INVESTMENT STRATEGIES AND RISKS
The Fund’s Prospectuses discuss the investment objective of the Fund and the principal strategies to be employed to achieve that objective. This SAI
contains supplemental information concerning certain types of securities and other instruments in which the Fund may invest, additional strategies that the Fund may utilize in seeking to achieve its investment objective, and certain risks associated
with such investments and strategies. Subject to the investment policies and restrictions contained in the Prospectuses and herein, the Fund may invest in any of the securities described below.
The Fund’s debt securities may include obligations issued or guaranteed by the United States government, its agencies or instrumentalities
(including repurchase agreements secured by such instruments); obligations issued or guaranteed by a foreign government or any of its political subdivisions, agencies, or instrumentalities; and obligations (including convertible securities) of
domestic and foreign corporations, banks, thrift institutions, savings and loan institutions, finance companies, and supranational organizations.
In determining whether the Fund should invest in particular debt securities, the Adviser considers factors such as: the price, coupon and yield to maturity; its assessment of the credit quality of the
issuer; the issuer’s available cash flow and the related coverage ratios; the property, if any, securing the obligation; and the terms of the debt securities, including the subordination, default, sinking fund, and early redemption provisions.
It also will review the ratings, if any, assigned to the securities by Moody’s Investors Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Service (“S&P”), a division of McGraw Hill Companies,
Inc., or other recognized rating agencies. The judgment of the Adviser as to credit quality of a debt security may differ, however, from that suggested by the ratings published by a rating service.
In addition, the Fund may invest up to 25% of its total assets, measured at the time of investment, in a single industry, subject to certain exceptions.
The Fund may invest in a limited number of industries and the Fund may be more susceptible to any single economic, political, or regulatory occurrence than more widely diversified funds.
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The Fund intends to conduct its operations so as to qualify as a “regulated investment company”
for purposes of the Internal Revenue Code of 1986, as amended (the “Code”), which will relieve the Fund of any liability for federal income taxes to the extent its earnings are distributed to shareholders. To so qualify, among other
requirements, the Fund will limit its investments so that, at the close of each quarter of the taxable year, (i) not more than 25% of the market value of the Fund’s total assets will be invested in the securities of a single issuer, two or
more controlled issuers engaged in the same, similar, or related trades or businesses, or the securities of one or more qualified publicly-traded partnerships and (ii) with respect to 50% of the market value of its total assets, not more than
5% of the market value of its total assets will be invested in the securities of a single issuer and the Fund will not own more than 10% of the outstanding voting securities of a single issuer. The Fund’s investments in securities of the United
States government, its agencies or instrumentalities or other regulated investment companies are not subject to these limitations.
In many
instances, the Adviser will rely on ratings of debt securities and preferred stock in making its investment decisions. In analyzing unrated debt securities or preferred stock, the Adviser may consider the issuer’s experience and managerial
strength, changing financial condition, borrowing requirements, or debt maturity schedules, and its responsiveness to changes in business conditions and interest rates. The Adviser may also consider relative values based on anticipated cash flow,
interest or dividend coverage, and asset coverage and earnings prospects.
Certain Investment Techniques
The use of investment techniques such as engaging in financial futures and options and currency transactions, purchasing securities on a forward
commitment basis, lending portfolio securities, purchasing foreign securities, investing in illiquid securities, utilizing certain other specialized instruments and engaging in short-selling and leverage through borrowing, involves greater risk than
that incurred by many other funds with similar objectives to the Fund. In addition, using these techniques may produce higher than normal portfolio turnover and may affect the degree to which the Fund’s net asset value per share
(“NAV”) fluctuates. Higher portfolio turnover rates are likely to result in comparatively greater brokerage commissions or transaction costs. Short-term gains realized from portfolio transactions are taxable to shareholders as ordinary
income.
Lower Rated Securities
The Fund is permitted to invest in securities rated below Baa by Moody’s and below BBB by S&P. Such securities, though higher yielding, are characterized by risk. These securities, commonly
referred to as “junk bonds”, provide yields superior to those of more highly rated securities, but involve greater risks (including the possibility of default or bankruptcy of the issuers of such securities) and are regarded as speculative
in nature. While the market values of securities rated below investment grade and comparable unrated securities tend to react less to fluctuations in interest rate levels than do those of higher-rated securities, the market values of certain of
these securities also tend to be more sensitive to individual corporate developments and changes in economic conditions than higher rated securities. In addition, the markets in which securities rated below investment grade and comparable unrated
securities are traded are generally more limited than those in which higher rated securities are traded. Because of risks associated with an investment in securities rated below investment grade and comparable unrated securities, an investment in
the Fund should not be considered as a complete investment program and may not be appropriate for all investors.
Although ratings may be
useful in evaluating the safety of interest and principal payments, they do not evaluate the market value risk of these securities. The Fund will rely on the Adviser’s judgment, analysis, and experience in evaluating the creditworthiness of an
issuer. In this evaluation, the Adviser will take into consideration, among other things, the issuer’s financial resources, its sensitivity to economic conditions and trends, its operating history, and the quality of the issuer’s
management and regulatory matters. It also is possible that a rating agency might not timely change the rating on a particular issue to reflect subsequent events. Once the rating of a security in the Fund’s portfolio has been changed, the
Adviser will consider all circumstances deemed relevant in determining whether the Fund should continue to hold the security.
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The Fund is not subject to any limit on the percentage of its assets that may be invested in debt securities
having a certain rating. Thus, it is possible that a substantial portion of the Fund’s assets may be invested in debt securities that are unrated or rated in the lowest categories of the recognized rating agency, i.e., securities rated C by
Moody’s or D by S&P. The Fund intends to invest less than 35% of its assets in debt securities rated Ba or lower by Moody’s or BB or lower by S&P. The Adviser’s decision to invest in lower rated securities is not subject to
shareholder approval.
The market values of many of these securities tend to be more sensitive to economic conditions than are higher rated
securities and will fluctuate more over time. These securities are considered by S&P and Moody’s, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the
obligation and generally will involve more credit risk than securities in the higher rating categories.
You should carefully consider the
relative risks of the Fund investing in higher yielding (and, therefore, higher risk) debt securities. Lower rated securities are rated Ba by Moody’s or BB by S&P or as low as the lowest rating assigned by Moody’s or S&P. They
generally are not meant for short-term investing and may be subject to certain risks with respect to the issuing entity and to greater market fluctuations than certain lower yielding, higher rated fixed-income securities. Obligations rated Ba by
Moody’s are judged to have speculative elements; their future cannot be considered as well assured and often the protection of interest and principal payments may be very moderate. Obligations rated BB by S&P are regarded as having
predominantly speculative characteristics and, while such obligations have less near-term vulnerability to default than other speculative grade debt, they face major ongoing uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to inadequate capacity to meet timely interest and principal payments. Obligations rated C by Moody’s are regarded as having extremely poor prospects of ever attaining any real investment standing. Obligations rated
D by S&P are in default and the payment of interest and/or repayment of principal are in arrears. Such obligations, though high yielding, are characterized by great risk. See “Description of Bond and Commercial Paper Ratings” for a
general description of Moody’s and S&P securities ratings. The ratings of Moody’s and S&P represent their opinions as to the quality of the securities, which they undertake to rate. It should be emphasized, however, that ratings
are relative and subjective and, although ratings may be useful in evaluating the safety of interest and principal payments, they do not evaluate the market value risk of these securities. Therefore, although these ratings may be an initial
criterion for selection of portfolio investments, the Adviser also will evaluate these securities and the ability of the issuers of such securities to pay interest and principal. The Fund’s ability to achieve their investment objectives may be
more dependent on the Adviser’s credit analysis than might be the case for funds that invested in higher rated securities.
Companies
that issue certain of these securities often are highly leveraged and may not have available to them more traditional methods of financing. Therefore, the risk associated with acquiring the securities of such issuers generally is greater than is the
case with higher rated securities. For example, during an economic downturn or a sustained period of rising interest rates, highly leveraged issuers of these securities may experience financial stress. During such periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer’s ability to service its debt obligations also may be affected adversely by specific corporate developments or the issuer’s inability to meet specific projected
business forecasts, or the unavailability of additional financing. The risk of loss because of default by the issuer is significantly greater for the holders of these securities because such securities generally are unsecured and often are
subordinated to other creditors of the issuer.
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Such securities are generally traded only among dealers and institutional investors. The secondary trading
market for these securities generally is not as liquid as the secondary market for higher rated securities. The weaker secondary market may have an adverse impact on market price and a Fund’s ability to dispose of particular issues when
necessary to meet that fund’s liquidity needs or in response to a specific economic event such as deterioration in the creditworthiness of the issuer. The weaker secondary market also may make it more difficult for a fund to obtain accurate
market quotations for purposes of valuing that fund’s portfolio and calculating its NAV. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may further decrease the values and liquidity of these
securities.
The market values of certain lower rated debt securities tend to reflect individual corporate developments to a greater extent
than do higher rated securities, which react primarily to fluctuations in the general level of interest rates, and tend to be more sensitive to economic conditions than are higher rated securities.
The Fund may acquire these securities during an initial offering. Such securities may involve special risks because they are new issues. The Fund has no
arrangement with any persons concerning the acquisition of such securities, and the Adviser will review carefully the credit and other characteristics pertinent to such new issues.
Lower rated zero coupon securities and pay-in-kind bonds (in which the Capital Value Fund is limited to 5% of its total assets) involve special considerations. Such zero coupon securities, pay-in-kind, or
delayed interest bonds carry an additional risk in that, unlike bonds which pay interest throughout the period to maturity, the Fund will realize no cash until the cash payment date unless a portion of such securities are sold and, if the issuer
defaults, the Fund may obtain no return at all on their investment.
U.S. Government Securities
Securities issued or guaranteed by the U.S. government or its agencies or instrumentalities include U.S. Treasury securities, which differ in their
interest rates, maturities, and times of issuance. Some obligations issued or guaranteed by U.S. government agencies and instrumentalities, for example, Government National Mortgage Association pass-through certificates, are supported by the full
faith and credit of the U.S. Treasury; others, such as those of the Federal Home Loan Banks, by the right of the issuer to borrow from the Treasury; others, such as those issued by the Federal National Mortgage Association, by discretionary
authority of the U.S. government to purchase certain obligations of the agency or instrumentality; and others, such as those issued by the Student Loan Marketing Association, only by the credit of the agency or instrumentality. These securities bear
fixed, floating, or variable rates of interest. Principal and interest may fluctuate based on generally recognized reference rates or the relationship of rates. While the U.S. government provides financial support to such U.S. government sponsored
agencies and instrumentalities, no assurance can be given that it will always do so since it is not so obligated by law. The Fund will invest in such securities only when it is satisfied that the credit risk with respect to the issuer is minimal.
On September 7, 2008, the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association
(“FNMA”) were placed into conservatorship by their new regulator, the Federal Housing Finance Agency (“FHFA”), an agency of the U.S. government, with a stated purpose to preserve and conserve FHLMC’s and FNMA’s assets
and property and to put them in a sound and solvent condition. The U.S. Treasury has made a commitment of indefinite duration to maintain the positive net worth of FHLMC and FNMA in exchange for senior preferred stock and warrants for common stock
of the entities. No assurance can be given that the purposes of the conservatorship and related actions under the authority of FHFA will be met or that the U.S. Treasury’s initiative will be successful. The future status and role of FHLMC and
FNMA could be impacted by (among other things) the actions taken and restrictions placed on FHLMC and FNMA by the FHFA in its role as conservator, the restrictions placed on FHLMC’s and FNMA’s operations and activities under stock purchase
agreements with the FHFA, market responses to developments at FHLMC and FNMA, 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 securities guaranteed by FHLMC and FNMA.
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Foreign Securities
The Fund may invest up to 65% of its assets, in foreign securities, including securities of emerging market issuers. The Fund’s investments in foreign and emerging market securities involve certain
other considerations and risks not typically associated with investing in domestic securities, including: greater price volatility; uncertainties regarding future social, political and economic developments; the possible imposition of foreign
withholding or brokerage taxes or exchange controls; risks of seizure or expropriation; the availability of less information than is generally available in the U.S. and a lack of uniform accounting and auditing standards; higher transaction costs
and possible delays or problems with settlement; limited liquidity and relatively small market capitalization of securities markets; high rates of inflation and interest; less government supervision of exchanges, brokers and issuers; difficulty in
enforcing contractual obligations; and the possible adverse effects of changes in the exchange rates of foreign currencies in which the Fund’s investments may be denominated. All of these risks are greater in emerging markets.
Many countries providing investment opportunities for the Fund have experienced substantial, and in some periods extremely high, rates of inflation for
many years. Inflation and rapid fluctuations in inflation rates have had and may continue to have adverse effects on the economies and securities markets of certain of these countries. In an attempt to control inflation, wage and price controls have
been imposed in certain countries.
Because stock certificates and other evidences of ownership of such securities usually are held outside
the United States, the Fund will be subject to additional risks which include possible adverse political and economic developments, possible seizure or nationalization of foreign deposits, and possible adoption of governmental restrictions which
might adversely affect the payment of principal and interest on the foreign securities or might restrict the payment of principal and interest to investors located outside the country of the issuer, whether from currency blockage or otherwise.
Custodial expenses for a portfolio of non-U.S. securities generally are higher than for a portfolio of U.S. securities.
By investing in
foreign securities, the Fund will be exposed to the direct or indirect consequences of political, social, and economic changes in various countries. Political changes in a country may affect the willingness of a foreign government to make or provide
for timely payments of its obligations. The country’s economic status, as reflected, among other things, in its inflation rate, the amount of its external debt, and its gross domestic product, will also affect the government’s ability to
honor its obligations.
No established secondary markets may exist for many of the foreign securities in which the Fund may invest. Reduced
secondary market liquidity may have an adverse effect on the market price and a Fund’s ability to dispose of particular instruments when necessary to meet its liquidity requirements or in response to specific economic events such as
deterioration in the creditworthiness of the issuer. Reduced secondary market liquidity for certain foreign securities also may make it more difficult for a Fund to obtain accurate market quotations for purposes of valuing its portfolio. Market
quotations are generally available on many foreign securities only from a limited number of dealers and may not necessarily represent firm bids of those dealers or prices for actual sales.
Since foreign securities often are purchased with and payable in currencies of foreign countries, the value of these assets as measured in U.S. dollars may be affected favorably or unfavorably by changes
in currency rates and exchange control regulations. Some currency exchange costs may be incurred when the Fund changes investments from one country to another.
Furthermore, some of these securities may be subject to brokerage taxes levied by foreign governments, which have the effect of increasing the cost of such investment and reducing the realized gain or
increasing the realized loss on such securities at the time of sale. Income received by the Fund from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries
and the United States, however, may reduce or eliminate such taxes. All such taxes paid by the Fund will reduce its net income available for distribution to its shareholders.
