Principal Risks
As with
all funds, a shareholder is subject to the risk that his or her
investment could lose money. The Fund may not achieve its leveraged
investment objective and there is a risk that you could lose all of
your money invested in the Fund. The Fund is not a
complete investment program. The Fund presents risks not
traditionally associated with other mutual funds and ETFs. For
example, due to the Fund’s daily leveraged investment
objective, a small adverse move in the Index will result in larger
and potentially substantial declines in the Fund. It is important
that investors closely review all of the risks listed below and
understand them before making an investment in the
Fund.
Effects of Compounding and Market Volatility Risk:
The Fund has a daily leveraged
investment objective and the Fund’s performance for periods
greater than a trading day will be the result of each day's returns
compounded over the period, which is very likely to differ from two
times (2x) the Index’s performance, before fees and expenses.
Compounding affects all investments, but has a more significant
impact on funds that are leveraged and that rebalance daily. For a
leveraged fund, if adverse daily performance of the index reduces
the amount of a shareholder’s investment, any further adverse
daily performance will lead to a smaller dollar loss because the
shareholder’s investment had already been reduced by the
prior adverse performance. Equally, however, if favorable daily
performance of the index increases the amount of a
shareholder’s investment, the dollar amount lost due to
future adverse performance will increase because the
shareholder’s investment has increased.
The effect of compounding becomes more pronounced as Index
volatility and the holding period increase. The impact of
compounding will impact each shareholder differently depending on
the period of time an investment in the Fund is held and the
volatility of the Index during shareholder’s holding period
of an investment in the Fund.
The chart below provides examples of how Index volatility could
affect the Fund’s performance. Fund performance for periods
greater than one single day can be estimated given any set of
assumptions for the following factors: a) Index volatility; b)
Index performance; c) period of time; d) financing rates associated
with leveraged exposure; e) other Fund expenses; and f) dividends
or interest paid with respect to securities in the Index. The chart
below illustrates the impact of two principal factors –
Index volatility and Index performance – on Fund performance.
The chart shows estimated Fund returns for a number of combinations
of Index volatility and Index performance over a one-year period.
Performance shown in the chart assumes that: (i) no dividends were
paid with respect to the securities included in the Index; (ii)
there were no Fund expenses; and (iii) borrowing/lending rates (to
obtain leveraged exposure) of 0%. If Fund expenses and/or actual
borrowing/lending rates were reflected, the estimated returns would
be different than those shown. Particularly during periods of
higher Index volatility, compounding will cause results for periods
longer than a trading day to vary from two times (2x) the
performance of the Index.
As shown in the chart below, the Fund would be expected to
lose 6.1% if the Index provided no return over a one year period
during which the Index experienced annualized volatility of 25%. At
higher ranges of volatility, there is a chance of a significant
loss of value in the Fund, even if the Index’s return is
flat. For instance, if the
Index’s annualized volatility is 100%, the Fund would be
expected to lose 63.2% of its value, even if the cumulative Index
return for the year was 0%. Areas shaded red (or dark gray) represent
those scenarios where the Fund can be expected to return less than
two times (2x) the performance of the Index and those shaded green
(or light gray) represent those scenarios where the Fund can be
expected to return more than two times (2x) the performance of the
Index. The Fund’s actual returns may be significantly better
or worse than the returns shown below as a result of any of the
factors discussed above or in “Daily Index
Correlation/Tracking Risk”
below.
One Year Index
|
Two Times (2x) One Year Index
|
Volatility Rate
|
Return
|
Return
|
10%
|
25%
|
50%
|
75%
|
100%
|
-60%
|
-120%
|
-84.2%
|
-85.0%
|
-87.5%
|
-90.9%
|
-94.1%
|
-50%
|
-100%
|
-75.2%
|
-76.5%
|
-80.5%
|
-85.8%
|
-90.8%
|
-40%
|
-80%
|
-64.4%
|
-66.2%
|
-72.0%
|
-79.5%
|
-86.8%
|
-30%
|
-60%
|
-51.5%
|
-54.0%
|
-61.8%
|
-72.1%
|
-82.0%
|
-20%
|
-40%
|
-36.6%
|
-39.9%
|
-50.2%
|
-63.5%
|
-76.5%
|
-10%
|
-20%
|
-19.8%
|
-23.9%
|
-36.9%
|
-53.8%
|
-70.2%
|
0%
|
0%
|
-1.0%
|
-6.1%
|
-22.1%
|
-43.0%
|
-63.2%
|
10%
|
20%
|
19.8%
|
13.7%
|
-5.8%
|
-31.1%
|
-55.5%
|
20%
|
40%
|
42.6%
|
35.3%
|
12.1%
|
-18.0%
|
-47.0%
|
30%
|
60%
|
67.3%
|
58.8%
|
31.6%
|
-3.7%
|
-37.8%
|
40%
|
80%
|
94.0%
|
84.1%
|
52.6%
|
11.7%
|
-27.9%
|
50%
|
100%
|
122.8%
|
111.4%
|
75.2%
|
28.2%
|
-17.2%
|
60%
|
120%
|
153.5%
|
140.5%
|
99.4%
|
45.9%
|
-5.8%
|
The Index’s annualized historical volatility rate for the
period from December 15, 2017 (the inception date of the
Index) to December 31, 2020 was 45.29%. The Index’s highest
volatility rate for any one calendar year for the period from
December 15, 2017 (the inception date of the Index) through
December 31, 2020 was 50.06% and volatility for a shorter period of
time may have been substantially higher. The Index’s
annualized performance for the period from December 15, 2017 (the
inception date of the Index) to December 31, 2020 was -17.34%.
Historical Index volatility and performance are not indications of
what the Index volatility and performance will be in the future.
The volatility of ETFs or instruments that reflect the value of the
Index, such as swaps, may differ from the volatility of the
Index.
For information regarding the effects
of volatility and Index performance on the long-term
performance of the Fund, see “Additional Information
about the Fund’s Investment Objective and
Strategies” in the Fund’s
statutory prospectus, and “Special Note Regarding the
Correlation Risks of the Fund” in the Fund’s Statement
of Additional Information.
Leverage Risk: The Fund obtains
investment exposure in excess of its net assets by utilizing
leverage and may lose more money in market conditions that are
adverse to its investment objective than a fund that does not
utilize leverage. An investment in the Fund is exposed to the risk
that a decline in the daily performance of the Index will be
magnified. This means that an investment in the Fund will be
reduced by an amount equal to 2% for every 1% daily decline in the
Index, not including the costs of financing leverage and other
operating expenses, which would further reduce its value. The Fund
could theoretically lose an amount greater than its net assets in
the event of an Index decline of more than 50%. Leverage will also
have the effect of magnifying any differences in the Fund’s
correlation with the Index.
United States Regulatory Risks of the Marijuana Industry:
The possession and use of marijuana, even for medical purposes, is
illegal under federal and certain states’ laws, which may
negatively impact the value of the Fund’s investments. Use of
marijuana is regulated by both the federal government and state
governments, and state and federal laws regarding marijuana often
conflict. Even in those states in which the use of marijuana has
been legalized, its possession and use remains a violation of
federal law. Federal law criminalizing the use of marijuana
pre-empts state laws that legalizes its use for medicinal and
recreational purposes. It is not yet known whether the current
Administration will push back against states where marijuana use
and possession is legal, step up the enforcement of federal
marijuana laws and the prosecution of nonviolent federal drug
crimes and, in the event the Rohrabacher-Blumenauer amendment is
not renewed by Congress, begin using federal funds to prevent
states from implementing laws that authorize medical marijuana use,
possession, distribution, and cultivation. Such actions by the DOJ
could produce a chilling effect on the industry’s growth and
discourage banks from expanding their services to cannabis-related
companies where such services are currently limited. This conflict
between the regulation of marijuana under federal and state law
creates volatility and risk for all cannabis-related companies. In
particular, the stepped up enforcement of marijuana laws by the
federal government would adversely affect the value of the
Fund’s U.S. investments. Certain Cannabis Companies or
Pharmaceutical Companies may never be able to legally produce and
sell products in the United States or other national or local
jurisdictions.
Marijuana
is a Schedule I controlled substance under the Controlled
Substances Act (“CSA”) (21 U.S.C. § 811), meaning
that it has a high potential for abuse, has no currently
“accepted medical use” in the United States, lacks
accepted safety for use under medical supervision, and may not be
prescribed, marketed or sold in the United States. Few drug
products containing natural cannabis or naturally-derived cannabis
extracts have been approved by the Food and Drug Administration
(“FDA”) for use in the United States or obtained
registrations from the United States Drug Enforcement
Administration (“DEA”) for commercial
production.
Cannabis-related
companies in the U.S. that engage in medical or pharmaceutical
research or the production and distribution of controlled
substances such as marijuana must be registered with the DEA to
perform such activities and have the security, control,
recordkeeping, reporting and inventory mechanisms required by the
DEA to prevent drug loss and diversion. Failure to obtain the
necessary registrations or comply with necessary regulatory
requirements may significantly impair the ability of certain
companies in which the Fund invests to pursue medical marijuana
research or to otherwise cultivate, possess or distribute
marijuana.
Non-U.S. Regulatory Risks of the Marijuana Industry: The
companies in which the Fund invests are subject to various laws,
regulations and guidelines relating to the manufacture, management,
transportation, storage and disposal of marijuana, as well as being
subject to laws and regulations relating to health and safety, the
conduct of operations and the protection of the environment. Even
if a company’s operations are permitted under current law,
they may not be permitted in the future, in which case such company
may not be in a position to carry on its operations in its current
locations. Additionally, controlled substance legislation differs
between countries and legislation in certain countries may restrict
or limit the ability of certain companies in which the Fund invests
to sell their products.
Operational Risks of the Marijuana Industry: Companies
involved in the marijuana industry face intense competition, may
have limited access to the services of banks, may have substantial
burdens on company resources due to litigation, complaints or
enforcement actions, and are heavily dependent on receiving
necessary permits and authorizations to engage in medical marijuana
research or to otherwise cultivate, possess or distribute
marijuana. Since the use of marijuana is illegal under United
States federal law, federally regulated banking institutions may be
unwilling to make financial services available to growers and
sellers of marijuana.
United States Regulatory Risks of Hemp: The Agriculture Improvement Act of 2018 (or
the “Farm Bill”) effectively removes hemp from the list
of controlled substances and allows states to regulate its
production, commerce and research with approval from the United
States Department of Agriculture. Certain Index constituents
may sell dietary supplements and/or foods containing CBD within the
United States. The Farm Bill delegates to the FDA responsibility
for regulating products containing hemp or derivatives thereof
(including CBD) under the Federal Food, Drug, and Cosmetic Act (the
“FD&C”). Under the FD&C, if a substance
(such as CBD) is an active ingredient in a drug product that has
been approved by the FDA, then the substance cannot be sold in
dietary supplements or foods without FDA approval, unless the
substance was marketed as a dietary supplement or as a conventional
food before the drug was approved or before the new drug
investigations were authorized. The FDA has publicly taken
the position that CBD cannot be sold in dietary supplements or
foods because CBD is an active ingredient in an FDA-approved
drug. However, companies that sell CBD in dietary supplements
and foods have taken the position that CBD was marketed as a
dietary supplement and/or as a conventional food before the drug
was approved or before the new drug investigations were authorized,
and because the FDA has not brought enforcement action against such
companies, this question of fact has not yet been adjudicated. In
the absence of a conclusive legal determination to the contrary, as
of the date of this prospectus, it has not been determined that the
sale of dietary supplements and/or foods containing CBD within the
United States would cause a company’s securities to be
ineligible for inclusion in the Index. It is possible that such a
legal determination or future federal and/or state laws or
regulations could drastically curtail permissible uses of hemp,
which could have an adverse effect of the value of the Fund’s
investments in companies with business interests in hemp and
hemp-based products.
Market Disruption Risk: Geopolitical and other events, including public
health crises and natural disasters, have recently led to increased
market volatility and significant market losses. Significant market
volatility and market
downturns may limit the Fund’s ability to sell securities
and obtain long exposure to securities, and the Fund’s
sales and long exposures may exacerbate the market volatility and
downturn. Under such circumstances, the Fund may have difficulty
achieving its investment objective for one or more trading days,
which may adversely impact the Fund’s returns on those days
and periods inclusive of those days. Alternatively, the Fund may
incur higher costs (including swap financing costs) in order to
achieve its investment objective and may be forced to purchase and
sell securities (including other ETFs’ shares) at market
prices that do not represent their fair value (including in the
case of an ETF, its net asset value) or at times that result in
differences between the price the Fund receives for the security or
the value of the swap exposure and the market closing price of the
security or the market closing value of the swap exposure. Under
those circumstances, the Fund’s ability to track its Index is
likely to be adversely affected, the market price of Fund shares
may reflect a greater premium or discount to net asset value and
bid-ask spreads in the Fund’s shares may widen, resulting in
increased transaction costs for secondary market purchasers and
sellers. The Fund may also incur additional tracking error due to
the use of securities that are not perfectly correlated to the
Index.
Aggressive Investment Techniques Risk: The Fund uses investment techniques that may
result in significant losses.
Derivatives Risk: Derivatives
are financial instruments that derive value from the underlying
reference asset or assets, such as stocks, bonds, or funds
(including ETFs), interest rates or indexes. The Fund’s
investments in derivatives may pose risks in addition to, and
greater than, those associated with directly investing in
securities or other ordinary investments, including risk related to
the market, leverage, imperfect daily correlations with underlying
investments or the Fund’s other portfolio holdings, higher
price volatility, lack of availability, counterparty risk,
liquidity, valuation and legal restrictions. The use of
derivatives is a highly specialized activity that involves
investment techniques and risks different from those associated
with ordinary portfolio securities transactions. The use of
derivatives may result in larger losses or smaller gains than
directly investing in securities. When the Fund uses derivatives,
there may be imperfect correlation between the value of the
reference assets and the derivative, which may prevent the Fund
from achieving its investment objective. Because derivatives often
require only a limited initial investment, the use of derivatives
may expose the Fund to losses in excess of those amounts initially
invested.
The Fund may use a combination of swaps on the Index and swaps
on an ETF whose investment objective is to track the performance of
the same, or a substantially similar index to achieve its
investment objective. The reference ETF may not closely track the
performance of the Index due to fees and other costs borne by the
ETF and other factors, such as an ETF’s premium or discount.
Thus, to the extent that the Fund invests in swaps that use an ETF
as a reference asset, the Fund may be subject to greater
correlation risk and may not achieve as high a degree of
correlation with the Index as it would if the Fund used swaps that
utilized the Index as the reference asset. Any financing, borrowing
or other costs associated with using derivatives may also reduce
the Fund’s return.
In addition, the Fund’s investments in derivatives are
subject to the following risks:
Swap
Agreements:. Swap
agreements are entered into primarily with major global financial
institutions for a specified period, which may range from one day
to more than one year. The derivative transactions in which the
Fund invests are generally traded in the over-the-counter market,
which generally has less transparency than exchange-traded
derivatives instruments. In a standard swap transaction, two
parties agree to exchange the return (or differentials in rates of
return) earned or realized on particular predetermined reference
assets or underlying securities or instruments. The gross return to
be exchanged or swapped between the parties is calculated based on
a notional amount or the return on or change in value of a
particular dollar amount invested in a basket of securities
representing a particular index or an ETF that seeks to track an
index.
If
the Index has a dramatic move that causes a material decline
in the Fund’s net assets, the terms of a swap agreement
between the Fund and its counterparty may permit the counterparty
to immediately close out the swap transaction with the Fund. In
that event, the Fund may be unable to enter into another swap
agreement or invest in other derivatives to achieve exposure
consistent with the Fund’s investment objective. This may
prevent the Fund from achieving its leveraged investment objective,
even if the Index later reverses all or a portion of its
movement.
Counterparty Risk: A
counterparty may be unwilling or unable to make timely payments to
meet its contractual obligations or may fail to return holdings
that are subject to the agreement with the counterparty. If the
counterparty or its affiliate becomes insolvent, bankrupt or
defaults on its payment obligations to the Fund, the value of an
investment held by the Fund may decline. Additionally, if any
collateral posted by the counterparty for the benefit of the Fund
is insufficient or there are delays in the Fund’s ability to
access such collateral, the Fund may not be able to achieve its
leveraged investment objective. In addition, the Fund may enter
into swap agreements with a limited number of counterparties,
which may increase the Fund’s exposure to counterparty credit
risk. Further, there is a risk that no suitable counterparties will
be willing to enter into, or continue to enter into, transactions
with the Fund and, as a result, the Fund may not be able to achieve
its leveraged investment objective or may decide to change its
leveraged investment objective.
Intra-Day Investment Risk: The
Fund seeks leveraged investment results from the close of the
market on a given trading day until the close of the market on the
subsequent trading day. The exact exposure of an investment in the
Fund intraday in the secondary market is a function of the
difference between the value of the Index at the market close on
the first trading day and the value of the Index at the time of
purchase. If the Index gains value, the Fund’s net assets
will rise by the same amount as the Fund’s exposure.
Conversely, if the Index declines, the Fund’s net assets will
decline by the same amount as the Fund’s exposure. Thus, an
investor that purchases shares intra-day may experience performance
that is greater than, or less than, the Fund’s stated
multiple of the Index.
If there is a significant intra-day market event and/or
the securities of the Index experience a significant decrease,
the Fund may not meet its investment objective or rebalance its
portfolio appropriately. Additionally, the Fund may close to
purchases and sales of Shares prior to the close of regular trading
on the NYSE Arca, Inc. and incur significant losses.
Daily Index Correlation/Tracking Risk: There is no guarantee that the Fund will achieve a
high degree of correlation to the Index and therefore achieve its
daily leveraged investment objective. To achieve a high degree
of correlation with the Index, the Fund seeks to rebalance its
portfolio daily to keep leverage consistent with its daily
leveraged investment objective. In addition, the Fund’s
exposure to the Index is impacted by the Index’s movement.
Because of this, it is unlikely that the Fund will be perfectly
exposed to the Index at the end of each day. The possibility of the
Fund being materially over- or under-exposed to the Index increases
on days when the Index is volatile near the close of the trading
day. Market disruptions, regulatory restrictions and extreme
volatility will also adversely affect the Fund’s ability to
adjust exposure to the required levels.
The Fund may have difficulty achieving its daily
leveraged investment objective due to fees, expenses,
transaction costs, financing costs related to the use of
derivatives, investments in ETFs, directly or indirectly, income
items, valuation methodology, accounting standards and disruptions
or illiquidity in the markets for the securities or derivatives
held by the Fund. The Fund may be subject to large movements of
assets into and out of the Fund, potentially resulting in the Fund
being over- or under-exposed to the Index. Activities surrounding
periodic Index reconstitutions and other Index rebalancing events
may hinder the Fund’s ability to meet its daily leveraged
investment objective. The Fund may take or refrain from taking
positions to improve the tax efficiency or to comply with various
regulatory restrictions, either of which may negatively impact the
Fund’s correlation to the Index.
The remaining principal risks are presented in alphabetical order.
Each risk summarized below is considered a “principal
risk” of investing in the Fund, regardless of the order in
which it appears.
Associated Risks of Investments in SPACs: The Fund
invests in equity securities of SPACs, which raise assets to seek
potential acquisition opportunities. Unless and until an
acquisition is completed, a SPAC generally invests its assets in
U.S. government securities, money market securities, and cash.
Because SPACs have no operating history or ongoing business other
than seeking acquisitions, the value of their securities is
particularly dependent on the ability of the entity’s
management to identify and complete a profitable acquisition. There
is no guarantee that the SPACs in which the Fund invests will
complete an acquisition or that any acquisitions that are completed
will be profitable. Public stockholders of SPACs may not be
afforded a meaningful opportunity to vote on a proposed initial
business combination because certain stockholders, including
stockholders affiliated with the management of the SPAC, may have
sufficient voting power, and a financial incentive, to approve such
a transaction without support from public stockholders. As a
result, a SPAC may complete a business combination even though a
majority of its public stockholders do not support such a
combination. Because the SPACs included in the Index will be
designed to pursue acquisitions only within certain industries or
regions, their stock prices may experience greater volatility than
stocks of other SPACs.
Associated Risks of SPAC-Derived Companies: The Fund
invests in companies that are derived from a SPAC. These companies
may be unseasoned and lack a trading history, a track record of
reporting to investors, and widely available research coverage.
SPAC-derived companies are thus often subject to extreme price
volatility and speculative trading. These stocks may have
above-average price appreciation in connection with a potential
business combination with a SPAC prior to inclusion in the Index.
The price of stocks included in the Index may not continue to
appreciate and the performance of these stocks may not replicate
the performance exhibited in the past. In addition, SPAC-derived
companies may share similar illiquidity risks of private equity and
venture capital. The free float shares held by the public in a
SPAC-derived company are typically a small percentage of the market
capitalization. The ownership of many SPAC-derived companies often
includes large holdings by venture capital and private equity
investors who seek to sell their shares in the public market in the
months following a business combination transaction when shares
restricted by lock-up are released, causing greater volatility and
possible downward pressure during the time that locked-up shares
are released.
Concentration Risk: The Fund’s investments will be
concentrated in an industry or group of industries to the extent
that the Index is so concentrated. In such event, the value of the
Fund’s shares may rise and fall more than the value of shares
of a fund that invests in securities of companies in a broader
range of industries.
Consumer Staples Sector Risk: The consumer staples sector
may be affected by the permissibility of using various product
components and production methods, marketing campaigns and other
factors affecting consumer demand. Tobacco companies, in
particular, may be adversely affected by new laws, regulations and
litigation. The consumer staples sector may also be adversely
affected by changes or trends in commodity prices, which may be
influenced or characterized by unpredictable factors.
Early Close/Late Close/Trading Halt Risk: An exchange or market may close early, close
late or issue trading halts on specific securities or
financial instruments. As a result, the ability to trade
certain securities or financial instruments may be restricted,
which may disrupt the Fund’s creation and redemption
process, potentially affect the price at which the
Fund’s shares trade in the secondary market,
and/or result in the Fund being unable to trade certain
securities or financial instruments at all. In these
circumstances, the Fund may be unable to rebalance its
portfolio, may be unable to accurately price its investments
and/or may incur substantial trading losses. If trading in the
Fund’s shares are halted, investors may be temporarily
unable to trade shares of the Fund.
Equity Market Risk: The
equity securities held in the Fund’s portfolio may experience
sudden, unpredictable drops in value or long periods of decline in
value. This may occur because of factors that affect securities
markets generally or factors affecting specific issuers,
industries, or sectors in which the Fund invests such as political,
market and economic developments, as well as events that impact
specific issuers. Additionally, natural or environmental disasters,
widespread disease or other public health issues, war, acts of
terrorism or other events could result in increased premiums or
discounts to the Fund’s NAV.
ETF Risks:
Absence of an Active
Market: Although the Fund’s shares are approved
for listing on the NYSE Arca, Inc. (the “Exchange”),
there can be no assurance that an active trading market will
develop and be maintained for Fund shares. There can be no
assurance that the Fund will grow to or maintain an economically
viable size, in which case the Fund may ultimately
liquidate.
Authorized Participants
(“Aps”), Market Makers, and Liquidity Providers
Concentration Risk: The
Fund has a limited number of financial institutions that may act as
APs. In addition, there may be a limited number of market makers
and/or liquidity providers in the marketplace. To the extent either
of the following events occur, Shares may trade at a material
discount to net asset value ("NAV") and possibly face delisting:
(i) APs exit the business or otherwise become unable to
process creation and/or redemption orders and no other APs step
forward to perform these services, or (ii) market makers
and/or liquidity providers exit the business or significantly
reduce their business activities and no other entities step forward
to perform their functions. The risks associated with limited APs
may be heightened in scenarios where APs have limited or diminished
access to the capital required to post
collateral.
Costs of Buying or Selling
Shares: Investors buying
or selling Fund shares in the secondary market will pay brokerage
commissions or other charges imposed by brokers as determined by
that broker. Brokerage commissions are often a fixed amount and may
be a significant proportional cost for investors seeking to buy or
sell relatively small amounts of shares.
Fluctuation of
NAV: The NAV of Fund
shares will generally fluctuate with changes in the market value of
the Fund's securities holdings. The market prices of shares will
generally fluctuate in accordance with changes in the Fund's NAV
and supply and demand of shares on the Exchange. It cannot be
predicted whether Fund shares will trade below, at or above their
NAV. During periods of unusual volatility or market disruptions,
market prices of Fund shares may deviate significantly from the
market value of the Fund’s securities holdings or the NAV of
Fund shares. As a result, investors in the Fund may pay
significantly more or receive significantly less for Fund shares
than the value of the Fund's underlying securities or the NAV of
Fund shares.
Market Trading
Risk: An investment in the
Fund faces numerous market trading risks, including the potential
lack of an active market for Fund shares, losses from trading in
secondary markets, periods of high volatility and disruption in the
creation/redemption process of the Fund. Any of these factors,
among others, may lead to the Fund's shares trading at a premium or
discount to NAV.
Trading
Issues: Although Fund
shares are listed for trading on the NYSE Arca, Inc. (the
"Exchange"), there can be no assurance that an active trading
market for such shares will develop or be maintained. Trading in
Fund shares may be halted due to market conditions or for reasons
that, in the view of the Exchange, make trading in shares
inadvisable. There can be no assurance that the requirements of the
Exchange necessary to maintain the listing of any Fund will
continue to be met or will remain unchanged or that the shares will
trade with any volume, or at all. Further, secondary markets may be
subject to erratic trading activity, wide bid/ask spreads and
extended trade settlement periods in times of market stress because
market makers and Authorized Participants may step away from making
a market in Fund shares and in executing creation and redemption
orders, which could cause a material deviation in the Fund's market
price from its NAV.
Foreign Investment Risk: Returns on investments in foreign
stocks could be more volatile than, or trail the returns on,
investments in U.S. stocks.
Currency Risk: Indirect and direct
exposure to foreign currencies subjects the Fund to the risk that
currencies will decline in value relative to the U.S. dollar.
Currency rates in foreign countries may fluctuate significantly
over short periods of time for a number of reasons, including
changes in interest rates and the imposition of currency controls
or other political developments in the U.S. or abroad.
Depositary Receipts
Risk: The Fund may invest in depositary
receipts. Investment in ADRs and GDRs may be less liquid than the
underlying shares in their primary trading market and GDRs, many of
which are issued by companies in emerging markets, may be more
volatile and less liquid than depositary receipts issued by
companies in more developed markets.
Foreign Market and Trading
Risk: The trading markets for many foreign securities
are not as active as U.S. markets and may have less governmental
regulation and oversight. Foreign markets also may have clearance
and settlement procedures that make it difficult for the Fund to
buy and sell securities. These factors could result in a loss to
the Fund by causing the Fund to be unable to dispose of an
investment or to miss an attractive investment opportunity, or by
causing Fund assets to be uninvested for some period of
time.
Foreign Securities Risk: The Fund
invests a significant portion of its assets directly in securities
of issuers based outside of the U.S., or in depositary receipts
that represent such securities. Investments in securities of
non-U.S. issuers involve certain risks that may not be present with
investments in securities of U.S. issuers, such as risk of loss due
to foreign currency fluctuations or to political or economic
instability, as well as varying regulatory requirements applicable
to investments in non-U.S. issuers. There may be less information
publicly available about a non-U.S. issuer than a U.S. issuer.
Non-U.S. issuers may also be subject to different regulatory,
accounting, auditing, financial reporting and investor protection
standards than U.S. issuers.
Political and Economic Risk: The
Fund is subject to foreign political and economic risk not
associated with U.S. investments, meaning that political events,
social and economic events and natural disasters occurring in a
country where the Fund invests could cause the Fund’s
investments in that country to experience gains or losses. The Fund
also could be unable to enforce its ownership rights or pursue
legal remedies in countries where it invests.
Health Care Companies Risk: Health care companies are
subject to extensive government regulation and their profitability
can be significantly affected by restrictions on government
reimbursement for medical expenses, rising costs of medical
products and services, pricing pressure (including price
discounting), limited product lines, and an increased emphasis on
the delivery of healthcare through outpatient services. Health care
companies are heavily dependent on obtaining and defending patents,
which may be time consuming and costly, and the expiration of
patents may also adversely affect the profitability of the
companies. Health care companies are also subject to extensive
litigation based on product liability and similar claims. In
addition, their products can become obsolete due to industry
innovation, changes in technologies, or other market developments.
Many new products in the health care field require significant
research and development and may be subject to regulatory
approvals, all of which may be time consuming and costly with no
guarantee that any product will come to market.
Biotechnology Company
Risk: A biotechnology company’s valuation
can often be based largely on the potential or actual performance
of a limited number of products and can accordingly be greatly
affected if one of its products proves, among other things, unsafe,
ineffective or unprofitable. Biotechnology companies are subject to
regulation by, and the restrictions of, the FDA, the U.S.
Environmental Protection Agency, state and local governments, and
foreign regulatory authorities.
Pharmaceutical Company
Risk: Companies in the pharmaceutical industry
can be significantly affected by, among other things, government
approval of products and services, government regulation and
reimbursement rates, product liability claims, patent expirations
and protection and intense competition.
Liquidity Risk: In
certain circumstances, such as the disruption of the orderly markets for the financial
instruments in which the Fund invests, the Fund might not be able
to acquire or dispose of certain holdings quickly or at prices that
represent true market value in the judgment of the Adviser. Markets
for the financial instruments in which the Fund invests may be
disrupted by a number of events, including but not limited to
economic crises, health crises, natural disasters, excessive
volatility, new legislation, or regulatory changes inside or
outside of the U.S. For example, regulation limiting the ability of
certain financial institutions to invest in certain financial
instruments would likely reduce the liquidity of those instruments.
These situations may prevent the Fund from limiting losses,
realizing gains or achieving a high leveraged
correlation with the Index.
Money Market Instrument Risk: The Fund may use a variety of money market
instruments for cash management purposes, including money market
funds, depositary accounts and repurchase agreements. Money market
funds may be subject to credit risk with respect to the debt
instruments in which they invest. Depository accounts may be
subject to credit risk with respect to the financial institution in
which the depository account is held. Repurchase agreements are
contracts in which a seller of securities agrees to buy the
securities back at a specified time and price. Repurchase
agreements may be subject to market and credit risk related to the
collateral securing the repurchase agreement. Money market
instruments may lose money.
Natural Disaster/Epidemic Risk: Natural or environmental
disasters, such as earthquakes, fires, floods, hurricanes, tsunamis
and other severe weather-related phenomena generally, and
widespread disease, including pandemics and epidemics, have been
and may be highly disruptive to economies and markets, adversely
impacting individual companies, sectors, industries, markets,
currencies, interest and inflation rates, credit ratings, investor
sentiment, and other factors affecting the value of the
Fund’s investments, Given the increasing interdependence
among global economies and markets, conditions in one country,
market, or region are increasingly likely to adversely affect
markets, issues, and/or foreign exchange rates in other countries,
including the U.S. Any such events could have a significant adverse
impact on the value of the Fund’s investments.
New Fund Risk: The Fund is a
recently organized, non-diversified management investment company
with limited operating history. As a result, prospective investors
have a limited track record or history on which to base their
investment decision. There can be no assurance that the Fund will
grow to or maintain an economically viable
size.
Non-Cannabis Related Business Risk: Many of the companies in
the Index are engaged in other lines of business unrelated to the
activities identified in the principal investment strategies,
above, and these lines of business could adversely affect their
operating results. The operating results of these companies may
fluctuate as a result of events in the other lines of business. In
addition, a company’s ability to engage in new activities may
expose it to business risks with which it has less experience than
it has with the business risks associated with its traditional
businesses. There can be no assurance that the other lines of
business in which these companies are engaged will not have an
adverse effect on a company’s business or financial
condition.
Non-Diversification Risk: Because the Fund is
“non-diversified,” it may invest a greater percentage
of its assets in the securities of a single issuer or a small
number of issuers than if it was a diversified fund. As a result, a
decline in the value of an investment in a single issuer or a small
number of issuers could cause the Fund’s overall value to
decline to a greater degree than if the Fund held a more
diversified portfolio. This may increase the Fund’s
volatility and have a greater impact on the Fund’s
performance.
Other Investment Companies (including ETFs) Risk:
The Fund may invest directly in
another investment company by purchasing shares of the investment
company or indirectly by utilizing an investment company as the
reference asset of a derivative instrument. The Fund will
incur higher and duplicative expenses when it invests in other
investment companies such as ETFs (affiliated ETFs will not charge
duplicate fees and expenses). There is also the risk that the Fund
may suffer losses due to the investment practices of the
underlying funds. If the other
investment company fails to achieve its investment objective, the
value of the Fund’s investment will not perform as expected,
thus affecting the Fund’s performance and its correlation
with the Index. When the Fund invests in other investment
companies, the Fund will be subject to substantially the same risks
as those associated with the direct ownership of securities held by
such investment companies. Investments in ETFs are also subject to
the following risks: (i) the market price of an ETF’s shares
may trade above or below their net asset value; (ii) an active
trading market for an ETF’s shares may not develop or be
maintained; and (iii) trading of an ETF’s shares may be
halted for a number of reasons. Investments in such shares may be
subject to brokerage and other trading costs, which could result in
greater expenses to the Fund. Finally, depending on the demand in
the market, the Fund may not be able to liquidate its holdings in
ETFs at an optimal price or time, which may adversely affect the
Fund’s performance.
Portfolio Turnover Risk: The
Fund may incur high portfolio turnover to manage the Fund’s
investment exposure. Additionally, active market trading of the Fund’s shares
may cause more frequent creation or redemption activities that
could, in certain circumstances, increase the number of portfolio
transactions. High levels of portfolio transactions increase
brokerage and other transaction costs and may result in increased
taxable capital gains. Each of these factors could have a negative impact on the performance of
the Fund.
Risks Related to Investing in Canada: Because the
investments of the Fund are geographically concentrated in Canadian
companies or companies that have a significant presence in Canada,
investment results could be dependent on the financial condition of
the Canadian economy. The Canadian economy is reliant on the sale
of natural resources and commodities, which can pose risks such as
the fluctuation of prices and the variability of demand for
exportation of such products. Changes in spending on Canadian
products by the economies of other countries or changes in any of
these economies may cause a significant impact on the Canadian
economy. In particular, the Canadian economy is heavily dependent
on relationships with certain key trading partners, including the
United States and China.
Sector Risk: To the extent the Fund invests more heavily in
particular sectors of the economy, its performance will be
especially sensitive to developments that significantly affect
those sectors.
Securities Lending Risk: The Fund may engage in
securities lending. The Fund may lose money if the borrower of the
loaned securities delays returning in a timely manner or fails to
return the loaned securities. Securities lending involves the risk
that the Fund could lose money in the event of a decline in the
value of collateral provided for loaned securities. In addition,
the Fund bears the risk of loss in connection with its investment
of the cash collateral it receives from a borrower. To the extent
that the value or return of the Fund's investment of the cash
collateral declines below the amount owed to the borrower, the Fund
may incur losses that exceed the amount it earned on lending the
security.
Smaller Companies Risk: The Fund’s Index may be
composed primarily of, or have significant exposure to, securities
of smaller companies. If it does so, it may be subject to certain
risks associated with smaller companies. Smaller companies may be
more vulnerable to adverse business or economic events than larger,
more established companies, and may underperform other segments of
the market or the equity market as a whole. The securities of
smaller companies also tend to be bought and sold less frequently
and at significantly lower trading volumes than the securities of
larger companies. As a result, it may be more difficult for the
Fund to buy or sell a significant amount of the securities of a
smaller company without an adverse impact on the price of the
company’s securities, or the Fund may have to sell such
securities in smaller quantities over a longer period of time,
which may prevent the Fund from
achieving its investment objective.
Tax Risk: To qualify for the favorable tax treatment
generally available to regulated investment companies, the Fund
must satisfy certain diversification requirements under the
Internal Revenue Code of 1986, as amended (the “Code”).
In particular, the Fund generally may not acquire a security if, as
a result of the acquisition, more than 50% of the value of the
Fund’s assets would be invested in (a) issuers in which the
Fund has, in each case, invested more than 5% of the Fund’s
assets and (b) issuers more than 10% of whose outstanding voting
securities are owned by the Fund. When the Index is concentrated in
a relatively small number of securities, it may not be possible for
the Fund to fully implement a replication strategy or a
representative sampling strategy while satisfying these
diversification requirements. The Fund’s efforts to satisfy
the diversification requirements may cause the Fund’s return
to deviate from that of the Index, and the Fund’s efforts to
replicate the Index may cause it inadvertently to fail to satisfy
the diversification requirements. If the Fund were to fail to
qualify as a regulated investment company, it would be taxed in the
same manner as an ordinary corporation, and distributions to its
shareholders would not be deductible by the Fund in computing its
taxable income.
Valuation Risk: The sales price that the Fund could
receive for a security may differ from the Fund’s valuation
of the security and may differ from the value used by the Index,
particularly for securities that trade in low volume or volatile
markets or that are valued using a fair value methodology. In
addition, the value of the securities in the Fund’s portfolio
may change on days when shareholders will not be able to purchase
or sell the Fund’s shares.
Principal Investment Strategies
The Adviser uses a number of investment techniques in an effort to
achieve the stated investment objective for the Fund. The Fund
seeks two times (2x) the return of the Index on a given day. The
Adviser attempts to provide two times the returns of the Index for
a one-day period. To do this, the Adviser creates net
“long” positions for the Fund. The Adviser may create
short positions in the Fund even though the net exposure in the
Fund will be long. Long positions move in the same direction as the
Index, advancing when the Index advances and declining when the
Index declines.
In seeking to achieve the Fund’s investment objective, the
Adviser uses statistical and quantitative analysis to determine the
investments the Fund makes and the techniques it employs. The
Adviser relies upon a pre-determined model to generate orders that
result in repositioning the Fund’s investments in accordance
with its daily leveraged investment objective. Using this approach,
the Adviser determines the type, quantity and mix of investment
positions that it believes in combination should produce daily
returns consistent with the Fund’s investment objective. In
general, if the Fund is performing as designed, the return of the
Index will dictate the return for the Fund. The Adviser does not
invest the assets of the Fund in securities, derivatives or other
investments based on the Adviser’s view of the investment
merit of a particular security, instrument or company, nor does it
conduct conventional investment research or analysis or forecast
market movements or trends. The Fund generally pursues its
investment objective regardless of the market conditions and does
not take defensive positions.
