authorities to finance the acquisition of equipment and facilities. Municipal leases may be considered to be illiquid. They may
take the form of a lease, an installment purchase contract, a conditional sales contract, or a participation interest in any of the above. The Board of Trustees is responsible for determining the credit quality of unrated municipal leases on an
ongoing basis, including an assessment of the likelihood that the lease will not be canceled.
Premium Securities
.
During a period of declining interest rates, many Municipal Securities in which the Funds invest likely will bear coupon rates higher than current market rates, regardless of whether the securities were initially purchased at a premium.
Risk Factors in Municipal Securities
.
The following is a summary of certain risks associated
with Municipal Securities
Tax Risk.
The Code imposes certain continuing requirements on issuers of tax-exempt bonds
regarding the use, expenditure and investment of bond proceeds and the payment of rebates to the U.S. Failure by the issuer to comply subsequent to the issuance of tax-exempt bonds with certain of these requirements could cause interest on the bonds
to become includable in gross income retroactive to the date of issuance.
Housing Authority Tax Risk.
The exclusion
from gross income for Federal income tax purposes for certain housing authority bonds depends on qualification under relevant provisions of the Code and on other provisions of Federal law. These provisions of Federal law contain requirements
relating to the cost and location of the residences financed with the proceeds of the single-family mortgage bonds and the income levels of tenants of the rental projects financed with the proceeds of the multi-family housing bonds. Typically, the
issuers of the bonds, and other parties, including the originators and servicers of the single-family mortgages and the owners of the rental projects financed with the multi-family housing bonds, covenant to meet these requirements. However, there
is no assurance that the requirements will be met. If such requirements are not met:
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the interest on the bonds may become taxable, possibly retroactively from the date of issuance;
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the value of the bonds may be reduced;
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you and other Shareholders may be subject to unanticipated tax liabilities;
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a Fund may be required to sell the bonds at the reduced value;
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it may be an event of default under the applicable mortgage;
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the holder may be permitted to accelerate payment of the bond; and
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the issuer may be required to redeem the bond.
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In addition, if the mortgage securing the bonds is insured by the Federal Housing Administration (FHA), the consent of the FHA may be required before insurance proceeds would become payable.
Information Risk.
Information about the financial condition of issuers of Municipal Securities may be less available
than that of corporations having a class of securities registered under the SEC.
State and Federal Laws.
An
issuers obligations under its Municipal Securities are subject to the provisions of bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors. These laws may extend the time for payment of principal or interest, or
restrict the Funds ability to collect payments due on Municipal Securities. In addition, recent amendments to some statutes governing security interests (e.g., Revised Article 9 of the Uniform Commercial Code (UCC)) change the way
in which security interests and liens securing Municipal Securities are perfected. These amendments may have an adverse impact on existing Municipal Securities (particularly issues of Municipal Securities that do not have a corporate trustee who is
responsible for filing UCC financing statements to continue the security interest or lien).
Part II - 35
Litigation and Current Developments.
Litigation or other conditions may materially
and adversely affect the power or ability of an issuer to meet its obligations for the payment of interest on and principal of its Municipal Securities. Such litigation or conditions may from time to time have the effect of introducing uncertainties
in the market for tax-exempt obligations, or may materially affect the credit risk with respect to particular bonds or notes. Adverse economic, business, legal or political developments might affect all or a substantial portion of a Funds
Municipal Securities in the same manner.
New Legislation.
From time to time, proposals have been introduced before
Congress for the purpose of restricting or eliminating the federal income tax exemption for interest on tax exempt bonds, and similar proposals may be introduced in the future. The Supreme Court has held that Congress has the constitutional
authority to enact such legislation. It is not possible to determine what effect the adoption of such proposals could have on (i) the availability of Municipal Securities for investment by the Funds, and (ii) the value of the investment
portfolios of the Funds.
Limitations on the Use of Municipal Securities.
Certain Funds
may invest in Municipal Securities if the Adviser determines that such Municipal Securities offer attractive yields. The Funds may invest in Municipal Securities either by purchasing them directly or by purchasing certificates of accrual or similar
instruments evidencing direct ownership of interest payments or principal payments, or both, on Municipal Securities, provided that, in the opinion of counsel to the initial seller of each such certificate or instrument, any discount accruing on
such certificate or instrument that is purchased at a yield not greater than the coupon rate of interest on the related Municipal Securities will to the same extent as interest on such Municipal Securities be exempt from federal income tax and state
income tax (where applicable) and not treated as a preference item for individuals for purposes of the federal alternative minimum tax. The Funds may also invest in Municipal Securities by purchasing from banks participation interests in all or part
of specific holdings of Municipal Securities. Such participation interests may be backed in whole or in part by an irrevocable letter of credit or guarantee of the selling bank. The selling bank may receive a fee from a Fund in connection with the
arrangement.
Each Fund will limit its investment in municipal leases to no more than 5% of its total assets.
Options and Futures Transactions
A Fund may purchase and sell (a) exchange traded and OTC put and call options on securities, indexes of securities and futures contracts on securities and indexes of securities and (b) futures
contracts on securities and indexes of securities. Each of these instruments is a derivative instrument as its value derives from the underlying asset or index.
Subject to its investment objective and policies, a Fund may use futures contracts and options for hedging and risk management purposes and to seek to enhance portfolio performance.
Options and futures contracts may be used to manage a Funds exposure to changing interest rates and/or security prices. Some options
and futures strategies, including selling futures contracts and buying puts, tend to hedge a Funds investments against price fluctuations. Other strategies, including buying futures contracts and buying calls, tend to increase market exposure.
Options and futures contracts may be combined with each other or with forward contracts in order to adjust the risk and return characteristics of a Funds overall strategy in a manner deemed appropriate by the Funds Adviser and consistent
with the Funds objective and policies. Because combined options positions involve multiple trades, they result in higher transaction costs and may be more difficult to open and close out.
The use of options and futures is a highly specialized activity which involves investment strategies and risks different from those
associated with ordinary portfolio securities transactions, and there can be no guarantee that their use will increase a Funds return. While the use of these instruments by a Fund may reduce certain risks associated with owning its portfolio
securities, these techniques themselves entail certain other risks. If a Funds Adviser applies a strategy at an inappropriate time or judges market conditions or trends incorrectly, options and futures strategies may lower a Funds
return. Certain strategies limit a Funds possibilities to realize gains, as well as its exposure to losses. A Fund could also experience losses if the prices of its options and futures positions were poorly correlated with its other
investments, or if it could not close out its positions because of an illiquid secondary market. In addition, the Fund will incur transaction costs, including trading commissions and option premiums, in connection with its futures and options
transactions, and these transactions could significantly increase the Funds turnover rate.
Part II - 36
Certain Funds have filed a notice under the Commodity Exchange Act under Regulation 4.5 and
are operated by a person that has claimed an exclusion from the definition of the term commodity pool operator under the Commodity Exchange Act and, therefore, is not subject to registration or regulation as a pool operator under the
Commodity Exchange Act. Certain other Funds may rely on no action relief issued by the CFTC.
Purchasing Put and Call Options.
By purchasing a put option, a Fund obtains the right (but not the
obligation) to sell the instrument underlying the option at a fixed strike price. In return for this right, a Fund pays the current market price for the option (known as the option premium). Options have various types of underlying instruments,
including specific securities, indexes of securities, indexes of securities prices, and futures contracts. A Fund may terminate its position in a put option it has purchased by allowing it to expire or by exercising the option. A Fund may also close
out a put option position by entering into an offsetting transaction, if a liquid market exists. If the option is allowed to expire, a Fund will lose the entire premium it paid. If a Fund exercises a put option on a security, it will sell the
instrument underlying the option at the strike price. If a Fund exercises an option on an index, settlement is in cash and does not involve the actual purchase or sale of securities. If an option is American style, it may be exercised on any day up
to its expiration date. A European style option may be exercised only on its expiration date.
The buyer of a typical put
option can expect to realize a gain if the value of the underlying instrument falls substantially. However, if the price of the instrument underlying the option does not fall enough to offset the cost of purchasing the option, a put buyer can expect
to suffer a loss (limited to the amount of the premium paid, plus related transaction costs).
The features of call options are
essentially the same as those of put options, except that the purchaser of a call option obtains the right to purchase, rather than sell, the instrument underlying the option at the options strike price. A call buyer typically attempts to
participate in potential price increases of the instrument underlying the option with risk limited to the cost of the option if security prices fall. At the same time, the buyer can expect to suffer a loss if security prices do not rise sufficiently
to offset the cost of the option.
Selling (Writing) Put and Call Options.
When a Fund
writes a put option, it takes the opposite side of the transaction from the options purchaser. In return for the receipt of the premium, a Fund assumes the obligation to pay the strike price for the instrument underlying the option if the
other party to the option chooses to exercise it. A Fund may seek to terminate its position in a put option it writes before exercise by purchasing an offsetting option in the market at its current price. If the market is not liquid for a put option
a Fund has written, however, it must continue to be prepared to pay the strike price while the option is outstanding, regardless of price changes, and must continue to post margin as discussed below. If the market value of the underlying securities
does not move to a level that would make exercise of the option profitable to its holder, the option will generally expire unexercised, and the Fund will realize as profit the premium it received.
If the price of the underlying instrument rises, a put writer would generally expect to profit, although its gain would be limited to the
amount of the premium it received. If security prices remain the same over time, it is likely that the writer will also profit, because it should be able to close out the option at a lower price. If security prices fall, the put writer would expect
to suffer a loss. This loss should be less than the loss from purchasing and holding the underlying instrument directly, however, because the premium received for writing the option should offset a portion of the decline.
Writing a call option obligates a Fund to sell or deliver the options underlying instrument in return for the strike price upon
exercise of the option. The characteristics of writing call options are similar to those of writing put options, except that writing calls generally is a profitable strategy if prices remain the same or fall. Through receipt of the option premium a
call writer offsets part of the effect of a price decline. At the same time, because a call writer must be prepared to deliver the underlying instrument in return for the strike price, even if its current value is greater, a call writer gives up
some ability to participate in security price increases.
The writer of an exchange traded put or call option on a security, an
index of securities or a futures contract is required to deposit cash or securities or a letter of credit as margin and to make mark to market payments of variation margin as the position becomes unprofitable.
Certain Funds will usually sell covered call options or cash-secured put options. A call option is covered if the writer either owns the
underlying security (or comparable securities satisfying the cover requirements of the securities exchanges) or has the right to acquire such securities. A put option is cash-secured if the writer segregates cash, high-grade short-term debt
obligations, or other permissible collateral equal to the exercise price. As the writer of a covered call option, the Fund foregoes, during the options life, the opportunity to profit from increases in the
Part II - 37
market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security
decline. As the Fund writes covered calls over more of its portfolio, its ability to benefit from capital appreciation becomes more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation, but
may terminate its position by entering into an offsetting option. Once an option writer has received an exercise notice, it cannot effect an offsetting transaction in order to terminate its obligation under the option and must deliver the underlying
security at the exercise price.
When the Fund writes cash-secured put options, it bears the risk of loss if the value of the
underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Fund could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock
at the time of exercise plus the put premium the Fund received when it wrote the option. While the Funds potential gain in writing a cash-secured put option is limited to distributions earned on the liquid assets securing the put option plus
the premium received from the purchaser of the put option, the Fund risks a loss equal to the entire exercise price of the option minus the put premium.
Engaging in Straddles and Spreads.
In a straddle transaction, a Fund either buys a call and a put or sells a call and a put on the same security. In a spread, a Fund
purchases and sells a call or a put. A Fund will sell a straddle when the Funds Adviser believes the price of a security will be stable. The Fund will receive a premium on the sale of the put and the call. A spread permits a Fund to make a
hedged investment that the price of a security will increase or decline.
Options on Indexes.
Options on securities indexes are similar to options on securities, except that the exercise of securities index options is settled by cash payment and does not involve the actual purchase or sale of securities. In addition, these options are
designed to reflect price fluctuations in a group of securities or segment of the securities market rather than price fluctuations in a single security. A Fund, in purchasing or selling index options, is subject to the risk that the value of its
portfolio securities may not change as much as an index because a Funds investments generally will not match the composition of an index.
For a number of reasons, a liquid market may not exist and thus a Fund may not be able to close out an option position that it has previously entered into. When a Fund purchases an OTC option (as defined
below), it will be relying on its counterparty to perform its obligations and the Fund may incur additional losses if the counterparty is unable to perform.
Exchange-Traded and OTC Options.
All options purchased or sold by a Fund will be traded on a securities exchange or will be purchased or sold by securities dealers
(OTC options) that meet the Funds creditworthiness standards. While exchange-traded options are obligations of the Options Clearing Corporation, in the case of OTC options, a Fund relies on the dealer from which it purchased the
option to perform if the option is exercised. Thus, when a Fund purchases an OTC option, it relies on the dealer from which it purchased the option to make or take delivery of the underlying securities. Failure by the dealer to do so would result in
the loss of the premium paid by a Fund as well as loss of the expected benefit of the transaction.
Provided that a Fund has
arrangements with certain qualified dealers who agree that a Fund may repurchase any option it writes for a maximum price to be calculated by a predetermined formula, a Fund may treat the underlying securities used to cover written OTC options as
liquid. In these cases, the OTC option itself would only be considered illiquid to the extent that the maximum repurchase price under the formula exceeds the intrinsic value of the option.
Futures Contracts
.
When a Fund purchases a futures contract, it agrees to purchase a specified
quantity of an underlying instrument at a specified future date or, in the case of an index futures contract, to make a cash payment based on the value of a securities index. When a Fund sells a futures contract, it agrees to sell a specified
quantity of the underlying instrument at a specified future date or, in the case of an index futures contract, to receive a cash payment based on the value of a securities index. The price at which the purchase and sale will take place is fixed when
a Fund enters into the contract. Futures can be held until their delivery dates or the position can be (and normally is) closed out before then. There is no assurance, however, that a liquid market will exist when the Fund wishes to close out a
particular position.
When a Fund purchases a futures contract, the value of the futures contract tends to increase and
decrease in tandem with the value of its underlying instrument. Therefore, purchasing futures contracts will tend to increase a Funds exposure to positive and negative price fluctuations in the underlying instrument, much as if it had
purchased the underlying instrument directly. When a Fund sells a futures contract, by contrast, the value of its
Part II - 38
futures position will tend to move in a direction contrary to the value of the underlying instrument. Selling futures contracts, therefore, will tend to offset both positive and negative market
price changes, much as if the underlying instrument had been sold.
The purchaser or seller of a futures contract is not
required to deliver or pay for the underlying instrument unless the contract is held until the delivery date. However, when a Fund buys or sells a futures contract it will be required to deposit initial margin with a futures commission
merchant (FCM). Initial margin deposits are typically equal to a small percentage of the contracts value. If the value of either partys position declines, that party will be required to make additional variation
margin payments equal to the change in value on a daily basis. The party that has a gain may be entitled to receive all or a portion of this amount. A Fund may be obligated to make payments of variation margin at a time when it is
disadvantageous to do so. Furthermore, it may not always be possible for a Fund to close out its futures positions. Until it closes out a futures position, a Fund will be obligated to continue to pay variation margin. Initial and variation margin
payments do not constitute purchasing on margin for purposes of a Funds investment restrictions. In the event of the bankruptcy of an FCM that holds margin on behalf of a Fund, the Fund may be entitled to return of margin owed to it only in
proportion to the amount received by the FCMs other customers, potentially resulting in losses to the Fund. Each Fund will earmark and reserve Fund assets, in cash or liquid securities, in connection with its use of options and futures
contracts to the extent required by the staff of the SEC. Each Fund will earmark and reserve liquid assets in an amount equal to the current mark-to-market exposure, on a daily basis, of a futures contract that is contractually required to cash
settle. Such assets cannot be sold while the futures contract or option is outstanding unless they are replaced with other suitable assets. By setting aside assets equal only to its net obligation under cash-settled futures, a Fund will have the
ability to have exposure to such instruments to a greater extent than if a Fund were required to set aside assets equal to the full notional value of such contracts. There is a possibility that earmarking and reservation of a large percentage of a
Funds assets could impede portfolio management or a Funds ability to meet redemption requests or other current obligations.
The Funds only invest in futures contracts to the extent they could invest in the underlying instrument directly.
Cash Equitization.
The objective where equity futures are used to equitize cash is to match the notional value of all futures contracts to a Funds
cash balance. The notional values of the futures contracts and of the cash are monitored daily. As the cash is invested in securities and/or paid out to participants in redemptions, the Adviser simultaneously adjusts the futures positions. Through
such procedures, a Fund not only gains equity exposure from the use of futures, but also benefits from increased flexibility in responding to client cash flow needs. Additionally, because it can be less expensive to trade a list of securities as a
package or program trade rather than as a group of individual orders, futures provide a means through which transaction costs can be reduced. Such non-hedging risk management techniques involve leverage, and thus present, as do all leveraged
transactions, the possibility of losses as well as gains that are greater than if these techniques involved the purchase and sale of the securities themselves rather than their synthetic derivatives.
Options on Futures Contracts.
Futures contracts obligate the buyer to take and the seller to make
delivery at a future date of a specified quantity of a financial instrument or an amount of cash based on the value of a securities index. Currently, futures contracts are available on various types of securities, including but not limited to U.S.
Treasury bonds, notes and bills, Eurodollar certificates of deposit and on indexes of securities. Unlike a futures contract, which requires the parties to buy and sell a security or make a cash settlement payment based on changes in a financial
instrument or securities index on an agreed date, an option on a futures contract entitles its holder to decide on or before a future date whether to enter into such a contract. If the holder decides not to exercise its option, the holder may close
out the option position by entering into an offsetting transaction or may decide to let the option expire and forfeit the premium thereon. The purchaser of an option on a futures contract pays a premium for the option but makes no initial margin
payments or daily payments of cash in the nature of variation margin payments to reflect the change in the value of the underlying contract as does a purchaser or seller of a futures contract.
The seller of an option on a futures contract receives the premium paid by the purchaser and may be required to pay initial margin.
Amounts equal to the initial margin and any additional collateral required on any options on futures contracts sold by a Fund are earmarked by a Fund and set aside by the Fund, as required by the 1940 Act and the SECs interpretations
thereunder.
Combined Positions.
Certain Funds may purchase and write options in
combination with futures or forward contracts, to adjust the risk and return characteristics of the overall position. For example, a Fund may purchase a put option and write a call option on the same underlying instrument, in order to construct a
combined position whose risk and return characteristics are similar to selling a futures contract. Another possible combined position
Part II - 39
would involve writing a call option at one strike price and buying a call option at a lower price, in order to reduce the risk of the written call option in the event of a substantial price
increase. Because combined options positions involve multiple trades, they result in higher transaction costs and may be more difficult to open and close out.
Correlation of Price Changes.
Because there are a limited number of types of exchange-traded options and futures contracts, it is likely that the standardized options
and futures contracts available will not match a Funds current or anticipated investments exactly. A Fund may invest in options and futures contracts based on securities with different issuers, maturities, or other characteristics from the
securities in which it typically invests, which involves a risk that the options or futures position will not track the performance of a Funds other investments.
Options and futures contracts prices can also diverge from the prices of their underlying instruments, even if the underlying instruments match the Funds investments well. Options and futures
contracts prices are affected by such factors as current and anticipated short term interest rates, changes in volatility of the underlying instrument, and the time remaining until expiration of the contract, which may not affect security prices the
same way. Imperfect correlation may also result from differing levels of demand in the options and futures markets and the securities markets, from structural differences in how options and futures and securities are traded, or from imposition of
daily price fluctuation limits or trading halts. A Fund may purchase or sell options and futures contracts with a greater or lesser value than the securities it wishes to hedge or intends to purchase in order to attempt to compensate for differences
in volatility between the contract and the securities, although this may not be successful in all cases. If price changes in a Funds options or futures positions are poorly correlated with its other investments, the positions may fail to
produce anticipated gains or result in losses that are not offset by gains in other investments.
Liquidity of Options and Futures Contracts.
There is no assurance that a liquid market will exist for
any particular option or futures contract at any particular time even if the contract is traded on an exchange. In addition, exchanges may establish daily price fluctuation limits for options and futures contracts and may halt trading if a
contracts price moves up or down more than the limit in a given day. On volatile trading days when the price fluctuation limit is reached or a trading halt is imposed, it may be impossible for a Fund to enter into new positions or close out
existing positions. If the market for a contract is not liquid because of price fluctuation limits or otherwise, it could prevent prompt liquidation of unfavorable positions, and could potentially require a Fund to continue to hold a position until
delivery or expiration regardless of changes in its value. As a result, a Funds access to other assets held to cover its options or futures positions could also be impaired. (See Exchange-Traded and OTC Options above for a
discussion of the liquidity of options not traded on an exchange.)
Position Limits.
Futures exchanges can limit the number of futures and options on futures contracts that can be held or controlled by an entity. If an adequate exemption cannot be obtained, a Fund or the Funds Adviser may be required to reduce the size of
its futures and options positions or may not be able to trade a certain futures or options contract in order to avoid exceeding such limits.
Asset Coverage for Futures Contracts and Options Positions.
A Fund will comply with guidelines established by the SEC with respect to coverage of options and futures
contracts by mutual funds, and if the guidelines so require, will set aside or earmark appropriate liquid assets in the amount prescribed. Such assets cannot be sold while the futures contract or option is outstanding, unless they are replaced with
other suitable assets. As a result, there is a possibility that the reservation of a large percentage of a Funds assets could impede portfolio management or a Funds ability to meet redemption requests or other current obligations.
Real Estate Investment Trusts (REITs)
Certain of the Funds may invest in equity interests or debt obligations issued by REITs. REITs are pooled investment vehicles which invest
primarily in income producing real estate or real estate related loans or interest. REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of rents. Equity REITs can also realize capital gains by selling property that has appreciated in value. Mortgage REITs invest the majority of their assets in real estate
mortgages and derive income from the collection of interest payments. Similar to investment companies, REITs are not taxed on income distributed to shareholders provided they comply with several requirements of the Code. A Fund will indirectly bear
its proportionate share of expenses incurred by REITs in which a Fund invests in addition to the expenses incurred directly by a Fund.
Investing in REITs involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the
underlying property owned
Part II - 40
by the REITs, while mortgage REITs may be affected by the quality of any credit extended. REITs are dependent upon management skills and on cash flows, are not diversified, and are subject to
default by borrowers and self-liquidation. REITs are also subject to the possibilities of failing to qualify for tax free pass-through of income under the Code and failing to maintain their exemption from registration under the 1940 Act.
REITs (especially mortgage REITs) are also subject to interest rate risks. When interest rates decline, the value of a REITs
investment in fixed rate obligations can be expected to rise. Conversely, when interest rates rise, the value of a REITs investment in fixed rate obligations can be expected to decline. In contrast, as interest rates on adjustable rate
mortgage loans are reset periodically, yields on a REITs investment in such loans will gradually align themselves to fluctuate less dramatically in response to interest rate fluctuations than would investments in fixed rate obligations.
Investment in REITs involves risks similar to those associated with investing in small capitalization companies. These risks
include:
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limited financial resources;
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infrequent or limited trading; and
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more abrupt or erratic price movements than larger company securities.
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In addition, small capitalization stocks, such as certain REITs, historically have been more volatile in price than the larger
capitalization stocks included in the S&P 500 Index.
Recent Events Relating to the Overall Economy
The U.S. Government, the Federal Reserve, the Treasury, the Securities and Exchange Commission, the Federal Deposit
Insurance Corporation and other governmental and regulatory bodies have recently taken or are considering taking actions to address the financial crisis. These actions include, but are not limited to, the enactment by the United States Congress of
the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law on July 21, 2010 and imposes a new regulatory framework over the U.S. financial services industry and the consumer credit markets in general,
and proposed regulations by the Securities and Exchange Commission. Given the broad scope, sweeping nature, and relatively recent enactment of some of these regulatory measures, the potential impact they could have on securities held by the Funds is
unknown. There can be no assurance that these measures will not have an adverse effect on the value or marketability of securities held by the Funds. Furthermore, no assurance can be made that the U.S. Government or any U.S. regulatory body (or
other authority or regulatory body) will not continue to take further legislative or regulatory action in response to the economic crisis or otherwise, and the effect of such actions, if taken, cannot be known.
Repurchase Agreements
Repurchase agreements may be entered into with brokers, dealers or banks that meet the Advisers credit guidelines. A Fund will enter into repurchase agreements only with member banks of the Federal
Reserve System and securities dealers believed by the Adviser to be creditworthy. In a repurchase agreement, a Fund buys a security from a seller that has agreed to repurchase the same security at a mutually agreed upon date and price. The resale
price normally is in excess of the purchase price, reflecting an agreed upon interest rate. This interest rate is effective for the period of time a Fund is invested in the agreement and is not related to the coupon rate on the underlying security.
A repurchase agreement may also be viewed as a fully collateralized loan of money by a Fund to the seller. Except in the case of a tri-party agreement, the maximum maturity of a repurchase agreement will be seven days. In the case of a tri-party
agreement, the maximum maturity of a repurchase agreement will be 95 days, or as limited by the specific repurchase agreement. The securities which are subject to repurchase agreements, however, may have maturity dates in excess of 95 days from the
effective date of the repurchase agreement. Repurchase agreements maturing in more than seven days are treated as illiquid for purposes of a Funds restrictions on purchases of illiquid securities. A Fund will always receive securities as
collateral during the term of the agreement whose market value is at least equal to 100% of the dollar amount invested by the Fund in each agreement plus accrued interest. The repurchase agreements further authorize the Fund to demand additional
collateral in the event that the dollar value of the collateral falls below 100%. A Fund will make payment for such securities only upon physical delivery or upon evidence of book entry transfer to the account of the custodian. Repurchase agreements
are considered under the 1940 Act to be loans collateralized by the underlying securities.
Part II - 41
All of the Funds that are permitted to invest in repurchase agreements may engage in
repurchase agreement transactions that are collateralized fully as defined in Rule 5b-3 of the 1940 Act (except that Rule 5b-3(c)(1)(iv)(C) or (D) of the 1940 Act shall not apply for the Money Market Funds), which has the effect of enabling a
Fund to look to the collateral, rather than the counterparty, for determining whether its assets are diversified for 1940 Act purposes. With respect to the Money Market Funds, in accordance with Rule 2a-7 under the 1940 Act, the Adviser
evaluates the creditworthiness of each counterparty. Certain Funds may, in addition, engage in repurchase agreement transactions that are collateralized by money market instruments, debt securities, loan participations, equity securities or other
securities including securities that are rated below investment grade by the requisite NRSROs or unrated securities of comparable quality. For these types of repurchase agreement transactions, the Fund would look to the counterparty, and not the
collateral, for determining such diversification.
A repurchase agreement is subject to the risk that the seller may fail to
repurchase the security. In the event of default by the seller under a repurchase agreement construed to be a collateralized loan, the underlying securities would not be owned by the Fund, but would only constitute collateral for the sellers
obligation to pay the repurchase price. Therefore, a Fund may suffer time delays and incur costs in connection with the disposition of the collateral. The collateral underlying repurchase agreements may be more susceptible to claims of the
sellers creditors than would be the case with securities owned by the Fund.
Reverse Repurchase
Agreements
.
In a reverse repurchase agreement, a Fund sells a security and agrees to repurchase the
same security at a mutually agreed upon date and price reflecting the interest rate effective for the term of the agreement. For purposes of the 1940 Act, a reverse repurchase agreement is considered borrowing by a Fund and, therefore, a form of
leverage. Leverage may cause any gains or losses for a Fund to be magnified. The Funds will invest the proceeds of borrowings under reverse repurchase agreements. In addition, except for liquidity purposes, a Fund will enter into a reverse
repurchase agreement only when the expected return from the investment of the proceeds is greater than the expense of the transaction. A Fund will not invest the proceeds of a reverse repurchase agreement for a period which exceeds the duration of
the reverse repurchase agreement. A Fund would be required to pay interest on amounts obtained through reverse repurchase agreements, which are considered borrowings under federal securities laws. The repurchase price is generally equal to the
original sales price plus interest. Reverse repurchase agreements are usually for seven days or less and cannot be repaid prior to their expiration dates. Each Fund will earmark and reserve Fund assets, in cash or liquid securities, in an amount at
least equal to its purchase obligations under its reverse repurchase agreements. Reverse repurchase agreements involve the risk that the market value of the portfolio securities transferred may decline below the price at which a Fund is obliged to
purchase the securities. All forms of borrowing (including reverse repurchase agreements) are limited in the aggregate and may not exceed 33
1
/
3
% of a Funds total assets, except as permitted by law.
Securities Lending
To generate additional income, certain Funds may lend up to 33
1
/
3
% of such Funds total assets pursuant to agreements requiring that the loan be continuously secured by collateral
equal to at least 100% of the market value plus accrued interest on the securities lent. Certain Funds (generally some of the Funds with an investment strategy of investing primarily in U.S. equity securities) use Goldman Sachs Bank USA (formerly
known as The Goldman Sachs Trust Company), doing business as Goldman Sachs Agency Lending (Goldman Sachs), as their securities lending agent. Pursuant to an agreement among Goldman Sachs, JPMorgan Chase Bank and certain Funds (the
Third Party Securities Lending Agreement), approved by the Board of Trustees, Goldman Sachs compensates JPMorgan Chase Bank for certain operational services, which may include processing transactions, termination of loans and
recordkeeping, provided by JPMorgan Chase Bank. The other Funds that engage in securities lending use JPMorgan Chase Bank as their securities lending agent.
Pursuant to a securities lending agreement approved by the Board of Trustees between Goldman Sachs and the Trusts on behalf of certain J.P. Morgan U.S. equity funds (the Goldman Sachs
Agreement), collateral for loans will consist only of cash. Pursuant to a securities lending agreement approved by the Board of Trustees between JPMorgan Chase Bank and certain Funds (the JPMorgan Agreement), collateral for loans
will consist of cash. The Funds receive payments from the borrowers equivalent to the dividends and interest that would have been earned on the securities lent. For loans secured by cash, the Funds seek to earn interest on the investment of cash
collateral in investments permitted by the applicable securities lending agreement. Under both the Goldman Sachs Agreement and the JPMorgan Agreement, cash collateral may be invested in Capital Shares of the JPMorgan Prime Money Market Fund.
Part II - 42
Under the JPMorgan Agreement, JPMorgan Chase Bank performs a daily mark to market of the
loaned security and requests additional cash collateral if the amount of cash received from the borrower is less than 102% of the value of the loaned security in the case of securities denominated in U.S. dollars and 105% of the value of the loaned
security in the case of securities denominated in non-U.S. dollars subject to certain
de
minimis
guidelines. Such de minimis guidelines provide that for a loan of U.S. dollar denominated securities, the aggregate value of cash
collateral for such loan may be less than 102% but in no event less than 101.51% and for a loan of non-U.S. dollar denominated securities, the aggregate value of cash collateral held for such loan may be less than 105% but in no event less than
104.51%. Under the Goldman Sachs Agreement, Goldman Sachs marks to market the loaned securities on a daily basis. In the event the cash received from the borrower is less than 102% of the value of the loaned securities, Goldman Sachs requests
additional cash from the borrower so as to maintain a collateralization level of at least 102% of the value of the loaned securities plus accrued interest. Loans are subject to termination by a Fund or the borrower at any time, and are therefore not
considered to be illiquid investments. A Fund does not have the right to vote proxies for securities on loan. However, a Funds Adviser may terminate a loan if the vote is considered material with respect to an investment.
Securities lending involves counterparty risk, including the risk that the loaned securities may not be returned or returned in a timely
manner and/or a loss of rights in the collateral if the borrower or the lending agent defaults or fails financially. This risk is increased when a Funds loans are concentrated with a single or limited number of borrowers. The earnings on the
collateral invested may not be sufficient to pay fees incurred in connection with the loan. Also, the principal value of the collateral invested may decline and may not be sufficient to pay back the borrower for the amount of collateral posted.
There are no limits on the number of borrowers a Fund may use and a Fund may lend securities to only one or a small group of borrowers. In addition, under the Goldman Sachs Agreement, loans may be made to affiliates of Goldman Sachs as identified in
the Goldman Sachs Agreement. Funds participating in securities lending bear the risk of loss in connection with investments of the cash collateral received from the borrowers, which do not trigger additional collateral requirements from the
borrower.
To the extent that the value or return of a Funds investments of the cash collateral declines below the amount
owed to a borrower, the Fund may incur losses that exceed the amount it earned on lending the security. In situations where the Adviser does not believe that it is prudent to sell the cash collateral investments in the market, a Fund may borrow
money to repay the borrower the amount of cash collateral owed to the borrower upon return of the loaned securities. This will result in financial leverage, which may cause the Fund to be more volatile because financial leverage tends to exaggerate
the effect of any increase or decrease in the value of the Funds portfolio securities.
Short Selling
In short selling transactions, a Fund sells a security it does not own in anticipation of a decline in the market value of
the security. To complete the transaction, a Fund must borrow the security to make delivery to the buyer. A Fund is obligated to replace the security borrowed by purchasing it subsequently at the market price at the time of replacement. The price at
such time may be more or less than the price at which the security was sold by a Fund, which may result in a loss or gain, respectively. Unlike taking a long position in a security by purchasing the security, where potential losses are limited to
the purchase price, short sales have no cap on maximum losses, and gains are limited to the price of the security at the time of the short sale.