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Currency exchange rates may fluctuate significantly over short periods of time. They generally are
determined by the forces of supply and demand in the foreign exchange markets and the relative merits of investments in different countries, actual or perceived changes in interest rates and other complex factors, as seen from an international
perspective. Currency exchange rates also can be affected unpredictably by intervention by U.S. or foreign governments or central banks or the failure to intervene or by currency controls or political developments in the U.S. or abroad.
Foreign currency markets offer less protection against defaults in the forward trading of currencies than is available when trading in currencies occurs
on an exchange. Since a forward currency contract is not guaranteed by an exchange or clearinghouse, a default on the contract would deprive the Fund of unrealized profits or force the Fund to cover its commitments for purchase or resale, if any, at
the current market price.
Emerging markets will include any countries (i) having an “emerging stock market” as defined by the
International Finance Corporation; (ii) with low to middle-income economies according to the World Bank; or (iii) listed in World Bank publications as developing. Issuers whose principal activities are in countries with emerging markets
include issuers: (1) organized under the laws of, (2) whose securities have their primary trading market in, (3) deriving at least 50% of their revenues or profits from goods sold, investments made, or services performed in, or
(4) having at least 50% of their assets located in, a country with an emerging market. In emerging markets, the Fund may also purchase debt securities issued or guaranteed by foreign governments, including participations in loans between
foreign governments and financial institutions, and interests in entities organized and operated for the purpose of restructuring the investment characteristics of instruments issued or guaranteed by foreign governments (“Sovereign Debt
Obligations”). These include Brady Bonds, Structured Investments, and Loan Participations and Assignments (as defined below). See “Brady Bonds and Emerging Market Governmental Obligations,” “Structured Investments,” and
“Loan Participations and Assignments” below.
Investing in Sovereign Debt Obligations involves economic and political risks. The
Sovereign Debt Obligations in which the Fund will invest in most cases pertain to countries that are among the world’s largest debtors to commercial banks, foreign governments, international financial organizations, and other financial
institutions. In recent years, the governments of some of these countries have encountered difficulties in servicing their external debt obligations, which led to defaults on certain obligations and the restructuring of certain indebtedness.
Restructuring arrangements have included, among other things, reducing and rescheduling interest and principal payments by negotiating new or amended credit agreements or converting outstanding principal and unpaid interest to Brady Bonds, and
obtaining new credit to finance interest payments. Certain governments have not been able to make payments of interest on or principal of Sovereign Debt Obligations as those payments have come due. Obligations arising from past restructuring
agreements may affect the economic performance and political and social stability of those issuers. The ability of governments to make timely payments on their obligations is likely to be influenced strongly by the issuer’s balance of payments,
including export performance, and its access to international credits and investments. A country whose exports are concentrated in a few commodities could be vulnerable to a decline in the international prices of one or more of those commodities.
Increased protectionism on the part of a country’s trading partners also could adversely affect the country’s exports and diminish its trade account surplus, if any. To the extent that a country receives payment for its exports in
currencies other than dollars, its ability to make debt payments denominated in dollars could be adversely affected.
To the extent that a
country develops a trade deficit, it will need to depend on continuing loans from foreign governments, multilateral organizations or private commercial banks, aid payments from foreign governments, and on inflows of foreign investment. The access of
a country to these forms of external funding may not be certain, and a withdrawal of external funding could adversely affect the capacity of a
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government to make payments on its obligations. In addition, the cost of servicing debt obligations can be affected by a change in international interest rates since the majority of these
obligations carry interest rates that are adjusted periodically based upon international rates.
Central banks and other governmental
authorities which control the servicing of Sovereign Debt Obligations may not be willing or able to permit the payment of the principal or interest when due in accordance with the terms of the obligations. As a result, the issuers of Sovereign Debt
Obligations may default on their obligations. Defaults on certain Sovereign Debt Obligations have occurred in the past. Holders of certain Sovereign Debt Obligations may be requested to participate in the restructuring and rescheduling of these
obligations and to extend further loans to the issuers. These interests of holders of Sovereign Debt Obligations could be adversely affected in the course of restructuring arrangements or by certain other factors referred to below. Furthermore, some
of the participants in the secondary market for Sovereign Debt Obligations also may be directly involved in negotiating the terms of these arrangements and, therefore, may have access to information not available to other market participants.
The Fund is permitted to invest in Sovereign Debt Obligations that are not current in the payment of interest or principal or are in default,
so long as the Adviser believes it to be consistent with the Fund’s investment objective. The Fund may have limited legal recourse in the event of default with respect to certain Sovereign Debt Obligations it holds. Bankruptcy, moratorium, and
other similar laws applicable to issuers of Sovereign Debt Obligations may be substantially different from those applicable to issuers of private debt obligations. The political context, expressed as the willingness of an issuer of Sovereign Debt
Obligations to meet the terms of the debt obligation, for example, is of considerable importance. In addition, no assurance can be given that the holders of commercial bank debt will not contest payments to the holders of securities issued by
foreign governments in the event of default under commercial bank loan agreements.
Another factor bearing on the ability of a country to
repay Sovereign Debt Obligations is the level of the country’s international reserves. Fluctuations in the level of these reserves can affect the amount of foreign exchange readily available for external debt payments and, thus, could have a
bearing on the capacity of the country to make payments on its Sovereign Debt Obligations.
Expropriation, confiscatory taxation,
nationalization, political, economic, or social instability or other similar developments, such as military coups, have occurred in the past in countries in which the Fund will invest and could adversely affect the Fund’s assets should these
conditions or events recur.
Foreign investment in certain Sovereign Debt Obligations is restricted or controlled to varying degrees. These
restrictions or controls at times may limit or preclude foreign investment in certain Sovereign Debt Obligations and increase the costs and expenses of the Fund investing in such instruments. Certain countries in which the Fund will invest require
governmental approval prior to investments by foreign persons, limit the amount of investment by foreign persons in a particular issuer, limit the investment by foreign persons only to a specific class of securities of an issuer that may have less
advantageous rights than the classes available for purchase by a domiciliary of the countries, and/or impose additional taxes on foreign investors.
In addition, if deterioration occurs in a country’s balance of payments, the country could impose temporary restrictions on foreign capital remittances. The Fund could be adversely affected by delays
in, or a refusal to grant, any required governmental approval for repatriation of capital, as well as by the application to the Fund of any restrictions on investments. Investing in local markets may require the Fund to adopt special procedures,
seek local government approvals, or take other actions, each of which may involve additional costs to the Fund.
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Limitations on the Purchase and Sale of Futures Contracts, Certain Options and Swaps
Subject to the guidelines of the Board, the Fund may engage in “commodity interest” transactions (generally, transactions in futures, certain
options and certain currency transactions) only for bona fide hedging or other permissible transactions in accordance with the rules and regulations of the Commodity Futures Trading Commission (“CFTC”). Pursuant to amendments by the CFTC
to Rule 4.5 under the Commodity Exchange Act (“CEA”), the Adviser has filed a notice of exemption from registration as a “commodity pool operator” with respect to the Fund. The Fund and the Adviser are therefore not subject to
registration or regulation as a commodity pool operator under the CEA. Due to the recent amendments to Rule 4.5 under the CEA, certain trading restrictions are now applicable to the Fund as of January 1, 2013. These trading restrictions permit
the Fund to engage in commodity interest transactions that include (i) “bona fide hedging” transactions, as that term is defined and interpreted by the CFTC and its staff, without regard to the percentage of the Fund’s assets
committed to margin and options premiums and (ii) non-bona fide hedging transactions, provided that the Fund does not enter into such non-bona fide hedging transactions if, immediately thereafter, either (a) the sum of the amount of
initial margin deposits on the Fund’s existing futures positions and option premiums would exceed 5% of the market value of the Fund’s liquidating value, after taking into account unrealized profits and unrealized losses on any such
transactions, or (b) the aggregate net notional value of the Fund’s commodity interest transactions would exceed 100% of the market value of the Fund’s liquidating value, after taking into account unrealized profits and unrealized
losses on any such transactions. Therefore, in order to claim the Rule 4.5 exemption, the Fund is limited in its ability to invest in commodity futures, options and swaps (including securities futures, broad-based stock index futures and financial
futures contracts). As a result, in the future, the Fund will be more limited in its ability to use these instruments than in the past and these limitations may have a negative impact on the ability of the Adviser to manage the Fund, and on the
Fund’s performance.
Derivatives Transactions – Options, Futures, and Currencies
The Fund is authorized to use certain investment strategies commonly referred to as derivatives, such as trading in options, futures, and foreign
currencies for bona fide hedging and/or speculative purposes as specified in the Prospectuses. The Fund may write covered put and call options on securities and stock indices and purchase put and call options on securities and stock indices. In
addition, through the writing of covered options and the purchase of options and the purchase and sale of stock index futures contracts, interest rate futures contracts, and options thereon, the Fund at times may speculate or seek to hedge against
either a decline in the value of securities owned by them or an increase in the price of securities which it plans to purchase, provided that with respect to all futures contracts traded by the Fund, the Fund will establish segregated accounts
consisting of liquid assets in an amount equal to the total market value of such futures contracts less the amount of initial margin on deposit for such contracts. The Fund may also purchase put and call options and write covered put and call
options on foreign currencies and enter into exchange-traded contracts for the purchase and sale for future delivery of foreign currencies for speculative purposes or to hedge against declines in the dollar value of foreign portfolio securities and
against increases in the dollar value of foreign securities to be acquired. All futures and related options transactions engaged in by the Fund will constitute bona fide hedging or other permissible transactions in accordance with the CEA, as
amended, and the rules and regulations promulgated by the CFTC; provided, however, that the Fund may enter into futures contracts and options on futures for purposes other than bona fide hedging if, immediately thereafter, the sum of the amount of
its initial margin on futures contracts and premiums on options would not exceed 5% of the liquidation value of the Fund’s portfolio; provided further, that in the case of an option that is in-the-money at the time of the purchase, the
in-the-money amount may be excluded in calculating the 5% limitation. Because the 5% limitation applies only at the time the Fund enters into a futures contract or option thereon, the value of futures contracts and options thereon may be
significantly more or less than 5% of the value of the Fund’s portfolio. The Fund may also enter into forward foreign currency exchange contracts (“forward contracts”) for speculative purposes or to attempt to minimize the risk to the
Fund from adverse changes in the relationship between the United States dollar and foreign currencies. In addition, the Fund may engage in cross-hedging transactions with respect to forward contracts whereby, for example, if the Adviser believes
that a foreign currency may suffer a substantial decline against the United States dollar, it may enter into a forward contract to sell an amount of the foreign currency approximating the value of some or all of the Fund’s portfolio securities
denominated in such foreign currency.
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In addition to the limitations set forth in the preceding paragraph relating to the use of futures and
options on futures, the Fund has adopted certain additional policies relating to derivative transactions. The Fund will not purchase put or call options if, immediately after giving effect to such purchase, the value of all uncovered put and call
options held by the Fund would exceed 10% of the value of its net assets. The Fund may not write (i.e., sell) covered call and put option contracts in excess of 20% of the value of its net assets at the time such option contracts are written.
Because the foregoing limitations apply only at the time the Fund enters into a transaction, the value of the Fund’s holdings or its net exposure under the relevant instruments may be significantly more or less than at the time of its initial
investment.
The ability of the Fund to engage in the options and futures strategies described herein will depend on the availability of
liquid markets in such instruments. It is impossible to predict the amount of trading interest that may exist in various types of options or futures. In addition, daily limits on price fluctuations on exchanges on which the Fund conducts its futures
and options transactions may prevent the prompt liquidation of positions at the optimal time, thus subjecting the Fund to the potential for losses. Therefore no assurance can be given that the Fund will be able to utilize these instruments
effectively for the purposes stated above. Furthermore, the Fund’s ability to engage in options and futures transactions may be limited by tax considerations. Options and futures transactions may involve certain risks which are described
herein.
In connection with transactions in stock index futures contracts, interest rate futures contracts, and options thereon written by the
Fund on such futures contracts, the Fund engaging in such transactions will be required to deposit as “initial margin” an amount of cash and short-term United States government securities equal to 5% to 8% of the contract amount.
Thereafter, subsequent payments (referred to as “variation margin”) are made to and from the broker to reflect changes in the value of the futures contract.
Future Developments
The Fund may take advantage of opportunities in the area of
options and futures contracts and options on futures contracts and any other derivative investments which are not presently contemplated for use by the Fund or which are not currently available but which may be developed, to the extent such
opportunities are both consistent with the Fund’s investment objectives and legally permissible for the Fund.
Writing Covered
Options on Securities.
The Fund may write (sell) “covered call” options and covered put options on optionable securities and stock indices of the types in which it is permitted to invest from time to time as its Adviser determines is
appropriate in seeking to attain its objectives. Call options written by the Fund give the holder the right to buy the underlying securities from the Fund at a stated exercise price; put options give the holder the right to sell the underlying
security to the Fund at a stated price.
When the Fund writes covered options, the Fund owns (in the case of a call option) the underlying
securities subject to the option (or comparable securities satisfying the cover requirements of securities exchanges) or maintains in a segregated account liquid assets with a value equal to or greater than the exercise price of the underlying
securities (in the case of a put option). The Fund may also write combinations of covered puts and calls on the same underlying security.
The
Fund intends to treat certain options in respect of specific securities that are not traded on a securities exchange and the securities underlying covered call options written by the Fund as illiquid securities. See “Illiquid or Restricted
Securities.”
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The Fund will receive a premium from writing a put or call option, which increases the Fund’s return in
the event the option expires unexercised or is closed out at a profit. The amount of the premium will reflect, among other things, the relationship of the market price of the underlying security to the exercise price of the option, the term of the
option and the volatility of the market price of the underlying security. By writing a call option, the Fund limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By
writing a put option, the Fund assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its then current market value, resulting in a potential capital loss if the purchase price exceeds the
market value plus the amount of the premium received, unless the security subsequently appreciates in value.
The Fund may terminate an option
that it has written prior to its expiration by entering into a closing purchase transaction in which it purchases an option having the same terms as the option written. The Fund will realize a profit or loss from such transaction if the cost of such
transaction is less or more than the premium received from the writing of the option. In the case of a put option, any loss so incurred may be partially or entirely offset by the premium received from a simultaneous or subsequent sale of a different
put option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss to the Fund resulting from the repurchase of a call option is likely to be offset in whole
or in part by unrealized appreciation of the underlying security owned by the Fund.