The Fund has a clearly articulated daily leveraged investment
objective which requires the Fund to seek economic exposure in
excess of its net assets (i.e., economic leverage). To meet its objectives, the
Fund invests in some combination of financial instruments so that
it generates economic exposure consistent with the Fund’s
investment objective.
The Fund offered in this Prospectus may invest significantly in:
swap agreements, ETFs; and other financial instruments to obtain
economic “leverage.” Leveraging allows the Adviser to
generate a greater positive or negative return for the Fund than
what would be generated on the invested capital without leverage,
thus changing small market movements into larger changes in
the value of the investments of the Fund.
The Fund generally may hold a representative sample of the
securities in the Index. The sampling of securities that is
held by the Fund is intended to maintain high correlation
with, and similar aggregate characteristics (e.g., market capitalization and industry weightings)
to, the Index. The Fund also may invest in securities that are not
included in the Index or may overweight or underweight certain
components of the Index. Certain assets may be concentrated in an
industry or group of industries to the extent that the Index
concentrates in a particular industry or group of industries. In
addition, the Fund offered in this Prospectus is non-diversified,
which means that it may invest in the securities of a limited
number of issuers.
At the close of the markets each trading day, the Fund will
position its portfolio to ensure that the Fund’s exposure to
the Index is consistent with the Fund’s stated investment
objective. The impact of market movements during the day determines
whether a portfolio needs to be repositioned. If the Index has
risen on a given day, the Fund’s net assets should rise,
meaning its exposure will typically need to be increased.
Conversely, if the Index has fallen on a given day, the
Fund’s net assets should fall, meaning its exposure will
typically need to be reduced. The Fund’s portfolio may also
need to be changed to reflect changes in the composition of the
Index.
The Fund may have difficulty in achieving its daily leveraged
investment objective due to fees, expenses, transaction
costs, income items, accounting standards, significant
purchase and redemption activity by Fund shareholders and/or
disruptions or a temporary lack of liquidity in the markets for the
securities held by the Fund. Additionally, if the Index includes
foreign securities or tracks a foreign market index where the
foreign market closes before or after the New York Stock Exchange
(“NYSE”) closes (generally at 4 p.m. Eastern Time), the
performance of the Index may differ from the expected daily
leveraged performance. As such, correlation to the Index may be
measured by comparing the daily change in the Fund’s NAV per
share to the performance of one or more U.S. ETFs that tracks the
same underlying index (such as the ETFMG Alternative Harvest
ETF).
An exchange or market may close or issue trading halts on specific
securities, or the ability to buy or sell certain securities or
financial instruments may be restricted, which may result in the
Fund being unable to buy or sell certain securities or financial
instruments. In such circumstances, the Fund may be unable to
rebalance its portfolio, may be unable to accurately price its
investments and/or may incur substantial trading
losses.
If the Fund is unable to obtain sufficient leveraged exposure to
the Index due to the limited availability of necessary investments
or financial instruments, the Fund could, among other things, limit
or suspend creation units until the Adviser determines that the
requisite exposure to the Index is obtainable. During the period
that creation units are suspended, the Fund could trade at a
significant premium or discount to its NAV and could experience
substantial redemptions.
A Cautionary Note to Investors Regarding Dramatic Index
Movement
The Fund seeks daily exposure to the Index equal to 200% of its net
assets. As a consequence, the Fund could lose an amount greater
than its net assets in the event of a decline in the value of the
Index in excess of 50% of the value of the Index. The Adviser will
attempt to position the Fund’s portfolio to ensure that the
Fund does not gain or lose more than 90% of its NAV on a given day.
If the Adviser successfully positions the Fund’s portfolio to
provide such limits, the Fund’s portfolio and NAV will not be
responsive to movements in the Index beyond 45% in a given day,
whether that movement is favorable or adverse to the Fund. For
example, if the Index were to gain 55%, the Fund would be limited
to a daily gain of 90%, which corresponds to two times the Index
gain of 45%, rather than 110%, which is two times the Index gain of
55%. It may not be possible to limit the Fund’s losses, and
shareholders should not expect such protection. The risk of total
loss exists.
If the Index has a dramatic adverse move that causes a material
decline in the Fund’s net assets, the terms of the
Fund’s swap agreements may permit the counterparty to
immediately close out the swap transaction. In that event, the Fund
may be unable to enter into another swap agreement or invest in
other derivatives to achieve exposure consistent with the
Fund’s investment objective. This may prevent the Fund from
achieving its leveraged or inverse leveraged investment objective,
even if the Index later reverses all or a portion the
move.
Understanding the Risks and Long-Term Performance of Daily
Objective Funds – the Impact of Compounding
The Fund is designed to provide leveraged (2x) results on a daily
basis. The Fund, however, is unlikely to provide a simple multiple
(i.e., 2x) of an index’s performance over periods longer than
a single day.
●
Why? The hypothetical example below illustrates how
daily leveraged fund returns can behave for periods longer than a
single day.
Take
a hypothetical fund XYZ that seeks to achieve twice the daily
performance of index XYZ. On each day, fund XYZ performs in line
with its objective (2x the index’s daily performance before
fees and expenses). Notice that over the entire five-day period,
the fund’s total return is considerably less than two times
that of the period return of the index. For the five-day period,
index XYZ gained 5.1% while fund XYZ gained 9.9% (versus 2 x 5.1%
or 10.2%). In other scenarios, the return of a daily rebalanced
fund could be greater than three times the index’s
return.
|
Index XYZ
|
Fund XYZ
|
|
Level
|
Daily
Performance
|
Daily
Performance
|
Net Asset
Value
|
Start
|
100.0
|
|
|
$100.00
|
Day 1
|
103.0
|
3.0%
|
6.0%
|
$106.00
|
Day 2
|
99.9
|
-3.0%
|
-6.0%
|
$99.62
|
Day 3
|
103.9
|
4.0%
|
8.0%
|
$107.60
|
Day 4
|
101.3
|
-2.5%
|
-5.0%
|
$102.21
|
Day 5
|
105.1
|
3.8%
|
7.5%
|
$109.88
|
Total Return
|
|
5.1%
|
9.9%
|
|
●
Why does this happen?
This effect is caused by compounding,
which exists in all investments, but has a more significant impact
on a daily leveraged fund. The return of a daily leveraged fund for
a period longer than a single day is the result of its return for
each day compounded over the period and usually will differ in
amount, and possibly even direction, from the daily leveraged
fund’s stated multiple times the return of the daily
leveraged fund’s index for the same period. In general,
during periods of higher index volatility, compounding will cause
longer term results to be less than the multiple of the return of
the index. This effect becomes more pronounced as volatility
increases. Conversely, in periods of lower index volatility, fund
returns over longer periods can be higher than the multiple of
the return of the index. Actual results for a particular period,
before fees and expenses, are also dependent on the following
factors: a) the index’s volatility; b) the index’s
performance; c) period of time; d) financing rates associated with
derivatives; e) other fund expenses; and f) dividends or interest
paid with respect to the securities in the index. The examples
herein illustrate the impact of two principal factors — index
volatility and index performance — on fund
performance.
The
graphs that follow illustrate this point. Each of the graphs shows
a simulated hypothetical one year performance of an index compared
with the performance of a fund that perfectly achieves its
investment objective. The graphs demonstrate that, for periods
longer than a single day, a daily leveraged fund is likely to
underperform or overperform (but not match) the index performance
times the stated multiple in the fund’s investment objective.
Investors should understand the consequences of holding daily
rebalanced funds for periods longer than a single day, including
the impact of compounding on fund performance. Investors should
actively manage and monitor their investments, as frequently as
daily. A one-year period is used for illustrative purposes only.
Deviations from the index return times the fund multiple can occur
over periods as short as a single day (as measured from one
day’s NAV to the next day’s NAV) and may also occur in
periods shorter than a single day (when measured intraday as
opposed to NAV to NAV). An investor in a daily leveraged fund could
potentially lose the full principal value of his/her investment
within a single day.
To isolate the impact of leverage, these graphs
assume: a) no dividends paid with respect to securities in the
index; b) no fund expenses; and c) borrowing/lending rates (to
obtain required leverage) of zero percent. If these were reflected,
the fund’s performance would be different than that shown.
Each of the graphs also assumes a volatility rate of [ ]%, which is
the approximate average of the five-year historical volatility rate
of the Prime Alternative Harvest Index. An index’s volatility rate is a
statistical measure of the magnitude of fluctuations in the returns
of an index.
One-Year Simulation; Index Return 0%
(Annualized Index Volatility [ ]%)
[to be inserted by amendment]
The
graph above shows a scenario where the index, which exhibits
day-to-day volatility, is flat or trendless over the year (i.e.,
begins and ends the year at 0%), but the 2x Fund is
down.
One-Year Simulation; Index Return [ ]%
(Annualized Index Volatility [ ]%)
[to be inserted by amendment]
The
graph above shows a scenario where the index, which exhibits
day-to-day volatility, is up over the year, but the 2x Fund is up
less than two times the index.
One-Year Simulation; Index Return –[ ]%
(Annualized Index Volatility [ ]%)
[to be inserted by amendment]
The
graph above shows a scenario where the index, which exhibits
day-to-day volatility, is down over the year, the 2x Fund is down
more than two times the Index.
●
What it means to
you. Daily leveraged
funds, if used properly and in conjunction with the
investor’s view on the future direction and volatility of the
markets, can be useful tools for knowledgeable investors who want
to manage their exposure to various markets and market segments.
Investors should understand the consequences of seeking daily
investment results, before fees and expenses, that correspond to
the performance of a daily benchmark such as the multiple (i.e.,
2x) of the daily performance of an index for a single day, not for
any other period, including the impact of compounding on fund
performance. Investors should monitor and/or periodically rebalance
their portfolios (which will possibly trigger transaction
costs and tax consequences), as frequently as daily. Investors
considering these funds should understand that they are designed to
provide a positive or negative multiple of an index for a single
day, not for any other period.
Additionally,
investors should recognize that the degree of volatility of a
fund’s index can have a dramatic effect on a fund’s
longer-term performance. The more volatile an index is, the more a
fund’s longer-term performance will negatively deviate from a
simple multiple (e.g., 2x) of its index’s longer-term return.
The return of the fund for a period longer than a single day is the
result of its return for each day compounded over the period and
usually will differ in amount, and possibly even direction, from
the fund’s stated multiple times the return of the
fund’s index for the same period. For periods longer than a
single day, the fund will lose money if its index’s
performance is flat over time, and it is possible that the fund
will lose money over time regardless of the performance of its
index, as a result of daily rebalancing, the index’s
volatility, compounding and other factors. An investor in the fund
could potentially lose the full principal value of his/her
investment within a single day.
Additional Risk Information
You may lose the full principal value of your investment within a
single day.
The principal risks described below are intended to
provide information about the factors likely to have a
significant adverse impact on the Fund’s returns and
consequently the value of an investment in the
Fund.
Effects of Compounding and Market Volatility Risk:
The Fund has a daily leveraged
investment objective and the Fund’s performance for
periods greater than a trading day which is defined as the period
from the end of the last business day of one calendar month through
the close of trading on the last business day of the following
calendar month will be the result of each day's returns compounded
over the period, which is very likely to differ from Index’s
performance times the stated multiple in the Fund’s
investment objective, before fees and expenses. Compounding affects
all investments, but has a more significant impact on leveraged
funds and funds that rebalance monthly.
Over time, the cumulative percentage increase or decrease in
the value of the Fund’s portfolio may diverge significantly
from the cumulative percentage increase or decrease in two times
(2x) the return of the Index due to the compounding effect of
losses and gains on the returns of the Fund. It also is expected
that the Fund’s use of leverage will cause the Fund to
underperform the return of two times (2x) the Index in a trendless
or flat market.
The chart below provides examples of how index
volatility could affect the Fund’s performance. An
index’s volatility rate is a statistical measure of the
magnitude of fluctuations in the returns of the index. Fund
performance for periods greater than one single day can be
estimated given any set of assumptions for the following factors:
a) index volatility; b) index performance; c) period of time; d)
financing rates associated with leveraged exposure; e) other Fund
expenses; and f) dividends or interest paid with respect to
securities in the Index. The chart below illustrates the impact of
two principal factors – index volatility and index
performance – on Fund performance. The chart shows
estimated Fund returns for a number of combinations of index
volatility and index performance over a one-year period.
Performance shown in the chart assumes that: (i) no dividends were
paid with respect to the securities included in the Index; (ii)
there were no Fund expenses; and (iii) borrowing/lending rates (to
obtain leveraged exposure) of 0%. If Fund expenses and/or actual
borrowing/lending rates were reflected, the estimated returns would
be worse than those shown. Particularly during periods of higher
Index volatility, compounding will cause results for periods longer
than a full calendar month which is defined as the period from the
end of the last business day of one calendar month through the
close of trading on the last business day of the following calendar
month to vary from two times (2x) the performance of the
Index.
As shown below, the Fund would be expected to lose 6.1% if the
Index provided no return over a one year period during which the
Index experienced annualized volatility of 25%.
If the Index’s annualized volatility were to rise to 75%,
the hypothetical loss for a one-year period for the Fund
widens to approximately 43%.
At higher ranges of volatility, there is a chance of a
significant loss of value in the Fund. For instance, if the
Index’s annualized volatility is 100%, the Fund would be
expected to lose approximately 63.2% of its value, even if the
cumulative return of the Index for the year was 0%. The volatility
of ETFs or instruments that reflect the value of the Index, such as
swaps, may differ from the volatility of the
Index.
One Year Index
|
Two Times (2x) One Year Index
|
Volatility Rate
|
Return
|
Return
|
10%
|
25%
|
50%
|
75%
|
100%
|
-60%
|
-120%
|
-84.2%
|
-85.0%
|
-87.5%
|
-90.9%
|
-94.1%
|
-50%
|
-100%
|
-75.2%
|
-76.5%
|
-80.5%
|
-85.8%
|
-90.8%
|
-40%
|
-80%
|
-64.4%
|
-66.2%
|
-72.0%
|
-79.5%
|
-86.8%
|
-30%
|
-60%
|
-51.5%
|
-54.0%
|
-61.8%
|
-72.1%
|
-82.0%
|
-20%
|
-40%
|
-36.6%
|
-39.9%
|
-50.2%
|
-63.5%
|
-76.5%
|
-10%
|
-20%
|
-19.8%
|
-23.9%
|
-36.9%
|
-53.8%
|
-70.2%
|
0%
|
0%
|
-1.0%
|
-6.1%
|
-22.1%
|
-43.0%
|
-63.2%
|
10%
|
20%
|
19.8%
|
13.7%
|
-5.8%
|
-31.1%
|
-55.5%
|
20%
|
40%
|
42.6%
|
35.3%
|
12.1%
|
-18.0%
|
-47.0%
|
30%
|
60%
|
67.3%
|
58.8%
|
31.6%
|
-3.7%
|
-37.8%
|
40%
|
80%
|
94.0%
|
84.1%
|
52.6%
|
11.7%
|
-27.9%
|
50%
|
100%
|
122.8%
|
111.4%
|
75.2%
|
28.2%
|
-17.2%
|
60%
|
120%
|
153.5%
|
140.5%
|
99.4%
|
45.9%
|
-5.8%
|
Holding an unmanaged position opens the investor to the risk
of market volatility adversely affecting the performance of the
investment. The Fund is not appropriate for investors who do not
intend to actively monitor and manage their portfolios. The table
is intended to underscore the fact that the Fund is designed as a
short-term trading vehicle for investors who intend to actively
monitor and manage their portfolios.
Leverage Risk: To achieve its
daily investment objective, the Fund employs leverage and is
exposed to the risk that adverse daily performance of the Index
will be magnified. This means that, if the Index experiences an
adverse daily performance, an investment in the Fund will be
reduced by an amount equal to 2% for every 1% of adverse
performance, not including the costs of financing leverage and
other operating expenses, which would further reduce its value. The
Fund could theoretically lose an amount greater than its net
assets if the Index moves more than 50% in a direction adverse to
the Fund (meaning a decline in the value of the Index). Leverage
will also have the effect of magnifying any differences in the
Fund’s correlation with the Index.
United States Regulatory Risks of the Marijuana Industry:
The possession and use of marijuana, even for medical purposes, is
illegal under federal and certain states’ laws, which may
negatively impact the value of the Fund’s investments. Use of
marijuana is regulated by both the federal government and state
governments, and state and federal laws regarding marijuana often
conflict. Marijuana is a Schedule I controlled substance under the
CSA and is illegal under federal law. Currently, over half of the
states plus the District of Columbia have laws and/or regulations
that recognize, in one form or another, legitimate medical uses for
cannabis and consumer use of cannabis in connection with medical
treatment or for non-medical purposes. Even in those states in
which the use of marijuana for medical or non-medical purposes has
been legalized, its sale and use remains a violation of federal
law. Federal law criminalizing the use of marijuana pre-empts state
laws that legalizes its use for medicinal and recreational
purposes. It is not yet known whether the current Administration
will push back against states where marijuana use and possession is
legal and step up the enforcement of federal marijuana laws and the
prosecution of nonviolent federal drug crimes. Congress may fail to
renew the Rohrabacher-Blumenauer amendment, which currently
prohibits the DOJ from using federal funds to prevent states from
implementing laws that authorize medical marijuana use, possession,
distribution, and cultivation. Such actions could produce a
chilling effect on the industry’s growth and discourage banks
from expanding their services to cannabis-related companies. This
conflict between the regulation of marijuana under federal and
state law creates volatility and risk for all cannabis-related
companies. In particular, the stepped up enforcement of marijuana
laws by the federal government would adversely affect the value of
the Fund’s U.S. investments. Certain Cannabis Companies or
Pharmaceutical Companies may never be able to legally produce and
sell products in the United States or other national or local
jurisdictions.
As
noted above, marijuana is a Schedule I controlled substance in the
United States under the CSA. The DEA classifies controlled
substances into five schedules: Schedule I, II, III, IV or V
substances. Schedule I substances by definition have a high
potential for abuse, have no currently “accepted medical
use” in the United States, lack accepted safety for use under
medical supervision, and may not be prescribed, marketed or sold in
the United States. Pharmaceutical products approved by the FDA for
use in the United States may be listed as Schedule II, III, IV or
V, with Schedule II substances considered to present the highest
potential for abuse or dependence and Schedule V substances the
lowest relative risk among such substances.
Few
drug products containing natural cannabis or naturally-derived
cannabis extracts have been approved by the FDA for use in the
United States or obtained DEA registrations for commercial
production. Drug products containing cannabis or cannabis extracts
that receive the required government approvals for use in
commercial production may be subject to significant government
regulation regarding manufacture, importation, exportation,
domestic distribution, storage, sale, and legitimate use. In
addition, the scheduling process may take one or more years,
thereby delaying the launch of the drug product in the United
States.
Cannabis-related
companies in the U.S. that engage in medical or pharmaceutical
research or the production and distribution of controlled
substances such as marijuana must be registered with the DEA to
perform such activities and have the security, control,
recordkeeping, reporting and inventory mechanisms required by the
DEA to prevent drug loss and diversion. Failure to obtain the
necessary registrations or comply with necessary regulatory
requirements may significantly impair the ability of certain
companies in which the Fund invests to pursue medical marijuana
research or to otherwise cultivate, possess or distribute
marijuana.
Additionally,
U.S. Federal tax law prohibits a taxpayer from claiming a deduction
or credit for any amount paid or incurred during the tax year in
carrying on any trade or business if that trade or business (or the
activities that comprise that trade or business) consists of
trafficking in controlled substances (e.g., marijuana) where that
trafficking is prohibited by either federal law or the state law
for the state in which the trade or business is conducted.
Consequently, Cannabis Companies may pay higher amounts of taxes
than non-Cannabis Companies, which could result in less income to
the Fund and, in turn, less for the Fund to distribute to
shareholders.
Non-U.S. Regulatory Risks of the Marijuana Industry: The
companies in which the Fund invests are subject to various laws,
regulations and guidelines relating to the manufacture, management,
transportation, storage and disposal of marijuana, as well as being
subject to laws and regulations relating to health and safety, the
conduct of operations and the protection of the environment. Even
if a company’s operations are permitted under current law,
they may not be permitted in the future, in which case such company
may not be in a position to carry on its operations in its current
locations. Additionally, controlled substance legislation differs
between countries and legislation in certain countries may restrict
or limit the ability of certain companies in which the Fund invests
to sell their products.
Operational Risks of the Marijuana Industry: Companies
involved in the marijuana industry face intense competition, may
have limited access to the services of banks, may have substantial
burdens on company resources due to litigation, complaints or
enforcement actions, and are heavily dependent on receiving
necessary permits and authorizations to engage in medical marijuana
research or to otherwise cultivate, possess or distribute
marijuana. Since the use of marijuana is illegal under United
States federal law, federally regulated banking institutions may be
unwilling to make financial services available to growers and
sellers of marijuana. Additionally, to the extent that the United
States and other countries pass laws that permit the personal
cultivation of marijuana, the markets may shrink for certain
companies in which the Fund invests.
Companies
participating in the marijuana industry may face litigation, formal
or informal complaints, enforcement actions, and inquiries by
various federal, state, or local governmental authorities.
Litigation, complaints, and enforcement actions could consume
considerable amounts of financial and other corporate resources,
which could have a negative impact on sales, revenue,
profitability, and growth prospects. Similarly, certain companies
may not be able to obtain or maintain the necessary licenses,
permits, authorizations, or accreditations, or may only be able to
do so at great cost, to engage in medical marijuana research or to
otherwise cultivate, possess or distribute marijuana. Failure to
comply with or to obtain the necessary licenses, permits,
authorizations, or accreditations could result in restrictions on a
company’s ability to legally engage in medical marijuana
research or to otherwise cultivate, possess or distribute
marijuana, which could have a negative impact on the value of the
Fund’s investments.
United States Regulatory Risks of Hemp: The Agriculture Improvement Act of 2018 (or
the “Farm Bill”) effectively removes hemp from the list
of controlled substances and allows states to regulate its
production, commerce and research with approval from the United
States Department of Agriculture. Certain Index constituents
may sell dietary supplements and/or foods containing CBD within the
United States. The Farm Bill delegates to the FDA responsibility
for regulating products containing hemp or derivatives thereof
(including CBD) under the Federal Food, Drug, and Cosmetic Act (the
“FD&C”). Under the FD&C, if a substance
(such as CBD) is an active ingredient in a drug product that has
been approved by the FDA, then the substance cannot be sold in
dietary supplements or foods without FDA approval, unless the
substance was marketed as a dietary supplement or as a conventional
food before the drug was approved or before the new drug
investigations were authorized. The FDA has publicly taken
the position that CBD cannot be sold in dietary supplements or
foods because CBD is an active ingredient in an FDA-approved
drug. However, companies that sell CBD in dietary supplements
and foods have taken the position that CBD was marketed as a
dietary supplement and/or as a conventional food before the drug
was approved or before the new drug investigations were authorized,
and because the FDA has not brought enforcement action against such
companies, this question of fact has not yet been adjudicated. In
the absence of a conclusive legal determination to the contrary, as
of the date of this prospectus, it has not been determined that the
sale of dietary supplements and/or foods containing CBD within the
United States would cause a company’s securities to be
ineligible for inclusion in the Index. It is possible that such a
legal determination or future federal and/or state laws or
regulations could drastically curtail permissible uses of hemp,
which could have an adverse effect of the value of the Fund’s
investments in companies with business interests in hemp and
hemp-based products.
Market Disruption Risk: Geopolitical and other events, including public
health crises and natural disasters, have recently led to
increased market volatility and significant market losses.
Significant market volatility and market downturns may limit the
Fund’s ability to sell securities and obtain short exposure
to securities, and the Fund’s sales and short exposures may
exacerbate the market volatility and downturn. Under such
circumstances, the Fund may have difficulty achieving its
investment objective for one or more trading days, which may
adversely impact the Fund’s returns on those days and periods
inclusive of those days. Alternatively, the Fund may incur higher
costs (including swap financing costs) in order to achieve its
investment objective and may be forced to purchase and sell
securities (including other ETFs’ shares) at market prices
that do not represent their fair value (including in the case of an
ETF, its NAV) or at times that result in differences between the
price the Fund receives for the security or the value of the swap
exposure and the market closing price of the security or the market
closing value of the swap exposure. Under those circumstances, the
Fund’s ability to track the Index is likely to be adversely
affected, the market price of Fund shares may reflect a greater
premium or discount to NAV and bid-ask spreads in the Fund’s
shares may widen, resulting in increased transaction costs for
secondary market purchasers and sellers. The Fund may also incur
additional tracking error due to the use of securities that are not
perfectly correlated to the Index.
Aggressive Investment Techniques Risk: Using investment techniques that may be
considered aggressive, such as forward contracts, options and
swap agreements, includes the risk of potentially dramatic changes
(losses) in the value of the instruments, imperfect correlations
between the price of the instrument and the underlying security or
index, and volatility of the Fund.
Derivatives Risk: The Fund uses
investment techniques, including investments in derivatives,
such as swaps that may be considered aggressive. The use of
derivatives may result in larger losses or smaller gains than
investing in the underlying securities directly. Investments in
these derivatives may generally be subject to market risks that
cause their prices to fluctuate more than an investment directly in
a security and may increase the volatility of the Fund. The use of
derivatives may expose the Fund to additional risks such as
counterparty risk, liquidity risk and increased daily correlation
risk. When the Fund uses derivatives, there may be imperfect
correlation between the value of the underlying reference assets
and the derivative, which may prevent the Fund from achieving its
investment objective.
The Fund may use swaps on the Index. If the Index has
a dramatic intraday move in value that causes a material
decline in the Fund’s NAV, the terms of the swap agreement
between the Fund and its counterparty may allow the
counterparty to immediately close out of the transaction with
the Fund. In such circumstances, the Fund may be unable to enter
into another swap agreement or invest in other derivatives to
achieve the desired exposure consistent with the Fund’s daily
leveraged investment objective. This may prevent the Fund from
achieving its daily leveraged investment objective particularly if
the Index reverses all or a portion of its intraday move by the end
of the day. The value of an investment in the Fund may change
quickly and without warning. Any financing, borrowing or other
costs associated with using derivatives may also have the effect of
lowering the Fund’s return.
In addition, the Fund’s investments in derivatives are
subject to the following risks:
Swap
Agreements. Swap agreements are
entered into primarily with major global financial institutions for
a specified period which may range from one day to more than one
year. In a standard swap transaction, two parties agree to exchange
the return (or differentials in rates of return) earned or realized
on particular predetermined reference or underlying securities or
instruments. The gross return to be exchanged or swapped between
the parties is calculated based on a notional amount or the return
on or change in value of a particular dollar amount invested in a
reference asset.
Counterparty Risk: Counterparty
risk is the risk that a counterparty is unwilling or unable to
make timely payments to meet its contractual obligations with
respect to the amount the Fund expects to receive from a
counterparty to a financial instrument entered into by the Fund.
The Fund generally enters into derivatives transactions, such as
the swap agreements, with counterparties such that either party can
terminate the contract without penalty prior to the termination
date. The Fund may be negatively impacted if a counterparty becomes
bankrupt or otherwise fails to perform its obligations under such a
contract, or if any collateral posted by the counterparty for the
benefit of the Fund is insufficient or there are delays in the
Fund’s ability to access such collateral. If the counterparty
becomes bankrupt or defaults on its payment obligations to the
Fund, it may experience significant delays in obtaining any
recovery, may obtain only a limited recovery or obtain no recovery
and the value of an investment held by the Fund may
decline.
The Fund typically enters into transactions with
counterparties that present minimal risks based on the
Adviser’s assessment of the counterparty’s
creditworthiness, or its capacity to meet its financial obligations
during the term of the derivative agreement or contract. The
Adviser considers factors such as counterparty credit rating among
other factors when determining whether a counterparty is
creditworthy. The Adviser regularly monitors the creditworthiness
of each counterparty with which the Fund transacts. The Fund
generally enters into swap agreements or other financial
instruments with major, global financial institutions and seeks to
mitigate risks by generally requiring that the counterparties for
the Fund to post collateral, marked to market daily, in an amount
approximately equal to what the counterparty owes the Fund, subject
to certain minimum thresholds. To the extent any such collateral is
insufficient or there are delays in accessing the collateral, the
Fund will be exposed to the risks described above. If a
counterparty’s credit ratings decline, the Fund may be
subject to a bail-in, as described above.
In addition, the Fund may enter into swap agreements with a
limited number of counterparties, which may increase the
Fund’s exposure to counterparty credit risk. The Fund does
not specifically limit its counterparty risk with respect to
any single counterparty. There is a risk that no suitable
counterparties are willing to enter into, or continue to enter
into, transactions with the Fund and, as a result, the Fund may not
be able to achieve its investment objective or may decide to change
its leveraged investment objective. Additionally, although a
counterparty to a centrally cleared swap agreement is often backed
by a futures commission merchant (“FCM”) or a clearing
organization that is further backed by a group of financial
institutions, there may be instances in which a FCM or a clearing
organization would fail to perform its obligations, causing
significant losses to the Fund.
Intra-Day Investment Risk: The
Fund seeks daily leveraged investment results, which should
not be equated with seeking an investment objective for shorter
than a day. Thus, an investor who purchases Fund shares after the
close of the markets on one trading day and before the close of the
markets on the next trading day will likely have more, or less,
than two times (2x) the leveraged investment exposure to the Index,
depending upon the movement of the Index from the end of one
trading day until the time of purchase. If the Index moves in a
direction favorable to the Fund, the investor will receive less
than two times (2x) the exposure to the Index. Conversely, if the
Index moves in a direction adverse to the Fund, the investor will
receive exposure to the Index greater than two times (2x). Thus, an
investor that purchases shares intra-day may experience performance
that is greater than, or less than, the Fund’s stated
multiple of the Index.
If there is a significant intra-day market event and/or
the securities of the Index experience a significant change in
value, the Fund may not meet its investment objective or rebalance
its portfolio appropriately. Additionally, the Fund may close to
purchases and sales of Shares prior to the close of regular trading
on the Exchange and incur significant losses.
Daily Index Correlation/Tracking Risk: For the Fund, there is no guarantee that the Fund
will achieve a high degree of correlation to the Index and
therefore achieve its daily leveraged investment objective. To
achieve a high degree of correlation with the Index, the Fund seeks
to rebalance its portfolio daily to keep leverage consistent with
its daily leveraged investment objective. In addition, the target
amount of portfolio exposure to the Index is impacted dynamically
by the Index’s movement. Because of this, it is unlikely that
the Fund will be perfectly exposed to the Index at the end of each
day. The possibility of the Fund being materially over- or
under-exposed to the Index increases on days when the Index is
volatile near the close of the trading day. Market disruptions,
regulatory restrictions or extreme volatility will also adversely
affect the Fund’s ability to adjust exposure to the required
levels.
Because the Index may include instruments that trade on a
different market than the Fund , the Fund's return may vary from a
multiple of the performance of the underlying index because
different markets may close before the Exchange opens or may not be
open for business on the same calendar days as the Fund.
Additionally, due to differences in trading hours, and because the
underlying index may be calculated using prices obtained at times
other than the Fund’s NAV calculation time, the Fund's
performance may not correlate to the Index.
The Fund may have difficulty achieving its daily
leveraged investment objective due to fees, expenses,
transactions costs, financing costs related to the use of
derivatives, investments in ETFs, directly or indirectly as a
reference asset for derivative instruments, income items, valuation
methodology, accounting standards and disruptions or illiquidity in
the markets for the securities or derivatives held by the Fund. The
Fund may not have investment exposure to all securities in the
Index, or its weighting of investment exposure to such stocks or
industries may be different from that of the Index. In addition,
the Fund may invest in securities or financial instruments not
included in the Index. The Fund may be subject to large movements
of assets into and out of the Fund, potentially resulting in the
Fund being over- or under-exposed to the Index. Activities
surrounding periodic index reconstitutions and other index
rebalancing events may hinder the Fund’s ability to meet its
daily leveraged investment objective. The Fund may take or refrain
from taking positions to improve the tax efficiency or to comply
with various regulatory restrictions, either of which may
negatively impact the Fund’s correlation to the
Index.
The remaining principal risks are presented in alphabetical order.
Each risk summarized below is considered a "principal risk" of
investing in the Fund, regardless of the order in which it
appears.
Associated Risks of Investments in SPACs: The Fund invests in equity securities of SPACs,
which raise assets to seek potential acquisition opportunities.
Unless and until an acquisition is completed, a SPAC generally
invests its assets in U.S. government securities, money market
securities, and cash. If an acquisition that meets the requirements
for the SPAC is not completed within a pre-established period of
time (e.g., two years), the invested funds are returned to the
entity’s shareholders. Because SPACs have no operating
history or ongoing business other than seeking acquisitions, the
value of their securities is particularly dependent on the ability
of the entity’s management to identify and complete a
profitable acquisition. Public stockholders of SPACs may not be
afforded a meaningful opportunity to vote on a proposed initial
business combination because certain stockholders, including
stockholders affiliated with the management of the SPAC, may have
sufficient voting power, and a financial incentive, to approve such
a transaction without support from public stockholders. As a
result, a SPAC may complete a business combination even though a
majority of its public stockholders do not support such a
combination. There is no guarantee that the SPACs in which the Fund
invests will complete an acquisition or that any acquisitions that
are completed will be profitable. Because the SPACs included
in the Index will be designed to pursue acquisitions only within
certain industries or regions, their stock prices may experience
greater volatility than stocks of other SPACs. SPACs may also encounter intense competition from
other entities having a similar business objective, such as private
investors or investment vehicles and other SPACs, competing for the
same acquisition opportunities, which could make completing an
attractive business combination more difficult.
Associated Risks of SPAC-Derived
Companies: The Fund
invests in companies that are derived from a SPAC. These companies
may be unseasoned and lack a trading history, a track record of
reporting to investors, and widely available research coverage.
SPAC-derived companies are thus often subject to extreme price
volatility and speculative trading. These stocks may have
above-average price appreciation in connection with a potential
business combination with a SPAC prior to inclusion in the Index.
The price of stocks included in the Index may not continue to
appreciate and the performance of these stocks may not replicate
the performance exhibited in the past. In addition, SPAC-derived
companies may share similar illiquidity risks of private equity and
venture capital. The free float shares held by the public in a
SPAC-derived company are typically a small percentage of the market
capitalization. The ownership of many SPAC-derived companies often
includes large holdings by venture capital and private equity
investors who seek to sell their shares in the public market in the
months following a business combination transaction when shares
restricted by lock-up are released, causing greater volatility and
possible downward pressure during the time that locked-up shares
are released.
Concentration Risk: The Fund’s investments will be
concentrated in an industry or group of industries to the extent
the Index is so concentrated. To the extent the Fund invests more
heavily in particular industries, groups of industries, or sectors
of the economy, its performance will be especially sensitive to
developments that significantly affect those industries, groups of
industries, or sectors of the economy, and the value of Fund shares
may rise and fall more than the value of shares that invest in
securities of companies in a broader range of industries or
sectors.
Consumer Staples Sector Risk: Companies in the consumer
staples sector may be adversely affected by changes in the global
economy, consumer spending, competition, demographics and consumer
preferences, and production spending. Companies in the consumer
staples sector may also be affected by changes in global economic,
environmental and political events, economic conditions, the
depletion of resources, and government regulation. For instance,
government regulations may affect the permissibility of using
various food additives and production methods of companies that
make food products, which could affect company profitability. In
addition, tobacco companies may be adversely affected by the
adoption of proposed legislation and/or by litigation. Companies in
the consumer staples sector also may be subject to risks pertaining
to the supply of, demand for and prices of raw materials. The
prices of raw materials fluctuate in response to a number of
factors, including, without limitation, changes in government
agricultural support programs, exchange rates, import and export
controls, changes in international agricultural and trading
policies, and seasonal and weather conditions. Companies in the
consumer staples sector may be subject to severe competition, which
may also have an adverse impact on their
profitability.
Early Close/Trading Halt Risk:
An exchange or market may close or issue trading halts
on specific securities, or the ability to buy or sell certain
securities or financial instruments may be restricted, which may
result in the Fund being unable to buy or sell certain securities
or financial instruments. For example, there is a risk that sharp
price declines in securities owned by the Fund may trigger trading
halts, which may result in the Fund’s shares trading at an
increasingly large discount to NAV during part of, or all of, the
trading day. In such circumstances, the Fund may be unable to
rebalance its portfolio, may be unable to accurately price its
investments and/or may incur substantial trading
losses.
Equity Market Risk: An investment in the Fund involves risks
of investing in equity securities, such as market fluctuations
caused by such factors as economic and political developments,
changes in interest rates and perceived trends in securities
prices. The values of equity securities could decline generally or
could underperform other investments. Different types of equity
securities tend to go through cycles of out-performance and
under-performance in comparison to the general securities markets.
In addition, securities may decline in value due to factors
affecting a specific issuer, market or securities markets
generally. Holders of common stocks incur more risk than holders of
preferred stocks and debt obligations because common stockholders,
as owners of the issuer, have generally inferior rights to receive
payments from the issuer in comparison with the rights of creditors
of, or holders of debt obligations or preferred stocks issued by,
the issuer. Additionally, natural or environmental disasters,
widespread disease or other public health issues, war, acts of
terrorism or other events could result in increased premiums or
discounts to the Fund’s NAV.
ETF Risks:
Absence of an Active
Market: Although the Fund’s shares are approved
for listing on the Exchange, there can be no assurance that an
active trading market will develop and be maintained for Fund
shares. There can be no assurance that the Fund will grow to or
maintain an economically viable size, in which case the Fund may
ultimately liquidate.
