NOTE 1 ORGANIZATION
The Zweig Fund, Inc. (the Fund) is a closed-end, diversified management investment company registered under the Investment Company Act of 1940 (the Act). The Fund was incorporated
under the laws of the State of Maryland on June 18, 1986. The Funds investment objective is capital appreciation, with income as a secondary objective.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
The following is a
summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. The preparation of financial statements in conformity with accounting principals generally accepted in the United States of
America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of
increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates and those differences could be significant.
A. Security Valuation:
Security valuation procedures for the
Fund, which include, nightly price variance, as well as back-testing such as bi-weekly unchanged price, monthly secondary source and transaction analysis, have been approved by the Board of Directors. All internally fair valued securities are
approved by a valuation committee appointed by the Board. The valuation committee is comprised of the treasurer, assistant treasurer, secretary and chief compliance officer for the Fund. All internally fair valued securities, referred to below, are
updated daily and reviewed in detail by the valuation committee monthly unless changes occur within the period. The valuation committee reviews the validity of the model inputs and any changes to the model. Internal fair valuations are ratified by
the Board of Directors at least quarterly.
The Fund utilizes a fair value hierarchy which prioritizes the inputs to valuation
techniques used to measure fair value into three broad levels.
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Level 1 quoted prices in active markets for identical securities
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Level 2 prices determined using other significant observable inputs (including quoted prices for similar securities, interest rates,
prepayment speeds, credit risk, etc.)
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Level 3 prices determined using significant unobservable inputs (including the valuation committees own assumptions in
determining the fair value of investments)
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A description of the valuation techniques applied to the
Funds major categories of assets and liabilities measured at fair value on a recurring basis is as follows:
Equity
securities are valued at the official closing price (typically last sale) on the exchange on which the securities are primarily traded, or if no closing price is available, at the last bid price and are
20
categorized as Level 1 in the hierarchy. Restricted equity securities and private placements that are not widely traded, are illiquid or are internally fair valued by the valuation committee, are
generally categorized as Level 3 in the hierarchy.
Certain foreign securities may be fair valued in cases where closing
prices are not readily available or are deemed not reflective of readily available market prices. For example, significant events (such as movement in the U.S. securities market, or other regional and local developments) may occur between the time
that foreign markets close (where the security is principally traded) and the time that the Fund calculates its net asset value (generally, the close of the NYSE) that may impact the value of securities traded in these foreign markets. In such cases
the Fund fair values foreign securities using an external pricing service which considers the correlation of the trading patterns of the foreign security to the intraday trading in the U.S. markets for investments such as American Depositary
Receipts, financial futures, exchange-traded funds, and certain indexes as well as prices for similar securities. Such fair valuations are categorized as Level 2 in the hierarchy. Because the frequency of significant events is not predictable, fair
valuation of certain foreign common stocks may occur on a frequent basis.
Debt securities, including restricted securities,
are valued based on evaluated quotations received from independent pricing services or from dealers who make markets in such securities. For most bond types, the pricing service utilizes matrix pricing which considers yield or price of bonds of
comparable quality, coupon, maturity, current cash flows, type, and current day trade information, as well as dealer supplied prices. These valuations are generally categorized as Level 2 in the hierarchy. Structured debt instruments such as
mortgage-backed and asset-backed securities may also incorporate collateral analysis and utilize cash flow models for valuation and are generally categorized as Level 2 in the hierarchy. Pricing services do not provide pricing for all securities and
therefore dealer supplied prices are utilized representing indicative bids based on pricing models used by market makers in the security and are generally categorized as Level 2 in the hierarchy. Debt securities that are not widely traded, are
illiquid, or are internally fair valued by the valuation committee are generally categorized as Level 3 in the hierarchy.
Listed derivatives, such as options, that are actively traded are valued based on quoted prices from the exchange and are categorized as
Level 1 in the hierarchy. Over the counter (OTC) derivative contracts, which include forward currency contracts and equity linked instruments, are valued based on inputs observed from actively quoted markets and are categorized as Level 2 in the
hierarchy.
Investments in open-end mutual funds are valued at their closing net asset value determined as of the close of
business of the New York Stock Exchange (generally 4:00 p.m. Eastern time) each business day and are categorized as Level 1 in the hierarchy.
Short-term notes having a remaining maturity of 60 days or less are valued at amortized cost, which approximates market and are generally categorized as Level 2 in the hierarchy.
A summary of the inputs used to value the Funds major categories of assets and liabilities, which primarily include investments of
the Fund, by each major security type is disclosed at the end of the Schedule of Investments for the Fund. The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those
securities.