Ordinarily, written options will have expiration dates
between one and nine months from the date written. The exercise price of the options may be below, equal to, or above the market values of the underlying securities at the time the options are written.
In the case of call options, these exercise prices are referred to as “in-the-money,” “at-the-money,” and
“out-of-the-money,” respectively. The Fund may write (a) in-the-money call options when the Adviser expects that the price of the underlying security will remain stable or decline moderately during the option period,
(b) at-the-money call options when the Adviser expects that the price of the underlying security will remain stable or advance moderately during the option period, and (c) out-of-the-money call options when the Adviser expects that the
premiums received from writing the call option plus the appreciation in market price of the underlying security up to the exercise price will be greater than the appreciation in the price of the underlying security alone. In these circumstances, if
the market price of the underlying security declines and the security is sold at this lower price, the amount of any realized loss will be offset wholly or in part by the premium received. Out-of-the-money, at-the-money, and in-the-money put options
(the reverse of call options as to the relation of exercise price to market price) may be utilized in the same market environments that such call options are used in equivalent transactions.
So long as the Fund’s obligation as the writer of an option continues, the Fund may be assigned an exercise notice by the broker-dealer through which the option was sold, requiring the Fund to
deliver, in the case of a call, or take delivery of, in the case of a put, the underlying security against payment of the exercise price. This obligation terminates when the option expires or the Fund effects a closing purchase transaction. The Fund
can no longer effect a closing purchase transaction with respect to an option once it has been assigned an exercise notice.
Put and Call
Options on Securities.
The Fund may purchase put options for speculative purposes or to protect its portfolio holdings in an underlying security against a decline in market value. Such hedge protection is provided during the life of the put
option since the Fund, as holder of the put option, is able to sell the underlying security at the put exercise price regardless of any decline in the underlying security’s market price. In order for a put option to be profitable, the market
price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs. By using put options for hedging purposes, the Fund engaging in that transaction will reduce any profit it might
otherwise have realized on its underlying security by the premium paid for the put option and by transaction costs.
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The Fund may also purchase call options for speculative purposes or to hedge against an increase in prices
of securities that it wants ultimately to buy. Such hedge protection is provided during the life of the call option since the Fund, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase
in the underlying security’s market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call
options for hedging purposes, the Fund engaging in that transaction will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by
transaction costs. Alternatively, the Fund may purchase a call or a put option on a security in lieu of an actual investment in, or disposition of, a particular security if it expects an increase or a decrease, as the case may be, in the price of
the security.
The purchase of an option entails a risk of loss of the entire investment because an option may become worthless upon
expiration.
An option position may be closed out only if a secondary market for an option of the same series exists on a recognized national
securities exchange or in the over-the-counter (“OTC”) market. Because of this fact and current trading conditions, the Fund expects to purchase only call or put options issued by the Options Clearing Corporation. The Fund expects to write
options on national securities exchanges and in the OTC market.
While they may choose to do otherwise, the Fund generally will purchase or
write only those options for which the Adviser believes there is an active secondary market so as to facilitate closing transactions. There is no assurance that sufficient trading interest to create a liquid secondary market on a securities exchange
will exist for any particular option or at any particular time, and for some options no such secondary market may exist. A liquid secondary market in an option may cease to exist for a variety of reasons. In the past, for example, higher than
anticipated trading activity or order flow, or other unforeseen events, at times have rendered certain clearing facilities inadequate and resulted in the institution of special procedures, such as trading rotations, restrictions on certain types of
orders or trading halts or suspensions in one or more options. There can be no assurance that similar events, or events that may otherwise interfere with the timely execution of customers’ orders, will not recur. In such event, it might not be
possible to effect closing transactions in particular options. If, as a covered call option writer, the Fund is unable to effect a closing purchase transaction in a secondary market, it will not be able to sell the underlying security until the
option expires or it delivers the underlying security upon exercise or it otherwise covers its position.
Purchase and Sale of Options and
Futures Contracts on Stock Indices.
The Fund may purchase put and call options and write put and call options on stock indices as a hedge against movements in the equity markets or for speculative purposes. The Fund may also purchase and sell
stock index futures contracts as a hedge against movements in the equity markets or for speculative purposes.
Options on stock indices are
similar to options on specific securities except that, rather than the right to take or make delivery of the specific security at a specific price, an option on a stock index ordinarily gives the holder the right to receive, upon exercise of the
option, an amount of cash if the closing level of that stock index is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing
price of the index and the exercise price of the option expressed in dollars times a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on specific
securities, all settlements of options on stock indices are in cash and gain or loss depends on general movements in stock included in the index rather than price movements in particular stocks. When the Fund writes an option on a stock index, it
will “earmark” on the records of the custodian or Adviser or establish a segregated account with the Fund’s custodian in which it will deposit liquid assets in an amount equal to the market value of the option, and it will maintain
the account while the option is open. As indicated above, the purchase of an option entails a risk of loss of the entire investment because an option may become worthless upon expiration.
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A stock index futures contract is an agreement in which one party agrees to deliver to the other an amount
of cash equal to a specific amount times the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made.
If the Adviser expects general stock market prices to rise, it might cause the Fund to purchase a call option on a stock index or a futures
contract on that index as a hedge against an increase in prices of particular equity securities it wants ultimately to buy. If in fact the stock index does rise, the price of the particular equity securities intended to be purchased may also
increase, but that increase would be offset in part by the increase in the value of the Fund’s index option or futures contract resulting from the increase in the index. If, on the other hand, the Adviser expects general stock market prices to
decline, it might cause the Fund to purchase a put option or sell a futures contract on the index. If that index does in fact decline, the value of some or all of the equity securities in the Fund’s portfolio may also be expected to decline,
but that decrease would be offset in part by the increase in the value of the Fund’s position in such put option or futures contract.
Alternatively, the Fund may purchase a call or a put option (or buy or sell a futures contract) on a stock index in lieu of an actual investment in, or
disposition of, particular equity securities if it expects an increase or a decrease, as the case may be, in general stock market prices.
Purchase and Sale of Interest Rate Futures Contracts.
The Fund may purchase and sell interest rate futures contracts on United States Treasury
bills, notes, and bonds for speculative purposes or to hedge its portfolio of fixed income securities against the adverse effects of anticipated movements in interest rates.
The Fund may sell interest rate futures contracts in anticipation of an increase in the general level of interest rates. Generally, as interest rates rise, the market value of the fixed income securities
held by the Fund will fall, thus reducing the NAV of the Fund. This interest rate risk can be reduced without employing futures contracts as a hedge by selling long-term fixed income securities and either reinvesting the proceeds in securities with
shorter maturities or by holding assets in cash. This strategy, however, entails increased transaction costs in the form of dealer spreads and brokerage commissions and would, as a result of the shortening of maturities, typically reduce the average
yield of the Fund engaging in the strategy.
The sale of interest rate futures contracts provides an alternative means of hedging against
rising interest rates. As rates increase, the value of the Fund’s short position in the futures contracts will also tend to increase, thus offsetting all or a portion of the depreciation in the market value of the Fund’s investments which
are being hedged. While the Fund will incur commission expenses in selling and closing out futures positions (which is done by taking an opposite position which operates to terminate the position in the futures contract), commissions on futures
transactions are lower than the transaction costs incurred in the purchase and sale of portfolio securities.
The Fund may purchase interest
rate futures contracts in anticipation of a decline in interest rates when it is not fully invested in debt securities it intends to purchase. As such purchases are made, the Fund intends that an equivalent amount of futures contracts will be closed
out.
Alternatively, the Fund may buy or sell an interest rate futures contract in lieu of an actual investment in, or disposition of,
particular fixed income securities if it expects an increase or a decrease, as the case may be, in interest rates.
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Options on Stock Index Futures Contracts and Interest Rate Futures Contracts.
The Fund may purchase
call and put options and write covered call and put options on stock index and interest rate futures contracts. The Fund may use such options on futures contracts for speculative purposes or in connection with its hedging strategies in lieu of
purchasing and writing options directly on the underlying securities or stock indices or purchasing and selling the underlying futures. For example, the Fund may purchase put options or write call options on stock index futures contracts or interest
rate futures contracts, rather than selling futures contracts, in anticipation of a decline in general stock market prices or rise in interest rates, respectively, or purchase call options or write covered put options on stock index or interest rate
futures contracts, rather than purchasing such futures contracts, to hedge against possible increases in the price of equity securities or debt securities, respectively, which the Fund intends to purchase.
Foreign Derivatives Transactions.
Unlike trading on domestic exchanges for certain derivatives instruments, trading on foreign exchanges is not
regulated by the CFTC and may be subject to greater risks than trading on domestic exchanges. For example, some foreign exchanges are principal markets so that no common clearing facility exists and a trader may look only to the broker for
performance of the contract. In addition, unless the Fund hedges against fluctuations in the exchange rate between the U.S. dollar and the currencies in which trading is done on foreign exchanges, any profits that the Fund might realize in trading
could be eliminated by adverse changes in the exchange rate, or the Fund could incur losses as a result of those changes. Transactions on foreign exchanges may include both instruments which are traded on domestic exchanges and those which are not.
Foreign Currency Transactions.
The Fund may enter into forward foreign currency contracts for speculative purposes or to attempt
to minimize the risk to the Fund from adverse changes in the relationship between the United States dollar and foreign currencies. Forward contracts 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 agreed upon by the parties, at a price set at the time of the contract. Forward foreign currency exchange contracts generally are established in the interbank market directly between currency
traders (usually large commercial banks or other financial institutions) on behalf of their customers. Certain types of forward foreign currency exchange contracts are now regulated as swaps by the CFTC and, although they may still be established in
the interbank market by currency traders on behalf of their customers, such instruments now must be executed in accordance with applicable federal regulations. The regulation of such forward foreign currency exchange contracts as swaps is a recent
development and there can be no assurance that the additional regulation of these types of derivatives will not have an adverse effect on a fund that utilizes these instruments. A forward contract generally has no margin deposit requirement, and no
commissions are charged at any stage for trades.
The Fund may enter into forward contracts for a variety of purposes in connection with the
management of the foreign securities portion of its portfolio. The Fund’s use of such contracts will include, but not be limited to, the following situations.
First, when the Fund enters into a contract for the purchase or sale of a security denominated in or exposed to a foreign currency, it may desire to “lock in” the U.S. dollar price of the
security. By entering into a forward contract for the purchase or sale, for a fixed amount of dollars, of the amount of foreign currency involved in the underlying security transactions, the Fund will be able to protect itself against a possible
loss resulting from an adverse change in the relationship between the U.S. dollar and the subject foreign currency during the period between the date the security is purchased or sold and the date on which payment is made or received.
Second, when the Fund’s Adviser believes that one currency may experience a substantial movement against another currency, including the U.S.
dollar, it may enter into a forward contract to sell or buy the amount of the former foreign currency, approximating the value of some or all of the Fund’s portfolio securities denominated in or exposed to such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign currency exposure through the use of a basket of currencies, multinational currency units or a proxy currency where such currency or currencies act as an effective
14
proxy for other currencies. In such a case, the Fund may enter into a forward contract where the amount of the foreign currency to be sold exceeds the value of the securities denominated in or
exposed to such currency. The use of this basket hedging technique may be more efficient and economical than entering into separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the value of the securities involved will not generally be possible since the future value of such securities in foreign currencies will change as
a consequence of market movements in the value of those securities between the date the forward contract is entered into and the date it matures. The projection of short-term currency market movement is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain. Under normal circumstances, consideration of the prospect for currency parities will be incorporated into the diversification strategies. However, the Adviser to the Fund believes that
it is important to have the flexibility to enter into such forward contracts when it determines that the best interests of the Fund will be served.
The Fund may enter into forward contracts for any other purpose consistent with the Fund’s investment objective and program. However, the Fund will not enter into a forward contract, or maintain
exposure to any such contract(s), if the amount of foreign currency required to be delivered thereunder would exceed the Fund’s holdings of liquid securities and currency available for cover of the forward contract(s). In determining the amount
to be delivered under a contract, the Fund may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the
portfolio security and make delivery of the foreign currency, or it may retain the security and either extend the maturity of the forward contract (by “rolling” that contract forward) or may initiate a new forward contract. If the Fund
retains the portfolio security and engages in an offsetting transaction, the Fund will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the foreign currency.
Should forward prices decline during the
period between the Fund’s entering into a forward contract for the sale of a foreign currency and the date it enters into an offsetting contract for the purchase of the foreign currency, the Fund will realize a gain to the extent the price of
the currency it has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the Fund will suffer a loss to the extent the price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
Although the Fund values its assets daily in terms of U.S. dollars, it does not intend to convert its
holdings of foreign currencies into U.S. dollars on a daily basis. The Fund will convert foreign currencies to U.S. dollars and vice versa from time to time, and investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit based on the difference (“spread”) between the prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign
currency to the Fund at one rate, while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer.
Asset Coverage for Forward Contracts, Options, Futures, and Options on Futures
The Fund will comply with guidelines established by the SEC with respect to coverage of forward currency contracts; options written by the Fund on currencies, securities, and indexes; and currency,
interest rate, and index futures contracts and options on these futures contracts. These guidelines may, in certain instances, require segregation by the Fund of cash or liquid securities with their custodian or a designated sub-custodian or
“earmarked” on the records of the Adviser to the extent the Fund’s obligations with respect to these strategies are not otherwise “covered” through ownership of the underlying security, financial instrument, or currency, or
by other portfolio positions or by other means consistent with applicable regulatory policies. Segregated assets cannot be sold or transferred unless equivalent assets are substituted in their place or it is no longer necessary to segregate them. As
a result, there is a possibility that segregation of a large percentage of the Fund’s assets could impede portfolio
15
management or the Fund’s ability to meet redemption requests or other current obligations. For example, a call option written by the Fund on securities may require the Fund to hold the
securities subject to the call (or securities convertible into the securities without additional consideration) or to segregate assets (as described above) sufficient to purchase and deliver the securities if the call is exercised. A call option
written by the Fund on an index may require the Fund to own portfolio securities that correlate with the index or to segregate assets (as described above) equal to the excess of the index value over the exercise price on a current basis. A put
option written by the Fund may require the Fund to segregate assets (as described above) equal to the exercise price. The Fund could purchase a put option if the strike price of that option is the same or higher than the strike price of a put option
sold by the Fund. If the Fund holds a futures or forward contract, the Fund could purchase a put option on the same futures or forward contract with a strike price as high as or higher than the price of the contract held. The Fund may enter into
fully or partially offsetting transactions so that its net position, coupled with any segregated assets (equal to any remaining obligation), equals its net obligation. Asset coverage may be achieved by other means when consistent with applicable
regulatory policies.
Risk Factors in Derivatives Transactions.