Authorized Participants,
Market Makers and Liquidity Providers Concentration
Risk: The Fund has a
limited number of financial institutions that may act as Authorized
Participants ("APs"), none of which are obligated to engage in
creation and/or redemption transactions. In addition, there may be
a limited number of market makers and/or liquidity providers in the
marketplace. To the extent either of the following events occur,
there may be a significantly diminished trading market for Fund
shares and shares may trade at a material discount to NAV and
possibly face delisting: (i) APs exit the business or
otherwise become unable to process creation and/or redemption
orders and no other APs step forward to perform these services, or
(ii) market makers and/or liquidity providers exit the
business or significantly reduce their business activities and no
other entities step forward to perform their functions. The risks
associated with limited APs may be heightened in scenarios where
APs have limited or diminished access to the capital required to
post collateral.
Costs of Buying or Selling
Shares: Investors buying
or selling Fund shares in the secondary market will pay brokerage
commissions or other charges imposed by brokers as determined by
that broker. Brokerage commissions are often a fixed amount and may
be a significant proportional cost for investors seeking to buy or
sell relatively small amounts of shares. In addition, secondary
market investors will also incur the cost of the difference between
the price that an investor is willing to pay for shares (the "bid"
price) and the price at which an investor is willing to sell shares
(the "ask" price). This difference in bid and ask prices is often
referred to as the "spread" or "bid/ask spread." The bid/ask spread
varies over time for shares based on trading volume and market
liquidity, and is generally lower if the Fund's shares have more
trading volume and market liquidity and higher if the Fund's shares
have little trading volume and market liquidity. Further, increased
market volatility may cause increased bid/ask spreads. Due to the
costs of buying or selling shares, including bid/ask spreads,
frequent trading of shares may significantly reduce investment
results and an investment in shares may not be advisable for
investors who anticipate regularly making small
investments.
Fluctuation of
NAV: The NAV of Fund
shares will generally fluctuate with changes in the market value of
the Fund's securities holdings. The market prices of shares will
generally fluctuate in accordance with changes in the Fund's NAV
and supply and demand of shares on the Exchange. It cannot be
predicted whether Fund shares will trade below, at or above their
NAV. Price differences may be due, in large part, to the fact that
supply and demand forces at work in the secondary trading market
for shares will be closely related to, but not identical to, the
same forces influencing the prices of the securities of the Index
trading individually or in the aggregate at any point in time. The
market prices of Fund shares may deviate significantly from the NAV
of the shares during periods of market volatility. While the
creation/redemption feature is designed to make it likely that Fund
shares normally will trade close to the Fund's NAV, disruptions to
creations and redemptions may result in trading prices that differ
significantly from the Fund's NAV. As a result, investors in the
Fund may pay significantly more or receive significantly less for
Fund shares than the value of a Fund's underlying securities or the
NAV of Fund shares. If an investor purchases Fund shares at a time
when the market price is at a premium to the NAV of the shares or
sells at a time when the market price is at a discount to the NAV
of the shares, then the investor may sustain
losses.
Market Trading
Risk: An investment in the
Fund faces numerous market trading risks, including the potential
lack of an active market for Fund shares, losses from trading in
secondary markets, periods of high volatility and disruption in the
creation/redemption process of the Fund. Any of these factors,
among others, may lead to the Fund's shares trading at a premium or
discount to NAV.
Trading
Issues: Although Fund
shares are listed for trading on the Exchange, there can be no
assurance that an active trading market for such shares will
develop or be maintained. Trading in Fund shares may be halted due
to market conditions or for reasons that, in the view of the
Exchange, make trading in shares inadvisable. In addition, trading
in shares is subject to trading halts caused by extraordinary
market volatility pursuant to Exchange "circuit breaker" rules,
which temporarily halt trading on the Exchange when a decline in
the S&P 500 Index during a single day reaches certain
thresholds (e.g., 7%., 13%, and 20%). Additional rules applicable
to the Exchange may halt trading in Fund shares when extraordinary
volatility causes sudden, significant swings in the market price of
Fund shares. There can be no assurance that the requirements of the
Exchange necessary to maintain the listing of the Fund will
continue to be met or will remain unchanged or that the shares will
trade with any volume, or at all. In stressed market conditions,
the liquidity of the Fund's shares may begin to mirror the
liquidity of the Fund's underlying portfolio holdings, which can be
significantly less liquid than the Fund's shares, potentially
causing the market price of the Fund's shares to deviate from their
NAV.
Further,
secondary markets may be subject to erratic trading activity, wide
bid/ask spreads and extended trade settlement periods in times of
market stress because market makers and Authorized Participants may
step away from making a market in Fund shares and in executing
creation and redemption orders, which could cause a material
deviation in a Fund's market price from its NAV. Decisions by
market makers or Authorized Participants to reduce their role or
step away from these activities in times of market stress could
inhibit the effectiveness of the arbitrage process in maintaining
the relationship between the underlying value of a Fund's portfolio
securities and the Fund's market price. This reduced effectiveness
could result in Fund shares trading at a price which differs
materially from NAV and also in greater than normal intraday
bid/ask spreads for Fund shares.
Foreign Investment Risk: Returns on investments in foreign
stocks could be more volatile than, or trail the returns on,
investments in U.S. stocks.
Currency Risk. Indirect and direct
exposure to foreign currencies subjects the Fund to the risk that
currencies will decline in value relative to the U.S. dollar.
Currency rates in foreign countries may fluctuate significantly
over short periods of time for a number of reasons, including
changes in interest rates and the imposition of currency controls
or other political developments in the U.S. or abroad. The
Fund’s NAV is determined on the basis of U.S. dollars and,
therefore, the Fund may lose value if the local currency of a
foreign market depreciates against the U.S. dollar, even if the
local currency value of the Fund’s holdings goes
up.
Depositary Receipts Risk. The Fund
may invest in depositary receipts. Depositary receipts include ADRs
and GDRs. ADRs are U.S. dollar-denominated receipts representing
shares of foreign-based corporations. ADRs are issued by U.S. banks
or trust companies, and entitle the holder to all dividends and
capital gains that are paid out on the underlying foreign
shares.
GDRs
are depositary receipts which are similar to ADRs, but are shares
of foreign-based corporations generally issued by international
banks in one or more markets around the world. Investment in ADRs
and GDRs may be less liquid than the underlying shares in their
primary trading market and GDRs, many of which are issued by
companies in emerging markets, may be more volatile and less liquid
than depositary receipts issued by companies in more developed
markets.
Depositary receipts
may be sponsored or unsponsored. Sponsored depositary receipts are
established jointly by a depositary and the underlying issuer,
whereas unsponsored depositary receipts may be established by a
depositary without participation by the underlying issuer. Holders
of an unsponsored depositary receipt generally bear all the costs
associated with establishing the unsponsored depositary receipt. In
addition, the issuers of the securities underlying unsponsored
depositary receipts are not obligated to disclose material
information in the United States and, therefore, there may be less
information available regarding such issuers and there may not be a
correlation between such information and the market value of the
depositary receipts.
Depositary receipts
may be unregistered and unlisted. The Fund’s investments also
may include ADRs and GDRs that are not purchased in the public
markets and are restricted securities that can be offered and sold
only to “qualified institutional buyers” under
Rule 144A of the Securities Act of 1933, as amended. The
Adviser will determine the liquidity of such investments pursuant
to guidelines established by the Board. If a particular investment
in such ADRs or GDRs is deemed illiquid, that investment will be
included within the Fund’s limitation on investment in
illiquid securities. Moreover, if adverse market conditions were to
develop during the period between the Fund’s decision to sell
these types of ADRs or GDRs and the point at which the Fund is
permitted or able to sell such security, the Fund might obtain a
price less favorable than the price that prevailed when it decided
to sell.
Foreign Market and Trading
Risk. The trading markets for many foreign securities
are not as active as U.S. markets and may have less governmental
regulation and oversight. Foreign markets also may have clearance
and settlement procedures that make it difficult for the Fund to
buy and sell securities. These factors could result in a loss to
the Fund by causing the Fund to be unable to dispose of an
investment or to miss an attractive investment opportunity, or by
causing Fund assets to be uninvested for some period of time. Where
all or a part of the Fund’s underlying securities trade in a
market that is closed when the Exchange is open, there may be
changes between the last quotation from its closed foreign market
and the value of such securities during the Fund’s domestic
trading day. This could lead to differences between the market
price of the Fund shares and the value of the Fund’s
underlying securities.
Foreign Securities Risk. The Fund
invests in foreign securities, including non-U.S.
dollar-denominated securities traded outside of the United States
and U.S. dollar-denominated securities of foreign issuers traded in
the United States. Investment in foreign securities may involve
higher costs than investment in U.S. securities, including higher
transaction and custody costs as well as the imposition of
additional taxes by foreign governments. Foreign investments may
also involve risks associated with the level of currency exchange
rates, less complete financial information about the issuers, less
market liquidity, more market volatility and political instability,
as well as varying regulatory requirements applicable to investment
in non-U.S. issuers. Future political and economic developments,
the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of foreign holdings, the
possible establishment of exchange controls or freezes on the
convertibility of currency, or the adoption of other governmental
restrictions might adversely affect an investment in foreign
securities. Additionally, foreign issuers may be subject to less
stringent regulation, and to different accounting, auditing and
recordkeeping requirements.
Political and Economic Risk. The
Fund is subject to foreign political and economic risk not
associated with U.S. investments, meaning that political events
(civil unrest, national elections, changes in political conditions
and foreign relations, imposition of exchange controls and
repatriation restrictions), social and economic events (labor
strikes, rising inflation) and natural disasters occurring in a
country where the Fund invests could cause the Fund’s
investments in that country to experience gains or losses. The Fund
also could be unable to enforce its ownership rights or pursue
legal remedies in countries where it
invests.
Gain Limitation Risk: The Adviser will attempt to position
the Fund’s portfolio to ensure that the Fund does not gain or
lose more than 90% of its NAV on a given day. As a consequence, the
Fund’s portfolio should not be responsive to Index movements
of more than 45% in a given day. For example, for the Fund, if the
Index were to gain 50%, its gains should be limited to a daily gain
of 90% (i.e. two times (2x) 45%) rather than 100% (i.e. two times
(2x) 50%).
Health Care Companies Risk: Health care companies are
subject to extensive government regulation and their profitability
can be significantly affected by restrictions on government
reimbursement for medical expenses, rising costs of medical
products and services, pricing pressure (including price
discounting), limited product lines, and an increased emphasis on
the delivery of healthcare through outpatient services. Health care
companies are heavily dependent on obtaining and defending patents,
which may be time consuming and costly, and the expiration of
patents may also adversely affect the profitability of the
companies. Health care companies are also subject to extensive
litigation based on product liability and similar claims. In
addition, their products can become obsolete due to industry
innovation, changes in technologies, or other market developments.
Many new products in the health care field require significant
research and development and may be subject to regulatory
approvals, all of which may be time consuming and costly with no
guarantee that any product will come to market. Additionally,
liability for products that are later alleged to be harmful or
unsafe may be substantial, and may have a significant impact on a
health care company’s market value and/or share
price.
Biotechnology Company
Risk: A biotechnology company’s valuation
can often be based largely on the potential or actual performance
of a limited number of products and can accordingly be greatly
affected if one of its products proves, among other things, unsafe,
ineffective or unprofitable. Biotechnology companies are subject to
regulation by, and the restrictions of, the FDA, the U.S.
Environmental Protection Agency, state and local governments, and
foreign regulatory authorities.
Pharmaceutical Company
Risk: Companies in the pharmaceutical industry
can be significantly affected by, among other things, government
approval of products and services, government regulation and
reimbursement rates, product liability claims, patent expirations
and protection and intense competition. The process for obtaining
regulatory approval from the FDA or other governmental regulatory
authorities is long and costly and there is no assurance that the
necessary approvals will be obtained or maintained by these
companies.
Additionally,
companies in the pharmaceutical industry may be adversely affected
by government regulation and changes in reimbursement rates from
such third party payors, such as Medicare, Medicaid and other
government sponsored programs, private health insurance plans and
health maintenance organizations. The ability of pharmaceutical
companies to commercialize current and any futures products also
depends in part on the extent reimbursement for the cost of such
products and related treatments are available from these third
party payors. A pharmaceutical company’s valuation may also
be affected if one of its products prove unsafe, ineffective or
unprofitable. The stock prices of companies in this sector have
been and will likely continue to be volatile.
Liquidity Risk: Some securities
held by the Fund, including derivatives, may be difficult to
sell or illiquid, particularly during times of market turmoil.
Markets for securities or financial instruments could be disrupted
by a number of events, including, but not limited to, an economic
crisis, natural disasters, new legislation or regulatory changes
inside or outside the United States. Illiquid securities may be
difficult to value, especially in changing or volatile markets. If
the Fund is forced to sell an illiquid security at an unfavorable
time or price, the Fund may incur a loss. Certain market conditions
may prevent the Fund from limiting losses, realizing gains or
achieving a high correlation with the Index. There is no assurance
that a security that is deemed liquid when purchased will continue
to be liquid.
Market illiquidity may cause losses for the Fund. For
the Fund, to the extent that the Index moves adversely, the
Fund may be one of many market participants that are attempting to
transact in the securities of an underlying index or correlated
instruments. Under such circumstances, the market for investments
of the Index may lack sufficient liquidity for all market
participants' trades. Therefore, the Fund may have more difficulty
transacting in securities of the Index or correlated investments
such as financial instruments and a Fund's transactions could
exacerbate the price change of the securities of the Index.
Additionally, because the Fund is leveraged, a minor adverse change
in the value of the Index should be expected to have a substantial
adverse impact on the Fund.
Money Market Instrument Risk: Money market instruments, including money market
funds, depositary accounts and repurchase agreements may be
used for cash management purposes. Money market funds may be
subject to credit risk with respect to the short-term debt
instruments in which they invest. Depository accounts may be
subject to credit risk with respect to the financial institution in
which the depository account is held. Repurchase agreements are
contracts in which a seller of securities agrees to buy the
securities back at a specified time and price. Repurchase
agreements may be subject to market and credit risk related to the
collateral securing the repurchase agreement. Money market
instruments may also be subject to credit risks associated with the
instruments in which they invest. There is no guarantee that money
market instruments will maintain a stable value, and they may lose
money.
Natural Disaster/Epidemic Risk: Natural or environmental
disasters, such as earthquakes, fires, floods, hurricanes, tsunamis
and other severe weather-related phenomena generally, and
widespread disease, including pandemics and epidemics, have been
and may be highly disruptive to economies and markets, adversely
impacting individual companies, sectors, industries, markets,
currencies, interest and inflation rates, credit ratings, investor
sentiment, and other factors affecting the value of the
Fund’s investments, Given the increasing interdependence
among global economies and markets, conditions in one country,
market, or region are increasingly likely to adversely affect
markets, issues, and/or foreign exchange rates in other countries,
including the U.S. Any such events could have a significant adverse
impact on the value of the Fund’s investments.
New Fund Risk: The Fund is a
recently organized, non-diversified management investment company
with limited operating history. As a result, prospective investors
have a limited track record or history on which to base their
investment decision. There can be no assurance that the Fund will
grow to or maintain an economically viable
size.
Non-Cannabis Related Business Risk: Many of the companies in
the Index are engaged in other lines of business unrelated to the
activities identified in principal investment strategies, above,
and these lines of business could adversely affect their operating
results. The operating results of these companies may fluctuate as
a result of events in the other lines of business. In addition, a
company’s ability to engage in new activities may expose it
to business risks with which it has less experience than it has
with the business risks associated with its traditional businesses.
There can be no assurance that the other lines of business in which
these companies are engaged will not have an adverse effect on a
company’s business or financial condition.
Non-Diversification Risk: Because the Fund is
“non-diversified,” it may invest a greater percentage
of its assets in the securities of a single issuer or a small
number of issuers than if it was a diversified fund. As a result, a
decline in the value of an investment in a single issuer or a small
number of issuers could cause the Fund’s overall value to
decline to a greater degree than if the Fund held a more
diversified portfolio. This may increase the Fund’s
volatility and have a greater impact on the Fund’s
performance.
Other Investment Companies (including ETFs) Risk: The Fund
may invest directly in another investment company by
purchasing shares of the investment company or indirectly by
utilizing an investment company as the reference asset of a
derivative instrument. The Fund will incur higher and duplicative
expenses when it invests in other investment companies such as
ETFs. There is also the risk that the Fund may suffer losses due to
the investment practices of the underlying funds. If the other
investment company fails to achieve its investment objective, the
value of the Fund’s investment will not perform as expected,
thus affecting the Fund’s performance and its correlation
with the Index. When the Fund invests in other investment
companies, the Fund will be subject to substantially the same risks
as those associated with the direct ownership of securities held by
such investment companies. Investments in ETFs are also subject to
the following risks: (i) the market price of an ETF’s shares
may trade above or below their net asset value; (ii) an active
trading market for an ETF’s shares may not develop or be
maintained; and (iii) trading of an ETF’s shares may be
halted for a number of reasons. Investments in such shares may be
subject to brokerage and other trading costs, which could result in
greater expenses to a Fund. Finally, depending on the demand in the
market, the Fund may not be able to liquidate its holdings in ETFs
at an optimal price or time, which may adversely affect the
Fund’s performance.
Portfolio Turnover Risk: Daily
rebalancing of the Fund’s holdings pursuant to its
daily investment objective causes a much greater number of
portfolio transactions when compared to most ETFs. Additionally,
active market trading of the Fund’s shares on such exchanges
as the NYSE Arca, Inc., could cause more frequent creation and
redemption activities which could increase the number of portfolio
transactions. Frequent and active trading may lead to higher
transaction costs because of increased broker commissions resulting
from such transactions. In addition, there is the possibility of
significantly increased short-term capital gains (which will be
taxable to shareholders as ordinary income when distributed to
them). The Fund calculates portfolio turnover without including the
short-term cash instruments or derivative transactions that
comprise the majority of the Fund’s trading. As such, if the
Fund’s extensive use of derivative instruments were
reflected, the calculated portfolio turnover rate would be
significantly higher.
Risks Related to Investing in Canada: Because the
investments of the Fund are geographically concentrated in Canadian
companies or companies that have a significant presence in Canada,
investment results could be dependent on the financial condition of
the Canadian economy. The Canadian economy is reliant on the sale
of natural resources and commodities, which can pose risks such as
the fluctuation of prices and the variability of demand for
exportation of such products. Changes in spending on Canadian
products by the economies of other countries or changes in any of
these economies may cause a significant impact on the Canadian
economy. The United States is Canada’s largest trading and
investment partner, and the Canadian economy is significantly
affected by developments in the U.S. economy. Since the
implementation of North American Free Trade Agreement in 1994 among
Canada, the United States and Mexico, total two-way merchandise
trade between the United States and Canada has more than doubled.
Any downturn in U.S. or Mexican economic activity is likely to have
an adverse impact on the Canadian economy. The Canadian economy is
also dependent upon external trade with other key trading partners,
including China. In addition, Canada is a large supplier of natural
resources (e.g., oil, natural gas and agricultural products). As a
result, the Canadian economy is sensitive to fluctuations in
certain commodity prices.
Sector Risk: To the extent the Fund invests more heavily in
particular sectors of the economy, its performance will be
especially sensitive to developments that significantly affect
those sectors.
Securities Lending Risk: The Fund may engage in
securities lending. The Fund may lose money if the borrower of the
loaned securities delays returning in a timely manner or fails to
return the loaned securities. Securities lending involves the risk
that the Fund could lose money in the event of a decline in the
value of collateral provided for loaned securities. In addition,
the Fund bears the risk of loss in connection with its investment
of the cash collateral it receives from a borrower. When the
Fund invests cash collateral in other investment companies, such
investments of cash collateral will be subject to
substantially the same risks as those associated with the direct
ownership of securities held by such investment companies. To the
extent that the value or return of the Fund’s investment of
the cash collateral declines below the amount owed to the borrower,
the Fund may incur losses that exceed the amount it earned on
lending the security.
Smaller Companies Risk: The Fund’s Index may be
composed primarily of, or have significant exposure to, securities
of smaller companies. As a result, the Fund may be subject to the
risk that securities of smaller companies represented in the Index
may underperform securities of larger companies or the equity
market as a whole. In addition, in comparison to securities of
companies with larger capitalizations, securities of
smaller-capitalization companies may experience more price
volatility, greater spreads between their bid and ask prices, less
frequent trading, significantly lower trading volumes, and cyclical
or static growth prospects. As a result of the differences between
the securities of smaller companies and those of companies with
larger capitalizations, it may be more difficult for the Fund to
buy or sell a significant amount of the securities of a smaller
company without an adverse impact on the price of the
company’s securities, or the Fund may have to sell such
securities in smaller quantities over a longer period of time,
which may prevent the Fund from
achieving its investment objective. Smaller-capitalization
companies often have limited product lines, markets or financial
resources, and may therefore be more vulnerable to adverse
developments than larger capitalization companies. These securities
may or may not pay dividends.
Tax Risk: To qualify for the favorable tax treatment
generally available to regulated investment companies, the Fund
must satisfy certain diversification requirements under the Code.
In particular, the Fund generally may not acquire a security if, as
a result of the acquisition, more than 50% of the value of the
Fund’s assets would be invested in (a) issuers in which the
Fund has, in each case, invested more than 5% of the Fund’s
assets and (b) issuers more than 10% of whose outstanding voting
securities are owned by the Fund. When an Index is concentrated in
a relatively small number of securities, it may not be possible for
the Fund to fully implement a replication strategy or a
representative sampling strategy while satisfying these
diversification requirements. The Fund’s efforts to satisfy
the diversification requirements may cause the Fund’s return
to deviate from that of its Index, and the Fund’s efforts to
replicate its Index may cause it inadvertently to fail to satisfy
the diversification requirements.
If the
Fund were to fail to qualify as a regulated investment company, it
would be taxed in the same manner as an ordinary corporation, and
distributions to its shareholders would not be deductible by the
Fund in computing its taxable income. Distributions to the
Fund’s shareholders would generally be taxed as ordinary
dividends. Under certain circumstances, the Fund may be able to
cure a failure to qualify as a regulated investment company, but in
order to do so the Fund may incur significant Fund-level taxes and
may be forced to dispose of certain assets. 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 were to fail to qualify as a regulated investment company
in any taxable year, the Fund would be required to pay out its
earnings and profits accumulated in that year in order to qualify
for treatment as a regulated investment company in a subsequent
year. If the Fund failed to qualify as a regulated investment
company for a period greater than two taxable years, the Fund would
generally be required to pay the Fund-level tax on any net built-in
gains with respect to certain of its assets upon a disposition of
such assets within five years of qualifying as a regulated
investment company in a subsequent year.
Valuation Risk: The sales price that the Fund could
receive for a security may differ from the Fund’s valuation
of the security and may differ from the value used by the Index,
particularly for securities that trade in low volume or volatile
markets or that are valued using a fair value methodology. In
addition, the value of the securities in the Fund’s portfolio
may change on days when shareholders will not be able to purchase
or sell the Fund’s shares.
Portfolio Holdings
Information
about the Fund’s daily portfolio holdings is available at
www.[ ].com. A summarized description of the Fund’s policies
and procedures with respect to the disclosure of the Fund’s
portfolio holdings is available in the Fund’s Statement of
Additional Information (“SAI”).
STATEMENT OF ADDITIONAL INFORMATION
ETFMG 2X Daily Alternative Harvest Fund
[( )]
Listed
on: [NYSE Arca]
a series of ETF Managers Trust
[ ], 2021
This
Statement of Additional Information (“SAI”) is not a
prospectus and should be read in conjunction with the prospectus
dated [ ], 2021, as may be supplemented from time to time (the
“Prospectus”), of the ETFMG 2X Daily Alternative
Harvest Fund (the “Fund”), a series of ETF Managers
Trust (the “Trust”). Capitalized terms used herein that
are not defined have the same meaning as in the Prospectus, unless
otherwise noted. A copy of the Prospectus may be obtained without
charge, by writing the Fund’s distributor, ETFMG Financial
LLC (the “Distributor”), 30 Maple Street, Summit, New
Jersey 07901, by visiting the Fund’s website at www.etfmj.com
or by calling 1-844-ETFMGRS (383-6477).
GENERAL
INFORMATION ABOUT THE TRUST
|
|
1
|
CONTINUOUS
OFFERING
|
|
1
|
PORTFOLIO
HOLDINGS
|
|
2
|
ADDITIONAL
INFORMATION ABOUT INVESTMENT OBJECTIVES, POLICIES AND RELATED
RISKS
|
|
3
|
DESCRIPTION
OF PERMITTED INVESTMENTS
|
|
3
|
SPECIAL
CONSIDERATIONS AND RISKS
|
|
25
|
INVESTMENT
RESTRICTIONS
|
|
31
|
EXCHANGE
LISTING AND TRADING
|
|
33
|
MANAGEMENT
OF THE TRUST
|
|
33
|
BOARD
COMMITTEES
|
|
38
|
OWNERSHIP
OF SHARES
|
|
39
|
CODES
OF ETHICS
|
|
39
|
PROXY
VOTING POLICIES
|
|
39
|
INVESTMENT
ADVISORY AND OTHER SERVICES
|
|
40
|
THE PORTFOLIO
MANAGERS
|
|
40
|
THE
DISTRIBUTOR
|
|
41
|
THE
ADMINISTRATOR
|
|
42
|
THE
CUSTODIAN
|
|
42
|
THE
TRANSFER AGENT
|
|
42
|
LEGAL
COUNSEL
|
|
43
|
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
|
|
43
|
DESCRIPTION
OF SHARES
|
|
43
|
BROKERAGE
TRANSACTIONS
|
|
44
|
PORTFOLIO
TURNOVER RATE
|
|
45
|
BOOK
ENTRY ONLY SYSTEM
|
|
46
|
CONTROL
PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
|
|
47
|
PURCHASE
AND ISSUANCE OF SHARES IN CREATION UNITS
|
|
47
|
DETERMINATION
OF NET ASSET VALUE
|
|
53
|
DIVIDENDS
AND DISTRIBUTIONS
|
|
54
|
FEDERAL
INCOME TAXES
|
|
54
|
FINANCIAL
STATEMENTS
|
|
59
|
APPENDIX A
|
|
A-1
|
GENERAL INFORMATION ABOUT THE TRUST
ETF
Managers Trust (the “Trust”) is an open-end management
investment company currently consisting of multiple investment
series, one of which is the Fund. The Trust was organized as a
Delaware statutory trust on July 1, 2009. The Trust is registered
with the Securities and Exchange Commission (the “SEC”)
under the Investment Company Act of 1940, as amended, (the
“1940 Act”) as an open-end management investment
company and the offering of the Fund’s shares
(“Shares”) is registered under the Securities Act of
1933, as amended (the “Securities Act”). ETF Managers
Group, LLC (the “Adviser”) serves as investment adviser
to the Fund. The investment objective of the Fund is to seek
daily investment results, before fees
and expenses, that correspond to two times (2x) the return of a
specified market index (the
“Index” or “Underlying Index”)
for a single
day, not for any other
period. A “single
day” is measured from the time a Fund calculates its net
asset value (“NAV”) to the time of the Fund’s
next NAV calculation.
The
Fund offers and issues Shares at their net asset value only in
aggregations of a specified number of Shares (each, a
“Creation Unit”). The Fund generally offers and issues
Shares in exchange for a basket of securities included in its Index
(“Deposit Securities”) together with the deposit of a
specified cash payment (“Cash Component”). The Trust
reserves the right to permit or require the substitution of a
“cash in lieu” amount (“Deposit Cash”) to
be added to the Cash Component to replace any Deposit Security. The
Shares are listed on the NYSE Arca, Inc. (the
“Exchange”) and trade on the Exchange at market prices.
These prices may differ from the Shares’ net asset values.
The Shares are also redeemable only in Creation Unit aggregations,
and generally in exchange for portfolio securities and a specified
cash payment. A Creation Unit of the Fund generally consists of
[50,000] Shares, though this may change from time to time. As a
practical matter, only institutions or large investors purchase or
redeem Creation Units. Except when aggregated in Creation Units,
Shares are not redeemable securities.
Shares
may be issued in advance of receipt of Deposit Securities subject
to various conditions including a requirement to maintain on
deposit with the Trust an amount in cash at least equal to a
specified percentage of the market value of the missing Deposit
Securities as set forth in the Participant Agreement (as defined
below). The Trust may impose a transaction fee for each creation or
redemption. In all cases, such fees will be limited in accordance
with the requirements of the SEC applicable to management
investment companies offering redeemable securities.
CONTINUOUS OFFERING
The
method by which Creation Unit Aggregations of shares are created
and traded may raise certain issues under applicable securities
laws. Because new Creation Unit Aggregations of shares are issued
and sold by the Fund on an ongoing basis, at any point a
“distribution,” as such term is used in the Securities
Act, may occur. Broker-dealers and other persons are cautioned that
some activities on their part may, depending on the circumstances,
result in their being deemed participants in a distribution in a
manner which could render them statutory underwriters and subject
them to the prospectus delivery requirement and liability
provisions of the Securities Act.
For
example, a broker-dealer firm or its client may be deemed a
statutory underwriter if it takes Creation Unit Aggregations after
placing an order with the Distributor, breaks them down into
constituent shares, and sells such shares directly to customers, or
if it chooses to couple the creation of a supply of new shares with
an active selling effort involving solicitation of secondary market
demand for shares. A determination of whether one is an underwriter
for purposes of the Securities Act must take into account all the
facts and circumstances pertaining to the activities of the
broker-dealer or its client in the particular case, and the
examples mentioned above should not be considered a complete
description of all the activities that could lead to a
categorization as an underwriter. Broker-dealer firms should also
note that dealers who are not “underwriters” but are
effecting transactions in shares, whether or not participating in
the distribution of shares, generally are required to deliver a
prospectus. This is because the prospectus delivery exemption in
Section 4(a)(3) of the Securities Act is not available in respect
of such transactions as a result of Section 24(d) of the 1940 Act.
Firms that incur a prospectus delivery obligation with respect to
shares of the Fund are reminded that, pursuant to Rule 153 under
the Securities Act, a prospectus delivery obligation under Section
5(b)(2) of the Securities Act owed to an exchange member in
connection with a sale on the Exchange is satisfied by the fact
that the prospectus is available at the Exchange upon request. The
prospectus delivery mechanism provided in Rule 153 is only
available with respect to transactions on an exchange.
PORTFOLIO HOLDINGS
Policy on Disclosure of Portfolio Holdings
The
Board of Trustees of the Trust (the “Board”) has
adopted a policy on disclosure of portfolio holdings, which it
believes is in the best interest of the Fund’s shareholders.
The policy requires that the Fund’s portfolio holdings be
disclosed in a manner that: (i) is consistent with applicable legal
requirements and is in the best interests of the Fund’s
shareholders; (ii) does not put the interests of the Adviser or the
Distributor, or any affiliated person of the Adviser or the
Distributor, above those of the Fund’s shareholders; (iii)
does not advantage any current or prospective Fund shareholder over
any other current or prospective Fund shareholder, except to the
extent that certain entities (as described below) may receive
portfolio holdings information not available to other current or
prospective Fund shareholders in connection with the dissemination
of information necessary for transactions in Creation Units; and
(iv) does not provide selective access to portfolio holdings
information except pursuant to the procedures outlined below and to
the extent appropriate confidentiality arrangements limiting the
use of such information are in effect.
The
“entities” referred to in sub-section (iii) above are
generally limited to National Securities Clearing Corporation
(“NSCC”) members and subscribers to various fee-based
subscription services, including Authorized Participants (defined
below), and other institutional market participants and entities
that provide information services.
Information
with respect to the Fund’s portfolio holdings is disseminated
daily on the Fund’s website. Each business day portfolio
holdings information may also be provided to the Fund’s
transfer agent or other agent for dissemination through the
facilities of the NSCC and/or other fee based subscription services
to NSCC members and/or subscribers to those other fee based
subscription services, including Authorized Participants, and to
entities that publish and/or analyze such information in connection
with the process of purchasing or redeeming Creation Units or
trading shares of the Fund in the secondary market.
The
transfer agent may also make available portfolio holdings
information to other institutional market participants and entities
that provide information services. This information typically
reflects the Fund’s anticipated holdings on the following
business day. “Authorized Participants” are
broker-dealer firms that have entered into Authorized Participant
Agreements with the Distributor to purchase and redeem Creation
Units pursuant to legal requirements, including the exemptive order
granted by the SEC, through which the Fund offers and redeems
shares. Other than portfolio holdings information made available in
connection with the creation/redemption process, as discussed
above, portfolio holdings information that is not filed with the
SEC or posted on the publicly available website may be provided to
third parties only in limited circumstances, as described
above.
Disclosure
to providers of auditing, custody, proxy voting, liquidity risk
management and other similar services for the Fund, broker-dealers
that are involved in executing portfolio transactions on behalf of
the Fund, as well as rating and ranking organizations, will
generally be permitted; however, information may be disclosed to
other third parties (including, without limitation, individuals,
institutional investors, and Authorized Participants that sell
shares of the Fund) only upon approval by the CCO. The recipients
who may receive non-public portfolio holdings information are as
follows: the Adviser and its affiliates, the Fund’s
independent registered public accounting firm, the Fund’s
distributor, administrator and custodian, the Fund’s legal
counsel, the Fund’s financial printer and the Fund’s
proxy voting service. These entities are obligated to keep such
information confidential. Third-party providers of custodial or
accounting services to the Fund may release non-public portfolio
holdings information of the Fund only with the permission of the
CCO.
The
Fund will disclose its complete portfolio holdings in
public filings with the
SEC. on a quarterly basis within 60 days of the end of the quarter,
and will provide that information to shareholders, as required by
federal securities laws and regulations thereunder. These filings
are available, free of charge, on the EDGAR database on the
SEC’s website http://www.sec.gov. Under the
policy, the Board is to receive information, on a quarterly basis,
regarding any other disclosures of non-public portfolio holdings
information that were permitted during the preceding
quarter.
ADDITIONAL INFORMATION ABOUT INVESTMENT OBJECTIVES, POLICIES AND
RELATED RISKS
The
Fund’s investment objective and principal investment
strategies are described in the Prospectus. The following
information supplements, and should be read in conjunction with,
the Prospectus. For a description of certain permitted investments,
see “Description of Permitted Investments” in this
SAI.
Non-Diversification
The
Fund is classified as a non-diversified investment company under
the 1940 Act. A “non-diversified” classification means
that the Fund is not limited by the 1940 Act with regard to the
percentage of its assets that may be invested in the securities of
a single issuer. This means that the Fund may invest a greater
portion of its assets in the securities of a single issuer or a
small number of issuers than a diversified fund. The securities of
a particular issuer or a small number of issuers may constitute a
greater portion of the Underlying Index and, therefore, the
securities may constitute a greater portion of the Fund’s
portfolio. This may have an adverse effect on the Fund’s
performance or subject the Fund’s Shares to greater price
volatility than more diversified investment companies. Moreover, in
pursuing its objective, the Fund may hold the securities of a
single issuer in an amount exceeding 10% of the market value of the
outstanding securities of the issuer, subject to restrictions
imposed by the Internal Revenue Code of 1986, as amended (the
“Code”). In particular, as the Fund’s size grows
and its assets increase, it will be more likely to hold more than
10% of the securities of a single issuer if the issuer has a
relatively small public float as compared to other components in
its Underlying Index.
Concentration
The
Fund will, to the extent its Underlying Index does, concentrate its
investments in a particular industry or group of industries, as
described in the Prospectus. The securities of issuers in
particular industries may dominate the Underlying Index of the Fund
and consequently the Fund’s investment portfolio. This may
adversely affect the Fund’s performance or subject its Shares
to greater price volatility than that experienced by less
concentrated investment companies.
DESCRIPTION OF PERMITTED INVESTMENTS
The
following are descriptions of the permitted investments and
investment practices and the associated risk factors. The Fund will
only invest in any of the following instruments or engage in any of
the following investment practices if such investment or activity
is consistent with the Fund’s investment objective and
permitted by the Fund’s stated investment policies. The
information below should be read in conjunction with the
“Principal Investment Strategies” and “Principal
Risks” sections of the Prospectus. The information below
pertains to non-principal investment strategies and risks of the
Fund, while the information in the Prospectus pertains to principal
investment strategies and risks of the Fund.
EQUITY SECURITIES
Equity
securities represent ownership interests in a company and include
common stocks, preferred stocks, warrants to acquire common stock,
and securities convertible into common stock. 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.
Types
of Equity Securities:
Common
Stocks — Common stocks represent units of ownership in a
company. Common stocks usually carry voting rights and earn
dividends. Unlike preferred stocks, which are described below,
dividends on common stocks are not fixed but are declared at the
discretion of the company’s board of directors.
Preferred
Stocks — Preferred stocks are also units of ownership in a
company. Preferred stocks normally have preference over common
stock in the payment of dividends and the liquidation of the
company. However, in all other respects, preferred stocks are
subordinated to the liabilities of the issuer. Unlike common
stocks, preferred stocks are generally not entitled to vote on
corporate matters. Types of preferred stocks include
adjustable-rate preferred stock, fixed dividend preferred stock,
perpetual preferred stock, and sinking fund preferred
stock.
Generally,
the market values of preferred stock with a fixed dividend rate and
no conversion element vary inversely with interest rates and
perceived credit risk.
Convertible
Securities — Convertible securities are securities that may
be exchanged for, converted into, or exercised to acquire a
predetermined number of shares of the issuer’s common stock
at the Fund’s option during a specified time period (such as
convertible preferred stocks, convertible debentures and warrants).
A convertible security is generally a fixed income security that is
senior to common stock in an issuer’s capital structure, but
is usually subordinated to similar non-convertible securities. In
exchange for the conversion feature, many corporations will pay a
lower rate of interest on convertible securities than debt
securities of the same corporation. In general, the market value of
a convertible security is at least the higher of its
“investment value” (i.e., its value as a fixed income
security) or its “conversion value” (i.e., its value upon conversion into
its underlying common stock).
Convertible
securities are subject to the same risks as similar securities
without the convertible feature. The price of a convertible
security is more volatile during times of steady interest rates
than other types of debt securities. The price of a convertible
security tends to increase as the market value of the underlying
stock rises, whereas it tends to decrease as the market value of
the underlying common stock declines.