21
B. Security Transactions and Investment Income:
Security transactions are recorded on the trade date. Realized gains and losses from sales of securities are determined on the identified
cost basis. Dividend income is recognized on the ex-dividend date, or in the case of certain foreign securities, as soon as the Fund is notified. Interest income is recorded on the accrual basis. The Fund amortizes premiums and accretes discounts
using the effective interest method.
C. Income Taxes:
The Fund is treated as a separate taxable entity. It is the Funds intention to comply with the requirements of Subchapter M of the
Internal Revenue Code and to distribute substantially all of its taxable income to its shareholders. Therefore, no provision for federal income taxes or excise taxes has been made.
The Fund may be subject to foreign taxes on income, gains on investments or currency repatriation, a portion of which may be recoverable.
The Fund will accrue such taxes and recoveries as applicable based upon current interpretations of the tax rules and regulations that exist in the markets in which it invests.
The Fund has adopted the authoritative guidance on accounting for and disclosure of uncertainty in tax positions, which requires the Fund to determine whether a tax position is more likely than not to be
sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The Fund has determined that there was no effect on the financial statements from the adoption of this
authoritative guidance. As of December 31, 2012, the tax years that remain subject to examination by the major tax jurisdictions under the statute of limitations are from the year 2009 forward (with limited exceptions).
D. Dividends and Distributions to Shareholders:
Distributions are recorded by the Fund on the ex-dividend date. Income and capital gain distributions are determined in accordance with
income tax regulations, which may differ from accounting principles generally accepted in the United States of America. These differences may include the treatment of non-taxable dividends, market premium and discount, non-deductible expenses,
expiring capital loss carryovers, foreign currency gain or loss, operating losses and losses deferred due to wash sales. Permanent book and tax basis differences relating to shareholder distributions will result in reclassifications to capital paid
in on shares of beneficial interest.
The Fund has a Managed Distribution Plan to pay 6 percent of the Funds net asset
value (NAV) on an annualized basis. Distributions may represent earnings from net investment income, realized capital gains, or, if necessary, return of capital. Shareholders should not draw any conclusions about the Funds
investment performance from the terms of the Funds Managed Distribution Plan.
E. Foreign Currency
Translation:
Investment securities and other assets and liabilities denominated in foreign currencies are translated into
U.S. dollar amounts at the foreign currency exchange rate effective at the end of the reporting period. Cost of investments is translated at the currency exchange rate effective at the trade date. The gain or loss resulting from a change in currency
exchange rates between the trade and
22
settlement date of a portfolio transaction is treated as a gain or loss on foreign currency. Likewise, the gain or loss resulting from a change in currency exchange rates between the date income
is accrued and paid is treated as a gain or loss on foreign currency. The Fund does not isolate that portion of the results of operations arising from changes in foreign exchange rates on investments from the fluctuations arising from changes in the
market prices of securities held. Such fluctuations are included with the net realized and unrealized gain or loss on investments.
F. Derivative Financial Instruments:
Disclosures on derivatives
instruments and hedging activities are intended to improve financial reporting for derivative instruments by enhanced disclosure that enables the investors to understand how and why a fund uses derivatives, how derivatives are accounted for, and how
derivative instruments affect a funds results of operations and financial position. Summarized below is a specific type of derivative instrument used by the Fund.
Options contracts
An options contract provides the purchaser with the
right, but not the obligation, to buy (call option) or sell (put option) a financial instrument at an agreed upon price. The Fund may purchase or write listed covered and uncovered put and call options on portfolio securities for hedging purposes or
to facilitate the rapid implementation of investment strategies if the Fund anticipates a significant market or market sector advance. The Fund is subject to equity price risk in the normal course of pursuing its investment objectives. The Fund may
use options contracts to hedge against changes in the values of equities or for yield enhancement.
When the Fund purchases an
option, it pays a premium and an amount equal to that premium is recorded as an asset. When the Fund writes an option, it receives a premium and an amount equal to that premium is recorded as a liability. The asset or liability is adjusted daily to
reflect the current market value of the option. Holdings of the Fund designated to cover outstanding written options are noted in the Schedules of Investments. Purchased options are reported as an asset within Investment securities at value
before written options on the Statement of Assets and Liabilities. Options written are reported as a liability within Written options outstanding at value. Changes in value of the purchased option is included in unrealized
appreciation/(depreciation) on investments on the Statement of Operations. Changes in value of written options is included in unrealized appreciation/(depreciation) on written options on the Statement of Operations.