Derivatives transactions involve special risks, including possible default by the other party to the transaction, illiquidity, increased volatility in the Fund’s NAV and, to the extent the
Adviser’s view as to certain market movements is incorrect, the risk that the use of such instruments could result in substantially greater losses than if it had not been used. Use of put and call options could result in losses to the Fund,
force the purchase or sale of portfolio securities at inopportune times or for prices lower than current market values, or cause the Fund to hold a security it might otherwise sell. The use of currency transactions could result in the Fund’s
incurring losses as a result of the imposition of exchange controls, suspension of settlements, or the inability to deliver or receive a specified currency in addition to exchange rate fluctuations. The use of options and futures transactions
entails certain special risks. In particular, in the case of hedging, the variable degree of correlation between price movements of options or futures contracts and price movements in the related portfolio position of the Fund could create the
possibility that losses on the instrument will be greater than gains in the value of the Fund’s position. In addition, futures and options markets could be illiquid in some circumstances and certain OTC options could have no markets. The Fund
might not be able to close out certain positions without incurring substantial losses. To the extent the Fund utilizes futures and options transactions for hedging, such transactions should tend to minimize the risk of loss due to a decline in the
value of the hedged position and, at the same time, limit any potential gain to the Fund that might result from an increase in value of the position. Finally, the daily variation margin requirements for futures contracts create a greater ongoing
potential financial risk than would purchases of options, in which case the exposure is limited to the cost of the initial premium and transaction costs. Expenses and losses incurred as a result of the use of options, futures, or currency
transactions will reduce the Fund’s NAV, and possibly income, and the losses may be greater than if such instruments had not been used.
The value of a derivative instrument depends largely upon price movements in the securities or other instruments upon which it is based. Therefore, many
of the risks applicable to trading the underlying securities or other instruments are also applicable to derivatives trading. However, there are a number of other risks associated with derivatives trading, including the risk that derivatives often
fluctuate in value more than the securities or other instruments upon which they are based. Relatively small changes in the value of the underlying securities or instruments may have significantly larger effects on the value of derivatives held by
the Fund. Derivatives may entail the risk of loss of the entire amount invested or, in certain cases, losses in excess of the amount invested. A derivative utilized for hedging purposes may limit the amount of potential gain on the related
transaction or may result in greater losses than if the derivative had not been used. The Fund generally expects that its options and futures transactions will be conducted on recognized securities and commodity exchanges. In certain instances,
however, the Fund may purchase and sell stock options in the OTC market. The Fund’s ability to terminate stock option positions established in the OTC market may be more limited than in the case of exchange-traded options and may also involve
the risk that securities dealers participating in such transactions would fail to meet
16
their obligations to the Fund. The staff of the SEC generally considers OTC options to be illiquid. There can be no assurance that the Fund will be able to effect closing transactions at any
particular time or at an acceptable price. The use of options and futures for hedging purposes involves the risk of imperfect correlation between movements in options and futures prices and movements in the price of securities which are the subject
of the hedge. The use of derivatives for speculative purposes involves a variety of risks, including the risk of an increased volatility that may potentially increase losses. Certain provisions of the Code may limit the ability of the Fund to
quickly liquidate options, futures, and currency positions in which significant unrealized gains have developed when the Adviser deems it appropriate to realize the gains.
Short-Selling of Securities
The Fund may make short sales of securities, including short
sales “against the box”. A short sale is a transaction in which the Fund sells a security it does not own in anticipation that the market price of that security will decline. A short sale against the box occurs when, at the time of sale,
the Fund owns, or has the immediate and unconditional right to acquire at no additional cost, the identical security. The Fund expects to make short sales both to obtain capital gains from anticipated declines in securities and as a form of hedging
to offset potential declines in long positions in the same or similar securities. The short sale of a security is considered a speculative investment technique. Short sales against the box may be subject to special tax rules, one of the effects of
which may be to accelerate income to the Fund.
When the Fund makes a short sale, it must borrow the security sold short and deliver it to the
broker-dealer through which it made the short sale in order to satisfy its obligation to deliver the security upon conclusion of the sale.
In
connection with such short sales, the Fund may pay a fee to borrow securities or maintain an arrangement with a broker to borrow securities, and is often obligated to pay over any accrued interest and dividends on such borrowed securities. In a
short sale, the Fund does not immediately deliver the securities sold or receive the proceeds from the sale. The Fund closes out a short position by purchasing and delivering an equal amount of the securities sold short.
The successful use of short selling may be adversely affected by imperfect correlation between movements in the price of the security sold short and the
securities being hedged.
To the extent that the Fund engages in short sales, it will provide collateral to the broker-dealer and (except in
the case of short sales against the box) will maintain additional asset coverage in the form of segregated or “earmarked” assets on the records of the Adviser or with the Fund’s Custodian, consisting of cash, U.S. government
securities or other liquid securities that are equal to the current market value of the securities sold short, or (in the case of short sales against the box) will ensure that such positions are covered by offsetting positions, until the Fund
replaces the borrowed security. Depending on arrangements made with the broker-dealer from which it borrowed the security regarding payment over of any payments received by the Fund on such security, the Fund may not receive any payments (including
interest) on its collateral deposited with such broker-dealer. If the price of the security sold short increases between the time of the short sale and the time the Fund replaces the borrowed security, the Fund will incur a loss; conversely, if the
price declines, the Fund will realize a capital gain. Any gain will be decreased, any loss increased, by the transaction costs described above. Although the Fund’s gain is limited to the price at which it sold the security short, its potential
loss is theoretically unlimited.
The total market value of all of the Fund’s short sales may not exceed 50% of the value of the
Fund’s net assets. In addition, the Fund’s short sales of the securities of any single issuer listed on a national securities exchange may not exceed 5% of the value of the Fund’s net assets, and the Fund may not sell short more than
5% of the outstanding securities of a single class of securities of an issuer. The Fund may enter into short sales of securities the Fund owns, but such sales cannot exceed 15% of the value of the Fund’s net assets. The Fund’s compliance
with these limitations is calculated at the time a transaction is effected.
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Bank Obligations
Bank obligations that the Fund may purchase include time deposits (“TDs”), certificates of deposit (“CDs”), and banker acceptances (“BAs”). TDs are non-negotiable deposits
maintained in a banking institution for a specified period of time (in no event longer than seven days) at a stated interest rate. CDs are negotiable certificates evidencing the obligation of a bank to repay funds deposited with it for a specified
period of time. BAs are credit instruments evidencing the obligation of a bank to pay a draft drawn on it by a customer. These and other short-term instruments reflect the obligation both of the bank and of the drawer to pay the face amount of the
instrument upon maturity. The other short-term obligations may include uninsured, direct obligations bearing fixed, floating, or variable interest rates.
Domestic commercial banks organized under federal law are supervised and examined by the Comptroller of the Currency and are required to be members of the Federal Reserve System and to have their deposits
insured by the Federal Deposit Insurance Corporation (the “FDIC”). Domestic banks organized under state law are supervised and examined by state banking authorities but are members of the Federal Reserve System only if they elect to join.
In addition, state banks whose CDs may be purchased by the Fund are insured by the FDIC (although such insurance may not be of material benefit to the Fund, depending upon the principal amount of the CDs of each bank held by the Fund) and are
subject to federal examination and to a substantial body of federal law and regulation. As a result of federal or state laws and regulations, domestic branches of domestic banks generally are required, among other things, to maintain specified
levels of reserves, are limited in the amounts which they can loan to a single borrower, and are subject to other regulation designed to promote financial soundness. However, not all such laws and regulations apply to foreign branches of domestic
banks.
Obligations of foreign branches of domestic banks, foreign subsidiaries of domestic banks, and domestic and foreign branches of
foreign banks, such as CDs and TDs, may be general obligations of the parent banks in addition to the issuing branches, or may be limited by the terms of a specific obligation and governmental regulation. Such obligations are subject to different
risks than are those of domestic banks. These risks include foreign economic and political developments, foreign governmental restrictions that may adversely affect payment of principal and interest on the obligations, foreign exchange controls and
foreign withholding, and other taxes on interest income. Foreign branches and subsidiaries are not necessarily subject to the same or similar regulatory requirements that apply to domestic banks, such as mandatory reserve requirements, loan
limitations, and accounting, auditing, and financial recordkeeping requirements. In addition, less information may be publicly available about a foreign branch of a domestic bank or about a foreign bank than about a domestic bank.
Obligations of United States branches of foreign banks may be general obligations of the parent banks in addition to the issuing branches, or may be
limited by the terms of a specific obligation and by federal or state regulation as well as governmental action in the country in which the foreign bank has its head office. A U.S. branch of a foreign bank with assets in excess of $1 billion may be
subject to reserve requirements imposed by the Federal Reserve System or by the state in which the branch is located if the branch is licensed in that state. In addition, federal branches licensed by the Comptroller of the Currency and branches
licensed by certain states (“State Branches”) may be required to: (1) pledge to the regulator, by depositing assets with a designated bank within the state, a certain percentage of their assets as fixed from time to time by the
appropriate regulatory authority; and (2) maintain assets within the state in an amount equal to a specified percentage of the aggregate amount of liabilities of the foreign bank payable at or through all of its agencies or branches within the
state. The deposits of federal and state branches generally must be insured by the FDIC if such branches take deposits of less than $100,000.
In view of the foregoing factors associated with the purchase of CDs and TDs issued by foreign branches of domestic banks, foreign subsidiaries of
domestic banks, foreign branches of foreign banks, or U.S. branches of foreign banks, the Adviser carefully evaluates such investments on a case-by-case basis.
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Commercial Paper
The Fund may purchase commercial paper, which consists of short-term, unsecured promissory notes issued to finance short-term credit needs. The Fund will invest in commercial paper that is rated at least
Prime-1 by Moody’s or A-1 by S&P or, if not rated, is determined by the Adviser to be of comparable quality.
Repurchase
Agreements
The Fund may enter into repurchase agreements with banks and non-bank dealers of U.S. government securities which are listed as
reporting dealers of the Federal Reserve Bank and which furnish collateral at least equal in value or market price to the amount of their repurchase obligation. In a repurchase agreement, the Fund purchases a debt security from a seller that
undertakes to repurchase the security at a specified resale price on an agreed future date. The resale price generally exceeds the purchase price by an amount which reflects an agreed-upon market interest rate for the term of the repurchase
agreement.
The Fund’s risk is primarily that, if the seller defaults, the proceeds from the disposition of the underlying securities and
other collateral for the seller’s obligation are less than the repurchase price. If the seller becomes bankrupt, the Fund might be delayed in selling the collateral. Under the Investment Company Act of 1940, as amended (the “1940
Act”), repurchase agreements are considered loans. Repurchase agreements usually are for short periods, such as one week or less, but could be longer. Except for repurchase agreements for a period of a week or less in respect to obligations
issued or guaranteed by the U.S. Government, its agencies, or instrumentalities, not more than 5% of the Fund’s total assets may be invested in repurchase agreements. In addition, the Fund will not enter into repurchase agreements with a
duration of more than seven days if, taken together with restricted securities and other securities for which there are no readily available quotations, more than 10% of its total assets would be so invested. These percentage limitations are
fundamental and may not be changed without shareholder approval.
Brady Bonds and Emerging Market Governmental Obligations
The Fund may invest in emerging market governmental debt obligations commonly referred to as “Brady Bonds.” Brady Bonds are debt securities,
generally denominated in U.S. dollars, issued under the framework of the “Brady Plan,” an initiative announced by former U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to restructure their outstanding
external commercial bank indebtedness. Investors should recognize that Brady Bonds have only been issued relatively recently, and accordingly do not have a long payment history. In addition to Brady Bonds, the Fund may invest in emerging market
governmental obligations issued as a result of debt restructuring agreements outside of the scope of the Brady Plan. A substantial portion of the Brady Bonds and other similar obligations in which the Fund may invest are likely to be acquired at a
discount, which involves certain considerations discussed below under “Zero Coupon Securities and Discount Obligations.”
The Brady
Plan framework, as it has developed, contemplates the exchange of external commercial bank debt for newly issued bonds. Brady Bonds may also be issued in respect of new money being advanced by existing lenders in connection with the debt
restructuring. Brady Bonds issued to date generally have maturities of between 15 and 30 years from the date of issuance. The Fund may invest in Brady Bonds of emerging market countries that have been issued to date, as well as those which may be
issued in the future.
Agreements implemented under the Brady Plan to date are designed to achieve debt and debt-service reduction through
specific options negotiated by a debtor nation with its creditors. As a result, the financial packages offered by each country differ. The types of options have included the exchange of outstanding commercial bank debt for bonds issued at 100% of
face value of such debt which carry a below-market stated rate of interest (generally known as par bonds), bonds issued at a discount from the
19
face value of such debt (generally known as discount bonds), bonds bearing an interest rate which increases over time, and bonds issued in exchange for the advancement of new money by existing
lenders. Discount bonds issued to date under the framework of the Brady Plan have generally borne interest computed semiannually at a rate equal to 13/16 of one percent above the then current six month London Interbank Offered Rate
(“LIBOR”). Regardless of the stated face amount and stated interest rate of the various types of Brady Bonds, the Fund will purchase Brady Bonds in secondary markets, as described below, in which the price and yield to the investor reflect
market conditions at the time of purchase. Brady Bonds issued to date have traded at a deep discount from their face value. Certain sovereign bonds are entitled to “value recovery payments” in certain circumstances, which in effect
constitute supplemental interest payments but generally are not collateralized. Certain Brady Bonds have been collateralized as to principal due at maturity (typically 15 to 30 years from the date of issuance) by U.S. Treasury zero coupon bonds with
a maturity equal to the final maturity of such Brady Bonds, although the collateral is not available to investors until the final maturity of the Brady Bonds. Collateral purchases are financed by the International Monetary Fund, the World Bank, and
the debtor nations’ reserves. In addition, interest payments on certain types of Brady Bonds may be collateralized by cash or high-grade securities in amounts that typically represent between 12 and 18 months of interest accruals on these
instruments with the balance of the interest accruals being uncollateralized. Brady Bonds are often viewed as having three or four valuation components: (i) the collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest payments; and (iv) any uncollateralized repayment of principal at maturity (these uncollateralized amounts constitute the “residual risk”). The Fund may
purchase Brady Bonds with no or limited collateralization, and will be relying for payment of interest and (except in the case of principal collateralized Brady Bonds) principal primarily on the willingness and ability of the foreign government to
make payment in accordance with the terms of the Brady Bonds. Brady Bonds issued to date are purchased and sold in secondary markets through U.S. securities dealers and other financial institutions and are generally maintained through European
transnational securities depositories.