Rights
and Warrants — A right is a privilege granted to existing
shareholders of a corporation to subscribe to shares of a new issue
of common stock before it is issued. Rights normally have a short
life of usually two to four weeks, are freely transferable and
entitle the holder to buy the new common stock at a lower price
than the public offering price. Warrants are securities that are
usually issued together with a debt security or preferred stock and
that give the holder the right to buy proportionate amount of
common stock at a specified price. Warrants are freely transferable
and are traded on major exchanges. Unlike rights, warrants normally
have a life that is measured in years and entitles the holder to
buy common stock of a company at a price that is usually higher
than the market price at the time the warrant is issued.
Corporations often issue warrants to make the accompanying debt
security more attractive.
An
investment in warrants and rights may entail greater risks than
certain other types of investments. Generally, rights and warrants
do not carry the right to receive dividends or exercise voting
rights with respect to the underlying securities, and they do not
represent any rights in the assets of the issuer. In addition,
their value does not necessarily change with the value of the
underlying securities, and they cease to have value if they are not
exercised on or before their expiration date. Investing in rights
and warrants increases the potential profit or loss to be realized
from the investment as compared with investing the same amount in
the underlying securities.
Risks of Investing in Equity 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, 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:
●
Factors
that directly relate to that company, such as decisions made by its
management or lower demand for the company’s products or
services;
●
Factors
affecting an entire industry, such as increases in production
costs; and
●
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.
Small- and Medium-Sized Companies — Investors in
small- and medium-sized companies typically take on greater risk
and price volatility than they would by investing in larger, more
established companies. This increased risk may be due to the
greater business risks of their small or medium size, limited
markets and financial resources, narrow product lines and frequent
lack of management depth. The securities of small- and medium-sized
companies are often traded in the over-the-counter market and might
not be traded in volumes typical of securities traded on a national
securities exchange. Thus, the securities of small and medium
capitalization companies are likely to experience less frequent
trading and be less liquid, and subject to more abrupt or erratic
market movements, than securities of larger, more established
companies. As a result of the differences between the securities of
small- and medium-sized companies and those of companies with
larger capitalizations, it may be more difficult for the Fund to
buy or sell a significant amount of the securities of a small- or
medium- company without an adverse impact on the price of the
company’s securities, or the Fund may have to sell such
securities in smaller quantities over a longer period of time,
which may increase the Fund’s tracking error.
When-Issued Securities — A when-issued security is one
whose terms are available and for which a market exists, but which
have not been issued. When the Fund engages in when-issued
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 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.
Decisions
to enter into “when-issued” transactions will be
considered on a case-by-case basis when necessary to maintain
continuity in a company’s index membership. The Fund will
segregate cash or liquid securities equal in value to commitments
for the when-issued transactions. The Fund will segregate
additional liquid assets daily so that the value of such assets is
equal to the amount of the commitments.
FUTURES CONTRACTS, FORWARDS, OPTIONS AND SWAP
AGREEMENTS
The
Fund may purchase and sell in the U.S. or abroad futures contracts,
forward contracts, swaps and put and call options on securities,
futures, securities indices, swaps and currencies. In the future,
the Fund may employ instruments and strategies that are not
presently contemplated, but which may be subsequently developed, to
the extent such investment methods are consistent with the
Fund’s investment objectives, and are legally permissible.
There can be no assurance that an instrument, if employed, will be
successful. The Fund may buy and sell these investments for a
number of purposes, including hedging, investment or speculative
purposes, including to seek its desired exposure to the Underlying
Index.
Special Risk Factors Regarding Forwards, Futures, Swaps and
Options
Transactions
in derivative instruments (e.g., futures, options, forwards, and
swaps) involve a risk of loss or depreciation due to: unanticipated
adverse changes in securities or commodities prices, interest
rates, indices, the other financial instruments’ prices or
currency exchange rates; the inability to close out a position;
default by the counterparty; imperfect correlation between a
position and the desired hedge (if the derivative instrument is
being used for hedging purposes); tax constraints on closing out
positions; and portfolio management constraints on securities
subject to such transactions. The loss on derivative instruments
(other than purchased options) may substantially exceed the amount
invested in these instruments. In addition, the entire premium paid
for purchased options may be lost before they can be profitably
exercised. Transaction costs are incurred in opening and closing
positions.
The
Fund’s use of swaps, futures contracts, options, forward
contracts and certain other derivative instruments will have the
economic effect of financial leverage. Financial leverage magnifies
exposure to the swings in prices of an asset underlying a
derivative instrument and results in increased volatility, which
means the Fund will have the potential for greater gains, as well
as the potential for greater losses, than if the Fund does not use
derivative instruments that have a leveraging effect. Leveraging
tends to magnify, sometimes significantly, the effect of any
increase or decrease in the Fund’s exposure to an asset and
may cause the Fund’s NAV to be volatile. For example, if the
Fund seeks to gain enhanced exposure to a specific asset through a
derivative instrument providing leveraged exposure to the asset and
that derivative instrument increases in value, the gain to the Fund
will be enhanced; however, if that investment decreases in value,
the loss to the Fund will be magnified. A decline in the
Fund’s assets due to losses magnified by the derivative
instruments providing leveraged exposure may require the Fund to
liquidate portfolio positions to satisfy its obligations or to meet
redemption requests when it may not be advantageous to do so. There
is no assurance that the Fund’s use of derivative instruments
to obtain enhanced exposure will enable the Fund to achieve its
investment objective. The Fund’s success in using derivative
instruments to hedge portfolio assets depends on the degree of
price correlation between the derivative instruments and the hedged
asset. Imperfect correlation may be caused by several factors,
including temporary price disparities among the trading markets for
the derivative instrument, the assets underlying the derivative
instrument and the Fund’s assets.
OTC
derivative instruments involve an increased risk that the issuer or
counterparty will fail to perform its contractual obligations. Some
derivative instruments are not readily marketable or may become
illiquid under adverse market conditions. In addition, during
periods of market volatility, a commodity exchange may suspend or
limit trading in an exchange-traded derivative instrument, which
may make the contract temporarily illiquid and difficult to price.
Commodity exchanges may also establish daily limits on the amount
that the price of a futures contract or futures option can vary
from the previous day’s settlement price. Once the daily
limit is reached, no trades may be made that day at a price beyond
the limit. This may prevent the closing out of positions to limit
losses. Further, under certain circumstances commodity exchanges or
regulators may impose limits that are lower than current open
equity in a given futures contract, such limit changes have the
potential to cause liquidation of positions and may adversely
affect the Fund. Certain purchased OTC derivatives, and assets used
as cover for written OTC options, may be considered illiquid. The
ability to terminate OTC derivative instruments may depend on the
cooperation of the counterparties to such contracts. For thinly
traded derivative instruments, the only source of price quotations
may be the selling dealer or counterparty.
Regulations
adopted by prudential regulators require certain bank-regulated
counterparties and certain of their affiliates to include in
certain financial contracts, including many derivatives contracts,
terms that delay or restrict the rights of counterparties, such as
the Fund, to terminate such contracts, foreclose upon collateral,
exercise other default rights or restrict transfers of credit
support in the event that the counterparty and/or its affiliates
are subject to certain types of resolution or insolvency
proceedings. It is possible that these requirements, as well as
potential additional government regulation and other developments
in the market, could adversely affect the Fund’s ability to
terminate existing derivatives agreements or to realize amounts to
be received under such agreements.
The use
of derivatives is a highly specialized activity that involves
skills different from conducting ordinary portfolio securities
transactions. There can be no assurance that the Adviser’s
use of derivative instruments will be advantageous to the
Fund.
Exclusion from Commodity Pool Operator Regulation
The
Adviser has filed a claim of exclusion
from the definition of the term “commodity pool
operator” (“CPO”) under the Commodity Exchange
Act (“CEA”), pursuant to CFTC Rule 4.5
(the “Exclusion”) and therefore, the Adviser is
not subject to registration or regulation as a CPO under
the CEA with respect to the Fund. In order to remain eligible
for the Exclusion, the Fund will be limited in its ability to use
certain financial instruments including futures, options on futures
and certain swaps and will be limited in the manner in which
it holds out its use of such instruments.
Swap Agreements
The
Fund may utilize swap agreements in an attempt to gain exposure to
the securities in a market without actually purchasing those
securities, or to hedge a position. Swap agreements are two-party
contracts entered into primarily by institutional investors for
periods ranging from a day to more than one-year. In a standard
“swap” transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross
returns to be exchanged or “swapped” between the
parties are calculated with respect to a “notional
amount,” i.e., the return on or increase in value of a
particular dollar amount invested in a basket of securities
representing a particular index.
Forms
of swap agreements include interest rate caps, under which, in
return for a premium, one party agrees to make payments to the
other to the extent that interest rates exceed a specified rate, or
“cap” interest rate floors, under which, in return for
a premium, one party agrees to make payments to the other to the
extent that interest rates fall below a specified level, or
“floor;” and interest rate collars, under which a party
sells a cap and purchases a floor or vice versa in an attempt to
protect itself against interest rate movements exceeding given
minimum or maximum levels.
The
Fund’s obligations under a swap agreement will be accrued
daily (offset against any amounts owing to the Fund) [and any
accrued but unpaid net amounts owed to a swap counterparty will be
covered by segregating assets determined to be liquid]. Because
they are two-party contracts which may have terms of greater than
seven days, swap agreements may be considered to be illiquid for
purposes of the Fund’s illiquid investment limitations. The
Fund will not enter into any swap agreement unless the Adviser
believes that the other party to the transaction is creditworthy.
The Fund bears the risk of loss of the amount expected to be
received under a swap agreement in the event of the default or
bankruptcy of a swap agreement counterparty.
The
Fund may enter into swap agreements to invest in a market without
owning or taking physical custody of the underlying securities in
circumstances in which direct investment is restricted for legal
reasons or is otherwise impracticable. The counterparty to any swap
agreement will typically be a bank, investment banking firm or
broker-dealer. The counterparty will generally agree to pay the
Fund the amount, if any, by which the notional amount of the swap
agreement would have increased in value had it been invested in the
particular stocks, plus the dividends that would have been received
on those stocks. The Fund will agree to pay to the counterparty a
floating rate of interest on the notional amount of the swap
agreement plus the amount, if any, by which the notional amount
would have decreased in value had it been invested in such stocks.
Therefore, the return to the Fund on any swap agreement should be
the gain or loss on the notional amount plus dividends on the
stocks less the interest paid by the Fund on the notional
amount.
Swap
agreements typically are settled on a net basis, which means that
the two payment streams are netted out, with the Fund receiving or
paying, as the case may be, only the net amount of the two
payments. Payments may be made at the conclusion of a swap
agreement or periodically during its term. Other swap agreements,
may require initial premium (discount) payments as well as periodic
payments (receipts) related to the interest leg of the swap or to
the default of a reference obligation. The Fund will earmark and
reserve assets necessary to meet any accrued payment obligations
when it is the buyer of a credit default swap.
Swap
agreements do not involve the delivery of securities or other
underlying assets. Accordingly, the risk of loss with respect to
swap agreements is limited to the net amount of payments that the
Fund is contractually obligated to make. If a swap counterparty
defaults, the Fund’s risk of loss consists of the net amount
of payments the Fund is contractually entitled to receive, if any.
The net amount of the excess, if any, of the Fund’s
obligations over its entitlements with respect to each equity swap
will be accrued on a daily basis and an amount of cash or liquid
assets, having an aggregate NAV at least equal to such accrued
excess will be maintained in a segregated account by the
Fund’s custodian. Inasmuch as these transactions are entered
into for hedging purposes or are offset by segregated cash of
liquid assets, as permitted by applicable law, the Fund and the
Advisor believe that these transactions do not constitute senior
securities under the 1940 Act and, accordingly, will not treat them
as being subject to the Fund’s borrowing
restrictions.
The
swap market has grown substantially in recent years with a large
number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation.
As a result, the swap market has become relatively liquid in
comparison with the markets for other similar instruments, which
are traded in the OTC market. The Advisor, under the supervision of
the Board, is responsible for determining and monitoring the
liquidity of Fund transactions in swap agreements.
The use
of swap agreements is a highly specialized activity which involves
investment techniques and risks different from those associated
with ordinary portfolio securities transactions. If a
counterparty’s creditworthiness declines, the value of the
swap would likely decline. Moreover, there is no guarantee that the
Fund could eliminate its exposure under an outstanding swap
agreement by entering into an offsetting swap agreement with the
same or another party.
Swaps on Equities, Currencies, Commodities and Futures
The
Fund may enter into swaps with respect to a security, currency,
commodity or futures contract (each, an “asset”);
basket of assets; asset index; or index component (each, a
“reference asset”). An equity, currency, commodity or
futures swap is a two-party contract that generally obligates one
party to pay the positive return and the other party to pay the
negative return on a specified reference asset during the period of
the swap. The payments based on the reference asset may be adjusted
for transaction costs, interest payments, the amount of dividends
paid on the referenced asset or other economic
factors.
Equity,
currency, commodity or futures swap contracts may be structured in
different ways. For example, with respect to an equity swap, when
the Fund takes a long position, the counterparty may agree to pay
the Fund the amount, if any, by which the notional amount of the
equity swap would have increased in value had it been invested in a
particular stock (or group of stocks), plus the dividends that
would have been received on the stock. In these cases, the Fund may
agree to pay to the counterparty interest on the notional amount of
the equity swap plus the amount, if any, by which that notional
amount would have decreased in value had it been invested in such
stock.
Therefore,
in this case the return to the Fund on the equity swap should be
the gain or loss on the notional amount plus dividends on the stock
less the interest paid by the Fund on the notional amount. In other
cases, when the Fund takes a short position, a counterparty may
agree to pay the Fund the amount, if any, by which the notional
amount of the equity swap would have decreased in value had the
Fund sold a particular stock (or group of stocks) short, less the
dividend expense that the Fund would have paid on the stock, as
adjusted for interest payments or other economic factors. In these
situations, the Fund may be obligated to pay the amount, if any, by
which the notional amount of the swap would have increased in value
had it been invested in such stock.
Equity,
currency, commodity or futures swaps normally do not involve the
delivery of securities or other underlying assets. Accordingly, the
risk of loss with respect to these swaps is normally limited to the
net amount of payments that the Fund is contractually obligated to
make. If the other party to the swap defaults, the Fund’s
risk of loss consists of the net amount of payments that such Fund
is contractually entitled to receive, if any.
Equity,
currency, commodity or futures swaps are derivatives and their
value can be very volatile. To the extent that the Adviser or
Sub-Adviser, as applicable, does not accurately analyze and predict
future market trends, the values of assets or economic factors, the
Fund may suffer a loss, which may be substantial. The swap markets
in which many types of swap transactions are traded have grown
substantially in recent years, with a large number of banks and
investment banking firms acting both as principals and as agents.
As a result, the markets for certain types of swaps have become
relatively liquid.
Total Return and Interest Rate Swaps
In a
total return swap, the buyer receives a periodic return equal to
the total return of a specified security, securities or index, for
a specified period of time. In return, the buyer pays the
counterparty a variable stream of payments, typically based upon
short term interest rates, possibly plus or minus an agreed upon
spread. Interest rate swaps are financial instruments that involve
the exchange of one type of interest rate for another type of
interest rate cash flow on specified dates in the future. Some of
the different types of interest rate swaps are “fixed-for
floating rate swaps,” “termed basis swaps” and
“index amortizing swaps.” Fixed-for floating rate swaps
involve the exchange of fixed interest rate cash flows for floating
rate cash flows. Termed basis swaps entail cash flows to both
parties based on floating interest rates, where the interest rate
indices are different. Index amortizing swaps are typically
fixed-for floating swaps where the notional amount changes if
certain conditions are met. Like a traditional investment in a debt
security, the Fund could lose money by investing in an interest
rate swap if interest rates change adversely. For example, if the
Fund enters into a swap where it agrees to exchange a floating rate
of interest for a fixed rate of interest, the Fund may have to pay
more money than it receives. Similarly, if the Fund enters into a
swap where it agrees to exchange a fixed rate of interest for a
floating rate of interest, the Fund may receive less money than it
has agreed to pay.
Interest
rate and total return swaps entered into in which payments are not
netted may entail greater risk than a swap entered into on a net
basis. If there is a default by the other party to such a
transaction, the Fund will have contractual remedies pursuant to
the agreements related to the transaction.
Swap Regulation
In
recent years, regulators across the globe, including the CFTC and
the U.S. banking regulators, have adopted
collateral requirements applicable to uncleared swaps. While
the Fund is not directly subject to these requirements, where the
Fund’s counterparty is subject to the requirements, uncleared
swaps between the Fund and that counterparty are required to be
marked-to-market on a daily basis, and collateral is required to be
exchanged to account for any changes in the value of such swaps.
The rules impose a number of requirements as to these exchanges of
collateral, including as to the timing of transfers, the type of
collateral (and valuations for such collateral) and other matters
that may be different than what the Fund would agree with its
counterparty in the absence of such regulation. In all events,
where the Fund is required to post collateral to its swap
counterparty, such collateral will be posted to an independent bank
custodian, where access to the collateral by the swap counterparty
will generally not be permitted unless the Fund is in default on
its obligations to the swap counterparty.
In
addition to the marked-to-market collateral requirements,
regulators have adopted “initial” collateral
requirements applicable to uncleared swaps. Where applicable,
these rules require parties to an uncleared swap to post, to a
custodian that is independent from the parties to the swap,
collateral (in addition to any marked-to-market collateral noted
above) in an amount that is either (i) specified in a schedule in
the rules or (ii) calculated by the regulated party in accordance
with a model that has been approved by that party’s
regulator(s). At this time, the initial collateral rules do not
apply to the Fund’s swap trading relationships. However, the
rules are being implemented on a phased basis, and it is possible
that in the future, the rules could apply to the Fund. In the event
that the rules apply, they would impose significant costs on the
Fund’s ability to engage in uncleared swaps and, as such,
could adversely affect Adviser’s ability to manage the Fund,
may impair the Fund’s ability to achieve its investment
objective and/or may result in reduced returns to the Fund’s
investors.
Comprehensive Swaps
Regulation
The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(the “Dodd-Frank Act”) and related regulatory
developments have imposed comprehensive new regulatory requirements
on swaps and swap market participants. The regulatory framework
includes: (1) registration and regulation of swap dealers and major
swap participants; (2) requiring central clearing and execution of
standardized swaps; (3) imposing collateral requirements on swap
transactions; (4) regulating and monitoring swap transactions
through position limits and large trader reporting requirements;
and (5) imposing record keeping and centralized and public
reporting requirements, on an anonymous basis, for most swaps. The
CFTC is responsible for the regulation of most swaps. The SEC has
jurisdiction over a small segment of the market referred to as
“security-based swaps,” which includes swaps on single
securities or credits, or narrow-based indices of securities or
credits.
Uncleared swaps
In an
uncleared swap, the swap counterparty is typically a brokerage
firm, bank or other financial institution. The Fund customarily
enters into uncleared swaps based on the standard terms and
conditions of an International Swaps and Derivatives Association
(“ISDA”) Master Agreement. ISDA is a voluntary industry
association of participants in the OTC derivatives markets that has
developed standardized contracts used by such participants that
have agreed to be bound by such standardized contracts. In the
event that one party to a swap transaction defaults and the
transaction is terminated prior to its scheduled termination date,
one of the parties may be required to make an early termination
payment to the other. An early termination payment may be payable
by either the defaulting or non-defaulting party, depending upon
which of them is “in-the-money” with respect to the
swap at the time of its termination. Early termination payments may
be calculated in various ways, but are intended to approximate the
amount the “in-the-money” party would have to pay to
replace the swap as of the date of its termination. During the term
of an uncleared swap, the Fund will be required to pledge to the
swap counterparty, from time to time, an amount of cash and/or
other assets equal to the total net amount (if any) that would be
payable by the Fund to the counterparty if all outstanding swaps
between the parties were terminated on the date in question,
including any early termination payments. Periodically, changes in
the amount pledged are made to recognize changes in value of the
contract resulting from, among other things, interest on the
notional value of the contract, market value changes in the
underlying investment, and/or dividends paid by the issuer of the
underlying instrument. Likewise, the counterparty will be required
to pledge cash or other assets to cover its obligations to the
Fund. However, the amount pledged may not always be equal to or
more than the amount due to the other party. Therefore, if a
counterparty defaults in its obligations to the Fund, the amount
pledged by the counterparty and available to the Fund may not be
sufficient to cover all the amounts due to the Fund and the Fund
may sustain a loss. Rules requiring initial collateral to be posted
by certain market participants for uncleared swaps have been
adopted and are being phased in over time. When these rules take
effect with respect to the Fund, if the Fund is deemed to have
material swaps exposure under applicable swap regulations, it will
be required to post initial collateral in addition to
marked-to-market collateral.
Cleared swaps
Certain
standardized swaps are subject to mandatory central clearing and
exchange-trading. The Dodd-Frank Act and implementing rules will
ultimately require the clearing and exchange-trading of many swaps.
Mandatory exchange-trading and clearing will occur on a phased-in
basis based on the type of market participant, CFTC approval of
contracts for central clearing and public trading facilities making
such cleared swaps available to trade. To date, the CFTC has
designated only certain of the most common types of credit default
index swaps and interest rate swaps as subject to mandatory
clearing and certain public trading facilities have made certain of
those cleared swaps available to trade, but it is expected that
additional categories of swaps will in the future be designated as
subject to mandatory clearing and trade execution requirements.
Central clearing is intended to reduce counterparty credit risk and
increase liquidity, but central clearing does not eliminate these
risks and may involve additional costs and risks not involved with
uncleared swaps. For more information, see “Risks of cleared
swaps” below.
In a
cleared swap, the Fund’s ultimate counterparty is a central
clearinghouse rather than a brokerage firm, bank or
other financial institution. Cleared swaps are submitted for
clearing through each party’s FCM, which must be a member of
the clearinghouse that serves as the central counterparty.
Transactions executed on a swap execution facility may increase
market transparency and liquidity but may require the Fund to incur
increased expenses to access the same types of swaps that it has
used in the past. When the Fund enters into a cleared swap, it must
deliver to the central counterparty (via the FCM) initial
collateral. The initial collateral requirements are determined by
the central counterparty, and are typically calculated as an amount
equal to the volatility in market value of the cleared swap over a
fixed period, but an FCM may require additional collateral above
the amount required by the central counterparty. During the term of
the swap agreement, an additional collateral amount may also be
required to be paid by the Fund or may be received by the Fund in
accordance with collateral controls set for such accounts. If the
value of the Fund’s cleared swap declines, the Fund will be
required to make additional payments to the FCM to settle the
change in value. Conversely, if the market value of the
Fund’s position increases, the FCM will post additional
amounts to the Fund’s account. At the conclusion of the term
of the swap agreement, if the Fund has a loss equal to or greater
than the collateral amount, the collateral amount is paid to the
FCM along with any loss in excess of the collateral amount. If the
Fund has a loss of less than the collateral amount, the excess
collateral is returned to the Fund. If the Fund has a gain, the
full collateral amount and the amount of the gain is paid to the
Fund.
Risks of swaps generally
The use
of swap transactions is a highly specialized activity, which
involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. Whether
the Fund will be successful in using swap agreements to achieve its
investment goal depends on the ability of the Adviser to correctly
predict which types of investments are likely to produce greater
returns. If the Adviser, in using swap agreements, is incorrect in
its forecasts of market values, interest rates, inflation, currency
exchange rates or other applicable factors, the investment
performance of the Fund will be less than its performance would
have been if it had not used the swap agreements. The risk of loss
to the Fund for swap transactions that are entered into on a net
basis depends on which party is obligated to pay the net amount to
the other party. If the counterparty is obligated to pay the net
amount to the Fund, the risk of loss to the Fund is loss of the
entire amount that the Fund is entitled to receive. If the Fund is
obligated to pay the net amount, the Fund’s risk of loss is
generally limited to that net amount. If the swap agreement
involves the exchange of the entire principal value of a security,
the entire principal value of that security is subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. In addition, the Fund’s risk of loss
also includes any collateral at risk in the event of default by the
counterparty (in an uncleared swap) or the central counterparty or
FCM (in a cleared swap), plus any transaction costs.
Because
bilateral swap agreements are structured as two-party contracts and
may have terms of greater than seven days, these swaps may be
considered to be illiquid and, therefore, subject to the
Fund’s limitation on investments in illiquid securities. If a
swap transaction is particularly large or if the relevant market is
illiquid, the Fund may not be able to establish or liquidate a
position at an advantageous time or price, which may result in
significant losses. Participants in the swap markets are not
required to make continuous markets in the swap contracts they
trade. Participants could refuse to quote prices for swap contracts
or quote prices with an unusually wide spread between the price at
which they are prepared to buy and the price at which they are
prepared to sell. Some swap agreements entail complex terms and may
require a greater degree of subjectivity in their valuation.
However, the swap markets have grown substantially in recent years,
with a large number of financial institutions acting both as
principals and agents, utilizing standardized swap documentation.
As a result, the swap markets have become increasingly liquid. In
addition, central clearing and the trading of cleared swaps on
public facilities are intended to increase liquidity.
The
Adviser, under the supervision of the Board of Trustees, is
responsible for determining and monitoring the liquidity of the
Fund’s swap transactions. Rules adopted under the Dodd-Frank
Act require centralized reporting of detailed information about
many swaps, whether cleared or uncleared. This information is
available to regulators and also, to a more limited extent and on
an anonymous basis, to the public. Reporting of swap data is
intended to result in greater market transparency. This may be
beneficial to funds that use swaps in their trading strategies.
However, public reporting imposes additional recordkeeping burdens
on these funds, and the safeguards established to protect anonymity
are not yet tested and may not provide protection of the
Fund’s identity as intended. Certain IRS positions may limit
the Fund’s ability to use swap agreements in a desired tax
strategy. It is possible that developments in the swap markets
and/or the laws relating to swap agreements, including potential
government regulation, could adversely affect the Fund’s
ability to benefit from using swap agreements, or could have
adverse tax consequences. For more information about potentially
changing regulation, see “Developing government regulation of
derivatives” below.
Risks of uncleared swaps
Uncleared
swaps are typically executed bilaterally with a swap dealer rather
than traded on exchanges. As a result, swap participants may not be
as protected as participants on organized exchanges. Performance of
a swap agreement is the responsibility only of the swap
counterparty and not of any exchange or clearinghouse. As a result,
the Fund is subject to the risk that a counterparty will be unable
or will refuse to perform under such agreement, including because
of the counterparty’s bankruptcy or insolvency. The Fund
risks the loss of the accrued but unpaid amounts under a swap
agreement, which could be substantial, in the event of a default,
insolvency or bankruptcy by a swap counterparty. In such an event,
the Fund will have contractual remedies pursuant to the swap
agreements, but bankruptcy and insolvency laws could affect the
Fund’s rights as a creditor. If the counterparty’s
creditworthiness declines, the value of a swap agreement would
likely decline, potentially resulting in losses. The Adviser will
only approve a swap agreement counterparty for the Fund if the
Adviser deems the counterparty to be creditworthy. However, in
unusual or extreme market conditions, a counterparty’s
creditworthiness and ability to perform may deteriorate rapidly,
and the availability of suitable replacement counterparties may
become limited.
Risks of cleared swaps
As
noted above, under recent financial reforms, certain types of swaps
are, and others eventually are expected to be, required to be
cleared through a central counterparty, which may affect
counterparty risk and other risks faced by the Fund.
Central
clearing is designed to reduce counterparty credit risk and
increase liquidity compared to uncleared swaps because central
clearing interposes the central clearinghouse as the counterparty
to each participant’s swap, but it does not eliminate those
risks completely and may involve additional costs and risks not
involved with uncleared swaps. There is also a risk of loss by
the Fund of the initial and variation collateral deposits in the
event of bankruptcy of the FCM with which the Fund has an open
position, or the central counterparty in a swap contract. The
assets of the Fund may not be fully protected in the event of the
bankruptcy of the FCM or central counterparty because the Fund
might be limited to recovering only a pro rata share of all
available funds and collateral segregated on behalf of an
FCM’s customers. If the FCM does not provide accurate
reporting, the Fund is also subject to the risk that the FCM could
use the Fund’s assets, which are held in an omnibus account
with assets belonging to the FCM’s other customers, to
satisfy its own financial obligations or the payment obligations of
another customer to the central counterparty. Credit risk of
cleared swap participants is concentrated in a few clearinghouses,
and the consequences of insolvency of a clearinghouse are not
clear.
With
cleared swaps, the Fund may not be able to obtain terms as
favorable as it would be able to negotiate for a
bilateral, uncleared swap. In addition, an FCM may
unilaterally amend the terms of its agreement with the Fund, which
may include the imposition of position limits or additional
collateral requirements with respect to the Fund’s investment
in certain types of swaps. Central counterparties and FCMs can
require termination of existing cleared swap transactions upon the
occurrence of certain events, and can also require increases in
collateral above the amount that is required at the initiation of
the swap agreement. Currently, depending on a number of factors,
the collateral required under the rules of the clearinghouse and
FCM may be in excess of the collateral required to be posted by the
Fund to support its obligations under a similar uncleared swap.
However, regulators have proposed and are expected to adopt rules
imposing certain requirements on uncleared swaps in the near
future, which are likely to impose higher collateral requirements
on uncleared swaps.
Finally,
the Fund is subject to the risk that, after entering into a cleared
swap with an executing broker, no FCM or central counterparty
is willing or able to clear the transaction. In such an event, the
Fund may be required to break the trade and make an early
termination payment to the executing broker.
Forward Contracts
A
forward contract is an obligation to purchase or sell a specific
security, currency or other instrument for an agreed price at a
future date that is individually negotiated and privately traded by
traders and their customers. In contrast to contracts traded on an
exchange (such as futures contracts), forward contracts are not
guaranteed by any exchange or clearinghouse and are subject to the
creditworthiness of the counterparty of the trade. Forward
contracts are highly leveraged and highly volatile, and a
relatively small price movement in a forward contract may result in
substantial losses to the Fund. To the extent the Fund engages in
forward contracts to generate return, the Fund will be subject to
these risks.
Forward
contracts are not always standardized and are frequently the
subject of individual negotiation between the parties involved. By
contrast, futures contracts are generally standardized and futures
exchanges have central clearinghouses which keep track of all
positions.
Because
there is no clearinghouse system applicable to forward contracts,
there is no direct means of offsetting a forward contract by
purchase of an offsetting position on the same exchange as one can
with respect to a futures contract. Absent contractual termination
rights, the Fund may not be able to terminate a forward contract at
a price and time that it desires. In such event, the Fund will
remain subject to counterparty risk with respect to the forward
contract, even if the Fund enters into an offsetting forward
contract with the same, or a different, counterparty. If a
counterparty defaults, the Fund may lose money on the
transaction.
Depending
on the asset underlying the forward contract, forward transactions
can be influenced by, among other things, changing supply and
demand relationships, government commercial and trade programs and
policies, national and international political and economic events,
weather and climate conditions, insects and plant disease,
purchases and sales by foreign countries and changing interest
rates.
Futures Contracts
The
Fund may use futures to attempt to gain exposure to a particular
market, index, security, commodity or instrument or for speculative
purposes to increase return, to attempt to hedge or limit the
exposure of the Fund’s position, to create a synthetic money market position, for
certain tax-related purposes or to effect closing
transactions. Futures contracts generally provide for the
future sale by one party and purchase by another party of a
specified commodity or security at a specified future time and at a
specified price. Index futures contracts are settled daily with a
payment by one party to the other of a cash amount based on the
difference between the level of the index specified in the contract
from one day to the next. Futures contracts are standardized as to
maturity date and underlying instrument and are traded on futures
exchanges.
The
Fund is required to make a good faith margin deposit in cash or
U.S. government securities with a broker or custodian to initiate
and maintain open positions in futures contracts. A margin deposit
is intended to assure completion of the contract (delivery or
acceptance of the underlying commodity or payment of the cash
settlement amount) if it is not terminated prior to the specified
delivery date. Brokers may establish deposit requirements which are
higher than the exchange minimums. Futures contracts are
customarily purchased and sold on margin deposits which may range
upward from less than 5% of the value of the contract being
traded.
After a
futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to
the extent that the margin on deposit does not satisfy margin
requirements, payment of additional “variation” margin
will be required. Conversely, change in the contract value may
reduce the required margin, resulting in a repayment of excess
margin to the contract holder. Variation margin payments are made
to and from the futures broker for as long as the contract remains
open. In such case, the Fund would expect to earn interest income
on its margin deposits. Closing out an open futures position is
done by taking an opposite position (“buying” a
contract which has previously been “sold,” or
“selling” a contract previously
“purchased”) in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures
contract position is opened or closed.
U.S.
futures contracts are traded on organized exchanges regulated by
the CFTC. Transactions on such exchanges are cleared through a
clearing corporation, which guarantees the performance of the
parties to each contract. The Fund may also invest in non-U.S.
futures contracts.
There
are several risks in connection with the use of futures by the
Fund. The Fund may not be able to properly effect its strategy when
a liquid market is unavailable for the futures contract the Fund
wishes to close, which may at times occur. If the Fund were unable
to liquidate a futures position due to the absence of a liquid
secondary market or the imposition of price limits, it could incur
substantial losses. The Fund would continue to be subject to market
risk with respect to the position. In addition, the Fund would
continue to be required to make daily variation margin payments and
might be required to maintain cash or liquid assets in an
account.
A
purchase or sale of a futures contract may result in losses to the
Fund in excess of the amount that the Fund delivered as
initial margin. Because of the relatively low margin deposits
required, futures trading involves a high degree of leverage; as a
result, a relatively small price movement in a futures contract may
result in immediate and substantial loss, or gain, to the Fund. In
addition, if the Fund has insufficient cash to meet daily variation
margin requirements or close out a futures position, it may have to
sell securities from its portfolio at a time when it may be
disadvantageous to do so. Adverse market movements could cause the
Fund to experience substantial losses on an investment in a futures
contract. There is a risk of loss by the Fund of the initial and
variation margin deposits in the event of bankruptcy of the FCM
with which the Fund has an open position in a futures contract. The
assets of the Fund may not be fully protected in the event of the
bankruptcy of the FCM or central counterparty because the Fund
might be limited to recovering only a pro rata share of all
available funds and margin segregated on behalf of an FCM’s
customers. If the FCM does not provide accurate reporting, the Fund
is also subject to the risk that the FCM could use the Fund’s
assets, which are held in an omnibus account with assets belonging
to the FCM’s other customers, to satisfy its own financial
obligations or the payment obligations of another customer to the
central counterparty.
The
price of futures may not correlate perfectly with movement in the
cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures
contracts through offsetting transactions which could distort the
normal relationship between the cash and futures markets. Second,
with respect to financial futures contracts, the liquidity of the
futures market depends on participants entering into offsetting
transactions rather than making or taking delivery. To the extent
participants decide to make or take delivery, liquidity in the
futures market could be reduced, thus producing distortions. Third,
from the point of view of speculators, the deposit requirements in
the futures market are less onerous than margin requirements in the
securities market. Therefore, increased participation by
speculators in the futures market may also cause temporary price
distortions. Due to the possibility of price distortion in the
futures market, and because of the imperfect correlation between
the movements in the cash market and movements in the price of
futures, a correct forecast of general market trends or interest
rate movements by the Adviser may still not result in a successful
hedging transaction over a short time frame (in the event futures
are used for hedging purposes).
Positions
in futures may be closed out only on an exchange or board of trade
which provides a secondary market for such futures. Although the
Fund intends to purchase or sell futures only on exchanges or
boards of trade where there appear to be active secondary markets,
there is no assurance that a liquid secondary market on any
exchange or board of trade will exist for any particular contract
or at any particular time. When there is no liquid market, it may
not be possible to close a futures investment position, and in the
event of adverse price movements, the Fund would continue to be
required to make daily cash payments of variation margin (as
described below). In such circumstances, an increase in the price
of the securities, if any, may partially or completely offset
losses on the futures contract. However, as described above, there
is no guarantee that the price of the securities will in fact
correlate with the price movements in the futures contract and thus
provide an offset on a futures contract.
Futures
contracts that are traded on non-U.S. exchanges may not be as
liquid as those purchased on CFTC-designated contract markets. In
addition, non-U.S. futures contracts may be subject to varied
regulatory oversight. The price of any non-U.S. futures contract
and, therefore, the potential profit and loss thereon, may be
affected by any change in the non-U.S. exchange rate between the
time a particular order is placed and the time it is liquidated,
offset or exercised.
The
CFTC and the various exchanges have established limits referred to
as “speculative position limits” on the
maximum net long or net short position that any person, such
as the Fund, may hold or control in a particular futures contract.
Trading limits are also imposed on the maximum number of contracts
that any person may trade on a particular trading day. An exchange
may order the liquidation of positions found to be in violation of
these limits and it may impose other sanctions or restrictions. The
regulation of futures, as well as other derivatives, is a rapidly
changing area of law.
Further,
it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by “daily price
fluctuation limits” established by commodities exchanges
which limit the amount of fluctuation in a futures contract price
during a single trading day. Once the daily limit has been reached
in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures
positions. The trading of futures contracts is also subject to the
risk of trading halts, suspensions, exchange or clearing house
equipment failures, government intervention, insolvency of a
brokerage firm or clearing house or other disruptions of normal
activity, which could at times make it difficult or impossible to
liquidate existing positions or to recover equity.
Stock Index Futures
The
Fund may invest in stock index futures. A stock index assigns
relative values to the common stocks included in the index and
fluctuates with the changes in the market value of those
stocks.
Stock
index futures are contracts based on the future value of the basket
of securities that comprise the underlying stock index. The
contracts obligate the seller to deliver and the purchaser to take
cash to settle the futures transaction or to enter into an
obligation contract. No physical delivery of the securities
underlying the index is made on settling the futures obligation. No
monetary amount is paid or received by the Fund on the purchase or
sale of a stock index future. At any time prior to the expiration
of the future, the Fund may elect to close out its position by
taking an opposite position, at which time a final determination of
variation margin is made and additional cash is required to be paid
by or released to the Fund. Any gain or loss is then realized by
the Fund on the future for tax purposes. Although stock index
futures by their terms call for settlement by the delivery of cash,
in most cases the settlement obligation is fulfilled without such
delivery by entering into an offsetting transaction. All futures
transactions are effected through a clearing house associated with
the exchange on which the contracts are traded.
