INVESTMENT ADVISER:
STEIN ROE INVESTMENT COUNSEL, INC.
This Statement of Additional Information ("SAI") is not a prospectus. This SAI
is intended to provide additional information regarding the activities and
operations of The Advisors' Inner Circle Fund (the "Trust") and the AT
Disciplined Equity Fund (the "Fund"). This SAI is incorporated by reference
into and should be read in conjunction with the Fund's prospectus dated
September 5, 2013. Capitalized terms not defined herein are defined in the
prospectus. Shareholders may obtain copies of the Fund's prospectus or Annual
Report, when available, free of charge by writing to the Trust at AT
Disciplined Equity Fund, P.O. Box 219009, Kansas City, MO 64121-9009 (Express
Mail Address: AT Disciplined Equity Fund, c/o DST Systems, Inc., 430 West 7th
Street, Kansas City, MO 64105) or calling the Fund at 1-855-3AT-FUND
(1-855-328-3863).
TABLE OF CONTENTS
THE TRUST ................................................................. S-1
DESCRIPTION OF PERMITTED INVESTMENTS ...................................... S-2
INVESTMENT LIMITATIONS .................................................... S-27
THE ADVISER ............................................................... S-30
THE PORTFOLIO MANAGERS .................................................... S-31
THE ADMINISTRATOR ......................................................... S-33
THE DISTRIBUTOR ........................................................... S-33
PAYMENTS TO FINANCIAL INTERMEDIARIES ...................................... S-35
THE TRANSFER AGENT ........................................................ S-36
THE CUSTODIAN ............................................................. S-36
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ............................. S-36
LEGAL COUNSEL ............................................................. S-36
TRUSTEES AND OFFICERS OF THE TRUST ........................................ S-36
PURCHASING AND REDEEMING SHARES ........................................... S-47
DETERMINATION OF NET ASSET VALUE .......................................... S-47
TAXES ..................................................................... S-48
FUND TRANSACTIONS ......................................................... S-55
PORTFOLIO HOLDINGS ........................................................ S-58
DESCRIPTION OF SHARES ..................................................... S-59
SHAREHOLDER LIABILITY ..................................................... S-59
LIMITATION OF TRUSTEES' LIABILITY ......................................... S-59
PROXY VOTING .............................................................. S-60
CODES OF ETHICS ........................................................... S-60
5% AND 25% SHAREHOLDERS ................................................... S-60
APPENDIX A -- DESCRIPTION OF RATINGS ...................................... A-1
APPENDIX B -- PROXY VOTING POLICIES AND PROCEDURES ........................ B-1
September 5, 2013 ATF-SX-001-0100
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THE TRUST
GENERAL. The Fund is a separate series of the Trust, an open-end investment
management company established under Massachusetts law as a Massachusetts
voluntary association (commonly known as a business trust) under a Declaration
of Trust dated July 18, 1991, as amended and restated February 18, 1997 and
amended May 15, 2012. The Declaration of Trust permits the Trust to offer
separate series ("funds") of shares of beneficial interest ("shares"). The
Trust reserves the right to create and issue shares of additional funds. Each
fund is a separate mutual fund, and each share of each fund represents an equal
proportionate interest in that fund. All consideration received by the Trust
for shares of any fund, and all assets of such fund, belong solely to that fund
and would be subject to any liabilities related thereto. Each fund of the Trust
pays its (i) operating expenses, including fees of its service providers,
expenses of preparing prospectuses, proxy solicitation material and reports to
shareholders, costs of custodial services and registering its shares under
federal and state securities laws, pricing and insurance expenses, brokerage
costs, interest charges, taxes and organization expenses and (ii) pro rata
share of the fund's other expenses, including audit and legal expenses.
Expenses attributable to a specific fund shall be payable solely out of the
assets of that fund. Expenses not attributable to a specific fund are allocated
across all of the funds on the basis of relative net assets. The other funds of
the Trust are described in one or more separate Statements of Additional
Information.
HISTORY OF THE FUND. The Fund is the successor to the Invesco Disciplined
Equity Fund (the "Invesco Predecessor Fund") and the Atlantic Whitehall Equity
Income Fund (the "Atlantic Whitehall Predecessor Fund" and, together with the
Invesco Predecessor Fund, the "Predecessor Funds"). The Invesco Predecessor
Fund was managed by Invesco Advisers, Inc. ("Invesco") and the Atlantic
Whitehall Predecessor Fund was managed by the Adviser. The Predecessor Funds
had substantially similar investment objectives, investment strategies,
policies and restrictions as those of the Fund.
DESCRIPTION OF MULTIPLE CLASSES OF SHARES. The Trust is authorized to offer
shares of the Fund in Institutional Class Shares and Investor Class Shares. The
different classes provide for variations in certain distribution and
shareholder servicing expenses and minimum initial investment requirements.
Minimum investment requirements and investor eligibility are described in the
prospectus. The Trust reserves the right to create and issue additional classes
of shares. For more information on distribution and shareholder servicing
expenses, see "The Distributor" and "Shareholder Services" sections in this
SAI.
VOTING RIGHTS. Each shareholder of record is entitled to one vote for each
share held on the record date for the meeting. The Fund will vote separately
on matters relating solely to it. As a Massachusetts voluntary association,
the Trust is not required, and does not intend, to hold annual meetings of
shareholders. Approval of shareholders will be sought, however, for certain
changes in the operation of the Trust and for the election of Trustees under
certain circumstances. Under the Declaration of Trust, the Trustees have the
power to liquidate the Fund without shareholder approval. While the Trustees
have no present intention of exercising this power, they may do so if the Fund
fails to reach a viable size within a reasonable amount of time or for such
other reasons as may be determined by the Board of Trustees (each, a "Trustee"
and collectively, the "Board").
In addition, a Trustee may be removed by the remaining Trustees or by
shareholders at a special meeting called upon written request of shareholders
owning at least 10% of the outstanding shares of the Trust. In the event that
such a meeting is requested, the Trust will provide appropriate assistance and
information to the shareholders requesting the meeting.
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Any series of the Trust created on or after November 11, 1996 may reorganize or
merge with one or more other series of the Trust or of another investment
company. Any such reorganization or merger shall be pursuant to the terms and
conditions specified in an agreement and plan of reorganization authorized and
approved by the Trustees and entered into by the relevant series in connection
therewith. In addition, such reorganization or merger may be authorized by vote
of a majority of the Trustees then in office and, to the extent permitted by
applicable law and the Declaration of Trust, without the approval of
shareholders of any series.
DESCRIPTION OF PERMITTED INVESTMENTS
The Fund's investment objective and principal investment strategies are
described in the prospectus. The Fund is classified as a "diversified"
investment company under the Investment Company Act of 1940, as amended (the
"1940 Act"). The following information supplements, and should be read in
conjunction with, the prospectus. The following are descriptions of the
permitted investments and investment practices of the Fund and the associated
risk factors. The Fund may invest in any of the following instruments or engage
in any of the following investment practices unless such investment or activity
is inconsistent with or is not permitted by the Fund's stated investment
policies, including those stated below.
AMERICAN DEPOSITARY RECEIPTS. ADRs, as well as other "hybrid" forms of ADRs,
including European Depositary Receipts ("EDRs") and Global Depositary Receipts
("GDRs"), are certificates evidencing ownership of shares of a foreign issuer.
Depositary receipts are securities that evidence ownership interests in a
security or a pool of securities that have been deposited with a "depository"
and may be sponsored or unsponsored. These certificates are issued by
depository banks and generally trade on an established market in the United
States or elsewhere. The underlying shares are held in trust by a custodian
bank or similar financial institution in the issuer's home country. The
depository bank may not have physical custody of the underlying securities at
all times and may charge fees for various services, including forwarding
dividends and interest and corporate actions. ADRs are alternatives to
directly purchasing the underlying foreign securities in their national markets
and currencies. However, ADRs continue to be subject to many of the risks
associated with investing directly in foreign securities.
For ADRs, the depository is typically a U.S. financial institution and the
underlying securities are issued by a foreign issuer. For other depositary
receipts, the depository may be a foreign or a U.S. entity, and the underlying
securities may have a foreign or a U.S. issuer. Depositary receipts will not
necessarily be denominated in the same currency as their underlying securities.
Generally, ADRs are issued in registered form, denominated in U.S. dollars, and
designed for use in the U.S. securities markets. Other depositary receipts,
such as GDRs and EDRs, may be issued in bearer form and denominated in other
currencies, and are generally designed for use in securities markets outside
the U.S. While the two types of depositary receipt facilities (unsponsored or
sponsored) are similar, there are differences regarding a holder's rights and
obligations and the practices of market participants. A depository may
establish an unsponsored facility without participation by (or acquiescence of)
the underlying issuer; typically, however, the depository requests a letter of
non-objection from the underlying issuer prior to establishing the facility.
Holders of unsponsored depositary receipts generally bear all the costs of the
facility. The depository usually charges fees upon deposit and withdrawal of
the underlying securities, the conversion of dividends into U.S. dollars or
other currency, the disposition of non-cash distributions, and the performance
of other services. The depository of an unsponsored facility frequently is
under no obligation to distribute shareholder communications received from the
underlying issuer or to pass through voting rights to depositary receipt
holders with respect to the underlying securities.
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Sponsored depositary receipt facilities are created in generally the same
manner as unsponsored facilities, except that sponsored depositary receipts are
established jointly by a depository and the underlying issuer through a deposit
agreement. The deposit agreement sets out the rights and responsibilities of
the underlying issuer, the depository, and the depositary receipt holders. With
sponsored facilities, the underlying issuer typically bears some of the costs
of the depositary receipts (such as dividend payment fees of the depository),
although most sponsored depositary receipts agree to distribute notices of
shareholders meetings, voting instructions, and other shareholder
communications and information to the depositary receipt holders at the
underlying issuer's request. The depositary of an unsponsored facility
frequency is under no obligation to distribute shareholder communications
received from the issuer of the deposited security or to pass through, to the
holders of the receipts, voting rights with respect to the deposited
securities.
For purposes of the Fund's investment policies, investments in depositary
receipts will be deemed to be investments in the underlying securities. Thus, a
depositary receipt representing ownership of common stock will be treated as
common stock. Depositary receipts do not eliminate all of the risks associated
with directly investing in the securities of foreign issuers.
Investments in the securities of foreign issuers may subject the Fund to
investment risks that differ in some respects from those related to investments
in securities of U.S. issuers. Such risks include future adverse political and
economic developments, possible imposition of withholding taxes on income,
possible seizure, nationalization or expropriation of foreign deposits,
possible establishment of exchange controls or taxation at the source or
greater fluctuation in value due to changes in exchange rates. Foreign issuers
of securities often engage in business practices different from those of
domestic issuers of similar securities, and there may be less information
publicly available about foreign issuers. In addition, foreign issuers are,
generally speaking, subject to less government supervision and regulation and
different accounting treatment than are those in the United States.
EQUITY SECURITIES. Equity securities represent ownership interests in a company
or partnership and consist of common stocks, preferred stocks, warrants and
rights to acquire common stock, securities convertible into common stock, and
investments in master limited partnerships. Investments in equity securities in
general are subject to market risks that may cause their prices to fluctuate
over time. Fluctuations in the value of equity securities in which the Fund
invests will cause the net asset value of the Fund to fluctuate. The Fund
purchases equity securities traded on global securities exchanges or the
over-the-counter market. Equity securities are described in more detail below:
o COMMON STOCK. Common stock represents an equity or ownership interest in
an issuer. In the event an issuer is liquidated or declares bankruptcy, the
claims of owners of bonds and preferred stock take precedence over the
claims of those who own common stock.
o PREFERRED STOCK. Preferred stock represents an equity or ownership
interest in an issuer that pays dividends at a specified rate and that has
precedence over common stock in the payment of dividends. In the event an
issuer is liquidated or declares bankruptcy, the claims of owners of bonds
take precedence over the claims of those who own preferred and common
stock.
o ALTERNATIVE ENTITY SECURITIES. Alternative entity securities are the
securities of entities that are formed as limited partnerships, limited
liability companies, business trusts or other non-corporate entities that
are similar to common or preferred stock of corporations.
o EXCHANGE-TRADED FUNDS. An ETF is a fund whose shares are bought and sold
on a securities exchange as if it were a single security. An ETF holds a
portfolio of securities designed to track a
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particular market segment or index. Some examples of ETFs are SPDRs([R]),
DIAMONDS(SM), NASDAQ 100 Index Tracking Stock(SM) ("QQQs(SM)"), and
iShares([R]). The Fund could purchase an ETF to temporarily gain exposure
to a portion of the U. S. or foreign market while awaiting an opportunity
to purchase securities directly. Similarly, the Fund may establish a short
position in an ETF to gain inverse exposure to a portion of the U. S. or
foreign markets. The risks of owning an ETF generally reflect the risks of
owning the underlying securities they are designed to track, although lack
of liquidity in an ETF could result in it being more volatile than the
underlying portfolio of securities and ETFs have management fees that
increase their costs versus the costs of owning the underlying securities
directly. See also "Investment Company Shares" below.
o WARRANTS. Warrants are instruments that entitle the holder to buy an
equity security at a specific price for a specific period of time. Changes
in the value of a warrant do not necessarily correspond to changes in the
value of its underlying security. The price of a warrant may be more
volatile than the price of its underlying security, and a warrant may offer
greater potential for capital appreciation as well as capital loss.
Warrants do not entitle a holder to dividends or voting rights with respect
to the underlying security and do not represent any rights in the assets of
the issuing company. A warrant ceases to have value if it is not exercised
prior to its expiration date. These factors can make warrants more
speculative than other types of investments.
o CONVERTIBLE SECURITIES. Convertible securities are bonds, debentures,
notes, preferred stocks or other securities that may be converted or
exchanged (by the holder or by the issuer) into shares of the underlying
common stock (or cash or securities of equivalent value) at a stated
exchange ratio. A convertible security may also be called for redemption or
conversion by the issuer after a particular date and under certain
circumstances (including a specified price) established upon issue. If a
convertible security held by the Fund is called for redemption or
conversion, the Fund could be required to tender it for redemption, convert
it into the underlying common stock, or sell it to a third party.
Convertible securities generally have less potential for gain or loss than
common stocks. Convertible securities generally provide yields higher than
the underlying common stocks, but generally lower than comparable
non-convertible securities. Because of this higher yield, convertible
securities generally sell at a price above their "conversion value," which
is the current market value of the stock to be received upon conversion.
The difference between this conversion value and the price of convertible
securities will vary over time depending on changes in the value of the
underlying common stocks and interest rates. When the underlying common
stocks decline in value, convertible securities will tend not to decline to
the same extent because of the interest or dividend payments and the
repayment of principal at maturity for certain types of convertible
securities. However, securities that are convertible other than at the
option of the holder generally do not limit the potential for loss to the
same extent as securities convertible at the option of the holder. When the
underlying common stocks rise in value, the value of convertible securities
may also be expected to increase. At the same time, however, the difference
between the market value of convertible securities and their conversion
value will narrow, which means that the value of convertible securities
will generally not increase to the same extent as the value of the
underlying common stocks. Because convertible securities may also be
interest-rate sensitive, their value may increase as interest rates fall
and decrease as interest rates rise. Convertible securities are also
subject to credit risk, and are often lower-quality securities.
GENERAL RISKS OF INVESTING IN STOCKS - While investing in stocks allows
investors to participate in the benefits of owning a company, such investors
must accept the risks of ownership. Unlike bondholders, who have preference to
a company's earnings and cash flow, preferred stockholders,
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followed by common stockholders in order of priority, are entitled only to the
residual amount after a company meets its other obligations. For this reason,
the value of a company's stock will usually react more strongly to actual or
perceived changes in the company's financial condition or prospects than its
debt obligations. Stockholders of a company that fares poorly can lose money.
Stock markets tend to move in cycles with short or extended periods of rising
and falling stock prices. The value of a company's stock may fall because of:
o Factors that directly relate to that company, such as decisions made by
its management or lower demand for the company's products or services;
o Factors affecting an entire industry, such as increases in production
costs; and
o Changes in general financial market conditions that are relatively
unrelated to the company or its industry, such as changes in interest
rates, currency exchange rates or inflation rates.
Because preferred stock is generally junior to debt securities and other
obligations of the issuer, deterioration in the credit quality of the issuer
will cause greater changes in the value of a preferred stock than in a more
senior debt security with similar stated yield characteristics.
REAL ESTATE INVESTMENT TRUSTS ("REITs"). The Fund may invest up to 15% of its
total assets in equity interests and/or debt obligations issued by REITs.
A REIT is a corporation or business trust (that would otherwise be taxed as a
corporation) which meets the definitional requirements of the Internal Revenue
Code of 1986, as amended (the "Code"). The Code permits a qualifying REIT to
deduct from taxable income the dividends paid, thereby effectively eliminating
corporate level federal income tax and making the REIT a pass-through vehicle
for federal income tax purposes. To meet the definitional requirements of the
Code, a REIT must, among other things: invest substantially all of its assets
in interests in real estate (including mortgages and other REITs), cash and
government securities; derive most of its income from rents from real property
or interest on loans secured by mortgages on real property; and distribute
annually 95% or more of its otherwise taxable income to shareholders. Although
the REIT structure originated in the U.S., a number of countries around the
world have adopted, or are considering adopting, similar REIT and REIT-like
structures.
REITs are sometimes informally characterized as Equity REITs and Mortgage
REITs. An Equity REIT invests primarily in the fee ownership or leasehold
ownership of land and buildings; a Mortgage REIT invests primarily in mortgages
on real property, which may secure construction, development or long-term
loans.
REITs in which the Fund invests may be affected by changes in underlying real
estate values, which may have an exaggerated effect to the extent that REITs in
which the Fund invests may concentrate investments in particular geographic
regions or property types. Additionally, rising interest rates may cause
investors in REITs to demand a higher annual yield from future distributions,
which may in turn decrease market prices for equity securities issued by REITs.
Rising interest rates also generally increase the costs of obtaining financing,
which could cause the value of the Fund's investments to decline. During
periods of declining interest rates, certain Mortgage REITs may hold mortgages
that the mortgagors elect to prepay, which prepayment may diminish the yield on
securities issued by such Mortgage REITs. In addition, Mortgage REITs may be
affected by the ability of borrowers to repay when due the debt extended by the
REIT and Equity REITs may be affected by the ability of tenants to pay rent.