Zero Coupon Securities and Discount Obligations
The Fund may invest in zero coupon U.S. Treasury securities, which are Treasury Notes and Bonds that have been stripped of their unmatured interest
coupons, the coupons themselves and receipts or certificates representing interests in such stripped debt obligations and coupons. The Fund also may invest in zero coupon securities issued by financial institutions which constitute a proportionate
ownership of the issuer’s pool of underlying U.S. Treasury securities. Zero coupon securities are debt securities that pay no cash income but are sold at substantial discounts from their value at maturity. Certain zero coupon securities also
are sold at substantial discounts from their maturity value and provide for the commencement of regular interest payments at a deferred date. In addition, as indicated above, certain of the Fund’s emerging market governmental debt securities
may be acquired at a discount (“Discount Obligations”).
Zero coupon securities and Discount Obligations tend to be subject to
greater price fluctuations in response to changes in interest rates than are ordinary interest-paying debt securities with similar maturities. The value of zero coupon securities and Discount Obligations appreciates more during periods of declining
interest rates and depreciates more during periods of rising interest rates than ordinary interest-paying debt securities with similar maturities. When a zero coupon security is held to maturity, its entire return, which consists of the amortization
of discount, comes from the difference between its purchase price and its maturity value. This difference is known at the time of purchase, so that investors holding zero coupon securities until maturity know at the time of their investment what the
expected return on their investment will be.
Under current federal income tax law, the Fund is required to accrue as income each year a
portion of the original issue discount with respect to zero coupon securities and other securities issued at a discount to the stated redemption price prior to the receipt of cash payments. Accordingly, to maintain its
20
qualification as a regulated investment company and avoid liability for federal income taxes, the Fund may have to dispose of portfolio securities under disadvantageous circumstances in order to
generate current cash to satisfy certain distribution requirements of the Fund.
Stripped Mortgage-Backed Securities
The Fund may invest up to 10% of its total assets in stripped mortgage-backed securities (“SMBS”), all of which will be issued or guaranteed by
the United States government, its agencies, or instrumentalities. SMBS are derivative multiclass securities that indirectly represent a participation in, or are secured by and payable from, mortgage loans secured by real property. SMBS are
structured with two or more classes of securities that receive different proportions of the interest and principal payments on an underlying pool of mortgage assets. A common type of SMBS will have one class receiving all of the interest
(“IO” or interest-only class) and the other class receiving all of the principal (“PO” or principal-only class). SMBS may be highly sensitive to changes in prepayment and interest rates and, under certain interest rate or
prepayment rate scenarios, the Fund may fail to recoup fully its investment in these securities even if the securities are of the highest credit quality. Furthermore, the yield to maturity on these securities may be adversely affected.
Structured Investments
The Fund may
invest in structured investments, which are securities issued solely for the purpose of restructuring the investment characteristics of other securities, such as commercial bank loans or Brady Bonds. Structured investment products may involve
special risks, including substantial volatility in their market values and potential illiquidity. The Fund is permitted to invest in a class of structured investments, which is either subordinated or unsubordinated to the right of payment of another
class. Subordinated structured investments typically have higher yields and present greater risks than unsubordinated structured investments. Although the Fund’s purchase of subordinated structured investments would have a similar economic
effect to that of borrowing against the underlying securities, the purchase will not be deemed to be a borrowing by the Fund for purposes of the Fund’s fundamental investment restriction on borrowing.
Issuers of structured investments are typically organized by investment banking firms which receive fees in connection with establishing each issuing
entity and arranging for the placement of its securities. This type of restructuring of investment characteristics involves the deposit with or purchase by an entity, such as a corporation or trust, of specified instruments (such as Brady Bonds) and
the issuance by that entity of one or more classes of 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 investments to
create securities with different investment characteristics such as varying maturities, payment priorities or interest rate provisions; the extent of the payments made with respect to structured investments is dependent on the extent of the cash
flow on the underlying instruments. Because structured investments of the type in which the Fund anticipates investing typically involve no credit enhancement, their credit risk will generally be equivalent to that of the underlying instruments.
Certain issuers of structured investments may be deemed to be “investment companies” as defined in the 1940 Act. As a result, the
Fund’s investment in these structured investments may be limited by the restrictions contained in the 1940 Act. Structured investments are typically sold in private placement transactions, and there currently is no active trading market for
structured investments.
Preferred Stock
Preferred stock has a preference over common stock in liquidation and generally in dividends as well, but is subordinated to the liabilities of the issuer in all respects. Preferred stock may or may not
be convertible into common stock. As a general rule, the market value of preferred stock with a fixed dividend rate and no conversion element varies inversely with interest rates and perceived credit risk. Because preferred stock is junior to debt
securities and other obligations of the issuer, deterioration in the credit quality of the issuer will cause greater changes in the value of a preferred stock than in a debt security with similar stated yield characteristics.
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Convertible Securities
A convertible security is a fixed-income security that may be converted at either a stated price or stated rate into underlying shares of common stock. Convertible securities have general characteristics
similar to both fixed-income and equity securities. Although to a lesser extent than with fixed-income securities generally, the market value of convertible securities tends to decline as interest rates increase and, conversely, tends to increase as
interest rates decline. In addition, because of the conversion feature, the market value of convertible securities tends to vary with fluctuations in the market value of the underlying common stock, and therefore, also will react to variations in
the general market for equity securities. A unique feature of convertible securities is that as the market price of the underlying common stock declines, convertible securities tend to trade increasingly on a yield basis, and so may not experience
market value declines to the same extent as the underlying common stock. When the market price of the underlying common stock increases, the prices of the convertible securities tend to rise as a reflection of the value of the underlying common
stock. While no securities investments are without risk, investments in convertible securities generally entail less risk than investments in common stock of the same issuer.
As fixed-income securities, convertible securities are investments that provide for a stable stream of income with generally higher yields than common stocks. Of course, like all fixed-income securities,
there can be no assurance of current income because the issuers of the convertible securities may default on their obligations. Convertible securities, however, generally offer lower interest or dividend yields than non-convertible securities of
similar quality because of the potential for capital appreciation. A convertible security, in addition to providing fixed income, offers the potential for capital appreciation through the conversion feature, which enables the holder to benefit from
increases in the market price of the underlying common stock. There can be no assurance of capital appreciation, however, because securities prices fluctuate. Convertible securities generally are subordinated to other similar but non-convertible
securities of the same issuer, although convertible bonds, as corporate debt obligations, enjoy seniority in right of payment to all equity securities, and convertible preferred stock is senior to common stock, of the same issuer. Because of the
subordination feature, however, convertible securities typically have lower ratings than similar non-convertible securities.
Warrants
Equity warrants and rights are securities permitting, but not obligating, their holder to subscribe for other equity securities. Warrants
and rights do not carry with them the right to dividends or voting rights with respect to the securities that they entitle their holder to purchase, and they do not represent any rights in the assets of the issuer. As a result, an investment in
warrants or rights may be considered speculative. The value of a warrant does not necessarily change with the value of the underlying securities and a warrant ceases to have value if it is not exercised prior to its expiration date. The Fund may
invest up to 5% of the value of its net assets in warrants for equity securities, but will not invest more than 2% of the value of its net assets in warrants which are not listed on the New York or American Stock Exchange.
Depositary Receipts
American Depositary
Receipts (“ADRs”), Global Depositary Receipts (“GDRs”), European Depositary Receipts (“EDRs”) and other types of depositary receipts (which, together with ADRs, GDRs and EDRs, are collectively referred to as
“Depositary Receipts”) evidence ownership of underlying securities issued by either a non-U.S. or a U.S. corporation that have been deposited with a depositary or custodian bank. Depositary Receipts may be issued in connection with an
offering of securities by the issuer of the underlying securities or issued by a depositary bank as a vehicle to promote investment and trading in the
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underlying securities. ADRs are receipts issued by U.S. Banks or trust companies in respect of securities of non-U.S. issuers held on deposit for use in the U.S. securities markets. GDRs, EDRs
and other types of Depositary Receipts are typically issued by a U.S. bank or trust company and traded principally in the U.S. and other international markets.
The Fund treats Depositary Receipts as interests in the underlying securities for purposes of their investment policies. While Depositary Receipts may not necessarily be denominated in the same currency
as the securities into which they may be converted, they entail certain of the risks associated with investments in foreign securities. The Fund will limit its investment in Depositary Receipts not sponsored by the issuer of the underlying
securities to any more than 5% of the value of its net assets (at the time of the investment). A purchaser of unsponsored Depositary Receipts may not have unlimited voting rights and may not receive as much information about the issuer of the
underlying security as with sponsored Depositary Receipts.
Other Investment Companies
The Fund may invest in the securities of other publicly-offered or privately-issued investment companies or investment funds, subject to the limitations
imposed by the 1940 Act and the rules and regulations thereunder. By investing in another investment company or investment fund, the Fund bears a ratable share of the investment company’s or investment fund’s expenses, as well as
continuing to bear the Fund’s advisory and administrative fees with respect to the amount of the investment. The Fund’s investment in certain investment companies or investment funds will result in special U.S. federal income tax
consequences.
Illiquid or Restricted Securities
The Fund may purchase securities for which there is a limited or no trading market or which are subject to restrictions on resale to the public. Investments in securities which are illiquid or
“restricted” may involve added expense to the Fund should the Fund be required to bear registration or other costs to dispose of such securities and could involve delays in disposing of such securities which might have an adverse effect
upon the price and timing of sales of such securities and the liquidity of the Fund with respect to redemptions. The Fund may not enter into repurchase agreements providing for settlement in more than seven days after notice or purchase securities
which are illiquid (such as “restricted securities” which are illiquid, and securities that are not readily marketable) if, in the aggregate, more than 15% of the value of the Fund’s net assets would be so invested.
Rule 144A Securities
The Fund may
purchase certain restricted securities (“Rule 144A Securities”) for which there is a secondary market of qualified institutional buyers, as contemplated by Rule 144A under the Securities Act of 1933, as amended (“Securities
Act”). Rule 144A provides an exemption from the registration requirements of the Securities Act for the resale of certain restricted securities to qualified institutional buyers.
One effect of Rule 144A is that certain restricted securities may now be liquid, though there is no assurance that a liquid market for Rule 144A Securities will develop or be maintained. The Board of
Directors (the “Board” or “Directors”) has adopted policies and procedures for the purpose of determining whether securities that are eligible for resale under Rule 144A are liquid or illiquid for purposes of the Fund’s 15%
limitation on investment in illiquid securities. Pursuant to those policies and procedures, the Board has delegated to the Adviser the determination as to whether a particular security is liquid or illiquid, requiring that consideration be given to,
among other things, the frequency of trades and quotes for the security, the number of dealers willing to sell the security and the number of potential purchasers, dealer undertakings to make a market in the security, the nature of the security, and
the time needed to dispose of the security. The Board periodically reviews the Fund’s purchases and sales of Rule 144A Securities and the Adviser’s compliance with the above procedures.
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Loan Participations and Assignments
The Fund may invest in fixed and floating rate loans (“Loans”) arranged through private negotiations between a borrower (often an issuer of Sovereign Debt Obligations) and one or more financial
institutions (“Lenders”). The Fund’s investments in Loans are expected in most instances to be in the form of participations in Loans (“Participations”) and assignments of all or a portion of Loans (“Assignments”)
from third parties. The Fund’s investment in Participations typically will result in the Fund having a contractual relationship only with the Lender and not with the borrower. The Fund will have the right to receive payments of principal,
interest, and any fees to which it is entitled only from the Lender selling the Participations and only upon receipt by the Lender of the payments from the borrower. In connection with purchasing Participations, the Fund generally will have no right
to enforce compliance by the borrower with the terms of the loan agreement relating to the Loan, nor any rights of set-off against the borrower, and the Fund may not directly benefit from any collateral supporting the Loan in which it has purchased
the Participations. As a result, the Fund may be subject to the credit risk of both the borrower and the Lender that is selling the Participations and, accordingly, the Fund will consider both the borrower and the Lender to be issuers for purposes
of their investment restrictions. In the event of the insolvency of the Lender selling a Participation, the Fund may be treated as a general creditor of the Lender and may not benefit from any set-off between the Lender and the borrower. Certain
Participations may be structured in a manner designed to avoid purchasers of Participations being subject to the credit risk of the Lender with respect to the Participations, but even under such a structure, in the event of the Lender’s
insolvency, the Lender’s servicing of the Participations may be delayed and the assignability of the Participations impaired. The Fund will acquire Participations only if the Lender interpositioned between the Fund and the borrower is a Lender
having total assets of more than $25 billion and whose senior unsecured debt is rated investment grade or higher (i.e., Baa/BBB or higher). The Fund’s investments in Loans are considered to be debt obligations for purposes of its investment
restrictions. In addition, for purposes of the Fund’s investment restriction on investment in illiquid securities, the Fund will treat Loans as illiquid securities unless the staff of the SEC concludes that a market in these instruments has
developed sufficiently such that they may be treated as liquid.
When the Fund purchases Assignments from Lenders it will acquire direct
rights against the borrower on the Loan. Because Assignments are arranged through private negotiations between potential assignees and potential assignors, however, the rights and obligations acquired by the Fund as the purchaser of an Assignment
may differ from, and be more limited than, those held by the assigning Lender. The assignability of certain Sovereign Debt Obligations is restricted by the governing documentation as to the nature of the assignee such that the only way in which the
Fund may acquire an interest in a Loan is through a Participation and not an Assignment. The Fund may have difficulty disposing of Assignments and Participations because to do so it will have to assign such securities to a third party. Because there
is no established secondary market for such securities, the Fund anticipates that such securities could be sold only to a limited number of institutional investors. The lack of an established secondary market may have an adverse impact on the value
of such securities and the Fund’s ability to dispose of particular Assignments or Participations when necessary to meet the Fund’s liquidity needs or in response to a specific economic event such as a deterioration in the creditworthiness
of the borrower. The lack of an established secondary market for Assignments and Participations also may make it more difficult for the Fund to assign a value to these securities for purposes of valuing the Fund’s portfolio and calculating its
NAV. The Fund will not invest more than 15% of the value of its net assets in Participations and Assignments that are illiquid, and in other illiquid securities.
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Leverage Through Borrowing
The Fund may borrow for investment purposes up to 33
1
/
3
% of the value of its total assets. This borrowing, which is known as leveraging, generally will be unsecured, except to the extent the Fund enters into reverse repurchase agreements, described below.
Leveraging will exaggerate the effect on NAV of any increase or decrease in the market value of the Fund’s portfolio. Money borrowed for leveraging will be subject to interest costs which may or may not be recovered by appreciation of the
securities purchased; in certain cases, interest costs may exceed the return received on the securities purchased.