Futures on Securities
The
Fund may purchase and sell futures contracts on securities. A
futures contract sale creates an obligation by the Fund, as seller,
to deliver the specific type of financial instrument called for in
the contract at a specific future time for a specified price. A
futures contract purchase creates an obligation by the Fund, as
purchaser, to take delivery of the specific type of financial
instrument at a specific future time at a specific price. The
specific securities delivered or taken, respectively, at settlement
date, would not be determined until or near that date. The
determination would be in accordance with the rules of the exchange
on which the futures contract sale or purchase was
made.
Although
futures contracts on securities by their terms call for actual
delivery or acceptance of securities, in most cases the contracts
are closed out before the settlement date without making or taking
delivery of securities. The Fund may close out a futures contract
sale by entering into a futures contract purchase for the same
aggregate amount of the specific type of financial instrument and
the same delivery date. If the price of the sale exceeds the price
of the offsetting purchase, the Fund is immediately paid the
difference and thus realizes a gain. If the offsetting purchase
price exceeds the sale price, the Fund pays the difference and
realizes a loss. Similarly, the Fund may close out of a futures
contract purchase by entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the Fund realizes
a gain, and if the purchase price exceeds the offsetting sale
price, the Fund realizes a loss. Accounting for futures contracts
will be in accordance with generally accepted accounting
principles.
Options
The
value of an option position will reflect, among other things, the
current market value of the underlying investment, the time
remaining until expiration, the relationship of the exercise price
to the market price of the underlying investment and general market
conditions. Options that expire unexercised have no value. Options
currently are traded on the Chicago Board Options
Exchange® and other exchanges, as well as the OTC
markets.
By
buying a call option on a security, the Fund has the right, in
return for the premium paid, to buy the security
underlying the option at the exercise price. By writing
(selling) a call option and receiving a premium, the Fund becomes
obligated during the term of the option to deliver securities
underlying the option at the exercise price if the option is
exercised. By buying a put option, the Fund has the right, in
return for the premium, to sell the security underlying the option
at the exercise price. By writing a put option, the Fund becomes
obligated during the term of the option to purchase the securities
underlying the option at the exercise price.
Because
options premiums paid or received by the Fund are small in relation
to the market value of the investments underlying the options,
buying and selling put and call options can be more speculative
than investing directly in securities.
The
Fund may effectively terminate its right or obligation under an
option by entering into a closing transaction. For
example, the Fund may terminate its obligation under a call or
put option that it had written by purchasing an identical call or
put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call
option it had purchased by writing an identical put or call option;
this is known as a closing sale transaction. Closing transactions
permit the Fund to realize profits or limit losses on an option
position prior to its exercise or expiration.
Risks of Options on Currencies and Securities
Exchange-traded
options in the United States are issued by a clearing organization
affiliated with the exchange on which the option is listed that, in
effect, guarantees completion of every exchange-traded option
transaction. In contrast, OTC options are contracts between the
Fund and its counterparty (usually a securities dealer or a bank)
with no clearing organization guarantee. Thus, when the Fund
purchases an OTC option, it relies on the counterparty from which
it purchased the option to make or take delivery of the underlying
investment upon exercise of the option. Failure by the counterparty
to do so would result in the loss of any premium paid by the Fund
as well as the loss of any expected benefit of the
transaction.
The
Fund’s ability to establish and close out positions in
exchange-traded options depends on the existence of a
liquid market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can
be made for OTC options only by negotiating directly with the
counterparty, or by a transaction in the secondary market if any
such market exists. There can be no assurance that the Fund will in
fact be able to close out an OTC option position at a favorable
price prior to expiration. In the event of insolvency of the
counterparty, the Fund might be unable to close out an OTC option
position at any time prior to its expiration.
If the
Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize
any profit. The inability to enter into a closing purchase
transaction for a covered call option written by the Fund could
cause material losses because the Fund would be unable to sell the
investment used as cover for the written option until the option
expires or is exercised.
Options on Indices
An
index fluctuates with changes in the market values of the
securities included in the index. Options on indices give the
holder the right to receive an amount of cash upon exercise of the
option. Receipt of this cash amount will depend upon the closing
level of the index upon which the option is based being greater
than (in the case of a call) or less than (in the case of a put)
the exercise price of the option. Some stock index options are
based on a broad market index such as the S&P
500® Composite Stock Index, the NYSE Composite Index or
the NYSE Arca Major Market Index or on a narrower index such as the
Philadelphia Stock Exchange Over-the-Counter Index.
Each of
the exchanges has established limitations governing the maximum
number of call or put options on the same index that may be
bought or written by a single investor, whether acting alone or in
concert with others (regardless of whether such options are written
on the same or different exchanges or are held or written on one or
more accounts or through one or more brokers). Under these
limitations, option positions of all investment companies advised
by the Adviser are combined for purposes of these limits. Pursuant
to these limitations, an exchange may order the liquidation of
positions and may impose other sanctions or restrictions. These
position limits may restrict the number of listed options that the
Fund may buy or sell.
Puts
and calls on indices are similar to puts and calls on securities or
futures contracts except that all settlements are in cash and
gain or loss depends on changes in the index in question rather
than on price movements in individual securities or futures
contracts. When the Fund writes a call on an index, it receives a
premium and agrees that, prior to the expiration date, the
purchaser of the call, upon exercise of the call, will receive from
the Fund an amount of cash if the closing level of the index upon
which the call is based is greater than the exercise price of the
call. The amount of cash is equal to the difference between the
closing price of the index and the exercise price of the call
multiplied by a specific factor (“multiplier”), which
determines the total value for each point of such difference. When
the Fund buys a call on an index, it pays a premium and has the
same rights to such call as are indicated above. When the Fund buys
a put on an index, it pays a premium and has the right, prior to
the expiration date, to require the seller of the put, upon the
Fund’s exercise of the put, to deliver to the Fund an amount
of cash if the closing level of the index upon which the put is
based is less than the exercise price of the put, which amount of
cash is determined by the multiplier, as described above for calls.
When the Fund writes a put on an index, it receives a premium and
the purchaser of the put has the right, prior to the expiration
date, to require the Fund to deliver to it an amount of cash equal
to the difference between the closing level of the index and the
exercise price times the multiplier if the closing level is less
than the exercise price.
Risks of Options on Indices
If the
Fund has purchased an index option and exercises it before the
closing index value for that day is available, it runs the risk
that the level of the index may subsequently change. If such a
change causes the exercised option to fall out-of-the-money, the
Fund will be required to pay the difference between the closing
index value and the exercise price of the option (times the
applicable multiplier) to the assigned writer.
OTC Options
Unlike
exchange-traded options, which are standardized with respect to the
underlying instrument, expiration date, contract size and strike
price, the terms of OTC options (options not traded on exchanges)
generally are established through negotiation with the other party
to the option contract. While this type of arrangement allows the
Fund great flexibility to tailor the option to its needs, OTC
options generally involve greater risk than exchange-traded
options, which are guaranteed by the clearing organization of the
exchanges where they are traded.
Options on Futures Contracts
When
the Fund writes an option on a futures contract, it becomes
obligated, in return for the premium paid, to assume a position in
the futures contract at a specified exercise price at any time
during the term of the option. If the Fund writes a call, it
assumes a short futures position. If it writes a put, it assumes a
long futures position. When the Fund purchases an option on a
futures contract, it acquires the right in return for the premium
it pays to assume a position in a futures contract (a long position
if the option is a call and a short position if the option is a
put).
Whether
the Fund realizes a gain or loss from futures activities depends
upon movements in the underlying security or index. The extent
of the Fund’s loss from an unhedged short position from
writing unhedged call options on futures contracts is potentially
unlimited. The Fund only purchases and sells options on futures
contracts that are traded on a U.S. exchange or board of
trade.
Purchasers
and sellers of options on futures can enter into offsetting closing
transactions, similar to closing transactions in options, by
selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in options on futures
contracts may be closed only on an exchange or board of trade that
provides a secondary market. However, there can be no assurance
that a liquid secondary market will exist for a particular contract
at a particular time. In such event, it may not be possible to
close a futures contract or options position.
Under
certain circumstances, futures exchanges may establish daily limits
on the amount that the price of an option on a futures
contract can vary from the previous day’s settlement price;
once that limit is reached, no trades may be made that day at a
price beyond the limit. Daily price limits do not limit potential
losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the
Fund were unable to liquidate an option on a futures position due
to the absence of a liquid secondary market or the imposition
of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position.
In addition, except in the case of purchased options, the Fund
would continue to be required to make daily variation margin
payments and might be required to maintain cash or liquid assets in
an account.
Risks of Options on Futures Contracts
The
ordinary spreads between prices in the cash and futures markets
(including the options on futures markets), due to differences in
the natures of those markets, are subject to the following factors,
which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance
requirements. Rather than meeting additional margin deposit
requirements, investors may close futures contracts through
offsetting transactions, which could distort the normal
relationships between the cash and futures markets. Second, the
liquidity of the futures market depends on participants entering
into offsetting transactions rather than making or taking delivery.
To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced, thus producing
distortion. Third, from the point of view of speculators, the
deposit requirements in the futures market are less onerous than
margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may cause
temporary price distortions.
Combined Positions
The
Fund may purchase and write options in combination with each other.
For example, the Fund may purchase a put option and write a call
option on the same underlying instrument, in order to construct a
combined position whose risk and return characteristics are similar
to selling a futures contract. Another possible combined position
would involve writing a call option at one strike price and buying
a call option at a lower price, in order to reduce the risk of the
written call option in the event of a substantial price increase.
Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to
open and close out.
Regulation of Investment Company Use of Derivatives
SEC
Rule 18f-4 (“Rule 18f-4” or the “Derivatives
Rule”) regulates the ability of a Fund to enter into
derivative transactions and other leveraged transactions. The
Derivatives Rule defines the term “derivatives” to
include short sales and forward contracts, such as TBA
transactions, in addition to instruments traditionally classified
as derivatives, such as swaps, futures, and options. Rule 18f-4
also regulates other types of leveraged transactions, such as
reverse repurchase transactions and transactions deemed to be
“similar to” reverse repurchase transactions, such as
certain securities lending transactions in connection with which a
Fund obtains leverage. Among other things, under Rule 18f-4, a Fund
is prohibited from entering into these derivatives transactions
except in reliance on the provisions of the Derivatives Rule. The
Derivatives Rule establishes limits on the derivatives transactions
that a Fund may enter into based on the value-at-risk
(“VaR”) of the Fund inclusive of derivatives. A Fund
will generally satisfy the limits under the Rule if the VaR of its
portfolio (inclusive of derivatives transactions) does not exceed
200% of the VaR of its “designated reference
portfolio.” The “designated reference portfolio”
is a representative unleveraged index or the Fund’s own
portfolio absent derivatives holdings, as determined by the
Fund’s derivatives risk manager. This limits test is referred
to as the “Relative VaR Test.” As a result of the
Relative VaR Test, the Fund may not seek returns in excess of 2x
the Underlying Index.
In
addition, among other requirements, Rule 18f-4 requires the Fund to
establish a derivatives risk management program, appoint a
derivatives risk manager, and carry out enhanced reporting to the
Board, the SEC and the public regarding the Fund’s
derivatives activities. It is possible that the limits and
compliance costs imposed by the Derivatives Rule may adversely
affect the Fund’s performance, efficiency in implementing its
strategy, liquidity and/or ability to pursue its investment
objectives and may increase the cost of the Fund’s
investments and cost of doing business, which could adversely
affect investors.
FOREIGN SECURITIES
FOREIGN
ISSUERS
The
Fund may invest a significant portion of its assets in issuers
located outside the United States directly, or in financial
instruments that are indirectly linked to the performance of
foreign issuers. Examples of such financial instruments include
depositary receipts, which are described further below,
“ordinary shares,” and “New York shares”
issued and traded in the United States. Ordinary shares are shares
of foreign issuers that are traded abroad and on a United States
exchange. New York shares are shares that a foreign issuer has
allocated for trading in the United States. American Depositary
Receipts (“ADRs”), ordinary shares, and New York shares
all may be purchased with and sold for U.S. dollars, which protects
the Fund from the foreign settlement risks described
below.
Investing
in foreign companies may involve risks not typically associated
with investing in United States companies. The value of securities
denominated in foreign currencies, and of dividends from such
securities, can change significantly when foreign currencies
strengthen or weaken relative to the U.S. dollar. Foreign
securities markets generally have less trading volume and less
liquidity than United States markets, and prices in some foreign
markets can be more volatile than those of domestic securities.
Therefore, the Fund’s investment in foreign securities may be
less liquid and subject to more rapid and erratic price movements
than comparable securities listed for trading on U.S. exchanges.
Non-U.S. equity securities may trade at price/earnings multiples
higher than comparable U.S. securities and such levels may not be
sustainable. There may be less government supervision and
regulation of foreign stock exchanges, brokers, banks and listed
companies abroad than in the U.S. Moreover, settlement practices
for transactions in foreign markets may differ from those in U.S.
markets. Such differences may include delays beyond periods
customary in the U.S. and practices, such as delivery of securities
prior to receipt of payment, that increase the likelihood of a
failed settlement, which can result in losses to the Fund. The
value of non-U.S. investments and the investment income derived
from them may also be affected unfavorably by changes in currency
exchange control regulations. Foreign brokerage commissions,
custodial expenses and other fees are also generally higher than
for securities traded in the U.S. This may cause the Fund to incur
higher portfolio transaction costs than domestic equity funds.
Fluctuations in exchange rates may also affect the earning power
and asset value of the foreign entity issuing a security, even one
denominated in U.S. dollars. Dividend and interest payments may be
repatriated based on the exchange rate at the time of disbursement,
and restrictions on capital flows may be imposed. Many foreign
countries lack uniform accounting, auditing and financial reporting
standards comparable to those that apply to United States
companies, and it may be more difficult to obtain reliable
information regarding a foreign issuer’s financial condition
and operations. In addition, the costs of foreign investing,
including withholding taxes, brokerage commissions, and custodial
fees, generally are higher than for United States
investments.
Investing
in companies located abroad carries political and economic risks
distinct from those associated with investing in the United States.
Foreign investment may be affected by actions of foreign
governments adverse to the interests of United States investors,
including the possibility of expropriation or nationalization of
assets, confiscatory taxation, restrictions on United States
investment, or on the ability to repatriate assets or to convert
currency into U.S. dollars. There may be a greater possibility of
default by foreign governments or foreign-government sponsored
enterprises. Losses and other expenses may be incurred in
converting between various currencies in connection with purchases
and sales of foreign securities. Investments in foreign countries
also involve a risk of local political, economic, or social
instability, military action or unrest, or adverse diplomatic
developments.
Investing
in companies domiciled in emerging market countries may be subject
to greater risks than investments in developed countries. These
risks include: (i) less social, political, and economic
stability; (ii) greater illiquidity and price volatility due
to smaller or limited local capital markets for such securities, or
low or non-existent trading volumes; (iii) foreign exchanges
and broker-dealers may be subject to less scrutiny and regulation
by local authorities; (iv) local governments may decide to
seize or confiscate securities held by foreign investors and/or
local governments may decide to suspend or limit an issuer’s
ability to make dividend or interest payments; (v) local
governments may limit or entirely restrict repatriation of invested
capital, profits, and dividends; (vi) capital gains may be
subject to local taxation, including on a retroactive basis;
(vii) issuers facing restrictions on dollar or euro payments
imposed by local governments may attempt to make dividend or
interest payments to foreign investors in the local currency;
(viii) investors may experience difficulty in enforcing legal
claims related to the securities and/or local judges may favor the
interests of the issuer over those of foreign investors;
(ix) bankruptcy judgments may only be permitted to be paid in
the local currency; (x) limited public information regarding the
issuer may result in greater difficulty in determining market
valuations of the securities, and (xi) lax financial reporting
on a regular basis, substandard disclosure, and differences in
accounting standards may make it difficult to ascertain the
financial health of an issuer.
GEOGRAPHIC
CONCENTRATION
Funds
that are less diversified across countries or geographic regions
are generally riskier than more geographically diversified funds. A
fund that focuses on a single country or a specific region is more
exposed to that country’s or region’s economic cycles,
currency exchange rates, stock market valuations and political
risks, among others, compared with a more geographically
diversified fund. The economies and financial markets of certain
regions, such as Asia and the Middle East, can be interdependent
and may be adversely affected by the same events.
Set
forth below for certain markets in which a Fund may invest are
brief descriptions of some of the conditions and risks in each such
market.
Investments in Europe. The economies of Europe are highly
dependent on each other, both as key trading partners and as in
many cases as fellow members maintaining the euro. Reduction in
trading activity among European countries may cause an adverse
impact on each nation’s individual economies. European
countries that are part of the Economic and Monetary Union of the
EU are required to comply with restrictions on inflation rates,
deficits, interest rates, debt levels, and fiscal and monetary
controls, each of which may significantly affect every country in
Europe. Decreasing imports or exports, changes in governmental or
EU regulations on trade, changes in the exchange rate of the euro,
the default or threat of default by an EU member country on its
sovereign debt, and recessions in an EU member country may have a
significant adverse effect on the economies of EU member countries
and their trading partners.
The
European financial markets have recently experienced volatility and
adverse trends due to concerns about rising government debt levels
of several European countries, including Greece, Spain, Ireland,
Italy, and Portugal. These events have adversely affected the
exchange rate of the euro and may continue to significantly affect
every country in Europe. For some countries, the ability to repay
sovereign debt is in question, and default is possible, which could
affect their ability to borrow in the future. For example, Greece
has been required to impose harsh austerity measures on its
population to receive financial aid from the International Monetary
Fund and EU member countries. These austerity measures have also
led to social uprisings within Greece, as citizens have protested
– at times violently – the actions of their government.
The persistence of these factors may seriously reduce the economic
performance of Greece and pose serious risks for the
country’s economy in the future. Furthermore, there is the
possibility of contagion that could occur if one country defaults
on its debt, and that a default in one country could trigger
declines and possible additional defaults in other countries in the
region.
Responses
to the financial problems by European governments, central banks
and others, including austerity measures and reforms, may not work,
may result in social unrest and may limit future growth and
economic recovery or have other unintended consequences. Further
defaults or restructurings by governments and other entities of
their debt could have additional adverse effects on economies,
financial markets, and asset valuations around the world. In
addition, one or more countries may abandon the euro, the common
currency of the EU, and/or withdraw from the EU alongside the UK,
as discussed below. The impact of these actions, especially if they
occur in a disorderly fashion, is not clear but could be
significant and far-reaching.
In June
2016, the UK held a referendum resulting in a vote in favor of the
exit of the UK from the EU (known as “Brexit”). Because
of the referendum, Standard & Poor’s
(“S&P”) downgraded the UK’s credit rating
from “AAA” to “AA” and the EU’s
credit rating from “AA+” to “AA” in the
days that followed the vote. Other credit ratings agencies have
taken similar actions. On March 29, 2017, the UK invoked article 50
of the Lisbon Treaty, notifying the European Council of the
UK’s intention to withdraw from the EU by the end of March
2019. The effects of Brexit will depend, in part, on
whether the United Kingdom is able to negotiate agreements to
retain access to EU markets including, but not limited to, trade
and finance agreements. Brexit could lead to legal and
tax uncertainty and potentially divergent national laws and
regulations as the United Kingdom determines which EU laws to
replace or replicate. The extent of the impact of the withdrawal in
the United Kingdom and in global markets as well as any associated
adverse consequences remain unclear, and the uncertainty may have a
significant negative effect on the value of a Fund’s
investments. While certain measures are being proposed and/or will
be introduced, at the EU level or at the member state level, which
are designed to minimize disruption in the financial markets, it is
not currently possible to determine whether such measures would
achieve their intended effects.
On
January 31, 2020, the United Kingdom withdrew from the EU
subject to a withdrawal agreement that permits the United Kingdom
to effectively remain in the EU from an economic perspective during
a transition phase that expires at the end of 2020. During this
transition phase, the United Kingdom and the EU will seek to
negotiate and finalize a new, more permanent trade deal.
Negotiators representing the United Kingdom and EU came to a
preliminary trade agreement on December 24, 2020. The trade
agreement must be ratified by the UK Parliament and the European
Parliament. If approved, the agreement would take effect on
January 1, 2021, and many aspects of the United Kingdom-EU
trade relationship would remain subject to further negotiation. Due
to political uncertainty, it is not possible to anticipate whether
the United Kingdom and the EU will be able to agree on and
implement a new trade agreement or what the nature of such trade
arrangement will be. In the event that no agreement is reached, the
relationship between the United Kingdom and the EU would be based
on the World Trade Organization rules.
DEPOSITARY RECEIPTS
The
Fund’s investment in securities of foreign companies may be
in the form of depositary receipts or other securities convertible
into securities of foreign issuers. ADRs are dollar-denominated
receipts representing interests in the securities of a foreign
issuer, which securities may not necessarily be denominated in the
same currency as the securities into which they may be converted.
ADRs are receipts typically issued by United States banks and trust
companies which evidence ownership of underlying securities issued
by a foreign corporation. Generally, ADRs in registered form are
designed for use in domestic securities markets and are traded on
exchanges or over-the-counter in the United States. Global
Depositary Receipts (“GDRs”), European Depositary
Receipts (“EDRs”), and International Depositary
Receipts (“IDRs”) are similar to ADRs in that they are
certificates evidencing ownership of shares of a foreign issuer,
however, GDRs, EDRs, and IDRs may be issued in bearer form and
denominated in other currencies, and are generally designed for use
in specific or multiple securities markets outside the U.S. EDRs,
for example, are designed for use in European securities markets
while GDRs are designed for use throughout the world. Depositary
receipts will not necessarily be denominated in the same currency
as their underlying securities.
The
Fund will not invest in any unlisted Depositary Receipts or any
Depositary Receipt that the Adviser deems to be illiquid or for
which pricing information is not readily available. In addition,
all Depositary Receipts generally must be sponsored. However, the
Fund may invest in unsponsored Depositary Receipts under certain
limited circumstances. The issuers of unsponsored Depositary
Receipts are not obligated to disclose material information in the
United States, and, therefore, there may be less information
available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary
Receipts. The use of Depositary Receipts may increase tracking
error relative to an Underlying Index.
SPECIAL PURPOSE ACQUISITION COMPANIES
The
Fund may invest in stock, warrants, and other securities of special
purpose acquisition companies (“SPACs”) or similar
special purpose entities that pool funds to seek potential
acquisition opportunities. Unless and until an acquisition is
completed, a SPAC generally invests its assets (less a portion
retained to cover expenses) in U.S. Government securities, money
market fund securities, and cash. If an acquisition that meets the
requirements for the SPAC is not completed within a pre-established
period of time, the invested funds are returned to the
entity’s shareholders, less certain permitted expense, and
any warrants issued by the SPAC will expire worthless. Because
SPACs and similar entities are in essence blank check companies
without an operating history or ongoing business other than seeking
acquisitions, the value of their securities is particularly
dependent on the ability of the entity’s management to
identify and complete a profitable acquisition. SPACs may pursue
acquisitions only within certain industries or regions, which may
increase the volatility of their prices. In addition, these
securities, may be traded in the over-the-counter market, may be
considered illiquid and/or be subject to restrictions on
resale.
REAL ESTATE INVESTMENT TRUSTS (“REITS”)
A REIT
is a corporation or business trust (that would otherwise be taxed
as a corporation) that meets the definitional requirements of 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 90% or more of its otherwise taxable income to
shareholders.
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
may be affected by changes in underlying real estate values, which
may have an exaggerated effect to the extent that REITs in which a
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.
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 a
Fund, a shareholder will bear not only his or her 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 favorable tax
treatment under the 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.
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. There can be no
guarantee that the United States will be able to meet its payment
obligations with respect to such securities. Additionally, market
prices and yields of securities supported by the full faith and
credit of the U.S. government may decline or be negative for short
or long periods of time. 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 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 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.
The total public debt of the United States as a percentage of gross
domestic product has grown rapidly since the beginning of the
2008-2009 financial downturn. Although high debt levels do not
necessarily indicate or cause economic problems, they may create
certain systemic risks if sound debt management practices are not
implemented. A high national debt can raise concerns that the U.S.
government will not be able to make principal or interest payments
when they are due. This increase has also necessitated the need for
the U.S. Congress to negotiate adjustments to the statutory debt
limit to increase the cap on the amount the U.S. government is
permitted to borrow to meet its existing obligations and finance
current budget deficits. In August 2011, Standard &
Poor’s lowered its long-term sovereign credit rating on the
U.S. In explaining the downgrade at that time, S&P cited, among
other reasons, controversy over raising the statutory debt limit
and growth in public spending. On August 2, 2019, following passage
by Congress, the President of the United States signed the
Bipartisan Budget Act of 2019, which suspends the statutory debt
limit through July 31, 2021. Any controversy or ongoing uncertainty
regarding the statutory debt ceiling negotiations may impact the
U.S. long-term sovereign credit rating and may cause market
uncertainty. As a result, market prices and yields of securities
supported by the full faith and credit of the U.S. government may
be adversely affected.
The
value of direct or indirect investments in fixed income securities
will fluctuate with changes in interest rates. Typically, a rise in
interest rates causes a decline in the value of fixed income
securities. On the other hand, if rates fall, the value of the
fixed income securities generally increases. In general, the market
price of fixed income securities with longer maturities will
increase or decrease more in response to changes in interest rates
than shorter-term securities. The value of direct or indirect
investments in fixed income securities may be affected by the
inability of issuers to repay principal and interest or illiquidity
in debt securities markets.
●
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”).
●
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.
●
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
respond to a greater degree to interest rate changes than are
non-zero coupon securities with similar maturity and credit
qualities.
●
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 a
Fund’s Shares
BORROWING
Although
the Fund does not intend to borrow money, the Fund may do so to the
extent permitted by the 1940 Act. Under the 1940 Act, the Fund may
borrow up to one-third (1/3) of its net assets. The Fund will
borrow money only for short-term or emergency purposes. Such
borrowing is not for investment purposes and will be repaid by the
Fund promptly. Borrowing will tend to exaggerate the effect on net
asset value (“NAV”) of any increase or decrease in the
market value of the Fund’s portfolio. Money borrowed will be
subject to interest costs that may or may not be recovered by
earnings on the securities purchased. The Fund also may be required
to maintain minimum average balances in connection with a borrowing
or to pay a commitment or other fee to maintain a line of credit;
either of these requirements would increase the cost of borrowing
over the stated interest rate.
OTHER SHORT-TERM INSTRUMENTS
The
Fund may invest in short-term instruments, including money market
instruments, on an ongoing basis to provide liquidity or for other
reasons. Money market instruments are generally short-term
investments that may include but are not limited to:
(i) shares of money market funds; (ii) obligations issued
or guaranteed by the U.S. government, its agencies or
instrumentalities (including government-sponsored enterprises);
(iii) negotiable certificates of deposit (“CDs”),
bankers’ acceptances, fixed time deposits and other
obligations of U.S. and foreign banks (including foreign branches)
and similar institutions; (iv) commercial paper rated at the
date of purchase “Prime-1” by Moody’s or
“A-1” by S&P, or if unrated, of comparable quality
as determined by the Adviser; (v) non-convertible corporate
debt securities (e.g.,
bonds and debentures) with remaining maturities at the date of
purchase of not more than 397 days and that satisfy the rating
requirements set forth in Rule 2a-7 under the 1940 Act; and
(vi) short-term U.S. dollar-denominated obligations of foreign
banks (including U.S. branches) that, in the opinion of the
Adviser, are of comparable quality to obligations of U.S. banks
which may be purchased by the Fund. Any of these instruments may be
purchased on a current or a forward-settled basis. Money market
instruments also include shares of money market funds. Time
deposits are non-negotiable deposits maintained in banking
institutions for specified periods of time at stated interest
rates. Bankers’ acceptances are time drafts drawn on
commercial banks by borrowers, usually in connection with
international transactions. Short-term instruments that are
fixed-income instruments are generally subject to the same risks as
other fixed-income instruments, including credit risk and interest
rate risk, and short-term instruments that are money market funds
are generally subject to the same risks as other investment
companies, including the obligation to the pay the Fund’s
share of the underlying fund’s expenses.
INVESTMENT COMPANIES
The
Fund may invest in the securities of other investment companies,
including money market funds, subject to applicable limitations
under Section 12(d)(1) of the 1940 Act and the rules
thereunder. Pursuant to Section 12(d)(1), the Fund may invest in
the securities of another investment company (the “acquired
company”) provided that the Fund, immediately after such
purchase or acquisition, does not own in the aggregate:
(i) more than 3% of the total outstanding voting stock of the
acquired company; (ii) securities issued by the acquired
company having an aggregate value in excess of 5% of the value of
the total assets of the Fund; or (iii) securities issued by
the acquired company and all other investment companies (other than
Treasury stock of the Fund) having an aggregate value in excess of
10% of the value of the total assets of the Fund. To the extent
allowed by law or regulation, the Fund may invest its assets in
securities of investment companies that are money market funds in
excess of the limits discussed above.
If the
Fund invests in and, thus, is a shareholder of, another investment
company, the Fund’s shareholders will indirectly bear the
Fund’s proportionate share of the fees and expenses paid by
such other investment company, including advisory fees, in addition
to both the management fees payable directly by the Fund to the
Fund’s own investment adviser and the other expenses that the
Fund bears directly in connection with the Fund’s own
operations (affiliated ETFs will not charge duplicate fees and
expenses).
Section 12(d)(1)
of the 1940 Act restricts investments by registered investment
companies in securities of other registered investment companies,
including the Fund. The acquisition of a Fund’s Shares by
registered investment companies is subject to the restrictions of
Section 12(d)(1) of the 1940 Act and the rules thereunder,
except as may be permitted by exemptive rules under the 1940 Act or
as may at some future time be permitted by an exemptive order that
permits registered investment companies to invest in the Fund
beyond the limits of Section 12(d)(1), subject to certain
terms and conditions, including that the registered investment
company enter into an agreement with the Fund regarding the terms
of the investment.
The
Fund may rely on Section 12(d)(1)(F) and Rule 12d1-3 of the 1940
Act, which provide an exemption from Section 12(d)(1) that
allows the Fund to invest all of its assets in other registered
funds, including ETFs, if, among other conditions: (a) the
Fund, together with its affiliates, acquires no more than three
percent of the outstanding voting stock of any acquired fund, and
(b) the sales load charged on the Fund’s shares is no greater
than the limits set forth in Rule 2830 of the Conduct Rules of the
Financial Industry Regulatory Authority, Inc.
(“FINRA”).
The
Fund will incur higher and duplicative expenses when it invests in
other investment companies such as mutual funds and ETFs. There is
also the risk that the Fund may suffer losses due to the investment
practices of the underlying funds. When the Fund invests in other
investment companies, the Fund will be subject to substantially the
same risks as those associated with the direct ownership of
securities held by such investment companies.
LENDING PORTFOLIO SECURITIES
The
Fund may lend portfolio securities to certain creditworthy
borrowers in U.S. and
non-U.S. markets in an amount not to exceed one-third
(33 1/3%) of the value of its total assets. The
borrowers provide collateral that is maintained in an amount at
least equal to the current value of the securities loaned. The Fund
may terminate a loan at any time and obtain the return of the
securities loaned. The Fund receives the value of any interest or
cash or non-cash distributions paid on the loaned securities.
Distributions received on loaned securities in lieu of dividend
payments (i.e., substitute
payments) would not be considered qualified dividend
income.
The
borrower will be entitled to receive a fee based on the amount of
cash collateral. The Fund receives compensation in the form of
fees. The amount of fees depends on a number of factors including
the type of security and length of the loan. Any cash collateral
may be reinvested in certain short-term instruments either directly
on behalf of the lending Fund or through one or more joint accounts
or money market funds, which may include those managed by the
Adviser. In that case, the Fund would also be compensated by the
amount earned on the reinvestment of cash collateral.
The
Fund may pay a portion of the interest or fees earned from
securities lending to a borrower as described above, and to one or
more securities lending agents approved by the Board who administer
the lending program for the Fund in accordance with guidelines
approved by the Board. In such capacity, the lending agent causes
the delivery of loaned securities from the Fund to borrowers,
arranges for the return of loaned securities to the Fund at the
termination of a loan, requests deposit of collateral, monitors the
daily value of the loaned securities and collateral, requests that
borrowers add to the collateral when required by the loan
agreements, and provides recordkeeping and accounting services
necessary for the operation of the program.
Securities
lending involves exposure to certain risks, including operational
risk (i.e., the risk of
losses resulting from problems in the settlement and accounting
process), “gap” risk (i.e., the risk of a mismatch between
the return on cash collateral reinvestments and the fees the Fund
has agreed to pay a borrower), and credit, legal, counterparty and
market risk. Counterparty risk may be greater when the Fund loans
its securities to a single or small group of counterparties. In the
event a borrower does not return the Fund’s securities as
agreed, the Fund may experience losses if the proceeds received
from liquidating the collateral do not at least equal the value of
the loaned security at the time the collateral is liquidated plus
the transaction costs incurred in purchasing replacement
securities.
The
Fund will generally seek to recall securities on loan to vote on
matters if the result of the vote may materially affect the
investment. However, in some circumstances the Fund may be unable
to recall the securities in time to vote or may determine that the
benefits to the Fund of voting are outweighed by the direct or
indirect costs of such a recall. In these circumstances, loaned
securities may be voted or not voted in a manner adverse to the
best interests of the Fund.
FUTURE DEVELOPMENTS
The
Fund may take advantage of opportunities in the area of options and
futures contracts, options on futures contracts, warrants, swaps
and any other investments which are not presently contemplated for
use by the Fund or which are not currently available but which may
be developed, to the extent such opportunities are both consistent
with the Fund’s investment objective and legally permissible
for the Fund. Before entering into such transactions or making any
such investment, the Fund will provide appropriate
disclosure.
SPECIAL CONSIDERATIONS AND RISKS
A
discussion of the risks associated with an investment in the Fund
is contained in the Prospectus. The discussion below supplements,
and should be read in conjunction with, the
Prospectus.
GENERAL
Investment
in the Fund should be made with an understanding that the value of
the Fund’s portfolio securities may fluctuate in accordance
with changes in the financial condition of the issuers of the
portfolio securities, the value of securities generally and other
factors.
An
investment in the Fund should also be made with an understanding of
the risks inherent in an investment in securities, including the
risk that the financial condition of issuers may become impaired or
that the general condition of the securities markets may
deteriorate (either of which may cause a decrease in the value of
the portfolio securities and thus in the value of Shares).
Securities are susceptible to general market fluctuations and to
volatile increases and decreases in value as market confidence in
and perceptions of their issuers change. These investor perceptions
are based on various and unpredictable factors including
expectations regarding government, economic, monetary and fiscal
policies, inflation and interest rates, economic expansion or
contraction, and global or regional political, economic and banking
crises.
Holders
of common stocks incur more risk than holders of preferred stocks
and debt obligations because common stockholders, as owners of the
issuer, have generally inferior rights to receive payments from the
issuer in comparison with the rights of creditors of, or holders of
debt obligations or preferred stocks issued by, the issuer.
Further, unlike debt securities which typically have a stated
principal amount payable at maturity (whose value, however, will be
subject to market fluctuations prior thereto), or preferred stocks
which typically have a liquidation preference and which may have
stated optional or mandatory redemption provisions, common stocks
have neither a fixed principal amount nor a maturity. Common stock
values are subject to market fluctuations as long as the common
stock remains outstanding.
CYBER
SECURITY RISK
Investment
companies, such as the Fund, and their service providers may be
subject to operational and information security risks resulting
from cyber attacks. Cyber attacks include, among other behaviors,
stealing or corrupting data maintained online or digitally, denial
of service attacks on websites, the unauthorized release of
confidential information or various other forms of cyber security
breaches. Cyber attacks affecting the Fund or the Adviser,
custodian, transfer agent, intermediaries and other third-party
service providers may adversely impact the Fund. For instance,
cyber attacks may interfere with the processing of shareholder
transactions, impact the Fund’s ability to calculate its net
asset value, cause the release of private shareholder information
or confidential company information, impede trading, subject the
Fund to regulatory fines or financial losses, and cause
reputational damage. The Fund may also incur additional costs for
cyber security risk management purposes. Similar types of cyber
security risks are also present for issuers of securities in which
the Fund invests, which could result in material adverse
consequences for such issuers, and may cause the Fund’s
investment in such portfolio companies to lose value.
RECENT
MARKET EVENTS
Beginning
in the first quarter of 2020, financial markets in the United
States and around the world experienced extreme and in many cases
unprecedented volatility and severe losses due to the global
pandemic caused by COVID-19, a novel coronavirus. The pandemic has
resulted in a wide range of social and economic disruptions,
including closed borders, voluntary or compelled quarantines of
large populations, stressed healthcare systems, reduced or
prohibited domestic or international travel, supply chain
disruptions, and so-called “stay-at-home” orders
throughout much of the United States and many other countries. The
fall-out from these disruptions has included the rapid closure of
businesses deemed “non-essential” by federal, state, or
local governments and rapidly increasing unemployment, as well as
greatly reduced liquidity for certain instruments at times. Some
sectors of the economy and individual issuers have experienced
particularly large losses. Such disruptions may continue for an
extended period of time or reoccur in the future to a similar or
greater extent. In response, the U.S. government and the Federal
Reserve have taken extraordinary actions to support the domestic
economy and financial markets, resulting in very low interest rates
and in some cases negative yields. It is unknown how long
circumstances related to the pandemic will persist, whether they
will reoccur in the future, whether efforts to support the economy
and financial markets will be successful, and what additional
implications may follow from the pandemic. The impact of these
events and other epidemics or pandemics in the future could
adversely affect Fund performance.