Short sales of forward commitments and derivatives do not involve borrowing a security. These types of short sales may include futures, options, contracts for differences, forward contracts on financial
instruments and options such as contracts, credit linked instruments, and swap contracts.
A Fund may not always be able to
borrow a security it wants to sell short. A Fund also may be unable to close out an established short position at an acceptable price and may have to sell long positions at disadvantageous times to cover its short positions. The value of your
investment in a Fund will fluctuate in response to movements in the market. Fund performance also will depend on the effectiveness of the Advisers research and the management teams investment decisions.
Short sales also involve other costs. A Fund must repay to the lender an amount equal to any dividends or interest that accrues while the
loan is outstanding. To borrow the security, a Fund may be required to pay a premium. A Fund also will incur transaction costs in effecting short sales. The amount of any ultimate gain for a Fund resulting from a short sale will be decreased and the
amount of any ultimate loss will be increased by the amount of premiums, interest or expenses a Fund may be required to pay in connection with the short sale. Until a Fund closes the short position, it will earmark and reserve Fund assets, in cash
or liquid securities, to offset a portion of the leverage risk. Realized gains from short sales are typically treated as short-term gains/losses.
Part II - 43
Short-Term Funding Agreements
Short-term funding agreements issued by insurance companies are sometimes referred to as Guaranteed Investment Contracts
(GICs), while those issued by banks are referred to as Bank Investment Contracts (BICs). Pursuant to such agreements, a Fund makes cash contributions to a deposit account at a bank or insurance company. The bank or insurance
company then credits to the Fund on a monthly basis guaranteed interest at either a fixed, variable or floating rate. These contracts are general obligations of the issuing bank or insurance company (although they may be the obligations of an
insurance company separate account) and are paid from the general assets of the issuing entity.
A Fund will purchase
short-term funding agreements only from banks and insurance companies which, at the time of purchase, are rated in one of the three highest rating categories and have assets of $1 billion or more. Generally, there is no active secondary market in
short-term funding agreements. Therefore, short-term funding agreements may be considered by a Fund to be illiquid investments. To the extent that a short-term funding agreement is determined to be illiquid, such agreements will be acquired by a
Fund only if, at the time of purchase, no more than 15% of the Funds net assets (5% of the total assets for the Money Market Funds) will be invested in short-term funding agreements and other illiquid securities.
Structured Investments
A structured investment is a security having a return tied to an underlying index or other security or asset class. Structured investments generally are individually negotiated agreements and may be
traded over-the-counter. Structured investments are organized and operated to restructure the investment characteristics of the underlying security. This restructuring involves the deposit with or purchase by an entity, such as a corporation or
trust, or specified instruments (such as commercial bank loans) and the issuance by that entity or one or more classes of securities (structured securities) backed by, or representing interests in, the underlying instruments. The cash
flow on the underlying instruments may be apportioned among the newly issued structured securities to create securities with different investment characteristics, such as varying maturities, payment priorities and interest rate provisions, and the
extent of such payments made with respect to structured securities is dependent on the extent of the cash flow on the underlying instruments. Because structured securities typically involve no credit enhancement, their credit risk generally will be
equivalent to that of the underlying instruments. Investments in structured securities are generally of a class of structured securities that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured
securities typically have higher yields and present greater risks than unsubordinated structured securities. Structured instruments include structured notes. In addition to the risks applicable to investments in structured investments and debt
securities in general, structured notes bear the risk that the issuer may not be required to pay interest on the structured note if the index rate rises above or falls below a certain level. Structured securities are typically sold in private
placement transactions, and there currently is no active trading market for structured securities. Investments in government and government-related restructured debt instruments are subject to special risks, including the inability or unwillingness
to repay principal and interest, requests to reschedule or restructure outstanding debt and requests to extend additional loan amounts. Structured investments include a wide variety of instruments including, without limitation, Collateralized Debt
Obligations, credit linked notes, and participation notes and participatory notes.
Structured instruments that are registered
under the federal securities laws may be treated as liquid. In addition, many structured instruments may not be registered under the federal securities laws. In that event, a Funds ability to resell such a structured instrument may be more
limited than its ability to resell other Fund securities. The Funds will treat such instruments as illiquid and will limit their investments in such instruments to no more than 15% of each Funds net assets (5% of the total assets for the Money
Market Funds), when combined with all other illiquid investments of each Fund.
Total Annual Fund Operating Expenses set forth
in the fee table and Financial Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of
investment company provided by section 3(c)(1) or 3(c)(7) of the 1940 Act.
Credit Linked Notes.
Certain
Funds may invest in structured instruments known as credit linked securities or credit linked notes (CLNs). CLNs are typically issued by a limited purpose trust or other vehicle (the CLN trust) that, in turn, invests in a
derivative or basket of derivatives instruments, such as credit default swaps, interest rate swaps and/or other securities, in order to provide exposure to certain high yield, sovereign debt, emerging markets, or other fixed income markets.
Generally, investments in CLNs represent the right to receive periodic
Part II - 44
income payments (in the form of distributions) and payment of principal at the end of the term of the CLN. However, these payments are conditioned on the CLN trusts receipt of payments
from, and the CLN trusts potential obligations, to the counterparties to the derivative instruments and other securities in which the CLN trust invests. For example, the CLN trust may sell one or more credit default swaps, under which the CLN
trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default were to occur, the stream of
payments may stop and the CLN trust would be obligated to pay the counterparty the par (or other agreed upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that a Fund would receive as an
investor in the CLN trust.
Certain Funds may enter into CLNs structured as First-to-Default CLNs. In a
First-to-Default CLN, the CLN trust enters into a credit default swap on a portfolio of a specified number of individual securities pursuant to which the CLN trust sells protection to a counterparty. The CLN trust uses the proceeds of issuing
investments in the CLN trust to purchase securities, which are selected by the counterparty and the total return of which is paid to the counterparty. Upon the occurrence of a default or credit event involving any one of the individual securities,
the credit default swaps terminate and the Funds investment in the CLN trust is redeemed for an amount equal to par minus the amount paid to the counterparty under the credit default swap.
Certain Funds may also enter in CLNs to gain access to sovereign debt and securities in emerging market particularly in markets where the
Fund is not able to purchase securities directly due to domicile restrictions or tax restrictions or tariffs. In such an instance, the issuer of the CLN may purchase the reference security directly and/or gain exposure through a credit default swap
or other derivative.
A Funds investments in CLNs is subject to the risks associated with the underlying reference
obligations and derivative instruments, including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk.
Participation Notes and Participatory Notes.
Certain Funds may invest in participation notes or participatory notes
(P-notes). P-notes are participation interest notes that are issued by banks or broker-dealers and are designed to offer a return linked to a particular underlying equity, debt, currency or market. If the P-note were held to maturity,
the issuer would pay to, or receive from, the purchaser the difference between the nominal value of the underlying instrument at the time of purchase and that instruments value at maturity. The holder of a P-note that is linked to a particular
underlying security or instrument may be entitled to receive any dividends paid in connection with that underlying security or instrument, but typically does not receive voting rights as it would if it directly owned the underlying security or
instrument. P-notes involve transaction costs. Investments in P-notes involve the same risks associated with a direct investment in the underlying securities, instruments or markets that they seek to replicate. In addition, there can be no assurance
that there will be a trading market for a P-note or that the trading price of a P-note will equal the underlying value of the security, instrument or market that it seeks to replicate. Due to liquidity and transfer restrictions, the secondary
markets on which a P-note is traded may be less liquid than the market for other securities, or may be completely illiquid, which may also affect the ability of a fund to accurately value a P-note. P-notes typically constitute general unsecured
contractual obligations of the banks or broker-dealers that issue them, which subjects a Fund that holds them to counterparty risk (and this risk may be amplified if a Fund purchases P-notes from only a small number of issuers).
Swaps and Related Swap Products
Swap transactions may include, but are not limited to, interest rate swaps, currency swaps, cross-currency interest rate swaps, forward rate agreements, contracts for differences, total return swaps,
index swaps, basket swaps, specific security swaps, fixed income sectors swaps, commodity swaps, asset-backed swaps (ABX), credit default swaps, interest rate caps, price lock swaps, floors and collars and swaptions (collectively defined as
swap transactions).
A Fund may enter into swap transactions for any legal purpose consistent with its investment
objective and policies, such as for the purpose of attempting to obtain or preserve a particular return or spread at a lower cost than obtaining that return or spread through purchases and/or sales of instruments in cash markets, to protect against
currency fluctuations, to protect against any increase in the price of securities a Fund anticipates purchasing at a later date, or to gain exposure to certain markets in the most economical way possible.
Swap agreements are two-party contracts entered into primarily by institutional counterparties for periods ranging from a few weeks to
several years. In a standard swap transaction, two parties agree to exchange the returns
Part II - 45
(or differentials in rates of return) that would be earned or realized on specified notional investments or instruments. The gross returns to be exchanged or swapped between the
parties are calculated by reference to a notional amount, i.e., the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular foreign currency or commodity, or in a
basket of securities representing a particular index. The purchaser of an interest rate cap or floor, upon payment of a fee, has the right to receive payments (and the seller of the cap or floor is obligated to make payments) to the
extent a specified interest rate exceeds (in the case of a cap) or is less than (in the case of a floor) a specified level over a specified period of time or at specified dates. The purchaser of an interest rate collar, upon payment of a fee, has
the right to receive payments (and the seller of the collar is obligated to make payments) to the extent that a specified interest rate falls outside an agreed upon range over a specified period of time or at specified dates. The purchaser of an
option on an interest rate swap, also known as a swaption, upon payment of a fee (either at the time of purchase or in the form of higher payments or lower receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional amount with pre-specified terms with the seller of the swaption as the counterparty.
The notional amount of a swap transaction is the agreed upon basis for calculating the payments that the parties have agreed to exchange. For example, one swap counterparty may agree to pay a
floating rate of interest (e.g., 3 month LIBOR) calculated based on a $10 million notional amount on a quarterly basis in exchange for receipt of payments calculated based on the same notional amount and a fixed rate of interest on a semi-annual
basis. In the event a Fund is obligated to make payments more frequently than it receives payments from the other party, it will incur incremental credit exposure to that swap counterparty. This risk may be mitigated somewhat by the use of swap
agreements which call for a net payment to be made by the party with the larger payment obligation when the obligations of the parties fall due on the same date. Under most swap agreements entered into by a Fund, payments by the parties will be
exchanged on a net basis, and a Fund will receive or pay, as the case may be, only the net amount of the two payments.
The amount of a Funds potential gain or loss on any swap transaction is not subject to any fixed limit. Nor is there any fixed limit on a Funds potential loss if it sells a cap or collar. If a
Fund buys a cap, floor or collar, however, the Funds potential loss is limited to the amount of the fee that it has paid. When measured against the initial amount of cash required to initiate the transaction, which is typically zero in the
case of most conventional swap transactions, swaps, caps, floors and collars tend to be more volatile than many other types of instruments.
The use of swap transactions, caps, floors and collars involves investment techniques and risks that are different from those associated with portfolio security transactions. If a Funds Adviser is
incorrect in its forecasts of market values, interest rates, and other applicable factors, the investment performance of the Fund will be less favorable than if these techniques had not been used. These instruments are typically not traded on
exchanges. Accordingly, there is a risk that the other party to certain of these instruments will not perform its obligations to a Fund or that a Fund may be unable to enter into offsetting positions to terminate its exposure or liquidate its
position under certain of these instruments when it wishes to do so. Such occurrences could result in losses to a Fund. A Funds Adviser will consider such risks and will enter into swap and other derivatives transactions only when it believes
that the risks are not unreasonable.
A Fund will earmark and reserve Fund assets, in cash or liquid securities, in an amount
sufficient at all times to cover its current obligations under its swap transactions, caps, floors and collars. If a Fund enters into a swap agreement on a net basis, it will earmark and reserve assets with a daily value at least equal to the
excess, if any, of a Funds accrued obligations under the swap agreement over the accrued amount a Fund is entitled to receive under the agreement. If a Fund enters into a swap agreement on other than a net basis, or sells a cap, floor or
collar, it will earmark and reserve assets with a daily value at least equal to the full amount of a Funds accrued obligations under the agreement. A Fund will not enter into any swap transaction, cap, floor, or collar, unless the counterparty
to the transaction is deemed creditworthy by the Funds Adviser. If a counterparty defaults, a Fund may have contractual remedies pursuant to the agreements related to the transaction. The swap markets in which many types of swap transactions
are traded have grown substantially in recent years, with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the markets for certain types of swaps
(e.g., interest rate swaps) have become relatively liquid. The markets for some types of caps, floors and collars are less liquid.
The liquidity of swap transactions, caps, floors and collars will be as set forth in guidelines established by a Funds Adviser and approved by the Trustees which are based on various factors,
including: (1) the availability of dealer quotations and the estimated transaction volume for the instrument, (2) the number of dealers and end users for the instrument in the marketplace, (3) the level of market making by dealers in
the type of instrument, (4) the
Part II - 46
nature of the instrument (including any right of a party to terminate it on demand) and (5) the nature of the marketplace for trades (including the ability to assign or offset a Funds
rights and obligations relating to the instrument). Such determination will govern whether the instrument will be deemed within the applicable liquidity restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value of the instrument are recognized as unrealized gains or losses by
marking to market to reflect the market value of the instrument. When the instrument is terminated, a Fund will record a realized gain or loss equal to the difference, if any, between the proceeds from (or cost of) the closing transaction and a
Funds basis in the contract.
The federal income tax treatment with respect to swap transactions, caps, floors, and
collars may impose limitations on the extent to which a Fund may engage in such transactions.
Credit Default Swaps.
As described above, swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to more than one year. In the case of a credit default swap (CDS), the contract gives one party (the buyer) the right to recoup the economic value of a decline in
the value of debt securities of the reference issuer if the credit event (a downgrade or default) occurs. This value is obtained by delivering a debt security of the reference issuer to the party in return for a previously agreed payment from the
other party (frequently, the par value of the debt security). CDS include credit default swaps, which are contracts on individual securities, and CDX, which are contracts on baskets or indices of securities.
Credit default swaps may require initial premium (discount) payments as well as periodic payments (receipts) related to the interest leg
of the swap or to the default of a reference obligation. A Fund will earmark and reserve assets, in cash or liquid securities, to cover any accrued payment obligations when it is the buyer of a CDS. In cases where a Fund is a seller of a CDS
contract, the Fund will earmark and reserve assets, in cash or liquid securities, to cover its obligation.
If a Fund is a
seller of protection under a CDS contract, the Fund would be required to pay the par (or other agreed upon) value of a referenced debt obligation to the counterparty in the event of a default or other credit event by the reference issuer, such as a
U.S. or foreign corporate issuer, with respect to such debt obligations. In return, a Fund would receive from the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default
occurs, a Fund would keep the stream of payments and would have no payment obligations. As the seller, a Fund would be subject to investment exposure on the notional amount of the swap.
If a Fund is a buyer of protection under a CDS contract, the Fund would have the right to deliver a referenced debt obligation and receive
the par (or other agreed-upon) value of such debt obligation from the counterparty in the event of a default or other credit event (such as a downgrade in credit rating) by the reference issuer, such as a U.S. or foreign corporation, with respect to
its debt obligations. In return, the Fund would pay the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default occurs, the counterparty would keep the stream of payments
and would have no further obligations to the Fund.
The use of CDSs, like all swap agreements, is subject to certain risks. If
a counterpartys creditworthiness declines, the value of the swap would likely decline. Moreover, there is no guarantee that a Fund could eliminate its exposure under an outstanding swap agreement by entering into an offsetting swap agreement
with the same or another party. In addition to general market risks, CDSs involve liquidity, credit and counterparty risks. The recent increase in corporate defaults further raises these liquidity and credit risks, increasing the possibility that
sellers will not have sufficient funds to make payments. As unregulated instruments, CDSs are difficult to value and are therefore susceptible to liquidity and credit risks. Counterparty risks also stem from the lack of regulation of CDSs.
Collateral posting requirements are individually negotiated between counterparties and there is no regulatory requirement concerning the amount of collateral that a counterparty must post to secure its obligations under a CDS. Because they are
unregulated, there is no requirement that parties to a contract be informed in advance when a CDS is sold. As a result, investors may have difficulty identifying the party responsible for payment of their claims.
If a counterpartys credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could
increase the risk that the Fund may not receive adequate collateral. There is no readily available market for trading out of CDS contracts. In order to eliminate a position it has taken in a CDS, the Fund must terminate the existing CDS contract or
enter into an offsetting trade. The Fund may only exit its obligations under a CDS contract by terminating the contract and paying applicable breakage fees, which could result in additional losses to the Fund. Furthermore, the cost of entering into
an offsetting CDS position could cause the Fund to incur losses.
Part II - 47
Temporary Liquidity Guarantee Program (TLGP) Securities
In addition to those Funds that in the prospectus disclose investments in securities guaranteed by the Federal Deposit
Insurance Corporation (FDIC) under its TLGP, announced on October 14, 2008, other Funds may invest in such securities as well. Under this program, the FDIC guarantees, with the full faith and credit of the U.S. government, the
payment of principal and interest on the debt issued by private entities through either (i) the earlier of the maturity date of the debt or June 30, 2012, or (ii) for those entities participating in the extension of the program, the
earlier of the maturity date of the debt or December 31, 2012 (for debt issued on or after April 1, 2009 through October 31, 2009). The interest on securities guaranteed by the FDIC under the TLGP may be subject to state and local
income taxes.
Synthetic Variable Rate Instruments
Synthetic variable rate instruments generally involve the deposit of a long-term tax exempt bond in a custody or trust arrangement and the
creation of a mechanism to adjust the long-term interest rate on the bond to a variable short-term rate and a right (subject to certain conditions) on the part of the purchaser to tender it periodically to a third party at par. A Funds Adviser
reviews the structure of synthetic variable rate instruments to identify credit and liquidity risks (including the conditions under which the right to tender the instrument would no longer be available) and will monitor those risks. In the event
that the right to tender the instrument is no longer available, the risk to the Fund will be that of holding the long-term bond. In the case of some types of instruments credit enhancement is not provided, and if certain events occur, which may
include (a) default in the payment of principal or interest on the underlying bond, (b) downgrading of the bond below investment grade or (c) a loss of the bonds tax exempt status, then the put will terminate and the risk to the
Fund will be that of holding a long-term bond.
Total Annual Fund Operating Expenses set forth in the fee table and Financial
Highlights section of each Funds Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the definition of investment company provided by
section 3(c)(1) or 3(c)(7) of the 1940 Act.
Treasury Receipts
A Fund may purchase interests in separately traded interest and principal component parts of U.S. Treasury obligations that are issued by
banks or brokerage firms and are created by depositing U.S. Treasury notes and U.S. Treasury bonds into a special account at a custodian bank. Receipts include Treasury Receipts (TRs), Treasury Investment Growth Receipts
(TIGRs), and Certificates of Accrual on Treasury Securities (CATS). Receipts in which an entity other than the government separates the interest and principal components are not considered government securities unless such
securities are issued through the Treasury Separate Trading of Registered Interest and Principal of Securities (STRIPS) program.
Trust Preferred Securities
Certain Funds may purchase trust preferred securities, also known as trust preferreds, which are preferred stocks issued by a special purpose trust subsidiary backed by subordinated debt of
the corporate parent. An issuer creates trust preferred securities by creating a trust and issuing debt to the trust. The trust in turn issues trust preferred securities. Trust preferred securities are hybrid securities with characteristics of both
subordinated debt and preferred stock. Such characteristics include long maturities (typically 30 years or more), early redemption by the issuer, periodic fixed or variable interest payments, and maturities at face value. In addition, trust
preferred securities issued by a bank holding company may allow deferral of interest payments for up to 5 years. Holders of trust preferred securities have limited voting rights to control the activities of the trust and no voting rights with
respect to the parent company.
U.S. Government Obligations
U.S. government obligations may include direct obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all of which
are backed as to principal and interest payments by the full faith and credit of the U.S., and separately traded principal and interest component parts of such obligations that are transferable through the Federal book-entry system known as STRIPS
and Coupon Under Book Entry Safekeeping (CUBES). The Funds may also invest in TIPS.
Part II - 48
The principal and interest components of U.S. Treasury bonds with remaining maturities of
longer than ten years are eligible to be traded independently under the STRIPS program. Under the STRIPS program, the principal and interest components are separately issued by the U.S. Treasury at the request of depository financial institutions,
which then trade the component parts separately. The interest component of STRIPS may be more volatile than that of U.S. Treasury bills with comparable maturities.
Other obligations include those issued or guaranteed by U.S. government agencies or instrumentalities. These obligations may or may not be backed by the full faith and credit of the U.S.
Securities which are backed by the full faith and credit of the U.S. include obligations of the Government National Mortgage Association, the Farmers Home Administration, and the Export-Import Bank. In the case of securities not backed by the full
faith and credit of the U.S., the Funds must look principally to the federal agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the U.S. itself in the event the agency or
instrumentality does not meet its commitments. Securities in which the Funds may invest that are not backed by the full faith and credit of the U.S. include, but are not limited to: (i) obligations of the Tennessee Valley Authority, the Federal
Home Loan Banks and the U.S. Postal Service, each of which has the right to borrow from the U.S. Treasury to meet its obligations; (ii) securities issued by Freddie Mac and Fannie Mae, which are supported only by the credit of such securities,
but for which the Secretary of the Treasury has discretionary authority to purchase limited amounts of the agencys obligations; and (iii) obligations of the Federal Farm Credit System and the Student Loan Marketing Association, each of
whose obligations may be satisfied only by the individual credits of the issuing agency.
When-Issued
Securities, Delayed Delivery Securities and Forward Commitments
Securities may be purchased on a when-issued or delayed
delivery basis. For example, delivery of and payment for these securities can take place a month or more after the date of the purchase commitment. The purchase price and the interest rate payable, if any, on the securities are fixed on the purchase
commitment date or at the time the settlement date is fixed. The value of such securities is subject to market fluctuation, and for money market instruments and other fixed income securities, no interest accrues to a Fund until settlement takes
place. At the time a Fund makes the commitment to purchase securities on a when-issued or delayed delivery basis, it will record the transaction, reflect the value each day of such securities in determining its NAV and, if applicable, calculate the
maturity for the purposes of average maturity from that date. At the time of settlement, a when-issued security may be valued at less than the purchase price. To facilitate such acquisitions, each Fund will earmark and reserve Fund assets, in cash
or liquid securities, in an amount at least equal to such commitments. On delivery dates for such transactions, each Fund will meet its obligations from maturities or sales of the securities earmarked and reserved for such purpose and/or from cash
flow. If a Fund chooses to dispose of the right to acquire a when-issued security prior to its acquisition, it could, as with the disposition of any other portfolio obligation, incur a gain or loss due to market fluctuation. Also, a Fund may be
disadvantaged if the other party to the transaction defaults.
Forward Commitments
. Securities may be purchased for
delivery at a future date, which may increase their overall investment exposure and involves a risk of loss if the value of the securities declines prior to the settlement date. In order to invest a Funds assets immediately, while awaiting
delivery of securities purchased on a forward commitment basis, short-term obligations that offer same-day settlement and earnings will normally be purchased. When a Fund makes a commitment to purchase a security on a forward commitment basis, cash
or liquid securities equal to the amount of such Funds commitments will be reserved for payment of the commitment. For the purpose of determining the adequacy of the securities reserved for payment of commitments, the reserved securities will
be valued at market value. If the market value of such securities declines, additional cash, cash equivalents or highly liquid securities will be reserved for payment of the commitment so that the value of the Funds assets reserved for payment
of the commitments will equal the amount of such commitments purchased by the respective Fund.
Purchases of securities on a
forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in the respective Funds portfolio are subject to changes in value based upon the
publics perception of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place
may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the respective Fund will meet its obligations from then-available cash flow, sale of securities reserved for
payment of the commitment, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than such Funds payment obligations).
The sale of securities to meet such obligations may result in the realization of capital gains or losses. Purchasing securities on a forward commitment basis can also involve the risk of default by the other party on its obligation, delaying or
preventing the Fund from recovering the collateral or completing the transaction.
Part II - 49
To the extent a Fund engages in forward commitment transactions, it will do so for the
purpose of acquiring securities consistent with its investment objective and policies and not for the purpose of investment leverage.
RISK MANAGEMENT
Each Fund may employ
non-hedging risk management techniques. Risk management strategies are used to keep the Funds fully invested and to reduce the transaction costs associated with cash flows into and out of a Fund. The Funds use a wide variety of instruments and
strategies for risk management and the examples below are not meant to be exhaustive.
Examples of risk management strategies
include synthetically altering the duration of a portfolio or the mix of securities in a portfolio. For example, if the Adviser wishes to extend maturities in a fixed income portfolio in order to take advantage of an anticipated decline in interest
rates, but does not wish to purchase the underlying long-term securities, it might cause a Fund to purchase futures contracts on long term debt securities. Likewise, if the Adviser wishes to gain exposure to an instrument but does not wish to
purchase the instrument it may use swaps and related instruments. Similarly, if the Adviser wishes to decrease exposure to fixed income securities or purchase equities, it could cause the Fund to sell futures contracts on debt securities and
purchase futures contracts on a stock index. Such non-hedging risk management techniques involve leverage, and thus, present, as do all leveraged transactions, the possibility of losses as well as gains that are greater than if these techniques
involved the purchase and sale of the securities themselves rather than their synthetic derivatives.
SPECIAL FACTORS AFFECTING CERTAIN FUNDS
In addition to the investment strategies and policies described above, certain
Funds may employ other investment strategies and policies, or similar strategies and policies to a greater extent, and, therefore, may be subject to additional risks or similar risks to a greater extent. For instance, certain Funds which invest in
certain state specific securities may be subject to special considerations regarding such investments. For a description of such additional investment strategies and policies as well as corresponding risks for such Funds, see Part I of this SAI.
DIVERSIFICATION
Certain Funds are diversified funds and as such intend to meet the diversification requirements of the 1940 Act. Please refer to the Funds Prospectuses for information about whether a Fund is a
diversified or non-diversified Fund. Current 1940 Act diversification requirements require that with respect to 75% of the assets of a Fund, the Fund may not invest more than 5% of its total assets in the securities of any one issuer or own more
than 10% of the outstanding voting securities of any one issuer, except cash or cash items, obligations of the U.S. government, its agencies and instrumentalities, and securities of other investment companies. As for the other 25% of a Funds
assets not subject to the limitation described above, there is no limitation on investment of these assets under the 1940 Act, so that all of such assets may be invested in securities of any one issuer. Investments not subject to the limitations
described above could involve an increased risk to a Fund should an issuer be unable to make interest or principal payments or should the market value of such securities decline.
Each of the Money Market Funds intends to comply with the diversification requirements imposed by Rule 2a-7 of the 1940 Act.
Certain other Funds are registered as non-diversified investment companies. A Fund is considered non-diversified because a
relatively high percentage of the Funds assets may be invested in the securities of a single issuer or a limited number of issuers, primarily within the same economic sector. A non-diversified Funds portfolio securities, therefore, may
be more susceptible to any single economic, political, or regulatory occurrence than the portfolio securities of a more diversified investment company.
Regardless of whether a Fund is diversified under the 1940 Act, all of the Funds will comply with the diversification requirements imposed by the Code for qualification as a regulated investment company.
See Distributions and Tax Matters.
DISTRIBUTIONS AND TAX MATTERS
The following discussion is a brief summary of some of the important federal (and, where noted, state) income tax consequences affecting
each Fund and its shareholders. There may be other tax considerations applicable to particular shareholders. Except as otherwise noted in a Funds Prospectus, the Funds are not intended for foreign shareholders. As a result, this section does
not address in detail the tax consequences affecting any shareholder who,
Part II - 50
as to the U.S., is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership. This section is based on the Code, the regulations thereunder, published
rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. The following tax discussion is very general; therefore, prospective investors are urged to consult their tax advisors about
the impact an investment in a Fund may have on their own tax situations and the possible application of foreign, state and local law.
Each Fund generally will be treated as a separate entity for federal income tax purposes, and thus the provisions of the Code generally will be applied to each Fund separately. Net long-term and
short-term capital gain, net income and operating expenses therefore will be determined separately for each Fund.
Special tax
rules apply to investments held through defined contribution plans and other tax-qualified plans. Shareholders should consult their tax advisors to determine the suitability of shares of the Fund as an investment through such plans.
Qualification as a Regulated Investment Company
Each Fund intends to elect to be treated and qualify each year as a regulated investment company under Subchapter M of the Code. In order
to qualify for the special tax treatment accorded regulated investment companies and their shareholders, each Fund must, among other things:
|
(a)
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derive at least 90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gain from the
sale or other disposition of stock, securities, or foreign currencies, or other income (including, but not limited to, gain from options, swaps, futures, or forward contracts) derived with respect to its business of investing in such stock,
securities, or currencies and (ii) net income derived from interests in qualified publicly traded partnerships (QPTPs, defined below);
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(b)
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diversify its holdings so that, at the end of each quarter of the Funds taxable year, (i) at least 50% of the market value of the Funds total assets is
represented by cash and cash items, U.S. government securities, securities of other regulated investment companies, and other securities, limited in respect of any one issuer to an amount not greater than 5% of the value of the Funds total
assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets is invested (x) in the securities (other than cash or cash items, or securities
issued by the U.S. government or other regulated investment companies) of any one issuer or of two or more issuers that the Fund controls and that are engaged in the same, similar, or related trades or businesses, or (y) in the securities of
one or more QPTPs. In the case of a Funds investments in loan participations, the Fund shall treat both the financial intermediary and the issuer of the underlying loan as an issuer for the purposes of meeting this diversification requirement;
and
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(c)
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distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code, without regard to
the deduction for dividends paid generally, taxable ordinary income and any excess of net short-term capital gain over net long-term capital loss) and net tax-exempt interest income, for such year.
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In general, for purposes of the 90% gross income requirement described in paragraph (a) above, income derived from a partnership will
be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying income if realized by the regulated investment company. However, 100% of the net income derived from an
interest in a qualified publicly traded partnership (defined as a partnership (x) interests in which are traded on an established securities markets or readily tradable on a secondary market as the substantial equivalents thereof,
(y) that derives at least 90% of its income from passive income sources defined in Code section 7704(d), and (z) that derives less than 90% of its income from the qualifying income described in (a)(i) above) will be treated as qualifying
income. Although income from a QPTP is qualifying income, as discussed above, investments in QPTPs cannot exceed 25% of the Funds assets. In addition, although in general the passive loss rules of the Code do not apply to regulated investment
companies, such rules do apply to a regulated investment company with respect to items attributable to an interest in a QPTP.
Gains from foreign currencies (including foreign currency options, foreign currency swaps, foreign currency futures and foreign currency
forward contracts) currently constitute qualifying income for purposes of the 90% test, described in paragraph (a) above. However, the Treasury Department has the authority to issue regulations (possibly with retroactive effect) excluding from
the definition of qualifying income a funds foreign currency gains to the extent that such income is not directly related to the funds principal business of investing in stock or securities.
Part II - 51
For purposes of paragraph (b) above, the term outstanding voting securities of
such issuer will include the equity securities of a QPTP. A Funds investment in MLPs may qualify as an investment in (1) a QPTP, (2) a regular partnership, (3) a passive foreign investment company
(a PFIC) or (4) a corporation for U.S. federal income tax purposes. The treatment of particular MLPs for U.S. federal income tax purposes will affect the extent to which a Fund can invest in MLPs. The U.S. federal income tax
consequences of a Funds investments in PFICs and regular partnerships are discussed in greater detail below.
If a Fund qualifies for a taxable year as a regulated investment company that is accorded special tax treatment, the Fund will not be subject to federal income tax on income distributed in a timely manner
to its shareholders in the form of dividends (including Capital Gain Dividends, defined below). If a Fund were to fail to qualify as a regulated investment company accorded special tax treatment in any taxable year, the Fund would be subject to
taxation on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gain, would be taxable to shareholders as ordinary income. Some
portions of such distributions may be eligible for the dividends-received deduction in the case of corporate shareholders. In addition, the Fund could be required to recognize unrealized gain, pay substantial taxes and interest, and make substantial
distributions before re-qualifying as a regulated investment company that is accorded special tax treatment.
Each Fund intends
to distribute at least annually to its shareholders all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction) and may distribute its net capital gain (that is the excess of net
long-term capital gain over net short-term capital loss). Investment company taxable income which is retained by a Fund will be subject to tax at regular corporate tax rates. A Fund might also retain for investment its net capital gain. If a Fund
does retain such net capital gain, such gain will be subject to tax at regular corporate rates on the amount retained, but the Fund may designate the retained amount as undistributed capital gain in a notice to its shareholders who (i) will be
required to include in income for federal income tax purposes, as long-term capital gain, their respective shares of the undistributed amount, and (ii) will be entitled to credit their respective shares of the tax paid by the Fund on such
undistributed amount against their federal income tax liabilities, if any, and to claim refunds to the extent the credit exceeds such liabilities. For federal income tax purposes, the tax basis of shares owned by a shareholder of a Fund will be
increased by an amount equal under current law to the difference between the amount of undistributed capital gain included in the shareholders gross income and the tax deemed paid by the shareholder under clause (ii) of the preceding
sentence.