Among the forms of
borrowing in which the Fund may engage is the entry into reverse repurchase agreements with banks, brokers, or dealers. These transactions involve the transfer by the Fund of an underlying debt instrument in return for cash proceeds based on a
percentage of the value of the security. The Fund retains the right to receive interest and principal payments on the security. At an agreed upon future date, the Fund repurchases the security at principal, plus accrued interest.
For borrowings for investment purposes, the 1940 Act requires the Fund to maintain continuous asset coverage (that is, total assets including borrowings,
less liabilities exclusive of borrowings) of 300% of the amount borrowed. If the 300% asset coverage should decline as a result of market fluctuations or other reasons, the 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. The 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. To the extent the Fund enters into a reverse repurchase agreement, the
Fund will maintain in a segregated custodial account or “earmarked” on the records of the Adviser, liquid assets at least equal to the aggregate amount of its reverse repurchase obligations, plus accrued interest, in certain cases, in
accordance with releases promulgated by the SEC. The SEC views reverse repurchase transactions as collateralized borrowings by the Fund.
Lending Portfolio Securities
To a limited extent, the Fund may lend its portfolio securities to brokers, dealers, and other financial institutions, provided it receives cash collateral which at all times is maintained in an amount
equal to at least 100% of the current market value of the securities loaned. By lending its portfolio securities, the Fund can increase its income through the investment of the cash collateral. For the purposes of this policy, the Fund considers
collateral consisting of U.S. government securities or irrevocable letters of credit issued by banks whose securities meet the standards for investment by the Fund to be the equivalent of cash. Such loans may not exceed 33
1
/
3
% of the value of the Fund’s total assets. Such loans will be terminable at any time upon specified notice. The Fund might experience the risk of loss if the institution with which it has engaged in
a portfolio loan transaction breaches its agreement with the Fund. The Fund continues to be entitled to payments in amounts equal to the interest, dividends, or other distributions payable on the loaned security and receives interest on the amount
of the loan. Such loans will be terminable at any time upon specified notice. From time to time, the Fund may return to the borrower or a third party which is unaffiliated with the Fund, and which is acting as a “placing broker,” a part of
the interest earned from the investment of collateral received for securities loaned.
The SEC currently requires that the following
conditions must be met whenever portfolio securities are loaned: (i) the Fund must receive at least 100% cash collateral from the borrower; (ii) the borrower must increase such collateral whenever the market value of the securities rises
above the level of such collateral; (iii) the Fund must be able to terminate the loan at any time; (iv) the Fund must receive reasonable interest on the loan, as well as any dividends, interest or other distributions payable on the loaned
securities, and any increase in market value; (v) the Fund may pay only reasonable custodian fees in connection with the loan; and (vi) while voting rights on the loaned securities may pass to the borrower, the Company’s Board must
terminate the loan and regain the right to vote the securities if a material event adversely affecting the investment occurs. These conditions may be subject to future modification.
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Forward Commitments
The Fund may purchase securities on a when-issued or forward commitment basis, which means that delivery and payment take place a number of days after the date of the commitment to purchase. The payment
obligation and the interest rate that will be received on a when-issued security are fixed at the time the Fund enters into the commitment. The Fund will make commitments to purchase such securities only with the intention of actually acquiring the
securities, but the Fund may sell these securities before the settlement date if it is deemed advisable. The Fund will not accrue income in respect of a security purchased on a when-issued or forward commitment basis prior to its stated delivery
date.
Securities purchased on a when-issued or forward commitment basis and certain other securities held in the Fund’s portfolio are
subject to changes in value (both generally changing in the same way, i.e., appreciating when interest rates decline and depreciating when interest rates rise) based upon the public’s perception of the creditworthiness of the issuer and
changes, real or anticipated, in the level of interest rates. Securities purchased on a when-issued or forward commitment basis may expose the Fund to risks because they may experience such fluctuations prior to their actual delivery. Purchasing
securities on a when-issued or forward commitment basis can involve the additional risk that the yield available in the market when the delivery takes place actually may be higher than that obtained in the transaction itself. When the Fund purchases
securities on a forward commitment, when issued, or delayed delivery basis it does not pay for the securities until they are received, and the Fund is required to designate the segregation, either on the records of the Adviser or with the
Fund’s custodian, of cash or other liquid securities in an amount equal to or greater than, on a daily basis, the amount of the Fund’s forward commitments, when issued or delayed delivery commitments, or to enter into offsetting contracts
for the forward sale of other securities it owns. Purchasing securities on a when-issued or forward commitment basis when the Fund is fully or almost fully invested may result in greater potential fluctuations in the value of the Fund’s net
assets and its NAV.
Concentration
The Fund may invest up to 25% of its total assets, measured at the time of investment, in a single industry, subject to certain exceptions. Accordingly, the Fund may be more susceptible to any single
economic, political, or regulatory occurrence than more widely diversified funds.
Description of Bond and Commercial Paper Ratings
A rating by a rating service represents the service’s opinion as to the credit quality of the security being rated. However, the
ratings are general and are not absolute standards of quality or guarantees as to the creditworthiness of an issuer. Consequently, the Adviser believes that the quality of debt securities in which the Fund invests should be continuously reviewed and
that individual analysts give different weightings to the various factors involved in credit analysis. A rating is not a recommendation to purchase, sell, or hold a security, because it does not take into account market value or suitability for a
particular investor. When a security has received a rating from more than one service, each rating is evaluated independently. Ratings are based on current information furnished by the issuer or obtained by the rating services from other sources
that they consider reliable. Ratings may be changed, suspended, or withdrawn as a result of changes in or unavailability of such information, or for other reasons. The Adviser will utilize Moody’s and/or S&P for determining the applicable
ratings.
Bonds
Bonds rated
Aa by Moody’s are judged by Moody’s to be of high quality by all standards. Together with bonds rated Aaa (Moody’s highest rating), they comprise what are generally known as high-grade bonds. Aa bonds are rated lower than Aaa bonds
because margins of protection may not be as large as those of Aaa bonds, or fluctuations of protective elements may be of greater amplitude, or there may be other elements present which make the long-term risks appear somewhat larger than those
applicable to Aaa
26
securities. Bonds which are rated A by Moody’s possess many favorable investment attributes and are considered upper medium-grade obligations. Factors giving security to principal and
interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future.
Moody’s Baa rated bonds are considered medium-grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Bonds which are rated Ba are judged to have speculative elements because their future cannot be
considered as well assured. Uncertainty of position characterizes bonds in this class, because the protection of interest and principal payments may be very moderate and not well safeguarded.
Bonds which are rated B generally lack characteristics of a desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the security over any long period of time
may be small. Bonds which are rated Caa are of poor standing. Such securities may be in default or there may be present elements of danger with respect to principal or interest. Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked shortcomings. Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Bonds rated AA by S&P have a very strong capacity to pay interest and principal and differ only in a small degree
from issues rated AAA (S&P’s highest rating). Bonds rated AAA are considered by S&P to be the highest grade obligations and have an extremely strong capacity to pay interest and principal. Bonds rated A by S&P have a strong capacity
to pay principal and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions.
S&P’s BBB rated bonds are regarded as having adequate capacity to pay interest and principal. Although these bonds normally exhibit adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay interest and principal.
Bonds rated BB, B, CCC, CC and C are
regarded, on balance, as predominantly speculative with respect to the issuer’s capacity to pay interest and principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and C the highest degree of
speculation. While such bonds may have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. Bonds rated D are in default, and payment of interest and/or principal is
in arrears.
Commercial Paper
Moody’s: The rating Prime-1 is the highest commercial paper rating assigned by Moody’s. Issuers (or related supporting institutions) rated
Prime-1 are considered to have a superior capacity for repayment of short-term promissory obligations. Issuers (or related supporting institutions) rated Prime-2 have a strong capacity for repayment of short-term promissory obligations. Issuers (or
related supporting institutions) rated Prime-3 have an acceptable capacity for repayment of short-term promissory obligations.
S&P:
Commercial paper rated A-1 by S&P indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelmingly safe characteristics are denoted A-1+. Capacity for timely
payment on issues with an A-2 designation is strong. However, the relative degree of safety is not as high as for issues designated A-1. Issues carrying an A-3 designation have a satisfactory capacity for timely payment. They are, however, somewhat
more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations.
27
Recent Regulatory Events
Legal, tax and regulatory changes could occur that may adversely affect the Fund and its ability to pursue its investment strategies and/or increase the costs of implementing such strategies. The U.S.
Government, the Federal Reserve, the Treasury, the SEC, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and other governmental and regulatory bodies have recently taken or are considering taking actions in light
of the recent financial crisis. These actions include, but are not limited to, the enactment by the United States Congress of the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” which was signed into law on July 21, 2010,
and imposes a new regulatory framework over the U.S. financial services industry and the consumer credit markets in general, and proposed regulations by the SEC. Given the broad scope, sweeping nature, and relatively recent enactment of some of
these regulatory measures, the potential impact they could have on securities held by the Fund 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 Fund.
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 continuing economic turmoil or
otherwise, and the effect of such actions, if taken, cannot be known.
Recent Economic Events
Although the U.S. economy has seen gradual improvement since 2008, the effects of the global financial crisis that began to unfold in 2007 continue to
exist and economic growth has been slow and uneven. In addition, the negative impacts and continued uncertainty stemming from the sovereign debt crisis and economic difficulties in Europe and U.S. fiscal and political matters, including deficit
reduction and U.S. debt ratings, have impacted and may continue to impact the global
economic recovery. These events and possible continuing market turbulence may have an adverse effect on the Fund. In response to the global financial crisis,
the United States and other governments and the Federal Reserve and certain foreign central banks took steps to support financial markets. However, risks to a robust resumption of growth persist: a weak consumer weighed down by too much debt and
increasing joblessness, the growing size of the federal budget deficit and national debt, and the threat of inflation. A number of countries in Europe have experienced severe economic and financial difficulties. Many non-governmental issuers, and
even certain governments, have defaulted on, or been forced to restructure, their debts; many other issuers have faced difficulties obtaining credit or refinancing existing obligations; financial institutions have in many cases required government
or central bank support, have needed to raise capital, and/or have been impaired in their ability to extend credit; and financial markets in Europe and elsewhere have experienced extreme volatility and declines in asset values and liquidity. There
is continued concern about national-level support for the euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union (“EMU”) member countries. Member countries are required to maintain tight
control over inflation, public debt, and budget deficit to qualify for membership in the European EMU. These requirements can severely limit European EMU member countries’ ability to implement monetary policy to address regional economic
conditions. A return to unfavorable economic conditions could impair the Fund’s ability to execute its investment strategies.
INVESTMENT RESTRICTIONS
The Fund’s investment objectives
and the following investment restrictions are fundamental and cannot be changed without the affirmative vote of the holders of a majority of the Fund’s outstanding voting securities, as defined under “Description of the Fund’s
Shares.”
28
The Fund may not:
|
1.
|
Borrow money or issue senior securities, except to the extent permitted under the 1940 Act, which currently limits borrowing, except for certain
temporary purposes, to no more than
33
1
/
3
% of the value of the Fund’s total assets. (For purposes of this investment restriction, the entry into futures contracts, including those related to indices, and options on futures contracts or
indices shall not constitute borrowing.)
|
|
2.
|
Invest more than 25% of its total assets in any one industry. (Securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities are not
considered to represent industries.)
|
|
3.
|
Make loans to others, except through the purchase of debt obligations or the entry into repurchase agreements. However, the Fund may lend its portfolio
securities in any amount not to exceed
33
1
/
3
% of the value of its total assets. Any loans of portfolio securities will be made according to guidelines established by the SEC and the Fund’s Board.
|
|
4.
|
Purchase securities on margin, but the Fund may obtain such short-term credit as may be necessary for the clearance of purchases and sales of securities.
|
|
5.
|
Purchase or sell commodities or commodity contracts.
|
|
6.
|
Pledge, mortgage, or hypothecate its assets, except to the extent necessary to secure permitted borrowings and to the extent related to the deposit of assets in escrow
or similar arrangements in connection with portfolio transactions, such as in connection with writing covered options and the purchase of securities on a when-issued or delayed-delivery basis and collateral and initial or variation margin
arrangements with respect to options, futures contracts, including those relating to indices, and options on futures contracts or indices, or in connection with the purchase of any securities on margin for purposes of Investment Restriction
No. 4 above. (The deposit of assets in escrow in connection with portfolio transactions is not deemed to be a pledge or hypothecation for this purpose.)
|
|
7.
|
Purchase the obligations of any issuer if such purchase would cause more than 5% of the value of its total assets to be invested in securities of such issuer, except
that up to 25% of the value of the Fund’s total assets may be invested, and obligations issued or guaranteed by the U.S. government or its agencies or instrumentalities may be purchased, without regard to such limitations.
|
|
8.
|
Purchase, hold or deal in real estate, but this shall not prohibit the Fund from investing in securities of companies engaged in real estate activities or investments.
|
|
9.
|
Underwrite securities of other issuers, except insofar as the Fund may be deemed an underwriter under the Securities Act in selling portfolio securities.
|
In addition to the fundamental investment restrictions set forth above, the Company’s Board has adopted the following
investment restrictions with respect to the Fund in order to comply with certain legal requirements. The following restrictions are not fundamental policies of the Fund and may be changed by the Company’s Board without the approval of
shareholders of the Fund.
The Fund may not:
|
1.
|
With respect to 75% of its assets, invest more than 5% of its total assets in securities of a single issuer and may not hold more than 10% of the outstanding voting
securities of such issuer.
|
|
2.
|
Invest in interests in oil, gas, or mineral exploration or development programs.
|
|
3.
|
Enter into repurchase agreements providing for settlement in more than seven days after notice or purchase securities which are illiquid, if, in the aggregate, more
than 15% of the value of the Fund’s net assets would be so invested.
|
|
4.
|
Invest more than 15% of its net assets in illiquid securities.
|
29
The Fund adopted restriction 5 in order to comply with certain state securities laws no longer applicable to
the Fund. In these laws, the term “commodity contract” was defined as a “contract or option providing for the delivery or receipt at a future date of a specified amount and grade of a traded commodity at a specified price and delivery
point.” None of the Fund’s derivative and currency transactions involves the delivery or receipt of any asset that the Fund considers to be a commodity, and the Fund settles all such transactions by means of cash payments. Accordingly,
such transactions are not subject to the restrictions set forth above.
If a percentage restriction set forth above or elsewhere in this SAI
with respect to the Fund is adhered to at the time a transaction is effected, later changes in percentage resulting from changes in value or in the number of outstanding securities of an issuer will not be considered a violation. However, in the
event that the Fund’s asset coverage on any borrowing falls below the level required by Section 18 of the 1940 Act, the Fund will reduce its borrowings to the extent it is required to do so by Section 18(f)(1) of the 1940 Act. In
addition, in the event that the Fund’s aggregate holdings of illiquid securities exceed 15% of its net assets and are not expected to be reduced through purchases of liquid securities in the ordinary course of business, the Fund will take steps
to reduce in an orderly fashion its holdings of illiquid securities.