If an option expires unexercised, the Portfolio realizes a gain or loss to the extent of the premium received or paid. If an option is
exercised, the premium received or paid is recorded as an adjustment to the proceeds from the sale or the cost basis of the purchase. The difference between the premium and the amount received or paid on effecting a closing purchase or sale
transaction is also treated as a realized gain or loss. Gain or loss on purchased options is included in net realized gain/(loss) on investment transactions on the Statement of Operations. Gain or loss on written options is presented separately as
net realized gain/(loss) on written options transactions on the Statement of Operations.
The risk in writing call options is
that the Fund gives up the opportunity for profit if the market price of the security increases and the option is exercised. The risk in writing put options is that the Fund may incur a loss if the market price of the security decreases and the
option is exercised. The risk in buying options is that the Fund pays a premium whether or not the option is exercised. The use of
23
such instruments may involve certain additional risks as a result of unanticipated movements in the market. Writers (sellers) of options are subject to unlimited risk of loss, as the seller will
be obligated to deliver or take delivery of the security at a predetermined price which may, upon exercise of the option, be significantly different from the then-market value.
G. Short Sales:
($ reported in thousands)
A short sale is a transaction in which the Fund
sells a security it does not own in anticipation of a decline in market price. To sell a security short, the Fund must borrow the security. The Funds obligation to replace the security borrowed and sold short will be fully collateralized at
all times by the proceeds from the short sale retained by the broker and by cash and securities deposited in a segregated account with the Funds custodian. If the price of the security sold short increases between the time of the short sale
and the time the Fund replaces the borrowed security, the Fund will realize a loss, and if the price declines during the period, the Fund will realize a gain. Any realized gain will be decreased by, and any realized loss increased by, the amount of
transaction costs. Dividends on short sales are recorded as an expense to the Fund on ex-dividend date. At December 31, 2012 the value of securities sold short amounted to $11,200 against which collateral of $15,013 was held. The collateral includes
the deposits with broker for securities held short and the value of the segregated investments held long, as shown in the Schedule of Investments and Securities Sold Short. Short selling used in the management of the Fund may accelerate the velocity
of potential losses if the prices of securities sold short appreciate quickly. Stocks purchased may decline in value at the same time stocks sold short may appreciate in value, thereby increasing potential losses.
NOTE 3 INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
($ reported in thousands unless otherwise noted)
Zweig Advisers LLC, an
indirect wholly-owned subsidiary of Virtus Investment Partners, Inc. (Virtus), is the adviser to the Fund.
a) Investment Advisory Fee:
The Investment Advisory Agreement (the Agreement) between the Adviser and the
Fund provides that, subject to the direction of the Board of Directors of the Fund and the applicable provisions of the Act, the adviser is responsible for the actual management of the Funds portfolio. The responsibility for making decisions
to buy, sell, or hold a particular investment rests with the Adviser, subject to review by the Board of Directors and the applicable provisions of the Act. For the services provided by the Adviser under the Agreement, the Fund pays the Adviser a
monthly fee equal, on an annual basis of 0.85% of the Funds average daily managed assets. During the year ended December 31, 2012, the Fund incurred advisory fees of $2,697.
For the period of this report, the Adviser voluntarily waived 20% of the advisory fee. However, effective May 10, 2013, the Adviser will
be terminating its voluntary waiver of 20% of the advisory fees.
Prior to March 1, 2012, Zweig Consulting LLC served as the
Sub-Adviser to the Fund. From March 1, 2012 through current, Zweig Consulting LLC serves as a consultant to the Adviser. Fees to Zweig Consulting LLC are paid by the Adviser.
b) Administration Services:
VP Distributors, LLC, an indirect wholly-owned subsidiary of Virtus, serves as the
Funds Administrator (the Administrator) pursuant to an Administration Agreement. During the year ended December 31, 2012, the Fund incurred Administration fees of $206.
24
c) Directors Fee ($ not reported in thousands):
During the period the Fund paid each Director who is not an interested person of the Fund or the Adviser, a fee of $11,000 per year plus
$1,500 per Director for each committee meeting attended, together with the out-of-pocket costs relating to attendance at such meetings. The co-lead Directors are paid an additional $10,000 retainer each per year in lieu of compensation for executive
committee meetings. The Audit Committee chairperson is paid an additional fee of $5,000 per year. Any Director of the Fund who is an interested person of the Fund or the Adviser receives no remuneration from the Fund.