In determining its net capital gain for Capital Gain Dividend purposes, a regulated investment company generally
must treat any net capital loss or any net long-term capital loss incurred after October 31 as if it had been incurred in the succeeding year. Treasury regulations permit a regulated investment company, in determining its investment company
taxable income and net capital gain, to elect to treat all or part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year.
Excise Tax on Regulated Investment Companies
If a Fund fails to distribute in a calendar year an amount equal to the sum of 98% of its ordinary income for such year and 98.2% of its
capital gain net income for the one-year period ending October 31 (or later if the Fund is permitted to elect and so elects), plus any retained amount from the prior year, the Fund will be subject to a nondeductible 4% excise tax on the
undistributed amounts. The Funds intend to make distributions sufficient to avoid imposition of the 4% excise tax, although each Fund reserves the right to pay an excise tax rather than make an additional distribution when circumstances warrant
(e.g., the excise tax amount is deemed by a Fund to be
de minimis
). Certain derivative instruments give rise to ordinary income and loss. If a Fund has a taxable year that begins in one calendar year and ends in the next calendar year, the
Fund will be required to make this excise tax distribution during its taxable year. There is a risk that a Fund could recognize income prior to making this excise tax distribution and could recognize losses after making this distribution. As a
result, an excise tax distribution could constitute a return of capital (see discussion below).
Fund
Distributions
The Funds anticipate distributing substantially all of their net investment income for each taxable year.
Distributions are taxable to shareholders even if they are paid from income or gain earned by the Fund before a shareholders investment (and thus were included in the price the shareholder paid). Distributions are taxable whether shareholders
receive them in cash or reinvest them in additional shares. A shareholder whose distributions are reinvested in shares will be treated as having received a dividend equal to the fair market value of the new shares issued.
Part II - 52
Dividends and distributions on a Funds shares generally are subject to federal income
tax as described herein to the extent they do not exceed the Funds realized income and gains, even though such dividends and distributions may represent economically a return of a particular shareholders investment. Such dividends and
distributions are likely to occur in respect of shares purchased at a time when the Funds net asset value reflects gains that are either (i) unrealized, or (ii) realized but not distributed.
For federal income tax purposes, distributions of net investment income generally are taxable as ordinary income. Taxes on distributions
of capital gain are determined by how long a Fund owned the investment that generated it, rather than how long a shareholder may have owned shares in the Fund. Distributions of net capital gain from the sale of investments that a Fund owned for more
than one year and that are properly designated by the Fund as capital gain dividends (Capital Gain Dividends) will be taxable as long-term capital gain. Distributions of capital gain generally are made after applying any available
capital loss carryovers. For taxable years beginning before January 1, 2013, the long-term capital gain tax rate applicable to most individuals is 15% (with lower rates applying to taxpayers in the 10% and 15% rate brackets). A distribution of
gain from the sale of investments that a Fund owned for one year or less will be taxable as ordinary income. Distributions attributable to gain from the sale of MLPs that is characterized as ordinary income under the Codes recapture provisions
will be taxable as ordinary income.
For taxable years beginning before January 1, 2013, distributions of investment
income designated by a Fund as derived from qualified dividend income will be taxed in the hands of individuals at the rates applicable to long-term capital gain. In order for some portion of the dividends received by a Fund shareholder
to be qualified dividend income, the Fund must meet certain holding-period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio, and the shareholder must meet certain holding-period and other
requirements with respect to the Funds shares. A dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (i) if the dividend is received with respect to any share of stock held for fewer than 61
days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90
days before such date), (ii) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (iii) if
the recipient elects to have the dividend income treated as investment interest for purposes of the limitation on deductibility of investment interest, or (iv) if the dividend is received from a foreign corporation that is (a) not eligible
for the benefits of a comprehensive income tax treaty with the U.S. (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the U.S.) or (b) treated as a PFIC.
In general, distributions of investment income designated by a Fund as derived from qualified dividend income will be treated
as qualified dividend income by a non-corporate taxable shareholder so long as the shareholder meets the holding period and other requirements described above with respect to the Funds shares. In any event, if the qualified dividend income
received by each Fund during any taxable year is equal to or greater than 95% of its gross income, then 100% of the Funds dividends (other than dividends that are properly designated as Capital Gain Dividends) will be eligible to
be treated as qualified dividend income. For this purpose, the only gain included in the term gross income is the excess of net short-term capital gain over net long-term capital loss.
If a Fund receives dividends from an underlying fund, and the underlying fund designates such dividends as qualified dividend
income, then the Fund may, in turn, designate a portion of its distributions as qualified dividend income as well, provided the Fund meets the holding-period and other requirements with respect to shares of the underlying fund.
Any loss realized upon a taxable disposition of shares held for six months or less will be treated as long-term capital loss
to the extent of any Capital Gain Dividends received by the shareholder with respect to those shares. All or a portion of any loss realized upon a taxable disposition of Fund shares will be disallowed if other shares of such Fund are purchased
within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
A distribution paid to shareholders by a Fund in January of a year generally is deemed to have been received by shareholders on December 31 of the preceding year, if the distribution was declared and
payable to shareholders of record on a date in October, November, or December of that preceding year. The Funds will provide federal tax information annually, including information about dividends and distributions paid during the preceding year to
taxable investors and others requesting such information.
Part II - 53
If a Fund makes a distribution to its shareholders in excess of its current and accumulated
earnings and profits in any taxable year, the excess distribution will be treated as a return of capital to the extent of each shareholders basis (for tax purposes) in its shares, and any distribution in excess of basis will be
treated as capital gain. A return of capital is not taxable, but it reduces the shareholders basis in its shares, which reduces the loss (or increases the gain) on a subsequent taxable disposition by such shareholder of the shares.
Dividends of net investment income received by corporate shareholders (other than shareholders that are S corporations) of a Fund will
qualify for the 70% dividends-received deduction generally available to corporations to the extent of the amount of qualifying dividends received by the Fund from domestic corporations for the taxable year. A dividend received by a Fund will not be
treated as a qualifying dividend (1) if the stock on which the dividend is paid is considered to be debt-financed (generally, acquired with borrowed funds), (2) if it has been received with respect to any share of stock that
the Fund has held less than 46 days (91 days in the case of certain preferred stock) during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the
181-day period beginning 90 days before such date in the case of certain preferred stock) or (3) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in
substantially similar or related property. Moreover, the dividends-received deduction may be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of a Fund or (2) by
application of the Code. However, any distributions received by a Fund from real estate investment trusts (REITs) and PFICs will not qualify for the corporate dividends-received deduction.
For taxable years beginning after December 31, 2012, an additional 3.8% Medicare tax will be imposed on certain net investment income
(including ordinary dividends and capital gain distributions received from a Fund and net gains from redemptions or other taxable dispositions of Fund shares) of U.S. individuals, estates and trusts to the extent that such persons
modified adjusted gross income (in the case of an individual) or adjusted gross income (in the case of an estate or trust) exceeds a threshold amount.
Sale or Redemption of Shares
The sale,
exchange, or redemption of Fund shares may give rise to a gain or loss. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be long-term
capital gain or loss if the shares were held for more than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of
capital gain dividends received on (or undistributed capital gains credited with respect to) such shares. Capital gain of a non-corporate U.S. shareholder that is recognized in a taxable year beginning before January 1, 2013 generally is taxed
at a maximum rate of 15% (currently scheduled to increase to 20% after 2012) where the property is held by the shareholder for more than one year. Capital gain of a corporate shareholder is taxed at the same rate as ordinary income. Depending on a
shareholders percentage ownership in the Fund, a partial redemption of Fund shares could cause the shareholder to be treated as receiving a dividend, taxable as ordinary income in an amount equal to the full amount of the distribution, rather
than capital gain income.
Fund Investments
Certain investments of the Funds, including transactions in options, swaptions, futures contracts, forward contracts, straddles, swaps,
short sales, foreign currencies, inflation-linked securities and foreign securities, including for hedging purposes, will be subject to special tax rules (including mark-to-market, constructive sale, straddle, wash sale and short sale rules). In a
given case, these rules may accelerate income to a Fund, defer losses to a Fund, cause adjustments in the holding periods of a Funds securities, convert long-term capital gain into short-term capital gain, convert short-term capital losses
into long-term capital loss, or otherwise affect the character of a Funds income. These rules could therefore affect the amount, timing and character of distributions to shareholders and cause differences between a Funds book income and
its taxable income. If a Funds book income exceeds its taxable income, the distribution (if any) of such excess generally will be treated as (i) a dividend to the extent of the Funds remaining earnings and profits (including
earnings and profits arising from tax-exempt income), (ii) thereafter, as a return of capital to the extent of the recipients basis in its shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset. If a
Funds book income is less than taxable income, the Fund could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment. Income earned as a result of these
transactions would, in general, not be eligible for the dividends-received deduction or for treatment as exempt-interest dividends when distributed to shareholders. The Funds will endeavor to make any available elections pertaining to such
transactions in a manner believed to be in the best interest of each Fund and its shareholders.
Part II - 54
The Funds participation in loans of securities may affect the amount, timing, and
character of distributions to shareholders. With respect to any security subject to a securities loan, any (i) amounts received by the Fund in place of dividends earned on the security during the period that such security was not directly held
by the Fund will not give rise to qualified dividend income and (ii) withholding taxes accrued on dividends during the period that such security was not directly held by the Fund will not qualify as a foreign tax paid by the Fund and therefore
cannot be passed through to shareholders even if the Fund meets the requirements described in Foreign Taxes, below.
Certain debt securities purchased by the Funds are sold at an original issue discount and thus do not make periodic cash interest
payments. Similarly, zero-coupon bonds do not make periodic interest payments. Generally, the amount of the original issue discount is treated as interest income and is included in taxable income (and required to be distributed) over the term of the
debt security even though payment of that amount is not received until a later time, usually when the debt security matures. In addition, payment-in-kind securities will give rise to income that is required to be distributed and is taxable even
though the Fund holding the security receives no interest payment in cash on the security during the year. Because each Fund distributes substantially all of its net investment income to its shareholders (including such imputed interest), a Fund may
have to sell portfolio securities in order to generate the cash necessary for the required distributions. Such sales may occur at a time when the Adviser would not otherwise have chosen to sell such securities and may result in a taxable gain or
loss. Some of the Funds may invest in inflation-linked debt securities. Any increase in the principal amount of an inflation-linked debt security will be original issue discount, which is taxable as ordinary income and is required to be distributed,
even though the Fund will not receive the principal, including any increase thereto, until maturity. A Fund investing in such securities may be required to liquidate other investments, including at times when it is not advantageous to do so, in
order to satisfy its distribution requirements and to eliminate any possible taxation at the Fund level.
A Fund may invest to
a significant extent in debt obligations that are in the lowest rated categories (or are unrated), including debt obligations of issuers that are not currently paying interest or that are in default. Investments in debt obligations that are at risk
of being in default (or are presently in default) present special tax issues for a Fund. Tax rules are not entirely clear about issues such as when a Fund may cease to accrue interest, original issue discount or market discount, when and to what
extent deductions may be taken for bad debts or worthless securities and how payments received on obligations in default should be allocated between principal and income. These and other related issues will be addressed by each Fund when, as and if
it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company and does not become subject to U.S. federal income taxation or any excise tax.
Transactions of certain Funds in foreign currencies, foreign currency denominated debt securities and certain foreign currency options,
future contracts and forward contracts (and similar instruments) may accelerate income recognition and result in ordinary income or loss to a Fund for federal income tax purposes which will be taxable to the shareholders as such when it is
distributed to them.
Special tax considerations apply if a Fund invests in investment companies that are taxable as
partnerships for federal income tax purposes. In general, the Fund will not recognize income earned by such an investment company until the close of the investment companys taxable year. But the Fund will recognize such income as it is earned
by the investment company for purposes of determining whether it is subject to the 4% excise tax. Therefore, if the Fund and such an investment company have different taxable years, the Fund may be compelled to make distributions in excess of the
income recognized from such an investment company in order to avoid the imposition of the 4% excise tax. A Funds receipt of a non-liquidating cash distribution from an investment company taxable as a partnership generally will result in
recognized gain (but not loss) only to the extent that the amount of the distribution exceeds the Funds adjusted basis in shares of such investment company before the distribution. A Fund that receives a liquidating cash distribution from an
investment company taxable as a partnership will recognize capital gain or loss to the extent of the difference between the proceeds received by the Fund and the Funds adjusted tax basis in shares of such investment company; however, the Fund
will recognize ordinary income, rather than capital gain, to the extent that the Funds allocable share of unrealized receivables (including any accrued but untaxed market discount) exceeds the shareholders share of the basis
in those unrealized receivables.
Some amounts received by each Fund with respect to its investments in MLPs will likely be
treated as a return of capital because of accelerated deductions available with respect to the activities of such MLPs. On the disposition of an investment in such an MLP, the Fund will likely realize taxable income in excess of economic gain with
respect to that asset (or, if the Fund does not dispose of the MLP, the Fund likely will realize taxable income in excess of cash flow with respect to the MLP in a later period), and the Fund must take such income into account in determining whether
the Fund has satisfied its distribution requirements. The Fund may have to borrow or liquidate
Part II - 55
securities to satisfy its distribution requirements and to meet its redemption requests, even though investment considerations might otherwise make it undesirable for the Fund to sell securities
or borrow money at such time.
Some of the Funds may invest in REITs. Such investments in REIT equity securities may require a
Fund to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio (including when it is not advantageous to do so) that it
otherwise would have continued to hold. A Funds investments in REIT equity securities may at other times result in the Funds receipt of cash in excess of the REITs earnings; if the Fund distributes such amounts, such distribution
could constitute a return of capital to Fund shareholders for federal income tax purposes. Dividends received by a Fund from a REIT generally will not constitute qualified dividend income.
A Fund might invest directly or indirectly in residual interests in real estate mortgage investment conduits (REMICs) or
equity interests in taxable mortgage pools (TMPS). Under a notice issued by the IRS in October 2006 and Treasury regulations that have not yet been issued (but may apply with retroactive effect) a portion of a Funds income from a
REIT that is attributable to the REITs residual interest in a REMIC or a TMP (referred to in the Code as an excess inclusion) will be subject to federal income taxation in all events. This notice also provides, and the regulations
are expected to provide, that excess inclusion income of a regulated investment company, such as each of the Funds, will generally be allocated to shareholders of the regulated investment company in proportion to the dividends received by such
shareholders, with the same consequences as if the shareholders held the related REMIC or TMP residual interest directly.
In
general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions) and (ii) will constitute unrelated business taxable income
(UBTI) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated
excess inclusion income, and otherwise might not be required to file a tax return, to file a tax return and pay tax on such income. In addition, because the Code provides that excess inclusion income is ineligible for treaty benefits, a regulated
investment company must withhold tax on excess inclusions attributable to its foreign shareholders at a 30% rate of withholding, regardless of any treaty benefits for which a shareholder is otherwise eligible.
Any investment in residual interests of a Collateralized Mortgage Obligation (a CMO) that has elected to be treated as a REMIC
can create complex tax problems, especially if the Fund has state or local governments or other tax-exempt organizations as shareholders. Under current law, the Fund serves to block unrelated business taxable income (UBTI) from being
realized by its tax-exempt shareholders. Notwithstanding the foregoing, a tax-exempt shareholder will recognize UBTI by virtue of its investment in the Fund if shares in the Fund constitute debt-financed property in the hands of the tax-exempt
shareholder within the meaning of Code Section 514(b). Furthermore, a tax-exempt shareholder may recognize UBTI if the Fund recognizes excess inclusion income derived from direct or indirect investments in REMIC residual interests
or TMPs if the amount of such income recognized by the Fund exceeds the Funds investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in regulated investment
companies that invest directly or indirectly in residual interests in REMICs or in TMPs. Under legislation enacted in December 2006, a CRT, as defined in section 664 of the Code, that realizes UBTI for a taxable year must pay an excise tax annually
of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI solely as a result of investing in a Fund that recognizes excess inclusion income. Rather, if at any time during any taxable year a
CRT (or one of certain other tax-exempt shareholders, such as the U.S., a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a share in a Fund that recognizes excess
inclusion income, then the Fund will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to
which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the 1940 Act, each Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus
reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the Fund. The Funds have not yet determined whether such an election will be made. CRTs are urged to consult their
tax advisors concerning the consequences of investing in a Fund.
If a Fund invests in PFICs, certain special tax consequences
may apply. A PFIC is any foreign corporation in which (i) 75% or more of the gross income for the taxable year is passive income, or (ii) the average percentage of
Part II - 56
the assets (generally by value, but by adjusted tax basis in certain cases) that produce or are held for the production of passive income is at least 50%. Generally, passive income for this
purpose means dividends, interest (including income equivalent to interest), royalties, rents, annuities, the excess of gains over losses from certain property transactions and commodities transactions, and foreign currency gains. Passive income for
this purpose does not include rents and royalties received by the foreign corporation from active business and certain income received from related persons. A Funds investments in certain PFICs could subject the Fund to a U.S. federal income
tax (including interest charges) on distributions received from the company or on proceeds received from the disposition of shares in the company. This tax cannot be eliminated by making distributions to Fund shareholders. In addition, certain
interest charges may be imposed on the Fund as a result of such distributions.
If a Fund is in a position to treat a PFIC as a
qualified electing fund (QEF), the Fund will be required to include its share of the companys income and net capital gain annually, regardless of whether it receives any distributions from the company. Alternately, a
Fund may make an election to mark the gains (and to a limited extent losses) in such holdings to the market as though it had sold and repurchased its holdings in those PFICs on the last day of the Funds taxable year. Such gain and
loss are treated as ordinary income and loss. The QEF and mark-to-market elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed by the Fund to avoid
taxation. Making either of these elections, therefore, may require the Fund to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and
affect the Funds total return. A fund that invests indirectly in PFICs by virtue of the funds investment in other investment companies that qualify as U.S. persons within the meaning of the Code may not make such elections;
rather, such underlying investment companies investing directly in the PFICs would decide whether to make such elections. Dividends paid by PFICs will not be eligible to be treated as qualified dividend income.
The ability of a Fund to invest directly in commodities, and in certain commodity-related securities and other instruments, is subject to
significant limitations in order to enable a Fund to maintain its status as a regulated investment company under the Code.
Investment in Other Funds
If a Fund invests in shares of other mutual funds, ETFs or other companies that are taxable
as regulated investment companies, as well as certain investments in REITs (collectively, underlying funds), its distributable income and gains will normally consist, in part, of distributions from the underlying funds and gains and
losses on the disposition of shares of the underlying funds. To the extent that an underlying fund realizes net losses on its investments for a given taxable year, the Fund will not be able to recognize its share of those losses (so as to offset
distributions of net income or capital gains from other underlying funds) until it disposes of shares of the underlying fund. Moreover, even when the Fund does make such a disposition, a portion of its loss may be recognized as a long-term capital
loss, which will not be treated as favorably for federal income tax purposes as a short-term capital loss or an ordinary deduction. In particular, the Fund will not be able to offset any capital losses from its dispositions of underlying fund shares
against its ordinary income (including distributions of any net short-term capital gain realized by an underlying fund).
In
addition, in certain circumstances, the wash sale rules under Section 1091 of the Code may apply to a Funds sales of underlying fund shares that have generated losses. A wash sale occurs if shares of an underlying fund are
sold by the Fund at a loss and the Fund acquires substantially identical shares of that same underlying fund 30 days before or after the date of the sale. The wash-sale rules could defer losses in the Funds hands on sales of underlying fund
shares (to the extent such sales are wash sales) for extended (and, in certain cases, potentially indefinite) periods of time.
As a result of the foregoing rules, and certain other special rules, the amount of net investment income and net capital gain that each
Fund will be required to distribute to shareholders may be greater than what such amounts would have been had the Fund directly invested in the securities held by the underlying funds, rather than investing in shares of the underlying funds. For
similar reasons, the character of distributions from the Fund (e.g., long-term capital gain, exempt interest, eligibility for dividends-received deduction, etc.) will not necessarily be the same as it would have been had the Fund invested directly
in the securities held by the underlying funds.
If a Fund received dividends from an underlying fund that qualifies as a
regulated investment company, and the underlying fund designates such dividends as qualified dividend income, then the Fund is permitted in turn to designate a portion of its distributions as qualified dividend income,
provided the Fund meets holding period and other requirements with respect to shares of the underlying fund.
Part II - 57
Depending on a Funds percentage ownership in an underlying fund, both before and after
a redemption, a redemption of shares of an underlying fund by a Fund may cause the Fund to be treated as receiving a Section 301 distribution taxable as a dividend to the extent of its allocable shares of earnings and profits, on the full
amount of the distribution instead of receiving capital gain income on the shares of the underlying fund. Such a distribution may be treated as qualified dividend income and thus eligible to be taxed at the rates applicable to long-term capital
gain. If qualified dividend income treatment is not available, the distribution may be taxed as ordinary income. This could cause shareholders of the Fund to recognize higher amounts of ordinary income than if the shareholders had held the shares of
the underlying funds directly.
For taxable years beginning on or before December 22, 2010, a Fund cannot pass through to
shareholders foreign tax credits borne in respect of foreign securities income earned by an underlying fund. For taxable years beginning after December 22, 2010, a Fund may elect to pass through to shareholders foreign tax credits from an
underlying fund, provided that at least 50% of the Funds total assets are invested in other regulated investment companies at the end of each quarter of the taxable year.
Backup Withholding
Each Fund generally is
required to backup withhold and remit to the U.S. Treasury a percentage of the taxable dividends and other distributions paid to, and the proceeds of share sales, exchanges, or redemptions made by, any individual shareholder who fails to properly
furnish the Fund with a correct taxpayer identification number (TIN), who has under-reported dividend or interest income, or who fails to certify to the Fund that he or she is not subject to backup withholding. The backup withholding
rules may also apply to distributions that are properly designated as exempt-interest dividends. The backup withholding tax rate is 28% for amounts paid through 2012. The backup withholding rate will be 31% for amounts paid after December 31,
2012, unless Congress enacts tax legislation providing otherwise.
Foreign Shareholders
The Funds are not intended for foreign shareholders.
Distributions properly designated as Capital Gain Dividends and exempt-interest dividends generally will not be subject to withholding of federal income tax. However, exempt-interest dividends may be
subject to backup withholding (as discussed above). In general, dividends other than Capital Gain Dividends and exempt-interest dividends paid by a Fund to a shareholder that is not a U.S. person within the meaning of the Code (a
foreign person) are subject to withholding of U.S. federal income tax at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio interest, short-term capital gains, or foreign-source
dividend and interest income) that, if paid to a foreign person directly, would not be subject to withholding. However, effective for taxable years of a Fund beginning before January 1, 2012 (or a later date if extended by the U.S. Congress as
discussed below), the Fund will not be required to withhold any amounts (i) with respect to distributions (other than distributions to a foreign person (w) that has not provided a satisfactory statement that the beneficial owner is not a
U.S. person, (x) to the extent that the dividend is attributable to certain interest on an obligation if the foreign person is the issuer or is a 10% shareholder of the issuer, (y) that is within certain foreign countries that have
inadequate information exchange with the United States, or (z) to the extent the dividend is attributable to interest paid by a person that is a related person of the foreign person and the foreign person is a controlled foreign corporation)
from U.S.-source interest income of types similar to those not subject to U.S. federal income tax if earned directly by an individual foreign person, to the extent such distributions are properly designated by the Fund (interest-related
dividends), and (ii) with respect to distributions (other than (a) distributions to an individual foreign person who is present in the United States for a period or periods aggregating 183 days or more during the year of the
distribution and (b) distributions subject to special rules regarding the disposition of U.S. real property interests (as described below) of net short-term capital gains in excess of net long-term capital losses to the extent such
distributions are properly designated by the Fund (short-term capital gain dividends). Depending on the circumstances, a Fund may make designations of interest-related and/or short-term capital gain dividends with respect to all, some or
none of its potentially eligible dividends and/or treat such dividends, in whole or in part, as ineligible for these exemptions from withholding. In the case of shares held through an intermediary, the intermediary may withhold even if a Fund makes
a designation with respect to a payment. Foreign persons should contact their intermediaries regarding the application of these rules to their accounts. Absent legislation extending these exemptions for taxable years beginning on or after
January 1, 2012, these special withholding exemptions for interest-related and short-term capital gain dividends will expire and these dividends generally will be subject to withholding as described above
Part II - 58
A beneficial holder of shares who is a foreign person is not, in general, subject to U.S.
federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund or on Capital Gain Dividends or exempt-interest dividends unless (i) such gain or dividend is effectively connected with the
conduct of a trade or business carried on by such holder within the United States or (ii) in the case of an individual holder, the holder is present in the United States for a period or periods aggregating 183 days or more during the year of
the sale or the receipt of the Capital Gain Dividend and certain other conditions are met or (iii) the shares constitute U.S. real property interests (USRPIs) or the Capital Gain Dividends are attributable to gains from
the sale or exchange of USRPIs in accordance with the rules set forth below.
Special rules apply to distributions to foreign
shareholders from a Fund that is either a U.S. real property holding corporation (USRPHC) or would be a USRPHC but for the operation of the exceptions to the definition thereof described below. Additionally, special rules
apply to the sale of shares in a Fund that is a USRPHC. Very generally, a USRPHC is a domestic corporation that holds U.S. real property interests (USRPIs) USRPIs are defined as any interest in U.S. real property or any equity
interest in a USRPHC the fair market value of which equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests in real property located outside the United States and other assets. A Fund that holds
(directly or indirectly) significant interests in REITs may be a USRPHC. The special rules discussed in the next paragraph will also apply to distributions from a Fund that would be a USRPHC absent exclusions from USRPI treatment for interests in
domestically controlled REITs or regulated investment companies and not-greater-than-5% interests in publicly traded classes of stock in REITs or regulated investment companies.
In the case of a Fund that is a USRPHC or would be a USRPHC but for the exceptions from the definition of USRPI (described immediately
above), distributions by the Fund that are attributable to (a) gains realized on the disposition of USRPIs by the Fund and (b) distributions received by the Fund from a lower-tier regulated investment company or REIT that the Fund is
required to treat as USRPI gain in its hands will retain their character as gains realized from USRPIs in the hands of the Funds foreign shareholders. (However, absent legislation, after December 31, 2011, this look-through
treatment for distributions by the Fund to foreign shareholders will apply only to such distributions that, in turn, are attributable to distributions received by the Fund from a lower-tier REIT and required to be treated as USRPI gain in the
Funds hands.) If the foreign shareholder holds (or has held in the prior year) more than a 5% interest in the Fund, such distributions will be treated as gains effectively connected with the conduct of a U.S. trade or
business, and subject to tax at graduated rates. Moreover, such shareholders will be required to file a U.S. income tax return for the year in which the gain was recognized and the Fund will be required to withhold 35% of the amount of such
distribution. In the case of all other foreign shareholders (i.e., those whose interest in the Fund did not exceed 5% at any time during the prior year), the USRPI distribution will be treated as ordinary income (regardless of any designation by the
Fund that such distribution is a short-term capital gain dividend or a Capital Gain Dividend), and the Fund must withhold 30% (or a lower applicable treaty rate) of the amount of the distribution paid to such foreign shareholder. Foreign
shareholders of a Fund are also subject to wash sale rules to prevent the avoidance of the tax-filing and -payment obligations discussed above through the sale and repurchase of Fund shares.
In addition, with respect to open-end funds, a Fund that is a USRPHC must typically withhold 10% of the amount realized in a redemption by
a greater-than-5% foreign shareholder, and that shareholder must file a U.S. income tax return for the year of the disposition of the USRPI and pay any additional tax due on the gain. On or before December 31, 2011, no withholding is generally
required with respect to amounts paid in redemption of shares of a Fund if the Fund is a domestically controlled USRPHC or, in certain limited cases, if the Fund (whether or not domestically controlled) holds substantial investments in regulated
investment companies that are domestically controlled USRPHCs. Absent legislation extending this exemption from withholding beyond December 31, 2011, it will expire at that time and any previously exempt Fund will be required to withhold with
respect to amounts paid in redemption of its shares as described above.
In order to qualify for any exemptions from
withholding described above or for lower withholding tax rates under income tax treaties, or to establish an exemption from backup withholding, the foreign investor must comply with special certification and filing requirements relating to its
non-US status (including, in general, furnishing an IRS Form W-8BEN or substitute form). Foreign investors in a Fund should consult their tax advisers in this regard.
If a shareholder is eligible for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable
to a permanent establishment maintained by the shareholder in the United States.
Part II - 59
A beneficial holder of shares who is a foreign person may be subject to state and local tax
and to the U.S. federal estate tax in addition to the federal tax on income referred to above. Foreign shareholders in a Fund should consult their tax advisors with respect to the potential application of the above rules.
Effective January 1, 2014, a Fund will be required to withhold U.S. tax (at a 30% rate) on payments of taxable dividends and
(effective January 1, 2015) redemption proceeds made to certain non-U.S. entities that fail to comply (or be deemed compliant) with extensive new reporting and withholding requirements designed to inform the U.S. Department of the Treasury of
U.S.-owned foreign investment accounts. Shareholders may be requested to provide additional information to a Fund to enable the Fund to determine whether withholding is required.
Foreign Taxes
Certain Funds may be subject
to foreign withholding taxes or other foreign taxes with respect to income (possibly including, in some cases, capital gain) received from sources within foreign countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. If more than 50% of a Funds assets at year end consists of the securities of foreign corporations, the Fund may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata
portion of qualified taxes paid by the Fund to foreign countries in respect of foreign securities the Fund has held for at least the minimum period specified in the Code. In such a case, shareholders will include in gross income from foreign sources
their pro rata shares of such taxes. A shareholders ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by a Fund may be subject to certain limitations imposed by the Code and the Treasury Regulations issued
thereunder, as a result of which a shareholder may not get a full credit or deduction for the amount of such taxes. In particular, shareholders must hold their Fund shares (without protection from risk of loss) on the ex-dividend date and for at
least 15 additional days during the 30-day period surrounding the ex-dividend date to be eligible to claim a foreign tax credit with respect to a given dividend. Shareholders who do not itemize on their federal income tax returns may claim a credit
(but no deduction) for such foreign taxes.
If a Fund does not make the above election or if more than 50% of its assets at the
end of the year do not consist of securities of foreign corporations, the Funds net income will be reduced by the foreign taxes paid or withheld. In such cases, shareholders will not be entitled to claim a credit or deduction with respect to
foreign taxes.
The foregoing is only a general description of the treatment of foreign source income or foreign taxes under
the U.S. federal income tax laws. Because the availability of a credit or deduction depends on the particular circumstances of each shareholder, shareholders are advised to consult their own tax advisors.
Exempt-Interest Dividends
Some of the Funds intend to qualify to pay exempt-interest dividends to their respective shareholders. In order to qualify to pay exempt-interest dividends, at least 50% of the value of a Funds
total assets must consist of tax-exempt municipal bonds at the close of each quarter of the Funds taxable year. An exempt-interest dividend is that part of a dividend that is properly designated as an exempt-interest dividend and that consists
of interest received by a Fund on such tax-exempt securities. Shareholders of Funds that pay exempt-interest dividends would not incur any regular federal income tax on the amount of exempt-interest dividends received by them from a Fund, but an
investment in such a Fund may result in liability for federal and state alternative minimum taxation and may be subject to state and local taxes.
Interest on indebtedness incurred or continued by a shareholder, whether a corporation or an individual, to purchase or carry shares of a Fund is not deductible to the extent it relates to exempt-interest
dividends received by the shareholder from that Fund. Any loss incurred on the sale or redemption of a Funds shares held for six months or less will be disallowed to the extent of exempt-interest dividends received with respect to such shares.
Interest on certain tax-exempt bonds that are private activity bonds within the meaning of the Code is treated as a tax
preference item for purposes of the alternative minimum tax, and any such interest received by a Fund and distributed to shareholders will be so treated for purposes of any alternative minimum tax liability of shareholders to the extent of the
dividends proportionate share of a Funds income consisting of such interest. All exempt-interest dividends are subject to the corporate alternative minimum tax.
The exemption from federal income tax for exempt-interest dividends does not necessarily result in exemption for such dividends under the income or other tax laws of any state or local authority.
Shareholders that receive social security or railroad retirement benefits should consult their tax advisors to determine what effect, if any, an investment in a Fund may have on the federal taxation of their benefits.
Part II - 60
From time to time legislation may be introduced or litigation may arise that would
change the tax treatment of exempt-interest dividends. Such legislation or litigation may have the effect of raising the state or other taxes payable by shareholders on such dividends. Shareholders should consult their tax advisors for the current
federal, state and local law on exempt-interest dividends.
State and Local Tax Matters
Depending on the residence of the shareholders for tax purposes, distributions may also be subject to state and local
taxation. Rules of state and local taxation regarding qualified dividend income, ordinary income dividends and capital gain dividends from regulated investment companies may differ from the rules of U.S. federal income tax in many respects.
Shareholders are urged to consult their tax advisors as to the consequences of these and other state and local tax rules affecting investment in the Funds.