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Certain REITs have relatively small market capitalization, which may tend to
increase the volatility of the market price of securities issued by such REITs.
Furthermore, REITs are dependent upon specialized management skills, have
limited diversification and are, therefore, subject to risks inherent in
operating and financing a limited number of projects. By investing in REITs
indirectly through the Fund, a shareholder will bear not only his proportionate
share of the expenses of the Fund, but also, indirectly, similar expenses of
the REITs. REITs depend generally on their ability to generate cash flow to
make distributions to shareholders.
In addition to these risks, Equity REITs may be affected by changes in the
value of the underlying property owned by the trusts, while Mortgage REITs may
be affected by the quality of any credit extended. Further, Equity and Mortgage
REITs are dependent upon management skills and generally may not be
diversified. Equity and Mortgage REITs are also subject to heavy cash flow
dependency defaults by borrowers and self-liquidation. In addition, Equity and
Mortgage REITs could possibly fail to qualify for tax free pass-through of
income under the Internal Revenue Code or to maintain their exemptions from
registration under the 1940 Act. The above factors may also adversely affect a
borrower's or a lessee's ability to meet its obligations to the REIT. In the
event of default by a borrower or lessee, the REIT may experience delays in
enforcing its rights as a mortgagee or lessor and may incur substantial costs
associated with protecting its investments.
MICRO, SMALL AND MEDIUM CAPITALIZATION ISSUERS. Investing in equity securities
of micro, small and medium capitalization companies often involves greater risk
than is customarily associated with investments in larger capitalization
companies. This increased risk may be due to the greater business risks of
smaller size, limited markets and financial resources, narrow product lines and
frequent lack of depth of management. The securities of micro and smaller
companies are often traded in the over-the-counter market and even if listed on
a national securities exchange may not be traded in volumes typical for that
exchange. Consequently, the securities of micro and smaller companies are less
likely to be liquid, may have limited market stability, and may be subject to
more abrupt or erratic market movements than securities of larger, more
established growth companies or the market averages in general.
INITIAL PUBLIC OFFERINGS ("IPOS") - The Fund may invest a portion of its assets
in securities of companies offering shares in IPOs. IPOs may have a magnified
performance impact on a Fund with a small asset base. The impact of IPOs on the
Fund's performance likely will decrease as the Fund's asset size increases,
which could reduce the Fund's total returns. IPOs may not be consistently
available to the Fund for investing, particularly as the Fund's asset base
grows. Because IPO shares frequently are volatile in price, the Fund may hold
IPO shares for a very short period of time. This may increase the turnover of
the Fund's portfolio and may lead to increased expenses for the Fund, such as
commissions and transaction costs. By selling IPO shares, the Fund may realize
taxable gains it will subsequently distribute to shareholders. In addition,
the market for IPO shares can be speculative and/or inactive for extended
periods of time. The limited number of shares available for trading in some
IPOs may make it more difficult for the Fund to buy or sell significant amounts
of shares without an unfavorable impact on prevailing prices. Holders of IPO
shares can be affected by substantial dilution in the value of their shares, by
sales of additional shares and by concentration of control in existing
management and principal shareholders.
The Fund's investment in IPO shares may include the securities of unseasoned
companies (companies with less than three years of continuous operations),
which presents risks considerably greater than common stocks of more
established companies. These companies may have limited operating
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histories and their prospects for profitability may be uncertain. These
companies may be involved in new and evolving businesses and may be vulnerable
to competition and changes in technology, markets and economic conditions. They
may be more dependent on key managers and third parties and may have limited
product lines.
MASTER LIMITED PARTNERSHIPS ("MLPs"). MLPs are limited partnerships or limited
liability companies, whose partnership units or limited liability interests are
listed and traded on a U.S. securities exchange, and are treated as publicly
traded partnerships for federal income tax purposes. To qualify to be treated as
a partnership for tax purposes, an MLP must receive at least 90% of its income
from qualifying sources as set forth in Section 7704(d) of the Code. These
qualifying sources include activities such as the exploration, development,
mining, production, processing, refining, transportation, storage and marketing
of mineral or natural resources. MLPs generally have two classes of owners, the
general partner and limited partners. MLPs that are formed as limited liability
companies generally have two analogous classes of owners, the managing member
and the members. For purposes of this section, references to general partners
also apply to managing members and references to limited partners also apply to
members. The general partner is typically owned by a major energy company, an
investment fund, the direct management of the MLP or is an entity owned by one
or more of such parties. The general partner may be structured as a private or
publicly traded corporation or other entity. The general partner typically
controls the operations and management of the MLP through an equity interest of
as much as 2% in the MLP plus, in many cases, ownership of common units and
subordinated units. Limited partners own the remainder of the MLP through
ownership of common units and have a limited role in the MLP's operations and
management.
MLPs are typically structured such that common units and general partner
interests have first priority to receive quarterly cash distributions up to an
established minimum amount ("minimum quarterly distributions" or "MQD"). Common
and general partner interests also accrue arrearages in distributions to the
extent the MQD is not paid. Once common and general partner interests have been
paid, subordinated units receive distributions of up to the MQD; however,
subordinated units do not accrue arrearages. Distributable cash in excess of
the MQD paid to both common and subordinated units is distributed to both
common and subordinated units generally on a pro rata basis. The general
partner is also eligible to receive incentive distributions if the general
partner operates the business in a manner which results in distributions paid
per common unit surpassing specified target levels. As the general partner
increases cash distributions to the limited partners, the general partner
receives an increasingly higher percentage of the incremental cash
distributions. A common arrangement provides that the general partner can reach
a tier where it receives 50% of every incremental dollar paid to common and
subordinated unit holders. These incentive distributions encourage the general
partner to streamline costs, increase capital expenditures and acquire assets
in order to increase the partnership's cash flow and raise the quarterly cash
distribution in order to reach higher tiers. Such results benefit all security
holders of the MLP.
General partner interests of MLPs are typically retained by an MLP's original
sponsors, such as its founders, corporate partners, entities that sell assets
to the MLP and investors such as us. A holder of general partner interests can
be liable under certain circumstances for amounts greater than the amount of
the holder's investment in the general partner interest. General partner
interests often confer direct board participation rights and in many cases,
operating control, over the MLP. These interests themselves are not publicly
traded, although they may be owned by publicly traded entities. General partner
interests receive cash distributions, typically 2% of the MLP's aggregate cash
distributions, which are contractually defined in the partnership agreement. In
addition, holders of general partner interests typically hold incentive
distribution rights ("IDRs"), which provide them with a larger share of the
aggregate MLP cash distributions as the distributions to limited partner unit
holders are
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increased to prescribed levels. General partner interests generally cannot be
converted into common units. The general partner interest can be redeemed by
the MLP if the MLP unitholders choose to remove the general partner, typically
with a supermajority vote by limited partner unitholders.
FOREIGN SECURITIES. Foreign securities include equity securities of foreign
entities, obligations of foreign branches of U.S. banks and of foreign banks,
including, without limitation, European Certificates of Deposit, European Time
Deposits, European Bankers' Acceptances, Canadian Time Deposits, Europaper and
Yankee Certificates of Deposit, and investments in Canadian Commercial Paper
and foreign securities. These instruments have investment risks that differ in
some respects from those related to investments in obligations of U.S. domestic
issuers. Such risks include future adverse political and economic developments,
the possible imposition of withholding taxes on interest or other income,
possible seizure, nationalization, or expropriation of foreign deposits, the
possible establishment of exchange controls or taxation at the source, greater
fluctuations in value due to changes in exchange rates, or the adoption of
other foreign governmental restrictions which might adversely affect the
payment of principal and interest on such obligations. Such investments may
also entail higher custodial fees and sales commissions than domestic
investments. Foreign issuers of securities or obligations are often subject to
accounting treatment and engage in business practices different from those
respecting domestic issuers of similar securities or obligations. Foreign
branches of U.S. banks and foreign banks may be subject to less stringent
reserve requirements than those applicable to domestic branches of U.S. banks.
EMERGING MARKETS -- An "emerging country" is generally a country that the
International Bank for Reconstruction and Development (World Bank) and the
International Finance Corporation would consider to be an emerging or
developing country. Typically, emerging markets are in countries that are in
the process of industrialization, with lower gross national products (GNP) than
more developed countries. There are currently over 130 countries that the
international financial community generally considers to be emerging or
developing countries, approximately 40 of which currently have stock markets.
These countries generally include every nation in the world except the United
States, Canada, Japan, Australia, New Zealand and most nations located in
Western Europe.
INVESTMENT FUNDS -- Some emerging countries currently prohibit direct foreign
investment in the securities of their companies. Certain emerging countries,
however, permit indirect foreign investment in the securities of companies
listed and traded on their stock exchanges through investment funds that they
have specifically authorized. Investments in these investment funds are subject
to the provisions of the 1940 Act. If the Fund invests in such investment
funds, shareholders will bear not only their proportionate share of the
expenses (including operating expenses and the fees of the Adviser), but also
will bear indirectly bear similar expenses of the underlying investment funds.
In addition, these investment funds may trade at a premium over their net asset
value.
RISKS OF FOREIGN SECURITIES:
Foreign securities, foreign currencies, and securities issued by U.S. entities
with substantial foreign operations may involve significant risks in addition
to the risks inherent in U.S. investments.
POLITICAL AND ECONOMIC FACTORS -- Local political, economic, regulatory, or
social instability, military action or unrest, or adverse diplomatic
developments may affect the value of foreign investments. Listed below are some
of the more important political and economic factors that could negatively
affect an investment in foreign securities:
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o The economies of foreign countries may differ from the economy of the
United States in such areas as growth of gross national product, rate
of inflation, capital reinvestment, resource self- sufficiency, budget
deficits and national debt;
o Foreign governments sometimes participate to a significant degree,
through ownership interests or regulation, in their respective
economies. Actions by these governments could significantly influence
the market prices of securities and payment of dividends;
o The economies of many foreign countries are dependent on
international trade and their trading partners and they could be
severely affected if their trading partners were to enact protective
trade barriers and economic conditions;
o The internal policies of a particular foreign country may be less
stable than in the United States. Other countries face significant
external political risks, such as possible claims of sovereignty by
other countries or tense and sometimes hostile border clashes; and
o A foreign government may act adversely to the interests of U.S.
investors, including expropriation or nationalization of assets,
confiscatory taxation and other restrictions on U.S. investment. A
country may restrict or control foreign investments in its securities
markets. These restrictions could limit the Fund's ability to invest
in a particular country or make it very expensive for the Fund to
invest in that country. Some countries require prior governmental
approval or limit the types or amount of securities or companies in
which a foreigner can invest. Other countries may restrict the ability
of foreign investors to repatriate their investment income and capital
gains.
INFORMATION AND SUPERVISION -- There is generally less publicly available
information about foreign companies than companies based in the United States.
For example, there are often no reports and ratings published about foreign
companies comparable to the ones written about U.S. companies. Foreign
companies are typically not subject to uniform accounting, auditing and
financial reporting standards, practices and requirements comparable to those
applicable to U.S. companies. The lack of comparable information makes
investment decisions concerning foreign countries more difficult and less
reliable than domestic companies.
STOCK EXCHANGE AND MARKET RISK -- The Fund's investment managers anticipate
that in most cases an exchange or over-the-counter ("OTC") market located
outside of the United States will be the best available market for foreign
securities. Foreign stock markets, while growing in volume and sophistication,
are generally not as developed as the markets in the United States. Foreign
stock markets tend to differ from those in the United States in a number of
ways.
Foreign stock markets:
o are generally more volatile than, and not as developed or efficient
as, those in the United States;
o have substantially less volume;
o trade securities that tend to be less liquid and experience rapid and
erratic price movements;
o have generally higher commissions and are subject to set minimum
rates, as opposed to negotiated rates;
o employ trading, settlement and custodial practices less developed
than those in U.S. markets; and
o may have different settlement practices, which may cause delays and
increase the potential for failed settlements.
Foreign markets may offer less protection to shareholders than U.S. markets
because:
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o foreign accounting, auditing, and financial reporting requirements
may render a foreign corporate balance sheet more difficult to
understand and interpret than one subject to U.S. law and standards;
o adequate public information on foreign issuers may not be available,
and it may be difficult to secure dividends and information regarding
corporate actions on a timely basis;
o in general, there is less overall governmental supervision and
regulation of securities exchanges, brokers, and listed companies than
in the United States;
o OTC markets tend to be less regulated than stock exchange markets
and, in certain countries, may be totally unregulated;
o economic or political concerns may influence regulatory enforcement
and may make it difficult for shareholders to enforce their legal
rights; and
o restrictions on transferring securities within the United States or
to U.S. persons may make a particular security less liquid than
foreign securities of the same class that are not subject to such
restrictions.
FOREIGN CURRENCY RISK -- While the Fund denominates its net asset value in U.S.
dollars, the securities of foreign companies are frequently denominated in
foreign currencies. Thus, a change in the value of a foreign currency against
the U.S. dollar will result in a corresponding change in value of securities
denominated in that currency. Some of the factors that may impair the
investments denominated in a foreign currency are:
o It may be expensive to convert foreign currencies into U.S. dollars
and vice versa;
o Complex political and economic factors may significantly affect the
values of various currencies, including U.S. dollars, and their
exchange rates;
o Government intervention may increase risks involved in purchasing or
selling foreign currency options, forward contracts and futures
contracts, since exchange rates may not be free to fluctuate in
response to other market forces;
o There may be no systematic reporting of last sale information for
foreign currencies or regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely
basis;
o Available quotation information is generally representative of very
large round-lot transactions in the inter-bank market and thus may not
reflect exchange rates for smaller odd- lot transactions (less than $1
million) where rates may be less favorable; and
o The inter-bank market in foreign currencies is a global,
around-the-clock market. To the extent that a market is closed while
the markets for the underlying currencies remain open, certain markets
may not always reflect significant price and rate movements.
TAXES -- Certain foreign governments levy withholding taxes on dividend and
interest income. Although in some countries it is possible for the Fund to
recover a portion of these taxes, the portion that cannot be recovered will
reduce the income the Fund receives from its investments.
EMERGING MARKETS -- Investing in emerging markets may magnify the risks of
foreign investing. Security prices in emerging markets can be significantly
more volatile than those in more developed markets, reflecting the greater
uncertainties of investing in less established markets and economies. In
particular, countries with emerging markets may:
o Have relatively unstable governments;
o Present greater risks of nationalization of businesses, restrictions
on foreign ownership and prohibitions on the repatriation of assets;
o Offer less protection of property rights than more developed
countries; and
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o Have economies that are based on only a few industries, may be highly
vulnerable to changes in local or global trade conditions, and may
suffer from extreme and volatile debt burdens or inflation rates.
Local securities markets may trade a small number of securities and may be
unable to respond effectively to increases in trading volume, potentially
making prompt liquidation of holdings difficult or impossible at times.
MONEY MARKET SECURITIES. Money market securities include short-term U.S.
government securities; custodial receipts evidencing separately traded interest
and principal components of securities issued by the U.S. Treasury; commercial
paper rated in the highest short-term rating category by a nationally
recognized statistical ratings organization ("NRSRO"), such as Standard &
Poor's Rating Services ("S&P") or Moody's Investor Services, Inc. ("Moody's"),
or determined by the Adviser to be of comparable quality at the time of
purchase; short-term bank obligations (certificates of deposit, time deposits
and bankers' acceptances) of U.S. commercial banks with assets of at least $1
billion as of the end of their most recent fiscal year; and repurchase
agreements involving such securities. Each of these money market securities are
described below. For a description of ratings, see "Appendix A --Description of
Ratings" to this SAI.
U.S. GOVERNMENT SECURITIES. The Fund may invest in U.S. government securities.
Securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities include U.S. Treasury securities, which are backed by the
full faith and credit of the U.S. Treasury and which differ only in their
interest rates, maturities, and times of issuance. U.S. Treasury bills have
initial maturities of one-year or less; U.S. Treasury notes have initial
maturities of one to ten years; and U.S. Treasury bonds generally have initial
maturities of greater than ten years. Certain U.S. government securities are
issued or guaranteed by agencies or instrumentalities of the U.S. government
including, but not limited to, obligations of U.S. government agencies or
instrumentalities such as the Federal National Mortgage Association ("Fannie
Mae"), the Government National Mortgage Association ("Ginnie Mae"), the Small
Business Administration, the Federal Farm Credit Administration, the Federal
Home Loan Banks, Banks for Cooperatives (including the Central Bank for
Cooperatives), the Federal Land Banks, the Federal Intermediate Credit Banks,
the Tennessee Valley Authority, the Export-Import Bank of the United States,
the Commodity Credit Corporation, the Federal Financing Bank, the Student Loan
Marketing Association, the National Credit Union Administration and the Federal
Agricultural Mortgage Corporation ("Farmer Mac").
Some obligations issued or guaranteed by U.S. government agencies and
instrumentalities, including, for example, Ginnie Mae pass-through
certificates, are supported by the full faith and credit of the U.S. Treasury.
Other obligations issued by or guaranteed by federal agencies, such as those
securities issued by Fannie Mae, are supported by the discretionary authority
of the U.S. government to purchase certain obligations of the federal agency.
While other obligations issued by or guaranteed by federal agencies, such as
those of the Federal Home Loan Banks, are supported by the right of the issuer
to borrow from the U.S. Treasury, while the U.S. government provides financial
support to such U.S. government-sponsored federal agencies, no assurance can be
given that the U.S. government will always do so, since the U.S. government is
not so obligated by law. U.S. Treasury notes and bonds typically pay coupon
interest semi-annually and repay the principal at maturity.
On September 7, 2008, the U.S. Treasury announced a federal takeover of Fannie
Mae and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), placing the
two federal instrumentalities in conservatorship. Under the takeover, the U.S.