TAX
RISKS
As with
any investment, you should consider how your investment in Shares
of the Fund will be taxed. The tax information in the Prospectus
and this SAI is provided as general information. You should consult
your own tax professional about the tax consequences of an
investment in Shares of the Fund.
Unless
your investment in Shares is made through a tax-exempt entity or
tax-deferred retirement account, such as an individual retirement
account, you need to be aware of the possible tax consequences when
the Fund makes distributions or you sell Shares.
FURTHER INFORMATION ABOUT THE REGULATION OF CANNABIS
United States
The
risk of strict enforcement of federal marijuana laws in light of
recent Congressional activity, judicial holdings, and stated
federal policy remains uncertain. The U.S. Supreme Court declined
to hear a case brought by San Diego County, California that sought
to establish federal preemption over state medical marijuana laws.
The preemption claim was rejected by every court that reviewed the
case, holding that Congress does not have the authority to compel
the states to direct their law enforcement personnel to enforce
federal laws. The U.S. Supreme Court had previously held that, as
long as the Controlled Substances Act (“CSA”) contains
prohibitions against marijuana, under the Commerce Clause of the
United States Constitution, the United States may criminalize the
production and use of homegrown cannabis even where states approve
its use for medical purposes.
In an
effort to provide guidance to federal law enforcement, the
Department of Justice (“DOJ”) has issued Guidance
Regarding Marijuana Enforcement to all United States Attorneys in a
memorandum from Deputy Attorney General David Ogden on October 19,
2009, in a memorandum from Deputy Attorney General James Cole on
June 29, 2011 and in a memorandum from Deputy Attorney General
James Cole on August 29, 2013 (the “Cole Memorandum”).
Each memorandum states that the DOJ is committed to the enforcement
of the CSA, but, the DOJ is also committed to using its limited
investigative and prosecutorial resources to address the most
significant threats in the most effective, consistent, and rational
way.
The
Cole Memorandum provides updated guidance to federal prosecutors
concerning marijuana enforcement in light of state laws legalizing
medical and recreational marijuana possession in small
amounts.
The
memorandum sets forth certain enforcement priorities that are
important to the federal government:
●
Distribution of
marijuana to children;
●
Revenue from the
sale of marijuana going to criminals;
●
Diversion of
medical marijuana from states where it is legal to states where it
is not;
●
Using state
authorized marijuana activity as a pretext for other illegal drug
activity;
●
Preventing violence
in the cultivation and distribution of marijuana;
●
Preventing impaired
driving;
●
Growing marijuana
on federal property; and
●
Preventing
possession or use of marijuana on federal property.
In
January 2018, former Attorney General,
Jeff Sessions rescinded the Cole Memorandum.
However, the federal government, to date, has not determined to
devote federal government resources to companies operating in
states which have passed laws legalizing medical and recreational
marijuana use whose businesses are operating in conformity with the
provisions of the Cole Memorandum. President Biden has
nominated Merrick Garland to serve as Attorney General in his
administration. It is not yet known whether the Department of
Justice under President Biden and Attorney General Garland, if
confirmed, will re-adopt the Cole Memorandum or announce a
substantive cannabis enforcement policy. Currently, the
Rohrabacher-Blumenauer amendment to appropriations legislation
prohibits the DOJ from using federal funds to prevent states from
implementing laws that authorize medical marijuana use, possession,
distribution, and cultivation. In the event the
Rohrabacher-Blumenauer amendment (also referred to as the
Rohrabacher-Farr amendment) is not renewed by Congress, the DOJ may
begin using federal funds to prevent states from implementing such
laws.
On
December 20, 2018, President Trump signed the Agriculture
Improvement Act of 2018 (or the “Farm Bill”) that
effectively removes hemp from the list of controlled substances and
allows states to regulate its production, commerce and research
with approval from the United States Department of Agriculture
(“USDA”). Hemp is a cousin to marijuana, as both are
classified under the same botanical category of Cannabis sativa.
The major difference between the two is that recreational marijuana
has significant amounts of tetrahydrocannabinol (“THC”)
, whereas industrial hemp has virtually no THC (less than 0.3%).
This 0.3% THC in industrial hemp is not enough to provide
psychotropic effects, which renders industrial hemp useless for
recreational use or abuse. Products made from the seeds (incapable
of germination) and the mature stalks of the Cannabis sativa plant
are legal products that could potentially be used in pharmaceutical
products, nutritional products, cosmetics, plastics, fuel,
textiles, and medical delivery devices. Under the Farm Bill, state
departments of agriculture must consult with the state’s
governor and chief law enforcement officer to devise a plan that
must be submitted to the Secretary of USDA. A state’s plan to
license and regulate hemp can only commence once the Secretary of
USDA approves that state’s plan.
The
2018 Farm Bill delegates to the Food and Drug Administration
(“FDA”) responsibility for regulating products
containing hemp or derivatives thereof (including cannabidiol
(“CBD”)) under the Federal Food, Drug, and Cosmetic Act
(the “FD&C”). The FD&C Act establishes a
comprehensive federal scheme to regulate food, drugs, and
cosmetics, among other things. Under the FD&C Act, the
introduction of “new drugs” into interstate commerce
without meeting certain regulatory approvals is prohibited. In
addition, the FD&C Act proscribes the introduction of
adulterated or misbranded drugs into interstate commerce. With the
passing of the 2018 Farm Bill, the FDA issued a statement
“clarifying” its position on the regulation of products
containing cannabis and cannabis-derived products (the
“Statement”).
The
Statement begins with the broad proposition that the FDA will
“treat products containing cannabis or cannabis-derived
compounds as we do any other FDA-regulated products”
regardless of the source of the substance. Despite this position,
the Statement recognizes the “growing public interest in
cannabis and cannabis-derived products, including [CBD],” as
well as the “potential opportunities that cannabis or
cannabis-derived products.” The FDA then promises to
“continue to take steps to make the pathways for the
marketing of these products more efficient.” Conservative
estimates suggest that it will take another 18-24 months for the
FDA to implement these steps; the FDA has a designated group to
review the issue.
Substantively,
the Statement provides that “[c]annabis and cannabis-derived
products claiming in their marketing and promotion materials that
they are intended for use in the diagnosis, cure, mitigation,
treatment, or prevention of diseases (such as cancer,
Alzheimer’s disease, psychiatric disorders and diabetes) are
considered new drugs or new animal drugs and must go through the
FDA drug approval process for human or animal use before they are
marketed in the U.S.” The Statement also provides that
“it’s unlawful under the FD&C Act to introduce food
containing added CBD or THC into interstate commerce, or to market
CBD or THC products as, or in, dietary supplements. . . . because
both CBD and THC are active ingredients in FDA-approved drugs
(Epidiolex) and were the subject of substantial clinical
investigations before they were marketed as foods or dietary
supplements.” Considering that the FDA considers CBD a drug
and that ingestible products cannot be sold with CBD in them unless
and until they receive regulatory approval, there is regulatory and
financial risk to any company selling such products and, thus, to
the Fund’s investment in those companies.
That
said, a careful reading of the Statement suggests that the
FDA’s enforcement priorities involve only the most serious
health claims. In fact, since 2015, the FDA has issued warning
letters to twenty-two different entities: six in 2015, eight in
2016, four in 2017, one in 2018, and (to date) four in 2019 thus
far. A cursory reading of these letters supports the above
conclusion that the FDA is mainly focusing on serious health
claims. At bottom, “when a product is in violation of the
FD&C Act, the FDA considers many factors in deciding whether or
not to initiate an enforcement action. Those factors include, among
other things, agency resources and the threat to the public
health.” Although the FDA has focused only on sending cease
and desist letters to date regarding the marketing of CBD products,
there is a risk that the FDA changes it position and seeks to
further enforce the FD&C Act in a manner that has not been done
to date regarding cannabis-infused products.
On May
31, 2019, the FDA conducted hearings on, among other things, CBD.
The FDA is committed to review this issue further and to develop
regulations to oversee the use of CBD. Unfortunately, there is no
definitive timeframe for the FDA to take action and provide further
guidance on the sale of CBD products. Companies that sell CBD in
dietary supplements and foods have taken the position that CBD was
marketed as a dietary supplement and/or as a conventional food
before the drug was approved or before the new drug investigations
were authorized, and because the FDA has not brought enforcement
action against such companies, this question of fact has not yet
been adjudicated.
Canada
Several
recent court cases have influenced the law governing the medical
marijuana industry in Canada. On February 24, 2016, the Federal
Court of Canada ruled in the case of Allard et al v. Canada that
Canada's Marijuana for Medical Purposes Regulations
(“MMPR”), which governed production, distribution and
use of medical marijuana by creating a regime that provided access
to "licensed producers" of medical marijuana, violated the rights
of patients by limiting patient access medical marijuana. On that
basis, the entire MMPR was declared invalid. Additionally, the
Federal Court of Canada ruled that a previous injunction should be
upheld, allowing patients with an existing personal production
license under the prior legislation to continue to produce their
own medical marijuana, subject to certain conditions.
On June
11, 2015 the Supreme Court of Canada held that the restriction on
the use of non-dried forms of marijuana for medical marijuana users
violates the right to liberty and security of individuals in a
manner that is arbitrary and not in keeping with the principles of
fundamental justice. As a result, the Supreme Court of Canada
declared that the sections of Canada's Controlled Drugs and
Substances Act that prohibit possession and trafficking of
non-dried forms of marijuana no longer have force and effect to the
extent that they prohibit a person with medical authorization from
possessing cannabis derivatives for medical purposes. This ruling
means that medical marijuana patients authorized to possess and use
medical marijuana are no longer limited to using dried forms of
marijuana and may now consume marijuana and its derivative forms
for medical purposes.
As a
result of these court cases, on August 11, 2016, Health Canada, the
Canadian department with responsibility for national public health,
announced the new Access to Cannabis for Medical Purposes
Regulations (“ACMPR”), which took effect on August 24,
2016, to replace the MMPR. The ACMPR will allow Canadians who have
been authorized by their health care practitioner, and who are
registered with Health Canada, to produce a limited amount of
medical marijuana for their own medical purposes, or to designate
someone who is registered with Health Canada to produce it for
them, in addition to obtaining marijuana products from licensed
producers, as was permitted under the MMPR. Starting materials such
as plants or seeds are to be obtained from licensed producers
only.
On
October 19, 2015, the Liberal Party of Canada obtained a majority
government in Canada. The Liberal Party has committed to the
legalization of recreational cannabis in Canada. On June 30, 2016,
the Canadian Federal Government established the Task Force on
Cannabis Legalization and Regulation (the “Task Force”)
to seek input on the design of a new system to legalize, strictly
regulate and restrict access to marijuana. The Task Force has
completed its review and published a report dated November 30,
2016, which outlines its recommendations. The extent and impact of
any regulatory changes that may result from the Task Force's report
are unknown and may have a negative impact on the value of the
Fund's investments.
Prime
Minister Justin Trudeau introduced legislation in April 2017 to
legalize the recreational use of marijuana in Canada. The House of
Commons of Canada initially passed the legalization legislation in
November 2017. After amendments passed by the Senate of Canada, the
House passed a final version on June 18, 2018, to which the Senate
voted in favor on June 19, 2018. On June 20, 2018, Prime Minister
Trudeau announced that recreational use of cannabis would no longer
violate Canadian criminal law effective October 17, 2018. As of the
date of this Statement of Additional Information, the legal
cannabis market in Canada is novel and still
developing.
United Kingdom
Cannabis
is a Class B drug under the law of the United Kingdom
(“UK”) and its possession and sale are generally
illegal. There has been little progress in the United Kingdom
towards the general legalization of the use and possession of
marijuana. However, effective November 1, 2018, the law was changed
to give specialist doctors the option to legally issue
prescriptions for cannabis-based medicines when they believe that
their patients could benefit. A product license is necessary before
cannabis-based products can be legally sold, supplied or advertised
in the UK. In the UK, licenses to cultivate, possess and supply
cannabis for medical research may be granted by the Home Office. If
a company in which the Fund invests fails to receive the necessary
licenses, it may not be in a position to conduct its business in
the United Kingdom.
Correlation and Tracking Risk
Several factors may affect the Fund's ability to obtain its daily
leveraged investment objective. Among these factors are: (1)
Fund expenses, including brokerage expenses and commissions and
financing costs related to derivatives (which may be increased by
high portfolio turnover); (2) less than all of the securities in
the Index being held by the Fund and securities not included in the
Index being held by the Fund; (3) an imperfect correlation between
the performance of instruments held by the Fund, such as other
investment companies, including ETFs, futures contracts and
options, and the performance of the underlying securities in the
cash market comprising an index; (4) bid-ask spreads; (5) the Fund
holding instruments that are illiquid or the market for which
becomes disrupted; (6) the need to conform the Fund’s
portfolio holdings to comply with the Fund’s investment
restrictions or policies, or regulatory or tax law requirements;
(7) market movements that run counter to the Fund’s
investments (which will cause divergence between the Fund and the
Index over time due to the mathematical effects of leveraging); and
(8) disruptions and illiquidity in the markets for securities or
derivatives held by the Fund.
While index futures and options contracts closely correlate with
the applicable indices over long periods, shorter-term
deviation, such as on a daily basis, does occur with these
instruments. As a result, the Fund’s short-term performance
will reflect such deviation from the Index. The Fund may use a
combination of swaps on the Index and swaps on an ETF whose
investment objective is to track the performance of the same, or a
substantially similar index to achieve its investment objective.
The reference ETF may not closely track the performance of the
Index due to fees and other costs borne by the ETF and other
factors. Thus, to the extent that the Fund invests in swaps that
use an ETF as a reference asset, the Fund may be subject to greater
correlation risk and may not achieve as high a degree of leveraged
correlation with the Index as it would if the Fund used swaps that
utilized the Index as the reference asset. Any financing, borrowing
or other costs associated with using derivatives may also reduce
the Fund’s return.
Furthermore, the Fund has an investment objective to seek daily
investment results, before fees and expenses, that corresponds to
the performance of two times (2x) the daily performance of the
Index for a single day, not for any other period. A “single
day” is measured from the time the Fund calculates its NAV to
the time of the Fund’s next NAV calculation. While a close
correlation of the Fund to its benchmark may be achieved on any
single day, the Fund’s performance for any other period is
the result of its return for each day compounded over the period.
This usually will differ in amount and possibly even direction from
two times (2x) the daily return of the Index for the same period,
before accounting for fees and expenses, as further described in
the Prospectus and below.
In
addition, the Adviser will attempt to position the Fund’s
portfolio to ensure that the Fund does not gain or lose more than
90% of its NAV on a given day. As a consequence, the Fund’s
portfolio should not be responsive to Index movements of more than
45% in a given day. For example, for the Fund, if the Index were to
gain 50%, its gains should be limited to a daily gain of 90% (i.e.
two times (2x) 45%) rather than 100% (i.e. two times (2x)
50%).
Special Note Regarding the Correlation Risks of the
Funds. As discussed in the
Prospectus, the Fund is “leveraged” in the sense that
it has an investment objective to match 200% of the performance of
its Underlying Index on a given day. The Fund is subject to all of
the correlation risks described in the Prospectus. In addition,
there is a special form of correlation risk that derives from the
Fund’s use of leverage, which is that for periods greater
than one day, the use of leverage tends to cause the performance of
the Fund to be either greater than, or less than, 200% of the
performance of its Underlying Index.
The Fund’s return for periods longer than one day is
primarily a function of the following:
a)
Underlying
Index performance;
b)
Underlying
Index volatility;
c)
Financing
rates associated with leverage;
e)
Dividends
paid by companies in the underlying index; and
The performance for the Fund can be estimated given any set of
assumptions for the factors described above. Illustrated below is
the impact of two factors, Underlying Index volatility and
Underlying Index performance, on the Fund. Underlying Index
volatility is a statistical measure of the magnitude of
fluctuations in the returns of an index and is calculated as the
standard deviation of the natural logarithms of one plus the index
return (calculated daily), multiplied by the square root of the
number of trading days per year (assumed to be 252). The
illustration estimates Fund returns for a number of combinations of
Underlying Index performance and Underlying Index volatility over a
one year period and assumes: a) no dividends paid by the companies
included in the Underlying Index; b) no fund expenses; and c)
borrowing/lending rates (to obtain leverage) of zero percent. If
fund expenses were included, the Fund’s performance would be
lower than shown.
As shown below, the Fund would be expected to lose 6.1% if
the Underlying Index provided no return over a one year period
during which the Underlying Index experienced annualized volatility
of 25%. If the Underlying Index’s annualized volatility were
to rise to 75%, the hypothetical loss for a one year period widens
to approximately 43% for the Fund. At higher ranges of volatility,
there is a chance of a near complete loss of value even if the
Underlying Index is flat. For instance, if the Underlying
Index’s annualized volatility is 100%, it is likely that the
Fund would lose 63.2% of its value, even if the Underlying
Index’s cumulative return for the year was only 0%. The
volatility of ETFs or instruments that reflect the value of the
underlying index such as swaps, may differ from the volatility of a
Fund’s underlying index.
In the tables below, areas shaded green represent those scenarios
where the Fund will outperform (i.e., return more than) the Underlying Index’s
performance times the stated multiple in the Fund’s
investment objective; conversely areas shaded red represent those
scenarios where the Fund will underperform (i.e., return less than) the Underlying Index’s
performance times the stated multiple in the Fund’s
investment objective.
The tables below are intended to underscore the fact that the Fund
is designed as a short-term trading vehicle for investors who
intend to actively monitor and manage their portfolios. It is not
intended to be used by, and is not appropriate for, investors who
do not intend to actively monitor and manage their portfolios. For
additional information regarding correlation and volatility risk
for the Fund, see “Effects of Compounding and Market
Volatility Risk” in the Prospectus
One
Year
Index
|
200%
One
Year
Index
|
Volatility Rate
|
Return
|
Return
|
10%
|
25%
|
50%
|
75%
|
100%
|
-60%
|
-120%
|
-84.2%
|
-85.0%
|
-87.5%
|
-90.9%
|
-94.1%
|
-50%
|
-100%
|
-75.2%
|
-76.5%
|
-80.5%
|
-85.8%
|
-90.8%
|
-40%
|
-80%
|
-64.4%
|
-66.2%
|
-72.0%
|
-79.5%
|
-86.8%
|
-30%
|
-60%
|
-51.5%
|
-54.0%
|
-61.8%
|
-72.1%
|
-82.0%
|
-20%
|
-40%
|
-36.6%
|
-39.9%
|
-50.2%
|
-63.5%
|
-76.5%
|
-10%
|
-20%
|
-19.8%
|
-23.9%
|
-36.9%
|
-53.8%
|
-70.2%
|
0%
|
0%
|
-1.0%
|
-6.1%
|
-22.1%
|
-43.0%
|
-63.2%
|
10%
|
20%
|
19.8%
|
13.7%
|
-5.8%
|
-31.1%
|
-55.5%
|
20%
|
40%
|
42.6%
|
35.3%
|
12.1%
|
-18.0%
|
-47.0%
|
30%
|
60%
|
67.3%
|
58.8%
|
31.6%
|
-3.7%
|
-37.8%
|
40%
|
80%
|
94.0%
|
84.1%
|
52.6%
|
11.7%
|
-27.9%
|
50%
|
100%
|
122.8%
|
111.4%
|
75.2%
|
28.2%
|
-17.2%
|
60%
|
120%
|
153.5%
|
140.5%
|
99.4%
|
45.9%
|
-5.8%
|
The foregoing table is intended to isolate the effect of Underlying
Index volatility and Underlying Index performance on the return of
the Fund. The Fund’s actual returns may be significantly
greater or less than the returns shown above as a result of any of
factors discussed above or under “Effects of Compounding and
Market Volatility Risk” in the Prospectus.
INVESTMENT RESTRICTIONS
The
Trust has adopted the following investment restrictions as
fundamental policies with respect to the Fund. These restrictions
cannot be changed with respect to the Fund without the approval of
the holders of a majority of the Fund’s outstanding voting
securities. For the purposes of the 1940 Act, a “majority of
outstanding shares” means the vote of the lesser of:
(1) 67% or more of the voting securities of the Fund present
at the meeting if the holders of more than 50% of the Fund’s
outstanding voting securities are present or represented by proxy;
or (2) more than 50% of the outstanding voting securities of
the Fund. Except with the approval of a majority of the outstanding
voting securities, the Fund may not:
1.
Concentrate its
investments in an industry or group of industries (i.e. , hold 25% or more of its net
assets in the stocks of a particular industry or group of
industries), except that the Fund will concentrate to approximately
the same extent that its Underlying Index concentrates in the
stocks of such particular industry or group of industries. For
purposes of this limitation, securities of the U.S. government
(including its agencies and instrumentalities), and securities of
state or municipal governments and their political subdivisions are
not considered to be issued by members of any
industry.
2.
Borrow money or
issue senior securities (as defined under the 1940 Act), except to
the extent permitted under the 1940 Act, the rules and regulations
thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to
time.
3.
Lend any security
or make any other loan, except to the extent permitted under the
1940 Act the rules and regulations thereunder or any exemption
therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
4.
Purchase or sell
commodities or real estate, except to the extent permitted under
the 1940 Act, the rules and regulations thereunder or any exemption
therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
5.
Underwrite
securities issued by other persons, except to the extent permitted
under the 1940 Act, the rules and regulations thereunder or any
exemption therefrom, as such statute, rules or regulations may be
amended or interpreted from time to time.
In
addition to the investment restrictions adopted as fundamental
policies as set forth above, the Fund observes the following
restriction, which may be changed without a shareholder
vote.
1.
The Fund will not
invest in illiquid assets in excess of 15% of its net assets. An
illiquid asset is any asset that the Fund reasonably expects cannot
be sold or disposed of in current market conditions in seven
calendar days or less without the sale or disposition significantly
changing the market value of the asset.
If a
percentage limitation is adhered to at the time of investment or
contract, a later increase or decrease in percentage resulting from
any change in value or total or net assets will not result in a
violation of such restriction, except that the percentage
limitations with respect to the borrowing of money will be observed
continuously. In addition, if a Fund’s holdings of illiquid
securities exceeds 15% of net assets because of changes in the
value of the Fund’s investments, the Fund will act in
accordance with Rule 22e-4 under the 1940 Act and will take action
to reduce its holdings of illiquid securities pursuant to its
written liquidity risk management program.
The
following descriptions of certain provisions of the 1940 Act may
assist investors in understanding the above policies and
restrictions:
Concentration. The SEC has defined concentration as
investing 25% or more of an investment company’s net assets
in an industry or group of industries, with certain
exceptions.
Borrowing. The 1940 Act presently allows a fund to borrow
from any bank (including pledging, mortgaging or hypothecating
assets) in an amount up to 33 1/3% of its total assets (not
including temporary borrowings not in excess of 5% of its total
assets).
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.
Lending. Under the 1940 Act, a fund may only make loans if
expressly permitted by its investment policies. The Fund’s
current investment policy on lending is as follows: the Fund may
not make loans if, as a result, more than 33 1/3% of its total
assets would be lent to other parties, except that the Fund may:
(i) purchase or hold debt instruments in accordance with its
investment objective and policies; (ii) enter into repurchase
agreements; and (iii) engage in securities lending subject to the
limitations described in this SAI.
Underwriting. Under the 1940 Act, underwriting securities
involves a fund purchasing securities directly from an issuer for
the purpose of selling (distributing) them or participating in
any such activity either directly or indirectly.
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 a fundamental
investment policy governing such investments. The Fund will not
purchase or sell real estate, except that the Fund may purchase
marketable securities issued by companies which own or invest in
real estate (including REITs).
Commodities. The Fund will not purchase or sell physical
commodities or commodities contracts, except that the Fund may
purchase: (i) marketable securities issued by companies which
own or invest in commodities or commodities contracts; and
(ii) commodities contracts relating to financial instruments,
such as financial futures contracts and options on such
contracts.
EXCHANGE LISTING AND TRADING
A
discussion of exchange listing and trading matters associated with
an investment in the Fund is contained in the summary section of
the Fund’s Prospectus under the “PURCHASE AND SALE OF
FUND SHARES” and in the statutory Prospectus under
“BUYING AND SELLING THE FUND.” The discussion below
supplements, and should be read in conjunction with, such sections
of the Prospectus.
The
Shares of the Fund are approved for listing and trading on the
Exchange, subject to notice of issuance. The Shares trade on the
Exchange at prices that may differ to some degree from their net
asset value. There can be no assurance that the requirements of the
Exchange necessary to maintain the listing of Shares of the Fund
will continue to be met.
There
can be no assurance that the Fund will continue to meet the
requirements of the Exchange necessary to maintain the listing of
Shares. The Exchange will consider the suspension of trading in,
and will initiate delisting proceedings of, the Shares under any of
the following circumstances: (i) if any of the requirements set
forth in the Exchange rules, including compliance with Rule
6c-11(c) under the 1940 Act, are not continuously maintained; (ii)
if, following the initial 12-month period beginning at the
commencement of trading of the Fund, there are fewer than 50
beneficial owners of Shares of the Fund; or (iii) if such
other event shall occur or condition shall exist that, in the
opinion of the Exchange, makes further dealings on the Exchange
inadvisable. The Exchange will remove the Shares of the Fund from
listing and trading upon termination of the Fund.
The
Trust reserves the right to adjust the price levels of Shares in
the future to help maintain convenient trading ranges for
investors. Any adjustments would be accomplished through stock
splits or reverse stock splits, which would have no effect on the
net assets of the Fund.
MANAGEMENT OF THE TRUST
The
following information supplements and should be read in conjunction
with the section in the Prospectus entitled “Fund
Management.”
TRUSTEES AND OFFICERS OF THE TRUST
Board Responsibilities. The management and affairs of the
Trust and the Fund described in this SAI, are overseen by the
Trustees. The Board elects the officers of the Trust who are
responsible for administering the day-to-day operations of the
Trust and the Fund. The Board has approved contracts, as described
below, under which certain companies provide essential services to
the Trust.
Like
most registered investment companies, the day-to-day business of
the Trust, including the management of risk, is performed by third
party service providers, such as the Adviser, the Distributor and
the Fund’s administrator. The Trustees are responsible for
overseeing the Trust’s service providers and, thus, have
oversight responsibility with respect to risk management performed
by those service providers. Risk management seeks to identify and
address risks, i.e., events
or circumstances that could have material adverse effects on the
business, operations, shareholder services, investment performance
or reputation of the Fund. The Fund and its service providers
employ a variety of processes, procedures and controls to identify
various of those possible events or circumstances, to lessen the
probability of their occurrence and/or to mitigate the effects of
such events or circumstances if they do occur. Each service
provider is responsible for one or more discrete aspects of the
Trust’s business (e.g., the Adviser is responsible for
the day-to-day management of the Fund’s portfolio
investments) and, consequently, for managing the risks associated
with that business. The Board has emphasized to the Fund’s
service providers the importance of maintaining vigorous risk
management.
The
Trustees’ role in risk oversight begins before the inception
of the Fund, at which time certain of the Fund’s service
providers present the Board with information concerning the
investment objectives, strategies and risks of the Fund as well as
proposed investment limitations for the Fund. Additionally, the
Fund’s Adviser provides the Board with an overview of, among
other things, its investment philosophy, brokerage practices and
compliance infrastructure. Thereafter, the Board continues its
oversight function as various personnel, including the
Trust’s Chief Compliance Officer, as well as personnel of the
Adviser and other service providers such as the Fund’s
independent accountants, make periodic reports to the Audit
Committee or to the Board with respect to various aspects of risk
management. The Board and the Audit Committee oversee efforts by
management and service providers to manage risks to which the Fund
may be exposed.
The
Board is responsible for overseeing the nature, extent and quality
of the services provided to the Fund by the Adviser and receives
information about those services at its regular meetings. In
addition, on an annual basis, in connection with its consideration
of whether to renew the Advisory Agreements with the Adviser, the
Board meets with the Adviser to review such services. Among other
things, the Board regularly considers the Adviser’s adherence
to the Fund’s investment restrictions and compliance with
various Fund policies and procedures and with applicable securities
regulations. The Board also reviews information about the
Fund’s performance and the Fund’s investments,
including, for example, portfolio holdings schedules.
The
Trust’s Chief Compliance Officer reports regularly to the
Board to review and discuss compliance issues and Fund and Adviser
risk assessments. At least annually, the Trust’s Chief
Compliance Officer provides the Board with a report reviewing the
adequacy and effectiveness of the Trust’s policies and
procedures and those of its service providers, including the
Adviser. The report addresses the operation of the policies and
procedures of the Trust and each service provider since the date of
the last report; any material changes to the policies and
procedures since the date of the last report; any recommendations
for material changes to the policies and procedures; and any
material compliance matters since the date of the last
report.
The
Board receives reports from the Fund’s service providers
regarding operational risks and risks related to the valuation and
liquidity of portfolio securities. The Board has also established a
Fair Value Committee that is responsible for implementing the
Trust’s Fair Value Procedures and providing reports to the
Board concerning investments for which market quotations are not
readily available. Annually, the independent registered public
accounting firm reviews with the Audit Committee its audit of the
Fund’s financial statements, focusing on major areas of risk
encountered by the Fund and noting any significant deficiencies or
material weaknesses in the Fund’s internal controls.
Additionally, in connection with its oversight function, the Board
oversees Fund management’s implementation of disclosure
controls and procedures, which are designed to ensure that
information required to be disclosed by the Trust in its periodic
reports with the SEC are recorded, processed, summarized, and
reported within the required time periods. The Board also oversees
the Trust’s internal controls over financial reporting, which
comprise policies and procedures designed to provide reasonable
assurance regarding the reliability of the Trust’s financial
reporting and the preparation of the Trust’s financial
statements.
From
their review of these reports and discussions with the Adviser, the
Chief Compliance Officer, the independent registered public
accounting firm and other service providers, the Board and the
Audit Committee learn in detail about the material risks of the
Fund, thereby facilitating a dialogue about how management and
service providers identify and mitigate those risks.
The
Board recognizes that not all risks that may affect the Fund can be
identified and/or quantified, that it may not be practical or
cost-effective to eliminate or mitigate certain risks, that it may
be necessary to bear certain risks (such as investment-related
risks) to achieve the Fund’s goals, and that the processes,
procedures and controls employed to address certain risks may be
limited in their effectiveness. Moreover, reports received by the
Trustees as to risk management matters are typically summaries of
the relevant information. Most of the Fund’s investment
management and business affairs are carried out by or through the
Fund’s Adviser and other service providers each of which has
an independent interest in risk management but whose policies and
the methods by which one or more risk management functions are
carried out may differ from the Fund’s and each other’s
in the setting of priorities, the resources available or the
effectiveness of relevant controls. As a result of the foregoing
and other factors, the Board’s ability to monitor and oversee
the management of risk, as a practical matter, is subject to
limitations.
Members of the Board. There are three members of the
Board, two of whom are not interested persons of the Trust, as
that term is defined in the 1940 Act (“Independent
Trustees”). Samuel Masucci, III, an interested person of the
Trust, serves as Chairman of the Board. Terry Loebs serves as the
Trust’s Lead Independent Trustee. As Lead Independent
Trustee, Mr. Loebs acts as a spokesperson for the Independent
Trustees in between meetings of the Board, participates in setting
the agenda for meetings of the Board and separate meetings or
executive sessions of the Independent Trustees, and serves as chair
during executive sessions of the Independent Trustees.
The
Board is comprised of 67% Independent Trustees. There is an Audit
Committee of the Board that is chaired by an Independent Trustee
and comprised solely of Independent Trustees. The Audit Committee
chair presides at the Committee meetings, participates in
formulating agendas for Committee meetings, and coordinates with
management to serve as a liaison between the Independent Trustees
and management on matters within the scope of responsibilities of
the Committee as set forth in its Board-approved
charter.
The
Trust has determined its leadership structure is appropriate given
the specific characteristics and circumstances of the Trust. The
Trust made this determination in consideration of, among other
things, the fact that the Independent Trustees constitute 67%
of the Board, the number of Independent Trustees that constitute
the Board, the amount of assets under management in the Trust, and
the number of funds overseen by the Board. The Board also believes
that its leadership structure facilitates the orderly and efficient
flow of information to the Independent Trustees from Fund
management.
The
Board of Trustees has two standing committees: the Audit Committee
and Nominating Committee. The Audit Committee and Nominating
Committee are each chaired by an Independent Trustee and composed
of Independent Trustees.
Set
forth below are the names, birth years, positions with the Trust,
length of term of office, and the principal occupations and other
directorships held during at least the last five years of each of
the persons currently serving as a Trustee of the Trust, as well as
information about each officer. The business address of each
Trustee and officer is 30 Maple Street, 2nd Floor, Summit,
New Jersey 07901.
Name
and
Year of Birth
|
Position(s)
Held with
the Trust,
Term of
Office and
Length of
Time Served
|
Principal
Occupation(s)
During Past
5 Years
|
Number of
Portfolios in
Fund Complex
Overseen By
Trustee
|
Other
Directorships
Held by
TrusteeDuring Past
5 Years
|
Interested Trustee and Officers
|
Samuel R. Masucci, III(1962)
|
Trustee,
Chairman of the Board and President (since 2012);Secretary (since
2014)
|
Chief
Executive Officer, Exchange Traded Managers Group LLC (since 2013);
Chief Executive Officer, ETF Managers Group LLC (since 2016); Chief
Executive Officer, ETF Managers Capital LLC (commodity pool
operator) (since 2014); Chief Executive Officer (2012–2016)
and Chief Compliance Officer (2012–2014), Factor Advisors,
LLC (investment adviser); President and Chief Executive Officer,
Factor Capital Management LLC (2012-2014) (commodity pool
operator);
|
[ ]
|
None
|
John A. Flanagan, (1946)
|
Treasurer (since
2015)
|
President, John A.
Flanagan CPA, LLC (accounting services) (since 2010); Treasurer,
ETF Managers Trust (since 2015); Chief Financial Officer, ETF
Managers Capital LLC (commodity pool operator) (since
2015)
|
n/a
|
n/a
|
Reshma A. Tanczos(1978)
|
Chief
Compliance Officer (since 2016)
|
Chief
Compliance Officer of ETFMG Financial LLC (since 2017); Chief
Compliance Officer, ETF Managers Group LLC (since 2016); Chief
Compliance Officer, ETF Managers Capital LLC (since 2016); Partner,
Crow & Cushing (law firm) (2007‑2016).
|
n/a
|
n/a
|
Matthew J. Bromberg(1973)
|
Assistant
Secretary (since 2020)
|
General
Counsel and Secretary of Exchange Traded Managers Group LLC (since
2020); ETF Managers Group LLC (since 2020); ETFMG Financial LLC
(since 2020); ETF Managers Capital LLC (since 2020); Partner of
Dorsey & Whitney LLP (law firm) (2019-2020); General Counsel of
WBI Investments, Inc. (2016-2019); Millington Securities, Inc.
(2016-2019); and Partner of Reed Smith (law firm)
(2015-2016).
|
n/a
|
n/a
|
*
Mr. Masucci is an interested Trustee by virtue of his role as the
Chief Executive Officer of the Adviser.
Name
and
Year of Birth
|
Position(s)
Held with
the Trust,
Term of
Office and
Length of
Time Served
|
Principal
Occupation(s)
During Past
5 Years
|
Number of
Portfolios in
Fund Complex
Overseen By
Trustee
|
Other
Directorships
Held by
TrusteeDuring Past
5 Years
|
Independent Trustees
|
Terry
Loebs
(1963)
|
Trustee (since 2014); Lead Independent Trustee (since
2020)
|
Founder
and Managing Member, Pulsenomics LLC (index product development and
consulting firm) (since 2011); Managing Director, MacroMarkets, LLC
(exchange-traded products firm)
(2006–2011).
|
[
]
|
None
|
Eric
Weigel1
(1960)
|
Trustee (since 2020)
|
Little
House Capital (2019-present); Global Focus Capital, LLC
(2013-present); Insight Financial Strategist LLC
(2017-2018).
|
[
]
|
None
|
1 Effective September 4, 2020, Mr. Weigel was appointed as
an Independent Trustee to the Board.
Individual Trustee Qualifications. The Trust has concluded
that each of the Trustees should serve on the Board because of
their ability to review and understand information about the Fund
provided to them by management, to identify and request other
information they may deem relevant to the performance of their
duties, to question management and other service providers
regarding material factors bearing on the management and
administration of the Fund, and to exercise their business judgment
in a manner that serves the best interests of the Fund’s
shareholders. The Trust has concluded that each of the Trustees
should serve as a Trustee based on their own experience,
qualifications, attributes and skills as described
below.
The
Trust has concluded that Mr. Masucci should serve as Trustee
because of the experience he has gained as chief executive officer
of multiple investment advisory firms as well as his knowledge of
and experience in the financial services industry.
The
Trust has concluded that Mr. Loebs should serve as Trustee because
of his diverse experience in capital markets, including asset
pricing and trading, market research, index development, and
exchange-traded products, as well as his knowledge of and
experience in the financial services industry.
The
Trust has concluded that Mr. Weigel should serve as Trustee because
of his more than 30 years of executive experience at investment
advisory firms. He has gained in-depth knowledge of and experience
in the financial services industry.
BOARD COMMITTEES
The
Board has established the following standing
committees:
Audit Committee. The Board has a standing Audit Committee
that is composed of 100% of the Independent Trustees of the Trust,
with Mr. Weigel as Chairman. The Audit Committee operates under a
written charter approved by the Board. The principal
responsibilities of the Audit Committee include: recommending which
firm to engage as the Fund’s independent registered public
accounting firm and whether to terminate this relationship;
reviewing the independent registered public accounting firm’s
compensation, the proposed scope and terms of its engagement, and
the firm’s independence; pre-approving audit and non-audit
services provided by the Fund’s independent registered public
accounting firm to the Trust and certain other affiliated entities;
serving as a channel of communication between the independent
registered public accounting firm and the Trustees; reviewing the
results of each external audit, including any qualifications in the
independent registered public accounting firm’s opinion, any
related management letter, management’s responses to
recommendations made by the independent registered public
accounting firm in connection with the audit, reports submitted to
the Committee by the internal auditing department of the
Fund’s administrator, if any, and management’s
responses to any such reports; reviewing the Fund’s audited
financial statements and considering any significant disputes
between the Trust’s management and the independent registered
public accounting firm that arose in connection with the
preparation of those financial statements; considering, in
consultation with the independent registered public accounting firm
and the Trust’s senior internal accounting executive, if any,
the independent registered public accounting firms’ report on
the adequacy of the Trust’s internal financial controls;
reviewing, in consultation with the Fund’s independent
registered public accounting firm, major changes regarding auditing
and accounting principles and practices to be followed when
preparing the Fund’s financial statements; and other audit
related matters. All of the Independent Trustees currently serve as
members of the Audit Committee. The Audit Committee also acts as
the Trust’s qualified legal compliance committee. During the
fiscal year ended September 30, 2020, the Audit Committee met five
times.