Most states provide that a regulated investment company may pass through (without restriction) to its shareholders state and local income tax exemptions available to direct owners of certain types of U.S.
government securities (such as U.S. Treasury obligations). Thus, for residents of these states, distributions derived from a Funds investment in certain types of U.S. government securities should be free from state and local income taxation to
the extent that the interest income from such investments would have been exempt from state and local taxes if such securities had been held directly by the respective shareholders. Certain states, however, do not allow a regulated investment
company to pass through to its shareholders the state and local income tax exemptions available to direct owners of certain types of U.S. government securities unless a Fund holds at least a required amount of U.S. government securities.
Accordingly, for residents of these states, distributions derived from a Funds investment in certain types of U.S. government securities may not be entitled to the exemptions from state and local income taxes that would be available if the
shareholders had purchased U.S. government securities directly. The exemption from state and local income taxes does not preclude states from asserting other taxes on the ownership of U.S. government securities. To the extent that a Fund invests to
a substantial degree in U.S. government securities which are subject to favorable state and local tax treatment, shareholders of the Fund will be notified as to the extent to which distributions from the Fund are attributable to interest on such
securities.
Tax Shelter Reporting Regulations
If a shareholder realizes a loss on disposition of a Funds shares of $2 million or more for an individual shareholder or $10 million
or more for a corporate shareholder, the shareholder must file with the Internal Revenue Service a disclosure statement on Form 8886. Direct shareholders of portfolio securities are in many cases excepted from this reporting requirement, but under
current guidance, shareholders of a regulated investment company are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders of most or all regulated investment companies. The fact that a loss
is reportable under these regulations does not affect the legal determination whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax advisers to determine the applicability of these regulations in light of
their individual circumstances.
General Considerations
The federal income tax discussion set forth above is for general information only. Prospective investors should consult their tax advisers
regarding the specific federal tax consequences of purchasing, holding, and disposing of shares of each of the Funds, as well as the effects of state, local and foreign tax law and any proposed tax law changes.
TRUSTEES
The names of the Trustees of the Trusts, together with information regarding their year of birth, the year each Trustee became a Board member of the Trusts, the year each Trustee first became a Board
member of any of the heritage J.P. Morgan Funds or heritage One Group Mutual Funds, principal occupations and other board memberships, including those in any company with a class of securities registered pursuant to Section 12 of the Securities
Exchange Act of 1934, as amended (the Securities Exchange Act) or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company registered as an investment company under the 1940 Act, are shown
below. The contact address for each of the Trustees is 270 Park Avenue, New York, NY 10017.
Part II - 61
|
|
|
|
|
|
|
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|
Name (Year of Birth; Positions with
the Funds since)
|
|
Principal Occupation
During Past 5 Years
|
|
Number of Funds
in Fund Complex
Overseen by
Trustee
(1)
|
|
|
Other Directorships Held
During the Past 5 Years
|
Independent Trustees
|
|
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John F. Finn
(1947); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1998.
|
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Chairman (1985present), President and Chief Executive Officer, Gardner, Inc. (supply chain management company serving industrial and consumer markets)
(1974present).
|
|
|
170
|
|
|
Director, Cardinal Health, Inc (CAH) (1994present); Director, Greif, Inc. (GEF) (industrial package products and services) (2007present).
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Dr. Matthew Goldstein
(1941); Chairman since 2013; Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2003.
|
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Chancellor, City University of New York (1999present); President, Adelphi University (New York) (19981999).
|
|
|
170
|
|
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Director, New Plan Excel (NXL) (19992005); Director, National Financial Partners (NFP) (2003 2005); Director, Bronx-Lebanon Hospital Center; Director, United Way of New
York City (2002present).
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Robert J. Higgins
(1945); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2002.
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Retired; Director of Administration of the State of Rhode Island (20032004); President Consumer Banking and Investment Services, Fleet Boston Financial
(19712001).
|
|
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170
|
|
|
None
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|
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Peter C. Marshall
(1942); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1985.
|
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Self-employed business consultant (2002present).
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|
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170
|
|
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Director, Center for Communication, Hearing and Deafness (1990present).
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Mary E. Martinez
(1960); Trustee of Trusts since 2013
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Associate, Special Properties, a Christies International Real Estate Affiliate (2010Present); Managing Director, Bank of America (Asset Management) (20072008);
Chief Operating Officer, U.S. Trust Asset Management; U.S. Trust Company (asset management) (20032007); President, Excelsior Funds (registered investment companies) (20042005).
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|
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170
|
|
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Member, New York City Center Advisory Council (oversees public performing arts facilities) (2006Present)
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|
Marilyn McCoy*
(1948); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1999.
|
|
Vice President of Administration and Planning, Northwestern University (1985present).
|
|
|
170
|
|
|
Trustee, Carleton College
(2003present).
|
Part II - 62
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|
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|
|
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Name (Year of Birth; Positions with
the Funds since)
|
|
Principal Occupation
During Past 5 Years
|
|
Number of Funds
in Fund Complex
Overseen by
Trustee
(1)
|
|
|
Other Directorships Held
During the Past 5 Years
|
|
|
|
|
Mitchell M. Merin
(1953); Trustee of Trusts since 2013
|
|
Retired; President and Chief Operating Officer, Morgan Stanley Investment Management, Member Morgan Stanley & Co. Management Committee (registered investment adviser)
(19982005).
|
|
|
170
|
|
|
Director, Sun Life Financial (SLF) (2007 to Present) (financial services and insurance); Trustee, Trinity College, Hartford, CT (20022010)
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William G. Morton, Jr.
(1937); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2003.
|
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Retired; Chairman Emeritus (20012002), and Chairman and Chief Executive Officer, Boston Stock Exchange (19852001).
|
|
|
170
|
|
|
Director, Radio Shack Corp. (19872008); Trustee, Stratton Mountain School (2001present).
|
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|
Dr. Robert A. Oden, Jr.
(1946); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since 1997.
|
|
Retired; President, Carleton College (20022010); President, Kenyon College
(19952002).
|
|
|
170
|
|
|
Trustee, American University in Cairo (1999present); Trustee,
Dartmouth-Hitchcock Medical Center (2011present); Trustee, American Schools of Oriental Research (2011present); Trustee, Carleton College (20022010).
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Marian U. Pardo
***
(1946); Trustee of Trusts effective February 1, 2013
|
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Managing Director and Founder, Virtual Capital Management LLC (Investment Consulting) (2007present); Managing Director, Credit Suisse Asset Management (portfolio manager)
(20032006).
|
|
|
170
|
|
|
Member, Board of Governors, Columbus Citizens Foundation (not-for-profit supporting philanthropic and cultural programs) (2006Present)
|
|
|
|
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James J. Schonbachler
(1943); Trustee of Trusts since 2005; Trustee of heritage J.P. Morgan Funds since 2001.
|
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Retired; Managing Director of
Bankers Trust Company
(financial services)
(1968
1998).
|
|
|
170
|
|
|
None
|
|
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Frederick W. Ruebeck
(1939); Trustee of Trusts since 2005; Trustee of heritage One Group Mutual Funds since1994.
|
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Consultant (2000present);
Advisor, JP Greene & Associates, LLC (broker-dealer) (20002009); Chief Investment Officer, Wabash College (2004present); Director of
Investments, Eli Lilly and Company (pharmaceuticals) (19881999).
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|
|
170
|
|
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Trustee, Wabash College (1988present); Chairman, Indianapolis Symphony Orchestra Foundation (1994present).
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Interested Trustee Not Affiliated with the Adviser
|
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Frankie D. Hughes**
(1952); Trustee of Trusts since 2008.
|
|
President and Chief Investment Officer, Hughes Capital Management, Inc. (fixed income asset management) (1993present).
|
|
|
170
|
|
|
Trustee, The Victory Portfolios
(20002008).
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Part II - 63
(1)
|
A Fund Complex means two or more registered investment companies that hold themselves out to investors as related companies for purposes of investment and investor
services or have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other registered investment companies. The J.P. Morgan Funds Complex for which the Board of Trustees
serves currently includes eleven registered investment companies (170 funds), including JPMMFG which liquidated effective November 29, 2012, and is in the process of winding up its affairs.
|
*
|
Ms. McCoy has served as Vice President of Administration and Planning for Northwestern University since 1985. William M. Daley was the Head of Corporate
Responsibility for JPMorgan Chase & Co. prior to January 2011 and served as a member of the Board of Trustees of Northwestern University from 2005 through 2010. JPMIM, the Funds investment adviser, is a wholly-owned subsidiary of
JPMorgan Chase & Co. Five other members of the Board of Trustees of Northwestern University are executive officers of registered investment advisers (not affiliated with JPMorgan) that are under common control with sub-advisers to certain
J.P. Morgan Funds.
|
**
|
Ms. Hughes is treated as an interested person based on the portfolio holdings of clients of Hughes Capital Management, Inc.
|
***
|
In connection with prior employment with JPMorgan Chase, Ms. Pardo was the recipient of non-qualified pension plan payments from JPMorgan Chase in the amount of
approximately $2,055 per month, which she irrevocably waived effective January 1, 2013, and deferred compensation payments from JPMorgan Chase in the amount of approximately $7,294 per year, which ended on January 1, 2013. In
addition, Ms. Pardo receives payments from a fully funded qualified plan, which is not an obligation of JPMorgan Chase.
|
The Trustees serve for an indefinite term, subject to the Trusts current retirement policy, which is age 75 for all Trustees, except that the Board has determined Mr. Morton should continue to
serve until December 31, 2014. The Board of Trustees decides upon general policies and is responsible for overseeing the business affairs of the Trusts.
Qualifications of Trustees and Trustee Nominee
The Boards Governance Committee is responsible for selection and nomination of persons for election or appointment as Trustees. Effective December 31, 2012, Fergus A. Reid, William J. Armstrong
and Leonard Spalding retired from the Board. In order to fill the vacancies created by Messrs. Reid, Armstrong, and Spalding, the Governance Committee and the Board appointed Mary E. Martinez and Mitchell M. Merin to serve as Trustees effective
January 1, 2013 and Marian U. Pardo to serve as Trustee effective February 1, 2013. Information regarding Mr. Merins, Ms. Martinezs, and Ms. Pardos year of birth, principal occupations and other board
memberships, including those in any company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company
registered as an investment company under the 1940 Act, is set forth above.
In concluding that Ms. Martinez,
Mr. Merin, and Ms. Pardo should serve as Trustees of the Funds, the Governance Committee and Board evaluated Ms. Martinez, Mr. Merin, and Ms. Pardo both individually and in the context of their anticipated contribution to
the Boards overall effectiveness. The Governance Committee and the Board considered that Ms. Martinez, Mr. Merin and Ms. Pardo each has significant and relevant experience and knowledge concerning registered investment companies and asset
management. The Governance Committee and the Board also considered the strong leadership skills, commitment, and integrity that Ms. Martinez, Mr. Merin and Ms. Pardo each possesses as well as their ability to work effectively and collaboratively
with other members of the Board. In reaching its conclusion that Ms. Martinez, Mr. Merin, and Ms. Pardo should serve as Trustees of the Funds, the Board also considered the following additional specific qualifications:
Mary E. Martinez.
The Governance Committee and the Board considered the breadth and depth of Ms. Martinezs experience as
a senior financial services executive with 25 years of experience in asset management, wealth management and private banking services. The Governance Committee and the Board noted Ms. Martinezs qualifications with respect to registered
investment companies and asset management products as a result of serving as president to other registered investment companies and as a chief operating officer of an asset management firm with responsibility for product development, management,
infrastructure and operating oversight. The Governance Committee and the Board also considered Ms. Martinezs potential contribution to the effectiveness of the Board given her experience with respect to: (1) diversified product
offerings including fundamental, quantitative, traditional and alternative asset classes; (2) asset and portfolio management analytics; (3) risk management and governance; and (4) regulatory and financial reporting.
Mitchell M. Merin.
The Governance Committee and the Board noted that Mr. Merin has been in the securities and asset management
business for over 25 years and has served as both a board member and president of other registered investment companies. The Governance Committee and the Board also considered that Mr. Merin has held leadership positions within the investment
company industry including serving as a member of the Executive Committee of the Board of Governors of the Investment Company Institute and the Chair of the Fixed Income Securities Committee of NASDR. The Governance Committee and the Board also
considered Mr. Merins potential contribution to the effectiveness of the Board given his experience with respect to: (1) taxable fixed income products and derivatives; (2) investment oversight; and (3) board governance of
registered investment companies and other public companies.
Part II - 64
Marian U. Pardo.
The Governance Committee and the Board noted that Ms. Pardo has
been in the financial services industry since 1968, with experience in banking, lending, and investment management and served as a portfolio manager for equity funds across the capitalization spectrum including, prior to 2002, small cap US equity
funds advised by JPMIM. The Governance Committee and the Board also considered Ms. Pardos potential contribution to the effectiveness of the Board given her experience with respect to: (1) portfolio management, (2) the
Funds investment advisory business, and (3) banking and investment management.
With respect to the Trustees who
were members of the Board prior to December 31, 2012, the Governance Committee and Board have evaluated each Trustee both individually and in the broader context of the Boards overall effectiveness. The following is a description of the
factors considered by the Governance Committee and the Board in concluding that each Trustee should serve as Trustee of the Funds.
The Governance Committee and the Board considered the commitment that each Trustee has demonstrated in serving on the Board including the significant time each Trustee has devoted to preparing for
meetings and the active engagement and participation of each Trustee at Board meetings. The Governance Committee and the Board also considered the character of each Trustee and their commitment to executing his or her duties as a trustee with
diligence, honesty and integrity. The Governance Committee and the Board also considered the contributions that each Trustee has made to the Board in terms of experience, leadership, independence and the ability to work well with other Board
members.
The Governance Committee and the Board noted the additional experience that each of the Trustees has gained with
respect to registered investment companies as a result of his or her service on the Board. The Funds overseen by the Board represent almost every asset class, including: (1) fixed income funds including traditional bond funds, municipal bond
funds, high yield funds, government funds and emerging market debt funds; (2) money market funds; (3) international, emerging market and country/region funds; (4) equity funds including small, mid and large capitalization funds and
value and growth funds; (5) index funds; (6) funds of funds, including target date funds; and (7) specialty funds including market neutral funds, long/short funds and funds that invest in real estate securities and commodity-related
securities and derivatives. The Governance Committee and the Board also considered the experience that each Trustee had with respect to reviewing agreements with the Funds service providers including the Advisers, custodian, fund accountant
and securities lending agents.
The Governance Committee and the Board also considered the experience and contribution of each
Trustee in the context of the Boards leadership and committee structure. The Board has four committees: the Investments Committee, the Audit and Valuation Committee, the Compliance Committee and the Governance Committee. See Leadership
Structure and Oversight and Standing Committees. The Investments Committee has three sub-committees: an Equity Sub-Committee, a Money Market and Alternative Products Sub-Committee and a Fixed Income Sub-Committee. Different members
of the Investments Committee serve on the sub-committee with respect to each asset type thereby allowing the Board to effectively evaluate information for each of the Funds in the complex in a focused, disciplined manner.
The Governance Committee also considered the operational efficiencies achieved by having a single Board for all of the registered
investment companies overseen by the Advisers and their affiliates as well as the extensive experience of certain Trustees in serving on Boards for registered investment companies advised by subsidiaries or affiliates of Bank One Corporation or
JPMorgan Chase & Co. (known respectively as heritage J.P. Morgan Funds or heritage One Group Mutual Funds).
In reaching its conclusion that each Trustee should serve as a Trustee of the Funds, the Board also considered the experience as set forth above and the following additional specific qualifications,
contributions and experience of each of the following Trustees:
John F. Finn.
Mr. Finn has served on the J.P.
Morgan Funds Board since 2005 and was a member of the heritage One Group Mutual Funds Board since 1998. Mr. Finn also serves on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, Mr. Finn has participated
in the appointment of the Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its
oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds, and acting as a liaison between the Funds
independent registered public accounting firm and the full Board. Mr. Finn also serves on the Equity Sub-Committee.
Dr. Matthew Goldstein.
Dr. Goldstein has served as the Chairman of the Board since January 2013 and on the J.P. Morgan
Funds Board since 2005. Dr. Goldstein was a member of the heritage J.P. Morgan Funds Board since
Part II - 65
2003. Dr. Goldstein serves as a member of the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or
appointment as Trustees, periodic review of the compensation payable to the Trustees, review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the J.P. Morgan Funds, the Advisers or the
non-interested Trustees, oversight of regulatory issues or deficiencies affecting the Funds, oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds.
Dr. Goldstein also serves as the Chairman of the Money Market and Alternative Products Sub-Committee.
Robert J.
Higgins.
Mr. Higgins has served on the J.P. Morgan Funds Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2002. Mr. Higgins serves on the Audit and Valuation Committee. As a member of the Audit and
Valuation Committee, Mr. Higgins has participated in the appointment of the Funds independent accountants, the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal
controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the
Funds and acting as a liaison between the Funds independent registered public accounting firm and the full Board. Mr. Higgins also serves as Chairman of the Equity Sub-Committee.
Frankie D. Hughes.
Ms. Hughes has served on the Board since 2008. Ms. Hughes is a member of the Fixed Income
Sub-Committee. Ms. Hughes is also a member of the Compliance Committee. As a member of the Compliance Committee, she has participated in the oversight of the Funds compliance with legal and regulatory and contractual requirements and
compliance policies and procedures.
Peter C. Marshall.
Mr. Marshall has served on the J.P. Morgan Funds Board
since 2005 and is currently Vice Chairman. Mr. Marshall was also the Chairman of the heritage One Group Mutual Funds Board, serving as a member of such Board since 1985. Mr. Marshall was also an Audit Committee Financial Expert for the
heritage One Group Mutual Funds. Mr. Marshall serves as a member of the Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or appointment as Trustees,
periodic review of the compensation payable to the Trustees, review and evaluation of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the non-interested Trustees, oversight of
regulatory issues or deficiencies affecting the Funds, oversight of the Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. Mr. Marshall also serves as a member of the Money
Market and Alternative Products Sub-Committee.
Marilyn McCoy
. Ms. McCoy has served on the J.P. Morgan Funds Board
since 2005 and was a member of the heritage One Group Mutual Funds Board since 1999. Ms. McCoy is the Chairman of the Compliance Committee. As a member of the Compliance Committee, she has participated in the oversight of Funds compliance
with legal and regulatory and contractual requirements and compliance policies and procedures. Ms. McCoy also serves as a member of the Equity Sub-Committee.
William G. Morton, Jr.
Mr. Morton has served on the Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2003. Mr. Morton also serves as a member of the
Governance Committee. As a member of the Governance Committee, he has participated in the selection and nomination of persons for election or appointment as Trustees, periodic review of the compensation payable to the Trustees, review and evaluation
of the functioning of the Board and its committees, oversight of any ongoing litigation affecting the Funds, the Advisers or the non-interested Trustees, oversight of regulatory issues or deficiencies affecting the Funds, oversight of the
Funds risk management processes and oversight and review of matters with respect to service providers to the Funds. Mr. Morton also serves on the Equity Sub-Committee.
Dr. Robert A. Oden, Jr.
Dr. Oden has served on the J.P. Morgan Funds Board since 2005 and was a member of the
heritage One Group Mutual Funds Board since 1997. Dr. Oden is a member of the Fixed Income Sub-Committee. Dr. Oden is also a member of the Compliance Committee. As a member of the Compliance Committee, he has participated in the oversight
of the Funds and the J.P. Morgan Funds compliance with legal and regulatory and contractual requirements and compliance policies and procedures.
Frederick W. Ruebeck.
Mr. Ruebeck has served on the Board since 2005 and was a member of the heritage One Group Mutual Funds Board since 1994. Mr. Ruebeck is the Chairman of the Fixed
Income Sub-Committee. Mr. Ruebeck also serves on the Audit and Valuation Committee. As a member of the Audit and Valuation Committee, Mr. Ruebeck has participated in the appointment of the Funds independent accountants, the oversight
of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by the Advisers,
Part II - 66
overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds, and acting as a liaison between the Funds independent registered
public accounting firm and the full Board.
James J. Schonbachler.
Mr. Schonbachler has served on the J.P. Morgan
Funds Board since 2005 and was a member of the heritage J.P. Morgan Funds Board since 2001. Mr. Schonbachler is a member of the Fixed Income Sub-Committee. The Fixed Income Sub-Committee is responsible for fixed income funds.
Mr. Schonbachler serves as Chairman of the Audit and Valuation Committee. In connection with his duties to the Audit and Valuation Committee, Mr. Schonbachler has participated in the appointment of the Funds independent accountants,
the oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its oversight of the valuation of the Funds securities by
the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements, and acting as a liaison between the Funds independent registered public accounting firm and the full Board.
Board Leadership Structure and Oversight
The Board has structured itself in a manner that allows it to effectively perform its oversight function. The Chairman of the Board is an independent Trustee, which allows him to carry out his leadership
duties as Chairman with objectivity.
The Board has adopted a committee structure that allows it to effectively perform its
oversight function for all of the Funds in the complex. As described under Qualifications of Trustees and Standing Committees, the Board has four committees: the Investments Committee, the Audit and Valuation Committee, the
Compliance Committee and the Governance Committee. The Investments Committee has three sub-committees: an Equity Sub-Committee, a Money Market and Alternative Products Sub-Committee, and a Fixed Income Sub-Committee. The Board has determined that
the leadership and committee structure is appropriate for the Funds and allows the Board to effectively and efficiently evaluate issues that impact the J.P. Morgan Funds as a whole as well as issues that are unique to each Fund.
The Board and the Committees take an active role in risk oversight including the risks associated with registered
investment companies including investment risk, compliance and valuation. The Governance Committee oversees and reports to the Board on the risk management processes for the Funds. In addition, in connection with its oversight, the Board receives
regular reports from the Chief Compliance Officer (CCO), the Advisers, the Administrator, and the internal audit department of JPMorgan Chase & Co. The Board also receives periodic reports from the Chief Risk Officer of J.P.
Morgan Asset Management
1
(JPMAM) including
reports concerning operational controls that are designed to address market risk, credit risk, and liquidity risk among others. The Board also receives regular reports from personnel responsible for JPMAMs business resiliency and disaster
recovery.
In addition, the Board and its Committees work on an ongoing basis in fulfilling the oversight function. At each
quarterly meeting, each Investment Sub-Committee meets with representatives of the Advisers as well as an independent consultant to review and evaluate the ongoing performance of the Funds. Each Investment Sub-Committee reports these reviews to the
full Board. The Audit and Valuation Committee is responsible for oversight of the performance of the Funds audit, accounting and financial reporting policies, practices and internal controls and valuation policies, assisting the Board in its
oversight of the valuation of the Funds securities by the Advisers, overseeing the quality and objectivity of the Funds independent audit and the financial statements of the Funds, and acting as a liaison between the Funds
independent registered public accounting firm and the full Board. The Compliance Committee is responsible for oversight of the Funds compliance with legal, regulatory and contractual requirements and compliance with policy and procedures. The
Governance Committee is responsible for, among other things, oversight of matters relating to the Funds corporate governance obligations and risk management processes, Fund service providers and litigation. At each quarterly meeting, each of
the Governance Committee, the Audit and Valuation Committee and the Compliance Committee report their committee proceedings to the full Board. This Committee structure allows the Board to efficiently evaluate a large amount of material and
effectively fulfill its oversight function. Annually, the Board considers the efficiency of this committee structure.
Additional information about each of the Committees is included below in Standing Committees.
Part II - 67
1
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J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but
are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.
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Standing Committees
The Board of Trustees has four standing committees: the Audit and Valuation Committee, the Compliance Committee, the Governance Committee,
and the Investments Committee. The members of each Committee are set forth below:
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Name of Committee
|
|
Members
|
|
Committee Chair
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Audit and Valuation Committee
|
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Mr. Schonbachler
Mr.
Finn
Mr. Higgins
Mr.
Ruebeck
|
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Mr. Schonbachler
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|
Compliance Committee
|
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Ms. McCoy
Ms.
Hughes
Dr. Oden
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Ms. McCoy
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Governance Committee
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Dr. Goldstein
Mr.
Marshall
Mr. Morton
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Investments Committee
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Fixed Income Sub-Committee
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Mr. Ruebeck
Ms.
Hughes
Dr. Oden
Mr.
Schonbachler
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Mr. Ruebeck
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Equity Sub-Committee
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Mr. Higgins
Mr.
Finn
Ms. McCoy
Mr.
Morton
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Mr. Higgins
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Money Market Funds and
Alternative Products
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Dr. Goldstein
Mr.
Marshall
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Dr. Goldstein
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Audit and Valuation Committee.
The purposes of the Audit and Valuation Committee are to:
(i) appoint and determine compensation of the Funds independent accountants; (ii) evaluate the independence of the Funds independent accountants; (iii) oversee the performance of the Funds audit, accounting and
financial reporting policies, practices and internal controls and valuation policies; (iv) approve non-audit services, as required by the statutes and regulations administered by the SEC, including the 1940 Act and the Sarbanes-Oxley Act of
2002; (v) assist the Board in its oversight of the valuation of the Funds securities by the Adviser, as well as any sub-adviser; (vi) oversee the quality and objectivity of the Funds independent audit and the financial
statements of the Funds; and (vii) act as a liaison between the Funds independent registered public accounting firm and the full Board. The Audit and Valuation Committee has delegated valuation responsibilities to any member of the
Committee to respond to inquiries on valuation matters and participate in fair valuation determinations when the Funds valuation procedures require Board action, but it is impracticable or impossible to hold a meeting of the entire Board.
Prior to November 18, 2009, the Board delegated these valuation responsibilities to a Valuation Sub-Committee of the Audit Committee.
Compliance Committee.
The primary purposes of the Compliance Committee are to (i) oversee the Funds compliance with legal and regulatory and contractual requirements and the
Funds compliance policies and procedures; and (ii) consider the appointment, compensation and removal of the Funds Chief Compliance Officer.
Governance Committee.
The members of the Governance Committee are each Independent Trustees of the J.P. Morgan Funds. The duties of the Governance Committee include, but are not limited to,
(i) selection and nomination of persons for election or appointment as Trustees; (ii) periodic review of the compensation payable to the non-interested Trustees; (iii) establishment of non-interested Trustee expense policies;
(iv) periodic review and evaluation of the functioning of the Board and its committees; (v) with respect to the JPMT II Funds, appointment and removal of the Funds Senior Officer, and approval of compensation for the Funds
Senior Officer and retention and compensation of the Senior Officers staff and consultants; (vi) selection of independent legal counsel to the non-interested Trustees and legal counsel to the Funds; (vii) oversight of ongoing
litigation affecting the Funds, the Adviser or the non-interested Trustees; (viii) oversight of regulatory issues or deficiencies affecting the Funds (except financial matters considered by the Audit Committee); (ix) oversight of the risk
management processes for Funds; and (x) oversight and review of matters with respect to service providers to the Funds (except the Funds
Part II - 68
independent registered public accounting firm). When evaluating a person as a potential nominee to serve as an Independent Trustee, the Governance Committee may consider, among other factors,
(i) whether or not the person is independent and whether the person is otherwise qualified under applicable laws and regulations to serve as a Trustee; (ii) whether or not the person is willing to serve, and willing and able to
commit the time necessary for the performance of the duties of an Independent Trustee; (iii) the contribution that the person can make to the Board and the J.P. Morgan Funds, with consideration being given to the persons business
experience, education and such other factors as the Committee may consider relevant; (iv) the character and integrity of the person; (v) the desirable personality traits, including independence, leadership and the ability to work with the
other members of the Board; and (vi) to the extent consistent with the 1940 Act, such recommendations from management as are deemed appropriate. The process of identifying nominees involves the consideration of candidates recommended by one or
more of the following: current Independent Trustees, officers, shareholders and other sources that the Governance Committee deems appropriate. The Governance Committee will review nominees recommended to the Board by shareholders and will evaluate
such nominees in the same manner as it evaluates nominees identified by the Governance Committee. Nominee recommendations may be submitted to the Secretary of the Trusts at each Trusts principal business address.
Investments Committee.
Each member of the Board, other than Mr. Merin and Ms. Martinez (and Ms. Pardo when she joins
the Board on February 1, 2013), serves on the Investments Committee. The Investments Committee has three sub-committees divided by asset type and different members of the Investments Committee serve on the sub-committee with respect to each asset
type. The sub-committees are the Fixed Income Sub-Committee, the Equity Sub-Committee and the Money Market Funds and Alternative Products Sub-Committee. The function of the Investments Committee and its sub-committees is to assist the Board in the
oversight of the investment management services provided by the Adviser to the Funds, as well as any sub-adviser to the Funds. The primary purpose of each sub-committee is to (i) assist the Board in its oversight of the investment management
services provided by the Adviser to the Funds designated for review by each sub-committee; and (ii) review and make recommendations to the Investments Committee and/or the Board, concerning the approval of proposed new or continued advisory and
distribution arrangements for the Funds or for new funds. The full Board may delegate to the Investments Committee from time to time the authority to make Board level decisions on an interim basis when it is impractical to convene a meeting of the
full Board. Each of the sub-committees receives reports concerning investment management topics, concerns or exceptions with respect to particular Funds that the sub-committee is assigned to oversee, and work to facilitate the understanding by the
Investments Committee and the Board of particular issues related to investment management of Funds reviewed by the sub-committee.
For details of the number of times each of the four standing committees met during the most recent fiscal year, see TRUSTEES Standing Committees in Part I of this SAI.
For details of the dollar range of equity securities owned by each Trustee in the Funds, see TRUSTEES
Ownership of Securities in Part I of this SAI.
Trustee Compensation
The Trustees instituted a Deferred Compensation Plan for Eligible Trustees (the Deferred Compensation Plan) pursuant to which
the Trustees are permitted to defer part or all of their compensation. Amounts deferred are deemed invested in shares of one or more series of JPMT I, JPMT II, Undiscovered Managers Funds, JPMFMFG, and JPMMFIT, as selected by the Trustee from time
to time, to be used to measure the performance of a Trustees deferred compensation account. Amounts deferred under the Deferred Compensation Plan will be deemed to be invested in Select Class Shares of the identified funds, unless Select Class
Shares are not available, in which case the amounts will be deemed to be invested in Class A Shares. A Trustees deferred compensation account will be paid at such times as elected by the Trustee, subject to certain mandatory payment
provisions in the Deferred Compensation Plan (e.g., death of a Trustee). Deferral and payment elections under the Deferred Compensation Plan are subject to strict requirements for modification.
Each Declaration of Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses incurred in
connection with litigation in which they may be involved because of their offices with the Trust, unless, as to liability to the Trust or its shareholders, it is finally adjudicated that they engaged in willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in their offices or with respect to any matter unless it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interest of the
Trust. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or disposition, or by a reasonable
Part II - 69
determination based upon a review of readily available facts, by vote of a majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have
not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their duties.
For details of
Trustee compensation paid by the Funds, including deferred compensation, see TRUSTEES Trustee Compensation in Part I of this SAI.
OFFICERS
The Trusts executive
officers (listed below) generally are employees of the Adviser or one of its affiliates. The officers conduct and supervise the business operations of the Trusts. The officers hold office until a successor has been elected and duly qualified. The
Trusts have no employees. The names of the officers of the Funds, together with their year of birth, information regarding their positions held with the Trusts and principal occupations are shown below. The contact address for each of the officers,
unless otherwise noted, is 270 Park Avenue, New York, NY 10017.
|
|
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Name (Year of Birth),
Positions Held with
the Trusts
(Since)
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Principal Occupations During Past 5 Years
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Patricia A. Maleski (1960),
President and Principal Executive Officer (2010)
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Managing Director, J.P. Morgan Investment Management Inc. and Chief Administrative Officer, J.P. Morgan Funds and Institutional Pooled Vehicles since 2010; previously, Treasurer
and Principal Financial Officer of the Trusts from 2008 to 2010; previously, Head of Funds Administration and Board Liaison, J.P. Morgan Funds prior to 2010. Ms. Maleski has been with JPMorgan Chase & Co. since 2001.
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Joy C. Dowd (1972),
Treasurer
and Principal Financial Officer (2010)
|
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Assistant Treasurer of the Trusts from 2009 to 2010; Executive Director, JPMorgan Funds Management, Inc. from February 2011; Vice President, JPMorgan Funds Management, Inc. from
December 2008 to February 2011; prior to joining JPMorgan Chase, Ms. Dowd worked in MetLifes investments audit group from 2005 through 2008.
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Frank J. Nasta (1964),
Secretary (2008)
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Managing Director and Associate General Counsel, JPMorgan Chase since 2008; Previously, Director, Managing Director, General Counsel and Corporate Secretary, J. & W. Seligman
& Co. Incorporated; Secretary of each of the investment companies of the Seligman Group of Funds and Seligman Data Corp.; Director and Corporate Secretary, Seligman Advisors, Inc. and Seligman Services, Inc.
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Stephen M. Ungerman (1953),
Chief Compliance Officer (2005)
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Managing Director, JPMorgan Chase & Co.; Mr. Ungerman has been with JPMorgan Chase & Co. since 2000.