Treasury agreed to acquire $1 billion of senior preferred stock of each
instrumentality and obtained warrants for the purchase of common stock of
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each instrumentality (the "Senior Preferred Stock Purchase Agreement" or
"Agreement"). Under the Agreement, the U.S. Treasury pledged to provide up to
$200 billion per instrumentality as needed, including the contribution of cash
capital to the instrumentalities in the event their liabilities exceed their
assets. This was intended to ensure that the instrumentalities maintain a
positive net worth and meet their financial obligations, preventing mandatory
triggering of receivership. On December 24, 2009, the U.S. Treasury announced
that it was amending the Agreement to allow the $200 billion cap on the U.S.
Treasury's funding commitment to increase as necessary to accommodate any
cumulative reduction in net worth through the end of 2012. The unlimited
support the U.S. Treasury extended to the two companies expired at the
beginning of 2013 -- Fannie Mae's support is now capped at $125 billion and
Freddie Mac has a limit of $149 billion.
On August 17, 2012, the U.S. Treasury announced that it was again amending the
Agreement to terminate the requirement that Fannie Mae and Freddie Mac each pay
a 10% annual dividend. Instead, the companies will transfer to the U.S.
Treasury on a quarterly basis all profits earned during a quarter that exceed a
capital reserve amount of $3 billion. It is believed that the new amendment
puts Fannie Mae and Freddie Mac in a better position to service their debt
because the companies no longer have to borrow from the U.S. Treasury to make
fixed dividend payments. As part of the new terms, Fannie Mae and Freddie Mac
also will be required to reduce their investment portfolios at an annual rate
of 15 percent instead of the previous 10 percent, which puts each of them on
track to cut their portfolios to a targeted $250 billion in 2018.
Fannie Mae and Freddie Mac are the subject of several continuing class action
lawsuits and investigations by federal regulators over certain accounting,
disclosure or corporate governance matters, which (along with any resulting
financial restatements) may adversely affect the guaranteeing entities.
Importantly, the future of the entities is in serious question as the U.S.
Government reportedly is considering multiple options, ranging from
nationalization, privatization, consolidation, or abolishment of the entities.
o U. S. TREASURY OBLIGATIONS. U. S. Treasury obligations consist of bills,
notes and bonds issued by the U. S. Treasury and separately traded interest
and principal component parts of such obligations that are transferable
through the federal book-entry system known as Separately Traded Registered
Interest and Principal Securities ("STRIPS") and Treasury Receipts ("TRs").
o RECEIPTS. Interests in separately traded interest and principal component
parts of U. S. government obligations that are issued by banks or brokerage
firms and are created by depositing U. S. government obligations into a
special account at a custodian bank. The custodian holds the interest and
principal payments for the benefit of the registered owners of the
certificates or receipts. The custodian arranges for the issuance of the
certificates or receipts evidencing ownership and maintains the register.
TRs and STRIPS are interests in accounts sponsored by the U. S. Treasury.
Receipts are sold as zero coupon securities.
o U. S. GOVERNMENT ZERO COUPON SECURITIES. STRIPS and receipts are sold as
zero coupon securities, that is, fixed income securities that have been
stripped of their unmatured interest coupons. Zero coupon securities are
sold at a (usually substantial) discount and redeemed at face value at
their maturity date without interim cash payments of interest or principal.
The amount of this discount is accreted over the life of the security, and
the accretion constitutes the income earned on the security for both
accounting and tax purposes. Because of these features, the market prices
of zero coupon securities are generally more volatile than the market
prices of securities that have similar maturity but that pay interest
periodically. Zero coupon securities are likely to
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respond to a greater degree to interest rate changes than are non-zero
coupon securities with similar maturity and credit qualities.
o U. S. GOVERNMENT AGENCIES. Some obligations issued or guaranteed by
agencies of the U. S. government are supported by the full faith and credit
of the U. S. Treasury, others are supported by the right of the issuer to
borrow from the U. S. Treasury, while still others are supported only by
the credit of the instrumentality. Guarantees of principal by agencies or
instrumentalities of the U. S. government may be a guarantee of payment at
the maturity of the obligation so that in the event of a default prior to
maturity there might not be a market and thus no means of realizing on the
obligation prior to maturity. Guarantees as to the timely payment of
principal and interest do not extend to the value or yield of these
securities nor to the value of the Fund's shares.
COMMERCIAL PAPER. Commercial paper is the term used to designate unsecured
short-term promissory notes issued by corporations and other entities.
Maturities on these issues vary from a few to 270 days.
INVESTMENT GRADE FIXED INCOME SECURITIES. Fixed income securities are
considered investment grade if they are rated in one of the four highest rating
categories by an NRSRO, or, if not rated, are determined to be of comparable
quality by a Fund's adviser. See "Appendix A -Description of Ratings" for a
description of the bond rating categories of several NRSROs. Ratings of each
NRSRO represent its opinion of the safety of principal and interest payments
(and not the market risk) of bonds and other fixed income securities it
undertakes to rate at the time of issuance. Ratings are not absolute standards
of quality and may not reflect changes in an issuer's creditworthiness. Fixed
income securities rated BBB- or Baa3 lack outstanding investment
characteristics, and have speculative characteristics as well. Securities rated
Baa3 by Moody's or BBB- by S&P or higher are considered by those rating
agencies to be "investment grade" securities, although Moody's considers
securities rated in the Baa category to have speculative characteristics. While
issuers of bonds rated BBB by S&P are considered to have adequate capacity to
meet their financial commitments, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest
and principal for debt in this category than debt in higher rated categories.
In the event a security owned by the Fund is downgraded below investment grade,
the Adviser will review the situation and take appropriate action with regard
to the security, including the actions discussed below.
DEBT SECURITIES. Corporations and governments use debt securities to borrow
money from investors. Most debt securities promise a variable or fixed rate of
return and repayment of the amount borrowed at maturity. Some debt securities,
such as zero-coupon bonds, do not pay current interest and are purchased at a
discount from their face value.
TYPES OF DEBT SECURITIES:
o CORPORATE BONDS - Corporations issue bonds and notes to raise money
for working capital or for capital expenditures such as plant
construction, equipment purchases and expansion. In return for the
money loaned to the corporation by investors, the corporation promises
to pay investors interest, and repay the principal amount of the bond
or note.
o MORTGAGE-BACKED SECURITIES - Mortgage-backed securities are interests
in pools of mortgage loans that various governmental,
government-related and private organizations assemble as securities
for sale to investors. Unlike most debt securities, which pay interest
periodically and repay principal at maturity or on specified call
dates, mortgage-backed securities make monthly payments that consist
of both interest and principal payments. In effect, these
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payments are a "pass-through" of the monthly payments made by the
individual borrowers on their mortgage loans, net of any fees paid to
the issuer or guarantor of such securities. Since homeowners usually
have the option of paying either part or all of the loan balance
before maturity, the effective maturity of a mortgage-backed security
is often shorter than is stated.
Governmental entities, private insurers and mortgage poolers may
insure or guarantee the timely payment of interest and principal of
these pools through various forms of insurance or guarantees,
including individual loan, title, pool and hazard insurance and
letters of credit. The Adviser will consider such insurance and
guarantees and the creditworthiness of the issuers thereof in
determining whether a mortgage-related security meets its investment
quality standards. It is possible that the private insurers or
guarantors will not meet their obligations under the insurance
policies or guarantee arrangements.
Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be
readily marketable.
COMMERCIAL BANKS, SAVINGS AND LOAN INSTITUTIONS, PRIVATE MORTGAGE INSURANCE
COMPANIES, MORTGAGE BANKERS AND OTHER SECONDARY MARKET ISSUERS. Commercial
banks, savings and loan institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers also create pass-through
pools of conventional mortgage loans. In addition to guaranteeing the
mortgage-related security, such issuers may service and/or have originated the
underlying mortgage loans. Pools created by these issuers generally offer a
higher rate of interest than pools created by GNMA, FNMA and Freddie Mac
because they are not guaranteed by a government agency.
RISKS OF MORTGAGE-BACKED SECURITIES - Yield characteristics of mortgage-backed
securities differ from those of traditional debt securities in a variety of
ways. The most significant differences of mortgage-backed securities are: 1)
payments of interest and principal are more frequent (usually monthly) and 2)
falling interest rates generally cause individual borrowers to pay off their
mortgage earlier than expected, which results in prepayments of principal on
the securities, thus forcing the Fund to reinvest the money at a lower interest
rate. In addition to risks associated with changes in interest rates described
in "Factors Affecting the Value of Debt Securities," a variety of economic,
geographic, social and other factors, such as the sale of the underlying
property, refinancing or foreclosure, can cause investors to repay the loans
underlying a mortgage-backed security sooner than expected. When prepayment
occurs, the Fund may have to reinvest its principal at a rate of interest that
is lower than the rate on existing mortgage-backed securities.
OTHER ASSET-BACKED SECURITIES - These securities are interests in pools of a
broad range of assets other than mortgages, such as automobile loans, computer
leases and credit card receivables. Like mortgage-backed securities, these
securities are pass-through. In general, the collateral supporting these
securities is of shorter maturity than mortgage loans and is less likely to
experience substantial prepayments with interest rate fluctuations, but may
still be subject to prepayment risk.
Asset-backed securities present certain risks that are not presented by
mortgage-backed securities. Primarily, these securities may not have the
benefit of any security interest in the related assets, which raises the
possibility that recoveries on repossessed collateral may not be available to
support payments on these securities. For example, credit card receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which allow debtors to
reduce their balances by offsetting certain amounts owed on the credit cards.
Most issuers of asset-backed securities backed by automobile receivables permit
the servicers of such receivables to retain possession of the underlying
obligations. If the servicer were to sell these
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obligations to another party, there is a risk that the purchaser would acquire
an interest superior to that of the holders of the related asset-backed
securities. Due to the quantity of vehicles involved and requirements under
state laws, asset-backed securities backed by automobile receivables may not
have a proper security interest in all of the obligations backing such
receivables.
To lessen the effect of failures by obligors on underlying assets to make
payments, the entity administering the pool of assets may agree to ensure the
receipt of payments on the underlying pool occurs in a timely fashion
("liquidity protection"). In addition, asset-backed securities may obtain
insurance, such as guarantees, policies or letters of credit obtained by the
issuer or sponsor from third parties, for some or all of the assets in the pool
("credit support"). Delinquency or loss more than that anticipated or failure
of the credit support could adversely affect the return on an investment in
such a security.
The Fund may also invest in residual interests in asset-backed securities,
which consist of the excess cash flow remaining after making required payments
on the securities and paying related administrative expenses. The amount of
residual cash flow resulting from a particular issue of asset-backed securities
depends in part on the characteristics of the underlying assets, the coupon
rates on the securities, prevailing interest rates, the amount of
administrative expenses and the actual prepayment experience on the underlying
assets.
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements with
financial institutions. A repurchase agreement is an agreement under which a
fund acquires a fixed income security (generally a security issued by the U.S.
government or an agency thereof, a banker's acceptance, or a certificate of
deposit) from a commercial bank, broker, or dealer, and simultaneously agrees
to resell such security to the seller at an agreed upon price and date
(normally, the next business day). Because the security purchased constitutes
collateral for the repurchase obligation, a repurchase agreement may be
considered a loan that is collateralized by the security purchased. The
acquisition of a repurchase agreement may be deemed to be an acquisition of the
underlying securities as long as the obligation of the seller to repurchase the
securities is collateralized fully. The Fund follows certain procedures
designed to minimize the risks inherent in such agreements. These procedures
include effecting repurchase transactions only with creditworthy financial
institutions whose condition will be continually monitored by the Adviser. The
repurchase agreements entered into by the Fund will provide that the underlying
collateral at all times shall have a value at least equal to 102% of the resale
price stated in the agreement and consist only of securities permissible under
Section 101(47)(A)(i) of the Bankruptcy Code (the Adviser monitors compliance
with this requirement). Under all repurchase agreements entered into by the
Fund, the custodian or its agent must take possession of the underlying
collateral. In the event of a default or bankruptcy by a selling financial
institution, the Fund will seek to liquidate such collateral. However, the
exercising of the Fund's right to liquidate such collateral could involve
certain costs or delays and, to the extent that proceeds from any sale upon a
default of the obligation to repurchase were less than the repurchase price,
the Fund could suffer a loss. It is the current policy of the Fund not to
invest in repurchase agreements that do not mature within seven days if any
such investment, together with any other illiquid assets held by the Fund,
amounts to more than 15% of the Fund's total assets. The investments of the
Fund in repurchase agreements, at times, may be substantial when, in the view
of the Adviser, liquidity or other considerations so warrant.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements are transactions
in which a Fund sells portfolio securities to financial institutions, such as
banks and broker-dealers, and agrees to repurchase them at a mutually
agreed-upon date and price that is higher than the original sale price. Reverse
repurchase agreements are similar to a fully collateralized borrowing by a
Fund. At the time a Fund enters into a reverse repurchase agreement, it will
earmark on the books of the Fund or place in a
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segregated account cash or liquid securities having a value equal to the
repurchase price (including accrued interest) and will subsequently monitor the
account to ensure that such equivalent value is maintained.
Reverse repurchase agreements involve risks. Reverse repurchase agreements are
a form of leverage, and the use of reverse repurchase agreements by a Fund may
increase the Fund's volatility. Reverse repurchase agreements are also subject
to the risk that the other party to the reverse repurchase agreement will be
unable or unwilling to complete the transaction as scheduled, which may result
in losses to a Fund. Reverse repurchase agreements also involve the risk that
the market value of the securities sold by a Fund may decline below the price
at which it is obligated to repurchase the securities. In addition, when a Fund
invests the proceeds it receives in a reverse repurchase transaction, there is
a risk that those investments may decline in value. In this circumstance, the
Fund could be required to sell other investments in order to meet its
obligations to repurchase the securities.
The Fund may invest up to 10% of its net assets in reverse repurchase
agreements.
SECURITIES OF OTHER INVESTMENT COMPANIES. The Fund may invest in shares of
other investment companies, to the extent permitted by applicable law and
subject to certain restrictions. These investment companies typically incur
fees that are separate from those fees incurred directly by the Fund. The
Fund's purchase of such investment company securities results in the layering
of expenses, such that shareholders would indirectly bear a proportionate share
of the operating expenses of such investment companies, including advisory
fees, in addition to paying the Fund's expenses. Unless an exception is
available, Section 12(d)(1)(A) of the 1940 Act prohibits a fund from (i)
acquiring more than 3% of the voting shares of any one investment company, (ii)
investing more than 5% of its total assets in any one investment company, and
(iii) investing more than 10% of its total assets in all investment companies
combined, including its ETF investments.
For hedging or other purposes, the Fund may invest in investment companies that
seek to track the composition and/or performance of specific indexes or
portions of specific indexes. Certain of these investment companies, known as
exchange-traded funds, are traded on a securities exchange. (See "Exchange
Traded Funds" above). The market prices of index-based investments will
fluctuate in accordance with changes in the underlying portfolio securities of
the investment company and also due to supply and demand of the investment
company's shares on the exchange upon which the shares are traded. Index-based
investments may not replicate or otherwise match the composition or performance
of their specified index due to transaction costs, among other things.
Pursuant to orders issued by the SEC to each of certain iShares, Market
Vectors, Vanguard, ProShares, PowerShares, Guggenheim (formerly, Claymore),
Direxion, Wisdom Tree, Rydex, First Trust and SPDR exchange-traded funds
(collectively, the "ETFs") and procedures approved by the Board, the Fund may
invest in the ETFs in excess of the 3% limit described above, provided that the
Fund otherwise complies with the conditions of the SEC order, as it may be
amended, and any other applicable investment limitations. Neither the ETFs nor
their investment advisers make any representations regarding the advisability
of investing in the ETFs.
DERIVATIVES
Derivatives are financial instruments whose value is based on an underlying
asset, such as a stock or a bond, or an underlying economic factor, such as an
interest rate or a market benchmark. Unless otherwise stated in the Fund's
prospectus, the Fund may use derivatives for risk management purposes,
including to gain exposure to various markets in a cost efficient manner, to
reduce
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transaction costs or to remain fully invested. The Fund may also invest in
derivatives to protect it from broad fluctuations in market prices, interest
rates or foreign currency exchange rates (a practice known as "hedging"). When
hedging is successful, the Fund will have offset any depreciation in the value
of its portfolio securities by the appreciation in the value of the derivative
position. Although techniques other than the sale and purchase of derivatives
could be used to control the exposure of the Fund to market fluctuations, the
use of derivatives may be a more effective means of hedging this exposure.
Because many derivatives have a leverage or borrowing component, adverse
changes in the value or level of the underlying asset, reference rate, or index
can result in a loss substantially greater than the amount invested in the
derivative itself. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment. Accordingly, certain
derivative transactions may be considered to constitute borrowing transactions
for purposes of the Investment Company Act of 1940, as amended ("1940 Act").
Such a derivative transaction will not be considered to constitute the issuance
of a "senior security" by the Fund, and therefore such transaction will not be
subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the Fund, if the Fund covers the transaction or segregates
sufficient liquid assets (or such assets are "earmarked" by the Custodian) in
accordance with the requirements and interpretations of the SEC and its staff.
As a result of recent amendments to rules under the Commodity Exchange Act
("CEA") by the Commodity Futures Trading Commission ("CFTC"), a Fund must
either operate within certain guidelines and restrictions with respect to the
Fund's use of futures, options on such futures, commodity options and certain
swaps, or the Adviser will be subject to registration with the CFTC as a
"commodity pool operator" ("CPO").
Consistent with the CFTC's new regulations, the Trust, on behalf of the Fund,
has claimed an exclusion from the definition of the term CPO under the CEA and,
therefore, the Fund is not subject to registration or regulation as a CPO under
the CEA. As a result, the Fund will operate within certain guidelines and
restrictions with respect to its use of futures, options on such futures,
commodity options and certain swaps.
TYPES OF DERIVATIVES:
FUTURES - A futures contract is an agreement between two parties whereby one
party sells and the other party agrees to buy a specified amount of a financial
instrument at an agreed upon price and time. The financial instrument
underlying the contract may be a stock, stock index, bond, bond index, interest
rate, foreign exchange rate or other similar instrument. Agreeing to buy the
underlying financial information is called buying a futures contract or taking
a long position in the contract. Likewise, agreeing to sell the underlying
financial instrument is called selling a futures contract or taking a short
position in the contract.