Nominating Committee. The Board has a standing Nominating
Committee that is composed of 100% of the Independent Trustees of
the Trust, with Mr. Loebs as Chairman. The Nominating Committee
operates under a written charter approved by the Board. The
principal responsibility of the Nominating Committee is to
consider, recommend and nominate candidates to fill vacancies on
the Trust’s Board, if any. The Nominating Committee generally
will not consider nominees recommended by shareholders. All of the
Independent Trustees currently serve as members of the Nominating
Committee. During the fiscal year ended September 30, 2020, the
Nominating Committee met two times.
Fair Value Committee. In addition to the Board’s
standing committees described above, the Board has established a
Fair Value Committee that is composed of certain officers of the
Trust and representatives from the Adviser. The Fair Value
Committee operates under procedures approved by the Board. The Fair
Value Committee is responsible for the valuation and revaluation of
any portfolio investments for which market quotations or prices are
not readily available. The Fair Value Committee meets periodically,
as necessary.
OWNERSHIP OF SHARES
The
following table shows the dollar amount ranges of each
Trustee’s “beneficial ownership” of shares of the
Fund as of the end of the most recently completely calendar year.
Dollar amount ranges disclosed are established by the SEC.
“Beneficial ownership” is determined in accordance with
Rule 16a-1(a)(2) under the 1934 Act. As of the date of this
SAI there were no Shares of the Fund outstanding.
Name
|
Dollar Range of Shares of the Fund
|
Aggregate Dollar Range of Shares
(All Funds in the Complex)
|
Interested Trustee
|
Samuel
R. Masucci, III
|
None
|
None
|
Independent Trustees
|
Terry
Loebs
|
None
|
None
|
Eric
Weigel
|
None
|
None
|
COMPENSATION OF THE TRUSTEES AND OFFICER
The
Trustees are expected to receive the following compensation during
the fiscal year ending September 30, 2021. Because Trustee
compensation is covered by the unitary fee paid by the Fund, the
Adviser, and not the Fund, is responsible for compensating the
Trustees.
Name
|
Aggregate
Compensation
|
Pension or
Retirement
Benefits
Accrued as
Part of Fund Expenses
|
Estimated Annual
Benefits
Upon
Retirement
|
Total
Compensation
from the Trust and Fund Complex
|
Interested Trustee
|
Samuel
R. Masucci, III
|
$0
|
$0
|
$0
|
$0
|
Independent Trustees
|
Terry
Loebs
|
$0
|
$0
|
$0
|
$[
]*
|
Eric
Weigel
|
$0
|
$0
|
$0
|
$[
]*
|
*
Compensation reflected does not include certain additional hourly
fees which the Trustees may receive from the Adviser in connection
with special matters relating to the Trust.
CODES OF ETHICS
The
Trust, the Adviser, and ETFMG Financial LLC (the
“Distributor”) have each adopted codes of ethics
pursuant to Rule 17j-1 of the 1940 Act. These codes of ethics
are designed to prevent affiliated persons of the Trust, the
Adviser and the Distributor from engaging in deceptive,
manipulative or fraudulent activities in connection with securities
held or to be acquired by the Fund (which may also be held by
persons subject to the codes of ethics). Each Code of Ethics
permits personnel subject to that Code of Ethics to invest in
securities for their personal investment accounts, subject to
certain limitations, including limitations related to securities
that may be purchased or held by the Fund.
There
can be no assurance that the codes of ethics will be effective in
preventing such activities. Each code of ethics has been filed with
the SEC and may be examined at the office of the SEC in Washington,
D.C. or on the Internet at the SEC’s website at
http://www.sec.gov.
PROXY VOTING POLICIES
Proxies for the Fund’s portfolio securities are voted in
accordance with the Adviser’s proxy voting policies and
procedures, which are set forth in Appendix A to this
SAI.
Information
on how the Fund voted proxies relating to portfolio securities
during the most recent 12 month period ended June 30 is
available (1) without charge, upon request, by calling
1-844-ETF-MGRS
(383-6477) and (2) on the SEC’s website at
www.sec.gov.
INVESTMENT ADVISORY AND OTHER SERVICES
Investment Adviser. ETF
Managers Group, LLC, a Delaware limited liability company
located at 30 Maple Street, 2nd Floor,
Summit, New Jersey 07901, serves as the investment adviser
to the Fund. The Adviser is a wholly-owned subsidiary of Exchange
Traded Managers Group, LLC, an entity controlled by Samuel Masucci,
III, the Adviser’s Chief Executive Officer and a Trustee and
Chairman of the Board of the Trust.
The
Trust and the Adviser have entered into an investment advisory
agreement (the “Advisory Agreement”) with respect to
the Fund. Under the Advisory Agreement, the Adviser serves as the
investment adviser, makes investment decisions for the Fund, and
manages the investment portfolios of the Fund, subject to the
supervision of, and policies established by, the Board. The Adviser
is responsible for trading portfolio securities on behalf of the
Fund, including selecting broker-dealers to execute purchase and
sale transactions as instructed by the Adviser or in connection
with any rebalancing or reconstitution of the Fund’s Index,
subject to the supervision of the Board. The Advisory Agreement
provides that the Adviser shall not be protected against any
liability to the Trust or its shareholders by reason of willful
misfeasance, bad faith or gross negligence generally in the
performance of its duties hereunder or its reckless disregard of
its obligation and duties under the Advisory
Agreement.
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” or 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 voting securities of the Fund, or
by the Adviser on not more than 60 days’ nor less than
30 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.
For its
services, the Adviser receives a fee that is equal to [ ]% per
annum of the average daily net assets of the Fund, calculated daily
and paid monthly. Additionally, under the Investment Advisory
Agreement, the Adviser has agreed to pay all expenses of the Fund,
except for: the fee paid to the Adviser pursuant to the Investment
Advisory Agreement, interest charges on any borrowings, taxes,
brokerage commissions and other expenses incurred in placing orders
for the purchase and sale of securities and other investment
instruments, acquired fund fees and expenses, accrued deferred tax
liability, extraordinary expenses (such as, among other things and
subject to Board approval, certain proxy solicitation costs and
non-standard Board-related expenses and litigation against the
Board, Trustees, Fund, Adviser, and officers of the Adviser), and
distribution (12b-1) fees and expenses.
THE PORTFOLIO MANAGERS
This
section includes information about the Fund’s portfolio
managers, including information about other accounts they manage,
the dollar range of Shares they own and how they are
compensated.
Portfolio Manager Compensation. Samuel R. Masucci, III,
Devin Ryder, Frank Vallario and Donal Bishnoi are the portfolio
managers of the Fund. Their portfolio management compensation
includes a salary and discretionary bonus based on the
profitability of the Adviser. No compensation is directly related
to the performance of the underlying assets.
Portfolio Manager Fund Ownership. As of the date of this
SAI, Samuel R. Masucci, III, Devin Ryder, Frank Vallario and Donal
Bishnoi did not own Shares of the Fund.
Other Accounts
In
addition to the Fund, Samuel R. Masucci, III, Donal Bishnoi, and
Devin Ryder managed the following other accounts for the Adviser as
of [ ], 2021.
Type
of Accounts
|
Total Number of Accounts
|
Total Assets of Accounts
|
Total Number of Accounts with Performance Based Fees
|
Total Assets of Accounts with
Performance Based Fees
|
Registered
Investment Companies
|
|
$
|
|
|
Other
Pooled Investment Vehicles
|
|
$
|
|
|
Other
Accounts
|
|
|
|
|
Description of Material Conflicts of Interest. The portfolio
managers’ management of “other accounts” is not
expected to give rise to potential conflicts of interest in
connection with their management of the Fund’s investments,
on the one hand, and the investments of the other accounts, on the
other. The other accounts may have the same investment objectives
as the Fund. Therefore, a potential conflict of interest may arise
as a result of the identical investment objectives, whereby a
portfolio manager could favor one account over another. Another
potential conflict could include a portfolio manager’s
knowledge about the size, timing and possible market impact of Fund
trades, whereby the portfolio manager could use this information to
the advantage of other accounts and to the disadvantage of the
Fund. However, the Adviser has established policies and procedures
to ensure that the purchase and sale of securities among all
accounts the Adviser manages are fairly and equitably
allocated.
THE DISTRIBUTOR
The
Trust and ETFMG Financial LLC, an affiliate of the Adviser, are
parties to a distribution agreement (the “Distribution
Agreement”), whereby the Distributor acts as principal
underwriter for the Trust’s shares and distributes the shares
of the Fund. Shares are continuously offered for sale by the
Distributor only in Creation Units. Each Creation Unit is made up
of 50,000 Shares. The Distributor will not distribute Shares in
amounts less than a Creation Unit and does not maintain a secondary
market in Fund Shares. The principal business address of the
Distributor is 30 Maple Street, Summit, New Jersey
07901.
Under
the Distribution Agreement, the Distributor, as agent for the
Trust, will receive orders for the purchase and redemption of
Creation Units, provided that any subscriptions and orders will not
be binding on the Trust until accepted by the Trust. The
Distributor will deliver a prospectus to authorized participants
purchasing Shares in Creation Units and will maintain records of
both orders placed with it and confirmations of acceptance
furnished by it. The Distributor is a broker-dealer registered
under the Securities Exchange Act of 1934 (the “Exchange
Act”) and a member of FINRA.
Upon
direction from the Trust, the Distributor may also enter into
agreements with securities dealers (“Soliciting
Dealers”) who will solicit purchases of Creation Units of
Shares. Such Soliciting Dealers may also be Authorized Participants
(as discussed in “Procedures for Creation of Creation
Units” below) or DTC Participants (as defined
below).
The
Distribution Agreement will continue for two years from its
effective date and is renewable thereafter. 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 is terminable without
penalty by the Trust on 60 days’ written notice when
authorized either by majority vote of its outstanding voting shares
or by a vote of a majority of its Board (including a majority of
the Independent Trustees), or by the Distributor on 60 days
written notice, and will automatically terminate in the event of
its assignment. The Distribution Agreement provides that in the
absence of willful misfeasance, bad faith or negligence on the part
of the Distributor, or reckless disregard by it of its obligations
thereunder, the Distributor shall not be liable for any action or
failure to act in accordance with its 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. No
distribution fees are currently charged to the Fund; there are no
plans to impose these fees.
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 any class of
the Fund that is affected by such increase. All material amendments
of the Plan will require approval by a majority of the Trustees of
the Trust and of the Qualified Trustees.
The
Plan provides that Shares (“Shares”) of the Fund pay
the Distributor an annual fee of up to a maximum of 0.25% of the
average daily net assets of the Shares. Under the Plan, the
Distributor may make payments pursuant to written agreements to
financial institutions and intermediaries such as banks, savings
and loan associations and insurance companies including, without
limit, investment counselors, broker-dealers and the
Distributor’s affiliates and subsidiaries (collectively,
“Agents”) as compensation for services and
reimbursement of expenses incurred in connection with distribution
assistance. The Plan is characterized as a compensation plan since
the distribution fee will be paid to the Distributor without regard
to the distribution expenses incurred by the Distributor or the
amount of payments made to other financial institutions and
intermediaries. The Trust intends to operate the Plan in accordance
with its terms and with FINRA rules concerning sales
charges.
Under
the Plan, subject to the limitations of applicable law and
regulations, the Fund is authorized to compensate the Distributor
up to the maximum amount to finance any activity primarily intended
to result in the sale of Creation Units of the Fund or for
providing or arranging for others to provide shareholder services
and for the maintenance of shareholder accounts. Such activities
may include, but are not limited to: (i) delivering copies of the
Fund’s then current reports, prospectuses, notices, and
similar materials, to prospective purchasers of Creation Units;
(ii) marketing and promotional services, including advertising;
(iii) paying the costs of and compensating others, including
Authorized Participants with whom the Distributor has entered into
written Authorized Participant Agreements, for performing
shareholder servicing on behalf of the Fund; (iv) compensating
certain Authorized Participants for providing assistance in
distributing the Creation Units of the Fund, including the travel
and communication expenses and salaries and/or commissions of sales
personnel in connection with the distribution of the Creation Units
of the Fund; (v) payments to financial institutions and
intermediaries such as banks, savings and loan associations,
insurance companies and investment counselors, broker-dealers,
mutual fund supermarkets and the affiliates and subsidiaries of the
Trust’s service providers as compensation for services or
reimbursement of expenses incurred in connection with distribution
assistance; (vi) facilitating communications with beneficial owners
of Shares, including the cost of providing (or paying others to
provide) services to beneficial owners of Shares, including, but
not limited to, assistance in answering inquiries related to
shareholder accounts, and (vi) such other services and obligations
as are set forth in the Distribution Agreement.
THE ADMINISTRATOR
[ ]
The
Fund is new and has not paid any amount for administration
services.
THE CUSTODIAN
[ ]
THE TRANSFER AGENT
[ ]
LEGAL COUNSEL
Sullivan & Worcester LLP, 1666 K Street NW, Washington, D.C.
20006, serves as legal counsel to the
Trust.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
[ ], with offices located at [ ], serves as the independent
registered public accounting firm for the Fund.
ADDITIONAL INFORMATION ABOUT FINANCIAL INTERMEDIARY
COMPENSATION
The
Adviser or its affiliates, including the Distributor (for purposes
of this subsection only, collectively, “Advisory
Affiliates”) makes payments (“Payments”) to
certain broker-dealers and other financial intermediaries
(“Intermediaries”) related to activities that are
designed to make registered representatives, other professionals
and individual investors more knowledgeable about the Fund or for
other activities, such as participation in marketing activities and
presentations, educational training programs, the support of
technology platforms and/or reporting systems. The Advisory
Affiliates also make Payments to Intermediaries for certain
printing, publishing and mailing costs associated with the Fund or
materials relating to exchange traded funds in general. In
addition, Advisory Affiliates make Payments to Intermediaries that
make Fund shares available to their clients, including on zero or
negative transaction fee platforms, or for otherwise promoting the
Fund. Payments of this type are sometimes referred to as marketing
support or revenue-sharing payments. Any Payments made by an
Advisory Affiliate will be made from its own assets and not from
the assets of the Fund.
Although
a portion of the Advisory Affiliates’ revenue comes directly
or indirectly, in part, from management fees paid by the Fund,
Payments do not increase the price paid by investors for the
purchase of shares of, or the cost of owning, the Fund. As a
result, an Intermediary may make decisions about which investment
options it will recommend or make available to its clients or what
services to provide for various products based on payments it
receives or is eligible to receive. Payments create conflicts of
interest between the Intermediary and its clients and these
financial incentives may cause the Intermediary to recommend the
Fund over other investments. Advisory Affiliates determine to make
Payments based on any number of metrics. For example, Advisory
Affiliates may make Payments at year-end and/or other intervals in
a fixed amount, an amount based upon an Intermediary’s
services at defined levels, an amount based upon the total assets
represented by funds subject to arrangements with the Intermediary,
or an amount based on the Intermediary’s net sales of one or
more funds in a year or other period, any of which arrangements may
include an agreed upon minimum or maximum payment, or any
combination of the foregoing. A shareholder should contact his or
her Intermediary’s salesperson or other investment
professional for more information regarding any Payments the
Intermediary firm may receive.
DESCRIPTION OF SHARES
The
Declaration of Trust authorizes the issuance of an unlimited number
of funds and shares of each fund. Each share of a fund 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 classes 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.
Each
share has one vote with respect to matters upon which a shareholder
vote is required consistent with the requirements of the 1940 Act
and the rules promulgated thereunder. Shares of all funds vote
together as a single class, except that if the matter being voted
on affects only a particular fund it will be voted on only by that
fund and if a matter affects a particular fund differently from
other funds, that fund will vote separately on such matter. As a
Delaware statutory trust, 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. Upon the written request of shareholders
owning at least 10% of the Trust’s shares, the Trust will
call for a meeting of shareholders to consider the removal of one
or more trustees and other certain matters. In the event that such
a meeting is requested, the Trust will provide appropriate
assistance and information to the shareholders requesting the
meeting.
Under
the Declaration of Trust, the Trustees have the power to liquidate
each fund without shareholder approval. While the Trustees have no
present intention of exercising this power, they may do so if any
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.
BROKERAGE TRANSACTIONS
The
policy of the Trust regarding purchases and sales of securities for
the Fund is that primary consideration will be given to obtaining
the most favorable prices and efficient executions of transactions.
Consistent with this policy, when securities transactions are
effected on a stock exchange, the Trust’s policy is to pay
commissions which are considered fair and reasonable without
necessarily determining that the lowest possible commissions are
paid in all circumstances. The Trust believes that a requirement
always to seek the lowest possible commission cost could impede
effective portfolio management and preclude the Fund and the
Adviser from obtaining a high quality of brokerage and research
services. In seeking to determine the reasonableness of brokerage
commissions paid in any transaction, the Adviser will rely upon its
experience and knowledge regarding commissions generally charged by
various brokers and on its judgment in evaluating the brokerage and
research services received from the broker effecting the
transaction. Such determinations are necessarily subjective and
imprecise, as in most cases, an exact dollar value for those
services is not ascertainable. The Trust has adopted policies and
procedures that prohibit the consideration of sales of the
Fund’s shares as a factor in the selection of a broker or
dealer to execute its portfolio transactions.
The
Adviser owes a fiduciary duty to its clients to seek to provide
best execution on trades effected. In selecting a broker/dealer for
each specific transaction, the Adviser chooses the broker/dealer
deemed most capable of providing the services necessary to obtain
the most favorable execution. Best execution is generally
understood to mean the most favorable cost or net proceeds
reasonably obtainable under the circumstances. The full range of
brokerage services applicable to a particular transaction may be
considered when making this judgment, which may include, but is not
limited to: liquidity, price, commission, timing, aggregated
trades, capable floor brokers or traders, competent block trading
coverage, ability to position, capital strength and stability,
reliable and accurate communications and settlement processing, use
of automation, knowledge of other buyers or sellers, arbitrage
skills, administrative ability, underwriting and provision of
information on a particular security or market in which the
transaction is to occur. The specific criteria will vary depending
upon the nature of the transaction, the market in which it is
executed, and the extent to which it is possible to select from
among multiple broker/dealers. The Adviser will also use electronic
crossing networks (“ECNs”) when
appropriate.
The
Adviser may use a Fund’s assets for, or participate in,
third-party soft dollar arrangements, in addition to receiving
proprietary research from various full service brokers, the cost of
which is bundled with the cost of the broker’s execution
services. The Adviser does not “pay up” for the value
of any such proprietary research. Section 28(e) of the 1934 Act
permits the Adviser, under certain circumstances, to cause a 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. The Adviser may receive a variety of research services
and information on many topics, which it can use in connection with
its management responsibilities with respect to the various
accounts over which it exercises investment discretion or otherwise
provides investment advice. The research services may include
qualifying order management systems, portfolio attribution and
monitoring services and computer software and access charges which
are directly related to investment research. Accordingly, a Fund
may pay a broker commission higher than the lowest available in
recognition of the broker’s provision of such services to the
Adviser, but only if the Adviser determines the total commission
(including the soft dollar benefit) is comparable to the best
commission rate that could be expected to be received from other
brokers. The amount of soft dollar benefits received depends on the
amount of brokerage transactions effected with the brokers. A
conflict of interest exists because there is an incentive to: 1)
cause clients to pay a higher commission than the firm might
otherwise be able to negotiate; 2) cause clients to engage in more
securities transactions than would otherwise be optimal; and 3)
only recommend brokers that provide soft dollar
benefits.
The
Adviser faces a potential conflict of interest when it uses client
trades to obtain brokerage or research services. This conflict
exists because the Adviser is able to use the brokerage or research
services to manage client accounts without paying cash for such
services, which reduces the Adviser’s expenses to the extent
that the Adviser would have purchased such products had they not
been provided by brokers. Section 28(e) permits the Adviser to use
brokerage or research services for the benefit of any account it
manages. Certain accounts managed by the Adviser may generate soft
dollars used to purchase brokerage or research services that
ultimately benefit other accounts managed by the Adviser,
effectively cross subsidizing the other accounts managed by the
Adviser that benefit directly from the product. The Adviser may not
necessarily use all of the brokerage or research services in
connection with managing a Fund whose trades generated the soft
dollars used to purchase such products.
The
Adviser is responsible, subject to oversight by the Board, for
placing orders on behalf of the Fund for the purchase or sale of
portfolio securities. If purchases or sales of portfolio securities
of the Fund and one or more other investment companies or clients
supervised by the Adviser are considered at or about the same time,
transactions in such securities are allocated among the several
investment companies and clients in a manner deemed equitable and
consistent with its fiduciary obligations to all by the Adviser. In
some cases, this procedure could have a detrimental effect on the
price or volume of the security so far as the Fund is concerned.
However, in other cases, it is possible that the ability to
participate in volume transactions and to negotiate lower brokerage
commissions will be beneficial to the Fund. The primary
consideration is prompt execution of orders at the most favorable
net price.
The
Fund may deal with affiliates in principal transactions to the
extent permitted by exemptive order or applicable rule or
regulation.
The
Fund is new and has not paid any brokerage
commissions.
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. The
Fund is new and therefore paid no brokerage fees to any affiliated
broker.
Securities of “Regular Broker-Dealer.” The Fund
is required to identify any securities of its “regular
brokers and dealers” (as such term is defined in the 1940
Act) which it may hold at the close of its most recent fiscal year.
“Regular brokers or dealers” of the Trust are the ten
brokers or dealers that, during the most recent fiscal year:
(i) received the greatest dollar amounts of brokerage
commissions from the Trust’s portfolio transactions;
(ii) engaged as principal in the largest dollar amounts of
portfolio transactions of the Trust; or (iii) sold the largest
dollar amounts of the Trust’s shares.
The
Fund is new and has no securities of “regular broker
dealers” to report.
PORTFOLIO TURNOVER RATE
Portfolio
turnover may vary from year to year, as well as within a year. High
turnover rates are likely to result in comparatively greater
brokerage expenses. The overall reasonableness of brokerage
commissions is evaluated by the Adviser based upon its knowledge of
available information as to the general level of commissions paid
by other institutional investors for comparable
services.
The Fund is new and has no portfolio turnover rate to
report.
BOOK ENTRY ONLY SYSTEM
Depositary
Trust Company (“DTC”) acts as securities depositary for
the Shares. Shares of the Fund are represented by securities
registered in the name of DTC or its nominee, Cede & Co., and
deposited with, or on behalf of, DTC. Except in limited
circumstances set forth below, certificates will not be issued for
Shares.
DTC is
a limited-purpose trust company that was created to hold securities
of its participants (the “DTC Participants”) and to
facilitate the clearance and settlement of securities transactions
among the DTC Participants in such securities through electronic
book-entry changes in accounts of the DTC Participants, thereby
eliminating the need for physical movement of securities
certificates. DTC Participants include securities brokers and
dealers, banks, trust companies, clearing corporations and certain
other organizations, some of whom (and/or their representatives)
own DTC. More specifically, DTC is owned by a number of its DTC
Participants and by the NYSE and FINRA. Access to the DTC system is
also available to others such as banks, brokers, dealers, and trust
companies that clear through or maintain a custodial relationship
with a DTC Participant, either directly or indirectly (the
“Indirect Participants”).
Beneficial
ownership of Shares is limited to DTC Participants, Indirect
Participants, and persons holding interests through DTC
Participants and Indirect Participants. Ownership of beneficial
interests in Shares (owners of such beneficial interests are
referred to herein as “Beneficial Owners”) is shown on,
and the transfer of ownership is effected only through, records
maintained by DTC (with respect to DTC Participants) and on the
records of DTC Participants (with respect to Indirect Participants
and Beneficial Owners that are not DTC Participants). Beneficial
Owners will receive from or through the DTC Participant a written
confirmation relating to their purchase of Shares. The Trust
recognizes DTC or its nominee as the record owner of all Shares for
all purposes. Beneficial Owners of Shares are not entitled to have
Shares registered in their names, and will not receive or be
entitled to physical delivery of share certificates. Each
Beneficial Owner must rely on the procedures of DTC and any DTC
Participant and/or Indirect Participant through which such
Beneficial Owner holds its interests, to exercise any rights of a
holder of Shares.
Conveyance
of all notices, statements, and other communications to Beneficial
Owners is effected as follows. DTC will make available to the Trust
upon request and for a fee a listing of Shares held by each DTC
Participant. The Trust shall obtain from each such DTC Participant
the number of Beneficial Owners holding Shares, directly or
indirectly, through such DTC Participant. The Trust shall provide
each such DTC Participant with copies of such notice, statement, or
other communication, in such form, number and at such place as such
DTC Participant may reasonably request, in order that such notice,
statement or communication may be transmitted by such DTC
Participant, directly or indirectly, to such Beneficial Owners. In
addition, the Trust shall pay to each such DTC Participant a fair
and reasonable amount as reimbursement for the expenses attendant
to such transmittal, all subject to applicable statutory and
regulatory requirements.
Share
distributions shall be made to DTC or its nominee, Cede & Co.,
as the registered holder of all shares. DTC or its nominee, upon
receipt of any such distributions, shall credit immediately DTC
Participants’ accounts with payments in amounts proportionate
to their respective beneficial interests in the Fund as shown on
the records of DTC or its nominee. Payments by DTC Participants to
Indirect Participants and Beneficial Owners of Shares held through
such DTC Participants will be governed by standing instructions and
customary practices, as is now the case with securities held for
the accounts of customers in bearer form or registered in a
“street name,” and will be the responsibility of such
DTC Participants.
The
Trust has no responsibility or liability for any aspect of the
records relating to or notices to Beneficial Owners, or payments
made on account of beneficial ownership interests in the
Fund’s shares, or for maintaining, supervising, or reviewing
any records relating to such beneficial ownership interests, or for
any other aspect of the relationship between DTC and the DTC
Participants or the relationship between such DTC Participants and
the Indirect Participants and Beneficial Owners owning through such
DTC Participants.
DTC may
determine to discontinue providing its service with respect to the
Fund at any time by giving reasonable notice to the Fund and
discharging its responsibilities with respect thereto under
applicable law. Under such circumstances, the Fund shall take
action either to find a replacement for DTC to perform its
functions at a comparable cost or, if such replacement is
unavailable, to issue and deliver printed certificates representing
ownership of Shares, unless the Trust makes other arrangements with
respect thereto satisfactory to the Exchange.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
A
principal shareholder is any person who owns of record or
beneficially 5% or more of the outstanding shares of a fund. A
control person is a shareholder that owns beneficially or through
controlled companies more than 25% of the voting securities of a
company or acknowledges the existence of control. Shareholders
owning voting securities in excess of 25% may determine the outcome
of any matter affecting and voted on by shareholders of the
Fund.
As of the date of this SAI, there were no outstanding Shares
of the
Fund.
PURCHASE AND ISSUANCE OF SHARES IN CREATION UNITS
The Trust issues and sells Shares of the Fund only in Creation
Units on a continuous basis through the Distributor, without a
sales load (but subject to transaction fees), at their NAV per
share next determined after receipt of an order, on any Business
Day, in proper form pursuant to the terms of the Authorized
Participant Agreement (“Participant Agreement”). The
NAV of the Fund’s shares is calculated each business day as
of the close of regular trading on the New York Stock Exchange,
generally 4:00 p.m., Eastern Time. The Fund will not issue
fractional Creation Units. A Business Day is any day on which the
New York Stock Exchange is generally open for
business.
FUND DEPOSIT. The Trust has adopted policies and procedures
governing the process of constructing baskets of Deposit Securities
(defined below), Fund Securities (defined below) and/or cash, and
acceptance of the same (the “Basket Procedures”). The
consideration for purchase of a Creation Unit of the Fund generally
consists of either (i) in-kind deposit of a designated portfolio of
securities (the “Deposit Securities”) and a Cash
Component (defined below), or (ii) the substitution of a
“cash in lieu” amount (“Deposit Cash”) to
be added to the Cash Component to replace any Deposit Security.
When accepting purchases of Creation Units for all or a portion of
Deposit Cash, the Fund may incur additional costs associated with
the acquisition of Deposit Securities that would otherwise be
provided by an in-kind purchaser.
Together, the Deposit Securities or Deposit Cash, as applicable,
and the Cash Component constitute the “Fund Deposit,”
which represents the minimum initial and subsequent investment
amount for a Creation Unit of the Fund. The “Cash
Component” is an amount equal to the difference between the
net asset value of the Shares (per Creation Unit) and the market
value of the Deposit Securities or Deposit Cash, as applicable. If
the Cash Component is a positive number (i.e., the net asset value per Creation Unit exceeds
the market value of the Deposit Securities or Deposit Cash, as
applicable), the Cash Component shall be such positive amount. If
the Cash Component is a negative number (i.e., the net asset value per Creation Unit is less
than the market value of the Deposit Securities or Deposit Cash, as
applicable), the Cash Component shall be such negative amount and
the creator will be entitled to receive cash in an amount equal to
the Cash Component. The Cash Component serves the function of
compensating for any differences between the net asset value per
Creation Unit and the market value of the Deposit Securities or
Deposit Cash, as applicable. Computation of the Cash Component
excludes any stamp duty or other similar fees and expenses payable
upon transfer of beneficial ownership of the Deposit Securities, if
applicable, which shall be the sole responsibility of the
Authorized Participant (as defined below).
The Fund, through the National Securities Clearance Corporation
(the “NSCC”) or through other means of public
dissemination, makes available on each Business Day, immediately
prior to the opening of business on the Exchange (generally 9:30
a.m., Eastern time), the list of the names and the required number
of shares of each Deposit Security or the required amount of
Deposit Cash, as applicable, to be included in the current Fund
Deposit (based on information at the end of the previous Business
Day) for the Fund. Such Fund Deposit is subject to any applicable
adjustments as described below, in order to effect purchases of
Creation Units of the Fund until such time as the next-announced
composition of the Deposit Securities or the required amount of
Deposit Cash, as applicable, is made available.
The identity and number of shares of the Deposit Securities or the
amount of Deposit Cash, as applicable, required for the Fund
Deposit for the Fund may be changed from time to time by the
Adviser, in accordance with the Basket Procedures, with a view to
the investment objective of the Fund. The composition of the
Deposit Securities may also change in response to interest payments
and corporate action events.
The Trust reserves the right to permit or require the substitution
of an amount of cash (i.e., a “cash in lieu” amount) to replace
any Deposit Security, including, without limitation, in situations
where the Deposit Security: (i) may not be available in
sufficient quantity for delivery; (ii) may not be eligible for
transfer through the systems of DTC for corporate securities and
municipal securities; (iii) may not be eligible for trading by
an Authorized Participant (as defined below) or the investor for
which it is acting; (iv) would be restricted under the
securities laws or where the delivery of the Deposit Security to
the Authorized Participant would result in the disposition of the
Deposit Security by the Authorized Participant becoming restricted
under the securities laws; or (v) in certain other situations,
in accordance with the Basket Procedures.
PROCEDURES FOR PURCHASE OF CREATION UNITS. To be eligible to place
orders with the Distributor to purchase a Creation Unit of the
Fund, an entity must be (i) a “Participating
Party”, i.e., a broker-dealer or other participant in the
clearing process through the Continuous Net Settlement System of
the NSCC (the “Clearing Process”), a clearing agency
that is registered with the SEC; or (ii) a DTC Participant (see
“BOOK ENTRY ONLY SYSTEM”). In addition, each
Participating Party or DTC Participant (each, an “Authorized
Participant”) must execute a Participant Agreement that has
been agreed to by the Distributor, and that has been accepted by
the Transfer Agent, with respect to purchases and redemptions of
Creation Units. Each Authorized Participant will agree, pursuant to
the terms of a Participant Agreement, on behalf of itself or any
investor on whose behalf it will act, to certain conditions,
including that it will pay to the Trust, an amount of cash
sufficient to pay the Cash Component together with the Creation
Transaction Fee (defined below) and any other applicable fees and
taxes. The Adviser may retain all or a portion of the Transaction
Fee to the extent the Adviser bears the expenses that otherwise
would be borne by the Trust in connection with the purchase of a
Creation Unit, which the Transaction Fee is designed to
cover.
All orders to purchase Shares directly from the Fund must be placed
for one or more Creation Units and in the manner and by the time
set forth in the Participant Agreement and/or applicable order
form. The date on which an order to purchase Creation Units (or an
order to redeem Creation Units, as set forth below) is received and
accepted is referred to as the “Order Placement
Date.”
An Authorized Participant may require an investor to make certain
representations or enter into agreements with respect to the order,
(e.g., to provide for payments of cash, when required).
Investors should be aware that their particular broker may not have
executed a Participant Agreement and that, therefore, orders to
purchase Shares directly from the Fund in Creation Units have to be
placed by the investor’s broker through an Authorized
Participant that has executed a Participant Agreement. In such
cases there may be additional charges to such investor. At any
given time, there may be only a limited number of broker-dealers
that have executed a Participant Agreement and only a small number
of such Authorized Participants may have international
capabilities.
On days when the Exchange closes earlier than normal, the Fund may
require orders to create Creation Units to be placed earlier in the
day. In addition, if a market or markets on which the Fund’s
investments are primarily traded is closed, the Fund will also
generally not accept orders on such day(s). Orders must be
transmitted by an Authorized Participant by telephone or other
transmission method acceptable to the Distributor pursuant to
procedures set forth in the Participant Agreement and in accordance
with the applicable order form. With respect to the Fund, the
Distributor will notify the Custodian of such order. The Custodian
will then provide such information to the appropriate local
sub-custodian(s). Those placing orders through an Authorized
Participant should allow sufficient time to permit proper
submission of the purchase order to the Transfer Agent, and
accepted by the Distributor, by the cut-off time on such Business
Day. Economic or market disruptions or changes, or telephone or
other communication failure may impede the ability to reach the
Distributor or an Authorized Participant.
Fund Deposits must be delivered by an Authorized Participant
through the Federal Reserve System (for cash) or through DTC (for
corporate securities), through a sub-custody agent (for foreign
securities) and/or through such other arrangements allowed by the
Trust or its agents. With respect to foreign Deposit Securities,
the Custodian shall cause the sub-custodian of the Fund to maintain
an account into which the Authorized Participant shall deliver, on
behalf of itself or the party on whose behalf it is acting, such
Deposit Securities (or Deposit Cash for all or a part of such
securities, as permitted or required), with any appropriate
adjustments as advised by the Trust. Foreign Deposit Securities
must be delivered to an account maintained at the applicable local
sub-custodian. The Fund Deposit transfer must be ordered by the
Authorized Participant in a timely fashion so as to ensure the
delivery of the requisite number of Deposit Securities or Deposit
Cash, as applicable, to the account of the Fund or its agents by no
later than the Settlement Date. The “Settlement Date”
for the Fund is generally the second Business Day after the Order
Placement Date. All questions as to the number of Deposit
Securities or Deposit Cash to be delivered, as applicable, and the
validity, form and eligibility (including time of receipt) for the
deposit of any tendered securities or cash, as applicable, will be
determined by the Trust, whose determination shall be final and
binding. The amount of cash represented by the Cash Component must
be transferred directly to the Custodian through the Federal
Reserve Bank wire transfer system or through DTC in a timely manner
so as to be received by the Custodian no later than the Settlement
Date. If the Cash Component and the Deposit Securities or Deposit
Cash, as applicable, are not received by in a timely manner by the
Settlement Date, the creation order may be cancelled. Upon written
notice to the Distributor, such canceled order may be resubmitted
the following Business Day using the Fund Deposit as newly
constituted to reflect the then current NAV of the
Fund.
The order shall be deemed to be received on the Business Day on
which the order is placed provided that the order is placed in
proper form prior to the applicable cut-off time and the federal
funds in the appropriate amount are deposited with the Custodian on
the Settlement Date. If the order is not placed in proper form as
required, or federal funds in the appropriate amount are not
received on the Settlement Date, then the order may be deemed to be
rejected and the Authorized Participant shall be liable to the Fund
for losses, if any, resulting therefrom. A creation request is
considered to be in “proper form” if all procedures set
forth in the Participant Agreement, order form and this SAI are
properly followed.
ISSUANCE OF A CREATION UNIT. Except as provided herein, Creation
Units will not be issued until the transfer of good title to the
Trust of the Deposit Securities or payment of Deposit Cash, as
applicable, and the payment of the Cash Component have been
completed. When the sub-custodian has confirmed to the Custodian
that the required Deposit Securities (or the cash value thereof)
have been delivered to the account of the relevant sub-custodian or
sub-custodians, the Distributor and the Adviser shall be notified
of such delivery, and the Trust will issue and cause the delivery
of the Creation Units. The delivery of Creation Units so created
generally will occur no later than the second Business Day
following the day on which the purchase order is deemed received by
the Distributor. The Authorized Participant shall be liable to the
Fund for losses, if any, resulting from unsettled
orders.