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Kathryn A. Jackson (1962),
AML Compliance Officer (2012)*
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Vice President and AML Compliance Manager for JPMorgan Asset Management Compliance since 2011; Senior On-Boarding Specialist for
JPMorgan Distribution Services, Inc. in Global Liquidity from 2008 to 2011; prior to joining JPMorgan, Ms. Jackson was a Financial Services Analyst responsible for on-boarding, compliance and training with Nationwide Securities LLC and 1717
Capital Management Company, both registered broker-dealers, from 2005 until 2008.
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Elizabeth A. Davin (1964),
Assistant Secretary (2005)**
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Executive Director and Assistant General Counsel, JPMorgan Chase since February 2012; formerly Vice President and Assistant General Counsel, JPMorgan Chase from 2005 until
February 2012; Senior Counsel, JPMorgan Chase (formerly Bank One Corporation) from 2004 to 2005.
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Jessica K. Ditullio (1962),
Assistant Secretary (2005)**
|
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Executive Director and Assistant General Counsel, JPMorgan Chase since February 2011; Ms. Ditullio has served as an attorney with various titles for JPMorgan Chase (formerly Bank
One Corporation) since 1990.
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Part I - 70
|
|
|
Name (Year of Birth),
Positions Held with
the Trusts
(Since)
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Principal Occupations During Past 5 Years
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John T. Fitzgerald (1975),
Assistant Secretary (2008)
|
|
Executive Director and Assistant General Counsel, JPMorgan Chase since February 2011; formerly, Vice President and Assistant General Counsel, JPMorgan Chase from 2005 until
February 2011.
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Carmine Lekstutis (1980),
Assistant Secretary (2011)
|
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Vice President and Assistant General Counsel, JPMorgan Chase since 2011; Associate, Skadden, Arps, Slate, Meagher & Flom LLP (law firm) from 2006 to 2011.
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Gregory S. Samuels (1980)
Assistant Secretary (2010)
|
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Vice President and Assistant General Counsel, JPMorgan Chase since 2010; Associate, Ropes & Gray (law firm) from 2008 to 2010; Associate, Clifford Chance LLP (law firm) from
2005 to 2008.
|
Pamela L. Woodley (1971),
Assistant Secretary (2012)
|
|
Vice President and Assistant General Counsel, JPMorgan Chase since November 2004.
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Michael M. DAmbrosio (1969),
Assistant Treasurer (2012)
|
|
Executive Director, JPMorgan Funds Management, Inc. from July 2012; prior to joining JPMorgan Chase, Mr. DAmbrosio was a Tax Director at PricewaterhouseCoopers LLP since
2006.
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Jeffrey D. House (1972),
Assistant Treasurer (2006)**
|
|
Vice President, JPMorgan Funds Management, Inc. since July 2006.
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Joseph Parascondola (1963),
Assistant Treasurer (2011)
|
|
Vice President, JPMorgan Funds Management, Inc. since August 2006.
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Matthew J. Plastina (1970),
Assistant Treasurer (2011)
|
|
Vice President, JPMorgan Funds Management, Inc. since August 2010; prior to August 2010, Vice President and Controller, Legg Mason Global Asset Management.
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Jeffery Reedy (1973),
Assistant Treasurer (2011)**
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Vice President, JPMorgan Funds Management, Inc. since February 2006.
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Julie A. Roach (1971),
Assistant Treasurer (2012)**
|
|
Vice President, JPMorgan Funds Management, Inc. from August 2012; prior to joining JPMorgan Chase, Ms. Roach was a Senior Manager with Deloitte since 2001.
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Gillian I. Sands (1969),
Assistant Treasurer (2012)
|
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Vice President, JPMorgan Funds Management, Inc. from September 2012; Assistant Treasurer, Wells Fargo Funds Management (20072009)
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Timothy J. Stewart (1974),
Assistant Treasurer (2012)***
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Executive Director, JPMorgan Funds Management, Inc. from July 2012; Managing Director of Robeco Investment Management, Inc. (20112012); Chief Financial Officer
(20082011) and Director of Operations (20032008), Robeco-Sage, a division of Robeco Investment Management, Inc.
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*
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The contact address for the officer is 500 Stanton Christiana Road, Ops 1, Floor 02, Newark, DE 19173-2107.
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**
|
The contact address for the officer is 460 Polaris Parkway, Westerville, OH 43082.
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***
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Mr. Stewart is the Assistant Treasurer of JPMorgan Trust I only.
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For details of the percentage of shares of any class of each Fund owned by the officers and Trustees, as a group, see SHARE OWNERSHIP Trustees and Officers in Part I of this SAI.
INVESTMENT ADVISERS AND SUB-ADVISERS
Pursuant to investment advisory agreements, JPMIM serves as investment adviser to the Funds, except for the U.S. Real Estate Fund and U.S.
Core Real Estate Securities Fund. SCR&M serves as investment adviser for the U.S. Real Estate Fund pursuant to an agreement with JPMT II and for the U.S. Core Real Estate Securities Fund pursuant to an agreement with JPMT I. HCM serves as
investment sub-adviser to the Highbridge Dynamic Commodities Strategy Fund and the Highbridge Statistical Market Neutral Fund pursuant to an investment sub-advisory agreement with JPMIM. JFIMI serves as sub-adviser to certain funds pursuant to an
investment sub-advisory agreement with JPMIM.
The Trusts Shares are not sponsored, endorsed or guaranteed by, and do not
constitute obligations or deposits of JPMorgan Chase, any bank affiliate of JPMIM or any other bank, and are not insured by the FDIC or issued or guaranteed by the U.S. government or any of its agencies.
Part II - 71
For details of the investment advisory fees paid under an applicable advisory agreement,
see INVESTMENT ADVISERS Investment Advisory Fees in Part I of the SAI for the respective Fund.
For
details of the dollar range of shares of each Fund (excluding Money Market Funds) beneficially owned by the portfolio managers who serve on a team that manages such Fund, see PORTFOLIO MANAGERS Portfolio Managers Other Accounts
Managed in Part I of this SAI.
J.P. Morgan Investment Management Inc
.
JPMIM serves as investment adviser to certain Funds pursuant to the investment advisory agreements between JPMIM and certain of the Trusts (the JPMIM Advisory Agreements). Effective October 1, 2003, JPMIM became a wholly-owned
subsidiary of JPMorgan Asset Management Holdings Inc., which is a wholly-owned subsidiary of JPMorgan Chase & Co. (JPMorgan Chase). Prior to October 1, 2003, JPMIM was a wholly-owned subsidiary of JPMorgan Chase, a bank
holding company organized under the laws of the State of Delaware which was formed from the merger of J.P. Morgan & Co. Incorporated with and into The Chase Manhattan Corporation.
JPMIM is a registered investment adviser under the Investment Advisers Act of 1940, as amended. JPMIM is located at 270 Park Avenue, New
York, NY 10017.
Under the JPMIM Advisory Agreements, JPMIM provides investment advisory services to certain Funds, which
include managing the purchase, retention and disposition of such Funds investments. JPMIM may delegate its responsibilities to a sub-adviser. Any subadvisory agreements must be approved by the applicable Trusts Board of Trustees and the
applicable Funds shareholders, as required by the 1940 Act.
Under separate agreements, JPMorgan Chase Bank, JPMorgan
Funds Management, Inc. (formerly One Group Administrative Services, Inc.) (JPMFM), and JPMDS provide certain custodial, fund accounting, recordkeeping and administrative services to the Trusts and the Funds and shareholder services for
the Trusts. JPMDS is the shareholder servicing agent and the distributor for certain Funds. JPMorgan Chase Bank, JPMFM and JPMDS are each affiliates of JPMIM. See the Custodian, Administrator, Shareholder
Servicing and Distributor sections.
Under the terms of the JPMIM Advisory Agreements, the investment
advisory services JPMIM provides to certain Funds are not exclusive. JPMIM is free to and does render similar investment advisory services to others. JPMIM serves as investment adviser to personal investors and other investment companies and acts as
fiduciary for trusts, estates and employee benefit plans. Certain of the assets of trusts and estates under management are invested in common trust funds for which JPMIM serves as trustee. The accounts which are managed or advised by JPMIM have
varying investment objectives, and JPMIM invests assets of such accounts in investments substantially similar to, or the same as, those which are expected to constitute the principal investments of certain Funds. Such accounts are supervised by
employees of JPMIM who may also be acting in similar capacities for the Funds. See Portfolio Transactions.
The
Funds are managed by employees of JPMIM who, in acting for their customers, including the Funds, do not discuss their investment decisions with any personnel of JPMorgan Chase or any personnel of other divisions of JPMIM or with any of their
affiliated persons, with the exception of certain other investment management affiliates of JPMorgan Chase which execute transactions on behalf of the Funds.
As compensation for the services rendered and related expenses, such as salaries of advisory personnel borne by JPMIM or a predecessor, under the JPMIM Advisory Agreements, the applicable Trusts, on
behalf of the Funds, have agreed to pay JPMIM a fee, which is computed daily and may be paid monthly, equal to the annual rate of each Funds average daily net assets as described in the applicable Prospectuses.
The JPMIM Advisory Agreements continue in effect for annual periods beyond October 31 of each year only if specifically approved
thereafter annually in the same manner as the Distribution Agreement; except that for new funds, the initial approval will continue for up to two years, after which annual approvals are required. See the Distributor section. The JPMIM
Advisory Agreements will terminate automatically if assigned and are terminable at any time without penalty by a vote of a majority of the Trustees, or by a vote of the holders of a majority of a Funds outstanding voting securities (as defined
in the 1940 Act), on 60 days written notice to JPMIM and by JPMIM on 90 days written notice to the Trusts (60 days with respect to the International Equity Index Fund, Mid Cap Value Fund and Growth Advantage Fund). The continuation of
the JPMIM Advisory Agreements was last approved by the Board of Trustees at its meeting in August 2011.
The JPMIM Advisory
Agreements provide that the Adviser shall not be liable for any error of judgment or mistake of law or for any loss suffered by the Trust in connection with the performance of the respective investment advisory agreement, except a loss resulting
from willful misfeasance, bad faith, or gross negligence on the part of
Part II - 72
the Adviser in the performance of its duties, or from reckless disregard by it of its duties and obligations thereunder, or, with respect to all such Funds except the Mid Cap Value Fund, a loss
resulting from a breach of fiduciary duty with respect to the receipt of compensation for services.
Prior to January 1,
2010, JPMIA served as investment adviser to certain JPMT II Funds pursuant to the Amended and Restated Investment Advisory Agreement between JPMIA and JPMT II dated August 12, 2004 (the JPMIA Advisory Agreement). On July 1,
2004, Bank One Corporation, the former indirect corporate parent of JPMIA, merged into J.P. Morgan Chase & Co. (now officially known as JPMorgan Chase & Co.). On that date, JPMIA became an indirect, wholly-owned subsidiary of
JPMorgan Chase. JPMIA is a registered investment adviser under the Investment Advisers Act of 1940, as amended. Effective January 1, 2010 (the Effective Date), the investment advisory business of JPMIA was transferred to JPMIM and
JPMIM became the investment adviser for the applicable Funds under the JPMIA Advisory Agreement. The appointment of JPMIM did not change the portfolio management team, the investment strategies, the investment advisory fees charged to the Funds or
the terms of the JPMIA Advisory Agreement (other than the identity of the investment adviser). Shareholder approval was not required for the replacement of JPMIA by JPMIM.
Subject to the supervision of a Trusts Board of Trustees, JPMIM provides or will cause to be provided a continuous investment program for certain Funds, including investment research and management
with respect to all securities and investments and cash equivalents in those Funds. JPMIM may delegate its responsibilities to a sub-adviser. Any subadvisory agreements must be approved by the Trusts Board of Trustees and the applicable
Funds shareholders, as required by the 1940 Act.
The JPMIA Advisory Agreement continues in effect for annual periods
beyond October 31 of each year, if such continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund (as defined under Additional Information in this
SAI), and a majority of the Trustees who are not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective investment advisory agreements by votes cast in person at a
meeting called for such purpose. The continuation of the JPMIA Advisory Agreement was approved by the Trusts Board of Trustees at its meeting held in August 2009.
The JPMIA Advisory Agreement may be terminated as to a particular Fund at any time on 60 days written notice without penalty by the Trustees, by vote of a majority of the outstanding Shares of that
Fund, or by the Funds Adviser as the case may be. The JPMIA Advisory Agreement also terminates automatically in the event of any assignment, as defined in the 1940 Act.
As compensation for the services rendered and related expenses, such as salaries of advisory personnel borne by JPMIM, under the JPMIA Advisory Agreement, the applicable Trusts, on behalf of the Funds,
have agreed to pay JPMIM a fee, which is computed daily and may be paid monthly, equal to the annual rate of each Funds average daily net assets as described in the applicable Prospectuses.
The JPMIA Advisory Agreement provides that the Adviser shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Trust in connection with the performance of the respective investment advisory agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from
willful misfeasance, bad faith, or gross negligence on the part of the Adviser in the performance of its duties, or from reckless disregard by it of its duties and obligations thereunder.
JPMorgan Chase Bank, JPMFM and JPMDS are each subsidiaries of JPMorgan Chase and affiliates of JPMIM. See the Custodian,
Administrator, Shareholder Servicing and Distributor sections.
Security Capital Research & Management Incorporated (SCR&M).
Security Capital Research & Management Incorporated (SCR&M) serves as investment adviser to the U.S. Real Estate Fund pursuant to
an agreement with JPMT II, on behalf of the U.S. Real Estate Fund (the Real Estate Fund Investment Advisory Agreement). SCR&M serves as investment adviser to the U.S. Core Real Estate Securities Fund pursuant to an agreement with
JPMT I, on behalf of the U.S. Core Real Estate Securities Fund (the Core Real Estate Securities Fund Investment Advisory Agreement). SCR&M was formed in January 1995 to provide investment advisory services related to real estate
assets to various clients, including the Predecessor U.S. Real Estate Fund. SCR&M is a direct, wholly-owned subsidiary of JPMorgan Asset Management Holdings Inc.
SCR&M makes the investment decisions for the assets of the U.S. Real Estate Fund and U.S. Core Real Estate Securities Fund. SCR&M also reviews, supervises and administers each such Funds
investment program, subject to the supervision of, and policies established by, the Trustees. SCR&M is located at 10 South Dearborn Street, Suite 1400, Chicago, IL 60603.
Part II - 73
The Real Estate Fund Investment Advisory Agreement provides that it will continue in effect
for successive twelve month periods beyond October 31 of each year if not terminated or approved at least annually by the Trusts Board of Trustees. The Real Estate Fund Investment Advisory Agreement was initially approved by the
Trusts Board of Trustees at their quarterly meeting on September 30, 2004 and may be terminated as to the U.S. Real Estate Fund at any time on 60 days written notice without penalty by the Trustees, by vote of a majority of the
outstanding Shares of that Fund, or by the Funds Adviser. The Real Estate Fund Investment Advisory Agreement also terminates automatically in the event of any assignment, as defined in the 1940 Act. The continuation of the Real Estate Fund
Investment Advisory Agreement was approved by the Board of Trustees at its meeting in August 2009.
The Core Real Estate
Securities Fund Investment Advisory Agreement provides that it will continue in effect for successive twelve month periods beyond October 31 of each year if not terminated or approved at least annually by the Trusts Board of Trustees. The Core
Real Estate Securities Fund Investment Advisory Agreement was initially approved by the Trusts Board of Trustees at their quarterly meeting on May 17, 2011 and may be terminated as to the U.S. Core Real Estate Securities Fund at any time on 60
days written notice without penalty by the Trustees, by vote of a majority of the outstanding Shares of that Fund, or by the Funds Adviser. The Core Real Estate Securities Fund Investment Advisory Agreement also terminates automatically
in the event of any assignment, as defined in the 1940 Act.
The Real Estate Fund Investment Advisory Agreement and Core Real
Estate Securities Fund Investment Advisory Agreement provide that the Adviser shall not be liable for any error of judgment or mistake of law or for any loss suffered by the respective Trust in connection with the performance under the agreement,
except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith, or gross negligence on the part of the Adviser in the performance of its
duties, or from reckless disregard by it of its duties and obligations thereunder.
JF
International Management Inc. (JFIMI).
JPMIM has entered into two investment sub-advisory agreements with JFIMI, one agreement with respect to the Asia Equity Fund, one agreement with respect to the China Region Fund and India Fund
and one with respect to the Asia Pacific Fund (the JFIMI Sub-Advisory Agreements) pursuant to which JFIMI serves as investment sub-adviser to such Funds. JFIMI is registered as a registered investment adviser under the Investment
Advisers Act and the Hong Kong Securities and Futures Commission. JFIMI is a wholly- owned subsidiary of J.P. Morgan Asset Management (Asia) Inc., which is wholly-owned by JPMorgan Asset Management Holdings Inc. (JPMAMH). JFIMI is
located at 21F, Charter House, 8 Connaught Road, Central Hong Kong.
JFIMI may, in its discretion, provide such services
through its own employees or the employees of one or more affiliated companies that are qualified to act as an investment adviser to a Fund under applicable laws and that are under the common control of JPMIM; provided that (i) all persons,
when providing services under the JFIMI Sub-Advisory Agreements, are functioning as part of an organized group of persons, and (ii) such organized group of persons is managed at all times by authorized officers of JFIMI. This arrangement will
not result in the payment of additional fees by a Fund.
Pursuant to the terms of the applicable JPMIM Advisory Agreement and
the JFIMI Sub-Advisory Agreements, the Adviser and Sub-Adviser are permitted to render services to others. Each such agreement is terminable without penalty by the applicable Trusts, on behalf of the Funds, on not more than 60 days, nor less
than 30 days, written notice when authorized either by a majority vote of a Funds shareholders or by a vote of a majority of the Boards of Trustees of the Trusts, or by JPMIM or JFIMI on not more than 60 days, nor less than 30
days, written notice, and will automatically terminate in the event of its assignment (as defined in the 1940 Act). The applicable JPMIM Advisory Agreement provides that JPMIM or JFIMI shall not be liable for any error of judgment
or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of portfolio transactions for a Fund, except for willful misfeasance, bad faith or gross negligence in the performance of its duties, or by
reason of reckless disregard of its obligations and duties thereunder.
As compensation for the services rendered and related
expenses borne by JFIMI, under the applicable JFIMI Sub-Advisory Agreement, JPMIM has agreed to pay JFIMI a fee, which is computed daily and may be paid monthly, at the rate of 0.50% per annum, on the average daily net assets value of the
assets of the Asia Equity Fund, at the rate of 0.60% per annum on the average daily net asset value of the assets of the China Region Fund and the India Fund and at the rate of 0.40% per annum on the average daily net asset value of the assets
of the Asia Pacific Fund.
Part II - 74
The JFIMI Sub-Advisory Agreement applicable to the Asia Equity Fund provides that it will
continue in effect, if not terminated, from year to year, if such continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund (as defined under Additional
Information in this SAI), and a majority of the Trustees who are not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective investment advisory agreements by
votes cast in person at a meeting called for such purpose. The continuation of the JFIMI Sub-Advisory Agreement applicable to the Asia Equity Fund was approved by the Trusts Board of Trustees at its meeting held in August 2009.
The JFIMI Sub-Advisory Agreement applicable to the China Region Fund and India Fund provides that it will continue in effect for an
initial two-year period and thereafter, if not terminated, from year to year, if such continuance is approved at least annually by the Trusts Board of Trustees or by vote of a majority of the outstanding Shares of such Fund (as defined under
Additional Information in this SAI), and a majority of the Trustees who are not parties to the respective investment advisory agreements or interested persons (as defined in the 1940 Act) of any party to the respective investment
advisory agreements by votes cast in person at a meeting called for such purpose. The continuation of the JFIMI Sub-Advisory Agreement applicable to the China Region Fund and India Fund was approved by the Trusts Board of Trustees at its
meeting held in August 2009.
Each JFIMI Sub-Advisory Agreement provides that the Sub-Adviser shall not be liable for any error
of judgment or for any loss suffered by the Trust in connection with the performance under the agreement, except a loss resulting from willful misfeasance, bad faith, or gross negligence on the part of the Sub-Adviser in the performance of its
duties, or from reckless disregard by it of its duties and obligations thereunder.
Highbridge Capital Management, LLC (HCM).
HCM has been engaged by JPMIM to serve as
investment sub-adviser to the Highbridge Dynamic Commodities Strategy Fund and the Highbridge Statistical Market Neutral Fund (the HCM Sub-Advisory Agreement). HCM is wholly owned by JPMorgan Asset Management Holdings Inc.
HCM is an international asset management firm specializing in non-traditional investment management strategies. HCM
has approximately 350 employees, including approximately 100 investment professionals. The firm is based in New York, with offices in London, Hong Kong and Tokyo. HCM is located at 40 West 57
th
Street, New York, NY 10019.
HCM is paid monthly by JPMIM a fee equal to a percentage of the average daily net assets of the Highbridge Dynamic Commodities Strategy Fund and the Highbridge Statistical Market Neutral Fund. The
aggregate annual rate of the fees payable by JPMIM to HCM is 0.75% of the Highbridge Dynamic Commodities Strategy Funds average daily net assets and 1.25% of the Highbridge Statistical Market Neutral Funds average daily net assets.
The HCM Sub-Advisory Agreement will continue in effect for a period of two years from the date of its execution, unless
terminated sooner. It may be renewed from year to year thereafter, so long as continuance is specifically approved at least annually in accordance with the requirements of the 1940 Act. The HCM Sub-Advisory Agreement provides that it will terminate
in the event of an assignment (as defined in the 1940 Act), and may be terminated without penalty at any time by either party upon 60 days written notice, or upon termination of the JPMIM Advisory Agreement. Under the terms of the HCM
Sub-Advisory Agreement, HCM is not liable to JPMIM, the Highbridge Dynamic Commodities Strategy Fund or the Highbridge Statistical Market Neutral Fund, or their shareholders, for any error of judgment or mistake of law or for any losses sustained by
JPMIM, the Highbridge Dynamic Commodities Strategy Fund or the Highbridge Statistical Market Neutral Fund or their shareholders, except in the case of HCMs willful misfeasance, bad faith, gross negligence or reckless disregard of obligations
or duties under the HCM Sub-Advisory Agreement. The continuation of the HCM Sub-Advisory Agreement was approved by the Trusts Board of Trustees at its meeting held in August 2011.
J.P. Morgan Private Investments, Inc. (JPMPI).
JPMPI has been engaged by JPMIM to serve
as investment sub-adviser to the JPMorgan Access Balanced Fund and JPMorgan Access Growth Fund (the JPMPI Sub-Advisory Agreement). JPMPI is a wholly owned subsidiary of JPMorgan Chase & Co. JPMPI is located at 270 Park Avenue,
New York, NY 10017.
JPMPI is paid monthly by JPMIM a fee equal to a percentage of the average daily net assets of the JPMorgan
Access Balanced Fund and JPMorgan Access Growth Fund. The aggregate annual rate of the fees payable by JPMIM to JPMPI is 0.95% of the portion of each of the JPMorgan Access Balanced Funds and JPMorgan Access Growth Funds average daily
net assets managed by JPMPI.
Part II - 75
The JPMPI Sub-Advisory Agreement will continue in effect for a period of two years from the
date of its execution, unless terminated sooner. It may be renewed from year to year thereafter, so long as continuance is specifically approved at least annually in accordance with the requirements of the 1940 Act.
The JPMPI Sub-Advisory Agreement provides that it will terminate in the event of an assignment (as defined in the 1940 Act),
and may be terminated without penalty at any time by either party upon 60 days written notice, or upon termination of the JPMIM Advisory Agreement. Under the terms of the JPMPI Sub-Advisory Agreement, JPMPI is not liable to JPMIM, the JPMorgan
Access Balanced Fund or the JPMorgan Access Growth Fund, or their shareholders, for any error of judgment or mistake of law or for any losses sustained by JPMIM, the JPMorgan Access Balanced Fund or the JPMorgan Access Growth Fund or their
shareholders, except in the case of JPMPIs willful misfeasance, bad faith, gross negligence or reckless disregard of obligations or duties under the JPMPI Sub-Advisory Agreement.
POTENTIAL CONFLICTS OF INTEREST
The chart in Part I of this SAI (excluding the Money Market Funds) entitled Portfolio Managers Other Accounts Managed
shows the number, type and market value as of a specified date of the accounts other than the Funds that are managed by the Funds portfolio managers. The potential for conflicts of interest exists when portfolio managers manage other accounts
with similar investment objectives and strategies as the Funds (Similar Accounts). Potential conflicts may include, for example, conflicts between investment strategies and conflicts in the allocation of investment opportunities.
Responsibility for managing the Advisers and its affiliates clients portfolios is organized according to
investment strategies within asset classes. Generally, client portfolios with similar strategies are managed by portfolio managers in the same portfolio management group using the same objectives, approach and philosophy. Underlying sectors or
strategy allocations within a larger portfolio are likewise managed by portfolio managers who use the same approach and philosophy as similarly managed portfolios. Therefore, portfolio holdings, relative position sizes and industry and sector
exposures tend to be similar across similar portfolios and strategies, which minimizes the potential for conflicts of interest.
The Adviser and/or its affiliates may receive more compensation with respect to certain Similar Accounts than that received with respect
to the Funds or may receive compensation based in part on the performance of certain Similar Accounts. This may create a potential conflict of interest for the Adviser and its affiliates or the portfolio managers by providing an incentive to favor
these Similar Accounts when, for example, placing securities transactions. In addition, the Adviser or its affiliates could be viewed as having a conflict of interest to the extent that the Adviser or an affiliate has a proprietary investment in
Similar Accounts, the portfolio managers have personal investments in Similar Accounts or the Similar Accounts are investment options in the Advisers or its affiliates employee benefit plans. Potential conflicts of interest may arise
with both the aggregation and allocation of securities transactions and allocation of investment opportunities because of market factors or investment restrictions imposed upon the Adviser and its affiliates by law, regulation, contract or internal
policies. Allocations of aggregated trades, particularly trade orders that were only partially completed due to limited availability and allocation of investment opportunities generally, could raise a potential conflict of interest, as the Adviser
or its affiliates may have an incentive to allocate securities that are expected to increase in value to favored accounts. Initial public offerings, in particular, are frequently of very limited availability. The Adviser and its affiliates may be
perceived as causing accounts they manage to participate in an offering to increase the Advisers and its affiliates overall allocation of securities in that offering. A potential conflict of interest also may be perceived to arise if
transactions in one account closely follow related transactions in a different account, such as when a purchase increases the value of securities previously purchased by another account, or when a sale in one account lowers the sale price received
in a sale by a second account. If the Adviser or its affiliates manage accounts that engage in short sales of securities of the type in which the Fund invests, the Adviser or its affiliates could be seen as harming the performance of the Fund for
the benefit of the accounts engaging in short sales if the short sales cause the market value of the securities to fall.
As an
internal policy matter, the Adviser or its affiliates may from time to time maintain certain overall investment limitations on the securities positions or positions in other financial instruments the Adviser or its affiliates will take on behalf of
its various clients due to, among other things, liquidity concerns and regulatory restrictions. Such policies may preclude a Fund from purchasing particular securities or financial instruments, even if such securities or financial instruments would
otherwise meet the Funds objectives.
Part II - 76
The Adviser and/or its affiliates serve as adviser to the Funds as well as certain Funds of
Funds. The Funds of Funds may invest in shares of the Funds (other than the Funds of Funds). Because the Adviser and/or its affiliates is the adviser to the Funds and it or its affiliates is adviser to the Funds of Funds, it may be subject to
certain potential conflicts of interest when allocating the assets of the Funds of Funds among the Funds. Purchases and redemptions of Fund shares by a Fund of Funds due to reallocations or rebalancings may result in a Fund having to sell securities
or invest cash when it otherwise would not do so. Such transactions could accelerate the realization of taxable income if sales of securities resulted in gains and could also increase a Funds transaction costs. Large redemptions by a Fund of
Funds may cause a Funds expense ratio to increase due to a resulting smaller asset base. To the extent that the portfolio managers for the Funds of Funds also serve as portfolio managers for any of the Funds, the portfolio managers may have
regular and continuous access to the holdings of such Funds. In addition, the portfolio managers of the Funds of Funds may have access to the holdings of some of the Funds as well as knowledge of and a potential impact on investment strategies and
techniques of the Funds.
The goal of the Adviser and its affiliates is to meet their fiduciary obligation with respect to all
clients. The Adviser and its affiliates have policies and procedures that seek to manage conflicts. The Adviser and its affiliates monitor a variety of areas, including compliance with fund guidelines, review of allocation decisions and compliance
with the Advisers Codes of Ethics and JPMorgan Chase and Co.s Code of Conduct. With respect to the allocation of investment opportunities, the Adviser and its affiliates also have certain policies designed to achieve fair and equitable
allocation of investment opportunities among its clients over time. For example:
Orders for the same equity security traded
through a single trading desk or system are aggregated on a continual basis throughout each trading day consistent with the Advisers and its affiliates duty of best execution for its clients. If aggregated trades are fully executed,
accounts participating in the trade will be allocated their pro rata share on an average price basis. Partially completed orders generally will be allocated among the participating accounts on a pro-rata average price basis, subject to certain
limited exceptions. For example, accounts that would receive a
de minimis
allocation relative to their size may be excluded from the order. Another exception may occur when thin markets or price volatility require that an aggregated order be
completed in multiple executions over several days. If partial completion of the order would result in an uneconomic allocation to an account due to fixed transaction or custody costs, the Adviser and its affiliates may exclude small orders until
50% of the total order is completed. Then the small orders will be executed. Following this procedure, small orders will lag in the early execution of the order, but will be completed before completion of the total order.
Purchases of money market instruments and fixed income securities cannot always be allocated pro-rata across the accounts with the same
investment strategy and objective. However, the Adviser and its affiliates attempt to mitigate any potential unfairness by basing non-pro rata allocations traded through a single trading desk or system upon objective predetermined criteria for the
selection of investments and a disciplined process for allocating securities with similar duration, credit quality and liquidity in the good faith judgment of the Adviser or its affiliates so that fair and equitable allocation will occur over time.
Fees earned by HCM for managing certain accounts may vary, particularly because for certain accounts, HCM is paid based upon
the performance results for those accounts. This could create a conflict of interest because the portfolio managers could have an incentive to favor certain accounts over others, resulting in other accounts outperforming the Fund. However, HCM
believes that this risk is mitigated by the fact that investment decisions for each of the accounts advised by HCM are made through an automated system, and not by any one individual. Furthermore, for certain of these accounts, the automated system
processes each accounts transactions independent of those for the other accounts. For its other accounts, HCM has implemented policies and procedures to ensure the fair and equitable execution of trade orders, including the use of independent
trading functions.
Fees earned by JPMPI for managing certain accounts may vary, particularly because for multiple accounts,
JPMPI is paid based upon the performance results for those accounts. In addition, some of the portfolio managers have personal investments in other accounts. This could create a conflict of interest because the portfolio managers could have an
incentive to favor certain accounts over others, resulting in other accounts outperforming the Fund. JPMPI believes that such conflicts are mitigated in part because the Fund will be investing predominantly in mutual funds and structured notes, the
prices of which are fixed at the close of the trading day for all investors. With respect to other securities, JPMPI utilizes JPMIMs trading desk and systems in order to participate in JPMIMs policies designed to achieve fair and
equitable allocation of investment opportunities. JPMPI also has policies and procedures that seek to manage conflicts and monitors a variety of areas, including compliance with fund guidelines, review of allocation decisions and compliance with its
Code of Ethics and JPMCs Code of Conduct.
Part II - 77
For details of the dollar range of shares of each Fund (excluding the Money Market Funds)
beneficially owned by the portfolio managers, see PORTFOLIO MANAGERS Ownership of Securities in Part I of this SAI.
PORTFOLIO MANAGER COMPENSATION
Each
Advisers portfolio managers participate in a competitive compensation program that is designed to attract and retain outstanding people and closely link the performance of investment professionals to client investment objectives. The total
compensation program includes a base salary fixed from year to year and a variable performance bonus consisting of cash incentives and restricted stock and may include mandatory notional investments (as described below) in selected mutual funds
advised by the Adviser or its affiliates. These elements reflect individual performance and the performance of the Advisers business as a whole.
Each portfolio managers performance is formally evaluated annually based on a variety of factors including the aggregate size and blended performance of the portfolios such portfolio manager
manages. Individual contribution relative to client goals carries the highest impact. Portfolio manager compensation is primarily driven by meeting or exceeding clients risk and return objectives, relative performance to competitors or
competitive indices and compliance with firm policies and regulatory requirements. In evaluating each portfolio managers performance with respect to the mutual funds he or she manages, the Funds pre-tax performance is compared to the
appropriate market peer group and to each Funds benchmark index listed in the Funds prospectuses over one, three and five year periods (or such shorter time as the portfolio manager has managed the Fund). Investment performance is
generally more heavily weighted to the long-term.
Awards of restricted stock are granted as part of an employees annual
performance bonus and comprise from 0% to 40% of a portfolio managers total bonus. As the level of incentive compensation increases, the percentage of compensation awarded in restricted stock also increases. Up to 50% of the restricted stock
portion of a portfolio managers bonus may instead be subject to mandatory notional investment in selected mutual funds advised by the Adviser or its affiliates. When these awards vest over time, the portfolio manager receives cash equal to the
market value of the notional investment in the selected mutual funds.