Futures contracts are traded in the United States on commodity exchanges or
boards of trade - known as "contract markets" - approved for such trading and
regulated by the CFTC. These contract markets standardize the terms, including
the maturity date and underlying financial instrument, of all futures
contracts.
Unlike other securities, the parties to a futures contract do not have to pay
for or deliver the underlying financial instrument until some future date (the
delivery date). Contract markets require both the purchaser and seller to
deposit "initial margin" with a futures broker, known as a futures commission
merchant or custodian bank, when they enter into the contract. Initial margin
deposits are typically equal to a percentage of the contract's value. After
they open a futures contract, the parties to the
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transaction must compare the purchase price of the contract to its daily market
value. If the value of the futures contract changes in such a way that a
party's position declines, that party must make additional "variation margin"
payments so that the margin payment is adequate. On the other hand, the value
of the contract may change in such a way that there is excess margin on
deposit, possibly entitling the party that has a gain to receive all or a
portion of this amount. This process is known as "marking to the market."
Although the actual terms of a futures contract call for the actual delivery of
and payment for the underlying security, in many cases the parties may close
the contract early by taking an opposite position in an identical contract. If
the sale price upon closing out the contract is less than the original purchase
price, the person closing out the contract will realize a loss. If the sale
price upon closing out the contract is more than the original purchase price,
the person closing out the contract will realize a gain. If the purchase price
upon closing out the contract is more than the original sale price, the person
closing out the contract will realize a loss. If the purchase price upon
closing out the contract is less than the original sale price, the person
closing out the contract will realize a gain.
The Fund may incur commission expenses when it opens or closes a futures
position.
OPTIONS - An option is a contract between two parties for the purchase and sale
of a financial instrument for a specified price (known as the "strike price" or
"exercise price") at any time during the option period. Unlike a futures
contract, an option grants a right (not an obligation) to buy or sell a
financial instrument. Generally, a seller of an option can grant a buyer two
kinds of rights: a "call" (the right to buy the security) or a "put" (the right
to sell the security). Options have various types of underlying instruments,
including specific securities, indices of securities prices, foreign
currencies, interest rates and futures contracts. Options may be traded on an
exchange (exchange-traded-options) or may be customized agreements between the
parties (over-the-counter or "OTC" options). Like futures, a financial
intermediary, known as a clearing corporation, financially backs
exchange-traded options. However, OTC options have no such intermediary and are
subject to the risk that the counter-party will not fulfill its obligations
under the contract.
o PURCHASING PUT AND CALL OPTIONS
When the Fund purchases a put option, it buys the right to sell the instrument
underlying the option at a fixed strike price. In return for this right, the
Fund pays the current market price for the option (known as the "option
premium"). The Fund may purchase put options to offset or hedge against a
decline in the market value of its securities ("protective puts") or to benefit
from a decline in the price of securities that it does not own. The Fund would
ordinarily realize a gain if, during the option period, the value of the
underlying securities decreased below the exercise price sufficiently to cover
the premium and transaction costs. However, if the price of the underlying
instrument does not fall enough to offset the cost of purchasing the option, a
put buyer would lose the premium and related transaction costs.
Call options are similar to put options, except that the Fund obtains the right
to purchase, rather than sell, the underlying instrument at the option's strike
price. The Fund would normally purchase call options in anticipation of an
increase in the market value of securities it owns or wants to buy. The Fund
would ordinarily realize a gain if, during the option period, the value of the
underlying instrument exceeded the exercise price plus the premium paid and
related transaction costs. Otherwise, the Fund would realize either no gain or
a loss on the purchase of the call option.
The purchaser of an option may terminate its position by:
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o Allowing it to expire and losing its entire premium;
o Exercising the option and either selling (in the case of a put
option) or buying (in the case of a call option) the underlying
instrument at the strike price; or
o Closing it out in the secondary market at its current price.
o SELLING (WRITING) PUT AND CALL OPTIONS
When the Fund writes a call option it assumes an obligation to sell specified
securities to the holder of the option at a specified price if the option is
exercised at any time before the expiration date. Similarly, when the Fund
writes a put option it assumes an obligation to purchase specified securities
from the option holder at a specified price if the option is exercised at any
time before the expiration date. The Fund may terminate its position in an
exchange-traded put option before exercise by buying an option identical to the
one it has written. Similarly, it may cancel an OTC option by entering into an
offsetting transaction with the counter-party to the option.
The Fund could try to hedge against an increase in the value of securities it
would like to acquire by writing a put option on those securities. If security
prices rise, the Fund would expect the put option to expire and the premium it
received to offset the increase in the security's value. If security prices
remain the same over time, the Fund would hope to profit by closing out the put
option at a lower price. If security prices fall, the Fund may lose an amount
of money equal to the difference between the value of the security and the
premium it received. Writing covered put options may deprive the Fund of the
opportunity to profit from a decrease in the market price of the securities it
would like to acquire.
The characteristics of writing call options are similar to those of writing put
options, except that call writers expect to profit if prices remain the same or
fall. The Fund could try to hedge against a decline in the value of securities
it already owns by writing a call option. If the price of that security falls
as expected, the Fund would expect the option to expire and the premium it
received to offset the decline of the security's value. However, the Fund must
be prepared to deliver the underlying instrument in return for the strike
price, which may deprive it of the opportunity to profit from an increase in
the market price of the securities it holds.
The Fund is permitted only to write covered options. At the time of selling the
call option, the Fund may cover the option by owning, among other things:
o The underlying security (or securities convertible into the
underlying security without additional consideration), index, interest
rate, foreign currency or futures contract;
o A call option on the same security or index with the same or lesser
exercise price;
o A call option on the same security or index with a greater exercise
price and segregating cash or liquid securities in an amount equal to
the difference between the exercise prices;
o Cash or liquid securities equal to at least the market value of the
optioned securities, interest rate, foreign currency or futures
contract; or
o In the case of an index, the portfolio of securities that corresponds
to the index.
At the time of selling a put option, the Fund may cover the put option by,
among other things:
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o Entering into a short position in the underlying security;
o Purchasing a put option on the same security, index, interest rate,
foreign currency or futures contract with the same or greater exercise
price;
o Purchasing a put option on the same security, index, interest rate,
foreign currency or futures contract with a lesser exercise price and
segregating cash or liquid securities in an amount equal to the
difference between the exercise prices; or
o Maintaining the entire exercise price in liquid securities.
o OPTIONS ON SECURITIES INDICES
Options on securities indices are similar to options on securities, except that
the exercise of securities index options requires cash settlement payments and
does not involve the actual purchase or sale of securities. In addition,
securities index options are designed to reflect price fluctuations in a group
of securities or segment of the securities market rather than price
fluctuations in a single security.
o OPTIONS ON CREDIT DEFAULT SWAPS
An option on a credit default swap option gives the holder the right to enter
into a credit default swap at a specified future date and under specified terms
in exchange for a purchase price or premium. The writer of the option bears the
risk of any unfavorable move in the value of the CDS relative to the market
value on the exercise date, while the purchaser may allow the option to expire
unexercised.
o OPTIONS ON FUTURES
An option on a futures contract provides the holder with the right to buy a
futures contract (in the case of a call option) or sell a futures contract (in
the case of a put option) at a fixed time and price. Upon exercise of the
option by the holder, the contract market clearing house establishes a
corresponding short position for the writer of the option (in the case of a
call option) or a corresponding long position (in the case of a put option). If
the option is exercised, the parties will be subject to the futures contracts.
In addition, the writer of an option on a futures contract is subject to
initial and variation margin requirements on the option position. Options on
futures contracts are traded on the same contract market as the underlying
futures contract.
The buyer or seller of an option on a futures contract may terminate the option
early by purchasing or selling an option of the same series (i.e., the same
exercise price and expiration date) as the option previously purchased or sold.
The difference between the premiums paid and received represents the trader's
profit or loss on the transaction.
The Fund may purchase put and call options on futures contracts instead of
selling or buying futures contracts. The Fund may buy a put option on a futures
contract for the same reasons it would sell a futures contract. It also may
purchase such put options in order to hedge a long position in the underlying
futures contract. The Fund may buy call options on futures contracts for the
same purpose as the actual purchase of the futures contracts, such as in
anticipation of favorable market conditions.
The Fund may write a call option on a futures contract to hedge against a
decline in the prices of the instrument underlying the futures contracts. If
the price of the futures contract at expiration were below the exercise price,
the Fund would retain the option premium, which would offset, in part, any
decline in the value of its portfolio securities.
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The writing of a put option on a futures contract is similar to the purchase of
the futures contracts, except that, if the market price declines, the Fund
would pay more than the market price for the underlying instrument. The premium
received on the sale of the put option, less any transaction costs, would
reduce the net cost to the Fund.
o COMBINED POSITIONS
The Fund may purchase and write options in combination with each other, or in
combination with futures or forward contracts, to adjust the risk and return
characteristics of the overall position. For example, the Fund could construct
a combined position whose risk and return characteristics are similar to
selling a futures contract by purchasing a put option and writing a call option
on the same underlying instrument. Alternatively, the Fund could write a call
option at one strike price and buy a call option at a lower price to reduce the
risk of the written call option in the event of a substantial price increase.
Because combined options positions involve multiple trades, they result in
higher transaction costs and may be more difficult to open and close out.
STRADDLES AND SPREADS - The Fund, for hedging purposes, may enter into
straddles and spreads. In "spread" transactions, the Fund buys and writes a put
or buys and writes a call on the same underlying instrument with the options
having different exercise prices, expiration dates, or both. In "straddles,"
the Fund purchases a put option and a call option or writes a put option and a
call option on the same instrument with the same expiration date and typically
the same exercise price. When the Fund engages in spread and straddle
transactions, it seeks to profit from differences in the option premiums paid
and received and in the market prices of the related options positions when
they are closed out or sold. Because these transactions require the Fund to buy
and/or write more than one option simultaneously, the Fund's ability to enter
into such transactions and to liquidate its positions when necessary or deemed
advisable may be more limited than if the Fund were to buy or sell a single
option. Similarly, costs incurred by the Fund in connection with these
transactions will in many cases be greater than if the Fund were to buy or sell
a single option.
RISKS OF DERIVATIVES:
While transactions in derivatives may reduce certain risks, these transactions
themselves entail certain other risks. For example, unanticipated changes in
interest rates, securities prices or currency exchange rates may result in a
poorer overall performance of the Fund than if it had not entered into any
derivatives transactions. Derivatives may magnify the Fund's gains or losses,
causing it to make or lose substantially more than it invested.
When used for hedging purposes, increases in the value of the securities the
Fund holds or intends to acquire should offset any losses incurred with a
derivative. Purchasing derivatives for purposes other than hedging could expose
the Fund to greater risks.
CORRELATION OF PRICES - The Fund's ability to hedge its securities through
derivatives depends on the degree to which price movements in the underlying
index or instrument correlate with price movements in the relevant securities.
In the case of poor correlation, the price of the securities the Fund is
hedging may not move in the same amount, or even in the same direction as the
hedging instrument. The Adviser will try to minimize this risk by investing
only in those contracts whose behavior it expects to resemble with the
portfolio securities it is trying to hedge. However, if the Fund's prediction
of interest and currency rates, market value, volatility or other economic
factors is incorrect, the Fund may lose money, or may not make as much money as
it expected.
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Derivative prices can diverge from the prices of their underlying instruments,
even if the characteristics of the underlying instruments are very similar to
the derivative. Listed below are some of the factors that may cause such a
divergence:
o current and anticipated short-term interest rates, changes in volatility
of the underlying instrument, and the time remaining until expiration of
the contract;
o a difference between the derivatives and securities markets, including
different levels of demand, how the instruments are traded, the imposition
of daily price fluctuation limits or trading of an instrument stops; and
o differences between the derivatives, such as different margin
requirements, different liquidity of such markets and the participation of
speculators in such markets.
Derivatives based upon a narrower index of securities, such as those of a
particular industry group, may present greater risk than derivatives based on a
broad market index. Since narrower indices are made up of a smaller number of
securities, they are more susceptible to rapid and extreme price fluctuations
because of changes in the value of those securities.
While currency futures and options values are expected to correlate with
exchange rates, they may not reflect other factors that affect the value of the
investments of the Fund. A currency hedge, for example, should protect a
yen-denominated security from a decline in the yen, but will not protect the
Fund against a price decline resulting from deterioration in the issuer's
creditworthiness. Because the value of the Fund's foreign-denominated
investments changes in response to many factors other than exchange rates, it
may not be possible to match the amount of currency options and futures to the
value of the Fund's investments precisely over time.
LACK OF LIQUIDITY - Before a futures contract or option is exercised or
expires, the Fund can terminate it only by entering into a closing purchase or
sale transaction. Moreover, the Fund may close out a futures contract only on
the exchange the contract was initially traded. Although the Fund intends to
purchase options and futures only where there appears to be an active market,
there is no guarantee that such a liquid market will exist. If there is no
secondary market for the contract, or the market is illiquid, the Fund may not
be able to close out its position. In an illiquid market, the Fund may:
o have to sell securities to meet its daily margin requirements at a time
when it is disadvantageous to do so;
o have to purchase or sell the instrument underlying the contract;
o not be able to hedge its investments; and/or
o not be able to realize profits or limit its losses.
Derivatives may become illiquid (i.e., difficult to sell at a desired time and
price) under a variety of market conditions. For example:
o an exchange may suspend or limit trading in a particular derivative
instrument, an entire category of derivatives or all derivatives, which
sometimes occurs because of increased market volatility;
o unusual or unforeseen circumstances may interrupt normal operations of an
exchange;
S-22
o the facilities of the exchange may not be adequate to handle current
trading volume;
o equipment failures, government intervention, insolvency of a brokerage
firm or clearing house or other occurrences may disrupt normal trading
activity; or
o investors may lose interest in a particular derivative or category of
derivatives.
MANAGEMENT RISK - If the Adviser incorrectly predicts stock market and interest
rate trends, the Fund may lose money by investing in derivatives. For example,
if the Fund were to write a call option based on the Adviser's expectation that
the price of the underlying security would fall, but the price were to rise
instead, the Fund could be required to sell the security upon exercise at a
price below the current market price. Similarly, if the Fund were to write a
put option based on the Adviser's expectation that the price of the underlying
security would rise, but the price were to fall instead, the Fund could be
required to purchase the security upon exercise at a price higher than the
current market price.
PRICING RISK - At times, market conditions might make it hard to value some
investments. For example, if the Fund has valued its securities too high, you
may end up paying too much for Fund shares when you buy into the Fund. If the
Fund underestimates its price, you may not receive the full market value for
your Fund shares when you sell.
MARGIN - Because of the low margin deposits required upon the opening of a
derivative position, such transactions involve an extremely high degree of
leverage. Consequently, a relatively small price movement in a derivative may
result in an immediate and substantial loss (as well as gain) to the Fund and
it may lose more than it originally invested in the derivative.
If the price of a futures contract changes adversely, the Fund may have to sell
securities at a time when it is disadvantageous to do so to meet its minimum
daily margin requirement. The Fund may lose its margin deposits if a
broker-dealer with whom it has an open futures contract or related option
becomes insolvent or declares bankruptcy.
VOLATILITY AND LEVERAGE - The prices of derivatives are volatile (i.e., they
may change rapidly, substantially and unpredictably) and are influenced by a
variety of factors, including:
o actual and anticipated changes in interest rates;
o fiscal and monetary policies; and
o national and international political events.
Most exchanges limit the amount by which the price of a derivative can change
during a single trading day. Daily trading limits establish the maximum amount
that the price of a derivative may vary from the settlement price of that
derivative at the end of trading on the previous day. Once the price of a
derivative reaches this value, the Fund may not trade that derivative at a
price beyond that limit. The daily limit governs only price movements during a
given day and does not limit potential gains or losses. Derivative prices have
occasionally moved to the daily limit for several consecutive trading days,
preventing prompt liquidation of the derivative.
Because many derivatives have a leverage or borrowing component, adverse
changes in the value or level of the underlying asset, reference rate, or index
can result in a loss substantially greater than the amount invested in the
derivative itself. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment. Accordingly, certain
derivative transactions may be
S-23
considered to constitute borrowing transactions for purposes of the 1940 Act.
Such a derivative transaction will not be considered to constitute the issuance
of a "senior security" by the Fund, and therefore such a transaction will not
be subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the Fund, if the Fund covers the transaction or segregates
sufficient liquid assets in accordance with these requirements, and subject to
certain risks.
ILLIQUID SECURITIES. Illiquid securities are securities that cannot be sold or
disposed of in the ordinary course of business (i.e. within seven days) at
approximately the prices at which they are valued. Because of their illiquid
nature, illiquid securities must be priced at fair value as determined in good
faith pursuant to procedures approved by the Trust's Board. Despite such good
faith efforts to determine fair value prices, the Fund's illiquid securities
are subject to the risk that the security's fair value price may differ from
the actual price which the Fund may ultimately realize upon its sale or
disposition. Difficulty in selling illiquid securities may result in a loss or
may be costly to the Fund. Under the supervision of the Trust's Board, the
Adviser determines the liquidity of the Fund's investments. In determining the
liquidity of the Fund's investments, the Adviser may consider various factors,
including (1) the frequency and volume of trades and quotations, (2) the number
of dealers and prospective purchasers in the marketplace, (3) dealer
undertakings to make a market, and (4) the nature of the security and the
market in which it trades (including any demand, put or tender features, the
mechanics and other requirements for transfer, any letters of credit or other
credit enhancement features, any ratings, the number of holders, the method of
soliciting offers, the time required to dispose of the security, and the
ability to assign or offset the rights and obligations of the security). The
Fund will not hold more than 15% of its net assets in illiquid securities.
SECURITIES LENDING. The Fund may lend portfolio securities to brokers, dealers
and other financial organizations that meet capital and other credit
requirements or other criteria established by the Fund's Board of Trustees.