PORTFOLIO HOLDINGS
INFORMATION
Employees of the Adviser and its affiliates will often have access to information concerning the portfolio holdings of the
Fund. The Fund and the Adviser have adopted policies and procedures that require all employees to safeguard proprietary information of the Fund, which includes information relating to the Fund’s portfolio holdings as well as portfolio trading
activity of the Adviser with respect to the Fund (collectively, “Portfolio Holdings Information”). In addition, the Fund and the Adviser have adopted policies and procedures providing that Portfolio Holdings Information may not be
disclosed except to the extent that it is (a) made available to the general public by posting on the Fund’s website or filed as part of a required filing on Form N-Q or N-CSR or (b) provided to a third party for legitimate business
purposes or regulatory purposes, that has agreed to keep such data confidential under terms approved by the Adviser’s legal department or outside counsel, as described below. The Adviser will examine each situation under (b) with a view to
determine that release of the information is in the best interest of the Fund and their shareholders and, if a potential conflict between the Adviser’s interests and the Fund’s interests arises, to have such conflict resolved by the Chief
Compliance Officer or those Directors who are not considered to be “interested persons”, as defined in the 1940 Act (the “’Independent Directors”). These policies further provide that no officer of the Fund or employee of
the Adviser shall communicate with the media about the Fund without obtaining the advance consent of the Chief Executive Officer, Chief Operating Officer, or General Counsel of the Adviser. Under the foregoing policies, the Fund currently may
disclose Portfolio Holdings Information in the circumstances outlined below. Disclosure generally may be either on a monthly or quarterly basis with no time lag in some cases and with a time lag of up to sixty days in other cases (with the exception
of proxy voting services which require a regular download of data):
|
1.
|
To regulatory authorities in response to requests for such information and with the approval of the Chief Compliance Officer of the Fund;
|
|
2.
|
To mutual fund rating and statistical agencies and to persons performing similar functions where there is a legitimate business purpose for such disclosure and such
entity has agreed to keep such data confidential until at least it has been made public by the Adviser;
|
30
|
3.
|
To service providers of the Fund, as necessary for the performance of their services to the Fund and to the Board, where such entity has agreed to keep such data
confidential until at least it has been made public by the Adviser. The Fund’s current service providers that may receive such information are its administrator, sub-administrator, custodian, independent registered public accounting firm, legal
counsel, and financial printers;
|
|
4.
|
To firms providing proxy voting and other proxy services provided such entity has agreed to keep such data confidential until at least it has been made public by the
Adviser;
|
|
5.
|
To certain broker dealers, investment advisers, and other financial intermediaries for purposes of their performing due diligence on the Fund and not for dissemination
of this information to their clients or use of this information to conduct trading for their clients. Disclosure of Portfolio Holdings Information in these circumstances requires the broker, dealer, investment adviser, or financial intermediary to
agree to keep such information confidential until it has been made public by the Adviser and is further subject to prior approval of the Chief Compliance Officer of the Fund and shall be reported to the Board at the next quarterly meeting; and
|
|
6.
|
To consultants for purposes of performing analysis of the Fund, which analysis may be used by the consultant with its clients or disseminated to the public, provided
that such entity shall have agreed to keep such information confidential until at least it has been made public by the Adviser.
|
As of the date of this SAI, the Fund makes information about portfolio securities available to its administrator, sub-administrator, custodian, and proxy
voting services on a daily basis, with no time lag, to its typesetter on a quarterly basis with a ten day time lag, to its financial printers on a quarterly basis with a forty-five day time lag, and its independent registered public accounting firm
and legal counsel on an as needed basis with no time lag. The names of the Fund’s administrator, custodian, independent registered public accounting firm, and legal counsel are set forth is this SAI. The Fund’s proxy voting service is
Broadridge Financial Solutions, Inc. R.R. Donnelley and Data Communiqué provide typesetting services for the Fund and the Fund selects from a number of financial printers who have agreed to keep such information confidential at least until it
has been made public by the Adviser.
Other than those arrangements with the Fund’s service providers and proxy voting service, the Fund
has no ongoing arrangements to make available information about the Fund’s portfolio securities prior to such information being disclosed in a publicly available filing with the SEC that is required to include the information.
Disclosures made pursuant to a confidentiality agreement are subject to periodic confirmation by the Chief Compliance Officer of the Fund that the
recipient has utilized such information solely in accordance with the terms of the agreement. Neither the Fund, nor the Adviser, nor any of the Adviser’s affiliates will accept on behalf of itself, its affiliates, or the Fund any compensation
or other consideration in connection with the disclosure of portfolio holdings of the Fund. The Board will review such arrangements annually with the Fund’s Chief Compliance Officer.
Investment Adviser
The Adviser is a
New York limited liability company which serves as an investment adviser to sixteen open-end and ten closed-end registered investment companies and a Luxembourg SICAV with combined aggregate net assets in excess of $22.4 billion as of June 30,
2013. The Adviser is a registered investment adviser under the Investment Advisers Act of 1940, as amended. Mr. Mario J. Gabelli may be deemed a “controlling person” of the Adviser on the basis of his controlling interest in GBL,
the parent company of the Adviser. The Adviser has several affiliates that provide investment advisory services: GAMCO Asset Management Inc. acts as investment adviser for individuals, pension trusts, profit-sharing trusts, and endowments, and as
subadviser to certain third party investment funds, which include registered investment companies, and had assets under management of approximately $17.3 billion as of June 30, 2013. Teton Advisors, Inc., (formerly Gabelli Advisers, Inc.), an
affiliate of the Adviser with assets under management of approximately $1.5 billion as of June 30, 2013, acts as investment adviser to The TETON Westwood Funds and separately managed accounts; Gabelli Securities, Inc, a majority owned
subsidiary of GBL, acts as investment adviser to certain alternative investment products, consisting primarily of risk arbitrage and merchant banking limited partnerships and offshore companies, with assets under management of approximately $778
million as of June 30, 2013; and Gabelli Fixed Income LLC acts as investment adviser for separate accounts having assets under management of approximately $67 million as of June 30, 2013. Each of the forgoing companies, other than Teton
Advisors, Inc., is a subsidiary of GBL. Teton Advisors, Inc. was spun off by GBL in March 2009 and is an affiliate of GBL by virtue of Mr. Gabelli’s ownership of GGCP, Inc., the principal shareholder of Teton Advisors, Inc. as of
June 30, 2013.
Affiliates of the Adviser may, in the ordinary course of their business, acquire for their own account or for the
accounts of their advisory clients, significant (and possibly controlling) positions in the securities of companies that may also be suitable for investment by the Fund. The securities in which the Fund might invest may thereby be limited to some
extent. For instance, many companies in the past several years have adopted so-called “poison pill” or other defensive measures designed to discourage or prevent the completion of non-negotiated offers for control of the company. Such
defensive measures may have the effect of limiting the shares of the company which might otherwise be acquired by the Fund if the affiliates of the Adviser or their advisory accounts have or acquire a significant position in the same securities.
However, the Adviser does not believe that the investment activities of its affiliates will have a material adverse effect upon the Fund in seeking to achieve its investment objectives. Securities purchased or sold pursuant to contemporaneous orders
entered on behalf of the investment company accounts of the Adviser or the advisory accounts managed by its affiliates for their unaffiliated clients are allocated pursuant to principles believed to be fair and not disadvantageous to any such
accounts. In addition, all such orders are accorded priority of execution over orders entered on behalf of accounts in which the Adviser or its affiliates have a substantial pecuniary interest. The Adviser may on occasion give advice or take action
with respect to other clients that differs from the actions taken with respect to the Fund. The Fund may invest in the securities of companies which are investment management clients of GAMCO. In addition, portfolio companies or their officers or
directors may be minority shareholders of the Adviser or its affiliates.
The Adviser currently serves as investment adviser to the Fund
pursuant to the investment advisory contract (the “Contract”). Pursuant to the Contract, the Adviser furnishes a continuous investment program for the Fund’s portfolio, makes the day-to-day investment decisions for the Fund, arranges
the portfolio transactions of the Fund and generally manages the Fund’s investments in accordance with the stated policies of the Fund, subject to the general supervision of the Board.
42
Under the Contract, the Adviser also: (i) provides the Fund with the services of persons competent to
perform such supervisory, administrative, and clerical functions as are necessary to provide effective administration of the Fund, including maintaining certain books and records and overseeing the activities of the Fund’s Custodian and
Transfer Agent; (ii) oversees the performance of administrative and professional services to the Fund by others, including BNY Mellon Investment Servicing (US) Inc., the Fund’s Sub-Administrator (the “Sub-Administrator” or
“BNY Mellon”), The Bank of New York Mellon, the Company’s Custodian, State Street Bank and Trust Company (“State Street”), the Fund’s Transfer Agent and Dividend Disbursing Agent; as well as accounting, auditing, and
other services performed for the Fund; (iii) provides the Fund with adequate office space and facilities; (iv) supervises the preparation of, but does not pay for, the periodic updating of the Fund’s registration statement,
Prospectus, and SAI, including the printing of such documents for the purpose of filings with the SEC and state securities administrators, the Fund’s tax returns, and reports to the Fund’s shareholders and the SEC; (v) supervises, but
does not pay for the calculation of the NAV of each class of the Fund; (vi) supervises the preparation of, but does not pay for, all filings under the securities or “Blue Sky” laws of such states or countries as are designated by the
Distributor, which may be required to register or qualify, or continue the registration or qualification, of the Fund and/or its shares under such laws; and (vii) prepares notices and agendas for meetings of the Fund’s Board and minutes of
such meetings in all matters required by applicable law to be acted upon by the Board.
The cost of calculating the Fund’s NAV is an
expense payable by the Fund pursuant to its Contract. To the extent that a portion of the sub-administration fee is used to pay for personnel and equipment related to calculating the NAV, the Fund will reimburse the Adviser for such expense up to
$45,000. The Adviser will not seek reimbursements if assets are less than $50 million. During the fiscal year ended April 30, 2013, the Fund reimbursed the Adviser $45,000 in connection with the cost of computing the Fund’s NAV.
The Contract provides that absent willful misfeasance, bad faith, gross negligence, or reckless disregard of its duty, the Adviser and
its employees, officers, directors, and controlling persons are not liable to the Fund or any of its investors for any act or omission by the Adviser or for any error of judgment or for losses sustained by the Fund. However, the Contract provides
that the Fund is not waiving any rights they may have with respect to any violation of law which cannot be waived. The Contract also provides indemnification for the Adviser and each of these persons for any conduct for which they are not liable to
the Fund. The Contract in no way restricts the Adviser from acting as adviser to others.
By its terms, the Contract will remain in effect
from year to year, provided each such annual continuance is specifically approved by the Fund’s Board or by a “majority” (as defined pursuant to 1940 Act) vote of its shareholders and, in either case, by a majority vote of the
Independent Directors, cast in person at a meeting called specifically for the purpose of voting on the Contract. The Contract is terminable without penalty by the Fund on sixty days’ written notice when authorized either by majority vote of
its outstanding voting shares or by a vote of a majority of its Board, or by the Adviser on sixty days’ written notice, and will automatically terminate in the event of its “assignment” as defined by the 1940 Act.
As compensation for the services and the related expenses borne by the Adviser, the Fund pays the Adviser a fee, computed daily and paid monthly, at the
annual rate of 1.00% of the Fund’s average daily net assets and allocable to each class on the basis of the assets attributable to such class.
43
Advisory Fees Paid to the Adviser by the Fund
(Fiscal year ended April 30)
|
|
|
|
|
|
|
|
|
|
|
2011
|
|
2012
|
|
|
2013
|
|
|
$1,516,153
|
|
$
|
1,848,260
|
|
|
$
|
1,007,861
|
|
Portfolio Manager Information
Other Accounts Managed
The table below provides summary information regarding
other accounts for which the portfolio managers were primarily responsible for the day-to-day management during the fiscal year ended April 30, 2013.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Portfolio
Manager
|
|
Type of
Accounts
|
|
Total
#
of
Accounts
Managed
|
|
|
Total
Assets
|
|
|
# of Accounts
Managed with
Advisory Fee
Based
on
Performance
|
|
|
Total Assets with
Advisory Fee
Based on
Performance
|
|
|
Charles L. Minter
|
|
Registered Investment Companies:
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
|
Other Pooled Investment Vehicles:
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
|
Other Accounts:
|
|
|
4
|
|
|
$
|
110.1K
|
|
|
|
0
|
|
|
$
|
0
|
|
|
Martin Weiner, CFA
|
|
Registered Investment
Companies:
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
|
Other Pooled Investment Vehicles:
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
|
|
|
Other Accounts:
|
|
|
6
|
|
|
$
|
614.5K
|
|
|
|
0
|
|
|
$
|
0
|
|
|
*
|
For the Portfolio Managers, the above chart represents the portion of assets for which each Portfolio Manager has primary responsibility in the accounts indicated.
Certain assets included under “Other Accounts” may be invested in Registered Investment Companies or Other Pooled Investment Vehicles primarily managed by the Portfolio Manager and therefore may be duplicated.
|
Potential Conflicts of Interest
Actual or apparent conflicts of interest may arise when the portfolio managers also have day-to-day management responsibilities with respect to one or more other accounts. These potential conflicts
include:
Allocation of Limited Time and Attention.
Because the portfolio managers may manage more than one account, they may not be
able to formulate as complete a strategy or identify equally attractive investment opportunities for each of those accounts as if they were to devote substantially more attention to the management of only one Fund.
Allocation of Limited Investment Opportunities.
If the portfolio managers identify an investment opportunity that may be suitable for multiple
accounts, the Fund may not be able to take full advantage of that opportunity because the opportunity may need to be allocated among these accounts or other accounts managed primarily by other portfolio managers of the Adviser and its affiliates.
44
Pursuit of Differing Strategies.
At times, the portfolio managers may determine that an investment
opportunity may be appropriate for only some of the accounts for which they exercise investment responsibility, or may decide that certain of these accounts should take differing positions with respect to a particular security. In these cases, the
portfolio managers may execute differing or opposite transactions for one or more accounts which may affect the market price of the security or the execution of the transactions, or both, to the detriment of one or more other accounts.
Selection of Broker/Dealers.