CODES OF ETHICS
The Trusts, the Advisers and JPMDS have each adopted codes of ethics pursuant to Rule 17j-1 under the 1940 Act (and
pursuant to Rule 204A-1 under the Advisers Act with respect to the Advisers).
The Trusts code of ethics includes
policies which require access persons (as defined in Rule 17j-1) to: (i) place the interest of Trust shareholders first; (ii) conduct personal securities transactions in a manner that avoids any actual or potential conflict of
interest or any abuse of a position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of his or her position with the Trusts or a Fund. The Trusts code of ethics prohibits any access person from:
(i) employing any device, scheme or artifice to defraud the Trusts or a Fund; (ii) making to the Trusts or a Fund any untrue statement of a material fact or omit to state to the Trusts or a Fund a material fact necessary in order to make
the statements made, in light of the circumstances under which they are made, not misleading; (iii) engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon the Trusts or a Fund; or
(iv) engaging in any manipulative practice with respect to the Trusts or a Fund. The Trusts code of ethics permits personnel subject to the code to invest in securities, including securities that may be purchased or held by a Fund so long
as such investment transactions are not in contravention of the above noted policies and prohibitions.
The code of ethics
adopted by the Advisers requires that all employees must: (i) place the interest of the accounts which are managed by the Adviser first; (ii) conduct all personal securities transactions in a manner that is consistent with the code of
ethics and the individual employees position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of their position. Employees of each Adviser are also prohibited from certain mutual fund trading activity
including excessive trading of shares of a mutual fund as described in the applicable Funds Prospectuses or SAI and effecting or facilitating a mutual fund transaction to engage in market timing. The Advisers code of ethics permits
personnel subject to the code to invest in securities, including securities that may be purchased or held by a Fund subject to certain restrictions. However, all employees are required to preclear securities trades (except for certain types of
securities such as non-proprietary mutual fund shares and U.S. government securities). Each of the Advisers affiliated sub-advisers has also adopted the code of ethics described above.
Part II - 78
JPMDSs code of ethics requires that all employees of JPMDS must: (i) place the
interest of the accounts which are managed by affiliates of JPMDS first; (ii) conduct all personal securities transactions in a manner that is consistent with the code of ethics and the individual employees position of trust and
responsibility; and (iii) refrain from taking inappropriate advantage of their positions. Employees of JPMDS are also prohibited from certain mutual fund trading activity, including excessive trading of shares of a mutual fund as such term is
defined in the applicable Funds Prospectuses or SAI, or effecting or facilitating a mutual fund transaction to engage in market timing. JPMDSs code of ethics permits personnel subject to the code to invest in securities, including
securities that may be purchased or held by the Funds subject to the policies and restrictions in such code of ethics.
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions.
Pursuant
to the Advisory and sub-advisory Agreements, the Advisers determine, subject to the general supervision of the Board of Trustees of the Trusts and in accordance with each Funds investment objective and restrictions, which securities are to be
purchased and sold by each such Fund and which brokers are to be eligible to execute its portfolio transactions. The Advisers operate independently in providing services to their respective clients. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved. Thus, for example, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time.
Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In some instances, one client may sell a particular security to another client. It also happens that two or more clients
may simultaneously buy or sell the same security, in which event each days transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in the opinion of the Adviser is
equitable to each and in accordance with the amount being purchased or sold by each. There may be circumstances when purchases or sales of portfolio securities for one or more clients will have an adverse effect on other clients.
Brokerage and Research Services.
On behalf of the Funds, a Funds Adviser places orders for all
purchases and sales of portfolio securities, enters into repurchase agreements, and may enter into reverse repurchase agreements and execute loans of portfolio securities on behalf of a Fund unless otherwise prohibited. See Investment
Strategies and Policies.
Fixed income and debt securities and municipal bonds and notes are generally traded at a net
price with dealers acting as principal for their own accounts without a stated commission. The price of the security usually includes profit to the dealers. In underwritten offerings, securities are purchased at a fixed price, which includes an
amount of compensation to the underwriter, generally referred to as the underwriters concession or discount. Transactions on stock exchanges (other than foreign stock exchanges) involve the payment of negotiated brokerage commissions. Such
commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign securities generally involve payment of fixed
brokerage commissions, which are generally higher than those in the U.S. On occasion, certain securities may be purchased directly from an issuer, in which case no commissions or discounts are paid.
In connection with portfolio transactions, the overriding objective is to obtain the best execution of purchase and sales orders. In
making this determination, the Adviser considers a number of factors including, but not limited to: the price per unit of the security, the brokers execution capabilities, the commissions charged, the brokers reliability for prompt,
accurate confirmations and on-time delivery of securities, the broker-dealer firms financial condition, the brokers ability to provide access to public offerings, as well as the quality of research services provided. As permitted by
Section 28(e) of the Securities Exchange Act, the Adviser may cause the Funds to pay a broker-dealer which provides brokerage and research services to the Adviser, or the Funds and/or other accounts for which the Adviser exercises investment
discretion an amount of commission for effecting a securities transaction for a Fund in excess of the amount other broker-dealers would have charged for the transaction if the Adviser determines in good faith that the greater commission is
reasonable in relation to the value of the brokerage and research services provided by the executing broker-dealer viewed in terms of either a particular transaction or the Advisers overall responsibilities to accounts over which it exercises
investment discretion. Not all such services are useful or of value in advising the Funds. The Adviser reports to the Board of Trustees regarding overall commissions paid by the Funds and their reasonableness in relation to the benefits to the
Funds. In accordance with Section 28(e) of the Securities Exchange Act and consistent with applicable SEC guidance and interpretation, the term brokerage and research services includes (i) advice as to the value of securities;
(ii) the advisability of investing in, purchasing or selling securities; (iii) the availability of securities or of purchasers or sellers of securities; (iv) furnishing analyses and reports concerning issues, industries, securities,
economic factors and trends,
Part II - 79
portfolio strategy and the performance of accounts; and (v) effecting securities transactions and performing functions incidental thereto (such as clearance, settlement, and custody) or
required by rule or regulation in connection with such transactions.
Brokerage and research services received from such
broker-dealers will be in addition to, and not in lieu of, the services required to be performed by an Adviser under the Advisory Agreement (or with respect to a Sub-Adviser, under the sub-advisory agreement). The fees that the Funds pay to the
Adviser are not reduced as a consequence of the Advisers receipt of brokerage and research services. To the extent the Funds portfolio transactions are used to obtain such services, the brokerage commissions paid by the Funds may exceed
those that might otherwise be paid by an amount that cannot be presently determined. Such services generally would be useful and of value to the Adviser in serving one or more of its other clients and, conversely, such services obtained by the
placement of brokerage business of other clients generally would be useful to the Adviser in carrying out its obligations to the Funds. While such services are not expected to reduce the expenses of the Adviser, the Adviser would, through use of the
services, avoid the additional expenses that would be incurred if it should attempt to develop comparable information through its own staff.
Subject to the overriding objective of obtaining the best execution of orders, the Adviser may allocate a portion of a Funds brokerage transactions to affiliates of the Adviser. Under the 1940 Act,
persons affiliated with a Fund and persons who are affiliated with such persons are prohibited from dealing with the Fund as principal in the purchase and sale of securities unless an exemptive order allowing such transactions is obtained from the
SEC. The SEC has granted exemptive orders permitting each Fund to engage in principal transactions with J.P. Morgan Securities LLC, an affiliated broker, involving taxable and tax exempt money market instruments (including commercial paper, banker
acceptances and medium term notes) and repurchase agreements. The orders are subject to certain conditions. An affiliated person of a Fund may serve as its broker in listed or over-the-counter transactions conducted on an agency basis provided that,
among other things, the fee or commission received by such affiliated broker is reasonable and fair compared to the fee or commission received by non-affiliated brokers in connection with comparable transactions.
In addition, a Fund may not purchase securities during the existence of any underwriting syndicate for such securities of which JPMorgan
Chase Bank or an affiliate is a member or in a private placement in which JPMorgan Chase Bank or an affiliate serves as placement agent, except pursuant to procedures adopted by the Board of Trustees that either comply with rules adopted by the SEC
or with interpretations of the SECs staff. Each Fund expects to purchase securities from underwriting syndicates of which certain affiliates of JPMorgan Chase act as a member or manager. Such purchases will be effected in accordance with the
conditions set forth in Rule 10f-3 under the 1940 Act and related procedures adopted by the Trustees, including a majority of the Trustees who are not interested persons of a Fund. Among the conditions are that the issuer of any
purchased securities will have been in operation for at least three years, that not more than 25% of the underwriting will be purchased by a Fund and all other accounts over which the same investment adviser has discretion, and that no shares will
be purchased from JPMDS or any of its affiliates.
On those occasions when the Adviser deems the purchase or sale of a security
to be in the best interests of a Fund as well as other customers, including other Funds, the Adviser, to the extent permitted by applicable laws and regulations, may, but is not obligated to, aggregate the securities to be sold or purchased for a
Fund with those to be sold or purchased for other customers in order to obtain best execution, including lower brokerage commissions if appropriate. In such event, allocation of the securities so purchased or sold as well as any expenses incurred in
the transaction will be made by the Adviser in the manner it considers to be most equitable and consistent with its fiduciary obligations to its customers, including the Funds. In some instances, the allocation procedure might not permit a Fund to
participate in the benefits of the aggregated trade.
If a Fund that writes options effects a closing purchase transaction with
respect to an option written by it, normally such transaction will be executed by the same broker-dealer who executed the sale of the option. The writing of options by a Fund will be subject to limitations established by each of the exchanges
governing the maximum number of options in each class which may be written by a single investor or group of investors acting in concert, regardless of whether the options are written on the same or different exchanges or are held or written in one
or more accounts or through one or more brokers. The number of options that a Fund may write may be affected by options written by the Adviser for other investment advisory clients. An exchange may order the liquidation of positions found to be in
excess of these limits, and it may impose certain other sanctions.
Allocation of transactions, including their frequency, to
various broker-dealers is determined by a Funds Adviser based on its best judgment and in a manner deemed fair and reasonable to Shareholders and consistent with
Part II - 80
the Advisers obligation to obtain the best execution of purchase and sales orders. In making this determination, the Adviser considers the same factors for the best execution of purchase
and sales orders listed above. Accordingly, in selecting broker-dealers to execute a particular transaction, and in evaluating the best overall terms available, a Funds Adviser is authorized to consider the brokerage and research services (as
those terms are defined in Section 28(e) of the Securities Exchange Act) provided to the Funds and/or other accounts over which a Funds Adviser exercises investment discretion. A Funds Adviser may cause a Fund to pay a broker-dealer
that furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same transaction, provided that a Funds Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either the particular transaction or the overall responsibilities of a Funds Adviser to the Funds. To the extent such
services are permissible under the safe harbor requirements of Section 28(e) of the Securities Exchange Act and consistent with applicable SEC guidance and interpretation, such brokerage and research services might consist of advice as to the
value of securities, the advisability of investing in, purchasing, or selling securities, the availability of securities or purchasers or sellers of securities; analyses and reports concerning issuers, industries, securities, economic factors and
trends, portfolio strategy, and the performance of accounts, market data, stock quotes, last sale prices, and trading volumes. Shareholders of the Funds should understand that the services provided by such brokers may be useful to a Funds
Adviser in connection with its services to other clients and not all the services may be used by the Adviser in connection with the Fund.
Under the policy for JPMIM, soft dollar services refer to arrangements that fall within the safe harbor requirements of Section 28(e) of the Securities Exchange Act, as amended, which
allow JPMIM to allocate client brokerage transactions to a broker-dealer in exchange for products or services that are research and brokerage-related and provide lawful and appropriate assistance in the performance of the investment decision-making
process. These services include third party research, market data services, and proprietary broker-dealer research. The Funds receive proprietary research where broker-dealers typically incorporate the cost of such research into their commission
structure. Many brokers do not assign a hard dollar value to the research they provide, but rather bundle the cost of such research into their commission structure. It is noted in this regard that some research that is available only under a bundled
commission structure is particularly important to the investment process. However, the Funds, other than the U.S. Equity Funds and JPMorgan Market Neutral Fund, do not participate in soft dollar arrangements for market data services and third-party
research.
The U.S. Equity Funds (except the JPMorgan Equity Index Fund and JPMorgan Market Expansion Index Fund), JPMorgan
Research Market Neutral Fund JPMorgan Realty Income Fund, JPMorgan Research Equity Long/Short Fund, JPMorgan Tax Aware Disciplined Equity Fund and JPMorgan Tax Aware U.S. Equity Fund participate in soft dollar arrangements whereby a broker-dealer
provides market data services and third-party research in addition to proprietary research. In order to obtain such research, the Adviser may utilize a Client Commission Arrangement (CCA). CCAs are agreements between an investment
adviser and executing broker whereby the investment adviser and the broker agree to allocate a portion of commissions to a pool of credits maintained by the broker that are used to pay for eligible brokerage and research services. The Adviser will
only enter into and utilize CCAs to the extent permitted by Section 28(e) of the Securities Exchange Act. As required by interpretive guidance issued by the SEC, any CCAs entered into by the Adviser with respect to commissions generated by the
U.S. Equity Funds will provide that: (1) the broker-dealer pay the research preparer directly; and (2) the broker-dealer take steps to assure itself that the client commissions that the Adviser directs it to use to pay for such services
are only for eligible research under Section 28(e).
SCR&M does not enter into soft dollar arrangements whereby a
broker pays for research services such as Bloomberg, Reuters or Factset. From time to time, SCR&M may receive or have access to research generally provided by a broker to the brokers institutional clients that trade with the broker in the
sector of the securities markets in which SCR&M is active, namely in the case of real estate securities. In addition, SCR&M may consider the value-added quality of proprietary broker research received from brokers in allocating trades to
brokers subject always to the objective of obtaining best execution.
Investment decisions for each Fund are made independently
from those for the other Funds or any other investment company or account managed by an Adviser. Any such other investment company or account may also invest in the same securities as the Trusts. When a purchase or sale of the same security is made
at substantially the same time on behalf of a given Fund and another Fund, investment company or account, the transaction will be averaged as to price, and available investments allocated as to amount, in a manner which the Adviser of the given Fund
believes to be equitable to the Fund(s) and such other investment company or account. In some instances, this procedure may adversely affect the price paid or received by a Fund or the size of the position obtained by a Fund.
Part II - 81
To the extent permitted by law, the Adviser may aggregate the securities to be sold or purchased by it for a Fund with those to be sold or purchased by it for other Funds or for other investment
companies or accounts in order to obtain best execution. In making investment recommendations for the Trusts, the Adviser will not inquire or take into consideration whether an issuer of securities proposed for purchase or sale by the Trusts is a
customer of the Adviser or their parents or subsidiaries or affiliates and in dealing with its commercial customers, the Adviser and their respective parent, subsidiaries, and affiliates will not inquire or take into consideration whether securities
of such customers are held by the Trusts.
Under HCMs policy, HCM has the power and authority to establish and maintain
accounts on behalf of its clients with, and issue orders for the purchase or sale of securities for its clients directly to, a broker, dealer or other person, as well as to exercise or abstain from exercising any option, privilege or right held by
its clients. In selecting a broker with respect to effecting any securities transaction on behalf of its clients, HCM may pay a broker a commission in excess of the amount another broker would have charged for effect in such transaction, so long as,
in HCMs good faith judgment, the amount of the commission is reasonable in relation to the value of the brokerage and research services provided by such broker, viewed in terms of that particular transaction or HCMs overall investment
management business. HCM intends to comply with Section 28(e) of the Securities Exchange Act, under which HCMs use of its clients commission dollars to acquire research products and services is not a breach of its fiduciary duty to
its clients even if the brokerage commissions paid are higher than the lowest available as long as (among certain other requirements) HCM determines that the commissions are reasonable compensation for both the brokerage services and
the research acquired.
For details of brokerage commissions paid by the Funds, see BROKERAGE AND RESEARCH SERVICES
Brokerage Commissions in Part I of this SAI.
For details of the Funds ownership of securities of the
Funds regular broker dealers, see BROKERAGE AND RESEARCH SERVICES Securities of Regular Broker-Dealers in Part I of this SAI.
OVERVIEW OF SERVICE PROVIDER AGREEMENTS
The following sections provide an overview of the J.P. Morgan Funds agreements with various service providers including the
Administrator, Distributor, Securities Lending Agent, Custodian, Transfer Agent, and Shareholder Servicing Agent. As indicated below, some of the service agreements for the JPMorgan SmartRetirement Blend Funds and other J.P. Morgan Funds are
different than the services agreements for the other JPMorgan SmartRetirement Funds. For purposes of distinguishing between the agreements and expenses, the JPMorgan SmartRetirement Funds other than the JPMorgan SmartRetirement Blend Funds are
referred to in the following as the JPMorgan SR Funds.
ADMINISTRATOR
JPMorgan Funds Management, Inc. (JPMFM or the Administrator) serves as the administrator to the
Funds, pursuant to an Administration Agreement dated February 19, 2005 (the Administration Agreement), between the Trusts, on behalf of the Funds, and JPMFM. Additionally, JPMFM serves as the administrator to the JPMorgan SR Funds
pursuant to an agreement effective May 5, 2006 (the SR Administration Agreement), between JPMT I, on behalf of the JPMorgan SR Funds, and JPMFM. JPMFM is an affiliate of JPMorgan Chase Bank and an indirect, wholly-owned subsidiary
of JPMorgan Chase; it has its principal place of business at 460 Polaris Parkway, Westerville, OH 43082.
Pursuant to the
Administration Agreement and the SR Administration Agreement, JPMFM performs or supervises all operations of each Fund for which it serves (other than those performed under the advisory agreement, any sub-advisory agreements, the custodian and fund
accounting agreement, and the transfer agency agreement for that Fund). Under the Administration Agreement and the SR Administration Agreement, JPMFM has agreed to maintain the necessary office space for the Funds, and to furnish certain other
services required by the Funds with respect to each Fund. The Administrator prepares annual and semi-annual reports to the SEC, prepares federal and state tax returns and generally assists in all aspects of the Funds operations other than
those performed under the advisory agreement, any sub-advisory agreements, the custodian and fund accounting agreement, and the transfer agency agreement. JPMFM may, at its expense, subcontract with any entity or person concerning the provision of
services under the Administration Agreement and the SR Administration Agreement. JPMorgan Chase Bank serves as the Funds sub-administrator (the Sub-administrator). The Administrator pays JPMorgan Chase Bank a fee for its services
as the Funds Sub-administrator.
Part II - 82
If not terminated, the Administration Agreement and the SR Administration Agreement continue
in effect for annual periods beyond October 31 of each year, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees who are not parties to the Administration
Agreement or SR Administration Agreement or interested persons of any such party. The Administration Agreement and the SR Administration Agreement may be terminated without penalty, on not less than 60 days prior written notice, by the Board
of Trustees of each Trust or by JPMFM. The termination of the Administration Agreement or the SR Administration Agreement with respect to one Fund will not result in the termination of the Administration Agreement with respect to any other Fund.
The Administration Agreement and the SR Administration Agreement provide that JPMFM shall not be liable for any error of
judgment or mistake of law or any loss suffered by the Funds in connection with the matters to which the Administration Agreement relates, except a loss resulting from willful misfeasance, bad faith or negligence in the performance of its duties, or
from the reckless disregard by it of its obligations and duties thereunder.
In consideration of the services to be provided by
JPMFM pursuant to the Administration Agreement, JPMFM receives from each Fund a pro rata portion of a fee computed daily and paid monthly at an annual rate equal to 0.15% of the first $25 billion of average daily net assets of all funds in the J.P.
Morgan Funds Complex (excluding certain funds of funds and the series of J.P. Morgan Funds Complex that operate as money market funds (each a Money Market Fund)) and 0.075% of average daily net assets of all funds in the J.P. Morgan
Funds Complex (excluding certain funds of funds and the Money Market Funds) over $25 billion of such assets. For purposes of this paragraph, the J.P. Morgan Funds Complex includes most of the open-end investment companies in the J.P.
Morgan Funds Complex, including the series of the former One Group Mutual Funds.
With respect to the Money Market Funds, in
consideration of the services provided by JPMFM pursuant to the Administration Agreement, JPMFM will receive from each Fund a pro-rata portion of a fee computed daily and paid monthly at an annual rate of 0.10% on the first $100 billion of the
average daily net assets of all the money market funds in the J.P. Morgan Funds Complex and 0.05% of the average daily net assets of the money market funds in the J.P. Morgan Funds Complex over $100 billion. For purposes of this paragraph, the
J.P. Morgan Funds Complex includes most of the open-end investment companies in the J.P. Morgan Funds Complex including the series of the former One Group Mutual Funds.
With respect to the Investor Funds and JPMorgan Diversified Real Return Fund, in consideration of the services provided by JPMFM pursuant
to the Administration Agreement, JPMFM will receive from each Fund a pro rata portion of a fee computed daily and paid monthly at an annual rate of 0.10% of the first $500 million of average daily net assets of all the Investor Funds and JPMorgan
Diversified Real Return Fund in the J.P. Morgan Funds Complex, 0.075% of certain Funds of Funds average daily net assets between $500 million and $1 billion and 0.05% of certain Funds of Funds average daily net assets in excess of $1
billion.
JPMFM does not charge a fee for providing administrative services to the JPMorgan SR Funds under the
SR Administration Agreement, but does receive fees for its services to the acquired funds.
For details of the
administration and administrative services fees paid or accrued, see ADMINISTRATOR Administration Fees in Part I of this SAI.
DISTRIBUTOR
Since February 19, 2005,
JPMDS has served as the distributor for all the Trusts and holds itself available to receive purchase orders for each of the Funds shares. In that capacity, JPMDS has been granted the right, as agent of each Trust, to solicit and accept orders
for the purchase of shares of each of the Funds in accordance with the terms of the Distribution Agreement between each Trust and JPMDS. JPMDS began serving as JPMT IIs distributor pursuant to a Distribution Agreement dated as of April 1,
2002. JPMDS is an affiliate of JPMIM, JPMorgan Investment Advisors and JPMorgan Chase Bank and is a direct, wholly-owned subsidiary of JPMorgan Chase. The principal offices of JPMDS are located at 460 Polaris Parkway, Westerville, OH 43082.
Unless otherwise terminated, the Distribution Agreement with JPMDS will continue in effect for annual periods beyond
October 31 of each year, and will continue thereafter for successive one-year terms if approved at least annually by: (a) the vote of a majority of those members of the Board of Trustees who are not parties to the Distribution Agreement or
interested persons of any such party, cast in person at a meeting for the purpose of voting on such approval, and (b) the vote of the Board of Trustees or the vote of a majority of the outstanding voting securities of the Fund. The Distribution
Agreement may be terminated without penalty on not less than 60 days
Part II - 83
prior written notice by the Board of Trustees, by vote of majority of the outstanding voting securities of the Fund or by JPMDS. The termination of the Distribution Agreement with respect to one
Fund will not result in the termination of the Distribution Agreement with respect to any other Fund. The Distribution Agreement may also be terminated in the event of its assignment, as defined in the 1940 Act. JPMDS is a broker-dealer registered
with the SEC and is a member of the Financial Industry Regulatory Authority (FINRA).
For details of the
compensation paid to the principal underwriter, JPMDS, see DISTRIBUTOR Compensation paid to JPMDS in Part I of this SAI.
DISTRIBUTION PLAN
Certain Funds have
adopted a plan of distribution pursuant to Rule 12b-1 under the 1940 Act (the Distribution Plan) on behalf of the Class A Shares, Class B Shares, Class C Shares, Class R2 Shares, Cash Management Shares, Morgan Shares, Reserve
Shares, Service Shares, Eagle Shares and E*TRADE Class Shares of the applicable Funds, which provides that each of such classes shall pay for distribution services a distribution fee (the Distribution Fee) to JPMDS, at annual rates not
to exceed the amounts set forth in each applicable Funds prospectuses. The Institutional Class Shares, Select Class Shares, Class R5 Shares, Direct Shares, Class R6 Shares, IM Shares, Premier Shares, Capital Shares, Direct Shares and Agency
Shares of the Funds have no Distribution Plan.
JPMDS may use the Rule 12b-1 fees payable under the Distribution Plan to
finance any activity that is primarily intended to result in the sale of Shares, including, but not limited to, (i) the development, formulation and implementation of marketing and promotional activities, including direct mail promotions and
television, radio, magazine, newspaper, electronic and media advertising; (ii) the preparation, printing and distribution of prospectuses, statements of additional information and reports and any supplements thereto (other than prospectuses,
statements of additional information and reports and any supplements thereto used for regulatory purposes or distributed to existing shareholders of each Fund); (iii) the preparation, printing and distribution of sales and promotional materials
and sales literature which is provided to various entities and individuals, including brokers, dealers, financial institutions, financial intermediaries, shareholders, and prospective investors in each Fund; (iv) expenditures for sales or
distribution support services, including meetings with and assistance to brokers, dealers, financial institutions, and financial intermediaries and in-house telemarketing support services and expenses; (v) preparation of information, analyses,
surveys, and opinions with respect to marketing and promotional activities, including those based on meetings with and feedback from JPMDSs sales force and others including potential investors, shareholders and financial intermediaries;
(vi) commissions, incentive compensation, finders fees, or other compensation paid to, and expenses of employees of JPMDS, brokers, dealers, and other financial institutions and financial intermediaries that are attributable to any
distribution and/or sales support activities, including interest expenses and other costs associated with financing of such commissions, incentive compensation, other compensation, fees, and expenses; (vii) travel, promotional materials,
equipment, printing, delivery and mailing costs, overhead and other office expenses of JPMDS and its sales force attributable to any distribution and/or sales support activities, including meetings with brokers, dealers, financial institutions and
financial intermediaries in order to provide them with information regarding the Funds and their investment process and management; (viii) the costs of administering the Distribution Plan; (ix) expenses of organizing and conducting sales
seminars; and (x) any other costs and expenses relating to any distribution and/or sales support activities. Activities intended to promote one class of shares of a Fund may also benefit the Funds other shares and other Funds. Anticipated
benefits to the Funds that may result from the adoption of the Distribution Plan are economic advantages achieved through economies of scale and enhanced viability if the Funds accumulate a critical mass.
Class A, Class B, Class C Shares and Class R2 Shares
. Class A Shares of the Funds pay a Distribution Fee of 0.25% of
average daily net assets. Class R2 Shares of the Funds pay a Distribution Fee of 0.50% of average daily net assets. Class B and Class C Shares of the Funds pay a Distribution Fee of 0.75% of average daily net assets. JPMDS currently expects to pay
sales commissions to a dealer at the time of sale of Class B and Class C Shares of the Funds of up to 4.00% (2.75% for Class B Shares of the Short Duration Bond Fund, Short-Intermediate Municipal Bond Fund, Limited Duration Bond Fund and
Treasury & Agency Fund) and 1.00% respectively of the purchase price of the shares sold by such dealer. JPMDS will use its own funds (which may be borrowed or otherwise financed) to pay such amounts. Because JPMDS will receive a maximum
Distribution Fee of 0.75% of average daily net assets with respect to Class B and Class C Shares of the Funds, it will take JPMDS several years to recoup the sales commissions paid to dealers and other sales expenses. Some payments under the
Distribution Plan may be used to compensate broker-dealers with trail or maintenance commissions in an amount not to exceed 0.25% annualized of the average daily net asset value of the Class A Shares or 0.75% annualized of the average daily net
asset value of the Class B and Class C Shares or 0.50% annualized of the average daily net asset value of the
Part II - 84
Class R2 Shares maintained in a Fund by such broker-dealers customers. Such payments on Class A Shares and Class R2 Shares will be paid to broker-dealers immediately. Such
payments on Class B and Class C Shares will be paid to broker-dealers beginning in the 13th month following the purchase of such shares, except certain broker-dealers who have sold Class C Shares to certain defined contribution plans and who have
waived the 1.00% sales commission shall be paid trail or maintenance commissions immediately.
Money Market Funds
. Some
payments under the Distribution Plan may be used to compensate broker-dealers with trail or maintenance commissions in an amount not to exceed 0.75% annualized of the average daily net asset value of Class B Shares or Class C Shares maintained in a
Fund by such broker-dealers customers. With respect to Cash Management Shares, broker-dealers will be compensated with trail or maintenance commissions of 0.50% annualized of the average daily net asset value. With respect to Reserve Shares,
broker-dealers will be compensated with trail or maintenance commissions of 0.25% annualized of the average daily net asset value. For Class B, Class C and Morgan Shares, trail or maintenance commissions will be paid to broker-dealers beginning in
the 13th month following the purchase of such shares. Since the distribution fees are not directly tied to expenses, the amount of distribution fees paid by a class of a Fund during any year may be more or less than actual expenses incurred pursuant
to the Distribution Plan. JPMDS will use its own funds (which may be borrowed or otherwise financed) to pay such amounts. Because JPMDS will receive 0.75% on Class B and C Shares, 0.50% on Cash Management Shares, 0.10% on Morgan Shares (except for
Morgan Shares of the Prime Money Market Fund), 0.25% on Reserve Shares and Eagle Shares and 0.60% on E*TRADE Class and Service Shares of average daily net assets, the fee will take JPMDS several years to recoup the sales commissions paid to dealers
and other sales expenses. For this reason, this type of distribution fee arrangement is characterized by the staff of the SEC as being of the compensation variety (in contrast to reimbursement arrangements by which a
distributors payments are directly linked to its expenses).
No class of shares of a Fund will make payments or be liable
for any distribution expenses incurred by other classes of shares of any Fund.
Since the Distribution Fee is not directly tied
to expenses, the amount of Distribution Fees paid by a class of a Fund during any year may be more or less than actual expenses incurred pursuant to the Distribution Plan. For this reason, this type of distribution fee arrangement is characterized
by the staff of the SEC as being of the compensation variety (in contrast to reimbursement arrangements by which a distributors payments are directly linked to its expenses). With respect to Class B and Class C Shares
of the Funds, because of the 0.75% annual limitation on the compensation paid to JPMDS during a fiscal year, compensation relating to a large portion of the commissions attributable to sales of Class B or Class C Shares in any one year will be
accrued and paid by a Fund to JPMDS in fiscal years subsequent thereto. However, the shares are not liable for any distribution expenses incurred in excess of the Distribution Fee paid.
The Distribution Plan provides that it will continue in effect indefinitely if such continuance is specifically approved at least annually
by a vote of both a majority of the Trustees and a majority of the Trustees who are not interested persons (as defined in the 1940 Act) of the Trusts and who have no direct or indirect financial interest in the operation of the
Distribution Plan or in any agreement related to such plan (Qualified Trustees).
The Distribution Plan may be
terminated, with respect to any class of a Fund, at any time by a vote of a majority of the Qualified Trustees or by vote of a majority of the outstanding voting shares of the class of such Fund to which it applies (as defined in the 1940 Act and
the rules thereunder). The Distribution Plan may not be amended to increase materially the amount of permitted expenses thereunder without the approval of the affected shareholders and may not be materially amended in any case without a vote of the
majority of both the Trustees and the Qualified Trustees. Each of the Funds will preserve copies of any plan, agreement or report made pursuant to the Distribution Plan for a period of not less than six years from the date of the Distribution Plan,
and for the first two years such copies will be preserved in an easily accessible place. The Board of Trustees will review at least on a quarterly basis written reports of the amounts expended under the Distribution Plan indicating the purposes for
which such expenditures were made. The selection and nomination of Qualified Trustees shall be committed to the discretion of the disinterested Trustees (as defined in the 1940 Act) then in office.
For details of the Distribution fees that the Funds paid to or that were accrued by JPMDS, see DISTRIBUTOR Distribution
Fees in Part I of this SAI.
Part II - 85
SECURITIES LENDING AGENT
To generate additional income, certain Funds may lend up to 33
1
/
3
% of their total assets pursuant to agreements (Borrower Agreements) requiring that the loan be continuously secured by cash or U.S. Treasury securities. JPMorgan Chase Bank, an affiliate of
the Funds, and Goldman Sachs serve as lending agents pursuant to the JPMorgan Agreement and the Goldman Sachs Agreement, respectively.
Under the Goldman Sachs Agreement and the JPMorgan Agreement, Goldman Sachs and JPMorgan Chase Bank, respectively, acting as agents for certain of the Funds, loan securities to approved borrowers pursuant
to Borrower Agreements substantially in the form approved by the Board of Trustees in exchange for collateral. During the term of the loan, the Fund receives payments from borrowers equivalent to the dividends and interest that would have been
earned on securities lent while simultaneously seeking to earn income on the investment of cash collateral in accordance with investment guidelines contained in the JPMorgan Agreement or the Goldman Sachs Agreement. The Fund retains the interest on
cash collateral investments but is required to pay the borrower a rebate for the use of cash collateral. The net income earned on the securities lending (after payment of rebates and the lending agents fee) is included in the Statement of
Operations as income from securities lending (net in the Funds financial statements). Information on the investment of cash collateral is shown in the Schedule of Portfolio Investments (in the Funds financial statements).
Under the Goldman Sachs Agreement, Goldman Sachs is entitled to a fee equal to a percentage of the earnings on loans of securities. For
purposes of this calculation, earnings shall mean: (a) the earnings on investments of cash collateral including waivers and reimbursements made by the Funds adviser or its affiliates for the benefit of the Fund that are related solely to
investments of cash collateral less (b) the cash collateral fees paid to borrowers in connection with cash collateral. Pursuant to the Third Party Securities Lending Agreement, JPMorgan Chase Banks compensation is paid by Goldman Sachs.
Under the JPMorgan Agreement, JPMorgan Chase Bank is entitled to a fee, monthly in arrears, equal to (i) 0.03% of the average dollar value of loans of U.S. securities outstanding during a given month; and (ii) 0.09% of the average dollar
value of loans of non-U.S. securities outstanding during a given month. The purpose of these fees under the JPMorgan Agreement is to cover the custodial, administrative and related costs of securities lending including securities movement,
settlement of trades involving cash received as collateral, custody of collateral and marking to market loans.
CUSTODIAN
Pursuant to the Global Custody and Fund Accounting Agreement with JPMorgan Chase Bank, 270 Park Avenue, New
York, New York 10017 (the JPMorgan Custody Agreement), JPMorgan Chase Bank serves as the custodian and fund accounting agent for each of the Funds, other than the JPMorgan SR Funds. Pursuant to the JPMorgan Custody Agreement, JPMorgan
Chase Bank is responsible for holding portfolio securities and cash and maintaining the books of account and records of portfolio transactions. JPMorgan Chase Bank is an affiliate of the Advisers.
With respect to the JPMorgan SR Funds, pursuant to the Global Custody and Fund Accounting Agreement between JPMFM, JPMT I on behalf of the
JPMorgan SR Funds, and JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017, effective May 5, 2006 (the SR Custody Agreement), JPMorgan Chase Bank serves as the custodian and funds accounting agent and is responsible for holding
portfolio securities and cash and maintaining the books of account and records of portfolio transactions. The fees and expenses under the SR Custody Agreement for custody and fund accounting are paid by JPMFM.
CUSTODY AND FUND ACCOUNTING FEES AND EXPENSES
For custodian services, each Fund (other than the JPMorgan SR Funds) pays to JPMorgan Chase Bank annual safekeeping fees of between
0.0009% and 0.35% of assets held by JPMorgan Chase Bank (depending on the domicile in which the asset is held), calculated monthly in arrears and fees between $2.50 and $80 for securities trades (depending on the domicile in which the trade is
settled) and $5.00 for receipt of principal and/or interest on fixed income securities. JPMorgan Chase Bank is also reimbursed for its reasonable out-of-pocket or incidental expenses, including, but not limited to, legal fees.
For custodian services for the JPMorgan SR Funds, JPMFM pays to JPMorgan Chase Bank annual safekeeping fees of between 0.0009% and 0.35%
of assets held by JPMorgan Chase Bank (depending on the domicile in which the asset is held) calculated monthly in arrears. JPMFM also pays JPMorgan Chase Bank fees between $2.50 and $80 for securities trades (depending on the domicile in which the
trade is settled) and $5.00 for receipt of principal
Part II - 86
and/or interest on fixed income securities. JPMFM shall also pay JPMorgan Chase Banks ordinary, reasonable out-of-pocked or incidental expenses other than legal fees and tax or related fees
incidental to processing by governmental authorities, issuers or their agents.
JPMorgan Chase Bank also is paid $15, $35 or
$60 per proxy (depending on the country where the issuer is located) for its service which helps facilitate the voting of proxies throughout the world.
In addition, JPMorgan Chase Bank provides derivative servicing with respect to swaps, swaptions and bond and currency options. The fees for these services include a transaction fee of up to $40 per new
contract, a fee of up to $10 per contract amendment (including transactions such as trade amendments, cancellations, terminations, novations, option exercises, option expiries, maturities or credit events) and a daily fee of up to $0.40 per contract
per day for position management services.
With respect to fund accounting services, the following schedule shall be employed
in the calculation of the fees payable for the services provided under the JPMorgan Custody Agreement and the SR Custody Agreement. For purposes of determining the asset levels at which a Tier applies, assets for that fund type across the entire
J.P. Morgan Funds Complex shall be used.
|
|
|
|
|
|
|
Money Market Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $250 billion
|
|
|
0.0014%
|
|
Tier Two
|
|
Over $250 billion
|
|
|
0.0010%
|
|
|
|
|
U.S. Fixed Income Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $25 billion
|
|
|
0.0040%
|
|
Tier Two
|
|
Next $35 billion
|
|
|
0.0025%
|
|
Tier Three
|
|
Over $60 billion
|
|
|
0.0020%
|
|
|
|
|
U.S. Equity Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $25 billion
|
|
|
0.0035%
|
|
Tier Two
|
|
Next $35 billion
|
|
|
0.0020%
|
|
Tier Three
|
|
Over $60 billion
|
|
|
0.0015%
|
|
|
|
|
International Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $12.5 billion
|
|
|
0.0050%
|
|
Tier Two
|
|
Over $12.5 billion
|
|
|
0.0040%
|
|
|
|
|
Emerging Markets Funds:
|
|
|
|
|
|
|
Tier One
|
|
First $12.5 billion
|
|
|
0.0060%
|
|
Tier Two
|
|
Over $12.5 billion
|
|
|
0.0050%
|
|
|
|
|
Other Fees:
|
|
|
|
|
|
|
Multi-Managed Funds (per manager)
|
|
|
$10,000
|
|
Fund of Funds (for a Fund of Funds that invests in J.P. Morgan Funds only)
|
|
|
$15,000
|
|
Short Extension Portfolio Services
|
|
|
$70,000
|
|
Additional Share Classes
|
|
|
$2,000
|
|
(For certain Funds of Funds, this additional class expense applies after the third class.)
|
|
|
|
Minimums:
|
|
|
|
|
(except for certain Funds of Funds subject to the fee described above)
|
|
|
|
|
U.S. Equity Funds
|
|
|
$20,000
|
|
U.S. Fixed Income Funds
|
|
|
$25,000
|
|
Money Markets Funds
|
|
|
$15,000
|
|
International Funds
|
|
|
$35,000
|
|
Emerging Markets Funds
|
|
|
$40,000
|
|
Highbridge Statistical Market
|
|
|
|
|
Neutral Fund and
|
|
|
|
|
Highbridge Dynamic Commodities
|
|
|
|
|
Strategy Fund
|
|
|
$30,000
|
|
Part II - 87
TRANSFER AGENT
Boston Financial Data Services, Inc. (BFDS or Transfer Agent), 2000 Crown Colony Drive, Quincy, MA 02169, serves
as each Funds transfer and dividend disbursing agent. As transfer agent and dividend disbursing agent, BFDS is responsible for maintaining account records, detailing the ownership of Fund shares and for crediting income, capital gains and
other changes in share ownership to shareholder accounts.
SHAREHOLDER SERVICING
The Trusts, on behalf of the Funds have entered into a shareholder servicing agreement, effective February 19, 2005,
with JPMDS (Shareholder Servicing Agreement). The Shareholder Servicing Agreement for Institutional Class Shares of JPMT II became effective on August 12, 2004. Under the Shareholder Servicing Agreement, JPMDS will provide, or cause
its agents to provide, any combination of the (i) personal shareholder liaison services and shareholder account information services (Shareholder Services) described below and/or (ii) other related services (Other Related
Services) as also described below.
Shareholder Services include (a) answering shareholder inquiries
(through electronic and other means) regarding account status and history, the manner in which purchases and redemptions of Fund shares may be effected, and certain other matters pertaining to the Funds; (b) providing shareholders with
information through electronic means; (c) assisting shareholders in completing application forms, designating and changing dividend options, account designations and addresses; (d) arranging for or assisting shareholders with respect to
the wiring of the funds to and from shareholder accounts in connection with shareholder orders to purchase, redeem or exchange shares; (e) verifying shareholder requests for changes to account information; (f) handling correspondence from
shareholders about their accounts; (g) assisting in establishing and maintaining shareholder accounts with the Trusts; and (h) providing other shareholder services as the Trusts or a shareholder may reasonably request, to the extent
permitted by applicable law.
Other Related Services include (a) aggregating and processing purchase and
redemption orders for shares; (b) providing shareholders with account statements showing their purchases, sales, and positions in the applicable Fund; (c) processing dividend payments for the applicable Fund; (d) providing
sub-accounting services to the Trusts for shares held for the benefit of shareholders; (e) forwarding communications from the Trusts to shareholders, including proxy statements and proxy solicitation materials, shareholder reports, dividend and
tax notices, and updated Prospectuses and SAIs; (f) receiving, tabulating and transmitting proxies executed by shareholders; (g) facilitating the transmission and receipt of funds in connection with shareholder orders to purchase, redeem
or exchange shares; (h) developing and maintaining the Trusts website; (i) developing and maintaining facilities to enable transmission of share transactions by electronic and non-electronic means; (j) providing support and
related services to Financial Intermediaries in order to facilitate their processing of orders and communications with shareholders; (k) providing transmission and other functionalities for shares included in investment, retirement, asset
allocation, cash management or sweep programs or similar programs or services; and (l) developing and maintaining check writing functionality.
Fees earned by J.P. Morgan Private Investments Inc. (JPMPI, the Subadviser for the J.P. Morgan Access Funds) for managing certain accounts may vary, particularly because for multiple accounts, JPMPI is
paid based upon the performance results for those accounts. In addition, some of the portfolio managers have personal investments in other accounts. This could create a conflict of interest because the portfolio managers could have an incentive to
favor certain accounts over others, resulting in other accounts outperforming the Fund. JPMPI believes that such conflicts are mitigated in part because the Fund will be investing predominantly in mutual funds and structured notes the prices of
which are fixed at the close of the trading day for all investors. With respect to other securities, JPMPI utilizes JPMIMs trading desk and systems in order to participate in JPMIMs policies designed to achieve fair and equitable
allocation of investment opportunities. JPMPI also has policies and procedures that seek to manage conflicts and monitors a variety of areas, including compliance with fund guidelines, review of allocation decisions and compliance with its Code of
Ethics and J.P. Morgan Chase and Co.s Code of Conduct.
For details of fees paid by the Funds to JPMDS for Shareholder
Services and Other Related Services under the Shareholder Servicing Agreement, see SHAREHOLDER SERVICING Shareholder Services Fees in Part I of this SAI.
To the extent it is not otherwise required by its contractual agreement to limit a Funds expenses as described in the Prospectuses for the Funds, JPMDS may voluntarily agree from time to time to
waive a portion of the fees payable to it under the Shareholder Servicing Agreement with respect to each Fund on a month-to-month basis.
Part II - 88
JPMDS may enter into service agreements with Financial Intermediaries under which it will
pay all or a portion of such fees received from the Funds to such entities for performing Shareholder Services and/or Other Related Services, as described above, for shareholders. Such Financial Intermediaries may include, without limitation, any
person who is an affiliate of JPMDS.
If not terminated, the Shareholder Servicing Agreement will continue for successive one
year terms beyond October 31 of each year, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees of the Trusts who are not parties to the Shareholder
Servicing Agreement or interested persons (as defined in the 1940 Act) of any such party. The Shareholder Servicing Agreement may be terminated without penalty, on not less than 60 days prior written notice, by the Board of Trustees of the
Trusts or by JPMDS. The Shareholder Servicing Agreement will also terminate automatically in the event of its assignment.
Financial Intermediaries may offer additional services to their customers, including specialized procedures and payment for the purchase
and redemption of Fund shares, such as pre-authorized or systematic purchase and redemption programs, sweep programs, cash advances and redemption checks. Each Financial Intermediary may establish its own terms and conditions, including
limitations on the amounts of subsequent transactions, with respect to such services. Certain Financial Intermediaries may (although they are not required by the Trusts to do so) credit to the accounts of their customers from whom they are already
receiving other fees amounts not exceeding such other fees or the fees for their services as Financial Intermediaries.
For
shareholders that bank with JPMorgan Chase Bank, JPMDS may aggregate investments in the Funds with balances held in JPMorgan Chase Bank accounts for purposes of determining eligibility for certain bank privileges that are based on specified minimum
balance requirements, such as reduced or no fees for certain banking services or preferred rates on loans and deposits. JPMorgan Chase Bank and certain broker-dealers and other Financial Intermediaries may, at their own expense, provide gifts such
as computer software packages, guides and books related to investments or additional Fund shares valued up to $250 to their customers that invest in the J.P. Morgan Funds.
JPMDS or its affiliates may from time to time, at its or their own expense, out of compensation retained by them from the Funds or from other sources available to them, make additional payments to certain
selected dealers or other Financial Intermediaries for performing administrative services for their customers. These services include maintaining account records, processing orders to purchase, redeem and exchange Fund shares and responding to
certain customer inquiries. The amount of such compensation may be up to an additional 0.10% annually of the average net assets of the Funds attributable to shares of the Funds held by the customer of such Financial Intermediaries. Such compensation
does not represent an additional expense to the Funds or to their shareholders, since it will be paid by JPMDS.
JPMDS, the
Funds and their affiliates, agents and subagents may share certain information about shareholders and their accounts, as permitted by law and as described in the J.P. Morgan Funds Privacy Policy provided with your Prospectus, and also available on
the J.P. Morgan Funds website at www.jpmorganfunds.com.
EXPENSES
Except for the JPMorgan SR Funds, the Funds pay the expenses incurred in their operations, including their pro-rata share of expenses of
the Trusts. These expenses include: investment advisory and administrative fees; the compensation of the Trustees; registration fees; interest charges; taxes; expenses connected with the execution, recording and settlement of security transactions;
fees and expenses of the Funds custodian for all services to the Funds, including safekeeping of funds and securities and maintaining required books and accounts; expenses of preparing and mailing reports to investors and to government offices
and commissions; expenses of meetings of investors; fees and expenses of independent accountants, legal counsel and any transfer agent, registrar or dividend disbursing agent of the Trusts; insurance premiums; and expenses of calculating the NAV of,
and the net income on, shares of the Funds. Shareholder servicing and distribution fees are all allocated to specific classes of the Funds. In addition, the Funds may allocate transfer agency and certain other expenses by class. Service providers to
a Fund may, from time to time, voluntarily waive all or a portion of any fees to which they are entitled.
With respect to the
JPMorgan SR Funds, the Administrator pays many of the ordinary expenses incurred by the Funds in their operations including organization costs, taxes, ordinary fees and expenses for legal and auditing services, fees and expenses of pricing services,
the expenses of preparing (including typesetting), printing and mailing reports, prospectuses, statements of additional information, proxy solicitation material and notices to
Part II - 89
existing shareholders, all expenses incurred in connection with issuing and redeeming shares, the cost of custodial and fund accounting services, and the cost of initial and ongoing registration
of the shares under Federal and state securities laws. The Funds pay the following fees and expenses, including their pro-rata share of the following fees and expenses of the Trust: (1) transfer agency, (2) shareholder servicing,
(3) distribution fees, (4) brokerage costs, (5) all fees and expenses of Trustees, (6) the portion of the compensation of the Trusts Chief Compliance Officer (CCO) attributable to the Funds on the basis of relative net
assets, (7) costs of the Trusts CCO Program, (8) insurance, including fidelity bond and D&O insurance, (9) interest, (10) litigation and (11) other extraordinary or nonrecurring expenses. Shareholder servicing and
distribution fees are allocated to specific classes of the Funds. Service providers to the Funds may, from time to time, voluntarily waive all or a portion of any fees to which they are entitled.
JPMIM, SCR&M, JPMFM and JPMDS have agreed that they will waive fees or reimburse the Funds as described in the Prospectuses.
FINANCIAL INTERMEDIARIES
The services provided by Financial Intermediaries may include establishing and maintaining shareholder accounts, processing purchase and
redemption transactions, arranging for bank wires, performing shareholder subaccounting, answering client inquiries regarding the Funds, assisting clients in changing dividend options, account designations and addresses, providing periodic
statements showing the clients account balance and integrating these statements with those of other transactions and balances in the clients other accounts serviced by the Financial Intermediary, transmitting proxy statements, periodic
reports, updated prospectuses and other communications to shareholders and, with respect to meetings of shareholders, collecting, tabulating and forwarding executed proxies and obtaining such other information and performing such other services as
JPMDS or clients of the Financial Intermediary may reasonably request and agree upon with the Financial Intermediary.
Financial Intermediaries may establish their own terms and conditions for providing their services and may charge investors a
transaction-based or other fee for their services. Such charges may vary among Financial Intermediaries, but in all cases will be retained by the Financial Intermediary and will not be remitted to a Fund or JPMDS.
Certain Funds have authorized one or more Financial Intermediaries to accept purchase and redemption orders on their behalf. Such
Financial Intermediaries are authorized to designate other intermediaries to accept purchase and redemption orders on a Funds behalf. Such Funds will be deemed to have received a purchase or redemption order when a Financial Intermediary or,
if applicable, that Financial Intermediarys authorized designee accepts the order. These orders will be priced at the Funds NAV next calculated after they are so accepted.
The Funds may also enter into agreements with Financial Intermediaries pursuant to which the Funds will pay the Financial Intermediary for
services such as networking, sub-transfer agency and/or omnibus accounting. Payments made pursuant to such agreements are generally based on either (1) a percentage of the average daily net assets of clients serviced by such Financial
Intermediary up to a set maximum dollar amount per shareholder account serviced, or (2) the number of accounts serviced by such Financial Intermediary. Any payments made pursuant to such agreements are in addition to, rather than in lieu of,
Rule 12b-1 fees and shareholder servicing fees the Financial Intermediary may also be receiving pursuant to agreements with the Distributor and shareholder servicing agent, respectively. From time to time, JPMDS, JPMIM or their affiliates may pay a
portion of the fees for networking, sub-transfer agency and/or omnibus accounting at its or their own expense and out of its or their legitimate profits.
ADDITIONAL COMPENSATION TO FINANCIAL INTERMEDIARIES
JPMDS and JPMIM, at their own expense and out of their legitimate profits, may provide cash incentives (sometimes referred to as other cash compensation) to Financial Intermediaries.
Additional cash incentives may also be paid by other affiliates of JPMDS and JPMIM from time to time. Those additional cash incentives are payments over and above any sales charges (including 12b-1 fees), shareholder servicing, sub-transfer agency
or networking fees which are disclosed elsewhere in the Funds prospectuses or in this SAI. These additional cash payments are generally made to Financial Intermediaries that provide shareholder, sub-transfer agency or administrative services
or marketing support. Marketing support may include access to sales meetings, sales representatives and Financial Intermediary management representatives and/or for training and educating a Financial Intermediarys employees. Cash compensation
may also be paid to Financial Intermediaries for inclusion of the Funds on a sales list including a preferred or select sales list, in other sales programs or as an expense
Part II - 90
reimbursement in cases where the Financial Intermediary provides shareholder services to Fund shareholders. JPMIM and JPMDS may also pay cash compensation in the form of finders fees that
vary depending on the Fund and the dollar amount of shares sold. In addition, JPMDS may pay Financial Intermediaries an additional commission on the sale of Fund shares subject to a contingent deferred sales charge (CDSC). JPMIM and its
affiliates may pay any ticket charges applied to Fund shares.
Other cash compensation payments made by JPMDS, JPMIM and/or
their affiliates may be different for different Financial Intermediaries and may vary with respect to the type of fund (e.g., equity fund or fixed income fund) sold by the Financial Intermediary. Other cash compensation payments are usually
structured in one of three ways: (i) basis point payments on gross sales; (ii) basis point payments on net assets; and/or (iii) fixed dollar amount payments. Other cash compensation payments are always made only to the firm, never to
individuals.
For details of the amounts paid by the Funds Adviser and Distributor for all of the Funds pursuant to
their other cash compensation arrangements,
s
ee FINANCIAL INTERMEDIARIES Other Cash Compensation in Part I of this SAI.
To the extent permitted by the FINRA regulations, JPMIM, JPMDS and their affiliates may also pay non-cash compensation to sales representatives of Financial Intermediaries in the form of:
(i) occasional gifts; (ii) occasional meals, tickets or other entertainment; and/or (iii) sponsorship support of regional or national events of Financial Intermediaries or due diligence meetings.
If investment advisers, distributors or affiliates of mutual funds pay bonuses and incentives in differing amounts, Financial
Intermediaries and their financial consultants may have financial incentives for recommending a particular mutual fund over other mutual funds. In addition, depending on the arrangements in place at any particular time, a Financial Intermediary and
its financial consultants may also have a financial incentive for recommending a particular share class over the other share classes.
Finders Fees.
JPMDS may pay Financial Intermediaries who sell over $1 million of Class A Shares of certain Funds a finders fee. JPMDS reserves the right to alter or change the
finders fee policy at any time at its own discretion. If a plan redeems all of the shares for which a finders fee has been paid within 12 months of the purchase date, JPMDS will reclaim the finders fee paid to the Financial
Intermediary rather than charge a CDSC to the plan.
For details of finders fee commissions paid to Financial
Intermediaries, see FINANCIAL INTERMEDIARIES Finders Fee Commissions in Part I of this SAI.
For details of the finders fee amounts paid by the Adviser and Distributor for the Funds most recent fiscal year, see
FINANCIAL INTERMEDIARIES Finders Fee Commissions in Part I of this SAI.
TRUST COUNSEL
The law firm of Dechert LLP, 1095 Avenue of the Americas, New York, NY 10036-6797, is counsel to the
Trusts.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered public accounting firm for the Trusts and the Funds is PricewaterhouseCoopers LLP, 300 Madison Avenue, New
York, NY 10017. PricewaterhouseCoopers LLP conducts an annual audit of the financial statements of each of the Funds and assists in the preparation and/or review of each Funds federal and state income tax returns.
DIVIDENDS AND DISTRIBUTIONS
Each Fund declares and pays dividends and distributions as described under Distribution and Tax Matters in the Prospectuses. Dividends may differ between classes as a result of differences in
distribution expenses or other class-specific expenses.
Dividends and capital gains distributions paid by a Fund are
automatically reinvested in additional shares of the Fund unless the shareholder has elected to have them paid in cash. Dividends and distributions to be paid in cash are credited to the shareholders pre-assigned bank account or are mailed by
check in accordance with the customers instructions. The Funds reserve the right to discontinue, alter or limit the automatic reinvestment privilege at any time.
Part II - 91
If a shareholder has elected to receive dividends and/or capital gain distributions in cash
and the postal or other delivery service is unable to deliver checks to the shareholders address of record, such shareholders distribution option will automatically be converted to having all dividend and other distributions reinvested
in additional shares. No interest will accrue on amounts represented by uncashed distribution or redemption checks. With regard to Funds that accrue dividends daily, dividends will only begin to accrue after a Fund receives payment for shares. Once
a Fund distributes proceeds from a redemption, shares are no longer entitled to receive any dividends that are declared.
NET ASSET VALUE
Shares are sold at NAV per share, plus a sales charge, if any. This is also known as the offering
price. Shares are also redeemed at NAV, minus any applicable deferred sales charges. Each class of shares in each Fund has a different NAV. This is primarily because each class has class specific expenses such as distribution and shareholder
servicing fees.
The NAV per share of a class of a Fund is equal to the value of all the assets attributable to that class,
minus the liabilities attributable to that class, divided by the number of outstanding shares of that class. The following is a discussion of the procedures used by the Funds in valuing their assets.
Securities for which market quotations are readily available are generally valued at their current market value. Other securities and
assets, including securities for which market quotations are not readily available; market quotations are determined not to be reliable; or, their value has been materially affected by events occurring after the close of trading on the exchange or
market on which the security is principally traded (for example, a natural disaster affecting an entire country or region, or an event that affects an individual company) but before a Funds NAV is calculated, may be valued at its fair value in
accordance with policies and procedures adopted by the J.P. Morgan Funds Board of Trustees. Fair value represents a good faith determination of the value of a security or other asset based upon specifically applied procedures. Fair valuation
determinations may require subjective determinations. There can be no assurance that the fair value of an asset is the price at which the asset could have been sold during the period in which the particular fair value was used in determining the
Funds NAV.
Equity securities listed on a North American, Central American, South American or Caribbean
(Americas) securities exchange are generally valued at the last sale price on the exchange on which the security is principally traded that is reported before the time when the net assets of the Funds are valued. The value of securities
listed on the NASDAQ Stock Market, Inc. is generally the NASDAQ official closing price.
Generally, trading of foreign
securities on most foreign markets is completed before the close in trading in U.S. markets. The Funds have implemented fair value pricing on a daily basis for all equity securities other than Americas equity securities. The fair value pricing
utilizes the quotations of an independent pricing service. Trading on foreign markets may also take place on days on which the U.S. markets and the Funds are closed.
Shares of open-end investment companies are valued at their NAVs.
Fixed income
securities with a remaining maturity of 61 days or more are valued using market quotations supplied by approved independent third party pricing services, affiliated pricing services or broker/dealers. In determining security prices, pricing services
and broker/dealers may consider a variety of inputs and factors, including, but not limited to proprietary models that may take into account market transactions in securities with comparable characteristics, yield curves, option-adjusted spreads,
credit spreads, estimated default rates, coupon rates, underlying collateral and estimated cash flows.
Generally, short-term
securities which mature in 60 days or less are valued at amortized cost if their maturity at acquisition was 60 days or less, or by amortizing their value on the 61st day prior to maturity, if their maturity when acquired by a Fund was more than 60
days.
Assets and liabilities initially expressed in foreign currencies will be converted into U.S. dollars at the prevailing
market rates from an approved independent pricing service as of 4:00 PM ET.
Options (e.g., on stock indices, equity or debt
securities) traded on U.S. securities exchanges are valued at the last sale or close price at the close of options trading on such exchanges.
Options traded on foreign exchanges are valued at the settled price, or if no settled price is available, at the last sale price available prior to the calculation of a Funds NAV.
Part II - 92
Exchange traded futures (e.g., on stock indices, debt securities or commodities) are valued
at the settled price, or if no settled price is available, at the last sale price as of the close of the exchanges on which they trade.
Non-listed over-the-counter options and futures are valued at the evaluated price provided by a counterparty or broker/dealer.
Swaps and structured notes are priced generally by an approved independent third party or affiliated pricing service or at an evaluated price provided by a counterparty or broker/dealer.
Certain fixed income securities and swaps may be valued using market quotations or valuations provided by pricing services affiliated with
the Adviser. Valuations received by the Funds from affiliated pricing services are the same as those provided to other affiliated and unaffiliated entities by these affiliated pricing services.
The Money Market Funds portfolio securities are valued at their amortized cost. The purpose of this method of calculation is to
attempt to maintain a constant NAV per share of each Fund of $1.00. No assurances can be given that this goal can be attained. The amortized cost method of valuation values a security at its cost at the time of purchase and thereafter assumes an
amortization that would produce a constant yield to maturity of any discount or premium, regardless of the impact of fluctuating interest rates on the market value of the instrument. The Board of Trustees has established procedures and directed
certain officers of the Funds to monitor the differences between the NAVs calculated based on amortized cost and market value at predetermined intervals but no less frequently than weekly, and to report to the Board of Trustees such differences. If
a difference of more than 1/2 of 1% occurs between valuation based on the amortized cost method and valuation based on market value, the Board of Trustees may take steps necessary to reduce such deviation if it believes that such deviation will
result in material dilution or any unfair results to investors or existing shareholders. Actions that may be taken by the Board of Trustees include (i) redeeming shares in kind, (ii) selling portfolio instruments prior to maturity to
realize capital gains or losses or to shorten the average maturity of portfolio securities, (iii) withholding or supplementing dividends (iv) utilizing a net asset value per share as determined by using available market quotations, or
(v) reducing the number of outstanding Fund shares. Any reduction of outstanding shares will be accomplished by having each shareholder contribute to a Funds capital the necessary shares on a pro rata basis. Each shareholder will be
deemed to have agreed to such contribution in these circumstances by his or her investment in the Funds.
With respect to all
Funds, securities or other assets for which market quotations are not readily available or for which market quotations do not represent the value at the time of pricing (including certain illiquid securities) are fair valued in accordance with
procedures established by and under the supervision and responsibility of the Trustees. The Board of Trustees has established an Audit and Valuation Committee to assist the Board of Trustees in its oversight of the valuation of the Funds
securities. The Funds Administrator has established a Valuation Committee (VC) to (1) make fair value determinations in certain predetermined situations as outlined in the procedures approved by the Board of Trustees and
(2) provide recommendations to the Board of Trustees Audit and Valuation Committee in other situations. The VC includes senior representatives from the Funds management as well as the Funds investment adviser. Fair value
situations could include, but are not limited to: (1) a significant event that affects the value of a Funds securities (e.g., news relating to natural disasters affecting an issuers operations or earnings announcements);
(2) illiquid securities; (3) securities that may be defaulted or de-listed from an exchange and are no longer trading; or (4) any other circumstance in which the VC believes that market quotations do not accurately reflect the value
of a security.
DELAWARE TRUSTS
JPMT I and JPMT II.
JPMT I and JPMT II were each formed as Delaware statutory trusts on November 12, 2004 pursuant to separate
Declarations of Trust dated November 5, 2004. JPMT I assumed JPMMFS registration pursuant to the 1933 Act and the 1940 Act effective after the close of business on February 18, 2005, and JPMT II assumed One Group Mutual
Funds registration pursuant to the 1933 Act and the 1940 Act effective after the close of business on February 18, 2005.
Under Delaware law, shareholders of a statutory trust shall have the same limitation of personal liability that is extended to stockholders of private corporations for profit organized under Delaware law,
unless otherwise provided in the trusts governing trust instrument. JPMT Is and JPMT IIs Declarations of Trust each provides that shareholders of JPMT I and JPMT II shall not be personally liable for the debts, liabilities,
obligations and expenses incurred by, contracted for, or otherwise existing with respect to JPMT I or JPMT II or any series or class thereof. In addition, the Declarations of Trust each provides that neither JPMT I or JPMT II, nor the Trustees,
officers, employees, nor agents thereof shall have any power to bind personally any shareholders nor to call upon any
Part II - 93
shareholder for payment of any sum of money or assessment other than such as the shareholder may personally agree to pay. Moreover, Declarations of Trust for JPMT I and JPMT II each expressly
provide that the shareholders shall have the same limitation of personal liability that is extended to shareholders of a private corporation for profit incorporated in the State of Delaware.
The Declarations of Trust of JPMT I and JPMT II each provides for the indemnification out of the assets held with respect to a particular
series of shares of any shareholder or former shareholder held personally liable solely by reason of a claim or demand relating to the person being or having been a shareholder and not because of the shareholders acts or omissions. The
Declarations of Trust of JPMT I and JPMT II each also provide that JPMT I and JPMT II, on behalf of the applicable series, may, at its option with prior written notice, assume the defense of any claim made against a shareholder.
JPMT Is and JPMT IIs Declarations of Trust each provides that JPMT I and JPMT II will indemnify their respective Trustees and
officers against liabilities and expenses incurred in connection with any proceeding in which they may be involved because of their offices with JPMT I or JPMT II, unless, as to liability to JPMT I or JPMT II or the shareholders thereof, the
Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of their offices. In addition, the Declarations of Trust each provides that any Trustee who has been determined to be an
audit committee financial expert shall not be subject to a greater liability or duty of care because of such determination.
JPMT I and JPMT II shall continue without limitation of time subject to the provisions in the Declarations of Trust concerning termination by action of the shareholders or by action of the Trustees upon
written notice to the shareholders.
JPMT I is party to an Agreement and Plan of Investment and Transfer of Assets dated
January 17, 2006 pursuant to which it has agreed, out of the assets and property of certain Funds, to indemnify and hold harmless JPMorgan Chase Bank, in its corporate capacity and as trustee of certain common trust funds, and each of its
directors and officers, for any breach by JPMT I of its representations, warranties, covenants or agreements under such Agreement or any act, error, omission, neglect, misstatement, materially misleading statement, breach of duty or other act
wrongfully done or attempted to be committed by JPMT I or its Board of Trustees or officers, related to the transfer of assets from certain common trust funds to the respective Funds and other related transactions.
MASSACHUSETTS TRUSTS
JPMMFG and JPMMFIT.
JPMMFG and JPMMFIT are each organized as a Massachusetts business trust. The Growth Advantage Fund is a separate and distinct series of JPMMFIT. Copies of the Declarations of
Trust of each of JPMMFG and JPMMFIT are on file in the office of the Secretary of The Commonwealth of Massachusetts. The Declarations of Trust and By-laws of JPMMFG and JPMMFIT are designed to make JPMMFG and JPMMFIT similar in most respects to a
Massachusetts business corporation. The principal distinction between the two forms concerns shareholder liability as described below.
Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable as partners for the obligations of the trust, which is not the case for a corporation.
However, JPMMFGs and JPMMFITs Declarations of Trust provide that the shareholders shall not be subject to any personal liability for the acts or obligations of the Funds and that every written agreement, obligation, instrument or
undertaking made on behalf of the Funds shall contain a provision to the effect that the shareholders are not personally liable thereunder.