These loans, if and when made, may not exceed 33 1/3 % of the total asset
value of the Fund (including the loan collateral). The Fund will not lend
portfolio securities to the Adviser or its affiliates unless permissible under
the 1940 Act and the rules and promulgations thereunder. Loans of portfolio
securities will be fully collateralized by cash, letters of credit or U.S.
government securities, and the collateral will be maintained in an amount equal
to at least 100% of the current market value of the loaned securities by
marking to market daily. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account of
the Fund.
The Fund may pay a part of the interest earned from the investment of
collateral, or other fee, to an unaffiliated third party for acting as the
Fund's securities lending agent, but will bear all of any losses from the
investment of collateral.
By lending their securities, the Fund may increase their income by receiving
payments from the borrower that reflect the amount of any interest or any
dividends payable on the loaned securities as well as by either investing cash
collateral received from the borrower in short-term instruments or obtaining a
fee from the borrower when U.S. government securities or letters of credit are
used as collateral. Investing cash collateral subjects the Fund to market risk.
The Fund remains obligated to return all collateral to the borrower under the
terms of its securities lending arrangements, even if the value of investments
made with the collateral decline. Accordingly, if the value of a security in
which the cash collateral has been invested declines, the loss would be borne
by the Fund, and the Fund may be required to liquidate other investments in
order to return collateral to the borrower at the end of the loan. The Fund
will adhere to the following conditions whenever its portfolio securities are
loaned: (i) the Fund must receive at least 100% cash collateral or equivalent
securities of the type discussed in the preceding paragraph from the borrower;
(ii) the borrower must increase such collateral whenever the
S-24
market value of the securities rises above the level of such collateral; (iii)
the Fund must be able to terminate the loan on demand; (iv) the Fund must
receive reasonable interest on the loan, as well as any dividends, interest or
other distributions on the loaned securities and any increase in market value;
(v) the Fund may pay only reasonable fees in connection with the loan (which
fees may include fees payable to the lending agent, the borrower, the Fund's
administrator and the custodian); and (vi) voting rights on the loaned
securities may pass to the borrower, provided, however, that if a material
event adversely affecting the investment occurs, the Fund must terminate the
loan and regain the right to vote the securities. In such instances, the
Adviser will vote the securities in accordance with its proxy voting policies
and procedures. The Board has adopted procedures reasonably designed to ensure
that the foregoing criteria will be met. Loan agreements involve certain risks
in the event of default or insolvency of the borrower, including possible
delays or restrictions upon the Fund's ability to recover the loaned securities
or dispose of the collateral for the loan, which could give rise to loss
because of adverse market action, expenses and/or delays in connection with the
disposition of the underlying securities.
RESTRICTED SECURITIES. The Fund may purchase restricted securities. Restricted
securities are securities that may not be sold freely to the public absent
registration under the Securities Act of 1933, as amended (the "1933 Act") or
an exemption from registration. This generally includes securities that are
unregistered that can be sold to qualified institutional buyers in accordance
with Rule 144A under the 1933 Act or securities that are exempt from
registration under the 1933 Act, such as commercial paper. Institutional
markets for restricted securities have developed as a result of the
promulgation of Rule 144A under the 1933 Act, which provides a "safe harbor"
from 1933 Act registration requirements for qualifying sales to institutional
investors. When Rule 144A restricted securities present an attractive
investment opportunity and meet other selection criteria, the Fund may make
such investments whether or not such securities are "illiquid" depending on the
market that exists for the particular security. The Board has delegated the
responsibility for determining the liquidity of Rule 144A restricted securities
that the Fund may invest in to the Adviser.
SHORT SALES. The Fund may engage in short sales that are either "uncovered" or
"against the box." A short sale is "against the box" if at all times during
which the short position is open, the Fund owns at least an equal amount of the
securities or securities convertible into, or exchangeable without further
consideration for, securities of the same issue as the securities that are sold
short. A short sale against the box is a taxable transaction to the Fund with
respect to the securities that are sold short. The Fund will not sell a
security short if, as a result of such short sale, the aggregate market value
of all securities sold short exceeds 10% of the Fund's total assets. This
limitation does not apply to short sales against the box.
Uncovered short sales are transactions under which the Fund sells a security it
does not own. To complete such a transaction, the Fund must borrow the security
to make delivery to the buyer. The Fund then is obligated to replace the
security borrowed by purchasing the security at the market price at the time of
the replacement. The price at such time may be more or less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to pay the lender amounts equal to any dividends or interest
that accrue during the period of the loan. To borrow the security, the Fund
also may be required to pay a premium, which would increase the cost of the
security sold. The proceeds of the short sale will be retained by the broker,
to the extent necessary to meet margin requirements, until the short position
is closed out.
Until the Fund closes its short position or replaces the borrowed security, the
Fund may: (a) segregate cash or liquid securities at such a level that the
amount segregated plus the amount deposited with the
S-25
broker as collateral will equal the current value of the security sold short;
or (b) otherwise cover the Fund's short position.
WHEN-ISSUED, DELAYED--DELIVERY AND FORWARD TRANSACTIONS
A when-issued security is one whose terms are available and for which a market
exists, but which have not been issued. In a forward delivery transaction, the
Fund contracts to purchase securities for a fixed price at a future date beyond
customary settlement time. "Delayed-delivery" refers to securities transactions
on the secondary market where settlement occurs in the future. In each of these
transactions, the parties fix the payment obligation and the interest rate that
they will receive on the securities at the time the parties enter the
commitment; however, they do not pay money or deliver securities until a later
date. Typically, no income accrues on securities the Fund has committed to
purchase before the securities are delivered, although the Fund may earn income
on securities it has in a segregated account to cover its position. The Fund
will only enter into these types of transactions with the intention of actually
acquiring the securities, but may sell them before the settlement date.
The Fund may use when-issued, delayed-delivery and forward delivery
transactions to secure what it considers an advantageous price and yield at the
time of purchase. When the Fund engages in when-issued, delayed-delivery or
forward delivery transactions, it relies on the other party to consummate the
sale. If the other party fails to complete the sale, the Fund may miss the
opportunity to obtain the security at a favorable price or yield.
When purchasing a security on a when-issued, delayed delivery, or forward
delivery basis, the Fund assumes the rights and risks of ownership of the
security, including the risk of price and yield changes. At the time of
settlement, the market value of the security may be more or less than the
purchase price. The yield available in the market when the delivery takes place
also may be higher than those obtained in the transaction itself. Because the
Fund does not pay for the security until the delivery date, these risks are in
addition to the risks associated with its other investments.
The Fund will segregate cash or liquid securities equal in value to commitments
for the when-issued, delayed delivery or forward delivery transactions. The
Fund will segregate additional liquid assets daily so that the value of such
assets is equal to the amount of the commitments.
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INVESTMENT LIMITATIONS
FUNDAMENTAL POLICIES
The following investment limitations are fundamental, which means that the Fund
cannot change them without approval by the vote of a majority of the
outstanding shares of the Fund. The phrase "majority of the outstanding shares"
means the vote of (i) 67% or more of the Fund's shares present at a meeting, if
more than 50% of the outstanding shares of the Fund are present or represented
by proxy, or (ii) more than 50% of the Fund's outstanding shares, whichever is
less.
The Fund may not:
1. Purchase the securities of issuers conducting their principal business
activity in the same industry if, immediately after the purchase and as a
result thereof, the value of the Fund's investments in that industry would
equal or exceed 25% of the current value of the Fund's total assets,
provided that this restriction does not limit the Fund's investments in
securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, repurchase agreements involving such securities,
securities of other investment companies, or municipal securities.
2. With respect to 75% of its assets: (i) purchase the securities of any
issuer (except securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities or securities of other investment companies)
if, as a result, more than 5% of its total assets would be invested in the
securities of such issuer; or (ii) acquire more than 10% of the outstanding
voting securities of any one issuer.
3. Borrow money, except to the extent permitted under the 1940 Act, including
the rules, regulations and any orders obtained thereunder.
4. Issue senior securities, except to the extent permitted under the 1940
Act, including the rules, regulations and any orders obtained thereunder.
5. Make loans to other parties if, as a result, the aggregate value of such
loans would exceed one-third of the Fund's total assets. For the purposes
of this limitation, entering into repurchase agreements, lending securities
and acquiring any debt securities are not deemed to be the making of loans.
6. Underwrite securities of other issuers, except to the extent that the
purchase of permitted investments directly from the issuer thereof or from
an underwriter for an issuer and the later disposition of such securities
in accordance with the Fund's investment program may be deemed to be an
underwriting.
7. Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent the Fund from
investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business).
8. Purchase or sell commodities, provided that (i) currency will not be
deemed to be a commodity for purposes of this restriction, (ii) this
restriction does not limit the purchase or sale of futures contracts,
forward contracts or options, and (iii) this restriction does not limit
S-27
the purchase or sale of securities or other instruments backed by
commodities or the purchase or sale of commodities acquired as a result of
ownership of securities or other instruments.
The following descriptions of certain provisions of the 1940 Act may assist
investors in understanding the above policies and restrictions:
BORROWING. The 1940 Act restricts an investment company from borrowing in
excess of 33 1/3% of its total assets (including the amount borrowed, but
excluding temporary borrowings not in excess of 5% of its total assets).
Transactions that are fully collateralized in a manner that does not
involve the prohibited issuance of a "senior security" within the meaning
of Section 18(f) of the 1940 Act, shall not be regarded as borrowings for
the purposes of the Fund's investment restriction. Section 18(f) of the
1940 Act permits an investment company to borrow only from banks.
CONCENTRATION. The SEC has defined concentration as investing 25% or more
of an investment company's total assets in any particular industry or group
of industries, with certain exceptions such as with respect to investments
in obligations issued or guaranteed by the U.S. Government or its agencies
and instrumentalities, or tax-exempt obligations of state or municipal
governments and their political subdivisions. For purposes of the Fund's
concentration policy, each Fund may classify and re-classify companies in a
particular industry and define and re-define industries in any reasonable
manner.
DIVERSIFICATION. Under the 1940 Act and the rules, regulations and
interpretations thereunder, a "diversified company," as to 75% of its total
assets, may not purchase securities of any issuer (other than obligations
of, or guaranteed by, the U.S. government or its agencies, or
instrumentalities or securities of other investment companies) if, as a
result, more than 5% of its total assets would be invested in the
securities of such issuer, or more than 10% of the issuer's voting
securities would be held by a fund.
LENDING. Under the 1940 Act, an investment company may only make loans if
expressly permitted by its investment policies.
REAL ESTATE. The 1940 Act does not directly restrict an investment
company's ability to invest in real estate, but does require that every
investment company have the fundamental investment policy governing such
investments.
SENIOR SECURITIES. Senior securities may include any obligation or
instrument issued by a fund evidencing indebtedness. The 1940 Act generally
prohibits funds from issuing senior securities, although it does not treat
certain transactions as senior securities, such as certain borrowings,
short sales, reverse repurchase agreements, firm commitment agreements and
standby commitments, with appropriate earmarking or segregation of assets
to cover such obligation.
UNDERWRITING. Under the 1940 Act, underwriting securities involves an
investment company purchasing securities directly from an issuer for the
purpose of selling (distributing) them or participating in any such
activity either directly or indirectly. Under the 1940 Act, a diversified
fund may not make any commitment as underwriter, if immediately thereafter
the amount of its outstanding underwriting commitments, plus the value of
its investments in securities of issuers (other than investment companies)
of which it owns more than 10% of the outstanding voting securities,
exceeds 25% of the value of its total assets.
S-28
COMMODITIES. The 1940 Act does not directly restrict an investment
company's ability to invest in commodities, but does require that every
investment company have a fundamental investment policy governing such
investments.
NON-FUNDAMENTAL POLICIES
In addition to the investment objective of the Fund, the following limitations
are non-fundamental and may be changed by the Trust's Board without shareholder
approval.
1. The Fund may not invest or hold more than 15% of the Fund's net assets in
illiquid securities. For this purpose, illiquid securities include, among
others, (a) securities that are illiquid by virtue of the absence of a
readily available market or legal or contractual restrictions on resale,
(b) fixed time deposits that are subject to withdrawal penalties and that
have maturities of more than seven days, and (c) repurchase agreements not
terminable within seven days.
2. The Fund may lend securities from its portfolio to approved brokers,
dealers and financial institutions, to the extent permitted under the 1940
Act, including the rules, regulations and exemptions thereunder, which
currently limit such activities to one-third of the value of the Fund's
total assets (including the value of the collateral received). Any such
loans of portfolio securities will be fully collateralized based on values
that are marked-to-market daily.
3. The Fund may not make investments for the purpose of exercising control or
management, provided that this restriction does not limit the Fund's
investments in securities of other investment companies or investments in
entities created under the laws of foreign countries to facilitate
investment in securities of that country.
4. The Fund may not purchase securities on margin (except for short-term
credits necessary for the clearance of transactions).
5. The Fund may not sell securities short, unless it owns or has the right to
obtain securities equivalent in kind and amount to the securities sold
short (short sales "against the box"), and provided that transactions in
futures contracts and options are not deemed to constitute selling
securities short.
6. The Fund invests, under normal circumstances, at least 80% of its net
assets, plus any borrowings for investment purposes, in equity securities
and other instruments that have economic characteristics similar to equity
securities. This non-fundamental policy may be changed by the Board upon at
least 60 days' written notice to Fund shareholders.
Except with respect to Fund policies concerning borrowing and illiquid
securities, if a percentage restriction is adhered to at the time of an
investment, a later increase or decrease in percentage resulting from changes
in values or assets will not constitute a violation of such restriction. With
respect to the limitation on illiquid securities, in the event that a
subsequent change in net assets or other circumstances causes the Fund to
exceed its limitation, the Fund will take steps to bring the aggregate amount
of illiquid instruments back within the limitations as soon as reasonably
practicable. With respect to the limitation on borrowing, in the event that a
subsequent change in net assets or other circumstances cause a Fund to exceed
its limitation, the Fund will take steps to bring the aggregate amount of
borrowing back within the limitations within three days thereafter (not
including Sundays and holidays).
S-29
THE ADVISER
GENERAL. Stein Roe Investment Counsel, Inc. (the "Adviser"), a Delaware
corporation formed in 1932, located at One South Wacker Drive, Suite 3500,
Chicago, Illinois 60606, is a professional investment management firm
registered with the SEC under the Investment Advisers Act of 1940. The Adviser
is a wholly owned subsidiary of CIBC, a Canadian financial services company. As
of July 31, 2013, the Adviser had approximately $7.71 billion in assets under
management.
ADVISORY AGREEMENT WITH THE TRUST. The Trust and the Adviser have entered into
an investment advisory agreement (the "Advisory Agreement"). Under the Advisory
Agreement, the Adviser serves as the investment adviser and makes investment
decisions for the Fund and continuously reviews, supervises and administers the
investment program of the Fund, subject to the supervision of, and policies
established by, the Trustees of the Trust.
After the initial two-year term, the continuance of the Advisory Agreement must
be specifically approved at least annually: (i) by the vote of the Trustees or
by a vote of the shareholders of the Fund; and (ii) by the vote of a majority
of the Trustees who are not parties to the Advisory Agreement or "interested
persons" of any party thereto, cast in person at a meeting called for the
purpose of voting on such approval. The Advisory Agreement will terminate
automatically in the event of its assignment, and is terminable at any time
without penalty by the Trustees of the Trust or, with respect to the Fund, by a
majority of the outstanding shares of the Fund, on not less than 30 days' nor
more than 60 days' written notice to the Adviser, or by the Adviser on 90 days'
written notice to the Trust. As used in the Advisory Agreement, the terms
"majority of the outstanding voting securities," "interested persons" and
"assignment" have the same meaning as such terms in the 1940 Act.
ADVISORY FEES PAID TO THE ADVISER. For its services to the Fund, the Adviser is
entitled to a fee, which is calculated daily and paid monthly, at an annual
rate of 0.69% based on the average daily net assets of the Fund. The Adviser
has contractually agreed to reduce fees and/or reimburse expenses to the extent
necessary to keep the Fund's total annual operating expenses (excluding 12b-1
Fees, shareholder servicing fees, interest, dividend and interest expense on
securities sold short, taxes, brokerage commissions, acquired fund fees and
expenses, and extraordinary expenses (collectively, "excluded expenses")) from
exceeding 0.79% of the Fund's average daily net assets through at least two
years from the closing of the Reorganization. In addition, if at any point the
Fund's total annual operating expenses (not including excluded expenses) are
below the expense cap, the Adviser may retain the difference between the Fund's
total annual operating expenses (not including excluded expenses) and the
expense cap to recover all or a portion of its prior fee reductions or expense
reimbursements made during the preceding three-year period during which this
agreement was in place. This agreement may be terminated: (i) by the Board of
Trustees of the Trust, for any reason at any time, or (ii) by the Adviser, upon
ninety (90) days' prior written notice to the Trust, effective as of the close
of business on the date that is two years from the closing of the
Reorganization.
For the fiscal years ended October 31, 2010, 2011 and 2012, the Invesco
Predecessor Fund paid the following investment advisory fees to Invesco:
------------------------------------------------------------------------------------------------------------------------------------
FEES PAID FEES WAIVED TOTAL FEES PAID
------------------------------------------------------------------------------------------------------------------------------------
2010 2011 2012 2010 2011 2012 2010 2011 2012
------------------------------------------------------------------------------------------------------------------------------------
$1,248,459 $1,482,903 $1,952,148 $(9,255) $(11,301) $(14,857) $1,239,204 $1,471,602 $1,937,291
------------------------------------------------------------------------------------------------------------------------------------
|
S-30
THE PORTFOLIO MANAGERS
This section includes information about the Fund's portfolio managers,
including information about other accounts they manage, the dollar range of
Fund shares they own and how they are compensated.
COMPENSATION. The Adviser seeks to maintain a compensation program that is
competitively positioned to attract and retain high-caliber investment
professionals. Portfolio managers receive a base salary, an incentive bonus
opportunity and an equity compensation opportunity. Portfolio manager
compensation is reviewed and may be modified each year as appropriate to
reflect changes in the market, as well as to adjust the factors used to
determine bonuses to promote competitive Fund performance. The Adviser
evaluates competitive market compensation by reviewing compensation survey
results conducted by an independent third party of investment industry
compensation. Each portfolio manager's compensation consists of the following
three elements:
BASE SALARY. Each portfolio manager is paid a base salary. In setting the base
salary, the Adviser's intention is to be competitive in light of the particular
portfolio manager's experience and responsibilities.