In instances where the Trust accepts Deposit Securities for the
purchase of a Creation Unit, the Creation Units may be purchased in
advance of receipt by the Trust of all or a portion of the
applicable Deposit Securities as described below. In these
circumstances, the initial deposit will have a value greater than
the net asset value of the Shares on the date the order is placed
in proper form since in addition to available Deposit Securities,
cash must be deposited in an amount equal to the sum of
(i) the Cash Component, plus (ii) an additional amount of
cash equal to a percentage of the market value as set forth in the
Participant Agreement, of the undelivered Deposit Securities (the
“Additional Cash Deposit”), which shall be maintained
in a separate non-interest bearing collateral account. An
additional amount of cash shall be required to be deposited with
the Trust, pending delivery of the missing Deposit Securities to
the extent necessary to maintain the Additional Cash Deposit with
the Trust in an amount at least equal to the applicable percentage,
as set forth in the Participant Agreement, of the daily marked to
market value of the missing Deposit Securities. The Participant
Agreement will permit the Trust to buy the missing Deposit
Securities at any time. Authorized Participants will be liable to
the Trust for the costs incurred by the Trust in connection with
any such purchases. These costs will be deemed to include the
amount by which the actual purchase price of the Deposit Securities
exceeds the market value of such Deposit Securities on the day the
purchase order was deemed received by the Distributor plus the
brokerage and related transaction costs associated with such
purchases. The Trust will return any unused portion of the
Additional Cash Deposit once all of the missing Deposit Securities
have been properly received by the Custodian or purchased by the
Trust and deposited into the Trust. In addition, a Transaction Fee
as set forth below under “Creation Transaction Fee”
will be charged in all cases. The delivery of Creation Units so
created generally will occur no later than the Settlement
Date.
ACCEPTANCE OF ORDERS OF CREATION UNITS. The Trust reserves the
absolute right to reject an order for Creation Units transmitted to
it by the Distributor in respect of the Fund including, without
limitation, if (a) the order is not in proper form;
(b) the Deposit Securities or Deposit Cash, as applicable,
delivered by the Participant are not as disseminated through
the facilities of the NSCC for that date by the Custodian;
(c) the investor(s), upon obtaining the Shares ordered, would
own 80% or more of the currently outstanding Shares of the Fund;
(d) acceptance of the Deposit Securities would have certain
adverse tax consequences to the Fund; (e) the acceptance of
the Fund Deposit would, in the opinion of counsel, be unlawful;
(f) the acceptance of the Fund Deposit would otherwise, in the
discretion of the Trust or the Adviser, have an adverse effect on
the Trust or the rights of beneficial owners; (g) the
acceptance or receipt of the order for a Creation Unit would, in
the opinion of counsel to the Trust, be unlawful; or (h) in
the event that circumstances outside the control of the Trust, the
Custodian, the Transfer Agent and/or the Adviser make it for all
practical purposes not feasible to process orders for Creation
Units.
Examples of such circumstances include acts of God or public
service or utility problems such as fires, floods, extreme weather
conditions and power outages resulting in telephone, telecopy and
computer failures; market conditions or activities causing trading
halts; systems failures involving computer or other information
systems affecting the Trust, the Distributor, the Custodian, a
sub-custodian, the Transfer Agent, DTC, NSCC, Federal Reserve
System, or any other participant in the creation process, and other
extraordinary events. The Distributor shall notify a prospective
creator of a Creation Unit and/or the Authorized Participant acting
on behalf of the creator of a Creation Unit of its rejection of the
order of such person. The Trust, the Transfer Agent, the Custodian,
any sub-custodian and the Distributor are under no duty, however,
to give notification of any defects or irregularities in the
delivery of Fund Deposits nor shall either of them incur any
liability for the failure to give any such notification. The Trust,
the Transfer Agent, the Custodian and the Distributor shall not be
liable for the rejection of any purchase order for Creation
Units.
All questions as to the number of shares of each security in the
Deposit Securities and the validity, form, eligibility and
acceptance for deposit of any securities to be delivered shall be
determined by the Trust, and the Trust’s determination shall
be final and binding.
CREATION TRANSACTION FEE. A purchase (i.e., creation) transaction fee, payable to the
Fund’s custodian, may be imposed for the transfer and other
transaction costs associated with the purchase of Creation Units,
and investors will be required to pay a creation transaction fee
regardless of the number of Creation Units created in the
transaction. The Fund may adjust the creation transaction fee from
time to time. The standard fixed creation transaction fee for the
Fund will be $750. In addition, a variable fee will be charged on
all cash transactions or substitutes for Creation Units of up to a
maximum of 2% as a percentage of the value of the Creation Units
subject to the transaction. The variable charge may be imposed for
cash purchases, non-standard orders, or partial cash purchases
incurred by the Fund, primarily designed to cover expenses related
to broker commissions. Investors who use the services of a broker
or other such intermediary may be charged a fee for such services.
Investors are responsible for the fixed costs of transferring the
securities constituting the Deposit Securities to the account of
the Trust.
RISKS OF PURCHASING CREATION UNITS. There are certain legal risks
unique to investors purchasing Creation Units directly from the
Fund. Because the Fund’s shares may be issued on an ongoing
basis, a “distribution” of Shares could be occurring at
any time. Certain activities that a shareholder performs as a
dealer could, depending on the circumstances, result in the
shareholder being deemed a participant in the distribution in a
manner that could render the shareholder a statutory underwriter
and subject to the prospectus delivery and liability provisions of
the Securities Act. For example, a shareholder could be deemed a
statutory underwriter if it purchases Creation Units from the Fund,
breaks them down into the constituent Shares, and sells those
Shares directly to customers, or if a shareholder chooses to couple
the creation of a supply of new Shares with an active selling
effort involving solicitation of secondary-market demand for
Shares. Whether a person is an underwriter depends upon all of the
facts and circumstances pertaining to that person’s
activities, and the examples mentioned here should not be
considered a complete description of all the activities that could
cause you to be deemed an underwriter.
Dealers who are not “underwriters” but are
participating in a distribution (as opposed to engaging in ordinary
secondary-market transactions), and thus dealing with the
Fund’s Shares as part of an “unsold allotment”
within the meaning of Section 4(a)(3)(C) of the Securities
Act, will be unable to take advantage of the prospectus delivery
exemption provided by Section 4(a)(3) of the Securities
Act.
REDEMPTION. Shares may be redeemed only in Creation Units at their
net asset value next determined after receipt of a redemption
request in proper form by the Fund through the Transfer Agent and
only on a Business Day. EXCEPT UPON LIQUIDATION OF THE FUND, THE
TRUST WILL NOT REDEEM SHARES IN AMOUNTS LESS THAN CREATION UNITS.
Investors must accumulate enough Shares in the secondary market to
constitute a Creation Unit in order to have such Shares redeemed by
the Trust. There can be no assurance, however, that there will be
sufficient liquidity in the public trading market at any time to
permit assembly of a Creation Unit. Investors should expect to
incur brokerage and other costs in connection with assembling a
sufficient number of Shares to constitute a redeemable Creation
Unit.
With respect to the Fund, the Custodian, through the NSCC, makes
available immediately prior to the opening of business on the
Exchange (generally 9:30 a.m. Eastern time) on each Business Day,
the list of the names and share quantities of the Fund’s
portfolio securities that will be applicable (subject to possible
amendment or correction) to redemption requests received in proper
form (as defined below) on that day (“Fund
Securities”). Fund Securities received on redemption may not
be identical to Deposit Securities.
Redemption proceeds for a Creation Unit are paid either in-kind or
in cash, or a combination thereof, as determined by the Trust in
accordance with the Basket Procedures. With respect to in-kind
redemptions of the Fund, redemption proceeds for a Creation Unit
will consist of Fund Securities — as announced by the
Custodian on the Business Day of the request for redemption
received in proper form plus cash in an amount equal to the
difference between the net asset value of the Shares being
redeemed, as next determined after a receipt of a request in proper
form, and the value of the Fund Securities (the “Cash
Redemption Amount”), less a fixed redemption transaction fee
as set forth below. In the event that the Fund Securities have a
value greater than the net asset value of the Shares, a
compensating cash payment equal to the differential is required to
be made by or through an Authorized Participant by the redeeming
shareholder. Notwithstanding the foregoing, at the Trust’s
discretion, an Authorized Participant may receive the corresponding
cash value of the securities in lieu of the in-kind securities
value representing one or more Fund Securities.
REDEMPTION TRANSACTION FEE. A redemption transaction fee, payable
to the Fund’s custodian, may be imposed for the transfer and
other transaction costs associated with the redemption of Creation
Units, and investors will be required to pay a fixed redemption
transaction fee regardless of the number of Creation Units created
in the transaction, as set forth in the Fund’s Prospectus, as
may be revised from time to time. The redemption transaction fee is
the same no matter how many Creation Units are being redeemed
pursuant to any one redemption request. The Fund may adjust the
redemption transaction fee from time to time. The standard fixed
redemption transaction fee for the Fund will be $750. In addition,
a variable fee will be charged on all cash transactions or
substitutes for Creation Units of up to a maximum of 2% as a
percentage of the value of the Creation Units subject to the
transaction. The variable charge may be imposed for cash
redemptions, non-standard orders, or partial cash redemptions (when
cash redemptions are available) incurred by the Fund, primarily
designed to cover expenses related to broker commissions. Investors
who use the services of a broker or other such intermediary may be
charged a fee for such services. Investors are responsible for the
fixed costs of transferring the Fund Securities from the Trust to
their account or on their order.
PROCEDURES FOR REDEMPTION OF CREATION UNITS. Orders to redeem
Creation Units must be submitted in proper form to the Transfer
Agent prior to the time as set forth in the Participant Agreement.
A redemption request is considered to be in “proper
form” if (i) an Authorized Participant has transferred
or caused to be transferred to the Trust’s Transfer Agent the
Creation Unit(s) being redeemed through the book-entry system of
DTC so as to be effective by the time as set forth in the
Participant Agreement and (ii) a request in form satisfactory
to the Trust is received by the Transfer Agent from the Authorized
Participant on behalf of itself or another redeeming investor
within the time periods specified in the Participant Agreement. If
the Transfer Agent does not receive the investor’s Shares
through DTC’s facilities by the times and pursuant to the
other terms and conditions set forth in the Participant Agreement,
the redemption request shall be rejected.
The Authorized Participant must transmit the request for
redemption, in the form required by the Trust, to the Transfer
Agent in accordance with procedures set forth in the Authorized
Participant Agreement. Investors should be aware that their
particular broker may not have executed an Authorized Participant
Agreement, and that, therefore, requests to redeem Creation Units
may have to be placed by the investor’s broker through an
Authorized Participant who has executed an Authorized Participant
Agreement. Investors making a redemption request should be aware
that such request must be in the form specified by such Authorized
Participant. Investors making a request to redeem Creation Units
should allow sufficient time to permit proper submission of the
request by an Authorized Participant and transfer of the Shares to
the Trust’s Transfer Agent; such investors should allow for
the additional time that may be required to effect redemptions
through their banks, brokers or other financial intermediaries if
such intermediaries are not Authorized Participants.
ADDITIONAL REDEMPTION PROCEDURES. In connection with taking
delivery of shares of Fund Securities upon redemption of Creation
Units, the Authorized Participant must maintain appropriate custody
arrangements with a qualified broker-dealer, bank or other custody
providers in each jurisdiction in which any of the Fund Securities
are customarily traded, to which account such Fund Securities will
be delivered. Deliveries of redemption proceeds generally will be
made within two business days of the trade date. However, due to
the schedule of holidays in certain countries, the different
treatment among foreign and U.S. markets of dividend record dates
and dividend ex-dates (that is the last date the holder of a
security can sell the security and still receive dividends payable
on the security sold), and in certain other circumstances, the
delivery of in-kind redemption proceeds may take longer than two
Business Days after the day on which the redemption request is
received in proper form. If neither the redeeming shareholder nor
the Authorized Participant acting on behalf of such redeeming
shareholder has appropriate arrangements to take delivery of the
Fund Securities in the applicable foreign jurisdiction and it is
not possible to make other such arrangements, or if it is not
possible to effect deliveries of the Fund Securities in such
jurisdiction, the Trust may, in its discretion and in accordance
with the Basket Procedures, exercise its option to redeem such
Shares in cash, and the redeeming investor will be required to
receive its redemption proceeds in cash.
In addition, an investor may request a redemption in cash that the
Fund may, in its sole discretion, permit. In either case, the
investor will receive a cash payment equal to the NAV of its Shares
based on the NAV of Shares of the Fund next determined after the
redemption request is received in proper form (minus a redemption
transaction fee and additional charge for requested cash
redemptions specified above, to offset the Trust’s brokerage
and other transaction costs associated with the disposition of Fund
Securities).
The Fund may also, in its sole discretion and in accordance with
the Basket Procedures, upon request of a shareholder, provide such
redeemer a portfolio of securities that differs from the exact
composition of the Fund Securities but does not differ in net asset
value.
Redemptions of shares for Fund Securities will be subject to
compliance with applicable federal and state securities laws and
the Fund (whether or not it otherwise permits cash redemptions)
reserves the right to redeem Creation Units for cash to the extent
that the Trust could not lawfully deliver specific Fund Securities
upon redemptions or could not do so without first registering the
Fund Securities under such laws. An Authorized Participant or an
investor for which it is acting subject to a legal restriction with
respect to a particular security included in the Fund Securities
applicable to the redemption of Creation Units may be paid an
equivalent amount of cash. The Authorized Participant may request
the redeeming investor of the Shares to complete an order form or
to enter into agreements with respect to such matters as
compensating cash payment. Further, an Authorized Participant that
is not a “qualified institutional buyer”
(“QIB”), as such term is defined under Rule 144A
of the Securities Act, will not be able to receive Fund Securities
that are restricted securities eligible for resale under
Rule 144A. An Authorized Participant may be required by the
Trust to provide a written confirmation with respect to QIB status
in order to receive Fund Securities.
Because the portfolio securities of the Fund may trade on the
relevant exchange(s) on days that the Exchange is closed or are
otherwise not Business Days for the Fund, shareholders may not be
able to redeem their shares of the Fund, or to purchase or sell
shares of the Fund on the Exchange, on days when the NAV of the
Fund could be significantly affected by events in the relevant
foreign markets.
The right of redemption may be suspended or the date of payment
postponed with respect to the Fund (1) for any period during
which the Exchange is closed (other than customary weekend and
holiday closings); (2) for any period during which trading on
the Exchange is suspended or restricted; (3) for any period during
which an emergency exists as a result of which disposal of the
Shares of the Fund or determination of the NAV of the Shares is not
reasonably practicable; or (4) in such other circumstance as
is permitted by the SEC.
REQUIRED EARLY ACCEPTANCE OF ORDERS. Notwithstanding the foregoing,
as described in the Participant Agreement and/or applicable order
form, the Fund may require orders to be placed up to one or more
business days prior to the trade date, as described in the
Participant Agreement or the applicable order form, in order to
receive the trade date’s net asset value. Orders to purchase
Shares of the Fund that are submitted on the Business Day
immediately preceding a holiday or a day (other than a weekend)
that the equity markets in the relevant foreign market are closed
will not be accepted. Authorized Participants may be notified that
the cut-off time for an order may be earlier on a particular
business day, as described in the Participant Agreement and the
order form.
DETERMINATION OF NET ASSET VALUE
Net
asset value per Share for the Fund is computed by dividing the
value of the net assets of the Fund (i.e., the value of its total assets
less total liabilities) by the total number of Shares outstanding,
rounded to the nearest cent. Expenses and fees, including the
management fees, are accrued daily and taken into account for
purposes of determining net asset value. The net asset value of the
Fund is calculated by the Custodian and determined at the close of
the regular trading session on the NYSE (ordinarily 4:00 p.m.
Eastern time) on each day that such exchange is open, provided that
fixed-income assets may be valued as of the announced closing time
for trading in fixed-income instruments on any day that the
Securities Industry and Financial Markets Association
(“SIFMA”) announces an early closing time.
In
calculating the Fund’s net asset value per Share, the
Fund’s investments are generally valued using market
valuations. A market valuation generally means a valuation
(i) obtained from an exchange, a pricing service, or a major
market maker (or dealer), (ii) based on a price quotation or
other equivalent indication of value supplied by an exchange, a
pricing service, or a major market maker (or dealer) or
(iii) based on amortized cost. In the case of shares of other
funds that are not traded on an exchange, a market valuation means
such fund’s published net asset value per share. The Adviser
may use various pricing services, or discontinue the use of any
pricing service, as approved by the Board from time to time. A
price obtained from a pricing service based on such pricing
service’s valuation matrix may be considered a market
valuation. Any assets or liabilities denominated in currencies
other than the U.S. dollar are converted into U.S. dollars at the
current market rates on the date of valuation as quoted by one or
more sources.
In the
event that current market valuations are not readily available or
such valuations do not reflect current market value, the
Trust’s procedures require the Fair Value Committee to
determine a security’s fair value if a market price is not
readily available. In determining such value the Fair Value
Committee may consider, among other things, (i) price
comparisons among multiple sources, (ii) a review of corporate
actions and news events, and (iii) a review of relevant
financial indicators (e.g.,
movement in interest rates, market indices, and prices from the
Fund’s index provider). In these cases, the Fund’s net
asset value may reflect certain portfolio securities’ fair
values rather than their market prices. Fair value pricing involves
subjective judgments and it is possible that the fair value
determination for a security is materially different than the value
that could be realized upon the sale of the security. In addition,
fair value pricing could result in a difference between the prices
used to calculate the Fund’s net asset value and the prices
used by the Fund’s Underlying Index. This may result in a
difference between the Fund’s performance and the performance
of the Fund’s Underlying Index. With respect to securities
that are primarily listed on foreign exchanges, the value of the
Fund’s portfolio securities may change on days when you will
not be able to purchase or sell your Shares.
DIVIDENDS AND DISTRIBUTIONS
The
following information supplements and should be read in conjunction
with the section in the Prospectus entitled “Dividends,
Distributions and Taxes.”
General Policies. Dividends from net investment income, if
any, are declared and paid quarterly by the Fund. Distributions of
net realized securities gains, if any, generally are declared and
paid once a year, but the Fund may make distributions on a more
frequent basis for the Fund to improve index tracking or to comply
with the distribution requirements of the Code, in all events in a
manner consistent with the provisions of the 1940 Act.
Dividends
and other distributions on shares are distributed, as described
below, on a pro rata basis to Beneficial Owners of such shares.
Dividend payments are made through DTC Participants and Indirect
Participants to Beneficial Owners then of record with proceeds
received from the Fund.
The
Fund may make additional distributions to the extent necessary
(i) to distribute the entire annual taxable income of the
Fund, plus any net capital gains and (ii) to avoid imposition
of the excise tax imposed by Section 4982 of the Code.
Management of the Trust reserves the right to declare special
dividends if, in its reasonable discretion, such action is
necessary or advisable to preserve the status of the Fund as a
regulated investment company (“RIC”) or to avoid
imposition of income or excise taxes on undistributed
income.
Dividend Reinvestment Service. The Trust will not make the
DTC book-entry dividend reinvestment service available for use by
Beneficial Owners for reinvestment of their cash proceeds, but
certain individual broker-dealers may make available the DTC
book-entry Dividend Reinvestment Service for use by Beneficial
Owners of the Fund through DTC Participants for reinvestment of
their dividend distributions. Investors should contact their
brokers to ascertain the availability and description of these
services. Beneficial Owners should be aware that each broker may
require investors to adhere to specific procedures and timetables
in order to participate in the dividend reinvestment service and
investors should ascertain from their brokers such necessary
details. If this service is available and used, dividend
distributions of both income and realized gains will be
automatically reinvested in additional whole Shares issued by the
Trust of the Fund at NAV per share. Distributions reinvested in
additional shares of the Fund will nevertheless be taxable to
Beneficial Owners acquiring such additional shares to the same
extent as if such distributions had been received in
cash.
FEDERAL INCOME TAXES
The
following is only a summary of certain additional federal income
tax considerations generally affecting the Fund and its
shareholders. No attempt is made to present a comprehensive
explanation of the federal, state, local or foreign tax treatment
of the Fund or its shareholders, and the discussion here and in the
Prospectus is not intended to be a substitute for careful tax
planning.
The
following general discussion of certain federal income tax
consequences is based on provisions of 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, and may
have a retroactive effect with respect to the transactions
contemplated herein.
The
recently enacted tax legislation commonly referred to as the Tax
Cuts and Jobs Act (the “Tax Act”) makes significant
changes to the U.S. federal income tax rules for taxation of
individuals and corporations, generally effective for taxable years
beginning after December 31, 2017. Many of the changes
applicable to individuals are temporary and would apply only to
taxable years beginning after December 31, 2017 and before January
1, 2026. There are only minor changes with respect to the
specific rules only applicable to a RIC, such as the Fund.
The Tax Act, however, makes numerous other changes to the tax rules
that may affect shareholders and the Fund. You are urged to
consult with your own tax advisor regarding how the Tax Act affects
your investment in the Fund.
Shareholders
are urged to consult their own tax advisers regarding the
application of the provisions of tax law described in this SAI in
light of the particular tax situations of the shareholders and
regarding specific questions as to federal, state, or local
taxes.
Regulated Investment Company (RIC) Status. The Fund
will seek to qualify for treatment as a RIC under the Code.
Provided that for each tax year the Fund: (i) meets the
requirements to be treated as a RIC (as discussed below); and
(ii) distributes at least an amount equal to the sum of 90% of
the Fund’s net investment income for such year (including,
for this purpose, the excess of net realized short-term capital
gains over net long-term capital losses) and 90% of its net
tax-exempt interest income, the Fund itself will not be subject to
federal income taxes to the extent the Fund’s net investment
income and the Fund’s net realized capital gains, if any, are
distributed to the Fund’s shareholders. One of several
requirements for RIC qualification is that the Fund must receive at
least 90% of the Fund’s gross income each year from
dividends, interest, payments with respect to certain securities
loans, gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with
respect to the Fund’s business of investing in stock,
securities, foreign currencies and net income from an interest in a
qualified publicly traded partnership (the “90% Test”).
A second requirement for qualification as a RIC is that the Fund
must diversify its holdings so that, at the end of each quarter of
the Fund’s taxable year: (a) at least 50% of the market
value of the Fund’s total assets is represented by cash and
cash items, U.S. government securities, securities of other RICs,
and other securities, with these other securities limited, in
respect to any one issuer, to an amount not greater than 5% of the
value of the Fund’s total assets or 10% of the outstanding
voting securities of such issuer; and (b) not more than 25% of
the value of its total assets are invested in the securities (other
than U.S. government securities or securities of other RICs) of any
one issuer, the securities (other than securities of other RICs) of
two or more issuers which the Fund controls and which are engaged
in the same, similar, or related trades or businesses, or the
securities of one or more qualified publicly traded partnerships
(the “Asset Test”).
Under
the Asset Test, the Fund generally may not acquire a security if,
as a result of the acquisition, more than 50% of the value of the
Fund’s assets would be invested in (a) issuers in which
the Fund has, in each case, invested more than 5% of the
Fund’s assets and (b) issuers more than 10% of whose
outstanding voting securities are owned by the Fund. Because the
Underlying Index has a relatively small number of constituents, the
5% limitation could affect the Fund’s ability to effectively
implement a replication strategy or a representative sampling
strategy. As the Fund grows, the 10% limitation might also affect
its ability to effectively implement a replication strategy or a
representative sampling strategy.
If the
Fund fails to satisfy the 90% Test or the Asset Test, 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
Asset Test. In order to qualify for relief provisions for a failure
to meet the Asset Test, the Fund may be required to dispose of
certain assets. If the Fund fails to qualify for treatment as a RIC
for any year, and the relief provisions are not available, all of
its taxable income will be subject to federal income tax at regular
corporate rates (which the Tax Act reduced to 21%) without any
deduction for distributions to shareholders. In such case, its
shareholders would be taxed as if they received ordinary dividends,
although the dividends could be eligible for the dividends received
deduction for corporate shareholders and the dividends may be
eligible for the lower tax rates available to non-corporate
shareholders on qualified dividend income. To requalify for
treatment as a RIC in a subsequent taxable year, the Fund would be
required to satisfy the RIC qualification requirements for that
year and to distribute any earnings and profits from any taxable
year for which the Fund failed to qualify for tax treatment as a
RIC. If the Fund failed to qualify as a RIC for a period greater
than two taxable years, the Fund would generally be required to pay
a Fund-level tax on any net built-in gains recognized with respect
to certain of its assets upon a disposition of such assets within
five years of qualifying as a RIC in a subsequent year. The Board
reserves the right not to maintain the qualification of the Fund
for treatment as a RIC if it determines such course of action to be
beneficial to shareholders. If the Fund determines that it will not
qualify for treatment as a RIC, the Fund will establish procedures
to reflect the anticipated tax liability in the Fund’s
NAV.
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. 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 and certain other late-year
losses.
If the
Fund has a “net capital loss” (that is, capital losses
in excess of capital gains) for a taxable year, 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.
The
Fund will generally be subject to a nondeductible 4% federal excise
tax to the extent it fails to distribute by the end of any calendar
year at least the sum of 98% of its ordinary income for the year,
98.2% of its capital gain net income for the one-year period ending
on October 31 of that year, and certain other amounts. The
Fund intends to make sufficient distributions, or deemed
distributions, to avoid imposition of the excise tax, but can make
no assurances that all such tax liability will be
eliminated.
The
Fund intends to distribute substantially all its net investment
income and net realized capital gains to shareholders annually. The
distribution of net investment income and net realized capital
gains generally will be taxable to Fund shareholders regardless of
whether the shareholder elects to receive these distributions in
cash or in additional shares. However, the Fund may determine not
to distribute, or determine to defer the distribution of, some
portion of its income in non-routine circumstances. If the Fund
retains for investment an amount equal to all or a portion of its
net long-term capital gains in excess of its net short-term capital
losses (including any capital loss carryovers), it will be subject
to a corporate tax on the amount retained. In that event, the Fund
will designate such retained amounts as undistributed capital gains
in a notice to its shareholders who (a) will be required to
include in income for U.S. federal income tax purposes, as
long-term capital gains, their proportionate shares of the
undistributed amount, (b) will be entitled to credit their
proportionate shares of the income tax paid by the Fund on the
undistributed amount against their U.S. federal income tax
liabilities, if any, and to claim refunds to the extent their
credits exceed their liabilities, if any, and (c) will be
entitled to increase their tax basis, for U.S. federal income tax
purposes, in their shares by an amount equal to the excess of the
amount of undistributed net capital gain included in their
respective income over their respective income tax credits.
Organizations or persons not subject to U.S. federal income tax on
such capital gains will be entitled to a refund of their pro rata
share of such taxes paid by the Fund upon timely filing appropriate
returns or claims for refund with the Internal Revenue Service (the
“IRS”).
A
portion of the net investment income distributions of the Fund may
be treated as qualified dividend income (which, for non-corporate
shareholders, is generally eligible for taxation at reduced rates).
The portion of distributions that the Fund may report as qualified
dividend income is generally limited to the amount of qualified
dividend income received by the Fund, but if for any Fund taxable
year 95% or more of the Fund’s gross income (exclusive of net
capital gain from sales of stocks and securities) consists of
qualified dividend income, all distributions of such income for
that taxable year may be reported as qualified dividend income.
Qualified dividend income is, in general, dividend income from
taxable domestic corporations and certain foreign corporations
(i.e., foreign corporations
incorporated in a possession of the United States or in certain
countries with a comprehensive tax treaty with the United States,
and other foreign corporations if the stock with respect to which
the dividend income is paid is readily tradable on an established
securities market in the United States).
In
order for some portion of the dividends received by a shareholder
to be qualified dividend income, the Fund must meet holding period
and other requirements with respect to the dividend paying stocks
in its portfolio, and the shareholder must meet holding period and
other requirements with respect to the Fund’s shares.
Distributions reported to Fund shareholders as capital gain
dividends will be taxable at the rates applicable to long-term
capital gains (generally, at a maximum rate of 20% for
non-corporate shareholders), regardless of how long the shareholder
has owned the shares. The Fund’s shareholders will be
notified annually by the Fund as to the federal tax status of all
distributions made by the Fund. Distributions may be subject to
state and local taxes.
U.S.
individuals with income exceeding $200,000 ($250,000 if married and
filing jointly) are subject to an additional 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 shares of the Fund). This
3.8% tax also applies to all or a portion of the undistributed net
investment income of certain shareholders that are estates and
trusts.
Shareholders
who have held Fund shares for less than a full year should be aware
that the Fund may report and distribute, as ordinary dividends or
capital gain dividends, a percentage of income that is not equal to
the percentage of the Fund’s total ordinary income or net
capital gain, respectively, actually earned during the period of
investment in the Fund.
If the
Fund’s distributions for a taxable year exceed its taxable
income and capital gains realized during a taxable year, all or a
portion of the distributions made for the 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 generally
result in a higher reported capital gain or lower reported capital
loss when those shares on which the distribution was received are
sold.
A sale
or exchange of shares in the Fund may give rise to a capital gain
or loss. In general, any capital gain or loss realized upon a
taxable disposition of shares will be treated as long-term capital
gain or loss if the shares have been held for more than
12 months. Otherwise, the capital gain or loss on the taxable
disposition of shares will be treated as short-term capital gain or
loss. Any loss realized upon a taxable disposition of shares held
for six months or less will be treated as long-term, rather than
short-term, to the extent of any long-term capital gain
distributions received (or deemed received) by the shareholder with
respect to the shares. All or a portion of any loss realized upon a
taxable disposition of shares will be disallowed if substantially
identical shares are purchased (through reinvestment of dividends
or otherwise) within 30 days before or after the disposition.
In such a case, the basis of the newly purchased shares will be
adjusted to reflect the disallowed loss.
An
Authorized Participant who exchanges securities for Creation Units
generally will recognize a gain or a loss. The gain or loss will be
equal to the difference between the market value of the Creation
Units at the time and the sum of the exchanger’s aggregate
basis in the securities surrendered plus the amount of cash paid
for such Creation Units. A person who redeems Creation Units will
generally recognize a gain or loss equal to the difference between
the exchanger’s basis in the Creation Units and the sum of
the aggregate market value of any securities received plus the
amount of any cash received for such Creation Units. The IRS,
however, may assert that a loss realized upon an exchange of
securities for Creation Units cannot be deducted currently under
the rules governing “wash sales,” or on the basis that
there has been no significant change in economic
position.
Any
capital gain or loss realized upon the creation of Creation Units
will generally be treated as long-term capital gain or loss if the
securities exchanged for such Creation Units have been held for
more than one year. Any capital gain or loss realized upon the
redemption of Creation Units will generally be treated as long-term
capital gain or loss if the shares comprising the Creation Units
have been held for more than one year. Otherwise, such capital
gains or losses will be treated as short-term capital gains or
losses.
The
Trust on behalf of the Fund has the right to reject an order for a
purchase of shares of the Trust if the purchaser (or group of
purchasers) would, upon obtaining the shares so ordered, own 80% or
more of the outstanding shares of the Fund and if, pursuant to
Section 351 of the Code, the Fund would have a basis in the
securities different from the market value of such securities on
the date of deposit. The Trust also has the right to require
information necessary to determine beneficial share ownership for
purposes of the 80% determination. The Trust reserves the absolute
right to reject an order for Creation Units if acceptance of the
securities to be exchanged for the Creation Units would have
certain adverse tax consequences to the Fund.
Persons
purchasing or redeeming Creation Units should consult their own tax
advisors with respect to the tax treatment of any creation or
redemption transaction.
Foreign Investments.
Income received by the Fund from sources within foreign countries
(including, for example, dividends or interest on stock or
securities of non-U.S. issuers) may be subject to withholding and
other taxes imposed by such countries. Tax treaties between such
countries and the U.S. may reduce or eliminate such taxes in some
cases. If as of the end of the Fund’s taxable year more than
50% of the value of the Fund’s assets consist of the
securities of foreign corporations, the Fund may elect to permit
shareholders who are U.S. citizens, resident aliens, or U.S.
corporations to claim a foreign tax credit or deduction (but not
both) on their income tax returns for their pro rata portions of
qualified taxes paid by the Fund during that taxable year to
foreign countries in respect of foreign securities the Fund has
held for at least the minimum period specified in the Code. In such
a case, shareholders will include in gross income from foreign
sources their pro rata shares of such taxes. A shareholder’s
ability to claim a foreign tax credit or deduction in respect of
foreign taxes paid by the Fund may be subject to certain
limitations imposed by the Code, which may result in the
shareholder not getting a full credit or deduction for the amount
of such taxes. Shareholders who do not itemize deductions on their
federal income tax returns may claim a credit, but not a deduction,
for such foreign taxes.
Foreign Currency Transactions. Under the Code, gains or losses
attributable to fluctuations in exchange rates which occur between
the time the Fund accrues income or other receivables or accrues
expenses or other liabilities denominated in a foreign currency and
the time the Fund actually collects such income or receivables or
pays such expenses or liabilities generally are treated as ordinary
income or loss. Similarly, on the disposition of debt securities
denominated in a foreign currency and on the disposition of certain
other instruments, gains or losses attributable to fluctuations in
the value of the foreign currency between the date of acquisition
of the security or contract and the date of disposition are also
treated as ordinary gain or loss. The gains and losses may increase
or decrease the amount of the Fund’s income to be distributed
to its shareholders as ordinary income.
Options, Swaps and Other Complex Securities. The Fund may
invest in complex securities such as equity options, index options,
repurchase agreements, foreign currency contracts, hedges and
swaps, transactions treated as straddles for U.S. federal income
tax purposes, and futures contracts. 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, cause income or gain to be
recognized even though corresponding cash is not received by 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 by the Fund.
With
respect to any investments in zero coupon securities which are sold
at original issue discount and thus do not make periodic cash
interest payments, the Fund may be required to include as part of
its current income the imputed interest on such obligations even
though the Fund may not have received any interest payments on such
obligations during that period. Because the Fund is required to
distribute all of its net investment income to its shareholders,
the Fund may have to sell Fund securities to distribute such
imputed income. Those sales may occur at a time when the Advisor
would not otherwise have chosen to sell such securities and will
generally result in taxable gain or loss.
Because only a few regulations implementing the straddle rules have
been promulgated, the consequences of such transactions to the
Fund is not entirely clear. The straddle rules may increase the
amount of short-term capital gain realized by the Fund, which is
taxed as ordinary income when distributed to shareholders. Because
application of the straddle rules may affect the character of gains
or losses, defer losses and/or accelerate the recognition of gains
or losses from the affected straddle positions, the amount which
must be distributed to shareholders as ordinary income or long-term
capital gain may be increased or decreased substantially as
compared to a fund that did not engage in such
transactions.
More generally, investments by the Fund in options, futures,
forward contracts, swaps and other derivative financial
instruments are subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by the
Fund are treated as ordinary or capital, accelerate the recognition
of income or gains to the Fund and defer or possibly prevent the
recognition or use of certain losses by the Fund. The rules could,
in turn, affect the amount, timing or character of the income
distributed to shareholders by the Fund. In addition, because the
tax rules applicable to such instruments may be uncertain under
current law, an adverse determination or future IRS guidance with
respect to these rules (which determination or guidance could be
retroactive) may affect whether the Fund has made sufficient
distributions and otherwise satisfied the relevant requirements to
maintain its qualification as a RIC and avoid a Fund-level
tax.
Back-Up Withholding. The Fund or your broker will be
required to withhold (as “backup withholding”) on
taxable dividends paid to any shareholder, as well as the proceeds
of any redemptions of Creation Units, paid to a shareholder or
Authorized Participant who (1) fails to provide a correct
taxpayer identification number certified under penalty of perjury;
(2) is subject to withholding by the IRS for failure to
properly report all payments of interest or dividends;
(3) fails to provide a certified statement that he or she is
not subject to “backup withholding;” or (4) fails
to provide a certified statement that he or she is a U.S. person
(including a U.S. resident alien). The backup withholding rate is
currently 24%. Backup withholding is not an additional tax and any
amounts withheld may be credited against the shareholder’s
ultimate U.S. tax liability.
Foreign Shareholders. Foreign shareholders (i.e., nonresident alien individuals and
foreign corporations, partnerships, trusts and estates) are
generally subject to U.S. withholding tax at the rate of 30% (or a
lower tax treaty rate) on distributions derived from net investment
income and short-term capital gains. Gains from the sale or other
disposition of shares of the Fund generally are not subject to U.S.
taxation, unless the recipient is an individual who either
(1) meets the Code’s definition of “resident
alien” or (2) is physically present in the U.S. for
183 days or more per year. Different tax consequences may
result if the foreign shareholder is engaged in a trade or business
within the United States. In addition, the tax consequences to a
foreign shareholder entitled to claim the benefits of a tax treaty
may be different than those described above.
Ordinary
dividends paid to a shareholder that is a “foreign financial
institution” as defined in Section 1471 of the Code and that
does not meet the requirements imposed on foreign financial
institutions by Section 1471 will generally be subject to
withholding tax at a 30% rate. The extent, if any, to which such
withholding tax may be reduced or eliminated by an applicable tax
treaty is unclear. A non-U.S. shareholder may be exempt from the
withholding described in this paragraph under an applicable
intergovernmental agreement between the U.S. and a foreign
government, provided that the shareholder and the applicable
foreign government comply with the terms of such
agreement.
In
order for a foreign investor to qualify for an exemption from
backup withholding, the foreign investor must comply with special
certification and filing requirements. Foreign investors in the
Fund should consult their tax advisors in this regard.
Tax Shelter Reporting Regulations. Under U.S. Treasury
regulations, if a shareholder recognizes a loss of $2 million
or more for an individual shareholder or $10 million or more
for a corporate shareholder, the shareholder must file with the IRS
a disclosure statement on Form 8886. Direct shareholders of
portfolio securities are in many cases excepted from this reporting
requirement, but under current guidance shareholders of a RIC are
not excepted. 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.
Other Issues. The Fund may be subject to tax or taxes in
certain states where the Fund does business. Furthermore, in those
states which have income tax laws, the tax treatment of the Fund
and of Fund shareholders with respect to distributions by the Fund
may differ from federal tax treatment.
Shareholders
are advised to consult their tax advisors concerning their specific
situations and the application of state, local and foreign
taxes.
FINANCIAL STATEMENTS
Financial Statements and Annual Reports will be available after the
Fund has completed a fiscal year of operations. When available, you
may request a copy of the Fund’s Annual Report at no charge
by calling 1-844-ETFMGRS (383-6477) or through the
Fund’s website at www.etfmj.com.