No personal liability will attach to the shareholders under any undertaking containing such provision when adequate notice of such provision is given, except possibly in a few jurisdictions. With respect
to all types of claims in the latter jurisdictions, (i) tort claims, (ii) contract claims where the provision referred to is omitted from the undertaking, (iii) claims for taxes, and (iv) certain statutory liabilities in other
jurisdictions, a shareholder may be held personally liable to the extent that claims are not satisfied by the Funds. However, upon payment of such liability, the shareholder will be entitled to reimbursement from the general assets of the Funds. The
Boards of Trustees intend to conduct the operations of JPMMFG and JPMMFIT in such a way so as to avoid, as far as possible, ultimate liability of the shareholders for liabilities of the Funds.
JPMMFGs and JPMMITs Declarations of Trust each provides that JPMMFG and JPMMFIT will each indemnify their respective Trustees
and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with JPMMFG or JPMMFIT, unless, as to liability to JPMMFG or JPMMFIT or their shareholders, it is finally
adjudicated that the Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices or with respect
Part II - 94
to any matter unless it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interests of JPMMFG or JPMMFIT. In the case of
settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or other disposition, or by a reasonable determination based upon a review of readily available facts, by vote of a
majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their duties.
JPMMFIT shall continue without limitation of time subject to the provisions in its Declarations of Trust concerning termination by action
of the shareholders or by action of the Trustees upon notice to the shareholders. JPMMFG liquidated effective November 29, 2012, and is in the process of winding up its affairs.
MARYLAND CORPORATION
JPMFMFG.
JPMFMFG is a diversified open-end management investment company which was organized as a Maryland corporation, on August 19, 1997. Effective
April 30, 2003, the name of JPMFMFG was changed from Fleming Mutual Fund Group, Inc. to J.P. Morgan Fleming Mutual Fund Group, Inc.
The Articles of Incorporation of JPMFMFG provide that a Director shall be liable only for his own willful defaults and, if reasonable care has been exercised in the selection of officers, agents,
employees or investment advisers, shall not be liable for any neglect or wrongdoing of any such person. The Articles of Incorporation also provide that JPMFMFG will indemnify its Directors and officers against liabilities and expenses incurred in
connection with actual or threatened litigation in which they may be involved because of their offices with JPMFMFG to the fullest extent permitted by law. However, nothing in the Articles of Incorporation shall protect or indemnify a Director
against any liability for his willful misfeasance, bad faith, gross negligence or reckless disregard of his duties.
DESCRIPTION OF SHARES
Shares of JPMT I and JPMT II.
JPMT I and JPMT II are
open-end, management investment companies organized as Delaware statutory trusts. Each Fund represents a separate series of shares of beneficial interest. See Delaware Trusts.
The Declarations of Trust of JPMT I and JPMT II each permits the Trustees to issue an unlimited number of full and fractional shares
($0.0001 par value) of one or more series and classes within any series and to divide or combine the shares of any series or class without materially changing the proportionate beneficial interest of such shares of such series or class in the assets
held with respect to that series. Each share represents an equal beneficial interest in the net assets of a Fund with each other share of that Fund. The Trustees of JPMT I and JPMT II may authorize the issuance of shares of additional series and the
creation of classes of shares within any series with such preferences, voting powers, rights, duties and privileges as the Trustees may determine; however, the Trustees may not classify or change outstanding shares in a manner materially adverse to
shareholders of each share. Upon liquidation of a Fund, shareholders are entitled to share pro rata in the net assets of a Fund available for distribution to such shareholders. The rights of redemption and exchange are described in the Prospectuses
and elsewhere in this SAI.
The shareholders of each Fund are entitled to one vote for each dollar of NAV (or a proportionate
fractional vote with respect to the remainder of the NAV of shares, if any), on matters on which shares of a Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees themselves have the power to alter the number and the terms of office
of the Trustees, to lengthen their own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided, however, that immediately after such appointment the requisite majority of
the Trustees have been elected by the shareholders of JPMT I or JPMT II, respectively. The voting rights of shareholders are not cumulative with respect to the election of Trustees. It is the intention of JPMT I and JPMT II not to hold meetings of
shareholders annually. The Trustees may call meetings of shareholders for action by shareholder vote as may be required by either the 1940 Act or the Declarations of Trust of JPMT I and JPMT II.
Each share of a series or class represents an equal proportionate interest in the assets in that series or class with each other share of
that series or class. The shares of each series or class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMTI and JPMT II which are not attributable to a specific series or class are
allocated among all of their series in a manner deemed by the Trustees to be fair and equitable. Shares have no pre-emptive or conversion rights, and when issued, are fully paid and non-assessable. Shares of each series or class generally vote
together, except when required under federal securities laws to vote
Part II - 95
separately on matters that may affect a particular class, such as the approval of distribution plans for a particular class.
The Trustees of JPMT I and JPMT II may, without shareholder approval (unless otherwise required by applicable law): (i) cause JPMT I
or JPMT II to merge or consolidate with or into one or more trusts (or series thereof to the extent permitted by law, partnerships, associations, corporations or other business entities (including trusts, partnerships, associations, corporations, or
other business entities created by the Trustees to accomplish such merger or consolidation) so long as the surviving or resulting entity is an investment company as defined in the 1940 Act, or is a series thereof, that will succeed to or assume JPMT
I or JPMT IIs registration under the 1940 Act and that is formed, organized, or existing under the laws of the U.S. or of a state, commonwealth, possession or territory of the U.S., unless otherwise permitted under the 1940 Act;
(ii) cause any one or more series or classes of JPMT I or JPMT II to merge or consolidate with or into any one or more other series or classes of JPMT I or JPMT II, one or more trusts (or series or classes thereof to the extent permitted by
law), partnerships, associations, corporations; (iii) cause the shares to be exchanged under or pursuant to any state or federal statute to the extent permitted by law; or (iv) cause JPMT I or JPMT II to reorganize as a corporation,
limited liability company or limited liability partnership under the laws of Delaware or any other state or jurisdiction. However, the exercise of such authority may be subject to certain restrictions under the 1940 Act.
The Trustees may, without shareholder vote, generally restate, amend or otherwise supplement JPMT I or JPMT IIs governing
instruments, including the Declarations of Trust and the By-Laws, without the approval of shareholders, subject to limited exceptions, such as the right to elect Trustees.
The Trustees, without obtaining any authorization or vote of shareholders, may change the name of any series or class or dissolve or terminate any series or class of shares.
Shares have no subscription or preemptive rights and only such conversion or exchange rights as the Board may grant in its discretion.
When issued for payment as described in the Prospectus and this SAI, JPMT Is and JPMT IIs Shares will be fully paid and non-assessable. In the event of a liquidation or dissolution of JPMT I or JPMT II, Shares of a Fund are entitled to
receive the assets available for distribution belonging to the Fund, and a proportionate distribution, based upon the relative asset values of the respective Funds, of any general assets not belonging to any particular Fund which are available for
distribution.
Rule 18f-2 under the 1940 Act provides that any matter required to be submitted to the holders of the
outstanding voting securities of an investment company such as JPMT I or JPMT II shall not be deemed to have been effectively acted upon unless approved by the holders of a majority of the outstanding Shares of each Fund affected by the matter. For
purposes of determining whether the approval of a majority of the outstanding Shares of a Fund will be required in connection with a matter, a Fund will be deemed to be affected by a matter unless it is clear that the interests of each Fund in the
matter are identical, or that the matter does not affect any interest of the Fund. Under Rule 18f-2, the approval of an investment advisory agreement or any change in investment policy would be effectively acted upon with respect to a Fund only if
approved by a majority of the outstanding Shares of such Fund. However, Rule 18f-2 also provides that the ratification of independent public accountants, the approval of principal underwriting contracts, and the election of Trustees may be
effectively acted upon by Shareholders of the Trust voting without regard to series.
Each share class of a Fund has exclusive
voting rights with respect to matters pertaining to the Funds Distribution and Shareholder Services Plans, Distribution Plans or Shareholder Services Plan applicable to those classes.
Shares of JPMMFIT.
JPMMFIT is an open-end, management investment company which is organized as a
Massachusetts business trust. The Growth Advantage Fund represents a separate series of shares of beneficial interest of JPMMFIT. See Massachusetts Trust.
The Declaration of Trust of JPMMFIT permits the Trustees to issue an unlimited number of full and fractional shares ($0.001 par value) of one or more series and classes within any series and to divide or
combine the shares (of any series, if applicable) without changing the proportionate beneficial interest of each shareholder in the Fund (or in the assets of other series, if applicable). Each share represents an equal proportional interest in the
Fund with each other share. Upon liquidation of the Fund, holders are entitled to share pro-rata in the net assets of the Fund available for distribution to such shareholders. See Massachusetts Trusts. The rights of redemption and
exchange are described in the Prospectuses and elsewhere in this SAI.
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The shareholders of the Fund are entitled to one vote for each whole share (with fractional
shares entitled to a proportionate fractional vote) on matters on which shares of the Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees themselves have the power to alter the number and the terms of office of the Trustees, to
lengthen their own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided, however, that immediately after such appointment the requisite majority of the Trustees have
been elected by the shareholders of JPMMFIT. The voting rights of shareholders are not cumulative so that holders of more than 50% of the shares voting can, if they choose, elect all Trustees being selected while the shareholders of the remaining
shares would be unable to elect any Trustees. It is the intention of JPMMFIT not to hold meetings of shareholders annually. The Trustees may call meetings of shareholders for action by shareholder vote as may be required by either the 1940 Act or
the Declarations of Trust.
Each share of a series or class represents an equal proportionate interest in that series or class
with each other share of that series or class. The shares of each series or class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMMFIT which are not attributable to a specific series or
class are allocated among all of its series in a manner believed by management of JPMMFIT to be fair and equitable. Shares have no pre-emptive or conversion rights. Shares when issued are fully paid and non-assessable, except as set forth below.
Shares of each series or class generally vote together, except when required under federal securities laws to vote separately on matters that may affect a particular class, such as the approval of distribution plans for a particular class.
The Trustees may, however, authorize the issuance of shares of additional series and the creation of classes of shares within
any series with such preferences, privileges, limitations and voting and dividend rights as the Trustees may determine. The proceeds from the issuance of any additional series would be invested in separate, independently managed Funds with distinct
investment objectives, policies and restrictions, and share purchase, redemption and net asset valuation procedures. Any additional classes would be used to distinguish among the rights of different categories of shareholders, as might be required
by future regulations or other unforeseen circumstances. All consideration received by the Fund for shares of any additional series or class, and all assets in which such consideration is invested, would belong to that series or class, subject only
to the rights of creditors of the Fund and would be subject to the liabilities related thereto. Shareholders of any additional series or class will approve the adoption of any management contract or distribution plan relating to such series or class
and of any changes in the investment policies related thereto, to the extent required by the 1940 Act.
Shareholders of the
Fund have the right, upon the declaration in writing or vote of more than two-thirds of its outstanding shares, to remove a Trustee. The Trustees will call a meeting of shareholders to vote on removal of a Trustee upon the written request of the
record holders of 10% of the Funds shares. In addition, whenever ten or more shareholders of record who have been such for at least six months preceding the date of application, and who hold in the aggregate either shares having a NAV of at
least $25,000 or at least 1% of JPMMFITs outstanding shares, whichever is less, shall apply to the Trustees in writing, stating that they wish to communicate with other shareholders with a view to obtaining signatures to request a meeting for
the purpose of voting upon the question of removal of the Trustee or Trustees and accompanied by a form of communication and request which they wish to transmit, the Trustees shall within five business days after receipt of such application either:
(1) afford to such applicants access to a list of the names and addresses of all shareholders as recorded on the books of the Trust; or (2) inform such applicants as to the approximate number of shareholders of record, and the approximate
cost of mailing to them the proposed communication and form of request. If the Trustees elect to follow the latter course, the Trustees, upon the written request of such applicants, accompanied by a tender of the material to be mailed and of the
reasonable expenses of mailing, shall, with reasonable promptness, mail such material to all shareholders of record at their addresses as recorded on the books, unless within five business days after such tender the Trustees shall mail to such
applicants and file with the SEC, together with a copy of the material to be mailed, a written statement signed by at least a majority of the Trustees to the effect that in their opinion either such material contains untrue statements of fact or
omits to state facts necessary to make the statements contained therein not misleading, or would be in violation of applicable law, and specifying the basis of such opinion. After opportunity for hearing upon the objections specified in the written
statements filed, the SEC may, and if demanded by the Trustees or by such applicants shall, enter an order either sustaining one or more of such objections or refusing to sustain any of them. If the SEC shall enter an order refusing to sustain any
of such objections, or if, after the entry of an order sustaining one or more of such objections, the SEC shall find, after notice and opportunity for hearing, that all objections so sustained have been met, and shall enter an order so declaring,
the Trustees shall mail copies of such material to all shareholders with reasonable promptness after the entry of such order and the renewal of such tender.
Part II - 97
For information relating to mandatory redemption of Fund shares or their redemption at the
option of JPMMFIT under certain circumstances, see Purchases, Redemptions and Exchanges.
Shares of JPMFMFG.
The Articles of Incorporation of JPMFMFG permit the classes of JPMFMFG to offer 812,500,000 shares of common stock, with $.001 par value per share. Pursuant to JPMFMFGs Articles of Incorporation, the Board may
increase the number of shares that the classes of JPMFMFG are authorized to issue without the approval of the shareholders of each class of JPMFMFG. The Board of Directors has the power to designate and redesignate any authorized but unissued shares
of capital stock into one or more classes of shares and separate series within each such class, to fix the number of shares in any such class or series and to classify or reclassify any unissued shares with respect to such class or series.
Each share of a series in JPMFMFG represents an equal proportionate interest in that series with each other share. Shares are
entitled upon liquidation to a pro rata share in the net assets of the series. Shareholders have no preemptive rights. All consideration received by JPMFMFG for shares of any series and all assets in which such consideration is invested would belong
to that series and would be subject to the liabilities related thereto. Share certificates representing shares will not be issued.
Under Maryland law, JPMFMFG is not required to hold an annual meeting of its shareholders unless required to do so under the 1940 Act.
Each share in each series of the Fund represents an equal proportionate interest in that series of the Fund with each other share of that
series of the Fund. The shares of each series and class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of JPMFMFG which are not attributable to a specific series or class are allocated among all
the series and classes in a manner believed by management of JPMFMFG to be fair and equitable. Shares of each series or class generally vote together, except when required by federal securities laws to vote separately on matters that may affect a
particular series or class differently, such as approval of a distribution plan.
PORTFOLIO
HOLDINGS DISCLOSURE
As described in the Prospectuses and pursuant to the procedures approved by the Trustees, each
business day, a Fund will make available to the public upon request to J.P. Morgan Funds Services or the J.P. Morgan Institutional Funds Service Center (1-800-480-4111 or 1-800-766-7722, as applicable) a complete, uncertified schedule of its
portfolio holdings as of the prior business day for the Money Market Funds and as of the last day of that prior month for all other Funds. In addition, from time to time, each Fund may post portfolio holdings on the J.P. Morgan Funds website
on a more timely basis.
The Funds publicly available uncertified, complete list of portfolio holdings information, as
described above, may also be provided regularly pursuant to a standing request, such as on a monthly or quarterly basis, to (i) third party service providers, rating and ranking agencies, financial intermediaries, and affiliated persons of the
Funds and (ii) clients of the Funds Adviser or its affiliates that invest in the Funds or such clients consultants. No compensation or other consideration is received by a Fund or the Funds Adviser, or any other person for
these disclosures.
For a list of the entities that receive the Funds portfolio holdings information, the frequency
with which it is provided and the length of the lag between the date of the information and the date it is disclosed, see PORTFOLIO HOLDINGS DISCLOSURE in Part I of this SAI.
In addition, certain service providers to the Funds or the Adviser, Administrator, Shareholder Servicing Agent or Distributor may for
legitimate business purposes receive the Funds portfolio holdings information earlier than the time period specified in the applicable prospectus, such as sub-advisers, rating and ranking agencies, pricing services, proxy voting service
providers, accountants, attorneys, custodians, securities lending agents, consultants retained to assist in the drafting of management discussion of fund performance in shareholder reports, brokers in connection with Fund transactions and in
providing pricing quotations, transfer agents and entities providing CDSC financing (released weekly one day after trade date). When a Fund redeems a shareholder in kind, the shareholder generally receives its proportionate share of the Funds
portfolio holdings and, therefore, the shareholder and its agent may receive such information earlier than the time period specified in the Prospectuses. Such holdings are released on conditions of confidentiality, which include appropriate trading
prohibitions. Conditions of confidentiality include confidentiality terms included in written agreements, implied by the nature of the relationship (e.g., attorneyclient relationship), or required by fiduciary or regulatory
principles (e.g., custody services provided by financial institutions).
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Disclosure of a Funds portfolio securities as an exception to the Funds normal
business practice requires the business unit proposing such exception to identify a legitimate business purpose for the disclosure and to submit the proposal to the Funds Treasurer for approval following business and legal review.
Additionally, no compensation or other consideration is received by a Fund or the Funds Adviser, or any other person for these disclosures. The Funds Trustees will review annually a list of such entities that have received such
information, the frequency of such disclosures and the business purpose therefor. These procedures are designed to address conflicts of interest between the Funds shareholders on the one hand and the Funds Adviser or any affiliated
person of the Fund or such entities on the other hand by creating a structured review and approval process which seeks to ensure that disclosure of information about the Funds portfolio securities is in the best interests of the Funds
shareholders. There can be no assurance, however, that a Funds policies and procedures with respect to the disclosure of portfolio holdings information will prevent the misuse of such information by individuals or firms in possession of such
information.
In addition to the foregoing, the portfolio holdings of certain of the Advisers separately managed account
investment strategies, which are the same or substantially similar to certain of the J.P. Morgan Funds, are made available on a more timely basis than the time period specified in the applicable prospectus. It is possible that any such recipient of
these holdings could trade ahead of or against a Fund based on the information received.
Finally, the Funds release
information concerning any and all portfolio holdings when required by law. Such releases may include providing information concerning holdings of a specific security to the issuer of such security. With regard to the Money Market Funds, beginning
in October 2010, not later than five business days after the end of each calendar month, each Fund will post detailed information regarding its portfolio holdings, as well as its dollar-weighted average maturity and dollar-weighted average life, as
of the last day of that month on the J.P. Morgan Funds website and provide a link to the SEC website where the most recent twelve months of publicly available information filed by the Fund may be obtained. In addition, beginning in
December 2010, not later than five business days after the end of each calendar month, each Money Market Fund will file a schedule of detailed information regarding its portfolio holdings as of the last day of that month with the SEC. These filings
will be publicly available on a delayed basis on the J.P. Morgan Funds website at www.jpmorganfunds.com and the SECs website 60 days after the end of each calendar month. In addition to information on portfolio holdings, no sooner than
10 days after month end, the Funds may post a portfolio characteristics summary to the J.P. Morgan Funds website at www.jpmorganfunds.com. In addition, other fund statistical information may be found on the J.P. Morgan Funds website
from time to time.
PROXY VOTING PROCEDURES AND GUIDELINES
The Board of Trustees has delegated to the Advisers and their affiliated advisers, proxy voting authority with respect to the Funds
portfolio securities. To ensure that the proxies of portfolio companies are voted in the best interests of the Funds, the Funds Board of Trustees has adopted the Advisers detailed proxy voting procedures (the Procedures) that
incorporate guidelines (Guidelines) for voting proxies on specific types of issues.
The Adviser and its affiliated
advisers are part of a global asset management organization with the capability to invest in securities of issuers located around the globe. Because the regulatory framework and the business cultures and practices vary from region to region, the
Guidelines are customized for each region to take into account such variations. Separate Guidelines cover the regions of (1) North America, (2) Europe, Middle East, Africa, Central America and South America, (3) Asia (ex-Japan) and
(4) Japan, respectively.
Notwithstanding the variations among the Guidelines, all of the Guidelines have been designed
with the uniform objective of encouraging corporate action that enhances shareholder value. As a general rule, in voting proxies of a particular security, the Adviser and its affiliated advisers will apply the Guidelines of the region in which the
issuer of such security is organized. Except as noted below, proxy voting decisions will be made in accordance with the Guidelines covering a multitude of both routine and non-routine matters that the Adviser and its affiliated advisers have
encountered globally, based on many years of collective investment management experience.
To oversee and monitor the
proxy-voting process, the Adviser has established a proxy committee and appointed a proxy administrator in each global location where proxies are voted. The primary function of each proxy committee is to review periodically general proxy-voting
matters, review and approve the Guidelines annually, and provide advice and recommendations on general proxy-voting matters as well as on specific voting issues. The procedures permit an independent voting service to perform certain services
otherwise carried out or coordinated by the proxy administrator.
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Although for many matters the Guidelines specify the votes to be cast, for many others, the
Guidelines contemplate case-by-case determinations. In addition, there will undoubtedly be proxy matters that are not contemplated by the Guidelines. For both of these categories of matters and to override the Guidelines, the Procedures require a
certification and review process to be completed before the vote is cast. That process is designed to identify actual or potential material conflicts of interest (between the Fund on the one hand, and the Funds investment adviser, principal
underwriter or an affiliate of any of the foregoing, on the other hand) and ensure that the proxy vote is cast in the best interests of the Fund. A conflict is deemed to exist when the proxy is for JPMorgan Chase & Co. stock or for J.P. Morgan
Funds, or when the proxy administrator has actual knowledge indicating that a JPMorgan affiliate is an investment banker or rendered a fairness opinion with respect to the matter that is the subject of the proxy vote. When such conflicts are
identified, the proxy will be voted by an independent third party either in accordance with JPMorgan proxy voting guidelines or by the third party using its own guidelines.
When other types of potential material conflicts of interest are identified, the proxy administrator and JPMAMs Chief Fiduciary Officer will evaluate the potential conflict of interest and determine
whether such conflict actually exists, and if so, will recommend how the Adviser will vote the proxy. In addressing any material conflict, the Adviser may take one or more of the following measures (or other appropriate action): removing or
walling off from the proxy voting process certain Adviser personnel with knowledge of the conflict, voting in accordance with any applicable Guideline if the application of the Guideline would objectively result in the casting of a proxy
vote in a predetermined manner, or deferring the vote to or obtaining a recommendation from an third independent party, in which case the proxy will be voted by, or in accordance with the recommendation of, the independent third party.
The following summarizes some of the more noteworthy types of proxy voting policies of the non-U.S. Guidelines:
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Corporate governance procedures differ among the countries. Because of time constraints and local customs, it is not always possible for the Adviser to
receive and review all proxy materials in connection with each item submitted for a vote. Many proxy statements are in foreign languages. Proxy materials are generally mailed by the issuer to the sub-custodian which holds the securities for the
client in the country where the portfolio company is organized, and there may not be sufficient time for such materials to be transmitted to the Adviser in time for a vote to be cast. In some countries, proxy statements are not mailed at all, and in
some locations, the deadline for voting is two to four days after the initial announcement that a vote is to be solicited and it may not always be possible to obtain sufficient information to make an informed decision in good time to vote.
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Certain markets require that shares being tendered for voting purposes are temporarily immobilized from trading until after the shareholder meeting has
taken place. Elsewhere, notably emerging markets, it may not always be possible to obtain sufficient information to make an informed decision in good time to vote. Some markets require a local representative to be hired in order to attend the
meeting and vote in person on our behalf, which can result in considerable cost.
The Adviser also considers the cost of voting in light of the expected benefit of the vote. In certain instances, it may sometimes be in the
Funds best interests to intentionally refrain from voting in certain overseas markets from time to time.
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Where proxy issues concern corporate governance, takeover defense measures, compensation plans, capital structure changes and so forth, the Adviser
pays particular attention to managements arguments for promoting the prospective change. The Advisers sole criterion in determining its voting stance is whether such changes will be to the economic benefit of the beneficial owners of the
shares.
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The Adviser is in favor of a unitary board structure of the type found in the United Kingdom as opposed to tiered board structures. Thus, the Adviser
will generally vote to encourage the gradual phasing out of tiered board structures, in favor of unitary boards. However, since tiered boards are still very prevalent in markets outside of the United Kingdom, local market practice will always be
taken into account.
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The Adviser will use its voting powers to encourage appropriate levels of board independence, taking into account local market practice.
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The Adviser will usually vote against discharging the board from responsibility in cases of pending litigation, or if there is evidence of wrongdoing
for which the board must be held accountable.
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Part II - 100
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The Adviser will vote in favor of increases in capital which enhance a companys long-term prospects. The Adviser will also vote in favor of the
partial suspension of preemptive rights if they are for purely technical reasons (e.g., rights offers which may not be legally offered to shareholders in certain jurisdictions). However, the Adviser will vote against increases in capital which would
allow the company to adopt poison pill takeover defense tactics, or where the increase in authorized capital would dilute shareholder value in the long term.
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The Adviser will vote in favor of proposals which will enhance a companys long-term prospects. The Adviser will vote against an increase in bank
borrowing powers which would result in the company reaching an unacceptable level of financial leverage, where such borrowing is expressly intended as part of a takeover defense, or where there is a material reduction in shareholder value.
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The Adviser will generally vote against anti-takeover devices.
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Where social or environmental issues are the subject of a proxy vote, the Adviser will consider the issue on a case-by-case basis, keeping in mind at
all times the best economic interests of its clients.
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The following summarizes some of the more noteworthy
types of proxy voting policies of the U.S. Guidelines:
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The Adviser considers votes on director nominees on a case-by-case basis. Votes generally will be withheld from directors who: (a) attend less
than 75% of board and committee meetings without a valid excuse; (b) implement or renew a dead-hand poison pill; (c) are affiliated directors who serve on audit, compensation or nominating committees or are affiliated directors and the
full board serves on such committees or the company does not have such committees; or (d) ignore a shareholder proposal that is approved for two consecutive years by a majority of either the shares outstanding or the votes cast.
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The Adviser votes proposals to classify boards on a case-by-case basis, but normally will vote in favor of such proposal if the issuers governing
documents contain each of eight enumerated safeguards (for example, a majority of the board is composed of independent directors and the nominating committee is composed solely of such directors).
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The Adviser also considers management poison pill proposals on a case-by-case basis, looking for shareholder-friendly provisions before voting in
favor.
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The Adviser votes against proposals for a super-majority vote to approve a merger.
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The Adviser considers proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan on a case-by-case
basis, taking into account such factors as the extent of dilution and whether the transaction will result in a change in control.
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The Adviser votes proposals on a stock option plan based primarily on a detailed, quantitative analysis that takes into account factors such as
estimated dilution to shareholders equity and dilution to voting power. The Adviser generally considers other management compensation proposals on a case-by-case basis.
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The Adviser also considers on a case-by-case basis proposals to change an issuers state of incorporation, mergers and acquisitions and other
corporate restructuring proposals and certain social and environmental issue proposals.
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The Adviser reviews Say on Pay proposals on a case by case basis with additional review of proposals where the issuers previous years
proposal received a low level of support.
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HCM.
The Board of Trustees
has delegated to HCM proxy voting authority with respect to portfolio securities of the Highbridge Dynamic Commodities Strategy Fund and the Highbridge Statistical Market Neutral Fund. HCMs proxy voting policy is as follows (HCM being referred
to as the Firm):
HCM exercises voting authority over client proxies with one important
consideration in mind: to ensure that proxies are voted in the best interests of clients.
Voting by
Independent Third Party
.
HCM has engaged Institutional Shareholder Services, Inc. (ISS) to review and vote proxies received by HCM on behalf of certain clients. HCM has confirmed that ISS has the experience, capacity and
competence to vote proxies. ISS has represented that it will not provide this service in connection with any proxy concerning a company for which it provides substantial services, or with which it otherwise has a relationship that would
preclude it from making recommendations in an impartial manner and
Part II - 101
in the best interests of the Firms clients. The Firm has no affiliation or material business, professional or other relationship with ISS. ISS has also undertaken to inform the
HCM Compliance Department of any relationship it has or may have in the future with any company for which ISS proposes to provide proxy voting recommendations (including any compensation received or to be received from such company).
ISS is responsible for making sure proxies are voted in a timely manner. ISS determines how to vote proxies on behalf
of clients pursuant to predetermined guidelines and will post its proposed vote on its website. The Firm has access to the ISS website and is able to regularly review a record of the proxies and votes cast.
Portfolio Manager Override
.
Portfolio Managers requests to vote a particular proxy in a manner that is
different from the proposed vote of ISS are required to follow additional procedures to ensure a material conflict of interest does not exist. The Portfolio Manager will be required to confirm that neither they nor HCM (to the best of their
knowledge) has a material conflict of interest with the parties involved in the proxy contest.
Material
conflicts of interest between HCM, its supervised persons and its clients will be resolved as follows:
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Where the conflict of interest is among the Firm, the Firm will abstain from changing the ISS vote determination or abstain from voting at all; and
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Where the conflict of interest is a personal conflict involving the Portfolio Manager, the Portfolio Manager will abstain from the voting decision, and
the HCM Compliance Department will determine whether to vote the proxy or allow ISS to vote the proxy.
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Recordkeeping
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The Firm will retain copies of (i) its proxy voting policies and procedures and all amendments thereto; (ii) records of votes cast by ISS and the Firm on behalf of Clients;
(iii) records of Client requests for proxy voting information; (iv) any records relating to the qualification of ISS and how it addresses material conflicts of interest; and (v) records relating to how the Firm addressed material conflicts of
interest.
In accordance with regulations of the SEC, the Funds proxy voting records for the most recent 12-month period
ended June 30 are on file with the SEC and are available on the J.P. Morgan Funds website at www.jpmorganfunds.com and are on the SECs website at www.sec.gov.
ADDITIONAL INFORMATION
A Trust is not
required to hold a meeting of Shareholders for the purpose of electing Trustees except that (i) a Trust is required to hold a Shareholders meeting for the election of Trustees at such time as less than a majority of the Trustees holding
office have been elected by Shareholders and (ii) if, as a result of a vacancy on the Board of Trustees, less than two-thirds of the Trustees holding office have been elected by the Shareholders, that vacancy may only be filled by a vote of the
Shareholders. In addition, Trustees may be removed from office by a written consent signed by the holders of Shares representing two-thirds of the outstanding Shares of a Trust at a meeting duly called for the purpose, which meeting shall be called
and held in accordance with the bylaws of the applicable Trust. Except as set forth above, the Trustees may continue to hold office and may appoint successor Trustees.
As used in a Trusts Prospectuses and in this SAI, assets belonging to a Fund means the consideration received by a Trust upon the issuance or sale of Shares in that Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof, including any proceeds from the sale, exchange, or liquidation of such investments, and any funds or payments derived from any reinvestment of such proceeds, and any
general assets of a Trust not readily identified as belonging to a particular Fund that are allocated to that Fund by a Trusts Board of Trustees. The Board of Trustees may allocate such general assets in any manner it deems fair and equitable.
It is anticipated that the factor that will be used by the Board of Trustees in making allocations of general assets to particular Funds will be the relative net asset values of the respective Funds at the time of allocation. Assets belonging to a
particular Fund are charged with the direct liabilities and expenses in respect of that Fund, and with a share of the general liabilities and expenses of a Trust not readily identified as belonging to a particular Fund that are allocated to that
Fund in proportion to the relative net asset values of the respective Funds at the time of allocation. The timing of allocations of general assets and general liabilities and expenses of a Trust to particular Funds will be determined by the Board of
Trustees of a Trust and will be in accordance with generally accepted accounting principles. Determinations by the Board of Trustees of a Trust as to the timing of the allocation of general liabilities and expenses and as to the timing and allocable
portion of any general assets with respect to a particular Fund are conclusive.
Part II - 102
As used in this SAI and the Prospectuses, the term majority of the outstanding voting
securities of the Trust, a particular Fund or a particular class of a Fund means the following when the 1940 Act governs the required approval: the affirmative vote of the lesser of (a) more than 50% of the outstanding shares of the
Trust, such Fund or such class of such Fund, or (b) 67% or more of the shares of the Trust, such Fund or such class of such Fund present at a meeting at which the holders of more than 50% of the outstanding shares of the Trust, such Fund or
such class of such Fund are represented in person or by proxy. Otherwise, the declaration of trust, articles of incorporation or by-laws usually govern the needed approval and generally require that if a quorum is present at a meeting, the vote of a
majority of the shares of the Trust, such Fund or such class of such Fund, as applicable, shall decide the question.
Telephone
calls to the Funds, the Funds service providers or a Financial Intermediary as Financial Intermediary may be recorded. With respect to the securities offered hereby, this SAI and the Prospectuses do not contain all the information included in
the Registration Statements of the Trusts filed with the SEC under the 1933 Act and the 1940 Act. Pursuant to the rules and regulations of the SEC, certain portions have been omitted. The Registration Statement including the exhibits filed therewith
may be examined at the office of the SEC in Washington, D.C.
Statements contained in this SAI and the Prospectuses concerning
the contents of any contract or other document are not necessarily complete, and in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statements of the Trusts. Each such statement
is qualified in all respects by such reference.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in the Prospectuses and this SAI, in connection with the offer contained therein and, if given or made, such other information or representations must not be relied upon as
having been authorized by any of the Trusts, the Funds or JPMDS. The Prospectuses and this SAI do not constitute an offer by any Fund or by JPMDS to sell or solicit any offer to buy any of the securities offered hereby in any jurisdiction to any
person to whom it is unlawful for the Funds or JPMDS to make such offer in such jurisdictions.
Part II - 103