NOTE 4 PURCHASES AND SALES OF SECURITIES:
($ reported in thousands)
Purchases and sales of securities (excluding
U.S. Government and agency securities and short-term investments) for the period ended December 31, 2012, were as follows:
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Purchases
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$
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238,087
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Sales
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232,842
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Purchases and sales of long-term U.S. Government and agency securities for the period ended December 31,
2012 were as follows:
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Purchases
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$
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10,219
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Sales
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10,013
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Note 5 DERIVATIVE TRANSACTIONS
($ reported in thousands)
The Fund invested in derivative instruments
during the reporting period through the form of purchased and written options. The primary type of risk associated with these derivative instruments are equity risk. The Fund invests in uncovered options contracts to gain exposure to securities not
held in the portfolio, and to realize a greater return than investing in the underlying security alone.
For additional
information on the options in which the Fund was invested during the reporting period, refer to the Schedule of Investments and Note 2F.
Written options transactions, during the year ended December 31, 2012, were as follows:
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Call options
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# of contracts
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Premium Recd
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Options outstanding at beginning of year
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5,000
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$
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415
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Written options
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73,966
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12,338
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Options repurchased
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(75,918
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)
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(12,347
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)
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Options expired
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(752
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)
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(132
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)
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Options exercised
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(270
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)
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(22
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)
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Options outstanding at December 31, 2012
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2,026
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$
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252
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25
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Put options
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# of contracts
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Premium Paid
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Options outstanding at beginning of year
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5,000
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$
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455
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Written options
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66,729
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8,201
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Options repurchased
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(70,494
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)
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(8,461
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)
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Options expired
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(1,235
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)
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(195
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)
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Options outstanding at December 31, 2012
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$
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The average daily cost of purchased options during the year ended December 31, 2012 was $2,161. The
average daily premiums received on written options during the year was $1,466.
Written options as of December 31, 2012 are
located under Written options outstanding at value at a fair value of $192 in the Statement of Assets and Liabilities.
For the year ended December 31, 2012, changes in the value of purchased options is included in Net change in unrealized appreciation (depreciation) on investments in the Statement of
Operations in the amount of $(25). Written options are included in Net change in unrealized appreciation/(depreciation) on written options in the amount of 190. Realized gains/loss related to purchased options are disclosed in the
Net realized gain (loss) on investments in the amount of 3,514. Written options are disclosed in the Net realized gain (loss) on written options in the amount of $(6,462).
NOTE 6 INDEMNIFICATIONS
Under the Funds organizational documents and related agreements, its directors and officers are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In
addition, the Fund enters into contracts that contain a variety of indemnifications. The Funds maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these arrangements.
NOTE 7 CAPITAL STOCK AND REINVESTMENT PLAN
At December 31, 2012, the Fund had one class of common stock, par value $.10 per share, of which 200,000,000 shares are authorized and 22,258,146 shares are outstanding.
Registered shareholders may elect to have all distributions paid by check mailed directly to the shareholder by Computershare as dividend
paying agent. Pursuant to the Automatic Reinvestment and Cash Purchase Plan (the Plan), shareholders not making such election will have all such amounts automatically reinvested by Computershare, as the Plan agent, in whole or fractional
shares of the Fund, as the case may be. During the periods ended December 31, 2012 and December 31, 2011, there were no shares issued pursuant to the Plan.
Pursuant to the Board approved stock repurchase program, the Fund may repurchase up to 10% of its outstanding shares in the open market at a discount to NAV. The Fund started its buyback of shares on
April 13, 2012. From the period of April 13, 2012 through December 31, 2012, the Fund repurchased 730,744 shares at an average price of $12.26. The average weekly discount during this period was 11.89%. There are 1,568,145 shares remaining
that are authorized to be purchased under the repurchase plan in the future.
26
On January 2, 2013, the Fund announced a distribution of $0.208 per share to
shareholders of record on December 31, 2012. This distribution has an ex-dividend date of January 3, 2013, and is payable on January 9, 2013. Please see inside front cover for more information on fund distributions.
NOTE 8 REVERSE STOCK SPLIT
Prior to the opening of trading on the NYSE on June 27, 2012, the Fund implemented a 1 for 4 reverse stock split. The Funds shares are trading on a split-adjusted basis under a new CUSIP number
(989834205). The net effect of the Funds reverse stock split was to decrease the number of the Funds outstanding common shares and increase the net asset value per common share by a proportionate amount. While the number of the
Funds outstanding common shares declined, neither the Funds holdings nor the total value of shareholders investments were affected. Immediately after the reverse stock split, each common shareholder held the same percentage of the
Funds outstanding common shares that he or she held immediately prior to the reverse stock split, subject to adjustments for fractional shares resulting from the split. Capital share activity referenced on the Statement of Changes in Net
Assets, and per share data, including the proportionate impact to market price, in the Financial Highlights table have been restated to reflect the reverse stock split.