A portfolio manager may be able to select or influence the selection of the brokers and dealers that are used to
execute securities transactions for the Fund or accounts that they supervise. In addition to providing execution of trades, some brokers and dealers provide portfolio managers with brokerage and research services which may result in the payment of
higher brokerage fees than might otherwise be available. These services may be more beneficial to certain funds or accounts of the Adviser and its affiliates than to others. Although the payment of brokerage commissions is subject to the requirement
that the Adviser determines in good faith that the commissions are reasonable in relation to the value of the brokerage and research services provided to the Fund, a portfolio manager’s decision as to the selection of brokers and dealers could
yield disproportionate costs and benefits among the Fund or other accounts that the Adviser and its affiliates manage. In addition, with respect to certain types of accounts (such as pooled investment vehicles and other accounts managed for
organizations and individuals) the Adviser may be limited by the client concerning the selection of brokers or may be instructed to direct trades to particular brokers. In these cases, the Adviser or its affiliates may place separate,
non-simultaneous transactions in the same security for the Fund and another account that may temporarily affect the market price of the security or the execution of the transaction, or both, to the detriment of the Fund or the other accounts.
Variation in Compensation.
A conflict of interest may arise where the financial or other benefits available to a portfolio manager
differ among the accounts that they manage. If the structure of the Adviser’s management fee or the portfolio manager’s compensation differs among accounts (such as where certain accounts pay higher management fees or performance based
management fees), the portfolio managers may be motivated to favor certain accounts over others. The portfolio managers also may be motivated to favor accounts in which they have investment interests or in which the Adviser or its affiliates have
investment interests. Similarly, the desire to maintain assets under management or to enhance a portfolio manager’s performance record or to derive other rewards, financial or otherwise, could influence the portfolio managers in affording
preferential treatment to those accounts that could most significantly benefit the portfolio managers.
The Adviser and the Fund have adopted
compliance policies and procedures that are designed to address the various conflicts of interest that may arise for the Adviser and its staff members. However, there is no guarantee that such policies and procedures will be able to detect and
address every situation in which an actual or potential conflict may arise.
Compensation Structure
The compensation of the portfolio managers in the Gabelli organization is structured to enable the Adviser to attract and retain highly qualified
professionals in a competitive environment. The portfolio managers receive a compensation package that includes equity-based incentive compensation via awards of equity awards, and incentive based variable compensation based on a percentage of net
revenue received by the Adviser for managing the Fund. Net revenues of the Fund are determined by deducting from gross investment management fees certain of the firm’s expenses (other than the respective portfolio manager’s compensation)
allocable to the Fund. This method of compensation is based on the premise that superior long-term performance in managing a portfolio should be rewarded with higher compensation as a result of growth of assets through appreciation and net
investment activity. Equity-based incentive compensation is based on an evaluation by the Adviser’s parent, GAMCO Investors, Inc., of quantitative and qualitative performance evaluation criteria.
45
Ownership of Shares in the Fund
Set forth in the table below is the dollar range of equity securities in the Fund beneficially owned by each of the portfolio managers:
|
|
|
|
|
Team Member
|
|
Dollar Range of
Equity
Securities Held in the Fund*
|
|
Charles L. Minter
|
|
E
|
|
Martin Weiner
|
|
D
|
|
*
|
Key to Dollar Ranges- Information as of April 30, 2013
|
Sub-Administrator
The Adviser has entered into an agreement (the “Sub-Administration Agreement”) with BNY Mellon, which is located at 301
Bellevue Parkway, Wilmington, DE 19809. Under the Sub-Administration Agreement, the Sub-Administrator (a) assists in supervising all aspects of the Fund’s operations except those performed by the Adviser under its advisory agreement with
the Fund; (b) supplies the Fund with office facilities (which may be in the Sub-Administrator’s own offices), statistical and research data, data processing services, clerical, accounting and bookkeeping services, including, but not
limited to, the calculation of the NAV of each class of the Fund’s shares, internal auditing and regulatory administration services, internal executive and administrative services, and stationery and office supplies; (c) prepares and
distributes materials for all Company Board meetings, including the mailing of all Board materials and collates the same materials into the Board books, and assists in the drafting of minutes of the Board meetings; (d) prepares reports to Fund
shareholders, tax returns, and reports to and filings with the SEC and state “Blue Sky” authorities; (e) provides any equipment or services necessary for the purpose of pricing shares or valuing the Fund’s investment portfolio;
(f) provides compliance testing of all Fund activities against applicable requirements of the 1940 Act and the rules thereunder, the Code, and the Fund’s investment restrictions; (g) furnishes to the Adviser such statistical and other
factual information and information regarding economic factors and trends as the Adviser from time to time may require; and (h) generally provides all administrative services that may be required for the ongoing operation of the Fund in a
manner consistent with the requirements of the 1940 Act.
For the services it provides, the Adviser pays the Sub-Administrator an annual
fee based on the value of the aggregate average daily net assets of all funds under its administration managed by the Adviser as follows: up to $10 billion - 0.0275%; $10 billion to $15 billion - 0.0125%; over $15 billion - 0.0100%.
The Sub-Administrator’s fee is paid by the Adviser and will result in no additional expense to the Fund.
Counsel
Paul Hastings LLP, 75 E. 55
th
Street, New York, New York 10022, serves as the Company’s legal counsel.
46
Independent Registered Public Accounting Firm
Ernst & Young LLP (“E&Y”), 5 Times Square, New York, NY 10036-6530, independent registered public accounting firm for the Fund, has
been selected to audit the Fund’s annual financial statements.
Custodian
The Bank of New York Mellon, One Wall Street, New York, New York 10286 acts as the U.S. and international Custodian for the Fund. The Custodian does not
assist in and is not responsible for investment decisions involving assets of the Fund.
Transfer and Dividend Disbursing Agent
Boston Financial Data Services, Inc. (“BFDS”), an affiliate of State Street, located at The BFDS Building, 30 Dan Road, Canton,
Massachusetts 02021-2809, performs the services of transfer agent and dividend disbursing agent for the Fund. Neither BFDS nor State Street assists in or is responsible for investment decisions involving assets of the Fund.
Distributor
To implement the
Fund’s Rule 12b-1 Plans the Fund has entered into a Distribution Agreement with G.distributors, LLC, a Delaware limited liability company which is a wholly owned subsidiary of GBL, having principal offices located at One Corporate Center, Rye,
New York 10580-1422. The Distributor acts as agent of the Fund for the continuous offering of the Fund’s shares on a best efforts basis. The Distributor also acts as distributor for other funds in the Fund Complex.
Purchases of Class A Shares of the Fund may pay an up-front sales charge. Of such sales charge, certain portions are retained by the Distributor.
Set forth in the table below are the amounts of sales charges paid on the purchases of Class A Shares and contingent deferred sales charges (“CDSCs”) for Class A and Class C Shares received and retained by the Distributor for the
past three fiscal years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales Commissions for the Years Ended April 30
|
|
|
|
|
2011
|
|
|
2012
|
|
|
2013
|
|
|
Share Class
|
|
Commissions
|
|
|
Retained by
Distributor
|
|
|
Commissions
|
|
|
Retained by
Distributor
|
|
|
Commissions
|
|
|
Retained by
Distributor
|
|
|
Class A Sales Commissions
|
|
$
|
667,001
|
|
|
$
|
129,984
|
|
|
$
|
23,809
|
*
|
|
$
|
4,495
|
*
|
|
$
|
71,344
|
|
|
$
|
12,574
|
|
|
|
|
|
|
|
|
|
|
|
$
|
184,040
|
**
|
|
$
|
35,274
|
**
|
|
|
|
|
|
|
|
|
|
Class A CDSCs
|
|
|
Not
Applicable
|
|
|
$
|
17,417
|
|
|
|
Not
Applicable
|
|
|
$
|
100
|
*
|
|
|
Not
Applicable
|
|
|
$
|
254
|
|
|
|
|
|
|
|
|
|
|
|
—
|
**
|
|
|
|
|
|
|
Class C CDSCs
|
|
|
Not
Applicable
|
|
|
$
|
9,969
|
|
|
|
Not
Applicable
|
|
|
$
$
|
12,536
2,879
|
*
**
|
|
|
Not
Applicable
|
|
|
$
|
2,841
|
|
|
*
|
Payments made to G.research. G.research was the Fund’s distributor prior to August 1, 2011.
|
|
**
|
Payments made to G.distributors. G.distributors replaced G.research as the Fund’s distributor effective August 1, 2011.
|
47
Set forth in the table below are the amounts of brokerage commissions and other compensation received by
the Distributor during the fiscal year ended April 30, 2013:
|
|
|
|
|
|
|
|
|
Net Underwriting
Discounts and
Commissions
|
|
Compensation on
Redemptions and
Repurchases
|
|
Brokerage
Commissions
|
|
Other
Compensation
|
|
$ 12,574
|
|
$2,841
|
|
—
|
|
—
|
DISTRIBUTION PLANS
The Fund has adopted separate distribution and service plans (each, a “Plan” and collectively the “Plans”) pursuant to Rule 12b-1
under the 1940 Act on behalf of the Fund’s Class AAA, Class A, and Class C Shares. The Board has concluded that there is a reasonable likelihood that the Plans will benefit these classes and their respective shareholders. Payments may be
made by the Fund under each Plan for the purpose of financing any activity primarily intended to result in the sales of shares of the class to which such Plan relates as determined by the Board. Such activities typically include advertising,
compensation for sales and marketing activities of the Distributor and other banks, broker-dealers, and service providers; shareholder account servicing; production and dissemination of prospectuses and sales and marketing materials; and capital or
other expenses of associated equipment, rent, salaries, bonuses, interest, and other overhead. To the extent any activity is one which the Fund may finance without a distribution plan, the Fund may also make payments to finance such activity outside
of the Plans and not be subject to their limitations. Payments under the Plans are not dependent on distribution expenses actually incurred by the Distributor. The Plans compensate the Distributor regardless of expense, and accordingly, a portion of
the payments by the Fund may be used indirectly to finance distribution activities on behalf of other Gabelli/GAMCO funds, and a portion of the payments by such other funds may be used to finance distribution activities on behalf of the Fund. The
Plans are intended to benefit the Fund, among other things, by increasing its assets and thereby reducing the Fund’s expense ratio.
Under its terms, each Plan remains in effect so long as its continuance is specifically approved at least annually by vote of the Company’s Board,
including a majority of the Independent Directors and who have no direct or indirect financial interest in the operation of the Fund. No Plan may be amended to materially increase the amount to be spent for services provided by the Distributor
thereunder without shareholder approval, and all material amendments of any Plan must also be approved by the Directors in the manner described above. Each Plan may be terminated at any time, without penalty, by vote of a majority of the Independent
Directors, or by a vote of a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act). Under each Plan, the Distributor will provide the Directors with periodic reports of amounts expended under each Plan and the
purpose for which such expenditures were made.
Pursuant to each Plan, the Board will review at least quarterly a written report of the
distribution expenses incurred on behalf of each class of shares of the Fund by the Distributor. The report includes an itemization of the distribution expenses and the purposes of such expenditures. In addition, as long as the Plans remain in
effect, the selection and nomination of Independent Directors shall be limited to the Independent Directors.
For the fiscal year ended
April 30, 2013, the Fund incurred distribution costs for Class AAA, Class A, and Class C Shares of $344,787 payable to the Distributor. The Plans compensate the Distributor regardless of its expense.
48
Distribution Costs and Expenses
Incurred for the Year Ended April 30, 2013
|
|
|
|
|
|
|
Class AAA
|
|
Class A
|
|
Class C
|
|
$13,532
|
|
$206,513
|
|
$124,713
|
For the fiscal year ended April 30, 2013, the Distributor identified expenditures for the Fund of
approximately: $6,000 for advertising and promotion, $3,200 for printing, postage and stationery, $1,200 for overhead support expenses, $48,100 for advanced commissions, $98,800 for salaries of personnel of the Distributor and $231,700 for third
party servicing fees.
Pursuant to the Plans, the Fund pays the Distributor 0.25% of its average daily net assets of Class AAA and
Class A Shares and 1.00% of its average daily net assets of Class C Shares. Due to the possible continuing nature of Rule 12b-1 payments, long-term investors may pay more than the economic equivalent of the maximum front end sales charge
permitted by the Financial Industry Regulatory Authority, Inc. (“FINRA”). Pursuant to the Distribution Agreements, the Fund appoints the Distributor as its general distributor and exclusive agent for the sale of the Fund’s shares. The
Fund has agreed to indemnify the Distributor to the extent permitted by applicable law against certain liabilities under federal securities laws. The Distribution Agreements shall remain in effect from year to year provided that continuance of such
agreements shall be approved at least annually (a) by the Company’s Board, including a vote of a majority of the Independent Directors cast in person at a meeting called for the purpose of voting on such approval or (b) by the vote of
holders of a majority of the outstanding voting securities of the Fund and by the Board. The Distribution Agreements may be terminated by either party thereto upon sixty days’ written notice.
The amounts included in a previous paragraph as third party servicing fees include amounts paid to the providers of various programs that make shares
available to their customers. Subject to approvals by the Board, the Fund also makes payments to the providers of these programs out of its assets other than Rule 12b-1 payments, in amounts not greater than savings of expenses the Fund would incur
in maintaining shareholder accounts for those who invest in the Fund directly rather than through these programs. The Adviser and its affiliates may also pay for all or a portion of these program’s charges out of their financial resources other
than Rule 12b-1 fees.
The following table provides the dates the Fund’s classes of shares were first offered to the public.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class AAA
|
|
Class A
|
|
|
Class C
|
|
|
Class R
|
|
|
12/8/08
|
|
|
10/10/85
|
|
|
|
8/22/95
|
|
|
|
8/22/95
|
|
Shares of the Fund may also be purchased through shareholder agents that are not affiliated with the Fund or the
Distributor. There is no sales or service charge imposed by the Fund other than as described in the applicable Prospectus for Class A, Class C, and Class R Shares under the “Classes of Shares” section and in the Prospectus for Class
AAA shares under the “Management of the Fund” section, but agents who do not receive distribution payments or sales charges may impose a charge to the investor for their services. Such fees may vary among agents, and such agents may impose
higher initial or subsequent investment requirements than those established by the Fund. Services provided by broker-dealers may include allowing the investor to establish a margin account and to borrow on the value of the Fund’s shares in that
account. It is the responsibility of the shareholder’s agent to establish procedures which would assure that upon receipt of an order to purchase shares of the Fund the order will be transmitted so that it will be received by the Distributor
before the time when the price applicable to the buy order expires.
No Independent Director of the Company had a direct or indirect financial
interest in the operation of any Plan or related agreements. Those interested persons who beneficially own stock in affiliates of the Adviser or the Distributor or are employed by one of the Gabelli companies may be deemed to have an indirect
financial interest.
49