ANNUAL BONUS. The portfolio managers are eligible, along with other employees
of the Adviser, to participate in a discretionary year-end bonus pool. The
Adviser reviews and approves the amount of the bonus pool available for the
Adviser's investment centers. The Adviser considers investment performance and
financial results in its review. Each portfolio manager is eligible to receive
an annual cash bonus which is based on quantitative (i.e. investment
performance) and non-quantitative factors (which may include, but are not
limited to, individual performance, risk management and teamwork).
Each portfolio manager's compensation is linked to the pre-tax investment
performance of the Fund/accounts managed by the portfolio manager.
High investment performance (against applicable peer group and/or benchmarks)
would deliver compensation generally associated with top pay in the industry
(determined by reference to the third party provided compensation survey
information) and poor investment performance (versus applicable peer group)
would result in low bonus compared to the applicable peer group or no bonus at
all. These decisions are reviewed and approved collectively by senior
leadership which has responsibility for executing the compensation approach
across the organization.
EQUITY-BASED COMPENSATION. Portfolio managers may be granted an annual deferral
award of CIBC restricted stock units.
Portfolio managers also participate in benefit plans and programs available
generally to all employees.
FUND SHARES OWNED BY PORTFOLIO MANAGERS. The Fund is required to show the
dollar amount range of each portfolio manager's "beneficial ownership" of
shares of the Fund as of the end of the most recently completed fiscal year.
Dollar amount ranges disclosed are established by the SEC. "Beneficial
ownership" is determined in accordance with Rule 16a-1(a)(2) under the
Securities Exchange Act of 1934, as amended (the "1934 Act").
--------------------------------------------------------------------------------
NAME DOLLAR RANGE OF FUND SHARES OWNED(1)
--------------------------------------------------------------------------------
Patricia Bannan $100,001-$500,000
--------------------------------------------------------------------------------
Brant Houston $50,001-$100,000
--------------------------------------------------------------------------------
|
1 Valuation date is October 31, 2012.
S-31
OTHER ACCOUNTS. In addition to the Fund, the portfolio managers are responsible
for the day-to-day management of certain other accounts, as listed below. None
of the accounts listed below are subject to a performance-based advisory fee.
The information below is provided as of July 31, 2013.
------------------------------------------------------------------------------------------------------------------------------------
REGISTERED OTHER POOLED
INVESTMENT COMPANIES INVESTMENT VEHICLES OTHER ACCOUNTS
------------------------------------------------------------------------------------------------------------------------------------
NUMBER OF TOTAL ASSETS NUMBER OF TOTAL ASSETS NUMBER OF TOTAL ASSETS
NAME ACCOUNTS (IN MILLIONS) ACCOUNTS (IN MILLIONS) ACCOUNTS (IN MILLIONS)
------------------------------------------------------------------------------------------------------------------------------------
Patricia Bannan 0 $0 0 $0 0 $0
------------------------------------------------------------------------------------------------------------------------------------
Brant Houston 0 $0 0 $0 81 $67.1
------------------------------------------------------------------------------------------------------------------------------------
|
Actual or apparent conflicts of interest may arise when a portfolio manager has
day-to-day management responsibilities with respect to the Fund and other
accounts. More specifically, portfolio managers who manage the Fund and other
accounts may be presented with one or more of the following potential
conflicts:
o The management of the Fund and other accounts may result in a portfolio
manager devoting unequal time and attention to the management of the Fund
and each other account. The Adviser seeks to manage such competing
interests for the time and attention of portfolio managers by having
portfolio managers focus on a particular investment discipline. Most other
accounts managed by a portfolio manager are managed using the same
investment models that are used in connection with the management of the
Fund.
o If a portfolio manager identifies a limited investment opportunity which
may be suitable for the Fund and one or more other accounts, the Fund may
not be able to take full advantage of that opportunity due to an allocation
of filled purchase or sale orders across the Fund and other account(s). To
deal with these situations, the Adviser has adopted procedures for
allocating portfolio transactions across multiple accounts.
o The Adviser determines which broker to use to execute each order for
securities transactions for the Fund, consistent with its duty to seek best
execution of the transaction. However, for certain other accounts (such as
mutual funds for which the Adviser or an affiliate acts as sub-adviser,
other pooled investment vehicles that are not registered mutual funds, and
other accounts managed for organizations and individuals), the Adviser may
be limited by the client with respect to the selection of brokers or may be
instructed to direct trades through a particular broker. In these cases,
trades for the Fund in a particular security may be placed separately from,
rather than aggregated with, such other accounts. Having separate
transactions with respect to a security may temporarily affect the market
price of the security or the execution of the transaction, or both, to the
possible detriment of the Fund or other account(s) involved.
S-32
o Finally, the appearance of a conflict of interest may arise where the
Adviser has an incentive, such as a performance-based management fee, which
relates to either the management of the Fund or other account but not both
the Fund and other account for which a portfolio manager has day-to- day
management responsibilities.
The Adviser has adopted certain compliance procedures which are designed to
address these types of conflicts. However, there is no guarantee that such
procedures will detect each and every situation in which a conflict arises.
THE ADMINISTRATOR
GENERAL. SEI Investments Global Funds Services (the "Administrator"), a
Delaware statutory trust, has its principal business offices at One Freedom
Valley Drive, Oaks, Pennsylvania 19456. SEI Investments Management Corporation
("SIMC"), a wholly-owned subsidiary of SEI Investments Company ("SEI
Investments"), is the owner of all beneficial interest in the Administrator.
SEI Investments and its subsidiaries and affiliates, including the
Administrator, are leading providers of funds evaluation services, trust
accounting systems, and brokerage and information services to financial
institutions, institutional investors, and money managers. The Administrator
and its affiliates also serve as administrator or sub-administrator to other
mutual funds.
ADMINISTRATION AGREEMENT WITH THE TRUST. The Trust and the Administrator have
entered into an administration agreement dated November 14, 1991, as amended
and restated November 12, 2002 (the "Administration Agreement"). Under the
Administration Agreement, the Administrator provides the Trust with
administrative services, including regulatory reporting and all necessary
office space, equipment, personnel and facilities. Pursuant to a schedule to
the Administration Agreement, the Administrator also serves as the shareholder
servicing agent for the Fund whereby the Administrator provides certain
shareholder services to the Fund.
The Administration Agreement provides that the Administrator shall not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Trust in connection with the matters to which the Administration Agreement
relates, except a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Administrator in the performance of its duties or
from reckless disregard by it of its duties and obligations thereunder.
ADMINISTRATION FEES PAID TO THE ADMINISTRATOR. For its services under the
Administration Agreement, the Administrator is entitled to a fee, which is
calculated daily and paid monthly, at an annual rate of 0.08% of the Fund's
average daily net assets.
For the fiscal years ended October 31, 2010, 2011 and 2012, the Invesco
Predecessor Fund paid the following administration fees to its administrator:
FEES PAID
2010 2011 2012
--------------------------------------------------------------------------------
$50,000 $50,000 $64,869
--------------------------------------------------------------------------------
|
THE DISTRIBUTOR
GENERAL. The Trust and SEI Investments Distribution Co. (the "Distributor"), a
wholly-owned
S-33
subsidiary of SEI Investments, and an affiliate of the Administrator, are
parties to a distribution agreement dated November 14, 1991, as amended and
restated November 14, 2005 and as amended August 30, 2010 ("Distribution
Agreement"). The principal business address of the Distributor is One Freedom
Valley Drive, Oaks, Pennsylvania 19456.
The continuance of the Distribution Agreement must be specifically approved at
least annually (i) by the vote of the Trustees or by a vote of the shareholders
of the Fund and (ii) by the vote of a majority of the Trustees who are not
"interested persons" of the Trust and have no direct or indirect financial
interest in the operations of the Distribution Agreement or any related
agreement, cast in person at a meeting called for the purpose of voting on such
approval. The Distribution Agreement will terminate automatically in the event
of its assignment (as such term is defined in the 1940 Act), and is terminable
at any time without penalty by the Board or, with respect to the Fund, by a
majority of the outstanding shares of the Fund, upon not more than 60 days'
written notice by either party. The Distribution Agreement provides that the
Distributor shall not be protected against any liability to the Trust or its
shareholders by reason of willful misfeasance, bad faith or gross negligence on
its part in the performance of its duties or from reckless disregard of its
obligations or duties thereunder.
DISTRIBUTION PLAN. The Trust has adopted a Distribution Plan (the "Plan") in
accordance with the provisions of Rule 12b-1 under the 1940 Act, which
regulates circumstances under which an investment company may directly or
indirectly bear expenses relating to the distribution of its shares.
Continuance of the Plan must be approved annually by a majority of the Trustees
of the Trust and by a majority of the Trustees who are not interested persons
(as defined in the 1940 Act) of the Trust and have no direct or indirect
financial interest in the Plan or in any agreements related to the Plan
("Qualified Trustees"). The Plan requires that quarterly written reports of
amounts spent under the Plan and the purposes of such expenditures be furnished
to and reviewed by the Trustees. The Plan may not be amended to increase
materially the amount that may be spent thereunder without approval by a
majority of the outstanding shares of the Trust. All material amendments of the
Plan will require approval by a majority of the Trustees of the Trust and of
the Qualified Trustees.
o INVESTOR CLASS SHARES. Under the Plan, the Distributor, or third
parties that enter into agreements with the Distributor ("Service
Providers"), may receive up to 0.25% of the assets of the Fund
attributable to Investor Class Shares as compensation for distribution
and shareholder services pursuant to Rule 12b-1 of the 1940 Act. The
Plan is characterized as a compensation plan since the distribution
fee will be paid to the Distributor without regard to the distribution
or shareholder service expenses incurred by the Distributor or the
amount of payments made to other financial institutions and
intermediaries. Investors should understand that some Service
Providers may charge their clients fees in connection with purchases
of shares or the provision of shareholder services with respect to
shares. The Trust intends to operate the Plan in accordance with its
terms and with the Financial Industry Regulatory Authority ("FINRA")
rules concerning sales charges.
o DESCRIPTION OF DISTRIBUTION SERVICES. Distribution services may
include: (i) services in connection with distribution assistance; or
(ii) payments to financial institutions and other financial
intermediaries, such as banks, savings and loan associations,
insurance companies, investment counselors, broker-dealers, mutual
fund "supermarkets" and the Distributor's affiliates and subsidiaries,
as compensation for services, reimbursement of expenses incurred in
connection with distribution assistance or provision of shareholder
services. The Distributor may, at its discretion, retain a portion of
such payments to compensate itself for distribution services and
distribution related expenses such as the costs of preparation,
printing, mailing or otherwise disseminating sales literature,
advertising, and prospectuses
S-34
(other than those furnished to current shareholders of the Fund),
promotional and incentive programs, and such other marketing expenses
that the Distributor may incur.
SHAREHOLDER SERVICES
SHAREHOLDER SERVICING PLAN. The Fund has adopted a shareholder servicing plan
(the "Service Plan") under which a shareholder servicing fee of up to 0.15% of
average daily net assets of the Fund attributable to Investor Class Shares will
be paid to other service providers. Under the Service Plan, other service
providers may perform, or may compensate other service providers for performing
certain shareholder and administrative services as discussed below.
DESCRIPTION OF SHAREHOLDER SERVICES. Shareholder services may include: (i)
maintaining accounts relating to clients that invest in shares; (ii) arranging
for bank wires; (iii) responding to client inquiries relating to the services
performed by the services provider; (iv) responding to inquiries from clients
concerning their investment in shares; (v) assisting clients in changing
dividend options, account designations and addresses; (vi) providing
information periodically to clients showing their position in shares; (vii)
forwarding shareholder communications from the Fund such as proxies,
shareholder reports, annual reports, and dividend distribution and tax notices
to clients; and (viii) processing dividend payments from the Fund on behalf of
clients.
PAYMENTS TO FINANCIAL INTERMEDIARIES
The Adviser and/or its affiliates, at their discretion, may make payments from
their own resources and not from Fund assets to affiliated or unaffiliated
brokers, dealers, banks (including bank trust departments), trust companies,
registered investment advisers, financial planners, retirement plan
administrators, insurance companies, and any other institution having a
service, administration, or any similar arrangement with the Fund, its service
providers or their respective affiliates, as incentives to help market and
promote the Fund and/or in recognition of their distribution, marketing,
administrative services, and/or processing support.
These additional payments may be made to financial intermediaries that sell
Fund shares or provide services to the Fund, the Distributor or shareholders of
the Fund through the financial intermediary's retail distribution channel
and/or fund supermarkets. Payments may also be made through the financial
intermediary's retirement, qualified tuition, fee-based advisory, wrap fee bank
trust, or insurance (e.g., individual or group annuity) programs. These
payments may include, but are not limited to, placing the Fund in a financial
intermediary's retail distribution channel or on a preferred or recommended
fund list; providing business or shareholder financial planning assistance;
educating financial intermediary personnel about the Fund; providing access to
sales and management representatives of the financial intermediary; promoting
sales of Fund shares; providing marketing and educational support; maintaining
share balances and/or for sub-accounting, administrative or shareholder
transaction processing services. A financial intermediary may perform the
services itself or may arrange with a third party to perform the services.
The Adviser and/or its affiliates may also make payments from their own
resources to financial intermediaries for costs associated with the purchase of
products or services used in connection with sales and marketing, participation
in and/or presentation at conferences or seminars, sales or training programs,
client and investor entertainment and other sponsored events. The costs and
expenses associated with these efforts may include travel, lodging, sponsorship
at educational seminars and conferences, entertainment and meals to the extent
permitted by law.
Revenue sharing payments may be negotiated based on a variety of factors,
including the level of
S-35
sales, the amount of Fund assets attributable to investments in the Fund by
financial intermediaries customers, a flat fee or other measures as determined
from time to time by the Adviser and/or its affiliates. A significant purpose
of these payments is to increase the sales of Fund shares, which in turn may
benefit the Adviser through increased fees as Fund assets grow.
THE TRANSFER AGENT
DST Systems, Inc., 333 West 11(th) Street, Kansas City, Missouri 64105 (the
"Transfer Agent"), serves as the Fund's transfer agent.
THE CUSTODIAN
Union Bank, N.A. (the "Custodian"), acts as custodian of the Fund. The
Custodian holds cash, securities and other assets of the Fund as required by
the 1940 Act.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Ernsy & Young LLP, serves as independent registered public accounting firm for
the Fund.
LEGAL COUNSEL
Morgan, Lewis & Bockius LLP, 1701 Market Street, Philadelphia, PA 19103-2921,
serves as legal counsel to the Trust.
DETERMINATION OF NET ASSET VALUE
GENERAL POLICY. The Fund adheres to Section 2(a)(41), and Rule 2a-4 thereunder,
of the 1940 Act with respect to the valuation of portfolio securities. In
general, securities for which market quotations are readily available are
valued at current market value, and all other securities are valued at fair
value as determined in good faith by the Board. In complying with the 1940 Act,
the Trust relies on guidance provided by the SEC and by the SEC staff in
various interpretive letters and other guidance.
EQUITY SECURITIES. Securities listed on a securities exchange, market or
automated quotation system for which quotations are readily available (except
for securities traded on NASDAQ), including securities traded over the counter,
are valued at the last quoted sale price on the primary exchange or market
(foreign or domestic) on which they are traded on valuation date (or at
approximately 4:00 p.m., Eastern Time, if a security's primary exchange is
normally open at that time), or, if there is no such reported sale on the
valuation date, at the most recent quoted bid price. For securities traded on
NASDAQ, the NASDAQ Official Closing Price will be used. If such prices are not
available or determined to not represent the fair value of the security as of
the Fund's pricing time, the security will be valued at fair value as
determined in good faith using methods approved by the Board.
S-47
MONEY MARKET SECURITIES AND OTHER DEBT SECURITIES. If available, money market
securities and other debt securities are priced based upon valuations provided
by recognized independent, third-party pricing agents. Such values generally
reflect the last reported sales price if the security is actively traded. The
third-party pricing agents may also value debt securities by employing
methodologies that utilize actual market transactions, broker-supplied
valuations, or other methodologies designed to identify the market value for
such securities. Such methodologies generally consider such factors as security
prices, yields, maturities, call features, ratings and developments relating to
specific securities in arriving at valuations. Money market securities and
other debt securities with remaining maturities of sixty days or less may be
valued at their amortized cost, which approximates market value. If such prices
are not available or determined to not represent the fair value of the security
as of the Fund's pricing time, the security will be valued at fair value as
determined in good faith using methods approved by the Board.
DERIVATIVES AND OTHER COMPLEX INSTRUMENTS. Exchange traded options on
securities and indices purchased by the Fund generally are valued at their last
trade price or, if there is no last trade price, the last bid price. Exchange
traded options on securities and indices written by the Fund generally are
valued at their last trade price or, if there is no last trade price, the last
asked price. In the case of options traded in the over-the-counter ("OTC")
market, if the OTC option is also an exchange traded option, the Fund will
follow the rules regarding the valuation of exchange traded options. If the OTC
option is not also an exchange traded option, the Fund will value the option at
fair value in accordance with procedures adopted by the Board. Futures
contracts and options on futures contracts are valued at the last trade price
prior to the end of the Fund's pricing cycle.
Illiquid securities, securities for which reliable quotations or pricing
services are not readily available, and all other assets will be valued either
at the average of the last bid price of the securities obtained from two or
more dealers or otherwise at their respective fair value as determined in good
faith by, or under procedures established by the Board. The Board has adopted
fair valuation procedures for the Fund and has delegated responsibility for
fair value determinations to the Fair Valuation Committee. The members of the
Fair Valuation Committee report, as necessary, to the Board regarding portfolio
valuation determination. The Board, from time to time, will review these
methods of valuation and will recommend changes which may be necessary to
assure that the investments of the Fund are valued at fair value.
USE OF THIRD-PARTY INDEPENDENT PRICING AGENTS. Pursuant to contracts with the
Trust's Administrator, market prices for most securities held by the Fund are
provided daily by third-party independent pricing agents that are approved by
the Board. The valuations provided by third-party independent pricing agents
are reviewed daily by the Administrator.
TAXES
The following is only a summary of certain additional federal income tax
considerations generally affecting the Fund and its shareholders that is
intended to supplement the discussion contained in the Fund's prospectus. No
attempt is made to present a detailed explanation of the tax treatment of the
Fund or its shareholders, and the discussion here and in the Fund's prospectus
is not intended as a substitute for careful tax planning. Shareholders are
urged to consult their tax advisors with specific reference to their own tax
situations, including their state and local tax liabilities.
This general discussion of certain federal income tax consequences is based on
the Code and the regulations issued thereunder as in effect on the date of this
SAI. New legislation, as well as administrative changes or court decisions,
may significantly change the conclusions expressed herein,
S-48
and may have a retroactive effect with respect to the transactions contemplated
herein.
QUALIFICATIONS AS A REGULATED INVESTMENT COMPANY ("RIC"). The Fund intends to
qualify and elect to be treated as a RIC under Subchapter M of the Code. By
following such a policy, the Fund expects to eliminate or reduce to a nominal
amount the federal taxes to which they may be subject. The Board reserves the
right not to maintain the qualification of the Fund as a RIC if it determines
such course of action to be beneficial to shareholders.
In order to be taxable as a RIC, the Fund must distribute at least 90% of its
net investment income (which includes dividends taxable interest, and the
excess of net short-term capital gains over net long-term capital losses, less
operating expenses) and at least 90% of its net tax exempt interest income, for
each tax year, if any, to its shareholders and also must meet several
additional requirements. Among these requirements are the following: (i) at
least 90% of the Fund's gross income each taxable year must be derived from
dividends, interest, payments with respect to certain securities loans, and
gains from the sale or other disposition of stock, securities, or foreign
currencies, or certain other income (including, but not limited to, gains from
options, futures or forward contracts) derived with respect to its business of
investing in such stocks, securities, or currencies, and net income derived
from an interest in a qualified publicly traded partnership (the "Qualifying
Income Test"); (ii) at the close of each quarter of the Fund's taxable year, at
least 50% of the value of the Fund's total assets must be represented by cash
and cash items, U.S. government securities, securities of other RICs and other
securities, with such other securities limited, in respect to any one issuer,
to an amount that does not exceed 5% of the value of the Fund's assets and that
does not represent more than 10% of the outstanding voting securities of such
issuer; and (iii) at the close of each quarter of the Fund's taxable year, not
more than 25% of the value of the Fund's assets may be invested in securities
(other than U.S. government securities or the securities of other RICs) of any
one issuer or the securities (other than the securities of another RIC) of two
or more issuers that the Fund controls and that are engaged in the same,
similar or related trades or business, or the securities of one or more
qualified publicly traded partnerships (the "Diversification Test"). Although
the Fund intends to distribute substantially all of their net investment income
and may distribute their capital gains for any taxable year, the Fund will be
subject to federal income taxation to the extent any such income or gains are
not distributed.
If the Fund fails to satisfy the qualifying income or diversification
requirements in any taxable year, the Fund may be eligible for relief
provisions if the failures are due to reasonable cause and not willful neglect
and if a penalty tax is paid with respect to each failure to satisfy the
applicable requirements. Additionally, relief is provided for certain de
minimis failures of the diversification requirements where the Fund corrects
the failure within a specified period. If the Fund fails to qualify for any
taxable year as a RIC and these relief provisions are not available, all of its
taxable income will be subject to tax at regular corporate income tax rates
without any deduction for distributions to shareholders, and such distributions
generally will be taxable to shareholders as ordinary dividends to the extent
of the Fund's current and accumulated earnings and profits. In this event,
distributions generally will be eligible for the dividend-received deduction
for corporate shareholders and for the lower capital gains rates on qualified
dividend income for individual shareholders to the extent they would qualify if
the Fund was a regular corporation. In addition, the Fund could be required to
recognize unrealized gains, pay substantial taxes and interest, and make
substantial distributions before requalifying as a RIC.
The Fund may elect to treat part or all of any "qualified late year loss" as if
it had been incurred in the succeeding taxable year in determining the Fund's
taxable income, net capital gain, net short-term capital gain, and earnings and
profits. The effect of this election is to treat any such "qualified late year
loss" as if it had been incurred in the succeeding taxable year in
characterizing Fund distributions
S-49
for any calendar. A "qualified late year loss" generally includes net capital
loss, net long-term capital loss, or net short-term capital loss incurred after
October 31 of the current taxable year (commonly referred to as "post-October
losses") and certain other late-year losses.
If the Fund has a "net capital loss" (that is, capital losses in excess of
capital gains), the excess of the Fund's net short-term capital losses over its
net long-term capital gains is treated as a short-term capital loss arising on
the first day of the Fund's next taxable year, and the excess (if any) of the
Fund's net long-term capital losses over its net short-term capital gains is
treated as a long-term capital loss arising on the first day of the Fund's next
taxable year. In addition, the carryover of capital losses may be limited under
the general loss limitation rules if the Fund experiences an ownership change
as defined in the Code.
FEDERAL EXCISE TAX. If the Fund fails to distribute in a calendar year at least
98% of its ordinary income for the year and 98.2% of its capital gain net
income (the excess of short- and long-term capital gains over short- and
long-term capital losses) for the one-year period ending October 31 of that
year (and any retained amount from the prior calendar year on which the Fund
paid no federal income tax), the Fund will be subject to a nondeductible 4%
Federal excise tax on the undistributed amounts. The Fund intends to make
sufficient distributions to avoid imposition of this tax, or to retain, at most
their net capital gains and pay tax thereon.
DISTRIBUTIONS TO SHAREHOLDERS. The Fund may derive capital gains and losses in
connection with sales or other dispositions of their portfolio of securities.
Distributions of net short-term capital gains will be taxable to you as
ordinary income. Distributions of net long-term capital gains will be taxable
to you as long-term capital gain regardless of how long you have held your
shares. Distributions of dividends will be taxed as ordinary income except that
distributions of qualified dividend income will be taxed at the lower capital
gains rates available for individual shareholders.
Certain distributions by the Fund may be eligible for the reduced maximum tax
rate to individuals of 20% (lower rates apply to individuals in lower tax
brackets) to the extent that the Fund receives qualified dividend income on the
securities it holds and the Fund designates the distributions as qualified
dividend income. A distribution from the Fund generally qualifies as qualified
dividend income to the extent it is designated as such by the Fund and was
distributed from dividends received by the Fund from taxable domestic
corporations and certain qualified foreign corporations, subject to limitations
including holding period limitations, imposed on the Fund and its shareholders.
Distributions the Fund receives from REITs generally will not be treated as
qualified dividend income. Capital gain distributions consisting of the Fund's
net capital gains will be taxable as long-term capital gains at a maximum rate
of 20%.
The Fund will inform you of the amount of your ordinary income dividends,
qualified dividend income and capital gain distributions, if any, at the time
they are paid and will advise you of their tax status for federal income tax
purposes shortly after the close of each calendar year. REITs in which the Fund
may invest often do not provide complete and final tax information until after
the time that the Fund issues the tax reporting statement. As a result, the
Fund may at times find it necessary to reclassify the amount and character of
its distributions to you after it issues your tax reporting statement. When
such reclassification is necessary, the Fund will send you a corrected, final
Form 1099-DIV to reflect the reclassified information. If you receive a
corrected Form 1099-DIV, use the information on this corrected form, and not
the information on the previously issued tax reporting statement, in completing
your tax returns. If you have not held Fund shares for a full year, the Fund
may designate and distribute to you, as ordinary income, qualified dividend
income or capital gain, a percentage of income that is not equal to the actual
amount of such income earned during the period of your investment in the Fund.
S-50
If the Fund's distributions exceed its taxable income and capital gains
realized during a taxable year, all or a portion of the distributions made in
the same taxable year may be recharacterized as a return of capital to
shareholders. A return of capital distribution will generally not be taxable,
but will reduce each shareholder's cost basis in the Fund and result in a
higher reported capital gain or lower reported capital loss when those shares
on which the distribution was received are sold. If the net asset value of
shares were reduced below the shareholder's cost by dividends or distributions
representing gains realized on sales of securities, such dividends or
distributions would be a return of investment though taxable to the shareholder
in the same manner as other dividends or distributions.
A dividend or distribution received shortly after the purchase of shares
reduces the net asset value of the shares by the amount of the dividend or
distribution and, although in effect a return of capital, will be taxable to
the shareholder.
Dividends declared to shareholders of record in October, November or December
and actually paid in January of the following year will be treated as having
been received by shareholders on December 31 of the calendar year in which
declared. Under this rule, therefore, a shareholder may be taxed in one year on
dividends or distributions actually received in January of the following year.
In the case of corporate shareholders, Fund distributions (other than capital
gains distributions) generally qualify for the dividend-received deduction to
the extent such distributions are so designated and do not exceed the gross
amount of qualifying dividends received by the Fund for the year. Generally,
and subject to certain limitations (including certain holding period
limitations), a dividend will be treated as a qualifying dividend if it has
been received from a domestic corporation. All such qualifying dividends
(including the deducted portion) must be included in your alternative minimum
taxable income calculation.
SALES OR REDEMPTIONS. Any gain or loss recognized on a sale or redemption of
shares of the Fund by a shareholder who is not a dealer in securities will
generally, for individual shareholders, be treated as a long-term capital gain
or loss if the shares have been held for more than twelve months and otherwise
will be treated as a short-term capital gain or loss. However, if shares on
which a shareholder has received a net capital gain distribution are
subsequently sold or redeemed and such shares have been held for six months or
less, any loss recognized will be treated as a long-term capital loss to the
extent of the net capital gain distribution. In addition, the loss realized on
a sale or other disposition of shares will be disallowed to the extent a
shareholder repurchases (or enters into a contract to or option to repurchase)
shares within a period of 61 days (beginning 30 days before and ending 30 days
after the disposition of the shares). This loss disallowance rule will apply to
shares received through the reinvestment of dividends during the 61-day
period.
In certain cases, the Fund will be required to withhold at a rate of 28% and
remit to the United States Treasury, back up withholding on any distributions
paid to a shareholder who (1) has failed to provide a correct taxpayer
identification number, (2) is subject to backup withholding by the Internal
Revenue Service ("IRS"), (3) has not certified to the Fund that such
shareholder is not subject to backup withholding, or (4) has failed to certify
that he or she is a U.S. citizen or U.S. resident alien.
The Fund (or its administrative agent) must report to the IRS and furnish to
Fund shareholders the cost basis information for Fund shares. In addition, the
Fund is also required to report whether these shares had a short-term or
long-term holding period. For each sale of Fund shares the Fund will permit
Fund shareholders to elect from among several IRS-accepted cost basis methods,
including average basis.
S-51
In the absence of an election, the Fund will use the average basis method as
its default cost basis method. The cost basis method elected by the Fund
shareholder (or the cost basis method applied by default) for each sale of Fund
shares may not be changed after the settlement date of each such sale of Fund
shares. Fund shareholders should consult with their tax advisors to determine
the best IRS-accepted cost basis method for their tax situation and to obtain
more information about how cost basis reporting applies to them.
Beginning January 1, 2013, U.S. individuals with income exceeding $200,000
($250,000 if married and filing jointly) are subject to a 3.8% Medicare
contribution tax on their "net investment income," including interest,
dividends, and capital gains (including capital gains realized on the sale or
exchange of Fund shares).
The Fund may invest in complex securities. These investments may be subject to
numerous special and complex tax rules. These rules could affect whether gains
and losses recognized by the Fund are treated as ordinary income or capital
gain, accelerate the recognition of income to the Fund and/or defer the Fund's
ability to recognize losses. In turn, those rules may affect the amount, timing
or character of the income distributed to you by the Fund.
With respect to investments in STRIPS, TRs, and other zero coupon securities
which are sold at original issue discount and thus do not make periodic cash
interest payments, the Fund will be required to include as part of its current
income the imputed interest on such obligations even though the Fund has not
received any interest payments on such obligations during that period. Because
the Fund distributes all of its net investment income to its shareholders, the
Fund may have to sell Fund securities to distribute such imputed income which
may occur at a time when the Adviser would not have chosen to sell such
securities and which may result in taxable gain or loss.
The Fund may invest in certain MLPs which may be treated as qualified publicly
traded partnerships. Income from qualified publicly traded partnerships is
qualifying income for purposes of the Qualifying Income Test, but the Fund's
investment in one or more of such qualified publicly traded partnerships is
limited under the Diversification Test to no more than 25% of the value of the
Fund's assets. The Fund will monitor its investment in such qualified publicly
traded partnerships in order to ensure compliance with the Qualifying Income
Test.
The Fund may invest in certain royalty trusts. The taxation of a royalty trust
for U.S. tax purposes depends on the particular structure used by such trust
and may be different from trust to trust. For example, some royalty trusts are
taxable for U.S. tax purposes as grantor trusts, while others are taxable as
corporations for U.S. tax purposes. The Fund will monitor its investment in
such royalty trusts in order to ensure compliance with the Qualifying Income
and Diversification Tests. There may be uncertainty regarding the Fund's
compliance with these tests because compliance depends on the amount and
character of income it receives and the type of security it holds from the
royalty trusts. As a result, the Fund may fail to qualify as a RIC in a given
tax year in which it fails the Qualifying Income Test or the Diversification
Test. See discussion regarding the consequences of failing to qualify as a RIC
above.
The Fund may invest in entities taxable as REITs under the Code. Investments in
REIT equity securities may require the Fund to accrue and distribute income not
yet received. To generate sufficient cash to make the requisite distributions,
the Fund may be required to sell securities in its portfolio (including when it
is not advantageous to do so) that it otherwise would have continued to hold.
The Fund's investments in REIT equity securities may at other times result in
the Fund's receipt of cash in excess of the REIT's earnings if the Fund
distributes these amounts, these distributions
S-52
could constitute a return of capital to Fund shareholders for federal income
tax purposes. Dividends paid by a REIT, other than capital gain distributions,
will be taxable as ordinary income up to the amount of the REIT's current and
accumulated earnings and profits. Capital gain dividends paid by a REIT to the
Fund will be treated as long-term capital gains by the Fund and, in turn, may
be distributed by the Fund to its shareholders as a capital gain distribution.
Dividends received by the Fund from a REIT generally will not constitute
qualified dividend income and will not qualify for the dividends received
deduction. If a REIT is operated in a manner such that it fails to qualify as a
REIT, an investment in the REIT would become subject to double taxation,
meaning the taxable income of the REIT would be subject to federal income tax
at regular corporate rates without any deduction for dividends paid to
shareholders and the dividends would be taxable to shareholders as ordinary
income (or possibly as qualified dividend income) to the extent of the REIT's
current and accumulated earnings and profits.
Certain tax-exempt shareholders, including qualified pension plans, individual
retirement accounts, salary deferral arrangements, 401(k)s, and other
tax-exempt entities, generally are exempt from federal income taxation except
with respect to their unrelated business taxable income ("UBTI"). Under current
law, the Fund generally serves to block UBTI from being realized by its
tax-exempt shareholders. However, notwithstanding the foregoing, the tax-exempt
shareholder could realize UBTI by virtue of an investment in the Fund where,
for example: (i) the Fund invests in residual interests of Real Estate Mortgage
Investment Conduits (REMICs); (ii) the Fund invests in a REIT that is a taxable
mortgage pool (TMP) or that has a subsidiary that is a TMP or that invests in
the residual interest of a REMIC; or (iii) shares in the Fund constitute
debt-financed property in the hands of the tax-exempt shareholder within the
meaning of section 514(b) of the Code. Charitable remainder trusts are subject
to special rules and should consult their tax advisor. The IRS has issued
guidance with respect to these issues and prospective shareholders, especially
charitable remainder trusts, are encouraged to consult with their tax advisors
regarding these issues.
Transactions by the Fund in foreign currencies and forward foreign currency
contracts will be subject to special provisions of the Code that, among other
things, may affect the character of gains and losses realized by the Fund
(i.e., may affect whether gains or losses are ordinary or capital), accelerate
recognition of income to the Fund and defer losses. These rules could therefore
affect the character, amount and timing of distributions to shareholders. These
provisions also may require the Fund to mark-to-market certain types of
positions in its portfolio (i.e., treat them as if they were closed out) which
may cause the Fund to recognize income without receiving cash with which to
make distributions in amounts necessary to satisfy the distribution
requirements for avoiding income and excise taxes. The Fund intends to monitor
its transactions, intends to make the appropriate tax elections, and intends to
make the appropriate entries in its books and records when it acquires any
foreign currency or forward foreign currency contract in order to mitigate the
effect of these rules so as to prevent disqualification of the Fund as a RIC
and minimize the imposition of income and excise taxes.
If the Fund owns shares in certain foreign investment entities, referred to as
"passive foreign investment companies" or "PFIC," the Fund will be subject to
one of the following special tax regimes: (i) the Fund will be liable for
federal income tax, and an additional interest charge, on a portion of any
"excess distribution" from such foreign entity or any gain from the disposition
of such shares, even if the entire distribution or gain is paid out by the Fund
as a dividend to its shareholders; (ii) if the Fund is able and elect to treat
a PFIC as a "qualifying electing fund" or "QEF," the Fund would be required
each year to include in income, and distribute to shareholders in accordance
with the distribution requirements set forth above, the Fund's pro rata share
of the ordinary earnings and net capital gains of the PFIC, whether or not such
earnings or gains are distributed to the Fund; or (iii)
S-53
annually the Fund may be entitled to mark-to-market shares of the PFIC, and in
such event, would be required to distribute to shareholders any such
mark-to-market gains in accordance with the distribution requirements set forth
above and any market-to-market losses, as well as loss from an actual
disposition of PFIC stock, would be reported as ordinary loss to the extent of
any net market-to-market gains included in income in prior years.
FOREIGN TAXES. Dividends and interest received by the Fund may be subject to
income, withholding or other taxes imposed by foreign countries and U.S.
possessions that would reduce the yield on the Fund's securities. Tax
conventions between certain countries and the United States may reduce or
eliminate these taxes. Foreign countries generally do not impose taxes on
capital gains with respect to investments by foreign investors. If more than
50% of the value of the Fund's total assets at the close of its taxable year
consists of stock or securities of foreign corporations, the Fund will be
eligible to, and will, file an election with the IRS that will enable
shareholders, in effect, to receive the benefit of the foreign tax credit with
respect to any foreign and U.S. possessions income taxes paid by the Fund.
Pursuant to the election, the Fund will treat those taxes as dividends paid to
its shareholders. Each shareholder will be required to include a proportionate
share of those taxes in gross income as income received from a foreign source
and must treat the amount so included as if the shareholder had paid the
foreign tax directly. The shareholder may then either deduct the taxes deemed
paid by him or her in computing his or her taxable income or, alternatively,
use the foregoing information in calculating the foreign tax credit (subject to
significant limitations) against the shareholder's federal income tax. If the
Fund makes the election, it will report annually to its shareholders the
respective amounts per share of the Fund's income from sources within, and
taxes paid to, foreign countries and U.S. possessions. Foreign tax credits, if
any, received by the Fund as a result of an investment in an ETF which is
taxable as a RIC will generally not be passed through to you.
Most foreign exchange gains realized on the sale of debt securities are treated
as ordinary income by the Fund. Similarly, foreign exchange losses realized by
the Fund on the sale of debt securities are generally treated as ordinary
losses by the Fund. These gains when distributed will be taxed to you as
ordinary dividends, and any losses will reduce the Fund's ordinary income
otherwise available for distribution to you. This treatment could increase or
reduce the Fund's ordinary income distributions to you, and may cause some or
all of the Fund's previously distributed income to be classified as a return of
capital.
Under U.S. Treasury regulations, generally, if an individual shareholder
recognizes a loss of $2 million or more or a corporate shareholder recognizes a
loss of $10 million or more, the shareholder must file with the IRS a
disclosure statement on Form 8886. Direct shareholders of portfolio securities
are in many cases excepted from this reporting requirement, but under current
guidance, shareholders of a RIC such as the Fund are not excepted. Future
guidance may extend the current exception from this reporting requirement to
shareholders of most or all RICs. The fact that a loss is reportable under
these regulations does not affect the legal determination of whether the
taxpayer's treatment of the loss is proper. Shareholders should consult their
tax advisors to determine the applicability of these regulations in light of
their individual circumstances.
A U.S. withholding tax at a 30% rate will be imposed on dividends beginning
after December 31, 2013 (and proceeds of sales in respect of Fund shares
received by Fund shareholders beginning after December 31, 2016) for
shareholders who own their shares through foreign accounts or foreign
intermediaries if certain disclosure requirements related to U.S. accounts or
ownership are not satisfied. The Fund will not pay any additional amounts in
respect to any amounts withheld.
S-54
Any non-U.S. investors in the Fund may be subject to U.S. withholding and
estate tax and are encouraged to consult their tax advisors prior to investing
in the Fund.
STATE TAXES. It is expected that the Fund will not be liable for any corporate
excise, income or franchise tax in Massachusetts if it qualifies as a RIC for
federal income tax purposes. Distributions by the Fund to shareholders and the
ownership of shares may be subject to state and local taxes. Rules of state and
local taxation of dividend and capital gains distribution from RICs often
differ from rules for federal income taxation described above. Shareholders are
urged to consult their tax advisors regarding state and local taxes applicable
to an investment in the Fund.
Many states grant tax-free status to dividends paid to you from interest earned
on direct obligations of the U.S. government, subject in some states to minimum
investment requirements that must be met by a fund. Investment in Ginnie Mae or
Fannie Mae securities, banker's acceptances, commercial paper, and repurchase
agreements collateralized by U.S. government securities do not generally
qualify for such tax-free treatment. The rules on exclusion of this income are
different for corporate shareholders.
FUND TRANSACTIONS
BROKERAGE TRANSACTIONS. Generally, equity securities, both listed and
over-the-counter, are bought and sold through brokerage transactions for which
commissions are payable. Purchases from underwriters will include the
underwriting commission or concession, and purchases from dealers serving as
market makers will include a dealer's mark-up or reflect a dealer's mark-down.
Money market securities and other debt securities are usually bought and sold
directly from the issuer or an underwriter or market maker for the securities.
Generally, the Fund will not pay brokerage commissions for such purchases. When
a debt security is bought from an underwriter, the purchase price will usually
include an underwriting commission or concession. The purchase price for
securities bought from dealers serving as market makers will similarly include
the dealer's mark up or reflect a dealer's mark down. When the Fund executes
transactions in the over-the-counter market, they will generally deal with
primary market makers unless prices that are more favorable are otherwise
obtainable.
In addition, the Adviser may place a combined order for two or more accounts it
manages, including the Fund, engaged in the purchase or sale of the same
security if, in its judgment, joint execution is in the best interest of each
participant and will result in best price and execution. Transactions involving
commingled orders are allocated in a manner deemed equitable to each account or
fund. Although it is recognized that, in some cases, the joint execution of
orders could adversely affect the price or volume of the security that a
particular account or the Fund may obtain, it is the opinion of the Adviser
that the advantages of combined orders outweigh the possible disadvantages of
separate transactions. Nonetheless, the Adviser believes that the ability of
the Fund to participate in higher volume transactions will generally be
beneficial to the Fund.
For the fiscal years ended October 31, 2010, 2011, and 2012, the Invesco
Predecessor Fund paid the following aggregate brokerage commissions on fund
transactions:
AGGREGATE DOLLAR AMOUNT OF BROKERAGE COMMISSIONS PAID
2010 2011 2012
--------------------------------------------------------------------------------
$130,320 $174,734 $150,711
--------------------------------------------------------------------------------
|
BROKERAGE SELECTION. The Trust does not expect to use one particular broker or
dealer, and when one or more brokers is believed capable of providing the best
combination of price and execution, the
S-55
Adviser may select a broker based upon brokerage or research services provided
to the Adviser. The Adviser may pay a higher commission than otherwise
obtainable from other brokers in return for such services only if a good faith
determination is made that the commission is reasonable in relation to the
services provided.
Section 28(e) of the 1934 Act permits the Adviser, under certain circumstances,
to cause the Fund to pay a broker or dealer a commission for effecting a
transaction in excess of the amount of commission another broker or dealer
would have charged for effecting the transaction in recognition of the value of
brokerage and research services provided by the broker or dealer. In addition
to agency transactions, the Adviser may receive brokerage and research services
in connection with certain riskless principal transactions, in accordance with
applicable SEC guidance. Brokerage and research services include: (1)
furnishing advice as to the value of securities, the advisability of investing
in, purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities; (2) furnishing analyses and reports
concerning issuers, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts; and (3) effecting
securities transactions and performing functions incidental thereto (such as
clearance, settlement, and custody). In the case of research services, the
Adviser believes that access to independent investment research is beneficial
to its investment decision-making processes and, therefore, to the Fund.
To the extent research services may be a factor in selecting brokers, such
services may be in written form or through direct contact with individuals and
may include information as to particular companies and securities as well as
market, economic, or institutional areas and information which assists in the
valuation and pricing of investments. Examples of research-oriented services
for which the Adviser might utilize Fund commissions include research reports
and other information on the economy, industries, sectors, groups of
securities, individual companies, statistical information, political
developments, technical market action, pricing and appraisal services, credit
analysis, risk measurement analysis, performance and other analysis. The
Adviser may use research services furnished by brokers in servicing all client
accounts and not all services may necessarily be used by the Adviser in
connection with the Fund or any other specific client account that paid
commissions to the broker providing such services. Information so received by
the Adviser will be in addition to and not in lieu of the services required to
be performed by the Fund's Adviser under the Advisory Agreement. Any advisory
or other fees paid to the Adviser are not reduced as a result of the receipt of
research services.
In some cases the Adviser may receive a service from a broker that has both a
"research" and a "non-research" use. When this occurs, the Adviser makes a
good faith allocation, under all the circumstances, between the research and
non-research uses of the service. The percentage of the service that is used
for research purposes may be paid for with client commissions, while the
Adviser will use its own funds to pay for the percentage of the service that is
used for non-research purposes. In making this good faith allocation, the
Adviser faces a potential conflict of interest, but the Adviser believes that
its allocation procedures are reasonably designed to ensure that it
appropriately allocates the anticipated use of such services to their research
and non-research uses.
From time to time, the Fund may purchase new issues of securities for clients
in a fixed price offering. In these situations, the seller may be a member of
the selling group that will, in addition to selling securities, provide the
adviser with research services. The Financial Industry Regulatory Authority
("FINRA") has adopted rules expressly permitting these types of arrangements
under certain circumstances. Generally, the seller will provide research
"credits" in these situations at a rate that is higher than that which is
available for typical secondary market transactions. These arrangements may not
fall within the safe harbor of Section 28(e).
S-56
For the most recently completed fiscal year, the Invesco Predecessor Fund paid
the following commissions on brokerage transactions directed to brokers
pursuant to an agreement or understanding whereby the broker provides research
or other brokerage services to the Adviser:
--------------------------------------------------------------------------------------------------------------
TOTAL DOLLAR AMOUNT OF TRANSACTIONS INVOLVING
TOTAL DOLLAR AMOUNT OF BROKERAGE COMMISSIONS BROKERAGE COMMISSIONS
FOR RESEARCH SERVICES FOR RESEARCH SERVICES
--------------------------------------------------------------------------------------------------------------
$144,307 $175,645,833
--------------------------------------------------------------------------------------------------------------
|
BROKERAGE WITH FUND AFFILIATES. The Fund may execute brokerage or other agency
transactions through registered broker-dealer affiliates of either the Fund,
the Adviser or the Distributor for a commission in conformity with the 1940
Act, the 1934 Act and rules promulgated by the SEC. These rules require that
commissions paid to the affiliate by the Fund for exchange transactions not
exceed "usual and customary" brokerage commissions. The rules define "usual and
customary" commissions to include amounts which are "reasonable and fair
compared to the commission, fee or other remuneration received or to be
received by other brokers in connection with comparable transactions involving
similar securities being purchased or sold on a securities exchange during a
comparable period of time." The Trustees, including those who are not
"interested persons" of the Fund, have adopted procedures for evaluating the
reasonableness of commissions paid to affiliates and review these procedures
periodically.
For the fiscal year ended October 31, 2012, the Invesco Predecessor Fund did
not pay any brokerage commissions on fund transactions effected by affiliated
brokers.
SECURITIES OF "REGULAR BROKER-DEALERS." The Fund is required to identify any
securities of its "regular brokers and dealers" (as such term is defined in the
1940 Act) that the Fund held during its most recent fiscal year. For the most
recently completed fiscal year, the Invesco Predecessor Fund did not hold any
securities of "regular brokers and dealers."
PORTFOLIO TURNOVER RATES. Portfolio turnover rate is defined under SEC rules as
the greater of the value of the securities purchased or securities sold,
excluding all securities whose maturities at the time of acquisition were
one-year or less, divided by the average monthly value of such securities owned
during the year. Based on this definition, instruments with remaining
maturities of less than one-year are excluded from the calculation of the
portfolio turnover rate. Instruments excluded from the calculation of portfolio
turnover generally would include the futures contracts in which the Fund may
invest since such contracts generally have remaining maturities of less than
one-year. The Fund may at times hold investments in other short-term
instruments, such as repurchase agreements, which are excluded for purposes of
computing portfolio turnover.
For the fiscal years ended October 31, 2012 and 2011, the portfolio turnover
rates for the Invesco Predecessor Fund are presented in the table below.
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FISCAL YEAR PORTFOLIO TURNOVER RATE
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2012 22%
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2011 38%
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PORTFOLIO HOLDINGS
The Board has approved a policy and procedures that govern the timing and
circumstances regarding the disclosure of Fund portfolio holdings information
to shareholders and third parties. These policies and procedures are designed
to ensure that disclosure of information regarding the Fund's portfolio
securities is in the best interests of the Fund's shareholders, and include
procedures to address conflicts between the interests of the Fund's
shareholders, on the one hand, and those of the Fund's Adviser, principal
underwriter, or any affiliated person of the Fund, the Adviser, or the
principal underwriter, on the other. Pursuant to such procedures, the Board has
authorized the Adviser's Chief Compliance Officer ("Adviser CCO") to authorize
the release of the Fund's portfolio holdings, as necessary, in conformity with
the foregoing principles. The Adviser CCO, either directly or through reports
by the Fund's Chief Compliance Officer, reports quarterly to the Board
regarding the operation and administration of such policies and procedures.
Pursuant to applicable law, the Fund is required to disclose its complete
portfolio holdings quarterly, within 60 days of the end of each fiscal quarter
(currently, each January 31, April 30, July 31, and October 31). The Fund will
disclose a complete or summary schedule of investments (which includes the
Fund's 50 largest holdings in unaffiliated issuers and each investment in
unaffiliated issuers that exceeds one percent of the Fund's net asset value
("Summary Schedule")) in its Semi-Annual and Annual Reports, which are
distributed to the Fund's shareholders. The Fund's complete schedule of
investments following the first and third fiscal quarters will be available in
quarterly holdings reports filed with the SEC on Form N-Q, and the Fund's
complete schedule of investments following the second and fourth fiscal
quarters will be available in shareholder reports filed with the SEC on Form
N-CSR.
Reports filed with the SEC on Form N-Q and Form N-CSR are not distributed to
the Fund's shareholders but are available, free of charge, on the EDGAR
database on the SEC's website at www.sec.gov. Should the Fund include only a
Summary Schedule rather than a complete schedule of investments in its
Semi-Annual and Annual Reports, its Form N-CSR will be available without
charge, upon request, by calling 1-855-3AT-FUND (1-855-328-3863).
In addition to information provided to shareholders and the general public,
portfolio holdings information may be disclosed as frequently as daily to
certain service providers, such as the custodian, administrator or transfer
agent, in connection with their services to the Fund. From time to time rating
and ranking organizations, such as S&P, Lipper and Morningstar, Inc., may
request non-public portfolio holdings information in connection with rating the
Fund. Similarly, institutional investors, financial planners, pension plan
sponsors and/or their consultants or other third-parties may request portfolio
holdings information in order to assess the risks of the Fund's portfolio along
with related performance attribution statistics. The lag time for such
disclosures will vary. The Fund believes that these third parties have
legitimate objectives in requesting such portfolio holdings information.
The Fund's policies and procedures provide that the Adviser's CCO may authorize
disclosure of non-public portfolio holdings information to such parties at
differing times and/or with different lag times. Prior to making any disclosure
to a third party, the Adviser's CCO must determine that such disclosure serves
a reasonable business purpose, is in the best interests of the Fund's
shareholders and that to the extent conflicts between the interests of the
Fund's shareholders and those of the Fund's Adviser, principal underwriter, or
any affiliated person of the Fund exist, such conflicts are addressed.
Portfolio holdings information may be disclosed no more frequently than monthly
to ratings agencies,
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consultants and other qualified financial professionals or individuals. The
disclosures will not be made sooner than three days after the date of the
information. The Fund's Chief Compliance Officer will regularly review these
arrangements and will make periodic reports to the Board regarding disclosure
pursuant to such arrangements.
With the exception of disclosures to rating and ranking organizations as
described above, the Fund requires any third party receiving non-public
holdings information to enter into a confidentiality agreement with the
Adviser. The confidentiality agreement provides, among other things, that
non-public portfolio holdings information will be kept confidential and that
the recipient has a duty not to trade on the non-public information and will
use such information solely to analyze and rank the Fund, or to perform due
diligence and asset allocation, depending on the recipient of the information.
The Fund's policies and procedures prohibit any compensation or other
consideration from being paid to or received by any party in connection with
the disclosure of portfolio holdings information, including the Fund, Adviser
and its affiliates or recipients of the Fund's portfolio holdings information.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number of
funds and shares of each fund, each of which represents an equal proportionate
interest in that fund with each other share. Shares are entitled upon
liquidation to a pro rata share in the net assets of the fund. Shareholders
have no preemptive rights. The Declaration of Trust provides that the Trustees
of the Trust may create additional series or class of shares. All consideration
received by the Trust for shares of any additional funds and all assets in
which such consideration is invested would belong to that fund and would be
subject to the liabilities related thereto. Share certificates representing
shares will not be issued. The Fund's shares, when issued, are fully paid and
non-assessable.
SHAREHOLDER LIABILITY
The Trust is an entity of the type commonly known as a "Massachusetts business
trust." Under Massachusetts law, shareholders of such a trust could, under
certain circumstances, be held personally liable as partners for the
obligations of the Trust. Even if, however, the Trust were held to be a
partnership, the possibility of the shareholders incurring financial loss for
that reason appears remote because the Trust's Declaration of Trust contains an
express disclaimer of shareholder liability for obligations of the Trust and
requires that notice of such disclaimer be given in each agreement, obligation
or instrument entered into or executed by or on behalf of the Trust or the
Trustees, and because the Declaration of Trust provides for indemnification out
of the Trust property for any shareholder held personally liable for the
obligations of the Trust.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only for his
or her own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person. The Declaration of
Trust also provides that the Trust will indemnify its Trustees and officers
against liabilities and expenses incurred in connection with actual or
threatened litigation in which they may be involved because of their offices
with the Trust unless it is determined in the manner provided in the
Declaration of Trust that they have not acted in good faith in the reasonable
belief that their actions were in the best interests of the Trust. However,
nothing in the Declaration of Trust shall protect or
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indemnify a Trustee against any liability for his or her willful misfeasance,
bad faith, gross negligence or reckless disregard of his or her duties. Nothing
contained in this section attempts to disclaim a Trustee's individual liability
in any manner inconsistent with the federal securities laws.
PROXY VOTING
The Board has delegated responsibility for decisions regarding proxy voting for
securities held by the Fund to the Adviser. The Adviser will vote such proxies
in accordance with its proxy policies and procedures, which are included in
Appendix B to this SAI. The Board will periodically review the Fund's proxy
voting record.
The Trust is required to disclose annually the Fund's complete proxy voting
record during the most recent 12-month period ended June 30 on Form N-PX. This
voting record is available: (i) without charge, upon request, by calling
1-855-3AT-FUND (1-855-328-3863); and (ii) on the SEC's website at
http://www.sec.gov.