NOTE 9 BORROWINGS
($ reported in thousands)
The Fund employs leverage in the form of borrowing on margin, which allows the Fund to use its long positions as collateral, in order to
purchase additional securities. Borrowings are secured by assets of the Fund that are held with the Funds custodian in a separate account. The Fund is permitted to borrow up to 33.33% of its total assets.
Effective December 21, 2012, the Fund began using margin financing. During the year ended December 31, 2012, the fund utilized
margin financing for 11 days at an average interest rate of 0.58% and with an average daily borrowing balance during that period of $3,000. As of December 31, 2012, outstanding margin debt amounted to $3,000, which is located under
Borrowings on the Statement of Assets and Liabilities. For the year ended December 31, 2012, the interest costs related to borrowing amounted to $1 and are included within the Interest Expense on the Statement of
Operations.
NOTE 10 CREDIT RISK AND ASSET CONCENTRATIONS
In countries with limited or developing markets, investments may present greater risks than in more developed markets and the prices of
such investments may be volatile. The consequences of political, social or economic changes in these markets may have disruptive effects on the market prices of these investments and the income they generate, as well as the Funds ability to
repatriate such amounts.
The Fund may invest a high percentage of its assets in specific sectors of the market in its pursuit
of a greater investment return. Fluctuations in these sectors of concentration may have a greater impact on the Fund, positive or negative, than if the Fund did not concentrate its investments in such sectors.
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NOTE 11 REGULATORY EXAMS
Federal and state regulatory authorities from time to time make inquiries and conduct examinations regarding compliance by Virtus and its
subsidiaries (collectively the Company) with securities and other laws and regulations affecting their registered products.
There are currently no such matters which the Company believes will be material to these financial statements.
NOTE 12 FEDERAL INCOME TAX INFORMATION
($ reported in thousands)
At December 31, 2012, federal tax cost and aggregate gross unrealized appreciation (depreciation) of securities held by
the Fund were as follows:
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|
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|
|
|
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Federal
Tax
Cost
|
|
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Unrealized
Appreciation
|
|
|
Unrealized
Depreciation
|
|
|
Net Unrealized
Appreciation
(Depreciation)
|
|
Investments
|
|
$
|
278,455
|
|
|
$
|
36,522
|
|
|
$
|
(3,222
|
)
|
|
$
|
33,300
|
|
Securities Sold Short
|
|
|
(10,714
|
)
|
|
|
38
|
|
|
|
(524
|
)
|
|
|
(486
|
)
|
Written Options
|
|
|
(252
|
)
|
|
|
82
|
|
|
|
(22
|
)
|
|
|
60
|
|
The Fund has $15,204 of capital loss carryover expiring in 2017, which may be used to offset future
capital gains.
Under the Regulated Investment Company Modernization Act of 2010 (the Act), net capital losses
recognized for tax years beginning after December 22, 2010 may be carried forward indefinitely, and their character is retained as short-term and/or long-term losses. Previously, net capital losses were carried forward for eight years and treated as
short-term losses. As a transition rule, the Act requires that post-enactment net capital losses be used before pre-enactment net capital losses.
The Fund may not realize the benefit of these losses to the extent it does not realize gains on investments prior to the expiration of the capital loss carryovers. In addition, under certain conditions,
the Fund may lose the benefit of these losses to the extent that distributions to shareholders exceed required distribution amounts as defined under the Internal Revenue Code. Shareholders may also pay additional taxes on these excess distributions.
For the period ended December 31, 2012, the Fund utilized losses of $7,795 deferred in prior years against current year
capital gains.
Capital losses realized after October 31 and certain late year losses may be deferred and treated as occurring
on the first day of the following fiscal year. For the fiscal year ended December 31, 2012, the Fund recognized qualified late year losses of $41.
The components of distributable earnings on a tax basis (excluding unrealized appreciation (depreciation) which is disclosed in the table above) consist of undistributed ordinary income of $0 and
undistributed long-term capital gains of $0.
28
The differences between the book and tax basis components of distributable earnings relate
principally to the timing of recognition of income and gains for federal income tax purposes. Short-term gain distributions reported in the Statement of Changes in Net Assets, if any, are reported as ordinary income for federal tax purposes.
Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes.
The tax character of dividends and distributions paid during the years ended December 31, 2012 and 2011 was as follows: